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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 June 30, 2004
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 July 30, 2004, there were 37,468,785 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 3,668 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 June 30, 2004 and
September 30, 2003...................................................... 2
Condensed Consolidated Statements of Operations for the three and
nine months ended June 30, 2004 and 2003................................ 3
Condensed Consolidated Statements of Cash Flows for the nine months
ended June 30, 2004 and 2003............................................ 4
Notes to Condensed Consolidated Financial Statements...................... 5
TRANSACTION SYSTEMS ARCHITECTS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
June 30, September 30,
2004 2003
----------- -------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents.................................................... $ 158,859 $ 113,986
Marketable securities........................................................ - 1,296
Billed receivables, net of allowances of $4,435 and $4,037, respectively..... 49,998 42,225
Accrued receivables.......................................................... 7,560 9,592
Recoverable income taxes..................................................... 10,434 11,985
Deferred income taxes, net................................................... 3,135 10,316
Other........................................................................ 6,168 5,104
---------- ----------
Total current assets....................................................... 236,154 194,504
Property and equipment, net.................................................... 8,458 9,405
Software, net.................................................................. 1,386 2,319
Goodwill....................................................................... 46,684 46,425
Deferred income taxes, net..................................................... 21,122 9,638
Other.......................................................................... 1,354 1,609
---------- ----------
Total assets............................................................... $ 315,158 $ 263,900
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of debt - financing agreements............................... $ 8,211 $ 15,493
Accounts payable............................................................. 6,195 6,965
Accrued employee compensation................................................ 11,488 9,822
Accrued liabilities.......................................................... 11,902 9,714
Deferred revenue............................................................. 82,756 70,798
Other........................................................................ 101 628
---------- ----------
Total current liabilities.................................................. 120,653 113,420
Debt - financing agreements.................................................... 3,634 9,444
Deferred revenue............................................................... 15,688 17,689
Other.......................................................................... 780 473
---------- ----------
Total liabilities.......................................................... 140,755 141,026
---------- ----------
Commitments and contingencies (Note 8)
Stockholders' equity:
Class A Common Stock, $.005 par value; 50,000,000 shares
authorized; 38,944,930 and 37,660,731 shares issued at
June 30, 2004 and September 30, 2003, respectively......................... 195 188
Treasury stock, at cost, 1,476,145 shares.................................... (35,258) (35,258)
Additional paid-in capital................................................... 252,811 235,767
Accumulated deficit.......................................................... (32,923) (69,602)
Accumulated other comprehensive loss, net.................................... (10,422) (8,221)
---------- ----------
Total stockholders' equity................................................. 174,403 122,874
---------- ----------
Total liabilities and stockholders' equity................................. $ 315,158 $ 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 Nine Months Ended
June 30, June 30,
-------------------- --------------------
2004 2003 2004 2003
-------- -------- -------- --------
Revenues:
Software license fees.............................. $ 37,549 $ 40,717 $121,162 $110,214
Maintenance fees................................... 23,087 20,675 66,770 58,740
Services........................................... 11,896 12,382 35,144 36,559
-------- -------- -------- --------
Total revenues................................... 72,532 73,774 223,076 205,513
Expenses:
Cost of software license fees...................... 6,280 6,339 19,108 18,567
Cost of maintenance and services................... 13,390 15,082 43,108 45,583
Research and development........................... 9,303 9,478 28,308 25,785
Selling and marketing.............................. 16,030 13,686 45,947 40,951
General and administrative......................... 14,554 15,245 44,056 41,932
Impairment of goodwill............................. - 9,290 - 9,290
-------- -------- -------- --------
Total expenses................................... 59,557 69,120 180,527 182,108
-------- -------- -------- --------
Operating income..................................... 12,975 4,654 42,549 23,405
-------- -------- -------- --------
Other income (expense):
Interest income.................................... 354 281 1,226 876
Interest expense................................... (284) (682) (1,196) (2,425)
Other, net......................................... 995 225 3,069 (835)
-------- -------- -------- --------
Total other income (expense)..................... 1,065 (176) 3,099 (2,384)
-------- -------- -------- --------
Income before income taxes........................... 14,040 4,478 45,648 21,021
Income tax (provision) benefit....................... 4,622 (6,331) (8,969) (15,809)
Net income (loss).................................... $ 18,662 $ (1,853) $ 36,679 $ 5,212
======== ======== ======== ========
Earnings (loss) per share information:
Weighted average shares outstanding:
Basic........................................... 37,277 35,571 36,833 35,489
======== ======== ======== ========
Diluted......................................... 38,352 35,571 38,009 35,601
======== ======== ======== ========
Earnings (loss) per share:
Basic........................................... $ 0.50 $ (0.05) $ 1.00 $ 0.15
======== ======== ======== ========
Diluted......................................... $ 0.49 $ (0.05) $ 0.97 $ 0.15
======== ======== ======== ========
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)
Nine Months Ended
June 30,
-------------------------
2004 2003
---------- ----------
Cash flows from operating activities:
Net income................................................................... $ 36,679 $ 5,212
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation............................................................... 3,212 3,804
Amortization............................................................... 1,839 3,151
Loss on sale of marketable equity securities............................... 107 84
Impairment of goodwill..................................................... - 9,290
Deferred income taxes...................................................... (4,135) 9,828
Tqx benefit of stock options exercised..................................... 4,001 176
Changes in operating assets and liabilities:
Billed and accrued receivables, net...................................... (3,751) (763)
Other current and noncurrent assets...................................... (4,232) (3,687)
Accounts payable......................................................... (1,078) 410
Current income taxes..................................................... 1,551 (4,398)
Deferred revenue......................................................... 7,433 4,391
Other current and noncurrent liabilities................................. 3,028 (1,441)
---------- ----------
Net cash provided by operating activities.............................. 44,654 26,057
---------- ----------
Cash flows from investing activities:
Purchases of property and equipment, net..................................... (2,099) (1,972)
Purchases of software and distribution rights................................ (454) (367)
Proceeds from sales of marketable securities................................. 1,375 629
---------- ----------
Net cash used in investing activities.................................. (1,178) (1,710)
---------- ----------
Cash flows from financing activities:
Proceeds from issuance of Class A Common Stock............................... 719 789
Proceeds from sale and exercise of stock options............................. 12,231 318
Payments on debt - financing agreements...................................... (13,092) (14,725)
Other........................................................................ (474) (611)
---------- ----------
Net cash used in financing activities.................................. (616) (14,229)
---------- ----------
Effect of exchange rate fluctuations on cash................................... 2,013 2,881
---------- ----------
Net increase in cash and cash equivalents...................................... 44,873 12,999
Cash and cash equivalents, beginning of period................................. 113,986 87,894
---------- ----------
Cash and cash equivalents, end of period....................................... $ 158,859 $ 100,893
========== ==========
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
(unaudited)
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 June 30, 2004, and for the three and nine months ended June 30,
2004 and 2003, are unaudited and reflect all adjustments (consisting only of
normal recurring adjustments except as otherwise discussed herein) which are, in
the opinion of management, necessary for a fair presentation of the financial
position and operating results for the interim periods. Certain amounts
previously reported have been reclassified to conform to the current period
presentation.
The 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 and nine months ended June 30, 2004, 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," Securities and Exchange Commission ("SEC") Staff Accounting
Bulletin ("SAB") 101, "Revenue Recognition in Financial Statements," and SAB
104, "Revenue Recognition." For software license arrangements for which services
rendered are not considered essential to the functionality of the software, the
Company recognizes revenue upon delivery, provided (1) there is persuasive
evidence of an arrangement, (2) collection of the fee is considered probable,
and (3) the fee is fixed or determinable. In most arrangements, vendor-specific
objective evidence ("VSOE") of fair value does not exist for the license
element; therefore, the Company uses the residual method under SOP 98-9 to
determine the amount of revenue to be allocated to the license element. Under
SOP 98-9, the fair value of all undelivered elements, such as postcontract
customer support (maintenance or "PCS") or other products or services, is
deferred and subsequently recognized as the products are delivered or the
services are performed, with the residual difference between the total
arrangement fee and revenues allocated to undelivered elements being allocated
to the delivered element.
5
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 for revenue recognition have been met. For software license
arrangements in which the Company has concluded that collection of the fees is
not probable, revenue is recognized as cash is collected, provided all other
conditions for revenue recognition have been met. In making the determination of
collectibility, the Company considers the creditworthiness of the customer,
economic conditions in the customer's industry and geographic location, and
general economic conditions.
SOP 97-2 requires the seller of software that includes PCS to establish
VSOE of fair value of the undelivered element of the contract in order to
account separately for the PCS revenue. For certain of the Company's products,
VSOE of the fair value of PCS is determined by a consistent pricing of PCS and
PCS renewals as a percentage of the software license fees. In other products,
the Company determines VSOE by reference to contractual renewals, when the
renewal terms are substantive. In those cases where VSOE of the fair value of
PCS is determined by reference to contractual renewals, the Company considers
factors such as whether the period of the initial PCS term is relatively long
when compared to the term of the software license or whether the PCS renewal
rate is significantly below the Company's normal pricing practices.
Certain of the Company's software arrangements 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. Revenues from
less-established products are typically recognized upon acceptance or first
production use by the customer due to uncertainties surrounding customer
acceptance of the product.
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.
6
Maintenance Fees. Revenues for PCS are recognized ratably over the
maintenance term specified in the contract. In arrangements where VSOE of fair
value of PCS cannot be determined (for example, a time-based software license
with a duration of one year or less), the Company recognizes revenue for the
entire arrangement ratably over the PCS term.
Services. The Company provides various professional services to customers,
primarily project management, software implementation and software modification
services. Revenues from arrangements to provide professional services are
generally recognized as the related services are performed. For those
arrangements in which services revenue is deferred and the Company determines
that the costs of installation services are recoverable, such costs are
capitalized and subsequently expensed in proportion to the services revenue as
it is recognized.
Accrued Receivables. Accrued receivables represent amounts to be billed in
the near future (less than 12 months).
Deferred Revenue. Deferred revenue includes (1) amounts currently due and
payable from customers, and payments received from customers, for software
licenses, maintenance and/or services in advance of providing the product or
performing services, (2) amounts deferred whereby VSOE of the fair value of
undelivered elements in a bundled arrangement does not exist, and (3) amounts
deferred if other conditions for revenue recognition have not been met.
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 and nine months ended June 30, 2004 and 2003 would have approximated the
following pro forma amounts (in thousands, except per share amounts):
Three Months Ended Nine Months Ended
June 30, June 30,
-------------------- --------------------
2004 2003 2004 2003
-------- -------- -------- --------
Net income:
As reported............................................ $ 18,662 $ (1,853) $ 36,679 $ 5,212
Deduct: stock-based employee compensation
expense determined under the fair value based
method for all awards, net of related tax effects.... (648) (1,427) (1,860) (4,455)
Add: stock-based employee compensation expense
recorded under intrinsic value based method,
net of related tax effects........................... 19 - 71 -
-------- -------- -------- --------
Pro forma.............................................. $ 18,033 $ (3,280) $ 34,890 $ 757
======== ======== ======== ========
Earnings per share:
Basic, as reported..................................... $ 0.50 $ (0.05) $ 1.00 $ 0.15
======== ======== ======== ========
Basic, pro forma....................................... $ 0.48 $ (0.09) $ 0.95 $ 0.02
======== ======== ======== ========
Diluted, as reported................................... $ 0.49 $ (0.05) $ 0.97 $ 0.15
======== ======== ======== ========
Diluted, pro forma..................................... $ 0.47 $ (0.09) $ 0.92 $ 0.02
======== ======== ======== ========
7
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 Nine Months Ended
June 30, June 30,
------------------ -----------------
2004 2003 2004 2003
------- ------- ------- -------
Expected life................ 3.4 6.0 3.8 6.0
Interest rate................ 3.4% 3.2% 2.9% 3.2%
Volatility................... 93.3% 45.0% 87.8% 45.0%
Dividend yield............... - - - -
The effects of applying SFAS No. 123 in this pro forma disclosure are not
indicative of future amounts. Additional future awards are anticipated.
2. Goodwill and Software
Changes to the carrying amount of goodwill during the nine months ended
June 30, 2004 resulted primarily 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):
June 30, Sept. 30,
2004 2003
-------- --------
Internally-developed software....................... $ 15,852 $ 15,725
Purchased software.................................. 45,222 44,186
-------- --------
61,074 59,911
Less: accumulated amortization...................... (59,688) (57,592)
-------- --------
Software, net....................................... $ 1,386 $ 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 and nine months ended
June 30, 2004 was $0.4 million and $1.3 million, respectively. Based on
capitalized software at June 30, 2004, 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........................................................... $ 462
2005........................................................... 522
2006........................................................... 266
2007........................................................... 116
Thereafter..................................................... 20
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................. (127)
------
Balance, June 30, 2004....................................... $ 554
======
8
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................ (1,612)
Adjustments to previously-recognized liabilities............ (159)
--------
Balance, June 30, 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
Common Stock for presentation purposes on the June 30, 2004 and September 30,
2003 consolidated balance sheets, and are included in common shares outstanding
for earnings per share ("EPS") computations for the three and nine months ended
June 30, 2004 and 2003. Included in Common Stock are 3,668 and 6,248 MDL
options, respectively, as of June 30, 2004 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 June
30, 2004, which amounted to approximately 1,075,000 shares, and for the nine
months ended June 30, 2004 and 2003, which amounted to approximately 1,176,000
and 112,000 shares, respectively, were due to the dilutive effect of the
Company's outstanding stock options. For the three months ended June 30, 2003,
basic and diluted EPS are the same, as any outstanding dilutive securities were
antidilutive due to the net loss. Antidilutive shares of 654,000 were excluded
from the computations of diluted EPS for the three months ended June 30, 2004,
and antidilutive shares of 754,000 and 5,065,000 were excluded from the
computations of diluted EPS for the nine months ended June 30, 2004 and 2003,
respectively, because the exercise prices of the corresponding stock options
were greater than the average market price of the Company's common shares. If
the Company had net income for the three months ended June 30, 2003,
antidilutive shares from outstanding stock options of 4,916,000 would have been
excluded from the computation of diluted EPS because the exercise prices of the
corresponding 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 Nine Months Ended
June 30, June 30,
-------------------- --------------------
2004 2003 2004 2003
-------- -------- -------- --------
Net income (loss)........................................ $ 18,662 $ (1,853) $ 36,679 $ 5,212
Other comprehensive income (loss):
Foreign currency translation adjustments............... (662) (718) (2,385) (1,249)
Change in unrealized investment holding loss:
Unrealized holding gain (loss) arising during the
period............................................. - (266) 77 (321)
Reclassification for (gain) loss included in net
income (loss)...................................... - (31) 107 84
-------- -------- -------- --------
Comprehensive income (loss).............................. $ 18,000 $ (2,868) $ 34,478 $ 3,726
======== ======== ======== ========
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............................ (2,385) 77 (2,308)
Reclassification adjustment for loss included in
net income................................................ - 107 107
-------- -------- ---------
Balance, June 30, 2004....................................... $(10,405) $ (17) $ (10,422)
======== ======== =========
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 makers, together with other senior
management personnel, review 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. Each distribution network has its own sales force.
The Company supplements its distribution networks with independent reseller
and/or distributor arrangements. No single customer accounted for more than 10%
of the Company's consolidated revenues during the three or nine months ended
June 30, 2004 or 2003.
10
The following are revenues and operating income for these business units
for the periods indicated (in thousands):
Three Months Ended Nine Months Ended
June 30, June 30,
---------------------- ----------------------
2004 2003 2004 2003
--------- --------- --------- ---------
Revenues:
ACI Worldwide................................. $ 55,365 $ 56,358 $ 170,956 $ 150,629
Insession Technologies........................ 9,382 8,600 28,348 24,428
IntraNet...................................... 7,785 8,816 23,772 30,456
--------- --------- --------- ---------
$ 72,532 $ 73,774 $ 223,076 $ 205,513
========= ========= ========= =========
Operating income:
ACI Worldwide................................. $ 9,019 $ 1,960 $ 30,259 $ 12,220
Insession Technologies........................ 2,205 1,907 7,449 5,135
IntraNet...................................... 1,751 787 4,841 6,050
--------- --------- --------- ---------
$ 12,975 $ 4,654 $ 42,549 $ 23,405
========= ========= ========= =========
7. Income Taxes
It is the Company's policy to report income tax expense for interim
reporting periods using an estimated annual effective income tax rate. However,
the tax effects of significant or unusual items are not considered in the
estimated annual effective tax rate. The tax effect of such events is recognized
in the interim period in which the event occurs.
During the third quarter of fiscal 2004, the Company completed a tax
reorganization of its MessagingDirect Ltd. subsidiary and its related entities
(collectively referred to as "MDL") and elected to treat certain foreign
operations as branches of the U.S. parent company, which resulted in the
recognition of a $12.0 million tax benefit. This tax benefit arises from the
excess of tax basis over the book carrying value of these foreign assets
following the tax election. The Company recorded a deferred tax asset in the
same amount, which is included in the June 30, 2004 consolidated balance sheet
and is expected to be recovered over the next 11 1/2 years. Offsetting this tax
benefit were other tax expense adjustments totaling $1.4 million that were
recorded during the third quarter of fiscal 2004, including a $1.1 million
adjustment to the Company's deferred tax assets related to a change in the
effective state tax rates.
The effective tax rate for the third quarter of fiscal 2004 was a benefit
of approximately 32.9% as compared to expense of 141.4% for the same period of
fiscal 2003. The effective tax rate for the first nine months of fiscal 2004 was
approximately 19.6% as compared to 75.2% for the same period of fiscal 2003. The
differences between the statutory federal income tax rate and the effective tax
rates per the consolidated statements of operations are summarized as follows:
Three Months Ended Nine Months Ended
June 30, June 30,
------------------- -------------------
2004 2003 2004 2003
-------- -------- -------- --------
Federal tax rate................................................. 35.0 % 35.0 % 35.0 % 35.0 %
MDL restructuring................................................ (85.8) - (26.4) -
State tax adjustment............................................. 7.8 - 2.4 -
Impairment of goodwill........................................... - 95.4 - 20.3
Foreign taxes deducted on U.S. return, net of federal benefit.... - 9.1 - 9.1
Increase in valuation allowance.................................. 3.4 11.5 3.4 11.5
Other............................................................ 6.7 (9.6) 5.2 (0.7)
------- -------- -------- --------
Effective income tax expense (benefit) rate.................... (32.9)% 141.4 % 19.6 % 75.2 %
======= ======== ======== ========
11
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 individuals alleging violations of Sections
10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5
thereunder. Pursuant to a Court order, the two complaints were consolidated as
Desert Orchid Partners v. Transaction Systems Architects, Inc., et al., with
Genesee County Employees' Retirement System designated as the Lead Plaintiff.
The First Amended Consolidated Class Action Complaint, filed on June 30, 2003
(the "Consolidated Complaint"), alleges that during the purported class period,
the Company and the named defendants misrepresented the Company's historical
financial condition, results of operations and its future prospects, and failed
to disclose facts that could have indicated an impending decline in the
Company's revenues. The Consolidated Complaint seeks unspecified damages,
interest, fees, costs and rescission. The class period alleged in the
Consolidated Complaint is January 21, 1999 through November 18, 2002. The
Company and the individual defendants filed a motion to dismiss the Consolidated
Complaint. In response, on December 15, 2003, the Court dismissed, without
prejudice, Gregory Derkacht, the Company's President and Chief Executive
Officer, as a defendant, but denied the motion to dismiss with respect to the
remaining defendants, including the Company. On February 6, 2004, the Court
entered a mediation reference order requiring the parties to mediate before a
private mediator. The parties held a mediation session on March 18, 2004, which
did not result in a settlement of the matter. Discovery has commenced and is in
the early stages.
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 stockholders 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 stockholder 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. 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.
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," "the Company is well positioned" and words
and phrases of similar impact, and include, but are not limited to, statements
regarding future 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 is not obligated, and does not intend, 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.
Merger and acquisition ("M&A") activity in the financial services industry
has increased over past years and is expected to remain at higher than usual
levels for some time. It is difficult to determine whether increased levels of
M&A activity will have an overall positive or negative effect on the Company's
future operating results. There are potential negative effects of increased M&A
activity. For example, if non-customers acquire customers of the Company and in
turn decide to forego future use of the Company's products, the Company's
revenue would decline. Conversely, the Company could benefit if the acquisition
of non-customers by customers leads to additional sales, software upgrades
and/or capacity increases. The expected continuing consolidation of financial
institutions may result in a fewer number of potential customers for the
Company's products and services. At this time, however, the Company cannot
determine the net effect of M&A activity on its future operating results.
Several factors related to the Company's business may have a significant
impact on its operating results from quarter 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 timing of
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 designed 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.
13
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.
The following are revenues and operating income for these business units for the
periods indicated (in thousands):
Three Months Ended Nine Months Ended
June 30, June 30,
---------------------- ----------------------
2004 2003 2004 2003
--------- --------- --------- ---------
Revenues:
ACI Worldwide................................. $ 55,365 $ 56,358 $ 170,956 $ 150,629
Insession Technologies........................ 9,382 8,600 28,348 24,428
IntraNet...................................... 7,785 8,816 23,772 30,456
--------- --------- --------- ---------
$ 72,532 $ 73,774 $ 223,076 $ 205,513
========= ========= ========= =========
Operating income:
ACI Worldwide................................. $ 9,019 $ 1,960 $ 30,259 $ 12,220
Insession Technologies........................ 2,205 1,907 7,449 5,135
IntraNet...................................... 1,751 787 4,841 6,050
--------- --------- --------- ---------
$ 12,975 $ 4,654 $ 42,549 $ 23,405
========= ========= ========= =========
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 June 30, 2004 (in thousands):
Non-
Recurring Recurring Total
--------- --------- ---------
ACI Worldwide......................... $ 138,004 $ 46,608 $ 184,612
Insession Technologies................ 21,553 6,780 28,333
IntraNet, Inc......................... 14,016 5,848 19,864
--------- --------- ---------
$ 173,573 $ 59,236 $ 232,809
========= ========= =========
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
14
estimates on historical experience and other assumptions that it believes to be
proper and reasonable under the circumstances. The Company continually evaluates
the appropriateness of its estimates and assumptions, including those related to
revenue recognition, provision for doubtful accounts, fair value of goodwill and
software, useful lives of intangible and fixed assets, and income taxes, among
others. Actual results could differ from those estimates.
The following key accounting policies are impacted significantly by
judgments, assumptions and estimates used in the preparation of the consolidated
financial statements.
Revenue Recognition
For software license arrangements for the Company's more-established
("mature") products for which other products or services rendered are not
considered essential to the functionality of the software, the Company
recognizes software license fee revenue upon delivery, provided (1) there is
persuasive evidence of an arrangement, (2) collection of the fee is considered
probable, and (3) the fee is fixed or determinable. In most arrangements,
because vendor-specific objective evidence of fair value does not exist for the
license element, the Company uses the residual method to determine the amount of
revenue to be allocated to the license element. Under the residual method, the
fair value of all undelivered elements, such as postcontract customer support or
other products or services, is deferred and subsequently recognized as the
products are delivered or the services are performed, with the residual
difference between the total arrangement fee and revenues allocated to
undelivered elements being allocated to the delivered element. For software
license arrangements in which the Company has concluded that collection of the
fees is not probable, revenue is recognized as cash is collected, provided all
other conditions for revenue recognition have been met. In making the
determination of collectibility, the Company considers the creditworthiness of
the customer, economic conditions in the customer's industry and geographic
location, and general economic conditions.
In recent years, the Company's sales focus has shifted from its mature
products to its newer BASE24-es product, its Payments Management products and
other less-established (collectively referred to as "newer") products. As a
result of this shift to newer products, absent other factors, the Company
initially experiences an increase in deferred revenues and a corresponding
decrease in revenues due to differences in the timing of revenue recognition for
the respective products. Revenues from newer products are typically recognized
upon acceptance or first production use by the customer due to uncertainties
surrounding customer acceptance of the product, whereas revenues from mature
products, such as BASE24, are generally recognized upon delivery of the product.
For those arrangements in which services revenue is being deferred and the
Company determines that the costs of installation services are recoverable, such
costs are capitalized and subsequently expensed proportionately with the
services revenue as it is recognized. Newer products are continually evaluated
by Company management and product development personnel to determine when any
such product meets the specific revenue recognition criteria that would support
its classification as a mature product. Evaluation criteria used in making this
determination include successful demonstration of product features and
functionality; standardization of sale, installation, and support functions; and
customer acceptance at multiple production site installations, among others. A
change in product classification (from newer to mature) would allow the Company
to recognize revenues from sales of the product upon delivery of the product,
resulting in earlier recognition of revenues from sales of that product,
provided all other revenue recognition criteria have been met.
When a software license arrangement includes services to provide
significant production, modification, or customization of software, those
services are not considered to be separable from the software. Accounting for
such services delivered over time (generally in excess of twelve months) is
referred to as contract accounting. Under contract accounting, the Company
generally uses the percentage-of-completion method. Under the
percentage-of-completion method, the Company records revenue for the software
license fee and services over the development and implementation period, with
the percentage of completion generally measured by the percentage of labor hours
incurred to-date to estimated total labor hours for each contract. Estimated
total labor hours for each contract are based on the project scope, complexity,
skill level requirements, and similarities with other projects of similar size
and scope. For those contracts subject to contract accounting, estimates of
total revenue under the contract, which are used in current percentage-complete
computations, exclude amounts due under extended payment terms.
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
15
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 would impact the level of the Company's future provision
for doubtful accounts. Specifically, if the financial condition of one or more
of the Company's customers were to deteriorate, affecting their ability to make
payments, additional customer-specific provisions for doubtful accounts may be
required. Also, should deterioration occur in general economic conditions, or
within a particular industry or region in which the Company has a number of
customers, additional provisions for doubtful accounts may be recorded to
reserve for potential future losses. Any additional such provisions would
reduce operating income in the periods in which they were recorded.
Impairment of Goodwill
Goodwill 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 the carrying value, no impairment loss is 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. Actual
useful life of capitalized software could differ from the estimated amortization
periods used.
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. In addition, changes in the
geographical mix or estimated amount of annual pretax income could impact the
Company's overall effective tax rate.
To the extent recovery of deferred tax assets is not likely based on
estimations 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
16
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.
Results of Operations
The following table sets forth certain financial data and the percentage of
total revenues of the Company for the periods indicated (in thousands):
Three Months Ended June 30, Nine Months Ended June 30,
------------------------------------- -------------------------------------
2004 2003 2004 2003
----------------- ----------------- ----------------- -----------------
% of % of % of % of
Amount Revenue Amount Revenue Amount Revenue Amount Revenue
-------- ------- -------- ------- -------- ------- -------- -------
Revenues:
Initial license fees (ILFs).. $ 17,372 24.0 % $ 18,902 25.6 % $ 57,761 25.9 % $ 46,383 22.6 %
Monthly license fees (MLFs).. 20,177 27.8 21,815 29.6 63,401 28.4 63,831 31.0
-------- ------- -------- ------- -------- ------- -------- -------
Software license fees........ 37,549 51.8 40,717 55.2 121,162 54.3 110,214 53.6
Maintenance fees............. 23,087 31.8 20,675 28.0 66,770 29.9 58,740 28.6
Services..................... 11,896 16.4 12,382 16.8 35,144 15.8 36,559 17.8
-------- ------- -------- ------- -------- ------- -------- -------
Total revenues............. 72,532 100.0 73,774 100.0 223,076 100.0 205,513 100.0
-------- ------- -------- ------- -------- ------- -------- -------
Expenses:
Cost of software license
fees....................... 6,280 8.6 6,339 8.6 19,108 8.6 18,567 9.0
Cost of maintenance and
services................... 13,390 18.5 15,082 20.4 43,108 19.3 45,583 22.2
Research and development..... 9,303 12.8 9,478 12.8 28,308 12.7 25,785 12.6
Selling and marketing........ 16,030 22.1 13,686 18.6 45,947 20.6 40,951 19.9
General and administrative... 14,554 20.1 15,245 20.7 44,056 19.7 41,932 20.4
Impairment of goodwill....... - - 9,290 12.6 - - 9,290 4.5
-------- ------- -------- ------- -------- ------- -------- -------
Total expenses............. 59,557 82.1 69,120 93.7 180,527 80.9 182,108 88.6
-------- ------- -------- ------- -------- ------- -------- -------
Operating income............... 12,975 17.9 4,654 6.3 42,549 19.1 23,405 11.4
-------- ------- -------- ------- -------- ------- -------- -------
Other income (expense):
Interest income.............. 354 0.5 281 0.4 1,226 0.5 876 0.4
Interest expense............. (284) (0.4) (682) (0.9) (1,196) (0.5) (2,425) (1.2)
Other, net................... 995 1.4 225 0.3 3,069 1.4 (835) (0.4)
-------- ------- -------- ------- -------- ------- -------- -------
Total other income 1,065 1.5 (176) (0.2) 3,099 1.4 (2,384) (1.2)
(expense)................
-------- ------- -------- ------- -------- ------- -------- -------
Income before income taxes..... 14,040 19.4 4,478 6.1 45,648 20.5 21,021 10.2
Income tax (provision) benefit. 4,622 6.3 (6,331) (8.6) (8,969) (4.1) (15,809) (7.7)
-------- ------- -------- ------- -------- ------- -------- -------
Net income (loss).............. $ 18,662 25.7 % $ (1,853) (2.5)% $ 36,679 16.4 % $ 5,212 2.5 %
======== ======= ======== ======= ======== ======= ======== =======
Revenues. Total revenues for the third quarter of fiscal 2004 decreased
$1.2 million, or 1.7%, as compared to the same period of fiscal 2003. Total
revenues for the first nine months of fiscal 2004 increased $17.6 million, or
8.5%, as compared to the same period of fiscal 2003. The three-month decrease is
the net result of a $3.2 million, or 7.8%, decrease in software license fee
revenues, a $2.4 million, or 11.7%, increase in maintenance fee revenues, and a
$0.5 million, or 3.9%, decrease in services revenues. The nine-month increase is
the net result of a $10.9 million, or 9.9%, increase in software license fee
revenues and a $8.0 million, or 13.7%, increase in maintenance fee revenues, and
a $1.4 million, or 3.9%, decrease in services revenues.
For the third quarter of fiscal 2004, as compared to the same period of
fiscal 2003, ACI Worldwide's software license fee revenues decreased by $3.1
million, primarily due to the number and size of transaction volume upgrades,
primarily in the EMEA region, during the third quarter of fiscal 2003 as
compared to the same period of fiscal 2004. For the first nine months of fiscal
2004, as compared to the same period of fiscal 2003, ACI Worldwide's software
license fee revenues increased by $13.3 million, a substantial portion of which
was due to a significant license renewal in the EMEA region during the first
quarter of fiscal 2004, a large capacity upgrade and term extension by a
customer in the Americas during the second quarter of fiscal 2004, increased
revenues from the Company's BASE24 and fraud detection products, and a number of
other large system and capacity increases
17
during the first six months of fiscal 2004. Insession Technologies' software
license fee revenues were $0.7 million higher for the third quarter of fiscal
2004 than for the same period of fiscal 2003 primarily due to increased activity
related to its data connectivity and web-based communication products. Insession
Technologies' software license fee revenues were $2.7 million higher for the
first nine months of fiscal 2004 than for same period of fiscal 2003 due to
increased activity related to its data connectivity and web-based communication
products, as well as its data center management enhancement products. For the
third quarter of fiscal 2004, as compared to the same period of fiscal 2003,
IntraNet's software license fee revenues decreased by $0.7 million. For the
first nine months of fiscal 2004, as compared to the same period of fiscal
2003, IntraNet's software license fee revenues decreased by $5.1 million,
primarily due to the completion of the final phase of an automated clearing
house ("ACH") processing project with a large European bank during the second
quarter of fiscal 2003, which allowed the Company to recognize approximately
$3.6 million in revenues. Also, as IntraNet's customers complete their
migration from the Digital VAX-based Money Transfer System ("MTS") product to
the RS6000-based MTS product, corresponding revenues associated with the
migration process have declined, which explains the remaining reduction in
IntraNet's software license fee revenues for the first nine months of fiscal
2004 as compared to the same period of fiscal 2003.
The increases in maintenance fee revenues for the third quarter and first
nine months of fiscal 2004, as compared to the same periods of fiscal 2003, were
primarily due to growth in the installed base of software products within the
ACI Worldwide and Insession Technologies business units in the Americas and
EMEA.
The decrease in services revenues for the third quarter and first nine
months of fiscal 2004, as compared to the same period of fiscal 2003, resulted
primarily from a decrease in IntraNet services revenues. Since the majority of
IntraNet's MTS customers have successfully completed their migration from the
Digital VAX-based MTS product to the RS6000-based MTS product, corresponding
services revenues associated with the migration process have declined.
Expenses. Total operating expenses for the third quarter of fiscal 2004
decreased $9.6 million, or 13.8%, as compared to the same period of fiscal 2003.
Total operating expenses for the first nine months of fiscal 2004 decreased $1.6
million, or 0.9%, as compared to the same period of fiscal 2003. Operating
expenses for the third quarter and first nine months of fiscal 2003 included a
goodwill impairment charge of $9.3 million. The effect of changes in foreign
currency exchange rates was to increase overall expenses by approximately $2.2
million and $7.2 million for the third quarter and first nine months of fiscal
2004, respectively, as compared to the same periods of fiscal 2003.
Cost of software license fees for the third quarter of fiscal 2004
decreased $0.1 million, or 0.9%, as compared to the same period of fiscal 2003.
Cost of software license fees for the first nine months of fiscal 2004 increased
$0.5 million, or 2.9%, as compared to the same period of fiscal 2003. The
comparative nine-month increase in cost of software license fees was due
primarily to increased commissions paid to distributors of the Company's
products along with higher product royalty fees paid on sales of third-party
products during the first quarter of fiscal 2004 as compared to the first
quarter of fiscal 2003, offset in part by a reduction in salaries resulting from
the 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 third quarter of fiscal 2004
decreased $1.7 million, or 11.2%, as compared to the same period of fiscal 2003.
Cost of maintenance and services for the first nine months of fiscal 2004
decreased $2.5 million, or 5.4%, as compared to the same period of fiscal 2003.
These comparative cost decreases were primarily due to a reduction in
compensation-related expenses resulting from a shift of certain personnel to
installation services associated with increasing sales of less-established
products such as the Company's newer BASE24-es product, in which revenue is
being deferred until acceptance or first production use and the associated costs
are capitalized and subsequently expensed when the related services revenue
recognition occurs, and the shift of certain personnel to R&D activities in the
latter part of fiscal 2003, offset in part by an increase in costs to perform
maintenance and services activities corresponding to an increase in the related
combined revenues.
R&D costs for the third quarter of fiscal 2004 decreased $0.2 million, or
1.8%, as compared to the same period of fiscal 2003. Enhancements to the
RS6000-based MTS product, specifically related to European functionality,
resulted in higher R&D costs within the IntraNet business unit during the third
quarter of fiscal 2003 as compared to the same period of fiscal 2004. Offsetting
this were higher R&D costs in fiscal 2004 due to the shift of certain personnel
from other areas of the Company to R&D activities in the latter part of fiscal
2003. R&D costs for the first nine months of fiscal 2004 increased $2.5 million,
or 9.8%, as compared to the same period of fiscal 2003. The comparative
nine-
18
month increase in R&D costs was primarily due to the shift of certain personnel
from other areas of the Company to R&D activities in the latter part of fiscal
2003.
Selling and marketing costs for the third quarter of fiscal 2004 increased
$2.3 million, or 17.1%, as compared to the same period of fiscal 2003. Selling
and marketing costs for the first nine months of fiscal 2004 increased $5.0
million, or 12.2%, as compared to the same period of fiscal 2003. The large
increase in selling and marketing costs reflects increased sales commissions
caused primarily by higher sales volumes in the ACI Worldwide business unit
during the second and third quarters of fiscal 2004 as compared to the same
periods of fiscal 2003.
General and administrative costs for the third quarter of fiscal 2004
decreased $0.7 million, or 4.5%, as compared to the same period of fiscal 2003.
General and administrative costs for the first nine months of fiscal 2004
increased $2.1 million, or 5.1%, as compared to the same period of fiscal 2003.
The comparative nine-month increase in general and administrative costs is
primarily due to increased professional fees for legal, tax and other services,
as well as increased insurance costs for director and officer liability
insurance.
Other Income and Expense. Interest expense for the third quarter of fiscal
2004 decreased $0.4 million, or 58.4%, as compared to the same period of fiscal
2003. Interest expense for the first nine months of fiscal 2004 decreased $1.2
million, or 50.7%, 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 June 30, 2004 of $11.8 million as compared to $29.2
million at June 30, 2003).
Other income for the third quarter of fiscal 2004 increased $0.8 million as
compared to the same period of fiscal 2003 due to increased foreign currency
gains realized. Other income for the first nine months of fiscal 2004 was $3.1
million as compared to other expense for the same period of fiscal 2003 of $0.8
million. This nine-month variance is primarily due to foreign currency gains and
losses, with the Company realizing $3.3 million in gains during the first nine
months of fiscal 2004 as compared to $0.5 million in losses during the same
period of fiscal 2003.
Income Taxes. It is the Company's policy to report income tax expense for
interim reporting periods using an estimated annual effective income tax rate.
However, the tax effects of significant or unusual items are not considered in
the estimated annual effective tax rate. The tax effect of such events is
recognized in the interim period in which the event occurs.
In fiscal 2003, the Company undertook an extensive review of its overall
tax position. Certain tax-saving strategies implemented during the latter part
of fiscal 2003 have resulted in lower effective tax rates for the third quarter
and first nine months of fiscal 2004 as compared to the same periods of fiscal
2003. Additionally, during the third quarter of fiscal 2004, the Company
completed a tax reorganization of its MessagingDirect Ltd. subsidiary and its
related entities (collectively referred to as "MDL") and elected to treat
certain foreign operations as branches of the U.S. parent company, which
resulted in the recognition of a $12.0 million tax benefit. This tax benefit
arises from the excess of tax basis over the book carrying value of these
foreign assets following the tax election. The Company recorded a deferred tax
asset in the same amount, which is included in the June 30, 2004 consolidated
balance sheet. The Company estimates the annual cash savings resulting from the
MDL restructuring to be approximately $1.0 million over the next 11 1/2 years.
Since the entire $12.0 million tax benefit was recognized during the third
quarter of fiscal 2004, the tax savings will not further affect the Company's
results of operations over future periods. Offsetting this tax benefit were
other tax expense adjustments totaling $1.4 million that were recorded during
the third quarter of fiscal 2004, including a $1.1 million adjustment to the
Company's deferred tax assets related to a change in the effective state tax
rates. On an ongoing basis, the state tax adjustment should result in a
reduction of state tax expenses.
The effective tax rate for the third quarter of fiscal 2004 was a benefit
of approximately 32.9% as compared to expense of 141.4% for the same period of
fiscal 2003. The effective tax rate for the first nine months of fiscal 2004 was
approximately 19.6% as compared to 75.2% for the same period of fiscal 2003. The
differences between the statutory federal income tax rate and the effective tax
rates per the consolidated statements of operations are summarized as follows:
19
Three Months Ended Nine Months Ended
June 30, June 30,
------------------- -------------------
2004 2003 2004 2003
-------- -------- -------- --------
Federal tax rate................................................. 35.0 % 35.0 % 35.0 % 35.0 %
MDL restructuring................................................ (85.8) - (26.4) -
State tax adjustment............................................. 7.8 - 2.4 -
Impairment of goodwill........................................... - 95.4 - 20.3
Foreign taxes deducted on U.S. return, net of federal benefit.... - 9.1 - 9.1
Increase in valuation allowance.................................. 3.4 11.5 3.4 11.5
Other............................................................ 6.7 (9.6) 5.2 (0.7)
------- -------- -------- --------
Effective income tax expense (benefit) rate.................... (32.9)% 141.4 % 19.6 % 75.2 %
======= ======== ======== ========
Improvements in the effective tax rates for the third quarter and first
nine months of fiscal 2004, as compared to the same periods during fiscal 2003,
after excluding the impact of the $10.6 million net benefit (discussed above)
during the third quarter and first nine months of fiscal 2004 and the impact of
the non-deductible goodwill impairment charge during the third quarter and first
nine months of fiscal 2003, resulted primarily from a reduction in state tax
expense, implementation of a new transfer pricing policy and expected
utilization of foreign tax credits. The Company continually reviews options that
could further reduce its effective tax rate. However, there can be no assurance
that the Company will be able to further reduce its effective tax rate, and even
if 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 June 30, 2004, the Company had deferred tax assets of
$24.3 million (net of a $52.7 million valuation allowance). The Company's
valuation allowance primarily relates to foreign net operating loss
carryforwards. The valuation allowance is based on the extent to which
management believes these carryforwards could expire unused due to the Company's
historical or projected losses in certain of its foreign subsidiaries. The
Company analyzes the recoverability of its net deferred tax assets at each
reporting period. Because unforeseen factors may affect future taxable income,
increases or decreases to the valuation reserve may be required in future
periods.
Liquidity and Capital Resources
As of June 30, 2004, the Company's principal sources of liquidity consisted
of $158.9 million in cash and cash equivalents.
The Company's net cash flows provided by operating activities for the first
nine months of fiscal 2004 amounted to $44.7 million as compared to $26.1
million during the same period of fiscal 2003. The increase in operating cash
flows resulted primarily from increased net income, including adjustments for
non-cash items. The largest changes in operating assets and liabilities related
to billed and accrued receivables, deferred revenue, current income taxes and
deferred income taxes.
The Company's net cash flows used in investing activities totaled $1.2
million for the first nine months of fiscal 2004 as compared to $1.7 million
during the same period of fiscal 2003. During the first nine months of fiscal
2004, the Company purchased software, property and equipment of $2.6 million as
compared to $2.3 million for the same period of fiscal 2003. During the first
nine months of fiscal 2004, the Company received proceeds from sales of
marketable securities of $1.4 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 $0.6
million for the first nine months of fiscal 2004 as compared to $14.2 million
during the same period of fiscal 2003. During the first nine months of fiscal
2004 and 2003, payments made to third-party financial institutions to repay
factoring debts were $13.1 million and $14.7 million, respectively. During the
first nine months of fiscal 2004, however, the Company received $12.2 million
from the exercise of stock options as compared to $0.3 million for the same
period of fiscal 2003.
The Company's net cash flows resulting from exchange rate fluctuations for
the first nine months of fiscal 2004
20
amounted to $2.0 million as compared to $2.9 million during the same period of
fiscal 2003.
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 believes that its existing sources
of liquidity, including cash on hand and cash provided by operating activities,
will satisfy the Company's projected short-term and long-term liquidity
requirements.
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 backlog estimate is based on management's assessment of
the customer contracts that exist as of the date the estimate is
made. A number of factors could result in actual revenues being less
than the amounts reflected in backlog. The Company's customers may
attempt to renegotiate or terminate their contracts for a number of
reasons, including mergers, changes in their financial condition, or
general changes in economic conditions in their industries or
geographic locations, or the Company may experience delays in the
development or delivery of products or services specified in customer
contracts. 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 Company continues to evaluate 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. The
Company's certificate of incorporation authorizes the use of
indemnification agreements and the Company enters into such agreements
with its directors and certain officers from time to time. These
indemnification agreements typically provide for a broader scope of the
Company's obligation to indemnify the directors and officers than set
forth in the certificate of incorporation. The Company's contractual
indemnification obligations under these agreements are in addition to
the respective directors' and officers' rights under the certificate of
incorporation or under Delaware law. However, the indemnification
agreements typically eliminate the Company's obligation to pay a
director or officer for any claims to the extent that he or she has
previously received payment for such claims under any insurance policy,
the certificate of incorporation or otherwise.
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
21
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. In
addition, the Company has implemented tax-saving strategies,
including those that resulted in a net benefit this quarter. The
Company believes that implemented tax-saving strategies comply with
applicable tax law. However, taxing authorities could disagree with
the Company's positions. If the taxing authorities are successful in
challenging any of the Company's tax positions, the Company's
financial condition and results of operations could be adversely
affected.
The Company's tax positions in its amended income tax returns filed for
its 1999 through 2002 tax years are the subject of an ongoing
examination by the Internal Revenue Service ("IRS"). The Company
believes that its tax positions comply with applicable tax law. This
examination may result in the IRS issuing proposed assessments that
could adversely affect the Company's financial condition and results of
operations.
Two of the Company's foreign subsidiaries are the subject of a tax
examination by the local taxing authority. Other foreign subsidiaries
could face challenges from various foreign tax authorities. It is not
certain that the local authorities will accept the Company's tax
positions. The Company believes its tax positions comply with
applicable tax law and it intends to defend its positions. However,
differing positions on certain issues could be upheld by foreign tax
authorities, which could adversely affect the Company's financial
condition and 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
developments in the various lawsuits filed against the Company
relating to its restatement of prior consolidated financial results.
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 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 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, which
is expected to be completed by 2005. 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 will materially affect
the Company's business, financial condition or results of operations.
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
22
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, or 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. 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, pay significant damages or even
stop selling certain products. 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.
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
nine months ended June 30, 2004. 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 in 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. Improvements in the Company's internal
23
controls over financial reporting related to the noted deficiencies have been
implemented during the first nine months of fiscal 2004, and corrective actions
have been initiated to address any deficiencies outstanding at June 30, 2004.
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 established substantial additional
procedures designed to ensure that these internal control deficiencies do not
lead to material misstatements in its consolidated financial statements. Based
upon an evaluation as of June 30, 2004 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 and evaluation of its internal
controls over financial reporting and has retained 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,
taking corrective action as appropriate.
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:
The Company had previously announced that on August 8, 2003, it was
informed that the Securities and Exchange Commission's Enforcement Division had
issued a formal order of private investigation in connection with the Company's
restatement of its prior consolidated financial statements. On April 14, 2004,
the Company filed a current report on Form 8-K indicating that a press release
was issued announcing its receipt of a letter from the Securities and Exchange
Commission indicating that it had terminated its investigation and that no
enforcement action was recommended. A copy of the press release issued on April
14, 2004 was attached thereto.
On April 28, 2004, the Company filed a current report on Form 8-K
announcing that on April 27, 2004, the Company issued a press release announcing
its financial results for the quarterly period ending March 31, 2004. A copy of
the press release was attached thereto.
On May 3, 2004, the Company filed a current report on Form 8-K announcing
that on April 27, 2004, the Company held a teleconference and web cast
discussing its financial performance for the quarterly period ending March 31,
2004. A transcript of the teleconference/web cast was attached thereto.
24
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: August 10, 2004 By: /s/ DAVID R. BANKHEAD
-------------------------------------
David R. Bankhead
Senior Vice President,
Chief Financial Officer and Treasurer
(principal financial officer)
25