================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-------------------
FORM 10-Q
-------------------
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003
Commission File Number 0-25346
-------------------
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)
-------------------
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 No x
--- ---
As of July 31, 2003, there were 35,635,104 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 7,680 options to purchase shares of the
registrant's Class A Common Stock at an exercise price of one cent per share).
================================================================================
TABLE OF CONTENTS
Page
----
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements...................................................................... 1
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations..... 15
Item 3. Quantitative and Qualitative Disclosures About Market Risk................................ 25
Item 4. Controls and Procedures................................................................... 25
PART II - OTHER INFORMATION
Item 1. Legal Proceedings......................................................................... 27
Item 6. Exhibits and Reports on Form 8-K.......................................................... 28
Signature.............................................................................................. 29
================================================================================
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Page
----
Condensed Consolidated Balance Sheets as of June 30, 2003 and September 30, 2002............................ 2
Condensed Consolidated Statements of Operations for the three and nine months ended June 30, 2003 and 2002.. 3
Condensed Consolidated Statements of Cash Flows for the nine months ended June 30, 2003 and 2002............ 4
Notes to Condensed Consolidated Financial Statements........................................................ 5
1
TRANSACTION SYSTEMS ARCHITECTS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
June 30, September 30,
2003 2002
------------- -------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents................................................... $ 100,893 $ 87,894
Marketable securities....................................................... 2,807 3,757
Billed receivables, net of allowances of $4,086 and 3,613, respectively..... 43,479 35,755
Accrued receivables......................................................... 6,888 13,132
Deferred income taxes, net.................................................. 9,657 17,554
Other....................................................................... 5,365 4,560
------------- -------------
Total current assets..................................................... 169,089 162,652
Property and equipment, net.................................................... 10,113 11,597
Software, net.................................................................. 2,684 5,609
Goodwill, net.................................................................. 46,457 55,947
Deferred income taxes, net..................................................... 25,615 27,546
Other.......................................................................... 2,391 3,168
------------- -------------
Total assets............................................................. $ 256,349 $ 266,519
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of debt - financing agreements.............................. $ 16,721 $ 18,444
Accounts payable............................................................ 6,946 7,348
Accrued employee compensation............................................... 8,680 7,583
Accrued liabilities......................................................... 9,116 11,494
Income taxes payable........................................................ 3,625 7,847
Deferred revenue............................................................ 68,830 59,598
Other....................................................................... 756 872
------------- -------------
Total current liabilities................................................ 114,674 113,186
Debt - financing agreements.................................................... 12,498 24,866
Deferred revenue............................................................... 20,014 23,860
Other.......................................................................... 1,472 1,749
------------- -------------
Total liabilities........................................................ 148,658 163,661
------------- -------------
Contingencies (Note 10)
Stockholders' equity:
Class A Common Stock, $.005 par value; 50,000,000 shares authorized;
37,111,249 and 36,887,805 shares issued at
June 30, 2003 and September 30, 2002, respectively....................... 183 183
Treasury stock, at cost, 1,476,145 shares................................... (35,258) (35,258)
Additional paid-in capital.................................................. 229,572 228,465
Accumulated deficit......................................................... (78,715) (83,927)
Accumulated other comprehensive loss, net................................... (8,091) (6,605)
------------- -------------
Total stockholders' equity............................................... 107,691 102,858
------------- -------------
Total liabilities and stockholders' equity............................... $ 256,349 $ 266,519
============= =============
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,
-------------------------- --------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
Revenues:
Software license fees.............................. $ 40,717 $ 38,706 $ 110,214 $ 119,152
Maintenance fees................................... 20,675 18,175 58,740 55,656
Services........................................... 12,382 12,572 36,559 39,119
------------ ------------ ------------ ------------
Total revenues.................................. 73,774 69,453 205,513 213,927
------------ ------------ ------------ ------------
Expenses:
Cost of software license fees...................... 6,339 6,673 18,567 23,838
Cost of maintenance fees and services.............. 15,082 14,953 45,583 47,366
Research and development........................... 9,478 8,711 25,785 26,678
Selling and marketing.............................. 13,686 15,264 40,951 43,002
General and administrative......................... 15,245 11,297 41,932 38,993
Impairment of goodwill............................. 9,290 - 9,290 -
------------ ------------ ------------ ------------
Total expenses.................................. 69,120 56,898 182,108 179,877
------------ ------------ ------------ ------------
Operating income...................................... 4,654 12,555 23,405 34,050
------------ ------------ ------------ ------------
Other income (expense):
Interest income.................................... 281 404 876 1,044
Interest expense................................... (682) (1,313) (2,425) (4,376)
Other, net......................................... 225 424 (835) 4,022
------------ ------------ ------------ ------------
Total other income (expense).................... (176) (485) (2,384) 690
------------ ------------ ------------ ------------
Income before income taxes............................ 4,478 12,070 21,021 34,740
Income tax provision.................................. (6,331) (7,066) (15,809) (20,528)
------------ ------------ ------------ ------------
Net income (loss)..................................... $ (1,853) $ 5,004 $ 5,212 $ 14,212
============ ============ ============ ============
Earnings (loss) per share information:
Weighted average shares outstanding:
Basic........................................... 35,571 35,355 35,489 35,303
============ ============ ============ ============
Diluted......................................... 35,571 35,735 35,601 35,576
============ ============ ============ ============
Earnings (loss) per share:
Basic........................................... $ (0.05) $ 0.14 $ 0.15 $ 0.40
============ ============ ============ ============
Diluted......................................... $ (0.05) $ 0.14 $ 0.15 $ 0.40
============ ============ ============ ============
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,
2003 2002
------------- -------------
Cash flows from operating activities:
Net income.................................................................. $ 5,212 $ 14,212
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation............................................................. 3,804 4,932
Amortization............................................................. 3,151 7,918
Gain on sale of business................................................. - (8,743)
Loss on sale of marketable equity securities............................. 84 -
Impairments of marketable equity securities.............................. - 4,775
Impairment of goodwill................................................... 9,290 -
Changes in operating assets and liabilities:
Billed and accrued receivables, net.................................... (763) 8,282
Other current and noncurrent assets.................................... (4,319) 2,079
Accounts payable....................................................... 410 (5,919)
Deferred revenue....................................................... 4,391 4,532
Income taxes........................................................... 5,606 17,097
Other current and noncurrent liabilities............................... (809) (5,502)
------------- -------------
Net cash provided by operating activities........................... 26,057 43,663
------------- -------------
Cash flows from investing activities:
Purchases of property and equipment, net.................................... (1,972) (3,037)
Purchases of software....................................................... (367) (765)
Net proceeds from sale of business.......................................... - 5,429
Other, net.................................................................. 629 585
------------- -------------
Net cash provided by (used in) investing activities................. (1,710) 2,212
------------- -------------
Cash flows from financing activities:
Proceeds from issuance of Class A Common Stock.............................. 789 910
Proceeds from exercise of stock options..................................... 318 69
Repayments on line of credit................................................ - (12,000)
Proceeds from debt - financing agreements................................... - 7,600
Payments on debt - financing agreements..................................... (14,725) (16,290)
Other, net.................................................................. (611) 411
------------- -------------
Net cash used in financing activities............................... (14,229) (19,300)
------------- -------------
Effect of exchange rate fluctuations on cash................................... 2,881 544
------------- -------------
Net increase in cash and cash equivalents...................................... 12,999 27,119
Cash and cash equivalents, beginning of period................................. 87,894 32,004
------------- -------------
Cash and cash equivalents, end of period....................................... $ 100,893 $ 59,123
============= =============
The accompanying notes are an integral part of the
condensed consolidated financial statements.
4
TRANSACTION SYSTEMS ARCHITECTS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
Nature of Business
Transaction Systems Architects, Inc., a Delaware corporation, and its
subsidiaries (collectively referred to as "TSA" or the "Company"), develop,
market, install and support a broad line of software products and services
primarily focused on facilitating electronic payments ("e-payments") and
electronic commerce ("e-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 e-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, 2003, and for the three and nine months ended June 30,
2003 and 2002, are unaudited and reflect all adjustments (consisting only of
normal recurring adjustments) which are, in the opinion of management, necessary
for a fair presentation of the financial position and operating results for the
interim periods. Certain amounts previously reported have been reclassified to
conform to current presentation.
The condensed consolidated financial statements contained herein should be
read in conjunction with the condensed 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, 2002. The results of
operations for the three and nine months ended June 30, 2003 are not necessarily
indicative of the results that may be achieved for the entire fiscal year ending
September 30, 2003.
Use of Estimates in Preparation of Condensed Consolidated Financial Statements
The preparation of the condensed consolidated financial statements in
conformity with accounting principles generally accepted in the United States
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the condensed consolidated financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Revenue Recognition, Accrued Receivables and Deferred Revenue
Software License Fees. The Company recognizes software license fee revenue
in accordance with American Institute of Certified Public Accountants ("AICPA")
Statement of Position ("SOP") 97-2, "Software Revenue Recognition," SOP 98-9,
"Modification of SOP 97-2, Software Revenue Recognition With Respect to Certain
Transactions," and Securities and Exchange Commission ("SEC") Staff Accounting
Bulletin ("SAB") 101, "Revenue Recognition in Financial Statements." For
software license arrangements for which services rendered are not considered
essential to the functionality of the software, the Company recognizes revenue
upon delivery, provided (1) there is persuasive evidence of an arrangement, (2)
collection of the fee is considered probable and (3) the fee is fixed or
determinable. In most arrangements, vendor-specific objective evidence ("VSOE")
of fair value does not exist for the license element; therefore, the Company
uses the residual method under SOP 98-9 to determine the amount of revenue to be
allocated to the license element. Under SOP 98-9, the fair value of all
undelivered elements, such as postcontract customer support (maintenance or
"PCS") or other products or services, is deferred and subsequently recognized as
the products are delivered or the services are performed, with the residual
difference between the total arrangement fee and revenues allocated to
undelivered elements being allocated to the delivered element.
When a software license arrangement includes services to provide
significant production, modification, or customization of software, those
services are not separable from the software and are accounted for in accordance
with Accounting Research Bulletin ("ARB") No. 45, "Long-Term Construction-Type
Contracts," and the relevant guidance provided by SOP 81-1, "Accounting for
Performance of Construction-Type and Certain Production-Type Contracts."
Accounting for services delivered over time under ARB No. 45 and SOP 81-1 is
referred to as contract
5
accounting. Under contract accounting, the Company uses
the percentage-of-completion method. Under the percentage-of-completion method,
the Company records revenue for the software license fee and services over the
development and implementation period, with the percentage of completion
measured by the percentage of labor hours incurred to-date to estimated total
labor hours for each contract. For those contracts subject to
percentage-of-completion contract accounting, estimates of total revenue 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, if all other
conditions to revenue recognition have been met. For software license
arrangements in which the Company has concluded that collection of the fees is
not probable, revenue is recognized as cash is collected. 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.
For software license arrangements in which the Company's ability to enforce
payment terms depends on customer acceptance provisions, software license fee
revenue is recognized upon the earlier of the point at which (1) the customer
accepts the software products or (2) the acceptance provisions lapse.
For software license arrangements in which VSOE of the fair value of
undelivered elements does not exist to allocate the total fee to all elements of
the arrangement, revenue is deferred until the earlier of the point at which (1)
such sufficient VSOE of the fair value of undelivered elements does exist or (2)
all elements of the arrangement have been delivered.
Gross versus Net. 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.
Subscriptions and Usage Fees. 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 software license fees based on
usage of the product, the Company recognizes revenue as usage occurs over the
term of the licenses, provided all other revenue recognition criteria have been
met.
Maintenance Fees. Revenues for PCS are recognized ratably over the
maintenance term specified in the contract. In arrangements where a time-based
software license has a duration of one year or less, or the initial PCS term is
relatively long (i.e. greater than fifty percent) compared to the term of the
software license, the Company recognizes revenue for the entire arrangement
ratably over the PCS term as VSOE of fair value cannot be established.
Services. Revenues from arrangements to provide professional services on a
time and materials basis are recognized as the related services are performed.
Revenues from professional services provided on a fixed-fee basis are recognized
using the percentage-of-completion method.
Non-monetary Transactions. Non-monetary transactions are accounted for in
accordance with Accounting Principles Board ("APB") Opinion No. 29, "Accounting
for Non-monetary Transactions," which requires that the transfer or distribution
of a non-monetary asset or liability generally be based on the fair value of the
asset or liability
6
that is received or surrendered, whichever is more clearly evident. In those
cases where fair value of the assets exchanged is not readily determinable, the
exchange is recorded at the historical cost of the asset surrendered.
Accrued Receivables. Accrued receivables represent amounts to be billed
in the near future (less than 12 months).
Deferred Revenue. Deferred revenue represents (1) 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
does not exist, or (3) amounts deferred if other conditions to revenue
recognition have not been met.
Debt - Financing Agreements
The Company periodically sells rights to future payment streams under
software license arrangements with extended payment terms. In accordance with
Financial Accounting Standards Board ("FASB") Emerging Issues Task Force
("EITF") 88-18, "Sales of Future Revenues," the Company records the proceeds
received from these arrangements as debt and reduces the debt principal as
payments are made. Interest on the debt accrues monthly and is computed using
the effective interest method.
Recent Accounting Pronouncements
In October 2002, the Company adopted EITF 01-14, "Income Statement
Characterization of Reimbursements Received for "Out-of-Pocket" Expenses
Incurred," which requires (1) that reimbursements received for out-of-pocket
expenses be classified as revenue, rather than as a reduction of expenses, and
(2) upon adoption, comparative financial statements for prior periods be
reclassified to comply with the guidance of EITF 01-14. As a result of adopting
EITF 01-14, results for the three and nine months ended June 30, 2002 were
restated to increase revenues and increase operating expenses by $0.5 million
and $1.5 million, respectively. The adoption of EITF 01-14 had no effect on net
income.
In December 2002, the FASB issued Statement of Financial Accounting
Standard ("SFAS") No. 148, "Accounting for Stock-Based Compensation - Transition
and Disclosure," which amends SFAS No. 123, "Accounting for Stock-Based
Compensation," to provide alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. In addition, SFAS No. 148 amends the disclosure requirements of
SFAS No. 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. SFAS No. 148
is effective for the Company's fiscal year ending September 30, 2003, with
disclosure provisions for interim periods beginning after December 15, 2002. The
Company does not expect to voluntarily adopt the fair value based method of SFAS
No. 123 and, therefore, does not expect the measurement provisions of SFAS No.
148 to affect the Company's financial position or results of operations. The
Company has adopted the disclosure provisions required by SFAS No. 148 (see Note
2).
In January 2003, the FASB issued Interpretation No. ("FIN") 46,
"Consolidation of Variable Interest Entities - An Interpretation of ARB No. 51,"
which addresses the consolidation by business enterprises of variable interest
entities as defined in FIN 46. FIN 46 applies immediately to variable
interests in variable interest entities created after January 31, 2003, and to
variable interests in variable interest entities obtained after January 31,
2003. FIN 46 applies as of July 1, 2003 for existing arrangements. The Company
is currently assessing the impact, if any, the application of FIN 46 is
expected to have on its financial position or results of operations.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity,"
which establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. SFAS
No. 150 is effective for financial instruments entered into or modified after
May 31, 2003 and for pre-existing instruments as of the beginning of the first
interim period that commences after June 15, 2003. The Company does not expect
the provisions of SFAS No. 150 to affect its financial position or results of
operations.
In May 2003, the EITF finalized certain provisions within EITF 00-21,
"Revenue Arrangements with Multiple Deliverables," which addresses accounting
for arrangements that include multiple revenue-generating activities. EITF 00-21
discusses how to determine whether an arrangement involving multiple
deliverables contain more than one unit
7
of accounting, and how consideration received pursuant to such an arrangement
should be measured and allocated to the separate units of accounting. The
guidance provided by EITF 00-21 is effective for revenue arrangements entered
into by the Company as of July 1, 2003. The Company does not expect the
provisions of EITF 00-21 to affect its financial position or results of
operations.
2. 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, as amended by SFAS No. 148. In accordance with APB No. 25, no compensation
expense has been recognized in the Company's consolidated statements of
operations for the three and nine months ended June 30, 2003 and 2002 related to
its stock-based compensation plans. 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/loss and
earnings/loss per share for the three and nine months ended June 30, 2003 and
2002 would have approximated the following pro forma amounts (in thousands,
except per share amounts):
Three Months Ended Nine Months Ended
June 30, June 30,
---------------------- ----------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
Net income (loss):
As reported......................................... $ (1,853) $ 5,004 $ 5,212 $ 14,212
Deduct: stock-based employee compensation expense
determined under fair value based method for
all awards, net of related tax effects............ (1,427) (1,433) (4,455) (2,108)
---------- ---------- ---------- ----------
Pro forma........................................... $ (3,280) $ 3,571 $ 757 $ 12,104
========== ========== ========== ==========
Earnings (loss) per share:
Basic and diluted, as reported...................... $ (0.05) $ 0.14 $ 0.15 $ 0.40
========== ========== ========== ==========
Basic and diluted, pro forma........................ $ (0.09) $ 0.10 $ 0.02 $ 0.34
========== ========== ========== ==========
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. The effects of applying SFAS No. 123 in this pro forma disclosure
are not indicative of future amounts. SFAS No. 123 applies only to options
granted since fiscal 1996, and additional future awards are anticipated.
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, 2002
(in thousands):
Lease
Obligations
-----------
Balance, September 30, 2002................................ $ 1,047
Amounts paid year-to-date during fiscal 2003............... (252)
-----------
Balance, June 30, 2003..................................... $ 795
===========
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.
8
4. Goodwill and Software
During the third quarter of fiscal 2003, the Company performed an analysis
of the carrying value of goodwill related to its 2001 acquisition of
MessagingDirect Ltd. ("MDL"). This analysis was performed as a result of the
Company's decision to reduce staffing levels within the MDL operating unit due
to the slower than expected adoption of MDL's secure document delivery
technology. As a result of this analysis, which included updated financial
forecasts, the Company determined that MDL's remaining goodwill was impaired.
The impairment was determined by comparing the estimated fair value of the MDL
goodwill to the related carrying value. The fair value was determined using a
discounted cash flow approach for the net cash flows of the MDL business and an
estimated terminal value. The assumptions supporting the estimated cash flows,
including the discount rate and estimated terminal value, reflect management's
best estimates at the time. As a result of the fair value test, the Company
wrote off the remaining carrying value of MDL goodwill of $9.3 million, which
is presented as impairment of goodwill in the accompanying consolidated
statements of operations. Other changes to the carrying amount of goodwill
during the nine months ended June 30, 2003 resulted 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,
2003 2002
---------- ----------
Internally-developed software............. $ 15,723 $ 15,372
Purchased software........................ 44,131 43,312
---------- ----------
59,854 58,684
Less: accumulated amortization............ (57,170) (53,075)
---------- ----------
Software, net............................. $ 2,684 $ 5,609
========== ==========
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, 2003 was $0.7 million and $2.3 million, respectively. Based on
capitalized software at June 30, 2003, and assuming no impairment of these
software assets, estimated amortization expense for the remainder of fiscal 2003
and in succeeding fiscal years is as follows (in thousands):
2003................................................ $ 613
2004................................................ 1,663
2005................................................ 289
2006................................................ 68
Thereafter.......................................... 51
5. Debt - Financing Agreements
During the nine months ended June 30, 2002, the Company sold the rights to
future payment streams under software license arrangements with extended payment
terms to financial institutions and received cash of approximately $7.6 million.
The Company did not sell any rights to future payment streams under software
license arrangements with extended payment terms during the nine months ended
June 30, 2003. The amount of the proceeds received from the financing
arrangements is typically determined by applying a discount rate to the gross
future payments to be received from the customer. The discount rates used to
determine the proceeds during the nine months ended June 30, 2002 ranged from
6.50% to 7.75%. The Company recorded interest expense of $0.7 million and $1.2
million during the three months ended June 30, 2003 and 2002, respectively, and
$2.4 million and $3.8 million during the nine months ended June 30, 2003 and
2002, respectively, related to debt - financing agreements.
9
6. Common Stock and Earnings Per Share
Exchangeable shares, and options to purchase shares of TSA Class A Common
Stock ("Common Stock") at an exercise price of one cent per share, received by
shareholders of MDL, that have not yet been converted into Common Stock are
included in Class A Common Stock for presentation purposes on the June 30, 2003
and September 30, 2002 consolidated balance sheets. Exchangeable shares and MDL
options included in Common Stock totaled 0 shares and 7,680 options as of June
30, 2003, and 73,909 shares and 11,010 options as of September 30, 2002,
respectively.
Earnings per share ("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 (the
numerator), by the weighted average number of common shares outstanding,
adjusted for the dilutive effect of outstanding dilutive securities (the
denominator). Exchangeable shares and options received by shareholders of MDL
that have not yet been converted into Common Stock are included in common shares
outstanding for EPS computations. The difference between the basic and diluted
EPS denominators for the three months ended June 30, 2002, which amounted to
approximately 380,000 shares, and for the nine months ended June 30, 2003 and
2002, which amounted to approximately 112,000 and 273,000 shares, respectively,
were due to the dilutive effect of the Company's outstanding stock options using
the treasury stock method. 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 from continuing operations. Weighted average
shares from stock options of 1,471,000 were excluded from the computation of
diluted EPS for the three months ended June 30, 2002, and weighted average
shares from stock options of 5,065,000 and 1,617,000 were excluded from the
computation of diluted EPS for the nine months ended June 30, 2003 and 2002,
respectively, because the exercise prices of the stock options were greater than
the average market price of the Company's common shares. Diluted shares for the
three months ended June 30, 2003 excludes 136,000 weighted average incremental
shares related to employee and director stock options. These shares are excluded
despite their exercise prices being below the average market price of the
Company's common shares as their effect is antidilutive. In addition, for the
three months ended June 30, 2003, the Company has excluded 4,916,000 shares
related to employee and director stock options that have exercise prices greater
than the average market price of the Company's common shares.
7. 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,
---------------------- ----------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
Net income (loss)............................... $ (1,853) $ 5,004 $ 5,212 $ 14,212
Other comprehensive income (loss):
Foreign currency translation adjustments...... (718) (793) (1,249) 484
Change in unrealized investment holding loss:
Unrealized holding gain (loss) arising during
the period.................................. (297) (2,817) (237) (212)
Reclassification for gain(loss) included in
net income (loss)........................... (28) 18 (85) 36
Reclassification for other than temporary
loss included in net income (loss).......... - 1,103 - 4,632
---------- ---------- ---------- ----------
Comprehensive income (loss)..................... $ (2,896) $ 2,515 $ 3,641 $ 19,152
========== ========== ========== ==========
10
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, 2002..................... $ (6,162) $ (443) $ (6,605)
Fiscal 2003 year-to-date activity............... (1,249) (237) (1,486)
---------- ---------- ----------
Balance, June 30, 2003.......................... $ (7,411) $ (680) $ (8,091)
========== ========== ==========
8. Income Taxes
The effective tax rate for the third quarter of fiscal 2003 was
approximately 141.4%, which includes the impact of a $9.3 million non-deductible
goodwill impairment charge negatively impacting the effective tax rate by 95.4%,
as compared to 58.5% for the same period of fiscal 2002. The effective tax rate
for the first nine months of fiscal 2003 was approximately 75.2%, which includes
the impact of a $9.3 million non-deductible goodwill impairment charge
negatively impacting the effective tax rate by 23.0%, as compared to 59.1% for
the same period of fiscal 2002. The remaining effective tax rates of 46.0% and
52.2% for the third quarter and first nine months of fiscal 2003 were primarily
impacted by non-recognition of tax benefits for operating losses in certain
foreign locations and recognition of a valuation allowance for foreign tax
credits. The improvement in the effective tax rates for the third quarter and
first nine months of fiscal 2003 (excluding the effect of the non-deductible
goodwill impairment charge), as compared to the same periods of fiscal 2002,
resulted primarily from recognition of R&D credits and extraterritorial income
exclusion benefits. The effective tax rates for the third quarter and first nine
months of fiscal 2002 were primarily impacted by non-recognition of tax benefits
for operating losses in certain foreign locations, recognition of a valuation
allowance for foreign tax credits, foreign tax rate differentials and gain on
sale of subsidiary.
9. 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 review business unit
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. No single customer accounted
for more than 10% of the Company's consolidated revenues during the three and
nine months ended June 30, 2003 and 2002. The following are revenues and
operating income for these business units for the periods indicated (in
thousands):
11
Three Months Ended Nine Months Ended
June 30, June 30,
---------------------- ----------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
Revenues:
ACI Worldwide................................. $ 56,358 $ 52,276 $150,629 $159,952
Insession Technologies........................ 8,600 7,675 24,428 25,744
IntraNet...................................... 8,816 9,502 30,456 28,231
---------- ---------- ---------- ----------
$ 73,774 $ 69,453 $205,513 $213,927
========== ========== ========== ==========
Operating income:
ACI Worldwide................................. $ 1,960 $ 9,791 $ 12,220 $ 26,729
Insession Technologies........................ 1,907 1,771 5,135 5,010
IntraNet...................................... 787 993 6,050 2,311
---------- ---------- ---------- ----------
$ 4,654 $ 12,555 $ 23,405 $ 34,050
========== ========== ========== ==========
Offsetting ACI Worldwide operating income for the three and nine months ended
June 30, 2003 is a $9.3 million goodwill impairment charge.
Most of the Company's products are sold and supported through distribution
networks covering the geographic regions of the Americas, Europe/Middle
East/Africa ("EMEA") and Asia/Pacific. The following are revenues for the
periods indicated and long-lived assets at each balance sheet date for these
geographic regions (in thousands):
Three Months Ended Nine Months Ended
June 30, June 30,
---------------------- ----------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
Revenues:
United States................................. $ 31,867 $ 26,626 $ 89,717 $ 90,373
Other Americas................................ 8,985 16,973 24,594 37,542
---------- ---------- ---------- ----------
Total Americas.............................. 40,582 43,599 114,311 127,915
EMEA.......................................... 25,153 18,582 66,988 64,782
Asia/Pacific.................................. 7,769 7,272 24,214 21,230
---------- ---------- ---------- ----------
$ 73,774 $ 69,453 $205,513 $213,927
========== ========== ========== ==========
June 30, Sept. 30,
2003 2002
---------- ----------
Long-lived assets:
United States............................... $ 52,848 $ 57,616
Other Americas.............................. 2,564 6,098
---------- ----------
Total Americas............................ 55,412 63,714
EMEA........................................ 5,387 11,805
Asia/Pacific ............................... 846 802
---------- ----------
$ 61,645 $ 76,321
========== ==========
10. Contingencies
Legal Proceedings
Class Action Litigation. Two class action complaints were filed against the
Company and certain individual named defendants in connection with the Company's
restatement of its prior consolidated financial statements. The two complaints
are Desert Orchid Partners v. the Company, et al. and Nancy Rosen v. the
Company, et al.
12
Pursuant to a Court Order, the two suits were consolidated and,
also in accordance with the Court Order, the Court-designated Lead Plaintiff,
Genesee County Employees' Retirement System, filed a First Amended Consolidated
Class Action Complaint on June 30, 2003 (the "Consolidated Complaint"). The Lead
Plaintiff alleges violations of Sections 10(b) and 20(a) of the Securities
Exchange Act of 1934 (the "Exchange Act") and Rule 10b-5 thereunder, on the
grounds that certain of the Company's Exchange Act reports and press releases
contained untrue statements of material facts, or omitted to state facts
necessary to make the statements therein not misleading, with regard to the
Company's revenues and expenses during the class period. The Consolidated
Complaint alleges that during the purported class period, the Company and the
named officers and directors misrepresented the Company's historical financial
condition, results of operations and its future prospects, and failed to
disclose facts that could have indicated an impending decline in the Company's
revenues. The Lead Plaintiff is seeking unspecified damages, interest, fees,
costs and rescission. The class period stated in the Consolidated Complaint is
January 21, 1999 through November 18, 2002. The Company and the individual
defendants were granted an extension of time to file an answer to the
Consolidated Complaint. An answer is due on August 20, 2003, at which time the
Company and the individual defendants anticipate filing a motion to dismiss.
Derivative Litigation. On January 10, 2003, Samuel Naito filed the suit of
"Samuel Naito, Derivatively on behalf of Nominal Defendant Transaction Systems
Architects, Inc. v. Roger K. Alexander, Gregory D. Derkacht, Gregory J. Duman,
Larry G. Fendley, Jim D. Kever, and Charles E. Noell, III and Transaction
Systems Architects, Inc." in the State District Court in Douglas County,
Nebraska (the "Naito matter"). The suit is a shareholder derivative action that
generally alleges that the named individuals breached their fiduciary duties of
loyalty and good faith owed to the Company and its shareholders by causing the
Company to conduct its business in an unsafe, imprudent and unlawful manner
resulting in damage to the Company. More specifically, the plaintiff alleges
that the individual defendants, and particularly the members of the Company's
audit committee, failed to implement and maintain an adequate internal
accounting control system that would have enabled the Company to discover
irregularities in its accounting procedures of 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'
breaches of fiduciary duties, as well as the plaintiff's costs and disbursements
related to the suit.
On January 24, 2003, Michael Russiello filed the suit of "Michael
Russiello, Derivatively on behalf of Nominal Defendant Transaction Systems
Architects, Inc. v. Roger K. Alexander, Gregory D. Derkacht, Gregory J. Duman,
Larry G. Fendley, Jim D. Kever, and Charles E. Noell, III and Transaction
Systems Architects, Inc." in the State District Court in Douglas County,
Nebraska (the "Russiello matter"). The suit is a shareholder derivative action
that generally alleges that the named individuals breached their fiduciary
duties of loyalty and good faith owed to the Company and its shareholders by
causing the Company to conduct its business in an unsafe, imprudent and unlawful
manner resulting in damage to the Company. More specifically, the plaintiff
alleges that the individual defendants, and particularly the members of the
Company's audit committee, failed to implement and maintain an adequate internal
accounting control system that would have enabled the Company to discover
irregularities in its accounting procedures of 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'
breaches of fiduciary duties, as well as the plaintiff's costs and disbursements
related to the suit.
The Company filed a Motion to Dismiss in the Naito matter on February 14,
2003, and a Motion to Dismiss in the Russiello matter on February 21, 2003. A
hearing was scheduled on those Motions for March 14, 2003. Just prior to that
date, Plaintiffs' counsel requested that the derivative lawsuits be stayed
pending a determination of an anticipated motion to dismiss to be filed in the
class action lawsuits when and if service of process is achieved. The Company,
by and through its counsel, agreed to that stay. As a result, no other
defendants have been served and no discovery has been commenced.
These class action and derivative lawsuits were brought in the United
States District Court for the District of Nebraska and the Nebraska District
Courts, respectively, and are at preliminary stages. The Company is currently in
the process of preparing to respond to the claims made in the lawsuits. The
Company intends to defend the foregoing lawsuits vigorously, but, since the
lawsuits have only recently been filed and are in the very early stages, the
Company cannot predict the outcome and is not currently able to evaluate the
likelihood of success or the
13
range of potential loss, if any, that might be
incurred in connection with such actions. However, if the Company were to lose
any of these lawsuits or if they were not settled on favorable terms, the
judgment or settlement may have a material adverse effect on the Company's
consolidated financial position, 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.
Additional suits against the Company may be commenced in the future. The
Company will fully analyze these allegations once all of the complaints are
received and intends to vigorously defend against them. There is a risk that
such litigation could result in substantial costs and divert management
attention and resources from its business, which could adversely affect the
Company's business.
Securities and Exchange Commission Investigation. In connection with the
Company's restatement of its prior consolidated financial statements, the
Company has been in contact with the Securities and Exchange Commission
Enforcement Division. On December 9, 2002, certain of the Company's officers and
external legal counsel held a telephone conference with representatives of the
SEC Enforcement Division. The Company had a follow-up meeting with the SEC
Enforcement Division on March 14, 2003. At this meeting, the SEC representatives
asked questions about the restatement. The SEC Enforcement Division also
requested that the Company provide additional written information regarding the
restatement. The Company supplied this information on March 21, 2003. On August
8, 2003, the Company was informed that the SEC Enforcement Division has issued a
formal order of private investigation in connection with the Company's
restatement of its prior consolidated financial statements. The Company intends
to cooperate fully with the SEC with respect to this investigation.
In addition to the foregoing, from time to time, the Company is involved in
litigation relating to claims arising out of its operations in the normal course
of business. The Company is not currently a party to any such legal proceedings,
other than as described above, 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.
14
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Overview
The Company develops, markets, installs and supports a broad line of
software products and services primarily focused on facilitating e-payments and
e-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 e-payment
processors, both in domestic and international markets.
Business Units
The Company's products and services are currently organized within three
operating segments, referred to as business units. These three business units
are ACI Worldwide, Insession Technologies and IntraNet. Most of the Company's
products and services are marketed 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 reseller and/or distributor networks. The following are
revenues and operating income for these business units for the three and nine
months ended June 30, 2003 and 2002 (in thousands):
Three Months Ended Nine Months Ended
June 30, June 30,
---------------------- ----------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
Revenues:
ACI Worldwide................................. $ 56,358 $ 52,276 $150,629 $159,952
Insession Technologies........................ 8,600 7,675 24,428 25,744
IntraNet...................................... 8,816 9,502 30,456 28,231
---------- ---------- ---------- ----------
$ 73,774 $ 69,453 $205,513 $213,927
========== ========== ========== ==========
Operating income:
ACI Worldwide................................. $ 1,960 $ 9,791 $ 12,220 $ 26,729
Insession Technologies........................ 1,907 1,771 5,135 5,010
IntraNet...................................... 787 993 6,050 2,311
---------- ---------- ---------- ----------
$ 4,654 $ 12,555 $ 23,405 $ 34,050
========== ========== ========== ==========
Offsetting ACI Worldwide operating income for the three and nine months ended
June 30, 2003 is a $9.3 million goodwill impairment charge.
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 one year. Recurring
backlog includes all monthly license fees, maintenance fees and facilities
management fees. Non-recurring backlog includes all other fees.
The following table sets forth the Company's recurring and non-recurring
backlog, by business unit, as of June 30, 2003 (in thousands):
Non-
Recurring Recurring Total
----------- ----------- -----------
ACI Worldwide.................................. $ 131,220 $ 45,892 $ 177,112
Insession Technologies......................... 20,370 5,704 26,074
IntraNet, Inc.................................. 12,706 10,004 22,710
----------- ---------- -----------
$ 164,296 $ 61,600 $ 225,896
=========== ========== ===========
15
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 the one-year period. In
evaluating the Company's backlog, the risk factors described below in
Forward-Looking Statements should be considered.
Critical Accounting Policies and Estimates
Management's discussion and analysis of financial condition and results of
operations are based upon the Company's condensed consolidated financial
statements, which have been prepared in accordance with accounting principles
generally accepted in the United States. The preparation of these financial
statements requires that the Company make estimates and assumptions that affect
the reported amounts of assets, liabilities, revenues and expenses, and related
disclosure of contingent assets and liabilities. The Company bases its estimates
on historical experience and other assumptions that are believed to be proper
and reasonable under the circumstances. The Company continually evaluates the
appropriateness of its estimates and assumptions, including those related to
revenue recognition, provision for doubtful accounts, fair value of investments,
fair value of goodwill and software, useful lives of intangible and fixed
assets, income taxes, and contingencies and litigation, among others. Actual
results could differ from those estimates.
The Company believes that there are several accounting policies that are
critical to understanding the Company's historical and future performance, as
these policies affect the reported amounts of revenue and the more significant
areas involving management's judgments and estimates. These critical policies,
and the Company's procedures related to these policies, are described in detail
below.
Revenue Recognition, Accrued Receivables and Deferred Revenue
Software License Fees. The Company recognizes software license fee revenue
in accordance with American Institute of Certified Public Accountants ("AICPA")
Statement of Position ("SOP") 97-2, "Software Revenue Recognition," SOP 98-9,
"Modification of SOP 97-2, Software Revenue Recognition With Respect to Certain
Transactions," and Securities and Exchange Commission ("SEC") Staff Accounting
Bulletin ("SAB") 101, "Revenue Recognition in Financial Statements." For
software license arrangements for which services rendered are not considered
essential to the functionality of the software, the Company recognizes revenue
upon delivery, provided (1) there is persuasive evidence of an arrangement, (2)
collection of the fee is considered probable and (3) the fee is fixed or
determinable. In most arrangements, vendor-specific objective evidence ("VSOE")
of fair value does not exist for the license element; therefore, the Company
uses the residual method under SOP 98-9 to determine the amount of revenue to be
allocated to the license element. Under SOP 98-9, the fair value of all
undelivered elements, such as postcontract customer support (maintenance or
"PCS") or other products or services, is deferred and subsequently recognized as
the products are delivered or the services are performed, with the residual
difference between the total arrangement fee and revenues allocated to
undelivered elements being allocated to the delivered element.
When a software license arrangement includes services to provide
significant production, modification, or customization of software, those
services are not separable from the software and are accounted for in accordance
with Accounting Research Bulletin ("ARB") No. 45, "Long-Term Construction-Type
Contracts," and the relevant guidance provided by SOP 81-1, "Accounting for
Performance of Construction-Type and Certain Production-Type Contracts."
Accounting for services delivered over time under ARB No. 45 and SOP 81-1 is
referred to as contract accounting. Under contract accounting, the Company uses
the percentage-of-completion method. Under the percentage-of-completion method,
the Company records revenue for the software license fee and services over the
development and implementation period, with the percentage of completion
measured by the percentage of labor hours incurred to-date to estimated total
labor hours for each contract. For those contracts subject to
percentage-of-completion contract accounting, estimates of total revenue 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 and
16
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, if all other
conditions to revenue recognition have been met. For software license
arrangements in which the Company has concluded that collection of the fees is
not probable, revenue is recognized as cash is collected. 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.
For software license arrangements in which the Company's ability to enforce
payment terms depends on customer acceptance provisions, software license fee
revenue is recognized upon the earlier of the point at which (1) the customer
accepts the software products or (2) the acceptance provisions lapse.
For software license arrangements in which VSOE of the fair value of
undelivered elements does not exist to allocate the total fee to all elements of
the arrangement, revenue is deferred until the earlier of the point at which (1)
such sufficient VSOE of the fair value of undelivered elements does exist or (2)
all elements of the arrangement have been delivered.
Gross versus Net. 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.
Subscriptions and Usage Fees. 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 software license fees based on
usage of the product, the Company recognizes revenue as usage occurs over the
term of the licenses, provided all other revenue recognition criteria have been
met.
Maintenance Fees. Revenues for PCS are recognized ratably over the
maintenance term specified in the contract. In arrangements where a time-based
software license has a duration of one year or less, or the initial PCS term is
relatively long (i.e. greater than fifty percent) compared to the term of the
software license, the Company recognizes revenue for the entire arrangement
ratably over the PCS term as VSOE of fair value cannot be established.
Services. Revenues from arrangements to provide professional services on a
time and materials basis are recognized as the related services are performed.
Revenues from professional services provided on a fixed fee basis are recognized
using the percentage-of-completion method.
Non-monetary Transactions. Non-monetary transactions are accounted for in
accordance with Accounting Principles Board ("APB") Opinion No. 29, "Accounting
for Non-monetary Transactions," which requires that the transfer or distribution
of a non-monetary asset or liability generally be based on the fair value of the
asset or liability that is received or surrendered, whichever is more clearly
evident. In those cases where fair value of the assets exchanged is not readily
determinable, the exchange is recorded at the historical cost of the asset
surrendered.
Accrued Receivables. Accrued receivables represent amounts to be billed
in the near future (less than 12 months).
Deferred Revenue. Deferred revenue represents (1) 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
does not exist, or (3) amounts deferred if other conditions to revenue
recognition have not been met.
17
Provision for Doubtful Accounts
The Company maintains a general allowance for doubtful accounts based on
its historical experience, along with additional customer-specific allowances.
The Company regularly monitors credit risk exposures in its accounts receivable.
In estimating the necessary level of its allowance for doubtful accounts,
management considers the aging of its accounts receivable, the creditworthiness
of the Company's customers, economic conditions within the customer's industry,
and general economic conditions, among other factors. Should any of these
factors change, the estimates made by management will also change, which in turn
impacts the level of the Company's future provision for doubtful accounts.
Specifically, if the financial condition of the Company's customers were to
deteriorate, affecting their ability to make payments, additional
customer-specific provision for doubtful accounts may be required. Also, should
deterioration occur in general economic conditions, or within a particular
industry or region in which the Company has a number of customers, additional
provision for doubtful accounts may be recorded to reserve for potential future
losses. A portion of the Company's allowance is related to issues other than
creditworthiness, such as disagreements with customers.
Impairment of Investments
The Company records a non-cash charge to earnings when it determines that
an investment has experienced an "other than temporary" decline in market value.
To make this determination, the Company reviews the carrying value of its
marketable equity security investments at the end of each reporting period for
impairment. Other-than-temporary impairments are generally recognized if the
market value of the investment is below its current carrying value for an
extended period, which the Company generally defines as six to nine months, or
if the issuer has experienced significant financial declines or difficulties in
raising capital to continue operations, among other factors. Future adverse
changes in market conditions or poor operating results of underlying investments
could result in an inability to recover the carrying value of the recorded
marketable securities, thereby possibly requiring additional impairment charges
in the future.
Impairment of Goodwill
In accordance with SFAS No. 142, goodwill is tested for impairment at the
reporting unit level and must be tested 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 to be recognized. However, if the carrying value of the
reporting unit exceeds its fair value, the goodwill of this unit may be
impaired. The amount of impairment, if any, is then measured in the second step.
For impairment testing purposes, the Company has utilized the services of an
independent consultant to perform valuations of the Company's reporting units
that contained goodwill. Under SFAS No. 142, goodwill is no longer amortized.
Software Amortization and Impairment
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 ("acquired software") 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 a
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 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 acquired and internal-use software is generally computed using the
straight-line method over its estimated useful life of approximately three
years.
The Company reviews its long-lived assets for impairment whenever events or
changes in circumstances indicate that the carrying amount of a long-lived asset
may not be recoverable. An impairment loss is recorded if the
18
sum of the future cash flows expected to result from the use of the asset
(undiscounted and without interest charges) is less than the carrying amount of
the asset. The amount of the impairment charge is measured based upon the fair
value of the asset.
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 would not be limited to, the likelihood the Company would realize
the benefits of net operating loss carryforwards, 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 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 those currently recorded. Changes in the
geographical mix or estimated amount of annual pretax income could impact the
Company's overall effective tax rate.
To the extent recovery of deferred tax assets is not likely based on
estimation of future taxable income in each jurisdiction, the Company records a
valuation allowance to reduce its deferred tax assets to the amount that is more
likely than not to be realized. Although the Company has considered future
taxable income along with prudent and feasible tax planning strategies in
assessing the need for the valuation allowance, if the Company should determine
that it would not be able to realize all or part of its deferred tax assets in
the future, an adjustment to deferred tax assets would be charged to income in
the period any such determination was made. Likewise, in the event the Company
was able to realize its deferred tax assets in the future in excess of the net
recorded amount, an adjustment to deferred tax assets would increase income in
the period any such determination was made.
19
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,
------------------------------------------ ------------------------------------------
2003 2002 2003 2002
-------------------- -------------------- -------------------- --------------------
% of % of % of % of
Amount Revenue Amount Revenue Amount Revenue Amount Revenue
---------- -------- ---------- -------- ---------- -------- ---------- --------
Revenues:
Initial license fees (ILFs). $ 18,902 25.6% $ 19,191 27.6% $ 46,383 22.6% $ 57,468 26.9%
Monthly license fees (MLFs). 21,815 29.6 19,515 28.1 63,831 31.0 61,684 28.8
---------- -------- ---------- -------- ---------- -------- ---------- --------
Software license fees....... 40,717 55.2 38,706 55.7 110,214 53.6 119,152 55.7
Maintenance fees............ 20,675 28.0 18,175 26.2 58,740 28.6 55,656 26.0
Services.................... 12,382 16.8 12,572 18.1 36,559 17.8 39,119 18.3
---------- -------- ---------- -------- ---------- -------- ---------- --------
Total revenues............ 73,774 100.0 69,453 100.0 205,513 100.0 213,927 100.0
---------- -------- ---------- -------- ---------- -------- ---------- --------
Expenses:
Cost of software license
fees...................... 6,339 8.6 6,673 9.6 18,567 9.0 23,838 11.2
Cost of maintenance fees
and services.............. 15,082 20.4 14,953 21.5 45,583 22.2 47,366 22.1
Research and development.... 9,478 12.8 8,711 12.5 25,785 12.6 26,678 12.5
Selling and marketing....... 13,686 18.6 15,264 22.0 40,951 19.9 43,002 20.1
General and administrative.. 15,245 20.7 11,297 16.3 41,932 20.4 38,993 18.2
Impairment of goodwill...... 9,290 12.6 - - 9,290 4.5 - -
---------- -------- ---------- -------- ---------- -------- ---------- --------
Total expenses............ 69,120 93.7 56,898 81.9 182,108 88.6 179,877 84.1
---------- -------- ---------- -------- ---------- -------- ---------- --------
Operating income............... 4,654 6.3 12,555 18.1 23,405 11.4 34,050 15.9
---------- -------- ---------- -------- ---------- -------- ---------- --------
Other income (expense):
Interest income............. 281 0.4 404 0.6 876 0.4 1,044 0.5
Interest expense............ (682) (0.9) (1,313) (1.9) (2,425) (1.2) (4,376) (2.1)
Other, net.................. 225 0.3 424 0.6 (835) (0.4) 4,022 1.9
---------- -------- ---------- -------- ---------- -------- ---------- --------
Total other income
(expense)......... (176) (0.2) (485) (0.7) (2,384) (1.2) 690 0.3
---------- -------- ---------- -------- ---------- -------- ---------- --------
Income before income taxes..... 4,478 6.1 12,070 17.4 21,021 10.2 34,740 16.2
Income tax provision........... (6,331) (8.6) (7,066) (10.2) (15,809) (7.7) (20,528) (9.6)
---------- -------- ---------- -------- ---------- -------- ---------- --------
Net income (loss).............. $ (1,853) (2.5)% $ 5,004 7.2% $ 5,212 2.5% $ 14,212 6.6%
========== ======== ========== ======== ========== ======== ========== ========
Revenues. Total revenues for the third quarter of fiscal 2003 increased
$4.3 million, or 6.2%, as compared to the same period of fiscal 2002. Total
revenues for the first nine months of fiscal 2003 decreased $8.4 million, or
3.9%, as compared to the same period of fiscal 2002. The three-month increase is
the result of a $2.0 million, or 5.2%, increase in software license fee revenues
and a $2.5 million, or 13.8%, increase in maintenance fee revenues, offset by a
$0.2 million, or 1.5%, decrease in services revenues. The nine-month decrease is
the result of an $8.9 million, or 7.5%, decrease in software license fee
revenues and a $2.6 million, or 6.5%, decrease in services revenues, offset by a
$3.1 million, or 5.5%, increase in maintenance fee revenues. Approximately $2.3
million of the decrease in total revenues for first nine months of fiscal 2003
was due to the sale of Regency Systems, Inc. ("Regency") in February 2002, which
was part of the ACI Worldwide business unit. The effect of changes in foreign
currency exchange rates was to increase overall revenues by approximately $2.6
million for the nine months ended June 30, 2003, as compared to the same period
of fiscal 2002.
For the third quarter ended June 30, 2003, as compared to the same period
of fiscal 2002, ACI Worldwide's software license fee revenues increased due to
an increase in the number and size of transaction volume upgrades, primarily in
the EMEA region. For the first nine months of fiscal 2003, as compared to the
same period of fiscal 2002, ACI Worldwide's software license fee revenues
decreased primarily due to a shift in sales focus from the Company's
more-established products to its newer BASE24-es product and its Payments
Management products. As a result of this shift to newer products, absent other
factors, the Company will experience a decrease in revenues due to differences
in the timing of revenue recognition for the respective products. Revenues under
20
less-established 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. Insession
Technologies' software license fee revenues were slightly higher for the third
quarter ended June 30, 2003, as compared to the same period of fiscal 2002. For
the first nine months of fiscal 2003, as compared to the same period of fiscal
2002, Insession Technologies' software license fee revenues decreased primarily
due to system consolidations and company consolidations. In addition, as
customers within the Insession Technologies business unit renew existing
contracts, the renewal contract generally has a higher proportion of the total
fees that relate to maintenance. For the third quarter ended June 30, 2003, as
compared to the same period of fiscal 2002, IntraNet's software license fee
revenues decreased due to a decline in the number of customers migrating from
the Digital VAX-based Money Transfer System ("MTS") product to the new
RS6000-based MTS product. For the first nine months of fiscal 2003, as compared
to the same period of fiscal 2002, IntraNet's software license fee revenues
increased due to the completion of the final phase of an ACH project with a
large European bank, allowing the Company to recognize approximately $3.6
million in revenues, offset by a decline in the number of customers migrating
from the Digital VAX-based MTS product to the new RS6000-based MTS product.
The increase in maintenance fee revenues is primarily due to growth in the
installed base of software products within the ACI Worldwide business unit,
along with the higher proportion of maintenance revenues resulting from contract
renewals within the Insession Technologies business unit, as discussed above,
offset by decreases resulting from the sale of Regency.
The decrease in services revenues for the third quarter and first nine
months of fiscal 2003, as compared to the same periods of fiscal 2002, is
primarily the result of a decreased demand in the ACI Worldwide and Insession
Technologies business units for technical and project management services. This
decreased demand is primarily due to (1) increased competition in the
marketplace by companies that offer services work at lower rates, (2) many
larger customers increasing their internal staffs in order to reduce their
dependence on external resources and (3) general decreases in worldwide demand
for services as a result of depressed economic conditions. In addition,
IntraNet's services revenues decreased for the third quarter and first nine
months of fiscal 2003, as compared to the same periods in fiscal 2002, due to a
decline in the number of customers migrating from the Digital VAX-based MTS
product to the new RS6000-based MTS product.
Expenses. Total operating expenses for the third quarter of fiscal 2003
increased $12.2 million, or 21.5%, as compared to the same period of fiscal
2002. Total operating expenses for the first nine months of fiscal 2003
increased $2.2 million, or 1.2%, as compared to the same period of fiscal 2002.
Operating expenses for the third quarter and first nine months of fiscal 2003
included a goodwill impairment charge of $9.3 million. Operating expenses
decreased by approximately $4.0 million during the first nine months of fiscal
2003, as compared to the same period of fiscal 2002, due to the sale of Regency
during the second quarter of fiscal 2002. Additionally, during fiscal 2002, the
Company placed an emphasis on reducing overall staffing levels through attrition
or delayed hiring decisions in an attempt to reduce operating expenses. The
effect of changes in foreign currency exchange rates was to increase overall
expenses by approximately $4.2 million for the nine months ended June 30, 2003,
as compared to the same period of fiscal 2002.
Cost of software license fees for the third quarter of fiscal 2003
decreased $0.3 million, or 5.0%, as compared to the same period of fiscal 2002.
Cost of software license fees for the first nine months of fiscal 2003 decreased
$5.3 million, or 22.1%, as compared to the same period of fiscal 2002. The
decrease in cost of software license fees for the third quarter and first nine
months of fiscal 2003, as compared to the same periods of fiscal 2002, was due
primarily to a decrease in amortization of software products that are now fully
amortized of $0.6 million and $4.1 million, respectively, for the three and nine
months ended June 30, 2003, as well as decreases in personnel-related expenses
due to reduced staff levels. In addition, distributor commissions decreased due
to lower revenue levels from those sources.
Cost of maintenance and services for the third quarter of fiscal 2003
increased $0.1 million, or 0.9%, as compared to the same period of fiscal 2002.
Cost of maintenance and services for the first nine months of fiscal 2003
decreased $1.8 million, or 3.8%, as compared to the same period of fiscal 2002.
The decrease in cost of maintenance and services for the first nine months of
fiscal 2003, as compared to the same period of fiscal 2002, was primarily the
result of fewer staff (internal and external) needed to support the Company's
ACI Worldwide and Insession Technologies services-related business, which
experienced declines in demand.
21
Research and development ("R&D") costs for the third quarter of fiscal 2003
increased $0.8 million, or 8.8%, as compared to the same period of fiscal 2002.
Research and development ("R&D") costs for the first nine months of fiscal 2003
decreased $0.9 million, or 3.3%, as compared to the same period of fiscal 2002.
R&D costs as a percentage of total revenues for the first nine months of fiscal
2003 and 2002 were 12.6% and 12.5%, respectively.
Selling and marketing costs for the third quarter of fiscal 2003 decreased
$1.6 million, or 10.3%, as compared to the same period of fiscal 2002. Selling
and marketing costs for the first nine months of fiscal 2003 decreased $2.1
million, or 4.8%, as compared to the same period of fiscal 2002. The decrease in
selling and marketing costs for the third quarter and first nine months of
fiscal 2003, as compared to the same periods of fiscal 2002, was due primarily
to a decreased emphasis on advertising and promotional programs, offset by
increased sales commissions. Selling and marketing costs as a percentage of
total revenues for the first nine months of fiscal 2003 and 2002 were 19.9% and
20.1%, respectively.
General and administrative costs for the third quarter of fiscal 2003
increased $3.9 million, or 34.9%, as compared to the same period of fiscal 2002.
General and administrative costs for the first nine months of fiscal 2003
increased $2.9 million, or 7.5%, as compared to the same period of fiscal 2002.
The increase in general and administrative costs for the third quarter of fiscal
2003, as compared to the same period of fiscal 2002, is primarily due to
increased bad debts expense and increased professional fees for legal, tax and
other services. Bad debts expense for the third quarter of fiscal 2002 was a
negative amount due to adjustments made to the allowance for doubtful accounts
at that time. The increase in general and administrative costs for the first
nine months of fiscal 2003, as compared to the same period of fiscal 2002, is
primarily due to increased bad debts expense and increased professional fees,
offset by reduced costs resulting from the sale of Regency during the second
quarter of fiscal 2002.
Other Income and Expense. Interest expense for the third quarter of fiscal
2003 decreased $0.6 million, or 48.1%, as compared to the same period of fiscal
2002. Interest expense for the first nine months of fiscal 2003 decreased $2.0
million, or 44.6%, as compared to the same period of fiscal 2002. The decrease
is attributable to a reduction in debt - financing agreements (balance at June
30, 2003 of $29.2 million as compared to $48.5 million at June 30, 2002) and a
change in the amount of borrowings outstanding under the Company's line of
credit (there were no borrowings under the line of credit during the nine months
ended June 30, 2003).
Other income (net) for the third quarter of fiscal 2003 decreased $0.2
million, or 46.9%, as compared to the same period of fiscal 2002. Other income
(net) for the first nine months of fiscal 2003 decreased by $4.9 million as
compared to the same period of fiscal 2002. During the first nine months of
fiscal 2002, the Company recorded a gain of $8.7 million from the sale of
Regency offset by impairments of marketable equity securities totaling $4.7
million, which resulted in the decrease between corresponding periods.
Income Taxes. The effective tax rate for the third quarter of fiscal 2003
was approximately 141.4%, which includes the impact of a $9.3 million
non-deductible goodwill impairment charge negatively impacting the effective tax
rate by 95.4%, as compared to 58.5% for the same period of fiscal 2002. The
effective tax rate for the first nine months of fiscal 2003 was approximately
75.2%, which includes the impact of a $9.3 million non-deductible goodwill
impairment charge negatively impacting the effective tax rate by 23.0%, as
compared to 59.1% for the same period of fiscal 2002. The remaining effective
tax rates of 46.0% and 52.2% for the third quarter and first nine months of
fiscal 2003 were primarily impacted by non-recognition of tax benefits for
operating losses in certain foreign locations and recognition of a valuation
allowance for foreign tax credits. The effective tax rates for the third quarter
and first nine months of fiscal 2002 were primarily impacted by non-recognition
of tax benefits for operating losses in certain foreign locations, recognition
of a valuation allowance for foreign tax credits, foreign tax rate differentials
and gain on sale of subsidiary.
Each quarter, the Company evaluates its historical operating results as
well as its projections for the future to determine the realizability of its
deferred tax assets. As of June 30, 2003, the Company has deferred tax assets of
$35.3 million (net of $58.4 million valuation allowance). The Company analyzes
the recoverability of its net deferred tax assets at each reporting period.
Because unforeseen factors may affect future taxable income, additional
increases to the valuation reserve may be required in future periods.
The Company has engaged tax professionals to review the Company's overall
tax position and make recommendations for reducing the effective tax rate.
Certain recommendations were implemented during the third
22
quarter of fiscal 2003, resulting in a lower effective tax rate (excluding the
effects of the non-deductible goodwill impairment charge) for the third quarter
and first nine months of fiscal 2003, as compared to the same periods of fiscal
2002. The improvement in the effective tax rates for the third quarter and first
nine months of fiscal 2003 (excluding the effect of the non-deductible goodwill
impairment charge), as compared to the same periods of fiscal 2002, resulted
primarily from recognition of R&D credits and extraterritorial income exclusion
benefits. The Company, with the assistance of these tax professionals, is
reviewing additional options that could reduce the Company's current effective
tax rate even further. However, there can be no assurance that the Company will
be able to further reduce its effective tax rate, and assuming the Company is
successful in reducing the rate, there can be no assurance of the timing and
amount of any such reduction.
Liquidity and Capital Resources
As of June 30, 2003, the Company's principal sources of liquidity consisted
of $103.7 million in cash, cash equivalents and marketable securities. The
Company had a $15.0 million line of credit agreement that expired in June 2003,
which was not renewed.
The Company's net cash flows provided by operating activities for the first
nine months of fiscal 2003 amounted to $25.5 million as compared to $43.7
million provided by operating activities during the same period of fiscal 2002.
The decrease in operating cash flows resulted primarily from changes in billed
and accrued receivables, accounts payable, and income taxes.
The Company's net cash flows used in investing activities totaled $1.8
million for the first nine months of fiscal 2003 as compared to $2.2 million
provided by investing activities during the same period of fiscal 2002. During
the first nine months of fiscal 2003, the Company purchased software, property
and equipment of $2.3 million as compared to $3.8 million for the same period of
fiscal 2002. The Company also realized net proceeds of $5.4 million related to
the sale of Regency during the first nine months of fiscal 2002.
The Company's net cash flows used in financing activities totaled $13.6
million for the first nine months of fiscal 2003 as compared to $19.3 million
used in financing activities during the same period of fiscal 2002. In the past,
an important contributor to the cash management program was the Company's
factoring of future revenue streams, whereby interest in its future monthly
license payments under installment or long-term payment arrangements is
transferred on a non-recourse basis to third-party financial institutions in
exchange for cash. The Company did not factor any future revenue streams during
the first nine months of fiscal 2003. During the first nine months of fiscal
2002, the Company generated cash flows from the factoring of future revenue
streams of $7.6 million. During the first nine months of fiscal 2003 and 2002,
payments made to the third-party financial institutions were $14.1 million and
$16.3 million, respectively. In addition, during the first nine months of fiscal
2002, the Company made payments on its line of credit facilities of $12.0
million.
The Company's net cash flows resulting from exchange rate fluctuations for
the first nine months of fiscal 2003 amounted to $2.9 million as compared to
$0.5 million during the same period of fiscal 2002.
The Company believes that its existing sources of liquidity, including cash
on hand, marketable securities and cash provided by operating activities, will
satisfy the Company's projected liquidity requirements for the foreseeable
future.
Forward-Looking Statements
This report contains forward-looking statements based on current
expectations that involve a number of risks and uncertainties. Generally,
forward-looking statements do not relate strictly to historical or current
facts, and include words or phrases such as "management anticipates," "the
Company believes," "the Company anticipates," "the Company expects," "the
Company plans," "the Company will," and words and phrases of similar impact, and
include but are not limited to statements regarding operations, business
strategy and business environment. The forward-looking statements are made
pursuant to safe harbor provisions of the Private Securities Litigation Reform
Act of 1995. Actual results could differ materially. Factors that could cause
actual results to differ include, but are not limited to, the following:
o The Company's calculation of backlog is based on customer contracts
that exist on the date of the
23
calculation. A number of factors may
change after the date of calculation that could result in actual
revenues being less than the amounts contained in backlog. The
Company's customers may attempt to renegotiate or terminate their
contracts 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 the one-year period.
o The Securities and Exchange Commission has issued a formal order of
private investigation in connection with the Company's restatement of
its prior consolidated financial statements. Although the Company has
fully cooperated with the SEC in this matter and intends to continue
to fully cooperate, the SEC may determine that the Company has violated
federal securities laws. The Company cannot predict when this
investigation will be completed or what the outcome will be. If the SEC
makes a determination that the Company has violated federal securities
laws, the Company may face sanctions including, but not limited to,
significant monetary penalties and injunctive relief. The findings and
outcome of the SEC investigation may affect the class action and
derivative lawsuits that are pending. There is risk that the
investigation could result in substantial costs and divert management
attention and resources, which could adversely affect the Company's
business.
o The Company is currently in the process of evaluating the claims made
in various lawsuits filed against the Company relating to its
restatement of prior consolidated financial results. The Company
intends to defend the foregoing lawsuits vigorously, but cannot predict
the outcome 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 these lawsuits or if they were not settled on favorable
terms, the judgment or settlement would likely have a material adverse
effect on its consolidated financial position, 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 lawsuits 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 certain liabilities
relating to these lawsuits, the Company's consolidated 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.
o New accounting standards, or additional interpretations or guidance
regarding existing standards, could be issued in the future, which
could lead to unanticipated changes in the Company's current financial
accounting policies. These changes could affect the timing of revenue
or expense recognition and cause fluctuations in operating results.
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
high-technology sector and changing market conditions in the industry.
The Company's stock price may also become volatile, in part, due to the
announced SEC formal order of private investigation related to the
Company's restatement of its prior consolidated financial statements.
o The Company will continue to derive a majority of its total revenue
from international operations and is 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 will continue to derive a substantial majority of its total
revenue from licensing its BASE24
24
family of software products and
providing services and maintenance related to those products. Any
reduction in demand for, or increase in competition with respect to,
BASE24 products would have a material adverse effect on the Company's
financial condition and results of operations.
o Prior to its May 2002 merger with HP, Compaq Computer Corporation
announced a plan to consolidate its high-end performance enterprise
servers on the Intel Corp. Itanium microprocessor by 2004. The Company
has not determined whether consolidation of the high-end servers, if it
occurs as announced, will materially affect the Company's business,
financial position or results of operations.
o The Company will continue to derive a substantial portion of its
revenues from licensing of software products that operate on HP NonStop
Himalaya servers. Any reduction in demand for these 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.
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.
Any or all of the forward-looking statements may turn out to be wrong. They
can be affected by inaccurate assumptions or by known or unknown risks and
uncertainties. Many of these factors will be important in determining the
Company's actual future results. Consequently, no forward-looking statement can
be guaranteed. Actual future results may vary materially from those expressed or
implied in any forward-looking statements.
These cautionary statements and any other cautionary statements that may
accompany such forward-looking statements, whether written or oral, expressly
qualify all of the forward-looking statements. In addition, the Company
disclaims any obligation to update any forward-looking statements after the date
of this report unless applicable securities laws require it to do so.
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, 2003. The Company conducts business in all parts of
the world and is thereby exposed to market risks related to fluctuations in
foreign currency exchange rates. As a general rule, the Company's revenue
contracts are denominated in U.S. dollars. Thus, any decline in the value of
local foreign currencies against the U.S. dollar results in the Company's
products and services being more expensive to a potential foreign customer, and
in those instances where the Company's goods and services have already been
sold, may result in the receivables being more difficult to collect. The Company
does at times enter into revenue contracts that are denominated in the currency
of the country in which it has substantive operations, principally the United
Kingdom, Australia, Canada and Singapore. This practice serves as a natural
hedge to finance the expenses incurred in those locations.
At times, the Company is exposed to market risks associated with changes in
interest rates. However, the Company currently has no outstanding borrowings on
its bank line of credit facilities. The Company does not utilize any derivative
financial instruments for purposes of managing its interest rate risk. 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,
2002 and in each Form 10-Q for the quarters ended March 31, 2003 and December
31, 2002, management and KPMG advised the Company's Audit Committee that within
the 90-day period prior to the date of filing those reports, they noted
deficiencies in internal controls relating to:
o revenue recognition procedures;
o formal policies and procedures for significant transactions;
o centralized oversight for international operations;
25
o timely reconciliation of general ledger accounts; and
o staffing and training of personnel.
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 constitute deficiencies in the Company's
disclosure controls. Within the 90-day period prior to the date of filing this
quarterly report on Form 10-Q, management has advised the Company's Audit
Committee that the previously noted deficiencies in internal controls continue
to exist although corrective actions have been taken and additional corrective
actions will be implemented in the future. The Company has performed substantial
additional procedures designed to ensure that these internal control
deficiencies do not lead to material misstatements in its consolidated financial
statements and to enable the completion of KPMG's quarterly review of its
consolidated financial statements, notwithstanding the presence of the internal
control weaknesses noted above. Based upon an evaluation of these additional
procedures, the Chief Executive Officer and Chief Financial Officer have
concluded with reasonable assurance that the Company's disclosure controls and
procedures are effective to ensure 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 within the time
periods specified in Securities and Exchange Commission rules and forms.
Corrective actions that have been taken by the Company are as follows:
1. The Company retained an independent accounting firm to assist in the
evaluation of the Company's existing internal controls and disclosure
controls and make suggestions for improvement. This evaluation includes
the identification, documentation and testing of significant controls
and processes. As a result of evaluations made to-date, certain
internal control enhancements have been incorporated into the Company's
policies and procedures;
2. The Company reviewed and revised certain of its revenue recognition
practices and contracting management policies and procedures;
3. The Company has conducted formalized training of finance, sales and
other staffs;
4. The Company restructured its worldwide finance organizations to report
directly to corporate finance management personnel rather than business
unit management personnel;
5. The Company hired a 30-year financial management veteran as its Chief
Financial Officer to strengthen its financial management team. Other
finance personnel have also been added to the Company's worldwide
finance organizations;
6. The Company enhanced its internal audit department and hired three
full-time audit professionals; and
7. The Company established a disclosure control committee to review all
public reporting.
The Company intends to implement additional corrective actions to enhance
the previously adopted corrective actions. In connection with the requirements
of Section 404 of the Sarbanes-Oxley Act, the Company has begun to evaluate its
internal controls over financial reporting and has retained an independent
accounting firm to assist in this evaluation. The Company will also continue to
evaluate the effectiveness of its disclosure controls and internal controls and
procedures on an ongoing basis, and will take further action as appropriate.
26
PART II--OTHER INFORMATION
Item 1. Legal Proceedings
Class Action Litigation. Two class action complaints were filed against the
Company and certain individual named defendants in connection with the Company's
restatement of its prior consolidated financial statements. The two complaints
are Desert Orchid Partners v. the Company, et al. and Nancy Rosen v. the
Company, et al. Pursuant to a Court Order, the two suits were consolidated and,
also in accordance with the Court Order, the Court-designated Lead Plaintiff,
Genesee County Employees' Retirement System, filed a First Amended Consolidated
Class Action Complaint on June 30, 2003 (the "Consolidated Complaint"). The Lead
Plaintiff alleges violations of Sections 10(b) and 20(a) of the Securities
Exchange Act of 1934 (the "Exchange Act") and Rule 10b-5 thereunder, on the
grounds that certain of the Company's Exchange Act reports and press releases
contained untrue statements of material facts, or omitted to state facts
necessary to make the statements therein not misleading, with regard to the
Company's revenues and expenses during the class period. The Consolidated
Complaint alleges that during the purported class period, the Company and the
named officers and directors misrepresented the Company's historical financial
condition, results of operations and its future prospects, and failed to
disclose facts that could have indicated an impending decline in the Company's
revenues. The Lead Plaintiff is seeking unspecified damages, interest, fees,
costs and rescission. The class period stated in the Consolidated Complaint is
January 21, 1999 through November 18, 2002. The Company and the individual
defendants were granted an extension of time to file an answer to the
Consolidated Complaint. An answer is due on August 20, 2003, at which time the
Company and the individual defendants anticipate filing a motion to dismiss.
Derivative Litigation. On January 10, 2003, Samuel Naito filed the suit of
"Samuel Naito, Derivatively on behalf of Nominal Defendant Transaction Systems
Architects, Inc. v. Roger K. Alexander, Gregory D. Derkacht, Gregory J. Duman,
Larry G. Fendley, Jim D. Kever, and Charles E. Noell, III and Transaction
Systems Architects, Inc." in the State District Court in Douglas County,
Nebraska (the "Naito matter"). The suit is a shareholder derivative action that
generally alleges that the named individuals breached their fiduciary duties of
loyalty and good faith owed to the Company and its shareholders by causing the
Company to conduct its business in an unsafe, imprudent and unlawful manner
resulting in damage to the Company. More specifically, the plaintiff alleges
that the individual defendants, and particularly the members of the Company's
audit committee, failed to implement and maintain an adequate internal
accounting control system that would have enabled the Company to discover
irregularities in its accounting procedures of 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'
breaches of fiduciary duties, as well as the plaintiff's costs and disbursements
related to the suit.
On January 24, 2003, Michael Russiello filed the suit of "Michael
Russiello, Derivatively on behalf of Nominal Defendant Transaction Systems
Architects, Inc. v. Roger K. Alexander, Gregory D. Derkacht, Gregory J. Duman,
Larry G. Fendley, Jim D. Kever, and Charles E. Noell, III and Transaction
Systems Architects, Inc." in the State District Court in Douglas County,
Nebraska (the "Russiello matter"). The suit is a shareholder derivative action
that generally alleges that the named individuals breached their fiduciary
duties of loyalty and good faith owed to the Company and its shareholders by
causing the Company to conduct its business in an unsafe, imprudent and unlawful
manner resulting in damage to the Company. More specifically, the plaintiff
alleges that the individual defendants, and particularly the members of the
Company's audit committee, failed to implement and maintain an adequate internal
accounting control system that would have enabled the Company to discover
irregularities in its accounting procedures of 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'
breaches of fiduciary duties, as well as the plaintiff's costs and disbursements
related to the suit.
The Company filed a Motion to Dismiss in the Naito matter on February 14,
2003, and a Motion to Dismiss in the Russiello matter on February 21, 2003. A
hearing was scheduled on those Motions for March 14, 2003. Just prior to that
date, Plaintiffs' counsel requested that the derivative lawsuits be stayed
pending a determination of an anticipated motion to dismiss to be filed in the
class action lawsuits when and if service of process is achieved. The Company,
by and through its counsel, agreed to that stay. As a result, no other
defendants have been served
27
and no discovery has been commenced.
These class action and derivative lawsuits were brought in the United
States District Court for the District of Nebraska and the Nebraska District
Courts, respectively, and are at preliminary stages. The Company is currently in
the process of preparing to respond to the claims made in the lawsuits. The
Company intends to defend the foregoing lawsuits vigorously, but, since the
lawsuits have only recently been filed and are in the very early stages, the
Company cannot predict the outcome and is not currently able to evaluate the
likelihood of success or the range of potential loss, if any, that might be
incurred in connection with such actions. However, if the Company were to lose
any of these lawsuits or if they were not settled on favorable terms, the
judgment or settlement may have a material adverse effect on the Company's
consolidated financial position, 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.
Additional suits against the Company may be commenced in the future. The
Company will fully analyze these allegations once all of the complaints are
received and intends to vigorously defend against them. There is a risk that
such litigation could result in substantial costs and divert management
attention and resources from its business, which could adversely affect the
Company's business.
Securities and Exchange Commission Investigation. In connection with the
Company's restatement of its prior consolidated financial statements, the
Company has been in contact with the Securities and Exchange Commission
Enforcement Division. On December 9, 2002, certain of the Company's officers and
external legal counsel held a telephone conference with representatives of the
SEC Enforcement Division. The Company had a follow-up meeting with the SEC
Enforcement Division on March 14, 2003. At this meeting, the SEC representatives
asked questions about the restatement. The SEC Enforcement Division also
requested that the Company provide additional written information regarding the
restatement. The Company supplied this information on March 21, 2003. On August
8, 2003, the Company was informed that the SEC Enforcement Division has issued a
formal order of private investigation in connection with the Company's
restatement of its prior consolidated financial statements. The Company intends
to cooperate fully with the SEC with respect to this investigation.
In addition to the foregoing, from time to time, the Company is involved in
litigation relating to claims arising out of its operations in the normal course
of business. The Company is not currently a party to any such legal proceedings,
other than as described above, 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.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
31.1 Certification of Chief Executive Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K:
On May 6, 2003, the Company filed a current report on Form 8-K announcing
that on April 29, 2003, the Company (1) issued a press release with its results
for the quarterly period ending March 31, 2003, and (2) held a teleconference
and web cast discussing its financial performance for the quarterly period
ending March 31, 2003. Copies of the press release and teleconference/web cast
were attached thereto.
28
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 14, 2003 By: /s/ Gregory D. Derkacht
---------------------------------------
Gregory D. Derkacht
President and Chief Executive Officer
29
Exhibit 31.1
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
I, Gregory D. Derkacht, certify that:
1. I have reviewed this Quarterly Report on Form 10-Q of Transaction Systems
Architects, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of
a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects
the financial condition, results of operations and cash flows of the registrant
as of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision, to
ensure that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being
prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end of
the period covered by this report based on such evaluation; and
c) Disclosed in this report any change in the registrant's internal control
over financial reporting that occurred during the registrant's most recent
fiscal quarter (the registrant's fourth fiscal quarter in the case of an
annual report) that has materially affected, or is reasonable likely to
materially affect, the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of registrant's board of directors
(or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably
likely to adversely affect the registrant's ability to record, process,
summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal control
over financial reporting.
Date: August 14, 2003 By: /s/ GREGORY D. DERKACHT
------------------------------------
Gregory D. Derkacht
Chief Executive Officer, President
and Director
Exhibit 31.2
CERTIFICATION OF CHIEF FINANCIAL OFFICER
I, David R. Bankhead, certify that:
1. I have reviewed this Quarterly Report on Form 10-Q of Transaction Systems
Architects, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of
a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects
the financial condition, results of operations and cash flows of the registrant
as of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision, to
ensure that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being
prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end of
the period covered by this report based on such evaluation; and
c) Disclosed in this report any change in the registrant's internal control
over financial reporting that occurred during the registrant's most recent
fiscal quarter (the registrant's fourth fiscal quarter in the case of an
annual report) that has materially affected, or is reasonable likely to
materially affect, the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of registrant's board of directors
(or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably
likely to adversely affect the registrant's ability to record, process,
summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal control
over financial reporting.
Date: August 14, 2003 By: /s/ DAVID R. BANKHEAD
------------------------------------
David R. Bankhead
Chief Financial Officer, Treasurer
and Senior Vice President
Exhibit 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
In connection with the Quarterly Report of Transaction Systems Architects, Inc.
(the "Company") on Form 10-Q for the quarter ended June 30, 2003 as filed with
the Securities and Exchange Commission on the date hereof (the "Report"), I,
Gregory D. Derkacht, Chief Executive Officer of the Company, certify, pursuant
to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, that to my knowledge:
1) The Report fully complies with the requirements of Sections 13(a) or 15(d)
of the Securities Exchange Act of 1934; and
2) The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company.
Date: August 14, 2003 By: /s/ GREGORY D. DERKACHT
------------------------------------
Gregory D. Derkacht
Chief Executive Officer, President
and Director
Exhibit 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
In connection with the Quarterly Report of Transaction Systems Architects, Inc.
(the "Company") on Form 10-Q for the quarter ended June 30, 2003 as filed with
the Securities and Exchange Commission on the date hereof (the "Report"), I,
David R. Bankhead, Chief Financial Officer of the Company, certify, pursuant to
18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002, that to my knowledge:
1) The Report fully complies with the requirements of Sections 13(a) or 15(d)
of the Securities Exchange Act of 1934; and
2) The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company.
Date: August 14, 2003 By: /s/ DAVID R. BANKHEAD
------------------------------------
David R. Bankhead
Chief Financial Officer, Treasurer
and Senior Vice President