UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For The Fiscal Year Ended June 30, 2007

Commission File Number: 0-26802

CheckFree Corporation

(Exact name of Registrant as specified in its charter)

 

4411 East Jones Bridge Road

Norcross, Georgia 30092

(Address of principal executive offices, including zip code)

(678) 375-3000

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act: None.

 

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ     No o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ

 

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 the filing requirements for at least the past 90 days.  Yes þ     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ

 

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

Large accelerated filer þ          Accelerated filer o          Non-accelerated filer o

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

The aggregate market value of our common stock held by our non-affiliates was approximately $3,273,837,417 on December 31, 2006.

 

There were 88,270,515 shares of our common stock outstanding on August 20, 2007.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of our Proxy Statement for the 2007 Annual Meeting of Stockholders are incorporated by reference in Part III.

 

 

Table of Contents

 

 

All references to “we,” “us,” “our,” “CheckFree” or the “Company” in this Annual Report on Form 10-K mean CheckFree Corporation and all entities owned or controlled by CheckFree Corporation, except where it is made clear that the term means only the parent company.

 

We own many trademarks and service marks.  This Annual Report on Form 10-K contains trade dress, trade names and trademarks of other companies. Use or display of other parties’ trademarks, trade dress or trade names is not intended to, and does not, imply a relationship with the trademark or trade dress owner.

 

Overview

 

CheckFree was founded in 1981 as an electronic payment processing company and has become a leading provider of financial electronic commerce products and services. Our current business was developed through the expansion of our core electronic payments business and the acquisition of companies operating in similar or complementary businesses.

 

Through our Electronic Commerce Division, we enable consumers to review bank accounts and receive and pay bills. For the year ended June 30, 2007, we processed more than1.3 billion payment transactions and delivered approximately 226 million electronic bills (“e-bills”). For the quarter ended June 30, 2007, we processed approximately 344 million payment transactions and delivered nearly 61 million e-bills. The number of transactions we process each year continues to grow. For the year ended June 30, 2007, growth in the number of consumer service provider (“CSP”) based transactions processed approached 24% and growth in total transactions processed exceeded 16%. The Electronic Commerce Division accounted for approximately 74% of our fiscal 2007 consolidated revenues. On May 15, 2007, we acquired Corillian Corporation (“Corillian”), a provider of online banking software and services. The addition of Corillian expands our ability to provide a fully integrated, secure and scalable online banking, electronic billing and payment platform.

 

Through our Software Division, we provide software, maintenance, support and consulting services under four product lines — Global Treasury, Reconciliations and Exception Management, Transaction Process Management and Electronic Billing — primarily to large global financial service providers and other companies across a range of industries. The Software Division accounted for approximately 13% of our fiscal 2007 consolidated revenues. On April 2, 2007, we acquired Carreker Corporation (“Carreker”), a provider of technology and consulting services for the financial services industry. The acquisition expands our ability to provide tools that assist global financial institutions with payments processing, fraud and risk management, cash logistics and expert consultancy in the areas of float management and the convergence of check and electronic payments.

 

Through our Investment Services Division, we provide a range of portfolio management services to financial institutions, including broker dealers, money managers and investment advisors. As of June 30, 2007, our clients used the CheckFree APL^sm portfolio accounting system (“CheckFree APL”) to manage nearly 2.7 million portfolios. The Investment Services Division accounted for approximately 13% of our fiscal 2007 consolidated revenues. On May 31, 2007, we acquired substantially all of the assets of Upstream Technologies, LLC (“Upstream”), a provider of advanced investment decision support and trade order management tools. The acquisition allows us to deliver web-based model management, decision support, trading and real-time order management tools as complementary capabilities to our core platform for the managed accounts industry.

 

Pending Acquisition of CheckFree

 

On August 2, 2007, we entered into an Agreement and Plan of Merger (“Merger Agreement”) pursuant to which Fiserv, Inc. (“Fiserv”) will acquire all of our outstanding shares of common stock for $48.00 per share in cash. Fiserv is a publicly traded Nasdaq company headquartered in Brookfield, Wisconsin and is a provider of technology solutions. We expect the transaction to close by December 31, 2007, subject to approval by our

stockholders and certain regulatory matters, although there can be no assurance that the merger will be consummated in a timely manner, if at all. We have filed a preliminary proxy statement and other relevant materials with the Securities and Exchange Commission (“SEC”), including a detailed description of the terms of the Merger Agreement, as well as other important information about the proposed transaction.

 

SHAREHOLDERS ARE URGED TO READ THE PROXY STATEMENT AND OTHER RELEVANT MATERIALS FILED WITH THE SEC AND POSTED TO OUR WEBSITE REGARDING IMPORTANT INFORMATION ABOUT THE PROPOSED TRANSACTION.

 

Our company, our directors and certain of our executive officers may be deemed to be participants in the solicitation of proxies from our stockholders with respect of the proposed transaction. Our stockholders may obtain information regarding the names, affiliations and interests of such individuals in the proxy statement.

 

All forward-looking statements in this Annual Report on Form 10-K, including those in the Management’s Discussion and Analysis of Financial Condition and Results of Operations and Risk Factors, are based on management’s plans for future operations without consideration given to the pending transaction.

 

Electronic Commerce Division

 

Introduction.  The Electronic Commerce Division enables consumers to:

 

 

Consumers using our services access CheckFree’s system primarily through CSPs, billers and retail agents. CSPs are organizations, such as banks, credit unions, brokerage firms and Internet portals. Consumers can also access our system through CheckFree hosted biller direct sites, www.mycheckfree.com, a network of retail agents for walk-in bill payments, or by phone on hosted interactive voice response applications.

 

Effective July 1, 2007, after our 2007 fiscal year-end, we re-aligned our resources in the Electronic Commerce Division into two new operating units to better service the Division’s customers: the Electronic Banking Services unit and the Electronic Biller Services unit. The Electronic Banking Services unit will combine our CSP business and the Corillian business to focus on providing integrated online banking, billing and payment solutions for our banking customers. The Electronic Biller Services unit will combine our biller business, including our phone pay business, walk-in payment business and health and fitness business, to focus on providing consumer billing and payment solutions to our corporate clients. The Electronic Banking Services unit and Electronic Biller Services unit continue to be part of our overall Electronic Commerce Division for reporting purposes.

 

Industry Background.  In 2006, 1.7 billion e-bills were delivered online, a 21% increase over the number of e-bills delivered in 2005, according to Tower Group. On average, the cost to a biller of submitting a paper bill, including printing, postage and billing inserts, is $1.25 per bill, according to a Tower Group study. In contrast, e-bills reduce that cost by over half.

 

According to Tower Group and the Federal Reserve, an estimated 26 billion paper checks were written in the United States in 2006, down from 30.6 billion in 2005 and 41.9 billion in 2000. The use of checks for bill payment imposes significant costs on financial services organizations, businesses and their customers. These costs include the writing, mailing, recording and processing of checks. The majority of today’s consumer bill payments are completed using traditional paper-based methods. According to Tower Group, of an estimated 21.8 billion consumer bill payments that occurred in 2006, 61.7% were paid by paper check, 27.6% were paid by electronic means and the remainder were paid by other means (cash, payroll deduction, money order, etc.). By comparison, in 2005, consumers used checks to pay 65.1% of bills, and paid their bills electronically 26% of the time. Many financial services organizations and businesses have invested in the infrastructure for recording, reporting and executing electronic transactions. We believe the broad impact of the Internet, the relatively high cost of producing, printing and mailing a paper bill, and the cost to financial services

organizations, businesses and customers of processing paper checks will continue the trend toward increased usage of electronic methods to execute financial transactions.

 

Products and Services.  We provide a variety of products that allow consumers to review bank accounts, receive and pay bills over the Internet and pay billers directly through biller-direct sites, by telephone or through our walk-in retail agent network. CSPs can offer our bill payment services to customers either through a hosted application, known as CheckFree Web^sm, or through various protocols that link online banking applications to our Genesis billing and payment engine. Through our CSPs, we support both Microsoft’s Money and Quicken^® for electronic bill payment. We also enable financial institutions to offer their customers a variety of financial services over the Internet, including Internet banking, web content management and intelligent authentication and security solutions. We also offer a variety of services to support our customers throughout the process of implementing and maintaining our solutions. For the fiscal year ending June 30, 2008, our Electronic Banking Services unit will be primarily responsible for the following products and services: CheckFree Web, CheckFree Web for Small Business^sm, CheckFree FraudNet^tm, CheckFree Builder^sm, CheckFree Online Open and Fund, CheckFree Online Transfer, Corillian Voyager^tm, Line of Business Applications and Enterprise Applications. For the fiscal year ending June 30, 2008, our Electronic Biller Services unit will be primarily responsible for the following products and services: electronic billing or e-bill services, walk-in payment services, phone payment services and other products and services for our corporate clients. The principal products and services in our Electronic Commerce Division are described below.

 

 

 

The most recent version of CheckFree Web, CheckFree Web RXP^sm, was made available in March 2007. Recent enhancements to CheckFree Web include transactional intelligence added to the payment center in which a payment assistant layer is presented with contextual just-in-time information. In addition, CheckFree Web RXP offers seamless integration with mobile banking and payments and a new electronic bill experience, and consumers may opt into a trial period for both features to experience their value and decide whether to cease receiving paper bills. In addition, we offer a small business-based version of CheckFree Web optimized for business users, CheckFree Web for Small Business. All products feature the ability to “pay anyone, anytime, anywhere” and most products feature the ability to receive hundreds of different bills electronically.

 

 

Usage Metrics.  For the year ended June 30, 2007, we processed more than 1.3 billion payment transactions, an increase of 16% over the previous year, and delivered approximately 226 million e-bills, which represents growth of 22% over e-bills delivered in the prior year. Our transaction-based metrics are divided between CSP and non-CSP results. CSPs are organizations such as banks, credit unions, brokerage firms and Internet portals. Non-CSP results include agent-based payments, phone-based payments and ancillary payment products including our biller direct and account balance transfer businesses. We believe the distinction between CSP and non-CSP results provide investors greater insight into the key underlying trends of our business.

 

The CheckFree Advantage.  We have developed numerous systems and programs to enhance our online banking, billing and payment products.

 

 

Our Business Strategy.  Our business strategy is to provide an expanding range of convenient, secure and cost-effective electronic commerce services and related products to financial services organizations, Internet-based information sites, businesses that generate recurring bills and statements, and their customers.

We have designed our services and products to take advantage of opportunities we perceive in light of current trends and our fundamental strategy. The key elements of our business strategy are to:

 

 

 

We believe this flexibility equips our customers to provide consumers with services that will meet their needs, and that this flexibility makes it more attractive for CSPs and billers to promote our electronic billing and payment service. We believe our recent acquisition of Corillian will help us to penetrate the large base of online banking consumers who do not currently use electronic bill payment by creating an integrated, secure Internet banking and electronic billing and payment platform with world-class usability.

 

 

Technology, Research and Development.  Our core technology capabilities were developed to handle settlement services, merchant database services and online inquiry services on a traditional mainframe system with direct communications to businesses. We have implemented a logical, nationwide internetworking infrastructure, which networks together any number of other networks, passing transaction data among them. For example, we internetwork groups of billers, consumers, CSPs, retail agents and financial institutions to complete electronic billing and payment transactions. Consumers, businesses and financial services organizations access our electronic billing and payment transaction internetworking infrastructure through the Internet, dial-up telephone lines, privately leased lines or various types of communications networks. Our primary computing complex in Norcross, Georgia, houses a wide variety of application servers that capture transactions and route them to our back-end banking, billing and payment applications for processing. The back-end applications are run on IBM mainframes, Intel platforms and UNIX servers. We have developed databases and information files that allow accurate editing and initiation of payments to billers. These databases have been constructed over the past 25 years as a result of our transaction processing experience. In addition, the acquisition of Corillian has expanded the breadth of knowledge and expertise within our company, specifically within the .NET technology space.

As part of our disaster recovery systems, we utilize IBM Business Recovery Services and EMC Corporation’s remote disk mirroring technology. Using this system, we are able to recover technical infrastructure, client communications, in-flight payments and first-tier customer care within 24 hours. As part of our efforts to enhance our high availability and disaster recovery capabilities, we have begun execution of our long-term data center strategy. We plan to build up to two dedicated data centers under a series of financing and leasing arrangements. Construction of the initial data center is underway and planned to become operational in the quarter ending December 31, 2007. We continue to evaluate whether we require the second data center to attain our operational, high availability and disaster recovery objectives. The initial data center will support the Electronic Commerce Division as well as our other divisions.

 

We maintain a research and development group with a long-term perspective of planning and developing new services and related products for the electronic commerce and financial application software markets. Additionally, we use independent third party software development contractors as needed.

 

Sales, Marketing and Distribution.  Our marketing and distribution strategy has been to create and maintain distribution alliances that maximize access to potential customers for our services. We do not, for the most part, market to, or have a direct relationship with, consumers or end-users of our products and services. We believe that these alliances enable us to offer services and related products to a larger customer base than can be reached through stand-alone marketing efforts. We seek distribution alliances with companies who have maximum penetration and leading reputations for quality with our target customers. These alliances include our relationship with CSPs, billers and value-added resellers such as Fiserv, FundsXpress, Digital Insight, PSCU Financial Services and S1 Corporation. The Corillian acquisition also brought us distribution relationships with other entities including NCR Corporation. These lists of resellers are not complete and do not fully represent our customer base.

 

In order to foster a better understanding of the needs of our CSPs, billers and resellers, we employ a number of relationship managers assigned to each of these specific customers. We also employ marketing personnel to facilitate joint consumer acquisition programs with each of these customer groups, and to share industry knowledge and previously developed campaigns with their marketing departments. Our alliance partners market our services in numerous ways, including television, radio, online and print advertising, in many cases offering bill payment services for free. Additionally, we participate in industry conferences and tradeshows, providing access to and interaction with our CSP, biller and reseller customers, as well as prospects.

 

We have one customer, Bank of America, that accounted for approximately 19% of our total consolidated revenues ($189.5 million) for fiscal year 2007, which reflects its use of products in all three of our operating divisions. The majority of this revenue comes from within our Electronic Commerce Division.

 

Competition.  We face significant competition for all of our products. Our primary competition is the continuance of traditional paper-based methods for receiving and paying bills and managing finances, on the part of both consumers and billers. In addition, the possibility of billers and CSPs, including large bank clients, continuing to use or deciding to create in-house systems to handle their own electronic billing and payment transactions remains a competitive threat. Our large bank customers may explore the possibility of internally performing portions of the outsourced billing and payment services that we provide to them. In-house solutions have always been and will continue to be an option for our customers and a competitive factor facing our business.

 

Metavante, a division of Marshall and Ilsley Corporation, competes with us most directly from the perspective of providing pay anyone solutions to financial services organizations. In 2006, Online Resources Corp. completed the acquisition of Princeton eCom to become a larger full service banking, billing and bill payment competitor. A number of other companies compete with us by providing some, but not all, of the services that make up our complete e-bill and electronic pay anyone service. For example, Yodlee has publicly stated its strategy is to shift from being an account aggregation provider to become more of a bill payment processor, online banking provider and end-to-end financial services provider. Also, MasterCard International provides a service that allows electronic bill payments, and Visa has recently promoted heavily its credit and debit card products as a convenient means for consumers to pay their bills. Numerous small firms provide

technologies that can enable these and other companies to compete with us and we regularly monitor combinations and alliances of any of the above.

 

In the area of Internet consumer banking, we primarily compete with other companies that provide outsourced Internet finance solutions to large financial institutions, including S1 Corporation and Financial Fusion, Inc. Within this market segment, we also compete with companies that offer software platforms designed for internal development of Internet-based financial services software, such as IBM’s WebSphere, and the internal information technology personnel of financial institutions that want to develop their own solutions. In addition, we occasionally compete with vendors who primarily target community financial institutions with Internet banking solutions. For the business banking services that financial institutions offer their commercial customers, we also compete with vendors of cash management systems for large corporations.

 

Our products and services that allow consumers to pay billers directly also face competition. We compete with biller-direct billing and payment Internet sites. Western Union and MoneyGram compete with our walk-in payment services. Each has a national network of retail and agent locations. We also compete with smaller walk-in payment providers in different regions of the United States and with billers who have created in-house systems to handle walk-in payments. BillMatrix, a division of Fiserv, and SpeedPay, a division of Western Union, compete with our phone payments business.

 

We expect competition to continue to increase as new companies enter our markets and existing competitors expand their product lines and services. In addition, many companies that provide outsourced Internet finance solutions are consolidating, creating larger competitors with greater resources and broader product lines.

 

Seasonality.  The sequence of long months or short months in a given quarter, the sequence of long or short months before and after a quarter-end date and the mix of processing and non-processing days within the quarter affects sequential quarter transaction growth in the Electronic Commerce Division. Barring unusual events, CSP based sequential quarterly transaction growth in the first and fourth quarters of our fiscal year tends to be lower than CSP based sequential quarterly transaction growth in the second and third quarters of our fiscal year.

 

Acquisitions.  Our current business was developed through expansion of our core Electronic Commerce business and the acquisition of companies operating in similar or complementary businesses. Our major acquisitions related to the Electronic Commerce Division include Servantis Systems Holdings, Inc. in February 1996, Intuit Services Corporation in January 1997, and MSFDC, L.L.C. (“TransPoint”) in September 2000. In October 2000, we completed a strategic agreement with Bank of America, under which we acquired certain of Bank of America’s electronic billing and payment assets. We acquired American Payment Systems, Inc. in June 2004, Aphelion, Inc. in October 2005, PhoneCharge, Inc. in January 2006 and Corillian in May 2007.

 

Software Division

 

During the year ended June 30, 2007, our Software Division provided software and services, including software, maintenance, support and consulting services, through four product lines. These product lines were Global Treasury, Reconciliation and Exception Management, Transaction Process Management (encompassing financial messaging and corporate actions), and Electronic Billing. Through our acquisition of Carreker in April 2007, we expanded our offerings into four additional product lines: Payments, Risk, Cash and Logistics and Global Payments Consulting (“GPC”).

 

 

Our ACH software is marketed under the product name PEP+^® (Paperless Entry Processing System). PEP+ enables the originating and receiving of payments through the ACH system. These electronic transactions are typically used for recurring payments such as direct deposit payroll payments; corporate payments to contractors and vendors; debit transfers that consumers make to pay insurance premiums, mortgages, loans and other bills; and business-to-business payments. Our PEP+ reACH^tm product, which can be used with our PEP+ software, allows returned checks, checks at the point-of-sale, and checks sent to a lockbox to be converted to electronic payments.

 

Our account reconciliation software is marketed under the product name CheckFree ARP/SMS^tm (Account Reconciliation Package/Service Management System). CheckFree ARP/SMS is an online, real-time positive pay and reconcilement system. We also provide add-on positive pay modules that enable banks/financial institutions to reduce exposure to check fraud and manage electronic check conversion.

 

Our compliance solutions enable banks, bank holding companies, securities and insurance firms, corporations and government agencies to maintain compliance with certain federal and state regulations. These products support unclaimed property management and government tax-related compliance reporting. Our compliance software solutions are marketed under the names CheckFree APECS^tm, CheckFree IRS^tm, CheckFree LCR^tm and CheckFree RRS^tm.

 

 

 

 

Licenses.  We generally grant non-exclusive, non-transferable perpetual licenses to use our application software. Our standard license agreements contain provisions designed to prevent disclosure and unauthorized use of our software. License fees vary according to a number of factors, including the types of software and levels of service we provide.

 

Maintenance, Support and Consulting Services.  Maintenance includes enhancements to our software. Customers who obtain maintenance service generally retain it from year to year. To complement customer support, we also offer consulting services at a separate charge.

 

Sales, Marketing and Distribution.  We market software products through our direct and indirect sales force. Salespersons have specific product responsibility and receive support from technical personnel as needed. We generate new customers through direct solicitations, user groups, advertisements, direct mail campaigns and strategic alliances. We also participate in trade shows and sponsor industry technology seminars for prospective customers. Existing customers are often candidates for sales of additional products or for enhancements to products they have already purchased. We also market through resellers for certain geographies and vertical markets.

 

Competition.  The financial services computer application software industry is highly competitive. We believe that there is at least one direct competitor for most of our software products, but no competitor competes with us in all of our software product areas.

 

Our Reconciliation and Exception Management solutions compete mainly with SmartStream and SunGard. Our Global Treasury solutions compete on a limited basis with Troy ACH Processing and in-house solutions. Our Transaction Process Management solutions compete mainly with SmartStream and CityNetworks for financial messaging and SmartStream, Information Mosaic, Mondas, Xcitek and Vermeg for

corporate actions. Our GPT Payments solutions compete with a wide array of competitors, including Wasau, NCR, Metavante and Pega Systems. Our GPT Risk solutions compete with SoftPro, AFS, SAS and Fair Isaac. Our GPT Cash and Logistics solutions compete with Transfot, Pitney Bowes and a variety of smaller competitors. Our GPC line of business competes with a wide variety of both large and small payments consultancies, including BearingPoint, Deloitte and Accenture.

 

Seasonality.  We have historically experienced seasonal fluctuations in our software sales, and we expect to experience similar fluctuations in the future. Our software sales and associated license revenue have historically been affected by our sales compensation structure, which measures sales performance at our June 30 fiscal year end, which typically leads to a fourth fiscal quarter of higher software sales, and then a lower first fiscal quarter. Further, buying patterns of financial services organizations, which tend to increase their purchases of software licenses at the end of the calendar year, have also resulted in higher sales in our second fiscal quarter.

 

Acquisitions.  Our current business was developed through the acquisition of Servantis Systems Holdings, Inc. in February 1996, BlueGill Technologies, Inc. (which we renamed CheckFree i-Solutions) in April 2000, HelioGraph, Ltd. (“HelioGraph”) in November 2003, Accurate Software, Ltd. in April 2005 and Carreker in April 2007.

 

Investment Services Division

 

Introduction.  The Investment Services Division provides a range of portfolio management services to help over 350 financial institutions, including broker dealers, money managers, investment advisors, banks and insurance companies, deliver portfolio management, enhanced trading solutions, performance measurement and reporting services to their clients.

 

Our fee-based investment management clients are typically sponsors or managers of “wrap,” or separately managed accounts (“SMA or SMAs”) or unified managed accounts (“UMA or UMAs”), money management products, or institutional money managers, managing investments of institutions and high net worth individuals. We also support a growing number of third party vendors providing turnkey or outsourced solutions.

 

Investment Services’ primary product is CheckFree APL^sm, a real-time portfolio management system used by 9 of the top 10 largest brokerage firms offering SMAs in the United States and 8 of the top 10 asset managers offering SMAs. As of June 30, 2007, our clients used CheckFree APL to manage nearly 2.7 million portfolios. In addition, as a result of our acquisition of Integrated Decision Systems, Inc. (“IDS”) in September 2005, Investment Services offers CALIPER^®, a software-based, high-volume performance reporting solution designed for firms with reporting needs from hundreds of thousands to millions of accounts, and GIM^® (Global Investment Manager), a multi-currency software-based portfolio accounting application.

 

Industry Background.  Industry analysts (including Cerulli Associates and Financial Research Corporation) predict a compound annual growth in the SMA business of around 15% each year over the next several years. This projected growth is due primarily to the marketing of fee-based services, such as SMAs by brokerage companies, and consumers’ desire to more efficiently manage the tax implications of their investments by leveraging SMAs and UMAs.

 

Products and Services.  Our portfolio management products and services provide the following functions: multiple strategy portfolios, account opening, workflow and decision support, trading and order management capabilities, performance measurement and reporting, tax lot accounting, tax efficient trading, unified managed accounts/unified managed households, straight through processing, and a wide network of interfaces, including Depository Trust Corporation interfacing.

 

In 2003, we enhanced CheckFree APL by creating a Multiple Strategy Portfolio (“MSP”) solution. This solution allows our clients to track, on a combined basis, the portfolios of their customers, even when multiple portfolios are managed by different asset managers. Further evolution of the MSP product has resulted in the UMA, and unified managed household, where investors get a holistic view of their total portfolio. Additionally, CheckFree APL has a Mutual Fund Advisory (“MFA”) product, which is a portfolio of mutual funds or

exchange traded funds (“ETFs”) that are selected to match a pre-set asset allocation model based on the investor’s objectives.

 

Revenues in our portfolio management services are generated per portfolio under management through multiple year agreements that provide for monthly revenue on a volume basis. Revenue from our software is typically generated through multi-year or annual agreements, software license fees, maintenance fees and professional services.

 

On July 1, 2007, after our 2007 fiscal year-end, all of CheckFree’s securities-focused software solutions officially became part of the Investment Services Division as a newly-formed group within the division called “CIS Software.” CIS Software will manage our GIM and CALIPER software solutions as well as solutions that were part of our Software Division during the fiscal year ended June 30, 2007, and which enable the management, monitoring and measurement of the flow of securities and cash transactions across a local or global enterprise. A description of the securities-focused software solutions that were part of our Software Division during the 2007 fiscal year are described more fully above under “Software Division — Transaction Process Management.”

 

Technology.  CheckFree APL is a UNIX-based application running on IBM technology. Portfolio management services are provided primarily as a service bureau offering with the data center residing in Chicago, Illinois. Divisional headquarters is located in Jersey City, New Jersey. In addition to a dedicated private network, clients use frame relay services from several telecommunications providers to access services, including via a virtual private network.

 

To continue to provide the leading system for all fee-based products, CheckFree has undertaken an initiative to enhance the reliability, efficiency, business process workflow and usability of our portfolio management services. This new technology platform, currently referred to as CheckFree EPL^sm (Enhanced Portfolio Lifecycle), is based on Microsoft.NET technology. Deployment of CheckFree EPL is currently expected to begin in the first half of fiscal 2008. We have contracted with Satyam Computer Services Ltd. as our application development service provider for CheckFree EPL.

 

CALIPER is a UNIX-based software application with Oracle database storage. GIM is a UNIX-based application with a web-based front-end and Oracle database storage. Users typically access the CALIPER and GIM applications via Microsoft Internet Explorer using a secure HTTPS connection.

 

Sales, Marketing and Distribution.  We market through our direct sales force; however, we do not generally market to or have a direct relationship with consumers or end-users of our products. We generate new financial institution clients through direct solicitation, user groups and advertisements, and we rely on these clients to offer our Investment Services products and services to a larger end-user base than can be reached through stand-alone marketing efforts. We also participate in trade shows and sponsor industry seminars for distribution alliances. CheckFree APL is also resold through Turnkey Asset Management Platforms (TAMPS) and outsourcers. These third party firms contract with us and resell the service to money managers and broker dealers. We receive revenue on these accounts, but based on our tiered pricing structure, the account fees may be discounted by volume.

 

Competition.  Investment Services competes with customers building their own internal portfolio accounting systems and with providers of portfolio accounting software and services, including Advent Software, DST, Vestmark and Market Street Advisors. Service bureau providers such as SunGard Portfolio Solutions and Financial Models Company, as well as smaller competitors partnering with large outsourcers, also compete in our market space. Also, TAMPS and outsourcers are marketing to our client base, so there are times when we are competing for the same client.

 

Acquisitions.  Our current business was developed through the acquisition of Security APL, Inc. in May 1996, and Möbius Group, Inc. in March 1999, which we referred to as our M-Solutions business. We divested the assets related to M-Solutions (M-Search, M-Watch and M-Pact) in February 2006. In September 2005, we acquired the assets of IDS, and in May 2007, we acquired the assets of Upstream. In addition, in July 2007 after our June 30, 2007 fiscal year-end, we acquired the membership interests in Upstream

Securities, LLC, which is a broker-dealer business registered with the National Association of Securities Dealers.

 

For further financial information about our segments, revenue derived from foreign sales and geographic locations of our long-lived assets, please see Note 19 to our consolidated financial statements.

 

Government Regulation

 

We perform certain services for federally-insured financial institutions and thus we are subject to examination by such financial institutions’ principal federal regulator pursuant to the Bank Service Company Act. As we perform these services for federal thrifts (regulated by the Office of Thrift Supervision), state non-member banks (regulated by the Federal Deposit Insurance Corporation), state member banks (regulated by the Board of Governors of the Federal Reserve System), and national banks (regulated by the Office of the Comptroller of the Currency), among others, the Federal Financial Institutions Examination Council (“FFIEC”) coordinates which federal regulator performs these examinations, and the timing and frequency of the examinations. In addition, because we use the Federal Reserve’s ACH Network to process many of our transactions, we are subject to the Federal Reserve Board’s rules with respect to its ACH Network.

 

In conducting our business, we are also subject to various laws and regulations relating to the electronic movement of money. In 2001, the USA Patriot Act amended the Bank Secrecy Act (“BSA”) to expand the definition of money services businesses so that it may include businesses such as ours. We submitted a request for an administrative ruling from the Financial Crimes Enforcement Network (“FinCEN”) on September 9, 2002, with respect to whether FinCEN believes us to be a money services business. To date, we have not received a ruling from FinCEN. If our business is determined to be a money services business, then we will have to register with FinCEN as a money services business with the attendant regulatory obligations. Also, 47 states and the District of Columbia have enacted statutes which require entities engaged in money transmission, the sale of traveler’s checks (including money orders), and the sale of stored value cards to register as a money transmitter with that jurisdiction’s banking department, and we have, where required, registered as a money transmitter where appropriate. In addition, as are all U.S. citizens, we are subject to the regulations of the Office of Foreign Assets Control (“OFAC”) which prohibit transactions between U.S. citizens and either Specially Designated Nationals (“SDNs”) or targeted countries in furtherance of U.S. foreign policy objectives. The processing of a “prohibited transaction,” as defined by OFAC, may lead to significant civil and criminal penalties. Further, we are a “financial institution” within the meaning of the Gramm-Leach-Bliley Act (“GLB”) as implemented by the Federal Trade Commission’s Financial Privacy Rule and, as such, we must give our customers notice and the right to “opt out” of any sharing of non-public personal information (“NPPI”) between us and unaffiliated third parties. Moreover, as a service provider to banks, which are also “financial institutions” under GLB, we are likewise bound to certain restrictions under GLB with respect to third party service providers who receive NPPI from financial institutions. Finally, we are also subject to the electronic funds transfer rules embodied in Regulation E, promulgated by the Federal Reserve Board. The Federal Reserve’s Regulation E implements the Electronic Fund Transfer Act, which was enacted in 1978. Regulation E protects consumers engaging in electronic transfers, and sets forth the basic rights, liabilities, and responsibilities of consumers who use electronic money transfer services and of financial services organizations that offer these services.

 

Our walk-in bill payment service conducted through CheckFreePay is considered a money services business and as such is registered with FinCEN. In consideration of certain risks posed, the nature of the products and services, the customer base served and the size of CheckFreePay’s operations, we have established and we maintain a program to provide a system of controls and procedures reasonably designed to detect, prevent and report actual or suspected violations of the BSA, money laundering statutes, anti-terrorism statutes and other illicit activity while assuring daily adherence to the BSA. In addition, CheckFreePay currently maintains 40 licenses to comply with the various money transmitter statutes mentioned above, and is subject to annual audits by such jurisdictions.

Intellectual Property Rights

 

We regard our financial transaction services and related products as proprietary and rely on a combination of patent, copyright, trademark and trade secret laws, employee and third party nondisclosure agreements, and other intellectual property protection methods to protect our services and related products. As of June 30, 2007, we had been issued 52 patents in the United States and abroad, including 10 patents issued to Carreker and 11 patents issued to Corillian prior to our acquisitions of those companies. Subsequent to our 2007 fiscal year-end, an additional patent was issued to us. The majority of these patents cover various electronic billing and/or payment innovations, other financial software products or services, or aspects of our separately managed accounts services. We also have 162 pending patent applications in the United States and abroad, including patent applications from our acquisitions of Carreker, Corillian and Upstream. We own numerous domestic and foreign trade and service mark registrations related to products or services and have additional registrations pending.

 

Employees

 

As of June 30, 2007, we employed approximately 4,300 full-time employees, including approximately 740 in research and development, approximately 1,160 in customer care, approximately 500 in sales and marketing and approximately 1,900 in administration, financial control, corporate services, human resources and other processing and service personnel. We are not a party to any collective bargaining agreement in the United States and are not aware of any efforts to unionize our U.S. employees. We believe that our relations with our employees are good. We believe our future success and growth will depend in large measure upon our ability to attract and retain qualified management, technical, marketing, business development and sales personnel.

 

Available Information

 

We make available free of charge on our corporate website, www.checkfreecorp.com, our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and, if applicable, amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as soon as reasonably practicable after such reports are electronically filed with or furnished to theSEC. Our Code of Business Conduct, which is applicable to all of our directors, officers and associates, including our principal executive officer, principal financial officer and principal accounting officer, is also available at the “Corporate Governance” section of the Investor Center page of our corporate website, www.checkfreecorp.com.

 

We desire to take advantage of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. Many of the following important factors discussed below have been contained in our prior filings with the SEC. In addition to the other information in this report, readers should carefully consider that the following important factors, among others, in some cases have affected, and in the future could affect, our actual results and could cause our actual consolidated results of operations for the fiscal year ending June 30, 2008 (and the individual fiscal quarters therein), and beyond, to differ materially from those expressed in any forward-looking statements made by us or on our behalf.

 

Risks Related to the Proposed Merger with Fiserv

 

The announced merger with Fiserv may adversely affect the market price of our common stock and our results of operations.

 

If the merger is not completed, the price of our common stock may decline to the extent that the current market price reflects a market assumption that the merger will be completed. In addition, in response to the announcement of the merger, our customers and strategic partners may delay or defer decisions which could have a material adverse effect on our business regardless of whether the merger is ultimately completed. Similarly, current and prospective employees of our company may experience uncertainty about their future

roles with the combined company. These conditions may adversely affect employee morale and our ability to attract and retain key management, sales, marketing and technical personnel. In addition, focus on the merger and related matters have resulted in, and may continue to result in, the diversion of management’s attention and resources. To the extent that there is uncertainty about the closing of the merger, or if the merger does not close, our business may be harmed if customers, strategic partners or others believe that they cannot effectively compete in the marketplace without the merger or if there is customer and employee uncertainty surrounding the future direction of the company on a stand-alone basis.

 

If the merger does not occur, we will not benefit from the expenses we have incurred in preparation for the merger.

 

If the merger is not consummated, we will have incurred substantial expenses for which no ultimate benefit will have been received by us. We currently expect to incur significant out-of-pocket expenses for services in connection with the merger, consisting of financial advisor, legal and accounting fees and financial printing and other related charges, many of which may be incurred even if the merger is not completed. Moreover, under specified circumstances, we may be required to pay a termination fee of $176 million, depending upon the reason for termination, to Fiserv in connection with a termination of the merger agreement.

 

Risks Related to Our Business

 

The market for our electronic commerce services is evolving and may not continue to develop or grow rapidly enough for us to sustain profitability.

 

If the number of electronic commerce transactions does not continue to grow or if consumers or businesses do not continue to adopt our services, it could have a material adverse effect on our business, financial condition and results of operations. We believe future growth in the electronic commerce market will be driven by the cost, ease-of-use, and quality of products and services offered to consumers and businesses. In order to consistently increase and maintain our profitability, consumers and businesses must continue to adopt our services.

 

Our future profitability depends upon our ability to implement our strategy successfully to increase adoption of electronic billing and payment methods.

 

Our future profitability will depend, in part, on our ability to implement our strategy successfully to increase adoption of electronic billing and payment methods. Our strategy includes investment of time and money during fiscal 2008 in programs designed to:

 

 

If we do not successfully implement our strategy, revenue growth may be minimized, and expenditures for these programs will not be justified.

Our investment in these programs may have a negative impact on our short-term profitability. Additionally, our failure to implement these programs successfully or to substantially increase adoption of electronic commerce billing and payment methods by consumers could have a material adverse effect on our business, financial condition and results of operations.

 

It is also possible that the significant amount of press connecting identity theft and online activities might inhibit the growth of consumers using the Internet, which could decrease the demand for our products or services, increase our cost of doing business or could otherwise have a material adverse effect on our business, financial condition and results of operations.

 

Competitive pressures we face may have a material adverse effect on us.

 

We face significant competition in our each of our Divisions — Electronic Commerce, Software and Investment Services. Increased competition or other competitive pressures may result in price reductions, reduced margins or loss of business, any of which could have a material adverse effect on our business, financial condition and results of operations. Further, competition will persist and may increase and intensify in the future.

 

In the Electronic Commerce Division, we face significant competition for all of our products. Our primary competition is the continuance of traditional paper-based methods for receiving and paying bills, on the part of both consumers and billers. In addition, the possibility of billers and CSPs, including large bank clients, continuing to use or deciding to create in-house systems to handle their own electronic billing and payment transactions remains a significant competitive threat. Our large bank customers may explore the possibility of internally performing portions of the outsourced billing and payment services that we provide to them. In-house solutions have always been and will continue to be an option for our customers and a competitive factor facing our business.

 

Metavante, a division of Marshall and Ilsley Corporation, competes with us most directly from the perspective of providing pay anyone solutions to financial services organizations. In 2006, Online Resources Corp. completed the acquisition of Princeton eCom to become a larger full service banking, billing and bill payment competitor. A number of other companies compete with us by providing some, but not all, of the services that make up our complete e-bill and electronic pay anyone service. For example, Yodlee has publicly stated its strategy is to shift from being an account aggregation provider to become more of a bill payment processor, online banking provider and end-to-end financial services provider. Also, MasterCard International provides a service which allows electronic bill payments, and Visa has recently promoted heavily its credit and debit card products as a convenient means for consumers to pay their bills. Numerous small firms provide technologies that can enable these and other companies to compete with us, and we regularly monitor combinations and alliances of any of the above.

 

In the area of Internet consumer banking, we primarily compete with other companies that provide outsourced Internet finance solutions to large financial institutions, including S1 Corporation and Financial Fusion, Inc. Within this market segment, we also compete with companies that offer software platforms designed for internal development of Internet-based financial services software, such as IBM’s WebSphere, and the internal information technology personnel of financial institutions that want to develop their own solutions. In addition, we occasionally compete with vendors who primarily target community financial institutions with Internet banking solutions. For the business banking services that financial institutions offer their commercial customers, we also compete with vendors of cash management systems for large corporations.

 

Our products and services that allow consumers to pay billers directly also face competition. We compete with biller-direct billing and payment Internet sites. Western Union and MoneyGram compete with our walk-in payment services. Each has a national network of retail and agent locations. We also compete with smaller walk-in payment providers in different regions of the United States and with billers who have created in-house systems to handle walk-in payments. BillMatrix, a division of Fiserv, and SpeedPay, a division of Western Union, compete with our phone payments business.

We expect competition to continue to increase as new companies enter our markets and existing competitors expand their product lines and services. In addition, many companies that provide outsourced Internet finance solutions are consolidating, creating larger competitors with greater resources and broader product lines.

 

The markets for our Software and Investment Services products are also highly competitive. In Software, our competition comes from several different market segments and geographies, including large diversified computer software and service companies and independent suppliers of software products. In Investment Services, our competition comes primarily from providers of portfolio accounting software and outsourced services and from in-house solutions developed by large financial institutions.

 

Security and privacy breaches in our electronic transactions may damage customer relations and inhibit our growth.

 

Any failures in our security and privacy measures could have a material adverse effect on our business, financial condition and results of operations. We electronically transfer large sums of money and store personal information about consumers, including bank account and credit card information, social security numbers and merchant account numbers. If we are unable to protect, or consumers perceive that we are unable to protect, the security and privacy of our electronic transactions, our growth and the growth of the electronic commerce market in general could be materially adversely affected. A security or privacy breach may:

 

 

New trends in criminal acquisition and illegal use of personally identifiable data make maintaining the security and privacy of such data more costly and time intensive. The increased cost, along with the increased ability of organized criminal elements focusing on identity theft and identity fraud, may materially impact our reputation as a provider of secure electronic billing and payment services.

 

While we believe that we utilize proven applications designed for data security and integrity to process electronic transactions, there can be no assurance that our use of these applications will be sufficient to address changing market conditions or the security and privacy concerns of existing and potential subscribers.

 

We rely on third parties to distribute our electronic commerce and investment services products, which may not result in widespread adoption.

 

In Electronic Commerce, we rely on our contracts with financial services organizations, businesses, billers, Internet portals and other third parties to provide branding for our electronic commerce services and to market our services to their customers. Similarly, in Investment Services, we rely upon financial institutions, including broker dealers, money managers and investment advisors, to market investment accounts to consumers and thereby increase portfolios on our CheckFree APL system and use of our portfolio management software products. These contracts are an important source of the growth in demand for our electronic commerce and investment service products. If any of these third parties abandons, curtails or insufficiently increases its marketing efforts, it could have a material adverse effect on our business, financial condition and results of operations.

Consolidation in the financial services industry may adversely affect our ability to sell our electronic commerce services, investment services and software.

 

Mergers, acquisitions and personnel changes at key financial services organizations have the potential to adversely affect our business, financial condition and results of operations. This consolidation could cause us to lose:

 

 

We may be unsuccessful in integrating acquisitions, which could result in increased expenditures or cause us to fail to achieve anticipated cost savings or revenue growth.

 

We are currently seeking to integrate recently acquired businesses as described in this report, including our acquisitions of Carreker, Corillian and Upstream. There are risks inherent in these types of transactions, such as: difficulty in assimilating or integrating the operations, technology, platforms and personnel of the combined companies; difficulties and costs associated with integrating and evaluating the internal control systems of acquired businesses; disruption of our ongoing business, including loss of management focus on existing businesses and marketplace developments; problems retaining key technical and managerial personnel; expenses associated with the amortization of identifiable intangible assets; additional or unanticipated operating losses, expenses or liabilities of acquired businesses; impairment of relationships with existing employees, customers and business partners; and fluctuations in value and losses that may arise from equity investments.

 

One customer accounts for a significant percentage of our consolidated revenues.

 

We have one customer, Bank of America, that accounted for approximately 19% of our total consolidated revenues ($189.5 million) for fiscal year 2007, which reflects its use of products and services in all three of our business segments. The majority of this revenue comes from within our Electronic Commerce Division. The loss or renegotiation of our Electronic Commerce Division contract with Bank of America or a significant decline in the number of transactions we process for it could have a material adverse effect on our business, financial condition and results of operations. No other customer accounts for more than 10% of our consolidated revenues.

 

If we do not successfully renew or renegotiate our agreements with our customers, our business may suffer.

 

Our agreements for electronic commerce services with financial services organizations generally provide for terms of two to five years. Our agreements with our portfolio management customers are generally for similar terms. If we are not able to renew or renegotiate these agreements on favorable terms as they expire, it could have a material adverse effect on our business, financial condition and results of operations.

 

The profitability of our Software Division and certain software products in our Electronic Commerce Division depend, to a substantial degree, upon our software customers electing to annually renew their maintenance agreements. If a substantial number of our software customers declined to renew these agreements, our revenues and profits in this business segment would be materially adversely affected.

 

Our future profitability depends on a decrease in the cost of processing payment transactions.

 

If we are unable to continue to decrease the cost of processing transactions, our margins could decrease, which could have a material adverse effect on our business, financial condition and results of operations. Many factors contribute to our ability to decrease the cost of processing transactions, including our Sigma quality

program, our customer care efficiency program, our processing technology optimization program, and our focus on continually increasing the number of transactions we process electronically. Our electronic rate, or percentage of transactions processed electronically, was approximately 84% at the end of fiscal years 2005, 2006 and 2007.

 

We experience seasonal and other fluctuations in our revenues causing our operating results to fluctuate.

 

We have historically experienced seasonal fluctuations in our software sales, and we expect to experience similar fluctuations in the future. Our software sales and associated license revenue have historically been affected by calendar year end, our fiscal year end, buying patterns of financial services organizations and our sales compensation structure, which measures sales performance at our June 30 fiscal year end.

 

Further, in our Electronic Commerce Division, we often experience fluctuations in transaction volume and revenue on a quarterly basis. Our analysis has revealed a previously undetected cyclical pattern within the quarters of a given fiscal year that does not impact overall annual transaction growth. We have learned that the sequence of long months or short months in a given quarter, the sequence of long or short months before and after a quarter end date and the mix of processing and non-processing days within the quarter affects sequential quarterly transaction growth. We now believe that, barring unusual events, CSP based sequential quarterly transaction growth in the first and fourth quarters of our fiscal year tends to be lower than CSP based sequential quarterly transaction growth in the second and third quarters of our fiscal year. As a result, we believe we are better able to forecast transaction growth; however, there can be no assurance that we will always be able to accurately forecast such growth. While we do not believe we have identified all factors that could negatively or positively affect transaction growth, including various consumer behavior patterns, we believe that recent consumers to the service engage in fewer transactions than new consumers added to the service in previous years. A slow down in our transaction growth could have a negative impact on our business, financial condition and results of operations.

 

Seasonality and other quarterly fluctuations can impact our quarterly revenue.

 

The transactions we process expose us to fraud and credit risks.

 

Losses resulting from returned transactions, merchant fraud or erroneous transmissions could result in liability to financial services organizations, merchants or subscribers, which could have a material adverse effect on our business, financial condition and results of operations. Although ameliorated by reversibility arrangements with many billers, the electronic and conventional paper-based transactions we process expose us to credit risks. These include risks arising from returned transactions caused by:

 

 

We are also exposed to credit risk from merchant fraud and erroneous transmissions.

 

The attempts by both federal and state governments to combat identity fraud may impose restrictions on the financial community which make the appropriate sharing of data for fraud prevention impractical and overly burdensome. In the event of legislation, our ability to mitigate fraud costs and write-offs may be negatively impacted.

If we, or our implementation partners, do not effectively implement our solutions acquired from Corillian, we may not achieve anticipated revenues or gross margins.

 

Our solutions acquired from Corillian are complex and must integrate with other complex data processing systems. Implementing those solutions is a lengthy process, generally taking between three and nine months to complete. In addition, we generally recognize revenues on a percentage-of-completion basis, so our revenues are often dependent on our ability to complete implementations within the time periods that we establish for our projects. We rely on a combination of internal and outsourced teams for our implementations. If these teams encounter significant delays in implementing our solutions for a customer or fail to implement our solutions effectively or at all, we may be unable to recognize any revenues from the contract or may incur losses from the contract if our revised project estimates indicate that we recognized excess revenues in prior periods. In addition, we may incur monetary damages or penalties if we are not successful in completing projects on schedule.

 

From time to time, we agree to penalty provisions in our contracts that require us to make payments to our customers if we fail to meet specified milestones or that permit our customers to terminate their contracts with us if we fail to meet specified milestones. If we fail to perform in accordance with established project schedules, we may be forced to make substantial payments as penalties or refunds and may lose our contractual relationship with the applicable customers.

 

We may experience significant losses due to our reliance on agents for walk-in payment services.

 

Through our contractual relationships with billers, we guarantee consumer payments made at our retail agent locations regardless of whether an agent makes timely deposits of funds collected. We could suffer significant losses if we are unable to manage and control agents making correct and timely deposits, or if we are unable to maintain a sufficient retail agent network.

 

We may experience breakdowns in our processing systems that could damage customer relations and expose us to liability.

 

We depend heavily on the reliability of our processing systems in both our Electronic Commerce and Investment Services Divisions. A system outage or data loss could have a material adverse effect on our business, financial condition and results of operations. Not only would we suffer damage to our reputation in the event of a system outage or data loss, but we may also be liable to third parties or owe service credits to our customers. Many of our contractual agreements with financial institutions require the payment of credits if our systems do not meet certain operating standards. In addition, in our Electronic Commerce Division, we guarantee the delivery of payments, and any failure on our part to perform may result in late payments or penalties to third parties on behalf of subscribers to our services. In our Investment Services Division, a failure of our system could result in incorrect or mistimed stock trades that may result in third party liability. To successfully operate our business, we must be able to protect our processing and other systems from interruption, including from events that may be beyond our control. Events that could cause system interruptions include but are not limited to:

 

 

Although we have taken steps to protect against data loss and system failures, there is still risk that we may lose critical data or experience system failures. Currently, with the exception of CheckFree APL, we outsource some of our disaster recovery operations to a third party vendor, which puts us at risk of the vendor’s unresponsiveness in the event of breakdowns in our systems. Furthermore, our property and business interruption insurance may not be adequate to compensate us for all losses or failures that may occur.

 

We may experience software defects, computer viruses and development delays, which could damage customer relations, decrease our potential profitability and expose us to liability.

 

Our products are based on sophisticated software and computing systems that often encounter development delays, and the underlying software may contain undetected errors, viruses or defects. Defects in our software products and errors or delays in our processing of electronic transactions could result in:

 

 

In addition, we rely on technologies supplied to us by third parties that may also contain undetected errors, viruses or defects that could have a material adverse effect on our business, financial condition and results of operations. Although we attempt to limit our potential liability for warranty claims through disclaimers in our software documentation and limitation-of-liability provisions in our license and customer agreements, we cannot assure you that these measures will be successful in limiting our liability.

 

Our products and services must interact with other vendors’ products, which may result in system errors.

 

Our products are often used in transaction processing systems that include other vendors’ products, and, as a result, our products must integrate successfully with these existing systems. System errors, whether caused by our products or those of another vendor, could adversely affect the market acceptance of our products, and any necessary modifications could cause us to incur significant expenses.

 

If we do not respond to rapid technological change or changes in industry standards, our services could become obsolete and we could lose our customers.

 

If competitors introduce new products and services embodying new technologies, or if new industry standards and practices emerge, our existing product and service offerings, proprietary technology and systems may become obsolete. Further, if we fail to adopt or develop new technologies or to adapt our products and services to emerging industry standards, we may lose current and future customers, which could have a material adverse effect on our business, financial condition and results of operations. The financial services industry is changing rapidly. To remain competitive, we must continue to enhance and improve the functionality and features of our products, services and technologies.

 

We may be unable to protect our intellectual property and technology, permitting competitors to duplicate our products and services.

 

Our success and ability to compete depends, in part, upon our proprietary technology, which includes several patents for our electronic billing and payment processing system and our operating technology. We rely primarily on patent, copyright, trade secret and trademark laws to protect our technology. We also enter into confidentiality and assignment agreements with our employees, consultants and vendors, and generally control access to and distribution of our software documentation and other intellectual property. We also limit customer use of our intellectual property by entering into license agreements which limit the scope of a

customer’s use of the intellectual property. We cannot assure you that these measures will provide all of the protection that we need.

 

Because our means of protecting our intellectual property rights may not be adequate, it may be possible for a third party to copy, reverse engineer or otherwise obtain and use our technology without authorization. In addition, the laws of some countries in which we sell our products do not protect software and intellectual property rights to the same extent as the laws of the United States. A competitor may also be able to sidestep our intellectual property rights by performing key process steps in foreign countries where our United States patent protection does not apply or where we do not have separate intellectual property protection. Unauthorized copying, use or reverse engineering of our products could have a material adverse effect on our business, financial condition and results of operations.

 

A third party also could claim that our technology infringes its proprietary rights. As the number of software products in our target markets increases and the functionality of these products overlap, we believe that software developers may increasingly face infringement claims. In addition, there has been an increase in patent activity by financial firms during recent years which may increase the number of infringement claims in our market space. These claims, even if without merit, can be time-consuming and expensive to defend. A third party asserting infringement claims against us in the future may require us to enter into costly royalty arrangements or litigation.

 

Our business could become subject to increased government regulation, which could make our business more expensive to operate.

 

Our business is currently subject to numerous rules and regulations promulgated by various local, state and federal governmental entities and it is likely that this regulation may increase or change in the future. Such increase or change could make our business more expensive to operate and our products less desirable to use. In particular, due to increased focus by the government on terrorist activities, we may see additional regulation and enforcement targeted at money laundering or making payments to certain prohibited individuals or groups. We have noticed an increased focus by the federal banking regulators, as well as OFAC, on the processing of electronic payments and this focus may shift to us, and other businesses like ours, in the future. FinCEN, the principal federal regulator charged with regulating money services businesses, continues to provide further interpretation on the meaning of “money transmission.” If those interpretations become applicable to our business, then we may be obligated to comply with significant additional regulatory obligations. Various governmental entities have become interested in further regulating the use and sharing of data and protection of the privacy of this data. This interest will likely result in increased regulation around security and privacy of personally identifiable information. It is also possible that new laws and regulations may be enacted with respect to the Internet, including taxation of electronic commerce activities. Because electronic commerce in general, and most of our products and services in particular, are so new, the effect of an increase in regulation or amendment to existing regulation is uncertain and difficult to predict. Any such changes, however, could lead to increased operating costs and reduce the convenience and functionality of our products or services, possibly resulting in reduced market acceptance.

 

The Federal Reserve rules with respect to its ACH Network incorporate the National Automated Clearinghouse Association (“NACHA”) Rules which provide that we can only access the ACH Network through a bank. If the NACHA Rules, which are incorporated into the Federal Reserves rules governing its ACH Network, were to change to further restrict our access to the ACH Network or limit our ability to provide ACH transaction processing services, it could have a material adverse effect on our business, financial condition and results of operations.

 

Our walk-in payment business is subject to government regulation and any violation of such regulations could result in civil or criminal penalties or a prohibition against providing money transmitter services in particular jurisdictions.

 

We conduct our walk-in payment business through CheckFreePay. CheckFreePay is licensed as a money transmitter in those states where such licensure is required. These licenses require CheckFreePay to

demonstrate and maintain certain levels of net worth and liquidity and also require CheckFreePay to file periodic reports. In addition to state licensing requirements, CheckFreePay is subject to regulation in the United States by FinCEN, including anti-money laundering regulations and certain restrictions on transactions to or from certain individuals or entities. CheckFreePay has developed a program to monitor its business for compliance with regulatory requirements and has developed and implemented policies and procedures to monitor all of its transactions in order to comply with federal reporting and recordkeeping requirements. Notwithstanding these efforts, the complexity of these regulations will continue to increase our cost of doing business. In addition, any violations of law may result in civil or criminal penalties against us and our officers or the prohibition against us providing money transmitter services in particular jurisdictions.

 

A weak economy could have a materially adverse impact on our business.

 

A weak United States economy could have a material adverse impact on our business. In a weak economy, companies may postpone or cancel new software purchases or limit the amount of money they spend on technology and marketing. In our Investment Services Division, growth depends upon individuals and companies continuing to invest in the United States equity markets.

 

Our quarterly operating results fluctuate and may not accurately predict our future performance.

 

Our quarterly results of operations have varied significantly and probably will continue to do so in the future as a result of a variety of factors, many of which are outside our control. These factors include:

 

 

As a result, we believe that period-to-period comparisons of our operating results are not necessarily predictive of our future results, and you should not rely on them as an indication of our future performance. In addition, our operating results in a future quarter or quarters may fall below expectations of securities analysts or investors and, as a result, the price of our common stock may fluctuate.

 

Risks Related to Our Common Stock

 

Our common stock has been volatile since December 31, 2000.

 

Since December 31, 2000, our stock price has been volatile, trading at a high of $58.25 per share and a low of $7.45 per share. The volatility in our stock price has been caused by but not limited to:

 

 

 

 

Availability of significant amounts of our common stock for sale in the future could adversely affect our stock price.

 

The availability for future sale of a substantial number of shares of our common stock in the public market or otherwise, or issuance of common stock upon the exercise of stock options or warrants could adversely affect the market price for our common stock. As of June 30, 2007, we had outstanding 87,974,284 shares of our common stock, of which 81,924,475 shares were held by non-affiliates. The holders of the remaining 6,049,809 shares were entitled to resell them only by a registration statement under the Securities Act of 1933 or an applicable exemption from registration. As of June 30, 2007, we also had:

 

 

As of June 30, 2007, the following entities held shares or warrants to purchase shares of our common stock in the following amounts:

 

 

Each of Bank One, Bank of America and the former members of Integrion may be entitled to registration rights under certain circumstances. If the former members of Integrion, Bank One or Bank of America, by exercising their registration rights, cause a large number of shares to be registered and sold in the public market, these sales may have an adverse effect on the market price of our common stock.

 

Sales of substantial amounts of our common stock by any of the parties described above, or the perception that these sales could occur, may adversely affect prevailing market prices for our common stock.

 

Anti-takeover provisions in the merger agreement with Fiserv, our organizational documents and Delaware corporation law make any change in control more difficult.

 

We have agreed to be acquired by Fiserv, subject to a number of conditions, including the approval of our stockholders. The merger agreement includes provisions that would make it more difficult for a competing party to acquire us. These provisions include our agreements not to solicit other offers and not to provide information to a potential bidder unless our board of directors determines that a superior proposal could be made by the person to whom we provide the information, as well as our agreement under specified circumstances to pay a termination fee to Fiserv if we terminate the merger agreement and complete another transaction.

 

Our certificate of incorporation and by-laws contain provisions that may have the effect of delaying or preventing a change in control, may discourage bids at a premium over the market price of our common stock

and may adversely affect the market price of our common stock and the voting and other rights of the holders of our common stock. These provisions include:

 

 

We also have a stockholder rights plan that allows us to issue preferred stock with rights senior to those of our common stock without any further vote or action by our stockholders. The issuance of our preferred stock under the stockholder rights plan could decrease the amount of earnings and assets available for distribution to the holders of our common stock or could adversely affect the rights and powers, including voting rights, of the holders of our common stock. In some circumstances, the issuance of preferred stock could have the effect of decreasing the market price of our common stock. In connection with our proposed merger with Fiserv, we entered into an amendment to our stockholder rights plan which provides that neither the merger agreement nor the consummation of the merger or the other transactions contemplated by the merger agreement will trigger the separation or exercise of the stockholder rights or any adverse event under the our stockholder rights plan.

 

We also are subject to provisions of the Delaware corporation law that, in general, prohibit any business combination with a beneficial owner of 15% or more of our common stock for five years unless the holder’s acquisition of our stock was approved in advance by our board of directors.

 

No such unresolved comments exist.

 

We lease the following office facilities (square footage is approximate):

 

Electronic Commerce Division:

 

 

 

CheckFree Investment Services Division:

 

 

Software Division:

 

 

Corporate:

 

 

We also own a 51,000-square-foot conference center in Norcross, Georgia that includes lodging, training, and fitness facilities for our customers and employees. Although we own the building, it is on land that is leased through June 30, 2015. As of June 30, 2007, we also owned an approximately 150,000-square-foot facility in Dublin, Ohio utilized by our Electronic Commerce Division and our corporate functions. During the quarter ended September 30, 2007, we closed on a sale-leaseback transaction for our Dublin facility. Under the terms of the sale-leaseback agreement, we received net proceeds of approximately $22 million from the sale and agreed to a 12-year lease of the facility.

 

We believe that our facilities are adequate for current and near-term growth and that additional space is available to provide for anticipated growth.

 

On or about April 10, 2007, the first of two related shareholder securities putative class actions was filed against CheckFree and Messrs. Peter J. Kight and David E. Mangum in federal court in Atlanta styled as follows: Skubella v. CheckFree Corporation, et al., Civil Action No. 1:07-CV-0796-TWT, United States District Court for the Northern District of Georgia, Atlanta Division; Gattelaro v. CheckFree Corporation, et al., Civil Action No. 1:07-CV-0945-TWT, United States District Court for the Northern District of Georgia, Atlanta Division. The actions were filed on behalf of a putative class of all purchasers of CheckFree common stock between April 4, 2006 and August 1, 2006 and allege violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder against CheckFree and the individual

defendants, as well as of Section 20(a) against the individual defendants, related to CheckFree’s disclosures concerning its Electronic Commerce and Payment Services business. Plaintiffs seek undisclosed damages. On June 29, 2007, the Court entered an order that, among other things, consolidated these two actions and appointed Southwest Carpenters Pension Trust as the Lead Plaintiff. We anticipate that the Lead Plaintiff will file a consolidated complaint in the near future.

 

A related derivative action was filed on or about June 14, 2007 in federal court in Atlanta styled as follows: Borroni v. Peter Kight, et al., Civil Action No. 1:07-CV-1382-TWT, United States District Court for the Northern District of Georgia, Atlanta Division. The complaint names the following as defendants: Peter Kight, Mark Johnson, William Boardman, James D. Dixon, C. Kim Goodwin, Eugene F. Quinn, Jeffrey M. Wilkins, and David Mangum. The complaint also names CheckFree Corporation as a nominal defendant. The complaint alleges breach of fiduciary duty, aiding and abetting, and contribution and indemnification against the individual defendants as well as unjust enrichment against one of the individual defendants. Following CheckFree’s announcement of its proposed acquisition by Fiserv, Inc., the plaintiffs filed a Corrected Verified First Amended Shareholder Derivative and Class Action Complaint on August 6, 2007, which added C. Beth Cotner as a defendant and also added a claim on behalf of a putative class of all holders of CheckFree common stock for breach of fiduciary duty against all the individual defendants related to their approval of the proposed acquisition.

 

We believe these actions are without merit and intend to defend vigorously. We intend to move to dismiss these lawsuits at the appropriate time. At this time, it is not possible to predict the outcome of these matters.

 

None.

 

Our common stock is traded on the Nasdaq Global Select Market under the symbol “CKFR.” The following table sets forth the high and low sales prices of our common stock for the periods indicated as reported by the Nasdaq Global Select Market.

 

 

On August 20, 2007, the last reported bid price for our common stock on the Nasdaq Global Select Market was $45.41 per share. As of August 20, 2007, there were approximately 2,076 holders of record of our common stock. We currently anticipate that all of our future earnings will be retained for the development of our business and do not anticipate paying cash dividends on our common stock for the foreseeable future. In addition, our current credit facility does not allow for the payment of cash dividends on our common stock. Our board of directors will determine future dividend policy based on our results of operations, financial condition, capital requirements and other circumstances. During the last 10 years, we have not paid cash dividends.

 

On August 3, 2005, we announced that our board of directors had approved a stock repurchase program under which we could repurchase up to $60.0 million of our common stock through July 31, 2006. During fiscal 2006, we purchased a total of 707,732 shares at an average purchase price of $47.48 per share, or approximately $33.6 million in the aggregate. The repurchased shares were retired and cancelled immediately. As of June 30, 2006, the dollar value of shares that remained available for repurchase under this program was approximately $26.4 million. This program expired on July 31, 2006, with such remaining approved repurchase amount still outstanding.

 

On August 1, 2006, we announced that our board of directors had approved a separate stock repurchase program under which we could repurchase up to $100.0 million of our common stock through July 31, 2007. During the month of August 2006, we repurchased a total of 2,176,158 shares of common stock at an average purchase price of $37.22; and in September 2006, we repurchased a total of 461,589 shares at an average purchase price of $41.15 per share, or approximately $100.0 million in the aggregate. The repurchased shares were immediately retired and cancelled.

 

On November 6, 2006, we announced that our board of directors had approved a separate stock repurchase program under which we could repurchase up to $100.0 million of our common stock through August 1, 2007. During the month of November 2006, we repurchased a total of 1,273,807 shares of common stock at an average purchase price of $39.25 per share, or approximately $50.0 million in the aggregate. The

repurchased shares were immediately retired and cancelled. There were no repurchases during the three-months ended June 30, 2007. This program expired on August 1, 2007, with such remaining approved repurchase amount still outstanding.

 

Performance Graph

 

The following Performance Graph compares our performance with that of The Nasdaq Stock Market — U.S. Index and The S & P Supercap Data Processing & Outsourced Services Index, which is a published industry index. The comparison of the cumulative total return to stockholders for each of the periods assumes that $100 was invested on June 30, 2002, in our common stock, and in The Nasdaq Stock Market — U.S. Index and The S & P Supercap Data Processing & Outsourced Services Index and that all dividends were reinvested.

 

COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*

 

Among CheckFree Corporation, The NASDAQ Composite Index

And The S&P SuperCap Data Processing &Outsourced Services

 

 

  Fiscal year ending June 30.

 

 

The following selected financial data should be read in conjunction with Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, and Item 8. Financial Statements and Supplementary Data.

 

(a)  Through January 2003, all revenues generated from Bank of America are classified as related party. During fiscal years 2003 and 2004, all revenues generated from Microsoft and FDC are classified as related party. During fiscal year 2005 and 2006, only the revenues generated from Microsoft are classified as related party.

 

(b)  During fiscal year ended June 30, 2003, we recorded an impairment charge related to other intangible assets and goodwill of CheckFree i-Solutions.

 

(c)  For the fiscal year ended June 30, 2003, we adjusted our estimate of the total reorganization charge that was recorded in the previous fiscal year in order to streamline operations in our Electronic Commerce Division, refine our strategy for CheckFree i-Solutions within our Software Division, and discontinue certain product lines associated with our Investment Services Division. During fiscal year ended June 30, 2005, we recorded a reorganization charge relating to the re-scoping of many positions with the intent to re-hire as quickly as possible, the elimination of some other positions and the relocation of our Electronic Billing and Payment operations from our Waterloo, Ontario, Canada to our headquarters in Norcross, Georgia.

 

(d)  During the fiscal year ended June 30, 2004, we entered into an agreement with Voca, Ltd. to form the joint venture OneVu located in the United Kingdom, which has incurred losses since inception.

 

(e)  During the fiscal year ended June 30, 2005, we recorded a gain on the sale of stock. We received shares of stock from an insurance vendor that demutualized. We sold the shares shortly after we received them, and recorded the proceeds as a gain on investments. During the fiscal year ended June 30 2003, we recorded losses on certain investments resulting from an other-than-temporary decline in their fair value.

 

(f)  On July 1, 2002, we adopted SFAS 142, “Goodwill and Other Intangible Assets.” Upon adoption, we performed a transitional impairment test and recorded an impairment charge related to the goodwill associated with CheckFree i-Solutions.

 

(g)  In the quarter ended March 31, 2006, we divested of M-Solutions, a business within our Investment Services segment. As a result of this disposition, the operating results of the M-Solutions business have been reclassified as discontinued operations.

 

(h)  In June 2005, we purchased a total of 891,200 shares of our own common stock at an average purchase price of $37.52 per share, or $33.5 million in the aggregate. In the year ended June 30, 2006, we purchased a total of 707,732 shares of our own common stock at an average purchase price of $47.47 per share, or $33.6 million in the aggregate. In the year ended June 30, 2007, we purchased a total of 3,911,554 shares of our common stock at an average purchase price of $38.34 per share, or $150.0 million in the aggregate. In all cases, the shares were immediately retired and cancelled.

 

The preparation of our financial statements in conformity with Generally Accepted Accounting Principles in the United States of America requires us 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 financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

Overview

 

CheckFree was founded in 1981 as an electronic payment processing company and has become a leading provider of financial electronic commerce products and services. Our current business was developed through the expansion of our core electronic payments business and the acquisition of companies operating similar or complementary businesses.

 

We operate our business through three independent but inter-related divisions:

 

 

Our Electronic Commerce Division products enable consumers to:

 

 

For the year ended June 30, 2007, we processed more than 1.3 billion payment transactions and delivered approximately 226 million electronic bills (“e-bills”). For the quarter ended June 30, 2007, we processed approximately 344 million payment transactions and delivered nearly 61 million e-bills. The number of payment transactions we process and the number of e-bills we deliver each year continue to grow. For the year ended June 30, 2007, growth in the number of consumer service provider (“CSP”) based payment transactions we processed was nearly 24%, growth in total transactions processed exceeded 16% and growth in the number of e-bills we delivered exceeded 22%. Our Electronic Commerce Division accounted for approximately 74% of our fiscal 2007 consolidated revenues.

 

Through our Software Division, we provide software, maintenance, support and consulting services, through four product lines. These product lines are global treasury, reconciliation and exception management, transaction process management, and electronic billing. Our Software Division operates both domestically and internationally, and accounted for approximately 13% of our consolidated revenues in the year ended June 30, 2007.

 

Through our Investment Services Division, we provide a range of portfolio management services to help financial institutions, including broker dealers, money managers and investment advisors. As of June 30, 2007, our clients used the CheckFree APLSM portfolio management system (“CheckFree APL”) to manage nearly 2.7 million portfolios. Our Investment Services Division accounted for approximately 13% of our consolidated revenues in the year ended June 30, 2007.

 

Recent Developments

 

On August 2, 2007, we entered into an Agreement and Plan of Merger (“Merger Agreement”) pursuant to which Fiserv, Inc. (“Fiserv”) will acquire all of our outstanding shares of common stock for $48.00 per share in cash. Fiserv is a publicly traded Nasdaq company headquartered in Brookfield, Wisconsin and is a provider of technology solutions. We expect the acquisition to close by December 31, 2007, subject to approval by our stockholders and certain regulatory matters, although there can be no assurance that the merger will be consummated in a timely manner, if at all. We have filed a preliminary proxy statement and other relevant materials with the Securities and Exchange Commission (“SEC”), including a detailed description of the terms of the Merger Agreement, as well as other important information about the proposed transaction. Shareholders are urged to read the proxy statement and other relevant materials filed with the SEC and posted to our website regarding important information about the proposed transaction. All forward-looking statements in this Annual Report on Form 10-K, including those in the Management’s Discussion and Analysis of

Financial Condition and Results of Operations and Risk Factors, are based on management’s plans for future operations without consideration given to the pending transaction.

 

Executive Summary

 

A number of events have had an impact on our operating results when comparing the fiscal year ended June 30, 2007 to the fiscal year ended June 30, 2006 and 2005, respectively.

 

 

Due to growth in all of our business segments, including the positive and negative impacts of the items identified above, our consolidated revenue grew by nearly 11% during the year ended June 30, 2007. We earned income from continuing operations of $190.9 million in the year ended June 30, 2007, an increase of about 3% over the $186.1 million earned last year. We generated more than $184 million of free cash flow for the year ended June 30, 2007, compared to $171 million in the prior year. We define free cash flow as net cash provided by operating activities, exclusive of the net change in settlement accounts, less capital expenditures, less the impact of an operating account conversion plus data center reimbursements. See “Use of Non-GAAP Financial Information” in this Management’s Discussion and Analysis for further discussion of this measure.

 

Revenue in our Electronic Commerce Division of $723.1 million for the year ended June 30, 2007, represents growth of 9% over the prior year. Excluding the $11.0 million charge for warrants to a customer and the impact of purchase accounting on deferred revenue of $2.7 million, year over year revenue growth would be 11%. Including the impact of telephone bill payments we acquired with PhoneCharge in January 2006, our volume of transactions processed grew by greater than 16%, to more than 1.3 billion for the year ended June 30, 2007, over the more than 1.1 billion we processed last year. We delivered approximately

226 million e-bills in the year ended June 30, 2007, representing a 22% increase above the nearly 185 million e-bills we delivered during the year ended June 30, 2006. Our acquisitions of Corillian in May 2007, the revenue enhancement (“RevE”) service of Carreker in April 2007, and Aphelion in October 2005 provided additional revenue to our Electronic Commerce business. Offsetting growth in our Electronic Commerce business were the previously mentioned $11.0 million non-cash charge against revenue for warrants held by a customer that vested in the quarter ended March 31, 2007, the impact of purchase accounting adjustments to deferred revenue related to Corillian and the RevE service from Carreker, the decline in revenues from Microsoft and FDC, and reductions in interest-based revenue resulting from our largest bank customer migrating to our standard risk-based payment processing model in the quarter ended March 31, 2006.

 

Successful efforts to improve efficiency and quality have resulted in lower cost per transaction, allowing us to share scale efficiencies with our customers through volume-based pricing discounts. When combined with the aforementioned reductions of high margin revenue minimums and interest-based revenue, and absent the non-cash charge for warrants, our Electronic Commerce operating margin has declined from 37% for the year ended June 30, 2006, to 35% for the year ended June 30, 2007. See “Segment Information” below for a presentation of financial information by segment, including a discussion of segment operating margin.

 

During the quarters ended June 30, 2006 and September 30, 2006, we experienced sequential quarterly transaction growth which was lower than our expectations. Since then, we have performed analysis on the causes, including a regression analysis of key transaction volume drivers on a large portion of our CSP customers for our last four fiscal years. Our analysis has revealed a previously undetected cyclical pattern within the quarters of a given fiscal year that does not impact overall annual transaction growth. We have learned that the sequence of long months or short months in a given quarter, the sequence of long or short months before and after a quarter end date and the mix of processing and non-processing days within the quarter affects sequential quarterly transaction growth. We now believe that, barring unusual events, CSP based sequential quarterly transaction growth in the first and fourth quarters of our fiscal year tends to be lower than CSP based sequential quarterly transaction growth in the second and third quarters of our fiscal year. As a result, we believe we are better able to forecast transaction activity; however, we cannot assure that we will always be able to accurately forecast such growth. While we do not believe we have identified all factors that could affect transaction growth, including various consumer behavior patterns, we believe that recent consumers to the service engage in fewer transactions than new consumers added to the service in previous years. Finally, our analysis has revealed that it is important for investors to understand the differing growth patterns between CSP and non-CSP customers. Therefore, we have enhanced the reporting of our Electronic Commerce Division metrics to include separate revenue and volume trends for our CSP, non-CSP and e-bill delivery customers. See “Electronic Commerce Segment Information” for the years ended June 30, 2007, 2006 and 2005 under “Segment Information” below in this Management’s Discussion and Analysis for a 12-quarter trend of these metrics.

 

Revenue in our Software Division of $125.5 million for the year ended June 30, 2007, represents growth of 15% over last year due primarily to our acquisition of Carreker, but also due to stronger sales in our global treasury and securities products in fiscal 2007. Excluding the $9.7 million impact of purchase accounting on deferred revenue, year over year revenue growth would have been 24%. Our operating margin decreased slightly from 19% for the year ended June 30, 2006 to 18% for the current year due primarily to the addition of a breakeven Carreker business in the quarter ended June 30, 2007.

 

Our Investment Services Division generated 17% year-over-year growth in portfolios managed to more nearly 2.7 million as of June 30, 2007, from nearly 2.3 million for the previous year. We continue to invest heavily in the rewrite of our CheckFree APL operating system, named CheckFree EPL^sm (Enhanced Portfolio Lifecycle). Despite the resulting lower near-term operating margin, we expect this investment to provide us the opportunity to expand our services into the rapidly growing separately managed accounts (“SMA” and “SMAs”) market. In September 2005, we purchased substantially all of the assets of Integrated Decision Systems, Inc. (“IDS”) and, in February 2006, we divested our M-Solutions business. Along with steady underlying portfolio growth, we expect our operating margin in Investment Services to remain in the upper teens to low twenty percent level until we complete our system rewrite and the related migration of our

customer base to the new operating platform. See “Segment Information” below for a presentation of financial information by segment, including a discussion of segment operating margin.

 

During the quarter ended September 30, 2006, we repurchased 2,637,747 shares of our common stock for $100 million, and during the quarter ended December 31, 2006, we repurchased another 1,273,807 shares for $50 million, at a combined weighted average per share price of $38.35. Additionally, due to the further use of cash combined with draws against our revolving credit facility to fund our acquisitions of Carreker, Corillian and Upstream, we ended fiscal 2007 with a $204 million outstanding balance on the revolving credit facility.

 

As you review our historical financial information in this Annual Report on Form 10-K, you should be aware that, in the quarter ended March 31, 2006, we divested of M-Solutions, a business within our Investment Services segment. SFAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” requires that we report the results of operations from the divested business separately as earnings from discontinued operations for all periods presented. Therefore, we have restated historical statements of operations data for the year ended June 30, 2006 and 2005, to exclude M-Solutions from income from continuing operations.

 

The following table sets forth as percentages of total revenues, consolidated statements of operations data:

 

Results of Operations

 

Years Ended June 30, 2007 and 2006

 

The following table sets forth our consolidated revenues for the years ended June 30, 2007 and 2006, respectively:

 

Total Revenues (000’s)

 

 

Our growth in total revenues of 10.6% was driven by 9% growth in our Electronic Commerce business, 15% growth in our Software business and 16% growth in our Investment Services business.

 

Overall growth in Electronic Commerce, including the acquisition of Corillian in May 2007 and the RevE service from the acquisition of Carreker in April 2007, continued to be driven primarily by more than 16% growth in transactions processed, from more than 1.1 billion in the year ended June 30, 2006, to more than 1.3 billion in the year ended June 30, 2007. Included in our transaction-based revenue was a full year of operations from our acquisition of PhoneCharge in January 2006, against only six months of operations in the prior year. We delivered approximately 226 million e-bills during fiscal 2007, a growth rate exceeding 22% over the nearly 185 million e-bills delivered during fiscal 2006. We have experienced growth in our Health & Fitness products, driven primarily by our acquisition of Aphelion in October 2005. Also, our previously mentioned acquisition of Corillian and the RevE service from Carreker provided more than $23 million of additional revenue on a combined basis in our year ended June 30, 2007. Revenue growth has been negatively impacted by several factors over the past year. We have established pricing models that provide volume-based discounts in order to share scale efficiencies with our customers. As a result of continued transaction growth and better utilization of efficiencies of scale, our CSP based average revenue per transaction continued to decline. During fiscal 2006, our TransPoint related contracts with Microsoft and FDC expired, which, on a combined basis, negatively impacted total company revenue growth by about 2%. Also, our largest bank customer migrated from a processing model that guarantees funds, to our standard risk-based processing model, which negatively impacted our interest-based revenue. Finally, within the quarter ended March 31, 2007, we recorded a non-cash charge of $11.0 million as a reduction in revenue for the fair value of one million performance-based warrants held by a bank customer that vested in the quarter.

 

Growth in our Software business has been driven primarily by increased sales of our global treasury and securities products, also known as transaction process management, combined with modest growth in maintenance revenue resulting from new license sales and positive annual customer retention, offset somewhat by lower consulting services revenue. Additionally, our acquisition of Carreker provided a full quarter of new license, maintenance and professional services revenue, albeit discounted by the impact of purchase accounting on deferred revenue assumed in the acquisition.

 

Growth in Investment Services revenue was driven primarily by a 17% increase in portfolios managed, from nearly 2.3 million at June 30, 2006, to nearly 2.7 million as of June 30, 2007. We continue to add new portfolios to our CheckFree APL system at lower price points, driven by increased volume coming from lower priced broker dealers, and by conscious price reductions at contract renewal, where we trade off near-term revenue growth against long-term strategic advantage. Additionally, our acquisition of IDS in September 2005 provided a full year of revenue during fiscal 2007 versus just over three quarters in fiscal 2006. We received little revenue from our May 31, 2007 acquisition of Upstream.

 

Across all segments of our business, for the year ended June 30, 2007, Bank of America generated total revenue of $189.5 million, which exceeded 19% of our consolidated revenues. The majority of this revenue comes from within our Electronic Commerce Division. Bank of America revenue was positively impacted by their acquisition of Fleet Bank, not previously a customer of ours, and MBNA, which was previously a customer but is now included in Bank of America’s revenue. Our Electronic Commerce agreement with Bank of America has a 10-year term expiring in 2010. The contract includes annual minimum revenue guarantees of

$50.0 million, provides tiered pricing which reflects the volume of activity provided by Bank of America and provides for up to five million incentive-based warrants that the bank can earn upon reaching various levels of subscriber adoption and the delivery of e-bills, one million of which the bank earned in the quarter ended March 31, 2007. Bank of America remains the only customer that exceeds 10% of our consolidated revenues.

 

The following tables set forth comparative revenues, by type, for the years ended June 30, 2007 and 2006, respectfully.

 

Processing and Servicing Revenue (000’s)

 

 

We earn processing and servicing revenue in both our Electronic Commerce and our Investment Services businesses. Annual revenue growth was driven primarily by growth in payment transactions processed and e-bills delivered within Electronic Commerce as well as portfolio growth within Investment Services. Total payment transactions increased by more than 16%, from more than 1.1 billion for the year ended June 30, 2006 to more than 1.3 billion for the year ended June 30, 2007, composed of approximately 24% growth in CSP based transactions and a decline of 4% in non-CSP based transactions. Revenue growth from CSP based payment transaction growth was offset by tier-based volume pricing discounts, the expiration of the monthly minimum revenue guarantees from Microsoft in December 2005 and FDC in August 2005, and the negative impact on interest-based revenue from the migration of our largest bank customer from a processing model that guarantees funds to our standard risk-based processing model; all of which, on a combined basis, resulted in a $0.10 decrease in average revenue per CSP transaction for the year. This revenue per transaction decrease does not reflect the $11.0 million non-cash warrant charge in the quarter ended March 31, 2007. Our acquisition of PhoneCharge in January 2006 provided transaction growth in relatively high-priced phone-based payments in our non-CSP based business. This growth was offset by a decline in walk-in payments as customers began shifting to a consumer fee-based pricing model, which provides us with fewer, but more profitable, transactions and a decline in payments made directly at biller websites. The change in the mix within the non-CSP area resulted in a $0.13 increase in average revenue per non-CSP transaction for the year. We delivered approximately 226 million e-bills during the year ended June 30, 2007, representing an increase of 22% over the nearly 185 million e-bills delivered in the previous year. We experienced year-over-year growth in our Health & Fitness products, driven primarily by our acquisition of Aphelion in October 2005. We experienced 17% growth in portfolios managed in our Investment Services division, from nearly 2.3 million as of June 30, 2006, to nearly 2.7 million as of June 30, 2007.

 

During the quarters ended June 30, 2006 and September 30, 2006, we experienced sequential quarterly transaction growth which was lower than our expectations. We experienced a greater-than-expected dip in transactions in April 2006 combined with transaction growth for the rest of the quarter that was not as significant as previous years, and a slowdown in consumer activity at our largest bank customer. Since then, we have performed analysis on the causes, including a regression analysis of key transaction volume drivers on a large portion of our CSP customers for our last four fiscal years. We have learned that the sequence of long months or short months in a given quarter, the sequence of long or short months before and after a quarter-end date and the mix of processing and non-processing days within the quarter affects sequential quarterly transaction growth. We have also learned that the slowdown in consumer activity at our largest bank customer was affected by the combination of that customer’s shift to our standard risk-based processing model in the quarter ended March 31, 2006, and a somewhat slower transaction growth rate given the industry-leading consumer penetration at that customer.

 

Our analysis has revealed a previously undetected cyclical pattern within the quarters of a given fiscal year that does not impact overall annual transaction growth. We now believe that, barring unusual events, CSP-based sequential quarterly transaction growth in the first and fourth quarters of our fiscal year tends to be lower than CSP-based sequential quarterly transaction growth in the second and third quarters of our fiscal year. As a result, based on what we have learned over the past year, we believe we are better able to forecast

transaction growth; however, we cannot assure that we will always be able to accurately forecast such growth. While we do not believe we have identified all factors that could affect transaction growth, including various consumer behavior patterns, and while we will continue to analyze our transaction growth patterns for evidence of other such factors, we believe that recent consumers to the service engage in fewer transactions than new consumers added to the service in previous years. Our analysis has revealed that it is important for investors to understand the differing growth patterns between CSP and non-CSP customers. Therefore, as previously mentioned, we have enhanced the reporting of our Electronic Commerce Division metrics to include separate revenue and volume trends for our CSP, non-CSP and e-bill delivery customers.

 

License Fee Revenue (000’s)

 

 

Historically, we derived license fee revenue almost entirely from product sales in our Software Division. However, with our May 2007 acquisition of Corillian, we will begin to reflect meaningful license fee revenue in our Electronic Commerce Division. Growth in license fee revenue is due primarily to increased sales of our global treasury products in fiscal 2007, due in large part to the successful integration of products resulting from our acquisition of Accurate Software, Ltd. (“Accurate”) in April 2005. Additionally, our acquisitions of Carreker and Corillian in the quarter ended June 30, 2007 contributed approximately 7% of our license revenue growth for the year.

 

Maintenance Fee Revenue (000’s)

 

 

Maintenance fees, which represent annually renewable product support for our software customers, primarily relate to our Software Division, and tend to grow with incremental license sales from previous periods. Our maintenance base continues to grow as a result of recent license sales, high annual customer retention, and moderate price increases across all of our Software businesses. However, our September 2005 acquisition of IDS within our Investment Services Division, our April 2007 acquisition of Carreker within our Software Division and our May 2007 acquisition of Corillian within our Electronic Commerce Division resulted in new sources of maintenance revenue for us, and represent nearly 16% of our annual growth in maintenance revenue on a combined basis. We recognize maintenance fees ratably over the term of the related contractual support period. Based on the nature of maintenance fees, we would expect minimal future growth without continued incremental license sales.

 

Professional Fee Revenue (000’s)

 

 

Professional fee revenue consists primarily of consulting and implementation fees across all three of our divisions. Our expanded product lines over the past several years, including our acquisitions of Carreker, Corillian and Upstream in the quarter ended June 30, 2007, have provided us additional opportunities to offer services to our customers. On a combined basis, the addition of Carreker, Corillian and Upstream provided nearly 26% of our growth in professional services revenue for the year. Because professional fees are typically project oriented, they will fluctuate from period to period. Unlike most of our existing software applications, software products associated with our recent acquisitions of Carreker and Corillian require significant consulting services for customer installation and customization. Therefore, we expect growth in professional service fee revenue in the coming fiscal year. Growth in professional fees from our recent acquisitions has

been offset somewhat by a modest decline in legacy software services due to fewer large contracts during fiscal 2007.

 

Cost of Processing, Servicing and Support (000’s)

 

 

Cost of processing, servicing and support, as a percentage of revenue, has increased by 2.3% on a year-over-year basis. Excluding the non-cash warrant charge in the quarter ended March 31, 2007, cost of processing, as a percentage of revenue, has increased by 1.8% on a year-over-year basis. This is due in large part to the previously mentioned loss of high margin Microsoft and FDC revenues in the first half of fiscal 2006 and the negative impact on interest-based revenue from our largest customer changing payment processing models in the quarter ended March 31, 2006. In both Electronic Commerce and Investment Services, we continue to focus investment on additional efficiency and quality improvement within our customer care processes and our information technology infrastructure, and are leveraging a significantly fixed cost infrastructure to drive improvement in cost per transaction processed and cost per portfolio managed. Within Electronic Commerce, our electronic payment rate is currently 84%. Electronic payments carry a significantly lower variable cost per unit than paper-based payments and are far less likely to result in a costly customer care claim. It is difficult to raise the electronic rate above the 84% level as it takes an increasing number of relatively small merchants to sign up for electronic payment receipt to improve the number a single percentage point. Also, a portion of the pay by phone transactions are credit card payments, carrying interchange fees, which place downward pressure on gross margins for that part of the business. Relatively high growth in credit card payments in the future could place downward pressure on the gains we expect from continued Six Sigma-based process improvements within our Electronic Commerce business. Looking forward, we expect some near-term pressure on our gross margin as we invest in resources to support our data center and high-availability disaster recovery efforts. These efforts began in earnest in the quarter ended June 30, 2006, and we expect continued incremental investment in this area well into fiscal 2008.

 

Due to the relative significance of the incremental maintenance and service fee revenue resulting from the acquisitions of Carreker and Corillian in the quarter ended June 30, 2007, nearly 3% of the growth in cost of processing, servicing and support has resulted from these two acquisitions alone.

 

Research and Development (000’s)

 

 

Research and development cost as a percentage of revenue has remained fairly consistent over the past year as we continue to invest in product enhancement and productivity improvement initiatives in all of our core businesses, including the rewrite of our operating system within Investment Services, named CheckFree EPL. Testing of EPL has begun and we are currently scheduled to begin initial customer migration in the first half of fiscal 2008. We have incurred combined incremental research and development costs of about $6.7 million from our acquisitions of IDS in September 2005, Aphelion in October 2005, PhoneCharge in January 2006, Carreker in April 2007, Corillian in May 2007 and Upstream in May 2007.

Sales and Marketing (000’s)

 

 

Approximately 9% of the absolute dollar increase in sales and marketing expense is the combined result of our acquisitions of IDS, Aphelion, PhoneCharge, Carreker, Corillian and Upstream. In addition to the impact of acquisitions, growth in sales and marketing cost is mainly due to a general increase in sales costs in our Software Division related to license sales growth and an increase in marketing program costs in Electronic Commerce geared toward improved consumer adoption and greater insight into consumer behavior.

 

General and Administrative (000’s)

 

 

Although acquisition related synergy actions were announced internally before June 30, 2007, certain of the associates within the general and administrative area will remain well into next fiscal year to ensure an effective migration of internal systems. Absent these carryover expenses, we have largely been able to leverage our general and administrative costs.

 

Depreciation and Amortization (000’s)

 

 

Depreciation and amortization expenses resulting from the purchase of operating fixed assets and capitalized software development costs increased to $47.0 million for the year ended June 30, 2007, from $43.1 million for the year ended June 30, 2006. It should be noted that approximately $30 million of the year-over-year property, plant and equipment additions on our balance sheet for the year ended June 30, 2007, relate to construction-in-progress for the addition of a data center facility. We do not expect to begin depreciating this asset until it becomes operational some time in the second quarter of fiscal 2008. The remainder of our depreciation and amortization expense represents purchase accounting amortization.

 

Despite additional amortization from intangible assets acquired from IDS in September 2005, Aphelion in October 2005, PhoneCharge in January 2006, Carreker in April 2007, Corillian in May 2007 and Upstream in May 2007, purchase accounting amortization expense decreased overall due to intangible assets that fully amortized during fiscal 2006. In particular, completion of the amortization of the TransPoint strategic agreements in the quarter ended September 30, 2005 resulted in a decrease in amortization expense of approximately $16.5 million on a year-over-year basis. We expect a full year of amortization of intangible assets resulting from the aforementioned acquisitions of Carreker, Corillian and Upstream will cause a relatively significant increase in purchase accounting amortization for the year ending June 30, 2008. See Note 2 to the consolidated financial statements included within this Annual Report on Form 10-K for further information regarding the value of intangible assets and their related useful lives, resulting from each acquisition.

Equity in Loss of Joint Venture (000’s)

 

 

In April 2004, we announced a joint venture, OneVu Limited (“OneVu”), with Voca Limited (“Voca”), to create an integrated electronic billing and payment network for billers and banks in the United Kingdom. We have an equity interest of approximately 46.6% in OneVu and, therefore, we account for our interest in OneVu under the equity method of accounting. We provided 100% of OneVu’s necessary working capital requirements during its formative stage and, therefore, the equity in net loss of OneVu represented 100% of losses incurred by OneVu through March 31, 2006. In March 2006, we entered into an additional funding arrangement with Voca related to OneVu whereby both joint venture partners contributed approximately $830,000 in exchange for a security interest in OneVu subordinate to our previous funding. OneVu obtained a line of credit facility from a bank in the amount of approximately $2.7 million and we have guaranteed the credit facility. Accordingly, beginning in April 2006, we continued to record the operations of OneVu on the equity basis of accounting now recognizing 46.6% of the results of operations of OneVu. Because of our debt guarantee, our portion of the operating losses has caused the carrying value of our investment in the joint venture to fall below zero, becoming a liability in the quarter ended September 30, 2006. The liability will continue to increase as long as the joint venture incurs losses and will be reduced by our share of any profits.

 

Net Interest (000’s)

 

 

Cash flow provided by operating activities during the year ended June 30, 2007 was used to fund a $150 million share repurchase program and a significant portion of our acquisitions of Carreker, Corillian and Upstream. The related decline in average invested assets for the year resulted in lower interest income. The remainder of our acquisition costs were funded through draws against our revolving credit facility in the quarter ended June 30, 2007. As of June 30, 2007 the outstanding balance on the revolving credit facility was approximately $204 million. The increase in interest expense is due primarily to the debt service on the revolving credit facility. Our data center financing agreement accumulated a balance of $40 million as of June 30, 2007; however, construction period interest expense related to the data center credit facility has been capitalized to construction-in-progress and interest expense from this credit facility will not impact our income statement until the data center is placed in service, currently expected in the second quarter of fiscal 2008.

 

Income Tax Expense (000’s)

 

 

Our overall blended statutory rate (federal, state and foreign combined) approached 38.5%. Our effective rate of 37.6% and 38.1% for the years ended June 30, 2007 and 2006, respectively, was lower than our blended statutory rate due to tax free municipal interest income earned on our investment portfolio, earned

research and development tax credits and differing income tax rates in the various tax jurisdictions in which we operate, net of certain valuation allowances against net operating losses in certain tax jurisdictions that we do not anticipate using in the future.

 

Earnings from Discontinued Operations (000’s)

 

 

In the quarter ended March 31, 2006, we divested the assets of M-Solutions, a component of Investment Services. SFAS 144, “Accounting for the Impairment or Disposal of Long-Lives Assets,” requires that we report the results of operations from the divested business, including the $12.8 million gain on the sale, separately as earnings from discontinued operations for all periods presented. Other than the gain itself, M-Solutions historically provided modest earnings on an annual basis.

 

Income Tax Expense on Discontinued Operations (000’s)

 

 

Our earnings from discontinued operations include a $12.8 million gain on the sale of M-Solutions in the year ended June 30, 2006. Our book basis gain on the sale includes the impact of the related write-off of goodwill, which is non-deductible for income tax purposes. The higher tax basis gain on the sale resulted in an effective rate of 56.4% for fiscal 2006.

 

Years Ended June 30, 2006 and 2005

 

The following table sets forth our consolidated revenues for the years ended June 20, 2006 and 2005, respectively.

 

Total Revenues (000’s)

 

 

Our growth in total revenues of 17% was driven by 14% growth in our Electronic Commerce business, 21.8% growth in our Investment Services business and 35% growth in our Software business.

 

Overall growth in Electronic Commerce, including our telephone bill pay business acquired in January 2006, was driven primarily by 25% growth in transactions processed, from almost 905 million in the year ended June 30, 2005, to over 1.1 billion in the year ended June 30, 2006. We also delivered nearly 185 million e-bills during fiscal 2006, a growth rate of 32% over about 140 million e-bills delivered during fiscal 2005. As interest rates rose throughout fiscal 2006, we experienced revenue growth in our interest-sensitive products such as Account Balance Transfer (“ABT”). Finally, we earned modest revenue growth from our October 2005 acquisition of Aphelion. Revenue growth was negatively impacted by several factors during the year ended June 30, 2006. Our pricing models provide volume-based discounts in order to share scale efficiencies with our customers. Therefore, as a result of significant transaction growth and better utilization of efficiencies of scale, our average revenue per transaction continued to decline with respect to our transaction-based revenue. During fiscal 2006, our TransPoint related contracts with Microsoft and FDC expired, which, on a combined basis, negatively impacted revenue growth by about 3% in the year. Also, our largest bank customer migrated from a processing model that guarantees funds to our standard risk-based processing model, which negatively

impacted our interest-based revenue and resulted in the loss of another percentage point of revenue growth in fiscal 2006.

 

Growth in our Investment Services business was driven primarily by a 20% increase in portfolios managed, from 1.9 million at June 30, 2005, to nearly 2.3 million at June 30, 2006. During the year ended June 30, 2006, we added new portfolios to our CheckFree APL system at a lower price point, driven by the increased volume coming from lower priced broker dealers, and by conscious price reductions, where we trade off near-term revenue growth against long-term strategic advantage. Additionally, our September 2005 acquisition of IDS improved fiscal 2006 revenue growth within Investment Services by about 5%.

 

Growth in our Software business was due primarily to a full year of Accurate operations in fiscal 2006 as compared to less than three months of Accurate operations in fiscal 2005. As a result of the effective integration of Accurate, we achieved solid growth in our ORM line of business. We believe this to have been the combined result of improved execution within the Software Division and improvement in the U.S. economy during fiscal 2006.

 

Across all segments of our business, for the year ended June 30, 2006, Bank of America generated total revenue of $173.7 million, which exceeded 19% of our consolidated revenues. Bank of America was the only customer that exceeded 10% of our consolidated revenue.

 

The following tables set forth comparative revenues, by type, for the years ended June 30, 2006 and 2005, respectively.

 

Processing and Servicing Revenue (000’s)

 

 

While stable growth in portfolios managed in our Investment Services business contributed positively, the increase in processing and servicing revenue was attributed primarily to the aforementioned transaction growth in our Electronic Commerce business. Annual growth in transactions was favorably influenced by our phone-based bill payment offering, resulting from the acquisition of PhoneCharge in January 2006. Our traditional electronic bill payment products provided the remainder of growth within Electronic Commerce. During fiscal 2006, we delivered nearly 185 million e-bills, representing 32% growth over the 140 million e-bills delivered during fiscal 2005, with an average price of $0.16 per e-bill in each year. Additionally, with interest rates rising over the fiscal year ended June 30, 2006, we experienced revenue growth from our interest-sensitive products. Annual volume-based growth in processing and servicing revenue was somewhat offset by tier-based volume pricing discounts within both our Electronic Commerce and Investment Services businesses. Additionally, growth was negatively impacted by the aforementioned expiration of our processing contracts with Microsoft in December 2005 and FDC in August 2005, and the impact on interest-based revenue resulting from our largest bank customer migrating to a risk-based processing model during the quarter ended March 31, 2006.

 

We experienced a greater than expected dip in transactions in April 2006 combined with transaction growth for the rest of the quarter that was no as significant as previous years, and a slowdown in consumer activity at our largest bank customer. This phenomenon was not solely bank-based, as transaction growth slowed in all payment channels — on-line, biller direct, walk-in and phone-based transactions. We were not fully certain as to all of the reasons for this lower than anticipated transaction growth and we entered fiscal 2007 focusing our analysis toward consumer and payment activity. See “Executive Summary” above in this Management’s Discussion and Analysis for a discussion of our analysis of transaction growth following the end of fiscal 2006.

License Fee Revenue (000’s)

 

 

Our acquisition of Accurate in April 2005 contributed significantly to our license revenue growth in fiscal 2006 as integration efforts with our core products resulted in a significant increase in sales of our ORM product line. Sales of our integrated ORM product line were improving both domestically and internationally, and we were guardedly optimistic about our license sale growth opportunities as we entered fiscal 2007.

 

Maintenance Fee Revenue (000’s)

 

 

Our fiscal 2006 acquisition of Accurate provided about half of our year-over-year growth in maintenance revenue. The remainder resulted from annual customer retention rates that continue to exceed 80% and modest price increases across our software product lines.

 

Professional Fee Revenue (000’s)

 

 

On a year-over-year basis, growth in professional fee revenue resulted from increased revenue from large software services engagements across several products, increased biller implementation revenue, and a positive impact from our acquisitions of Accurate in April 2005, IDS in September 2005 and Aphelion in October 2005.

 

The following set of tables provides line-by-line expense comparisons with their relative percentages of our consolidated revenues for the years ended June 30, 2006 and 2005, respectively.

 

Cost of Processing, Servicing and Support (000’s)

 

 

Cost of processing, servicing and support, as a percentage of revenue, improved by about 0.6% on a year-over-year basis. In both Electronic Commerce and Investment Services, we continued to focus investment on additional efficiency and quality improvements within our customer care processes and our information technology infrastructure, and leveraging a significantly fixed cost infrastructure to drive improvement in cost per transaction and cost per portfolio managed. Within Electronic Commerce, while our electronic payment rate hovered around 83% for over a year, our January 2006 acquisition of PhoneCharge added electronic phone-based payment transactions, helping to raise and maintain our electronic payment rate at 84%. Electronic payments carry a significantly lower variable cost per unit than paper-based payments and are far less likely to result in a costly customer care claim. Also, a portion of the PhoneCharge transactions are credit card payments, carrying interchange fees, which place downward pressure on gross margins for that part of the business. As we exited fiscal 2006, we expected near-term pressure on our gross margin as we invested in resources to support our high availability disaster recovery efforts beginning in the quarter ended June 30, 2006.

Research and Development (000’s)

 

 

Including capitalized development costs of $0.9 million for the year ended June 30, 2006, and $1.7 million for the year ended June 30, 2005, gross expenditures for research and development were $102.8 million, or 11.7% of consolidated revenues, for the year ended June 30, 2006, and $81.7 million, or 10.9% of consolidated revenues, for the year ended June 30, 2005. In addition to increased research and development costs resulting from our acquisitions of Accurate in April 2005, IDS in September 2005, Aphelion in October 2005 and PhoneCharge in January 2006, we continued to invest in product enhancement and productivity improvement initiatives in all of our core businesses. In particular, a rewrite of our operating system within Investment Services was the primary driver of the increase in research and development costs as a percentage of revenue on a year-over-year basis.

 

Sales and Marketing (000’s)

 

 

The increase in sales and marketing costs, both in absolute dollars and as a percentage of revenue, was due primarily to our acquisitions of Accurate in April 2005, IDS in September 2005, Aphelion in October 2005 and PhoneCharge in January 2006. These businesses provided non-redundant marketing personnel, sales commissions and program costs and accounted for over 60% of our incremental sales and marketing costs in fiscal 2006. However, we continued to invest in incremental marketing programs and resources designed to further revenue growth in all of our business segments.

 

General and Administrative (000’s)

 

 

Although general and administrative costs continued to increase, we experienced improvement in general and administrative costs as a percentage of revenue. While we incurred incremental costs associated with our various acquisitions over the past year, we were able to effectively leverage corporate general and administrative resources through elimination of redundancy. Additionally, during fiscal 2005, we incurred significant Sarbanes-Oxley Act Section 404 compliance costs in preparation for our first internal control certification as of June 30, 2005. Once initial documentation and testing standards were established, we experienced a reduction in these compliance costs throughout fiscal 2006.

 

Depreciation and Amortization (000’s)

 

 

Depreciation and amortization expenses from operating fixed assets and capitalized software development costs increased modestly from $42.1 million for the year ended June 30, 2005, to $42.6 million for the year

ended June 30, 2006. The remainder of the change in depreciation and amortization expense represents a net reduction in acquisition-related amortization.

 

Despite additional amortization expense from intangible assets acquired from Accurate in April 2005, IDS in September 2005, Aphelion in October 2005 and PhoneCharge in January 2006, acquisition-related amortization expense decreased overall from intangible assets that fully amortized during fiscal 2006. In particular, completion of the amortization of the TransPoint strategic agreements resulted in a decrease in amortization expense of approximately $83.0 million on a year-over-year basis. These strategic agreements, which provided $99.0 million of amortization expense in fiscal 2005, fully amortized by the end of the first quarter of fiscal 2006.

 

Reorganization Charge (000’s)

 

 

Late in the quarter ended June 30, 2005, we terminated the employment of approximately 200 associates, re-scoping many positions with the intent to re-hire quickly, and eliminating some others. As part of this action, we moved our electronic billing and payment operations from Waterloo, Ontario, Canada to Norcross, Georgia, and closed the Canadian facility in October 2005. These actions resulted in a charge of $5.6 million.

 

Equity in Loss of Joint Venture (000’s)