##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-Q (Mark One) [x]
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   [  ]
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 Commission file number: 0-26802 CHECKFREE CORPORATION  Delaware
    
    58-2360335(State or Other Jurisdiction of
    
    (I.R.S. EmployerIncorporation or Organization)
    
    Identification No.)
 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) Not Applicable
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report) 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  [X]  NO  [  ] Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). YES  [X]  NO  [  ] Indicate the number of shares outstanding of each of the issuers classes
of common stock, as of the latest practicable date: 90,043,283 shares of
Common Stock, $.01 par value, were outstanding at May 10, 2004.




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FORM 10-Q CHECKFREE CORPORATION Table of Contents Page No.PART I. FINANCIAL INFORMATIONItem 1.
    Financial StatementsUnaudited Condensed Consolidated Balance Sheets at March 31, 2004 and June 30, 2003
    
    
    3Unaudited Condensed Consolidated Statements of Operations For the Three and Nine Months Ended March 31, 2004 and 2003
    
    
    4Unaudited Condensed Consolidated Statements of Cash Flows For the Nine Months Ended March 31, 2004 and 2003
    
    
    5Notes to Interim Unaudited Condensed Consolidated Financial Statements For the Three and Nine Months Ended March 31, 2004 and 2003
    
    
    6Item 2.
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    14Item 3.
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    29Item 4.
    Controls and Procedures
    
    
    29PART II. OTHER INFORMATIONItem 6.
    Exhibits and Reports on Form 8-K
    
    
    31Signatures
    
    
    33EXHIBIT 31(A)EXHIBIT 31(B)EXHIBIT 32(A)EXHIBIT 32(B)




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##### Table of Contents



Part I. Financial Information 
 Item 1. Financial Statements CHECKFREE CORPORATION AND SUBSIDIARIES 
 Unaudited Condensed Consolidated Balance Sheets
 March 31,
    
    June 30,2004
    
    2003(In thousands, except share data)ASSETSCURRENT ASSETS:Cash and cash equivalents
    
    $
    162,851
    
    
    $
    209,358Investments
    
    
    77,795
    
    
    
    69,674Restricted investments
    
    
    
    
    
    
    3,000Accounts receivable, net
    
    
    84,321
    
    
    
    74,846Accounts receivable, related parties
    
    
    7,243
    
    
    
    6,780Prepaid expenses and other assets
    
    
    10,387
    
    
    
    9,708Deferred income taxes
    
    
    63,243
    
    
    
    41,202Total current assets
    
    
    405,840
    
    
    
    414,568PROPERTY AND EQUIPMENT, NET
    
    
    86,223
    
    
    
    94,853OTHER ASSETS:Capitalized software, net
    
    
    13,319
    
    
    
    23,612Goodwill
    
    
    537,878
    
    
    
    523,231Strategic agreements, net
    
    
    302,376
    
    
    
    395,332Other intangible assets, net
    
    
    3,470
    
    
    
    4,801Investments
    
    
    77,305
    
    
    
    121,615Other noncurrent assets
    
    
    5,159
    
    
    
    9,258Total other assets
    
    
    939,507
    
    
    
    1,077,849Total assets
    
    $
    1,431,570
    
    
    $
    1,587,270LIABILITIES AND STOCKHOLDERS EQUITYCURRENT LIABILITIES:Accounts payable
    
    $
    10,004
    
    
    $
    9,705Accrued liabilities
    
    
    55,669
    
    
    
    59,140Current portion of long-term obligations
    
    
    4,469
    
    
    
    4,894Deferred revenue
    
    
    36,636
    
    
    
    36,543Total current liabilities
    
    
    106,778
    
    
    
    110,282ACCRUED RENT AND OTHER
    
    
    3,733
    
    
    
    3,419DEFERRED INCOME TAXES
    
    
    35,936
    
    
    
    28,728LONG-TERM OBLIGATIONS  LESS CURRENT PORTION
    
    
    2,291
    
    
    
    4,192CONVERTIBLE SUBORDINATED NOTES
    
    
    
    
    
    
    172,500STOCKHOLDERS EQUITY:Preferred stock - 50,000,000 authorized shares, $0.01 par value;
no amounts issued or outstanding
    
    
    
    
    
    
    Common stock - 500,000,000 authorized shares, $0.01 par value;
issued and outstanding 90,006,163 and 89,266,370 shares, respectively
    
    
    900
    
    
    
    893Additional paid-in-capital
    
    
    2,465,046
    
    
    
    2,449,374Accumulated other comprehensive income
    
    
    344
    
    
    
    471Accumulated deficit
    
    
    (1,183,458
    )
    
    
    (1,182,589
    )Total stockholders equity
    
    
    1,282,832
    
    
    
    1,268,149Total liabilities and stockholders equity
    
    $
    1,431,570
    
    
    $
    1,587,270
 See Notes to Interim Unaudited Condensed Consolidated Financial Statements. 3




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##### Table of Contents



CHECKFREE CORPORATION AND SUBSIDIARIES 
 Unaudited Condensed Consolidated Statements of Operations
 Three Months Ended
    
    Nine Months EndedMarch 31,
    
    March 31,2004
    
    2003
    
    2004
    
    2003(In thousands, except per share data)Revenues:Processing and servicing:Third parties
    
    $
    123,633
    
    
    $
    113,434
    
    
    $
    360,594
    
    
    $
    329,718Related parties
    
    
    11,193
    
    
    
    8,465
    
    
    
    30,124
    
    
    
    22,680Total processing and servicing
    
    
    134,826
    
    
    
    121,899
    
    
    
    390,718
    
    
    
    352,398License fees
    
    
    7,628
    
    
    
    5,703
    
    
    
    17,306
    
    
    
    16,647Maintenance fees
    
    
    7,044
    
    
    
    6,563
    
    
    
    21,157
    
    
    
    19,066Other
    
    
    5,740
    
    
    
    7,136
    
    
    
    17,257
    
    
    
    18,930Total revenues
    
    
    155,238
    
    
    
    141,301
    
    
    
    446,438
    
    
    
    407,041Expenses:Cost of processing, servicing and support
    
    
    60,732
    
    
    
    59,103
    
    
    
    180,818
    
    
    
    177,994Research and development
    
    
    17,199
    
    
    
    13,595
    
    
    
    48,204
    
    
    
    39,104Sales and marketing
    
    
    13,126
    
    
    
    13,631
    
    
    
    38,657
    
    
    
    40,582General and administrative
    
    
    12,413
    
    
    
    9,656
    
    
    
    35,608
    
    
    
    28,657Depreciation and amortization
    
    
    42,381
    
    
    
    57,011
    
    
    
    135,378
    
    
    
    170,987In-process research and development
    
    
    
    
    
    
    
    
    
    
    324
    
    
    
    Total expenses
    
    
    145,851
    
    
    
    152,996
    
    
    
    438,989
    
    
    
    457,324Income (loss) from operations
    
    
    9,387
    
    
    
    (11,695
    )
    
    
    7,449
    
    
    
    (50,283
    )Interest, net
    
    
    1,098
    
    
    
    (1,589
    )
    
    
    (8,490
    )
    
    
    (4,055
    )Loss on investments
    
    
    
    
    
    
    (1,297
    )
    
    
    
    
    
    
    (3,228
    )Income (loss) before income taxes and
cumulative effect of accounting change
    
    
    10,485
    
    
    
    (14,581
    )
    
    
    (1,041
    )
    
    
    (57,566
    )Income tax expense (benefit)
    
    
    2,789
    
    
    
    (6,751
    )
    
    
    (172
    )
    
    
    (25,247
    )Income (loss) before cumulative effect of
accounting change
    
    
    7,696
    
    
    
    (7,830
    )
    
    
    (869
    )
    
    
    (32,319
    )Cumulative effect of accounting change
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,894
    )Net income (loss)
    
    $
    7,696
    
    
    $
    (7,830
    )
    
    $
    (869
    )
    
    $
    (35,213
    )Basic income (loss) per share:Income (loss) before cumulative effect
of accounting change
    
    $
    0.09
    
    
    $
    (0.09
    )
    
    $
    (0.01
    )
    
    $
    (0.36
    )Cumulative effect of accounting change
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (0.03
    )Net income (loss)
    
    $
    0.09
    
    
    $
    (0.09
    )
    
    $
    (0.01
    )
    
    $
    (0.40
    )Weighted average number of shares
    
    
    89,924
    
    
    
    88,949
    
    
    
    89,669
    
    
    
    88,672Diluted income (loss) per share:Income (loss) before cumulative effect
of accounting change
    
    $
    0.08
    
    
    $
    (0.09
    )
    
    $
    (0.01
    )
    
    $
    (0.36
    )Cumulative effect of accounting change
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (0.03
    )Net income (loss)
    
    $
    0.08
    
    
    $
    (0.09
    )
    
    $
    (0.01
    )
    
    $
    (0.40
    )Weighted average number of shares
    
    
    92,053
    
    
    
    88,949
    
    
    
    89,669
    
    
    
    88,672
 See Notes to Interim Unaudited Condensed Consolidated Financial Statements. 4




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CHECKFREE CORPORATION AND SUBSIDIARIES 
 Unaudited Condensed Consolidated Statements of Cash Flows
 Nine Months EndedMarch 31,2004
    
    2003(In thousands)Operating activities:Net loss
    
    $
    (869
    )
    
    $
    (35,213
    )Adjustments to reconcile net loss to net cash provided by
operating activities:Depreciation and amortization
    
    
    135,378
    
    
    
    170,987Deferred income tax benefit
    
    
    (11,767
    )
    
    
    (24,274
    )Write off of convertible notes issuance costs
    
    
    2,407
    
    
    
    Write off of in-process research and development
    
    
    324
    
    
    
    Cumulative effect of accounting change
    
    
    
    
    
    
    2,894Impact of warrants
    
    
    
    
    
    
    (644
    )Loss on investments
    
    
    
    
    
    
    3,228Net loss on disposition of property and equipment
    
    
    9
    
    
    
    426Change in certain assets and liabilities:Accounts receivable
    
    
    (7,027
    )
    
    
    6,524Prepaid expenses and other
    
    
    1,213
    
    
    
    (3,301
    )Accounts payable
    
    
    (591
    )
    
    
    (370
    )Accrued liabilities and other
    
    
    (681
    )
    
    
    (1,370
    )Deferred revenue
    
    
    (1,196
    )
    
    
    (2,971
    )Net cash provided by operating activities
    
    
    117,200
    
    
    
    115,916Investing activities:Purchase of property and software
    
    
    (16,893
    )
    
    
    (20,800
    )Proceeds from sale of assets
    
    
    
    
    
    
    580Capitalization of software development costs
    
    
    (2,269
    )
    
    
    (3,133
    )Purchase of investments  held to maturity
    
    
    (511
    )
    
    
    (38,031
    )Proceeds from maturities of investments  held to maturity
    
    
    32,279
    
    
    
    102,047Purchase of investments  available for sale
    
    
    (135,602
    )
    
    
    (102,990
    )Proceeds from investments  available for sale
    
    
    142,829
    
    
    
    10,966Purchase of other investments
    
    
    (74
    )
    
    
    (85
    )Purchase of business, net of cash acquired
    
    
    (16,173
    )
    
    
    Net cash provided by (used in) investing activities
    
    
    3,586
    
    
    
    (51,446
    )Financing activities:Principal payments under capital lease and other long-term
obligations
    
    
    (3,179
    )
    
    
    (9,208
    )Redemption of convertible notes
    
    
    (172,500
    )
    
    
    Proceeds from stock options exercised
    
    
    5,584
    
    
    
    5,407Proceeds from employee stock purchase plan
    
    
    2,630
    
    
    
    2,271Net cash used in financing activities
    
    
    (167,465
    )
    
    
    (1,530
    )Effect of exchange rate changes on cash and cash equivalents
    
    
    172
    
    
    
    Net increase (decrease) in cash and cash equivalents
    
    
    (46,507
    )
    
    
    62,940Cash and cash equivalents:Beginning of period
    
    
    209,358
    
    
    
    115,009End of period
    
    $
    162,851
    
    
    $
    177,949
 See Notes to Interim Unaudited Condensed Consolidated Financial Statements. 5




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CHECKFREE CORPORATION AND SUBSIDIARIES 
 Notes to Interim Unaudited Condensed Consolidated Financial Statements
for the Three and Nine Months Ended March 31, 2004 and 2003
 1. Basis of Presentation and Summary of Significant Accounting Policies Unaudited Interim Financial Information The accompanying unaudited condensed consolidated financial statements and
notes thereto have been prepared in accordance with the rules and regulations
of the Securities and Exchange Commission for Form 10-Q and include all of the
information and disclosures required by generally accepted accounting
principles (GAAP) for interim financial reporting. The results of operations
for the three and nine months ended March 31, 2004 and 2003, are not
necessarily indicative of the results for the full year. These financial statements should be read in conjunction with the
financial statements, accounting policies and financial notes thereto included
in the Companys Annual Report on Form 10-K for the fiscal year ended June 30,
2003, as filed with the Securities and Exchange Commission on September 15,
2003. In the opinion of management, the accompanying unaudited condensed
consolidated financial statements reflect all adjustments (consisting only of
normal recurring adjustments), which are necessary for a fair representation of
financial results for the interim periods presented. Stock-Based Compensation The Company accounts for stock-based compensation in accordance with the
provisions of Accounting Principles Board (APB) Opinion No. 25, Accounting
for Stock Issued to Employees, and related interpretations. Accordingly,
compensation expense is not required to be recorded when stock options are
granted to employees as long as the exercise price is not less than the fair
market value of the stock when the option is granted, and in connection with
our Associate Stock Purchase Plan as long as the purchase price is not less
than 85% of the lower of the fair market value at the beginning or end of each
offer period. In October 1995, the Financial Accounting Standards Board
(FASB) issued Statement of Financial Accounting Standards (SFAS) 123,
Accounting for Stock-Based Compensation. SFAS 123 allows the Company to
continue to follow the present APB Opinion 25 guidelines, but requires
pro-forma disclosures of net income and earnings per share as if the Company
had adopted the provisions of the Statement. In December 2002, the FASB
issued SFAS 148, Accounting for Stock-Based Compensation - Transition and
Disclosure - an Amendment of FASB Statement No. 123, which provides
alternative methods of transition for an entity that voluntarily changes to the
fair value based method of accounting for stock-based employee compensation.
SFAS 148 requires prominent disclosure about the effects on reported net income
of an entitys accounting policy decisions with respect to stock-based employee
compensation and amends APB Opinion 28, Interim Financial Reporting, to
require disclosure about those effects in interim financial information. These
disclosure requirements became effective for the Companys third quarter of
fiscal 2003. The Company has continued to account for stock-based compensation
under the provisions of APB Opinion 25 using the intrinsic value method. Had compensation cost for the Companys stock-based compensation plans
been determined based on the fair value at the grant dates for awards under
those plans in accordance with the provisions of SFAS 123, the Companys net
loss and net loss per share would have been as follows (in thousands, except
per share data): 6




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Three Months Ended
    
    Nine Months EndedMarch 31,
    
    March 31,2004
    
    2003
    
    2004
    
    2003Net income (loss), as reported
    
    $
    7,696
    
    
    $
    (7,830
    )
    
    $
    (869
    )
    
    $
    (35,213
    )Stock-based compensation (reversal)
included in net income (loss), net of
tax
    
    
    346
    
    
    
    (125
    )
    
    
    1,381
    
    
    
    (107
    )Stock-based compensation under SFAS
123, net of tax
    
    
    (3,124
    )
    
    
    (6,249
    )
    
    
    (13,200
    )
    
    
    (21,573
    )Pro forma net income (loss)
    
    $
    4,918
    
    
    $
    (14,204
    )
    
    $
    (12,688
    )
    
    $
    (56,893
    )Pro forma net income (loss) per share:Basic
    
    $
    0.05
    
    
    $
    (0.16
    )
    
    $
    (0.14
    )
    
    $
    (0.64
    )Diluted
    
    $
    0.05
    
    
    $
    (0.16
    )
    
    $
    (0.14
    )
    
    $
    (0.64
    )
 Foreign Currency Translation For all non-U.S. subsidiaries, the functional currency is the local
currency. Assets, liabilities, revenues and expenses are translated using
current and historical exchange rates in accordance with SFAS No. 52, Foreign
Currency Translation. Translation adjustments are reported in accumulated
other comprehensive income, a separate component of shareholders equity. Recent Accounting Pronouncements FASB Interpretation No. 46 Consolidation of Variable Interest Entities
(FIN 46) was issued in January 2003 and addresses consolidation by business
enterprises of special purpose or off-balance sheet entities. In addition to
numerous FASB Staff Positions written to clarify and improve the application of
FIN 46, the FASB issued an amendment to FIN 46 entitled FASB Interpretation No.
46 (revised December 2003) Consolidation of Variable Interest Entities. FIN
46 requires a variable interest entity (VIE) to be consolidated if the
Companys variable interest (i.e., investment in the entity) will absorb a
majority of the entitys expected losses and/or residual returns if they occur.
FIN 46 was applicable immediately to any VIE formed after January 31, 2003. A
public entity with variable interests in a VIE created before February 1, 2003,
was required to apply the provisions of FIN 46 for the first interim or annual
reporting period ending after December 15, 2003. The implementation of FIN 46
did not have a material effect on the Companys financial position or results
of operations. Reclassifications Certain amounts in the prior years financial statements have been
reclassified to conform to the 2004 presentation. 2. Goodwill and Other Intangible Assets On July 1, 2002, the Company adopted SFAS 142, Goodwill and Other
Intangible Assets. SFAS 142 changes the accounting for goodwill and other
intangible assets. Goodwill is no longer subject to amortization over its
estimated useful life. Rather, goodwill is subject to at least an annual
assessment for impairment by applying a fair-value-based test. The Company
performs its annual impairment test as of April 30. In November 2003, the Company completed its acquisition of HelioGraph,
Ltd. for approximately $18,756,000 in cash. HelioGraph is a part of CheckFree
Financial and Compliance Solutions, a business unit within the Companys
Software Division. In connection with the acquisition of HelioGraph, the
Company recorded a charge of $324,000 for purchased in-process research and
development. The HelioGraph acquisition is not material to the Company. In December 2003, the Company announced an agreement to acquire American
Payment Systems, Inc., from its parent corporation UIL Holdings, for
approximately $110,000,000 in cash. The transaction is expected to 7




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close before June 30, 2004, subject to the receipt of state regulatory
approvals and satisfaction of customary closing conditions. This acquisition
will not be significant to the Company. As of March 31, 2004, the Companys only non-amortizing intangible asset
is goodwill of $537,878,000. The changes in the carrying value of goodwill by
segment from June 30, 2002, to March 31, 2004, were as follows (in thousands): Electronic
    
    
    
    
    
    InvestmentCommerce
    
    Software
    
    Services
    
    TotalBalance as of June 30, 2002
    
    $
    503,255
    
    
    $
    16,116
    
    
    $
    11,387
    
    
    $
    530,758Reclassification of workforce, net of tax
    
    
    483
    
    
    
    867
    
    
    
    
    
    
    
    1,350Impairment loss from adoption of SFAS 142
    
    
    
    
    
    
    (2,894
    )
    
    
    
    
    
    
    (2,894
    )Fourth quarter impairment loss
    
    
    
    
    
    
    (5,983
    )
    
    
    
    
    
    
    (5,983
    )Balance as of June 30, 2003
    
    
    503,738
    
    
    
    8,106
    
    
    
    11,387
    
    
    
    523,231Goodwill acquired
    
    
    
    
    
    
    14,647
    
    
    
    
    
    
    
    14,647Balance as of March 31, 2004
    
    $
    503,738
    
    
    $
    22,753
    
    
    $
    11,387
    
    
    $
    537,878
 The components of the Companys various amortized intangible assets are as
follows (in thousands): March 31,
    
    June 30,2004
    
    2003Capitalized software:Product technology from acquisitions and strategic agreement
    
    $
    167,458
    
    
    $
    166,578Internal development costs

    
    
    31,438
    
    
    
    29,170Total
    
    
    198,896
    
    
    
    195,748Less: accumulated amortization
    
    
    185,577
    
    
    
    172,136Capitalized software, net
    
    $
    13,319
    
    
    $
    23,612Strategic agreements:Strategic agreements (1)
    
    $
    744,424
    
    
    $
    744,424Less: accumulated amortization
    
    
    442,048
    
    
    
    349,092Strategic agreements, net
    
    $
    302,376
    
    
    $
    395,332Other intangible assets:Tradenames
    
    $
    48,078
    
    
    $
    47,968Customer base
    
    
    35,278
    
    
    
    34,758Covenants not to compete
    
    
    1,610
    
    
    
    1,200Total
    
    
    84,966
    
    
    
    83,926Less: accumulated amortization
    
    
    81,496
    
    
    
    79,125Other intangible assets, net
    
    $
    3,470
    
    
    $
    4,801
  (1)
    
    Strategic agreements primarily include certain entity-level covenants not to compete. Amortization of intangible assets totaled $33,431,000 and $47,664,000 for
the three months ended March 31, 2004 and 2003, respectively, and $108,768,000
and $143,408,000 for the nine months ended March 31, 2004 and 2003,
respectively. Amortization expense for the year ended June 30, 2004 and the
next four fiscal years is estimated to be as follows (in thousands): Fiscal Year Ending June 30,2004
    
    $
    136,4212005
    
    
    126,3132006
    
    
    42,9892007
    
    
    25,7832008
    
    
    25,565
 8




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3. Convertible Subordinated Notes In December 2003, the Company redeemed its 6.5% Convertible Subordinated
Notes that were due on December 1, 2006. The $172,500,000 principal amount,
along with a call premium of $4,813,000, was paid in cash. In addition, the
Company incurred a non-cash charge of $2,407,000 due to the write off of the
remaining unamortized bond issuance costs. These amounts are included in
interest expense for the nine months ended March 31, 2004. 4. Common Stock In the nine months ended March 31, 2004, the Company issued stock for
various employee benefit programs. The Company issued 149,844 shares to fund
its 401(k) match, the cost of which was accrued in the year ended June 30,
2003, and 173,693 shares of common stock in conjunction with its employee stock
purchase plan, which was funded through employee payroll deductions in the
immediately preceding six-month period. In June 2003, the Company made an offer (the Tender Offer) to certain
employees to exchange options with exercise prices greater than or equal to
$44.00 per share currently outstanding under the Companys 1983 Incentive Stock
Option Plan, 1983 Non-Statutory Stock Option Plan, 1993 Stock Option Plan,
Third Amended and Restated 1995 Stock Option Plan, BlueGill Technologies, Inc.
1997 Stock Option Plan, BlueGill Technologies, Inc. 1998 Incentive and
Non-Qualified Stock Option Plan, and 2002 Stock Incentive Plan, for restricted
stock units of the Companys common stock, and in certain cases, cash payments.
Restricted stock units issued under the Tender Offer will vest ratably over a
three-year period. The offer period closed on July 17, 2003, and employees
holding 1,163,668 options participated in the Tender Offer. The Company made
cash payments totaling $586,000 in July 2003 representing the cash
consideration portion of the Tender Offer and will issue up to 246,000 shares
of stock under the 2002 Stock Incentive Plan over the next three years as the
restricted stock units vest. The Company recorded an expense of $519,000 and
$2,215,000 for the three and nine months ended March 31, 2004, respectively,
for cash payments made and the vesting of restricted stock units. 5. Earnings Per Share The following table reconciles the differences in income and shares
outstanding between basic and diluted for the periods indicated (in thousands
except per share data): For the Three Months EndedMarch 31, 2004
    
    March 31, 2003Per-
    
    
    
    
    
    
    
    
    
    Per-Income/(Loss)
    
    Shares
    
    Share
    
    Income/(Loss)
    
    Shares
    
    Share(Numerator)
    
    (Denominator)
    
    Amount
    
    (Numerator)
    
    (Denominator)
    
    AmountBasic EPS
    
    $
    7,696
    
    
    
    89,924
    
    
    $
    0.09
    
    
    $
    (7,830
    )
    
    
    88,949
    
    
    $
    (0.09
    )Effect of dilutive
securities:Options and
warrants
    
    
    
    
    
    
    2,129
    
    
    
    
    
    
    
    
    
    
    
    Diluted EPS
    
    $
    7,696
    
    
    
    92,053
    
    
    $
    0.08
    
    
    $
    (7,830
    )
    
    
    88,949
    
    
    $
    (0.09
    )
 For the Nine Months EndedMarch 31, 2004
    
    March 31, 2003Per-
    
    
    
    
    
    
    
    
    
    Per-Income/(Loss)
    
    Shares
    
    Share
    
    Income/(Loss)
    
    Shares
    
    Share(Numerator)
    
    (Denominator)
    
    Amount
    
    (Numerator)
    
    (Denominator)
    
    AmountBasic EPS
    
    $
    (869
    )
    
    
    89,669
    
    
    $
    (0.01
    )
    
    $
    (35,213
    )
    
    
    88,672
    
    
    $
    (0.40
    )Effect of dilutive
securities:Options and warrants
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Diluted EPS
    
    $
    (869
    )
    
    
    89,669
    
    
    $
    (0.01
    )
    
    $
    (35,213
    )
    
    
    88,672
    
    
    $
    (0.40
    )
 Anti-dilution provisions of SFAS 128, Earnings Per Share, require
consistency between diluted per-common-share amounts and basic per-common-share
amounts in loss periods. Had the Company recognized net 9




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##### Table of Contents



income for the nine months ended March 31, 2004, an additional 5,354,000
of in-the-money options and warrants would have been included in the diluted
earnings per share calculation. Had the company recognized net income for the
three and nine months ended March 31, 2003, an additional 3,973,000 and
1,923,000 of in-the-money options and warrants would have been included in the
diluted earnings per share calculation, respectively. Using the treasury stock
purchase method prescribed by SFAS 128, this would have increased diluted
shares outstanding by 1,933,000 for the nine months ended March 31, 2004, and
1,082,000 and 342,000 for the three and nine months ended March 31, 2003,
respectively. The weighted average diluted common shares outstanding for the three and
nine months ended March 31, 2004 and 2003, exclude the effect of approximately
2,961,000, 3,255,000, 6,481,000 and 8,030,000 of out-of-the-money options and
warrants, respectively. In addition, the weighted average diluted common
shares outstanding for all periods exclude the 2,357,000 share effect for the
assumed conversion of the convertible subordinated notes, as their effect would
be anti-dilutive. The after-tax effect of interest expense on the convertible
subordinated notes for all periods has not been added back to the numerator, as
its effect would be anti-dilutive. The convertible subordinated notes were
redeemed in December 2003. 6. Reorganization Charges During the year ended June 30, 2002, the Company announced it would
streamline operations in its Electronic Commerce division, refine its strategy
for the i-Solutions business unit of its Software division, and discontinue
certain product lines associated with its Investment Services division. As a
result of these actions, the Company closed or consolidated operations in
several locations and eliminated certain other positions in the Company. The
consolidation of three legacy transaction processing platforms into the Genesis
platform in the Electronic Commerce division resulted in the closing of its San
Francisco, California location on April 30, 2002; its Houston, Texas location
on June 30, 2002; and its Austin, Texas location on September 30, 2002. The
refinement in strategy for the i-Solutions business resulted in the closing of
its Ann Arbor, Michigan and Singapore locations on March 19, 2002. As a result of these actions, during the year ended June 30, 2002, the
Company recorded $16,365,000 of reorganization charges for the year ended June
30, 2002, which included $1,640,000 of non-cash impairment charges, $10,962,000
of severance and related benefits costs for the termination of 707 employees,
and $3,763,000 of other exit costs, including lease termination fees and other
closure, employee and professional costs. For the year ended June 30, 2003,
the Company reviewed its estimated remaining liabilities under this
reorganization plan and recorded an additional charge of $1,405,000, which
included $165,000 of severance and related benefits and $1,240,000 of other
exit costs, including lease termination fees and other closure, employee and
professional costs. The Company expects the reorganization to be completed by
October 2005 and anticipates no additional charges. A summary of activity
related to the reorganization reserve is as follows (in thousands): OfficeSeverance
    
    Closureand Other
    
    andEmployee
    
    Business
    
    Other ExitCosts
    
    Exit Costs
    
    Costs
    
    TotalInitial reorganization charge
    
    $
    10,962
    
    
    $
    3,677
    
    
    $
    86
    
    
    $
    14,725Cash payments, year ended June 30, 2002
    
    
    (6,261
    )
    
    
    (649
    )
    
    
    (15
    )
    
    
    (6,925
    )Reorganization reserve at June 30, 2002
    
    
    4,701
    
    
    
    3,028
    
    
    
    71
    
    
    
    7,800Additional reorganization charge
    
    
    165
    
    
    
    1,248
    
    
    
    (8
    )
    
    
    1,405Cash payments, year ended June 30, 2003
    
    
    (4,866
    )
    
    
    (2,739
    )
    
    
    (63
    )
    
    
    (7,668
    )Balance as of June 30, 2003
    
    
    
    
    
    
    1,537
    
    
    
    
    
    
    
    1,537Cash payments, nine months ended
March 31, 2004
    
    
    
    
    
    
    (537
    )
    
    
    
    
    
    
    (537
    )Balance as of March 31, 2004
    
    $
    
    
    
    $
    1,000
    
    
    $
    
    
    
    $
    1,000
 10




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##### Table of Contents



7. Supplemental Disclosure of Cash Flow Information (in thousands) Nine Months EndedMarch 31,2004
    
    2003Interest paid
    
    $
    5,986
    
    
    $
    6,192Call premium paid for redemption of convertible notes
    
    $
    4,813
    
    
    $
    Income taxes paid
    
    $
    8,322
    
    
    $
    1,951Supplemental disclosure of non-cash investing and
financing activities:Capital lease and other long-term asset additions
    
    $
    954
    
    
    $
    13,017Stock funding of 401(k) match
    
    $
    3,144
    
    
    $
    3,229Stock funding of Associate Stock Purchase Plan
    
    $
    3,208
    
    
    $
    3,272
 8. Related Parties On September 1, 2000, the Company acquired MSFDC, L.L.C. (TransPoint)
from Microsoft Corporation (Microsoft), First Data Corporation (First
Data), and Citibank, N.A. in exchange for 17 million shares of common stock.
As part of the TransPoint acquisition, Microsoft received 8,567,250 shares of
common stock and Microsoft continues to own those shares as of March 31, 2004.
Pursuant to the terms of the TransPoint acquisition, Microsoft is entitled to
nominate one director to the Companys board for such time as they own at least
6,425,438 shares of common stock. Therefore, Microsoft is considered a related
party. In addition, the Company entered into a commercial alliance agreement with
Microsoft as part of the TransPoint acquisition. Under the terms of the
commercial alliance agreement, Microsoft, among other things, agreed to use the
Company for pay anyone and bill presentment services offered by Microsoft. The
commercial alliance agreement also provided for a minimum fee and revenue
guarantee to the Company of $120 million over the five year term of the
agreement. Pursuant to the terms of the TransPoint acquisition, First Data is
entitled to nominate one director to the Companys board for such time as they
own at least 4,925,438 shares of common stock. Although First Data owned less
than 4,925,438 shares of common stock as of March 31, 2004, First Data owned in
excess of 4,925,438 shares of common stock at the time of the directors most
recent re-election to the Board. The directors term expires at the 2005
Annual Meeting of Stockholders, and First Data is considered a related party
until such time. In addition, the Company entered into a marketing agreement with First
Data as part of the TransPoint acquisition. Under the terms of the marketing
agreement, the Company agreed to use certain First Data payment processing
services if, in each case using reasonable judgment, substantially similar
services are not then obtainable from a third party at an overall economic cost
to the Company that is less than the overall economic cost of First Datas
services. The marketing agreement also provided for a minimum fee and revenue
guarantee to the Company of $60 million over the five-year term of the
agreement. On January 10, 2002, the Company entered into an agreement for
check processing services with Integrated Payment Systems Inc., a subsidiary of
First Data. Microsoft and First Data operate substantially below their minimum monthly
commitments, and the Company does not expect these customers to increase their
activity such that they would operate above the minimum commitments in the next
twelve months. 9. Comprehensive Income (Loss) Comprehensive income (loss) represents net income (loss), plus certain
other items that are recorded directly to stockholders equity, as follows (in
thousands): 11




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##### Table of Contents



Three Months Ended
    
    Nine Months EndedMarch 31,
    
    March 31,2004
    
    2003
    
    2004
    
    2003Net income (loss)
    
    $
    7,696
    
    
    $
    (7,830
    )
    
    $
    (869
    )
    
    $
    (35,213
    )Other comprehensive income (loss):Foreign currency translation adjustments
    
    
    108
    
    
    
    
    
    
    
    108
    
    
    
    Unrealized holding gains (losses) on
investments, net of
tax
    
    
    134
    
    
    
    (7
    )
    
    
    (329
    )
    
    
    306Less: reclassification adjustments for
gains (losses) realized in net income
    
    
    1
    
    
    
    
    
    
    
    94
    
    
    
    Net unrealized gains (losses) on investments
    
    
    135
    
    
    
    (7
    )
    
    
    (235
    )
    
    
    306Comprehensive income (loss)
    
    $
    7,939
    
    
    $
    (7,837
    )
    
    $
    (996
    )
    
    $
    (34,907
    )
 10. Business Segments The Company operates in three business segments  Electronic Commerce,
Software and Investment Services along with a Corporate services segment.
These reportable segments are strategic business units that offer different
products and services. The Company evaluates performance based on revenues and
operating income (loss) of the respective segments. Segment operating income
(loss) excludes acquisition related intangible asset amortization and
significant one-time charges. There are no inter-segment sales. The following sets forth certain financial information attributable to the
Companys business segments for the three and nine months ended March 31, 2004
and 2003 (in thousands): Three Months Ended
    
    Nine Months EndedMarch 31,
    
    March 31,2004
    
    2003
    
    2004
    
    2003Revenues:Electronic Commerce
    
    $
    115,181
    
    
    $
    104,521
    
    
    $
    334,224
    
    
    $
    299,337Investment Services
    
    
    21,546
    
    
    
    20,439
    
    
    
    63,304
    
    
    
    60,907Software
    
    
    18,511
    
    
    
    16,341
    
    
    
    48,910
    
    
    
    46,797Total
    
    $
    155,238
    
    
    $
    141,301
    
    
    $
    446,438
    
    
    $
    407,041Segment operating income (loss):Electronic Commerce
    
    $
    41,001
    
    
    $
    31,881
    
    
    $
    113,884
    
    
    $
    83,419Investment Services
    
    
    4,485
    
    
    
    5,642
    
    
    
    14,011
    
    
    
    16,269Software
    
    
    4,554
    
    
    
    5,116
    
    
    
    10,347
    
    
    
    12,139Corporate
    
    
    (8,584
    )
    
    
    (8,344
    )
    
    
    (25,807
    )
    
    
    (24,450
    )Total
    
    
    41,456
    
    
    
    34,295
    
    
    
    112,435
    
    
    
    87,377Amortization of acquired intangible assets
    
    
    (32,069
    )
    
    
    (45,990
    )
    
    
    (104,662
    )
    
    
    (138,304
    )Write off of in-process research and development costs
    
    
    
    
    
    
    
    
    
    
    (324
    )
    
    
    Impact of warrants
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    644Loss on investments
    
    
    
    
    
    
    (1,297
    )
    
    
    
    
    
    
    (3,228
    )Interest, net
    
    
    1,098
    
    
    
    (1,589
    )
    
    
    (8,490
    )
    
    
    (4,055
    )Total loss before income taxes and
cumulative effect of accounting change
    
    $
    10,485
    
    
    $
    (14,581
    )
    
    $
    (1,041
    )
    
    $
    (57,566
    )
 12




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##### Table of Contents



11. Subsequent Events On April 2, 2004, the Company received a $25 million deposit from one of
its customers in connection with a contract modification relating to the timing
of transaction settlements. The agreement has an initial term of four years
and automatically renews thereafter unless terminated with 180 days notice.
During the term of the agreement, the Company will pay the customer a variable
rate of interest on a monthly basis equal to the then current overnight
repurchase agreement rate. The deposit will be reflected as a long-term
liability in the Companys financial statements. There are no restrictions on
the deposit, and the funds will be available for general corporate use. The
deposit will be refunded to the customer upon termination of the agreement. On April 23, 2004, the Company entered into three interest rate swap
agreements. Each swap agreement has a notional amount of $25 million and an
average life of 2.13 years. 13




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##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations 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. We operate our business through three independent but inter-related
divisions:  
    
    Electronic Commerce;  
    
    Investment Services; and  
    
    Software. Through our Electronic Commerce division, we enable consumers to receive
and pay bills electronically. For the year ended June 30, 2003, we processed
approximately 434 million electronic transactions and delivered approximately
32 million electronic bills. For the quarter ended March 31, 2004, we
processed over 152 million electronic payments and delivered approximately 22.5
million electronic bills. In the quarter ended March 31, 2004, there were
about 13 million consumers initiating payments via CheckFree supported
technology. The number of transactions we process each year continues to grow.
Growth in the number of transactions processed exceeded 37% for the year ended
June 30, 2003, and 36% for the quarter ended March 31, 2004, against the same
periods in the prior year. The Electronic Commerce division accounted for
approximately 74% of our revenue in the quarter ended March 31, 2004. Our Electronic Commerce divisions products allow consumers to:  
    
    receive electronic bills through the Internet;  
    
    pay any bill  whether it arrives over the Internet or through traditional mail  to anyone;  
    
    make payments not related to bills  to anyone; and  
    
    perform customary banking transactions, including balance
inquiries, transfers between accounts and on-line statement
reconciliations. Through our Investment Services division, we provide a range of outsourced
portfolio management services to financial institutions, including broker
dealers, money managers and investment advisors. As of March 31, 2004, our
clients used the CheckFree APL Portfolio Accounting System to manage
approximately 1.5 million portfolios totaling more than $900 billion in assets.
The Investment Services division accounted for approximately 14% of our
revenue in the quarter ended March 31, 2004. Our institutional client base includes investment advisors, brokerage
firms, banks and insurance companies. Our fee-based money manager clients are
typically sponsors or managers of wrap or separately managed accounts, money
management products, or traditional money managers, managing investments of
institutions and high net worth individuals. We also support a growing number
of third party vendors providing quick-to-market turnkey solutions. Our portfolio management systems are marketed under the product name
CheckFree APL and provide the following functions:  
    
    account open and trading capabilities;  
    
    graphical client reporting;  
    
    performance measurement;  
    
    decision support tools;  
    
    account analytics;  
    
    tax lot accounting;  
    
    multiple strategy portfolios;  
    
    straight through processing; 14




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##### Table of Contents




    
    Depository Trust Corporation interfacing;  
    
    billing functions; and  
    
    system and data security. In addition to our APL portfolio management products, our Investment
Services division also offers proposal generation, investment performance, and
reporting products and services. Marketed under M-Pact, M-Search and M-Watch,
these products are a result of our acquisition of Mobius Group, Inc. in March
1999. Through our Software division, we deliver software, maintenance, support
and professional services to large financial service providers and other
companies across a range of industries. The Software division is comprised of
three units, each with its own distinct set of software products. The ACH
Solutions unit provides software and services that are used to process more
than two-thirds of the nations nine billion annual Automated Clearing House
(ACH) payments. The CheckFree Financial and Compliance Solutions (CFACS) unit
enables organizations to handle their reconciliation and compliance
requirements. On November 1, 2003, we acquired HelioGraph, Ltd., a UK based
company that brings a financial transactions management solution with straight
through processing expertise to our CFACS suite of products, in addition to
international presence. The i-Solutions unit provides software and services
that enable end-to-end e-billing and e-statement creation, delivery and
payment. The Software division accounted for approximately 12% of our revenue
in the quarter ended March 31, 2004. Executive Summary For the quarter ended March 31, 2004, we generated net income of $7.7
million. While on a year to date basis we generated a net loss of $0.9
million, we expect to be profitable for our fiscal year ending June 30, 2004.
Through continued efforts to improve quality and efficiency throughout the
company, we have generated $100.3 million in free cash flow (which we define as
GAAP net cash provided from operating activities less capital expenditures)
through the nine months ended March 31, 2004, and are on track to generate
approximately $150.0 million in free cash flow for the fiscal year ended June
30, 2004, compared to the $133.5 million of free cash flow we generated in our
fiscal year ended June 30, 2003. See Use of Non-GAAP Financial Information
below for a further discussion of this measure. Free cash flow in this fiscal
year, combined with cash, cash equivalents, short term and long term
investments of $400.6 million as of June 30, 2003, allowed us to call our
$172.5 million of 6.5% convertible subordinated notes during the year.
Additionally, we used internally generated cash to acquire HelioGraph, Ltd. for
its net purchase price of approximately $16.2 million, and expect to fund the
closing of our planned acquisition of American Payment Systems, Inc. (APS) with
approximately $110.0 million in cash by the end of our fiscal year. Although
we have experienced increasingly positive operating results, we continue to
invest heavily in all of our businesses, to take full advantage of anticipated
growth opportunities. We continue to experience significant growth in transactions processed in
our Electronic Commerce business, as over 13 million consumers initiated
payments through CheckFree managed systems in the quarter ended March 31, 2004,
up from nine million at this time last year. We previously reported that four
large banks were moving their bill payment transactions to in-house managed
systems. Despite the completion of this migration early in fiscal 2004, we
have generated total transaction growth exceeding 33% on a year over year
basis. In the quarter ended December 31, 2003, we announced amended contract
terms with our largest customer, Bank of America, that resulted in a dampening
of revenue growth in the quarter ended March 31, 2004, as the bank converted to
a transaction based pricing model with volume based discounts that are more
predictable than in the past. Continued efforts to improve quality and
efficiency in our operations, combined with a steadily improving electronic
payment rate and our ability to leverage a significant fixed cost base, have
resulted in lower cost per transaction, offsetting volume based pricing
discounts. Additionally, quarterly e-bills delivered in the three months ended
March 31, 2004, exceeded 22.5 million, compared to 8.8 million in the same
period last year. We believe that added availability of electronic bills will
make electronic payment offerings even more compelling to consumers. Finally,
in an effort to penetrate a part of the electronic billing and payment market
in which we have not materially participated previously, in December 2003, we
announced plans to acquire APS, a leading provider of agent based bill payments
to the 20% of U.S. consumers who do not typically rely on bank products and
services. We expect the acquisition to close in the quarter ending June 30,
2004, and plan to explore opportunities to leverage the strengths of both
companies to further grow our business. 15




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##### Table of Contents



After two years of slow growth due to the impact of a recessionary economy
on the stock market, our Investment Services business is beginning to see
growth in the number of portfolios managed and related revenue. To take full
advantage of the emerging separately managed accounts market, we are investing
heavily to upgrade our technology infrastructure in this business. While the
near term investments will reduce our operating results in this segment over
the next several quarters, we expect these investments to result in increased
penetration and growth in this evolving market in the long-term. Our Software business generated higher license revenues in the quarter
ended March 31, 2004, than we have seen in over two years. Some of this
increased license revenue resulted from deals that were initially expected to
close in the second quarter of 2004, while others closed earlier than expected.
As we continue to fully integrate HelioGraph, which has added revenue to this
business over the last two quarters, and continue to see new license sales, we
expect improved operating results from the Software business. The following table sets forth as percentages of total operating revenues,
certain consolidated statements of operations data: Three Months Ended
    
    Nine Months EndedMarch 31,
    
    March 31,2004
    
    2003
    
    2004
    
    2003Total Revenues:
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Expenses:Cost of processing, servicing and support
    
    
    39.1
    %
    
    
    41.8
    %
    
    
    40.5
    %
    
    
    43.7
    %Research and development
    
    
    11.1
    %
    
    
    9.6
    %
    
    
    10.8
    %
    
    
    9.6
    %Sales and marketing
    
    
    8.5
    %
    
    
    9.7
    %
    
    
    8.7
    %
    
    
    10.0
    %General and administrative
    
    
    8.0
    %
    
    
    6.8
    %
    
    
    8.0
    %
    
    
    7.0
    %Depreciation and amortization
    
    
    27.3
    %
    
    
    40.4
    %
    
    
    30.3
    %
    
    
    42.0
    %In-process research and development
    
    
    
    
    
    
    
    
    
    
    0.1
    %
    
    
    Total expenses
    
    
    94.0
    %
    
    
    108.3
    %
    
    
    98.4
    %
    
    
    112.4
    %Income (loss) from operations
    
    
    6.1
    %
    
    
    (8.3
    )%
    
    
    1.7
    %
    
    
    (12.4
    )%Interest, net
    
    
    0.7
    %
    
    
    (1.1
    )%
    
    
    (1.9
    )%
    
    
    (1.0
    )%Loss on investments
    
    
    
    
    
    
    (0.9
    )%
    
    
    
    
    
    
    (0.8
    )%Income (loss) before income taxes and
cumulative effect of accounting change
    
    
    6.8
    %
    
    
    (10.3
    )%
    
    
    (0.2
    )%
    
    
    (14.1
    )%Income tax expense (benefit)
    
    
    1.8
    %
    
    
    (4.8
    )%
    
    
    
    
    
    
    (6.2
    )%Income (loss) before cumulative effect of
accounting change
    
    
    5.0
    %
    
    
    (5.5
    )%
    
    
    (0.2
    )%
    
    
    (7.9
    )%Cumulative effect of accounting change
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (0.7
    )%Net income (loss)
    
    
    5.0
    %
    
    
    (5.5
    )%
    
    
    (0.2
    )%
    
    
    (8.6
    )%
 16




---



##### Table of Contents



Results of Operations The following table sets forth total company revenue for the three- and
nine-month periods ended March 31, 2004 and 2003, respectively. Total Revenue (000s)
    
    March 31,
    
    Change2004
    
    2003
    
    $
    
    %Three months ended
    
    $
    155,238
    
    
    $
    141,301
    
    
    $
    13,937
    
    
    
    9.9
    %Nine months ended
    
    $
    446,438
    
    
    $
    407,041
    
    
    $
    39,397
    
    
    
    9.7
    %
 Quarter over quarter revenue growth was driven by 10% growth in our
Electronic Commerce business, 5% percent growth in our Investment Services
business, and a 13% increase in our Software business. Year over year revenue
growth was driven by 12% growth in our Electronic Commerce business, 4% percent
growth in our Investment Services business, and 5% percent growth in our
Software business. The growth in our Electronic Commerce revenue was driven
primarily by an increase in transactions processed from 111.9 million for the
three months ended March 31, 2003, to 152.2 million for the three months ended
March 31, 2004, and from 313.6 million for the nine months ended March 31,
2003, to 418.1 million for the nine months ended March 31, 2004. Transaction
growth is offset by a decline in revenue per transaction caused primarily by a
combination of tiered contractual pricing discounts and contract renewal
pricing at lower than previous rates. Additionally, minimum revenue guarantees
from Microsoft and First Data Corporation have increased by $2.3 million on a
quarter over quarter basis, and by $6.8 million on a year over year basis. In
the quarter ended December 31, 2003, we announced that we amended the
contractual terms with our largest customer, Bank of America. The new contract
converts Bank of America to transaction based versus subscriber based pricing
and is expected to result in more predictable changes in quarterly revenue per
transaction going forward. Growth in our Investment Services revenue was driven primarily by growth
in the number of portfolios managed, from approximately 1.2 million as of March
31, 2003, to about 1.5 million as of March 31, 2004. Economic conditions
throughout our fiscal year ending June 30, 2003, resulted in portfolios managed
remaining essentially flat at about 1.2 million. As the stock market rebound
progressed into our 2004 fiscal year, the number of portfolios we manage
increased to approximately 1.3 million by September 30, 2003, to approximately
1.4 million as of December 31, 2003, and to about 1.5 million as of March 31,
2004. In some cases, new portfolios are being added to our APL system at a
lower price point, where we have granted price reductions in connection with
gaining long term revenue growth, and by a mix shift resulting from increased
volume from broker dealers at a lower price. As investors continue to move
back into equity investments, we expect growth rates of portfolios and revenue
to improve. Our Software business executed well in the third quarter of 2004. Our
sales pipeline remains strong, however, customers continue to take longer to
evaluate discretionary software purchases. The 13% growth we experienced in
total revenue on a quarter over quarter basis was driven primarily by our
acquisition of HelioGraph in the quarter ended December 31, 2003. On a year
over year basis, growth was driven primarily by the acquisition of HelioGraph.
Strong execution in the quarter was the result of carryover software
arrangements from the December 31, 2003 quarter and a few contracts closing
sooner than we expected. As a result, while we believe we will experience
similarly strong license revenue in the June 30, 2004 quarter, we do not expect
the same seasonal spike in license revenue in the quarter as experienced in
prior years. The following tables set forth comparative revenues, by type, for the
three- and nine-month periods ended March 31, 2004 and 2003, respectively. Processing and Servicing Revenue (000s)
    
    March 31,
    
    Change2004
    
    2003
    
    $
    
    %Three months ended
    
    $
    134,826
    
    
    $
    121,899
    
    
    $
    12,927
    
    
    
    10.6
    %Nine months ended
    
    $
    390,718
    
    
    $
    352,398
    
    
    $
    38,320
    
    
    
    10.9
    %
 17




---



##### Table of Contents



We earn processing and servicing revenue in both our Electronic Commerce
and our Investment Services businesses. Growth in processing and servicing
revenue has come primarily from the aforementioned growth in transactions
processed in our Electronic Commerce business. While expected transaction
volume diverted from CheckFree to in-house solutions by four large bank
customers has dampened our growth during the transition, growth in the
remainder of our Electronic Commerce business, including the addition of two
large bank customers, has outpaced diverted transactions. We delivered
approximately 55.7 million electronic bills in the nine months ended March 31,
2004, with a price point of approximately $0.20 per e-bill, representing an
increase of almost 175% over the 20.4 million bills delivered during the nine
months ended March 31, 2003. Our commercial agreements with Microsoft and
First Data Corporation, resulting from our acquisition of TransPoint in
September 2000, include monthly minimum revenue guarantees consistent with
other consumer service providers. The minimums for Microsoft and First Data
Corporation increase annually over the five-year term of the agreements. We
continue to operate below the minimum revenue levels with both, and as a result
of the increased minimum levels this quarter, revenue from Microsoft and First
Data Corporation grew by approximately $2.3 million from the quarter ended
March 31, 2003, to March 31, 2004, and by $6.8 million from the nine months
ended March 31, 2003, to the nine months ended March 31, 2004. Somewhat
offsetting this growth has been a reduction in market demand for our account
balance transfer products. Also, one of our larger Health and Fitness customers
migrated to an in-house solution over the past several months. Finally, as
expected, our previously mentioned contract revisions with Bank of America late
in the quarter ended December 31, 2003, caused a dampening of processing and
servicing revenue growth, and we expect to return to more normal sequential
growth rates in the quarter ending June 30, 2004. License Fee Revenue (000s)
    
    March 31,
    
    Change2004
    
    2003
    
    $
    
    %Three months ended
    
    $
    7,628
    
    
    $
    5,703
    
    
    $
    1,925
    
    
    
    33.8
    %Nine months ended
    
    $
    17,306
    
    
    $
    16,647
    
    
    $
    659
    
    
    
    4.0
    %
 Our quarter ended March 31, 2004, was our strongest license revenue
quarter in over two years. Although HelioGraph contributed somewhat in the
quarter ended December 31, 2003, we carried some software deals into the March
31, 2004 quarter from the previous quarter and closed a few in advance of what
we expected from future quarters. While we expect our June 30, 2004 quarter to
be about as strong as our March 31, 2004 quarter, we do not expect to see the
same seasonal spike in our fiscal fourth quarter we have experienced in
previous years. Maintenance Fee Revenue (000s)
    
    March 31,
    
    Change2004
    
    2003
    
    %
    
    $Three months ended
    
    $
    7,044
    
    
    $
    6,563
    
    
    $
    481
    
    
    
    7.3
    %Nine months ended
    
    $
    21,157
    
    
    $
    19,066
    
    
    $
    2,091
    
    
    
    11.0
    %
 Maintenance revenue, which represents annually renewable product support
for our software customers, is isolated to our Software business, and tends to
grow with incremental license sales from previous periods. Our maintenance
base has grown as a result of recent license sales, customer retention rates
exceeding 80%, moderate price increases across all business units, and five
months of revenue from the acquisition of HelioGraph. Although we defer
revenue recognition on maintenance billings until cash is collected, which can
cause quarter-to-quarter fluctuations, we expect minimal growth in maintenance
fee revenue without additional license sales growth. Other Revenue (000s)
    
    March 31,
    
    Change2004
    
    2003
    
    $
    
    %Three months ended
    
    $
    5,740
    
    
    $
    7,136
    
    
    $
    (1,396
    )
    
    
    (19.6
    )%Nine months ended
    
    $
    17,257
    
    
    $
    18,930
    
    
    $
    (1,673
    )
    
    
    (8.8
    )%
 Other revenue consists mostly of consulting and implementation fees across
all three of our businesses. In the nine months ended March 31, 2003, we had
one custom software implementation project that generated a significant amount
of consulting revenue in that period that has not recurred in the current year. 18




---



##### Table of Contents



The following set of tables provides line-by-line expense comparisons with
their relative percentages of total company revenue for the three- and
nine-month periods ending March 31, 2004. Cost of Processing, Servicing and Support (000s)
    
    March 31,2004
    
    2003%
    
    
    
    
    
    %$
    
    Revenue
    
    $
    
    RevenueThree months ended
    
    $
    60,732
    
    
    
    39.1
    %
    
    $
    59,103
    
    
    
    41.8
    %Nine months ended
    
    $
    180,818
    
    
    
    40.5
    %
    
    $
    177,994
    
    
    
    43.7
    %
 In addition to leveraging a significant fixed-cost processing
infrastructure, we continue to focus investment on additional efficiency and
quality improvements within our customer care processes and our information
technology infrastructure to drive cost per transaction improvement. Also, in
Electronic Commerce, our electronic payment rate has increased from 74% as of
March 31, 2003, to 78% as of March 31, 2004. 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. Cost per
transaction improvement continues to be one of our most important ongoing
efforts as we take advantage of scale efficiency opportunities in this part of
our business. Research and Development (000s)
    
    March 31,2004
    
    2003%
    
    
    
    
    
    %$
    
    Revenue
    
    $
    
    RevenueThree months ended
    
    $
    17,199
    
    
    
    11.1
    %
    
    $
    13,595
    
    
    
    9.6
    %Nine months ended
    
    $
    48,204
    
    
    
    10.8
    %
    
    $
    39,104
    
    
    
    9.6
    %
 Including capitalized development costs of $0.6 million for the three
months ended March 31, 2004, and $1.8 million for the three months ended March
31, 2003, gross expenditures for research and development were $17.8 million,
or 11.5% of total revenue, for the three months ended March 31, 2004, and were
$15.4 million, or 10.9% of total revenue, for the three months ended March 31,
2003. Including capitalized development costs of $2.3 million for the nine
months ended March 31, 2004, and $3.1 million for the nine months ended March
31, 2003, gross expenditures for research and development were $50.5 million,
or 11.3% of total revenue, for the nine months ended March 31, 2004, and were
$42.2 million, or 10.4% of total revenue, for the nine months ended March 31,
2003. We continue to invest heavily in product enhancement and productivity
improvement initiatives in all of our business segments, and we added moderate
levels of research and development spending with the acquisition of HelioGraph
beginning in the December 31, 2003 quarter. While we have seen growth both in
absolute dollars and as a percentage of revenue, quarter over quarter, we
expect the level of quarterly spending to remain about the same or modestly
higher in absolute dollars for the remainder of the fiscal year as we invest in
our Investment Services business. Sales and Marketing (000s)
    
    March 31,2004
    
    2003%
    
    
    
    
    
    %$
    
    Revenue
    
    $
    
    RevenueThree months ended
    
    $
    13,126
    
    
    
    8.5
    %
    
    $
    13,631
    
    
    
    9.7
    %Nine months ended
    
    $
    38,657
    
    
    
    8.7
    %
    
    $
    40,582
    
    
    
    10.0
    %
 The decrease in sales and marketing costs, as a percentage of revenue, is
due primarily to the fact that the predominance of our revenue growth has taken
place in our Electronic Commerce business, which has less associated variable
sales commissions. On an absolute dollar basis, we have incurred less general
awareness marketing program expense in the first nine months of fiscal 2004
than we had in the same period of the previous year. However, these expenses
have historically fluctuated due to the nature and timing of various programs.
As license revenues are expected to remain high for the fourth quarter of 2004,
and we resume general awareness marketing programs, we expect the dollar value
of spending in sales and marketing to approach historical levels as we close
out the fiscal year. 19




---



##### Table of Contents



General and Administrative (000s)
    
    March 31,2004
    
    2003%
    
    
    
    
    
    %$
    
    Revenue
    
    $
    
    RevenueThree months ended
    
    $
    12,413
    
    
    
    8.0
    %
    
    $
    9,656
    
    
    
    6.8
    %Nine months ended
    
    $
    35,608
    
    
    
    8.0
    %
    
    $
    28,657
    
    
    
    7.0
    %
 The acquisition of HelioGraph in the quarter ended December 31, 2003, has
added approximately $0.8 million of new quarterly general and administrative
costs to our cost base. In the quarter ended March 31, 2004, we incurred
approximately $0.5 million of costs associated with a closed facility in the
Ann Arbor, Michigan area. Finally, our formula based calculation for allowance
for doubtful account reserves resulted in a $0.8 million charge in the current
quarter. We expect our general and administrative costs to increase year over
year due primarily to regulatory compliance costs, and overall we expect that
they will run between 7% and 8% of revenue in the coming quarters. Depreciation and Amortization (000s)
    
    March 31,2004
    
    2003%
    
    
    
    
    
    %$
    
    Revenue
    
    $
    
    RevenueThree months ended
    
    $
    42,381
    
    
    
    27.3
    %
    
    $
    57,011
    
    
    
    40.4
    %Nine months ended
    
    $
    135,378
    
    
    
    30.3
    %
    
    $
    170,987
    
    
    
    42.0
    %
 Depreciation and amortization expense from operating fixed assets and
internally capitalized product costs has decreased from $11.0 million for the
three months ended March 31, 2003, to $10.3 million for the three months ended
March 31, 2004, and from $32.7 million for the nine months ended March 31,
2003, to $30.7 million for the nine months ended March 31, 2004. The remainder
of our depreciation and amortization costs represents acquisition related
amortization. The decrease in non-acquisition related depreciation and
amortization is the result of investments in replacement assets that carry
lower costs than the assets they are replacing. The remaining reduction in
depreciation and amortization is the result of lower acquisition related
intangible amortization from intangible assets that have fully amortized since
last year, or lower non-goodwill intangible assets balances resulting from
impairment charges in the prior year. In-Process Research and Development In the three month period ended December 31, 2003, we recorded immaterial
in-process research and development costs of $0.3 million associated with our
acquisition of HelioGraph. Net Interest (000s)
    
    March 31,2004
    
    2003%
    
    
    
    
    
    %$
    
    Revenue
    
    $
    
    RevenueThree months ended:Interest income
    
    $
    1,243
    
    
    
    
    
    
    $
    1,647Interest expense
    
    
    (145
    )
    
    
    
    
    
    
    (3,236
    )Net interest
    
    $
    1,098
    
    
    
    0.7
    %
    
    $
    (1,589
    )
    
    
    (1.1
    )%Nine months ended:Interest income
    
    $
    4,554
    
    
    
    
    
    
    $
    5,714Interest expense
    
    
    (5,824
    )
    
    
    
    
    
    
    (9,769
    )Call premium expense
    
    
    (4,813
    )
    
    
    
    
    
    
    Unamortized note issuance cost
    
    
    (2,407
    )
    
    
    
    
    
    
    Net interest
    
    $
    (8,490
    )
    
    
    (1.9
    )%
    
    $
    (4,055
    )
    
    
    (1.0
    )%
 20




---



##### Table of Contents



Despite an increase in average cash and invested assets on a year over
year basis, interest income has declined as a result of lower average yields. Our interest expense has decreased significantly for the respective three
and nine month periods. We continued to carry our 61/2% Convertible
Subordinated Notes due 2006 at a balance of $172.5 million throughout the
nine-month period ending March 31, 2003. We redeemed the notes in full on
December 12, 2003. However, we incurred a cash charge of $4.8 million for a
2.79% call premium to redeem the notes prior to their scheduled maturity date,
and we incurred a non-cash charge of $2.4 million to write off the remaining
unamortized note issuance costs. Loss on Investments Due to a decline in the market value of our investment in Payment Data
Systems, Inc. (formerly Billserv, Inc.), which had been below our book basis
for over six months, we judged the decline in the investment to be other than
temporary and, accordingly, in the quarter ended December 31, 2002, we
recorded a charge of $1.9 million to reflect the loss. As of March 31, 2004,
although our carrying value for this asset is $0, its current market value is
approximately $0.4 million. Income Tax Expense / (Benefit) (000s)
    
    March 31,2004
    
    2003Effective
    
    
    
    
    
    Effective$
    
    Rate
    
    $
    
    RateThree months ended
    
    $
    2,789
    
    
    
    26.6
    %
    
    $
    (6,751
    )
    
    
    46.3
    %Nine months ended
    
    $
    (172
    )
    
    
    16.5
    %
    
    $
    (25,247
    )
    
    
    43.9
    %
 Although we incurred a pre-tax loss for the first nine months of fiscal
2004, we achieved positive pre-tax earnings for the quarter ended March 31,
2004, and we expect to achieve positive pre-tax earnings on a full year basis
for the fiscal year ending June 30, 2004. Our expected effective tax rate for
the year will be approximately 17%. The research and experimentation tax
credits we are earning will reduce our effective tax rate for the current
fiscal year. Our effective rate will converge with the blended federal and
state statutory rate of approximately 40% as pre-tax income turns positive and
begins to grow. The increase in effective rate will have a significant impact
on our profitability on a going forward basis. Cumulative Effect of Accounting Change On July 1, 2002, we adopted SFAS 142, Goodwill and Other Intangible
Assets. SFAS 142 changes the accounting for goodwill and other intangible
assets. Goodwill is no longer subject to amortization over its estimated
useful life. Rather, goodwill is subject to at least an annual assessment for
impairment by applying a fair-value-based test. Upon adoption, we recorded a
$2.9 million impairment charge. Segment Information We evaluate the performance of our segments based on revenues and
operating income (loss) of the respective segments. Segment operating income
(loss) excludes acquisition related intangible asset amortization and
significant one-time charges. The following table sets forth revenue and
operating income by segment, for the periods noted: 21




---



##### Table of Contents



Three Months Ended
    
    Nine Months EndedMarch 31,
    
    March 31,2004
    
    2003
    
    2004
    
    2003(in thousands)Revenue:Electronic Commerce
    
    $
    115,181
    
    
    $
    104,521
    
    
    $
    334,224
    
    
    $
    299,337Investment Services
    
    
    21,546
    
    
    
    20,439
    
    
    
    63,304
    
    
    
    60,907Software
    
    
    18,511
    
    
    
    16,341
    
    
    
    48,910
    
    
    
    46,797Total revenue
    
    $
    155,238
    
    
    $
    141,301
    
    
    $
    446,438
    
    
    $
    407,041Operating income (loss):Electronic Commerce
    
    $
    41,001
    
    
    $
    31,881
    
    
    $
    113,884
    
    
    $
    83,419Investment Services
    
    
    4,485
    
    
    
    5,642
    
    
    
    14,011
    
    
    
    16,269Software
    
    
    4,554
    
    
    
    5,116
    
    
    
    10,347
    
    
    
    12,139Corporate
    
    
    (8,584
    )
    
    
    (8,344
    )
    
    
    (25,807
    )
    
    
    (24,450
    )Sub-Total
    
    
    41,456
    
    
    
    34,295
    
    
    
    112,435
    
    
    
    87,377Purchase accounting amortization:Electronic Commerce
    
    
    (31,007
    )
    
    
    (43,757
    )
    
    
    (101,577
    )
    
    
    (131,271
    )Investment Services
    
    
    (205
    )
    
    
    (578
    )
    
    
    (668
    )
    
    
    (2,068
    )Software
    
    
    (857
    )
    
    
    (1,655
    )
    
    
    (2,417
    )
    
    
    (4,965
    )Write off of in-process research and
development costs  Software
    
    
    
    
    
    
    
    
    
    
    (324
    )
    
    
    Warrants issued to third party 
Electronic
Commerce
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    644Total income (loss) from operations
    
    $
    9,387
    
    
    $
    (11,695
    )
    
    $
    7,449
    
    
    $
    (50,283
    )
 Electronic Commerce Segment Information: Electronic Commerce Revenue (000s)
    
    March 31,
    
    Change2004
    
    2003
    
    $
    
    %Three months ended
    
    $
    115,181
    
    
    $
    104,521
    
    
    $
    10,660
    
    
    
    10.2
    %Nine months ended
    
    $
    334,224
    
    
    $
    299,337
    
    
    $
    34,887
    
    
    
    11.7
    %
 Revenue growth in Electronic Commerce is primarily the result of an
increase in transactions processed, the addition of two large bank customers,
an increase in electronic bills distributed, and tiered TransPoint related
revenue minimums, offset by contractual volume based price discounts, four bank
customers transferring transaction volume to in-house systems, dampened demand
for our account balance transfer product offering, and the loss of a large
customer in our Health and Fitness business. We offer two basic levels of electronic billing and payment services to
our Electronic Commerce customers  a Full Service offering and a Payment
Services offering. Customers that use our Full Service offering generally
outsource their electronic billing and payment process to us. A Full Service
customer may or may not use a CheckFree-hosted user interface, but uses a broad
array of services, including payment processing, payment warehouse, claims
processing, e-bill, online proof of payment, various levels of customer care,
and other aspects of our service. Also, while a Full Service customer may have
its own payment warehouse, we maintain a customer record and payment history
within our payment warehouse to support the Full Service customers servicing
needs. Customers in the Full Service category may contract to pay us either on
a per-subscriber basis, a per-transaction basis, or a blend of both. The
distinction between Full Service and Payment Services is based solely on the
types of service the customer receives, not on our pricing methodology.
Customers that utilize our Payment Services offering receive a limited subset
of our electronic billing and payment services, primarily remittance
processing. Additionally, within Payment Services, we provide services to
billers for electronic bill delivery and hosting, as well as other payment
services, such as account balance transfer. A third category of revenue we
simply refer to as Other Electronic Commerce, which includes our Health and
Fitness business and other ancillary revenue sources, such as consumer service
provider and biller implementation and consulting services. 22




---



##### Table of Contents



The following table provides a trend of our core electronic billing and
payment metrics in the three and nine month periods ending March 31, 2004 and
March 31, 2003: Three Months Ended3/31/04
    
    12/31/03
    
    9/30/03
    
    3/31/03
    
    12/31/02
    
    9/30/02(In millions)Full Service RelationshipsRevenue
    
    $
    94.0
    
    
    $
    91.8
    
    
    $
    85.5
    
    
    $
    81.5
    
    
    $
    75.1
    
    
    $
    71.6Active Subscribers
    
    
    5.5
    
    
    
    5.0
    
    
    
    4.6
    
    
    
    3.9
    
    
    
    3.5
    
    
    
    3.2Transactions processed
    
    
    115.5
    
    
    
    106.1
    
    
    
    94.3
    
    
    
    80.3
    
    
    
    74.9
    
    
    
    67.2Payment Services RelationshipsRevenue
    
    $
    12.8
    
    
    $
    12.0
    
    
    $
    11.9
    
    
    $
    12.8
    
    
    $
    13.9
    
    
    $
    14.7Transactions processed
    
    
    36.7
    
    
    
    33.1
    
    
    
    32.4
    
    
    
    31.6
    
    
    
    30.1
    
    
    
    29.5Other Electronic CommerceRevenue
    
    $
    8.4
    
    
    $
    8.7
    
    
    $
    9.2
    
    
    $
    10.3
    
    
    $
    9.2
    
    
    $
    9.7Non-cash warrant impact on revenue
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    0.6TotalsElectronic Commerce revenue
    
    $
    115.2
    
    
    $
    112.5
    
    
    $
    106.6
    
    
    $
    104.6
    
    
    $
    98.2
    
    
    $
    96.6Transactions processed
    
    
    152.2
    
    
    
    139.2
    
    
    
    126.7
    
    
    
    111.9
    
    
    
    105.0
    
    
    
    96.7
 The primary drivers of the increase in Full Service revenue in the three
and nine months ended March 31, 2004, over the same periods in the prior year,
were growth in Full Service transactions processed of 42%, from 222.4 million
for the nine months ended March 31, 2003, to 315.9 million for the nine months
ended March 31, 2004, a $6.8 million increase in TransPoint revenue minimums on
a year over year basis, and the addition of two large bank customers since June
30, 2003. Since the quarter ended September 30, 2002, two large customers
moved Full Service transaction volume to in-house systems. Both banks
completed their moves by the quarter ended September 30, 2003. The combination
of these moves, price tier discounts earned by our largest customer, Bank of
America, during the last twelve months, and additional discounts resulting from
our previously mentioned contract amendment with Bank of America in the quarter
ended December 31, 2003, resulted in Full Service revenue per transaction
declines from $1.01 for the quarter ended March 31, 2003, to $0.81 for the
quarter ended March 31, 2004. In the Payment Services area, the primary driver of the revenue decline on
a year over year basis has been the movement of transactions to in-house
solutions by two large bank customers since the quarter ended September 30,
2002. The first bank completed its move by December 31, 2002, and the second
by the quarter ended December 31, 2003. Growth in the remaining Payment
Services businesses has surpassed lost volume from these banks as quarterly
revenue has returned to prior year levels and we expect transaction growth in
the Payment Services area to be more predictable in the near future. We
continued to see transaction growth in our other payment products on a year
over year basis. However, with lower interest rates we expect less demand for
balance transfers in the near term. The decline in Other Electronic Commerce revenue is due to the loss of a
large Health and Fitness customer and less implementation revenue since March
31, 2003. Additionally, we recorded a non-cash addition to revenue of $0.6
million in the quarter ended September 30, 2002 related to a true-up of a
previously recorded charge for warrants issued to a third party, that has
negatively impacted our comparable nine month results. Electronic Commerce Operating Income (000s)
    
    March 31,
    
    Change2004
    
    2003
    
    $
    
    %Three months ended
    
    $
    41,001
    
    
    $
    31,881
    
    
    $
    9,120
    
    
    
    28.6
    %Nine months ended
    
    $
    113,884
    
    
    $
    83,419
    
    
    $
    30,465
    
    
    
    36.5
    %
 Our ratio of electronic payments to total payments has improved from 74%
as of March 31, 2003, to 78% as of March 31, 2004. Electronic payments carry a
significantly lower variable cost per unit than paper payments and are far less
likely to result in a costly customer care inquiry or claim. When combined
with continued efforts 23




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##### Table of Contents



toward improved quality and efficiency throughout Electronic Commerce and the
leverage we are experiencing in the fixed cost base that is already in place,
we realize a reduction in cost per transaction in advance of continued
customer-based pressure on our revenue per transaction. This has resulted in
an increase in operating income. Investment Services Segment Information: Investment Services Revenue (000s)
    
    March 31,
    
    Change2004
    
    2003
    
    $
    
    %Three months ended
    
    $
    21,546
    
    
    $
    20,439
    
    
    $
    1,107
    
    
    
    5.4
    %Nine months ended
    
    $
    63,304
    
    
    $
    60,907
    
    
    $
    2,397
    
    
    
    3.9
    %
 Revenue derived from the volume of portfolios managed has begun to improve
again, after several quarters of relatively flat results. The total amount of
accounts managed has increased from 1.2 million at June 30, 2003 to almost 1.5
million at March 31, 2004. As the stock market has improved, we have seen
growth in the number of portfolios managed. We have provided certain
incentives for customers to sign multi-year contracts and are experiencing a
business mix shift to lower priced services, both of which we expect to result
in a modest reduction to our revenue per average portfolio managed on a going
forward basis. Investment Services Operating Income (000s)
    
    March 31,
    
    Change2004
    
    2003
    
    $
    
    %Three months ended
    
    $
    4,485
    
    
    $
    5,642
    
    
    $
    (1,157
    )
    
    
    (20.5
    )%Nine months ended.
    
    $
    14,011
    
    
    $
    16,269
    
    
    $
    (2,258
    )
    
    
    (13.9
    )%
 The reduction in operating income is due primarily to added investment in
research and development programs to further improve our product offering in
the market and efforts to improve our operational quality standards. Software Segment Information: Software Revenue (000s)
    
    March 31,
    
    Change2004
    
    2003
    
    $
    
    %Three months ended
    
    $
    18,511
    
    
    $
    16,341
    
    
    $
    2,170
    
    
    
    13.3
    %Nine months ended
    
    $
    48,910
    
    
    $
    46,797
    
    
    $
    2,113
    
    
    
    4.5
    %
 With the acquisition of HelioGraph in November 2003, our efforts in Europe
with an enterprise reconciliation solution, and new ACH software (marketed as
PEP+ reACHTM) designed to take advantage of recent check conversion rules and
regulations, we have seen Software revenue increase over the past two quarters.
While license revenue in our March 31, 2004 quarter was our strongest in over
two years, some of the revenue was a result of deals that were expected to
close in the previous quarter and some was a result of deals that closed
earlier than expected. Therefore, while we expect our June 30, 2004 quarter to
be similar to the March 31, 2004 quarter, we do not expect a fourth quarter
sequential increase in revenue. Software Operating Income (000s)
    
    March 31,
    
    Change2004
    
    2003
    
    $
    
    %Three months ended
    
    $
    4,554
    
    
    $
    5,116
    
    
    $
    (562
    )
    
    
    (11.0
    )%Nine months ended
    
    $
    10,347
    
    
    $
    12,139
    
    
    $
    (1,792
    )
    
    
    (14.8
    )%
 The decrease in operating income, both on quarter over quarter and year
over year bases, is due primarily to increased costs associated with the
HelioGraph acquisition that we completed in November 2003. Additionally, we
incurred approximately $0.5 million of accrued costs associated with a closed
facility we have been unable to sublease in the Ann Arbor, Michigan area. As
we continue to integrate HelioGraph into our Software business and our license
sales begin to improve, we expect near term improvement in operating income. 24




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##### Table of Contents



Corporate Segment Information: Corporate Operating Loss (000s)
    
    March 31,
    
    Change2004
    
    2003
    
    $
    
    %Three months ended
    
    $
    (8,584
    )
    
    $
    (8,344
    )
    
    $
    (240
    )
    
    
    (2.9
    )%Nine months ended
    
    $
    (25,807
    )
    
    $
    (24,450
    )
    
    $
    (1,357
    )
    
    
    (5.6
    )%
 Corporate results represent costs for legal, human resources, finance and
various other unallocated overhead expenses. We have been able to leverage our
infrastructure costs by limiting additional corporate costs primarily to
increased regulatory compliance costs. Purchase Accounting Amortization: Purchase Accounting AmortizationExpense (000s)March 31,
    
    Change2004
    
    2003
    
    $
    
    %Three months ended
    
    $
    32,069
    
    
    $
    45,990
    
    
    $
    (13,921
    )
    
    
    (30.3
    )%Nine months ended
    
    $
    104,662
    
    
    $
    138,304
    
    
    $
    (33,642
    )
    
    
    (24.3
    )%
 The purchase accounting amortization line in our segment revenue and
operating income chart above represents the amortization of intangible assets
resulting from all of our various acquisitions from 1996 forward. Although we
have incurred a nominal amount of additional purchase accounting amortization
expense related to intangible assets from the HelioGraph acquisition, the
reduction in depreciation and amortization quarter over quarter and year over
year is the result of intangible assets that have fully depreciated since last
year and lower non-goodwill intangible asset balances resulting from impairment
charges we incurred in fiscal 2003. In-Process Research and Development Costs: In the three month period ended December 31, 2003, we recorded immaterial
in-process research and development costs of $0.3 million associated with our
acquisition of HelioGraph. Warrants Issued to a Third Party: During the quarter ended June 30, 2002, we recorded a non-cash charge of
$2.7 million against revenue resulting from the probable vesting of warrants
issued to a third party. In the quarter ended September 30, 2002, the warrants
actually vested. On the date of vesting, however, the fair value of our stock
was lower than at June 30, 2002, when we calculated the initial charge. As a
result, a true-up of the value of the warrants resulted in a credit to revenue
of $0.6 million in the quarter ended September 30, 2002. The charge, and the
true-up credit, were based on a Black-Scholes valuation of the warrants and
were accounted for as a net charge to revenue in accordance with Emerging
Issues Task Force (EITF) 01-09, Accounting for Consideration Given by a Vendor
to a Customer. 25




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##### Table of Contents



Liquidity and Capital Resources The following chart summarizes our Consolidated Statement of Cash Flows
for the three and nine months ended March 31, 2004: Three
    
    NineMonths
    
    MonthsEnded
    
    EndedMarch 31,
    
    March 31,2004
    
    2004(in thousands)Net cash provided by (used in):Operating activities
    
    $
    48,824
    
    
    $
    117,200Investing activities
    
    
    4,033
    
    
    
    3,586Financing activities
    
    
    3,192
    
    
    
    (167,465
    )Effect of exchange rate changes on cash and cash equivalents
    
    
    172
    
    
    
    172Net increase (decrease) in cash and cash equivalents
    
    $
    56,221
    
    
    $
    (46,507
    )
 As of March 31, 2004, we have $240.6 million of cash, cash equivalents and
short-term investments on hand and an additional $77.3 million in long-term
investments. Our balance sheet reflects a current ratio of 3.8 and related
working capital of $299.1 million. On December 17, 2003, we announced our
intention to purchase American Payment Systems, Inc. (APS) from its parent
corporation, UIL Holdings, for approximately $110.0 million in cash. This
transaction is expected to close by the end of fiscal 2004, subject to the
receipt of state regulatory approvals and satisfaction of customary closing
conditions, and we expect to pay for the acquisition of APS out of existing
cash and investment balances. Due primarily to processing efficiency
improvement initiatives, we have experienced a significant increase in
operating cash flow over the past several years. We expect cash flow from
operating activities of over $170 million for our fiscal year ending June 30,
2004, which will drive free cash flow approaching $150 million for the same
period. Due to state and federal operating loss and credit carryforwards, we
do not expect to pay income taxes other than alternative minimum taxes for five
to eleven months, however, the acquisition of APS may further extend this
timeframe. Considering our existing balances and expectations of positive cash
flow from operations in the near future, we believe we have sufficient cash to
meet our presently anticipated requirements for the foreseeable future. Our
board of directors has approved up to $40 million for the purpose of
repurchasing shares of our common stock through August 2004. As of March 31,
2004, no such repurchases have taken place. In April 2004, we received a $25 million deposit from one of our customers
in connection with a contract modification relating to the timing of
transaction settlements. The agreement has an initial term of four years and
automatically renews thereafter unless terminated with 180 days notice. We
will pay the customer a variable rate of interest on a monthly basis equal to
the then current overnight repurchase agreement rate. There are no
restrictions on the deposit, and the funds will be available for general
corporate use. We will refund the deposit upon termination of the agreement. We are in the process of obtaining a line of credit facility, and we
expect the line of credit agreement to be completed in the fourth quarter of
2004. We have no immediate plans to borrow against this line of credit. Through the nine months ended March 31, 2004, we have generated $117.2
million of cash from operating activities. While timing of cash payments and
collections can cause fluctuations from quarter to quarter, we expect to
generate positive cash from operations for the full year ended June 30, 2004. From an investing perspective, we generated cash of $3.6 million in the
nine months ended March 31, 2004. We generated approximately $38.9 million
from the net sales and maturities of securities. We used $16.2 million of cash
for the acquisition of HelioGraph in our Software business, $16.9 million for
capital expenditures, and we have capitalized approximately $2.3 million in

software development costs. As previously noted, the expected closing of the
acquisition of APS between now and June 30, 2004, will result in a future use
of cash of approximately $110.0 million. We expect our full year purchases of
property and software for our existing 26




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##### Table of Contents



operations not to exceed $25 million, but based on the timing of the closing of
the APS acquisition, this expectation could change depending on the capital
needs of this business. From a financing perspective, for the nine months ended March 31, 2004, we
used $167.5 million of cash. In the quarter ended December 31, 2003, we used
$172.5 million of cash to redeem the entire outstanding balance of our 6.5%
convertible subordinated notes and, throughout the year, we used $3.2 million
of cash for principal payments under capital leases and other long-term
obligations. We have received $5.6 million of cash from the exercise of
employee stock options and an additional $2.6 million from our employee stock
purchase plan. Our agreement to use a bank routing number to process payments contains
certain financial covenants related to tangible net worth, cash flow coverage,
debt service coverage and maximum levels of debt to cash flow, as defined. We
are in compliance with all covenants as of March 31, 2004, and do not
anticipate any change in the foreseeable future. The following chart summarizes our contractual obligations (in thousands): Payments DueYear Ended June 30,Contractual Obligations
    

Total
    
    2004(Remaining)
    
    2005 to 2006
    
    2007 to 2008
    
    ThereafterOperating leases
    
    $
    95,420
    
    
    $
    4,208
    
    
    $
    23,625
    
    
    $
    19,913
    
    
    $
    47,674Capital lease obligations
    
    
    1,943
    
    
    
    402
    
    
    
    1,541
    
    
    
    
    
    
    
    Other long-term obligations
    
    
    5,631
    
    
    
    1,866
    
    
    
    3,670
    
    
    
    95
    
    
    
    Total contractual cash obligations
    
    $
    102,994
    
    
    $
    6,476
    
    
    $
    28,836
    
    
    $
    20,008
    
    
    $
    47,674
 When we combine existing cash and investment balances with expectations of
positive cash flow from operations in the near future, we believe we will have
sufficient cash to fund the acquisition of APS and meet our presently
anticipated operating and capital requirements and contractual obligations for
the foreseeable future. Use of Non-GAAP Financial Information Free cash flow, which we define as GAAP net cash from operating activities
less capital expenditures, is a measure we use in this Quarterly Report to
evaluate our operations. This financial measure is not prepared in accordance
with GAAP. We consider free cash flow to be a measure of liquidity that
provides useful information to management and investors about the amount of
cash we generate after the acquisition of property and equipment, which can be
used for strategic and other purposes. Our free cash flow should be considered
in addition to, and not as a substitute for, our GAAP results. Our free cash flow for the nine months ended March 31, 2004, and twelve
months ended June 30, 2003, is calculated as follows (in thousands): Nine Months
    
    Twelve MonthsEnded
    
    EndedMarch 31, 2004
    
    June 30, 2003Net cash provided by operating activities
    
    $
    117,200
    
    
    $
    157,793Less: capital expenditures
    
    
    16,893
    
    
    
    24,324Free cash flow
    
    $
    100,307
    
    
    $
    133,469
 GAAP net cash provided by (used in) investing activities for the nine
months ended March 31, 2004 and the twelve months ended June 30, 2003, was
approximately $3.6 million and $(61.2) million, respectively. GAAP net cash
provided by (used in) financing activities for the nine months ended March 31,
2004 and the twelve months ended June 30, 2003, was approximately $(167.5)
million and $(2.3) million, respectively. 27




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##### Table of Contents



Recent Accounting Pronouncements FASB Interpretation No. 46 Consolidation of Variable Interest Entities
(FIN 46) was issued in January 2003 and addresses consolidation by business
enterprises of special purpose or off-balance sheet entities. In addition to
numerous FASB Staff Positions written to clarify and improve the application of
FIN 46, the FASB issued an amendment to FIN 46 entitled FASB Interpretation No.
46 (revised December 2003) Consolidation of Variable Interest Entities. FIN
46 requires a variable interest entity (VIE) to be consolidated if our
variable interest (i.e., investment in the entity) will absorb a majority of
the entitys expected losses and/or residual returns if they occur. FIN 46 was
applicable immediately to any VIE formed after January 31, 2003. A public
entity with variable interests in a VIE created before February 1, 2003, was
required to apply the provisions of FIN 46 for the first interim or annual
reporting period ending after December 15, 2003. The implementation of FIN 46
did not have a material effect on our financial position or results of
operations. Application of Critical Accounting Policies The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires us to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosures of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Critical accounting policies are those policies
that are both important to the portrayal of our financial condition and results
of operations, and they require our most difficult, subjective or complex
judgments, often as a result of the need to make estimates about the effect of
matters that are inherently uncertain. In our Annual Report on Form 10-K for
the fiscal year ended June 30, 2003, as filed with the Securities and Exchange
Commission on September 15, 2003, we described the policies and estimates
relating to intangible assets, equity instruments issued to customers and
deferred income taxes as our critical accounting policies, and since then, we
have made no changes to our reported critical accounting policies. Inflation We believe the effects of inflation have not had a significant impact on
our results of operations. Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995 Except for the historical information contained herein, the matters
discussed in this Quarterly Report on Form 10-Q include certain forward-looking
statements within the meaning of Section 27A of the Securities Act, as amended,
and Section 21E of the Securities Exchange Act of 1934, as amended, which are
intended to be covered by the safe harbors created thereby. Those statements
include, but may not be limited to, all statements regarding managements
intent, belief and expectations, such as statements concerning our future
profitability, and our operating and growth strategy. Words such as believe,
anticipate, expect, will, may, should, intend, plan, estimate,
predict, potential, continue, likely and similar expressions are
intended to identify forward-looking statements. Investors are cautioned that
all forward-looking statements contained in this Quarterly Report or in other
statements we make involve risks and uncertainties including, without
limitation, the factors set forth under the caption Business  Business Risks
in our Annual Report on Form 10-K for the year ended June 30, 2003, and other
factors detailed from time to time in our filings with the Securities and
Exchange Commission. One or more of these factors have affected, and in the
future could affect, our businesses and financial results and could cause
actual results to differ materially from plans and projections. Although we
believe that the assumptions underlying the forward-looking statements
contained herein are reasonable, any of the assumptions could be inaccurate.
Therefore, there can be no assurance that the forward-looking statements
included in this Quarterly Report will prove to be accurate. In light of the
significant uncertainties inherent in the forward-looking statements included
herein, the inclusion of such information should not be regarded as
representations by us or any other person that our objectives and plans will be
achieved. All forward-looking statements made in this Quarterly Report are
based on information presently available to our management. We assume no
obligation to update any forward-looking statements contained herein. Recent Developments Agreement to Acquire American Payment Systems.On December 17, 2003, we
announced our intent to purchase APS from its parent, UIL Holdings Corporation,
for approximately $110 million. Pending the clearance of 28




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##### Table of Contents



state regulatory requirements and the satisfaction of customary closing
conditions, we expect the acquisition to be completed by the end of fiscal
2004. Upon completion of the transaction, we expect APS to become a part of
our Electronic Commerce business. Joint Venture.We also recently announced a joint venture with BACS
Limited, a United Kingdom-based payment network, that will utilize our i-Series
software and the commercial application BACS offers through the UK banking
network to develop and promote consolidated bill payment and presentment to the
millions of online consumers in the UK. Interest Rate Swaps.On April 23, 2004, the Company entered into three
interest rate swap agreements. Each swap agreement has a notional amount of
$25 million and an average life of 2.13 years. 
 Item 3. Quantitative and Qualitative Disclosures About Market Risk With the acquisition of BlueGill in April 2000, we obtained operations in
Canada, and with the acquisition of HelioGraph in November 2003, we now
maintain multiple offices in the United Kingdom. As a result, we have assets
and liabilities outside the United States that are subject to fluctuations in
foreign currency exchange rates. We utilize pounds sterling as the functional
currency for the United Kingdom, and the Canadian dollar as the functional
currency for Canada. Due to the relatively immaterial nature of the amounts
involved, our economic exposure from fluctuations in foreign exchange rates is
not significant enough at this time to engage in forward foreign exchange and
other similar instruments. While our international sales represented less than two percent of our
revenue for the three months ended March 31, 2004, we market, sell and license
our products throughout the world. As a result, our future revenue could be
somewhat affected by weak economic conditions in foreign markets that could
reduce demand for our products. Our exposure to interest rate risk is limited to the yield we earn on
invested cash, cash equivalents and investments and interest based revenue
earned on products such as our account balance transfer business. Our
outstanding lease obligations carry fixed interest rates. As part of processing certain types of transactions, we earn interest from
the time money is collected from our customers until the time payment is made
to merchants. These trust account balances are not included in our
consolidated balance sheets. Revenue earned from interest on such balances is
included in processing and servicing revenue. Our Investment Policy was changed effective October 30, 2003, to allow for
the use of derivatives, such as interest rate swaps, for hedging purposes to
effectively reduce the interest rate fluctuations on a portion of
interest-sensitive revenues. As of March 31, 2004, we had not entered into any
such derivative instruments. In April 2004, we entered into interest rate swap
transactions totaling $75 million. Our investment policy does not allow us to
use derivatives for speculative purposes. 
 Item 4. Controls and Procedures Disclosure Controls and Procedures.Disclosure controls and procedures
are controls and other procedures that are designed to ensure that information
required to be disclosed by us in the reports that we file or submit under the
Securities Exchange Act of 1934, as amended (the Exchange Act) is recorded,
processed, summarized and reported, within the time periods specified in the
SECs rules and forms. Disclosure controls and procedures include, without
limitation, controls and procedures designed to ensure that information we are
required to disclose in the reports that we file under the Exchange Act is
accumulated and communicated to our management as appropriate to allow timely
decisions regarding required disclosure. As of end of the period covered by this report, our management, with the
participation of our chief executive officer and chief financial officer,
carried out an evaluation of the effectiveness of our disclosure controls and
procedures pursuant to Rule 13a-15 promulgated under the Exchange Act. Based
upon this evaluation, our chief executive officer and our chief financial
officer concluded that our disclosure controls and procedures were (1) designed
to ensure that material information relating to our company is accumulated and
made known to our 29




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##### Table of Contents



management, including our chief executive officer and chief
financial officer, in a timely manner, particularly during the period in which this report was being prepared and (2)
effective, in that they provide reasonable assurance that information we are
required to disclose in the reports that we file or submit under the Exchange
Act is recorded, processed, summarized and reported within the time periods
specified in the SECs rules and forms. Management believes, however, that a controls system, no matter how well
designed and operated, cannot provide absolute assurance that the objectives of
the controls system are met, and no evaluation of controls can provide absolute
assurance that all control issues and instances of fraud, if any, within a
company have been detected. Internal Controls.There has been no change in our internal control over
financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) promulgated
under the Exchange Act) during our fiscal quarter ended March 31, 2004, that
has materially affected, or is reasonably likely to materially affect, our
internal control over financial reporting. 30




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##### Table of Contents



Part II. Other Information 
 Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits. Exhibit
    
    ExhibitNumber
    
    Description31(a)*
    
    Certification pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a)
of the Chief Executive Officer.31(b)*
    
    Certification pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a)
of the Chief Financial Officer.32(a)+
    
    Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002, of the Chief Executive
Officer.32(b)+
    
    Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002, of the Chief Financial
Officer.
   *
    
    Filed with this report.+
    
    Furnished with this report. 31




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##### Table of Contents



(b)  Reports onForm 8-K. We filed and/or furnished with the Securities and Exchange Commission the
following Current Reports on Form 8-K during the quarter ended March 31, 2004:  (i)
    
    On January 20, 2004, we furnished a Current
Report on Form 8-K (Form 8-K) (Item 12) in connection with
our issuance of earnings for our second quarter ended December
31, 2003; and(ii)
    
    On March 23, 2004, we filed a Form 8-K (Item 5)
in connection with our posting of our Code of Business Conduct
on the Investors Center homepage of our corporate website,
www.checkfreecorp.com. 32




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##### Table of Contents



Signatures Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. CHECKFREE CORPORATIONDate: May 14, 2004
    
    By:
    
    /s/ David E. MangumDavid E. Mangum, Executive VicePresident and Chief Financial Officer*(Principal Financial Officer)Date: May 14, 2004
    
    By:
    
    /s/ John J. Browne, Jr.John J. Browne, Jr., Vice President,Controller, and Chief Accounting Officer(Principal Accounting Officer)
  *
    
    In his capacity as Executive Vice President and Chief Financial Officer,
Mr. Mangum is duly authorized to sign this report on behalf of the
Registrant. 33




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##### Table of Contents



EXHIBIT INDEX Exhibit
    
    ExhibitNumber
    
    Description31(a)*
    
    Certification pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a)
of the Chief Executive Officer.31(b)*
    
    Certification pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a)
of the Chief Financial Officer.32(a)+
    
    Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002, of the Chief Executive
Officer.32(b)+
    
    Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002, of the Chief Financial
Officer.
   *
    
    Filed with this report.+
    
    Furnished with this report. 34