**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.20549**

 

# **FORM 10-Q**

 

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| **(Mark One)**                                       |
|------------------------------------------------------|
|                                                 |   |   |
| ý                                               |   | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |   |
|                                                 |   |   |   |
| **For the quarterly period ended December 31, 2003** |
|                                                 |
| **OR**                                               |
|                                                 |   |   |
| o                                                    |   | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |   |

 

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**Commission filenumber 000-23195**

 

**TIER TECHNOLOGIES, INC.**

(Exact name of Registrant as specified in itscharter)

 

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| **California**                                                  |   | **94-3145844**                        |
|-----------------------------------------------------------------|--------|---------------------------------------|
| (State or other jurisdiction  of incorporation or organization) |   | (I.R.S. Employer  Identification No.) |

 

**2001 N. Main Street,Suite 500Walnut Creek, California 94596**(Address ofprincipal executive offices)(Zip Code)

 

**(925) 937-3950**

(Registrant’s telephone number, includingarea code)

 

Indicate by check mark whetherthe Registrant (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the Registrant was required to file such reports)and (2) has been subject to such filing requirements for the past 90 days. 

 

| (1) Yes ý  No o |   | (2) Yes ý  No o |
|----------------------|--------|----------------------|

 

Indicate by check mark whetherthe Registrant is an accelerated filer (as defined in Rule 12b-2 of theExchange Act).

 

| (1) Yes ý  No o |   |   |
|----------------------|--------|--------|

 

As of January 31, 2004, thenumber of shares outstanding of the Registrant’s Class A Common Stock was880,000 and the number of shares outstanding of the Registrant’s Class B CommonStock was 17,897,613.

 

 

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**TIER TECHNOLOGIES, INC.**

 

**FORM 10-Q**

 

**TABLE OF CONTENTS**

 

**Part I—FINANCIAL INFORMATION**

** **
| Item 1.                        |   | Condensed Consolidated Financial Statements  (unaudited)                                                |   |
|--------------------------------|--------|---------------------------------------------------------------------------------------------------------|--------|
|                           |   |                                                                                                    |   |
|                           |   | Condensed  Consolidated Balance Sheets as of December 31, 2003 and September 30, 2003                   |   |
|                           |   |                                                                                                    |   |
|                           |   | Condensed Consolidated Statements of Operations for the three months  ended  December 31, 2003 and 2002 |   |
|                           |   |                                                                                                    |   |
|                           |   | Condensed Consolidated Statements of Cash  Flows for the three months ended  December 31, 2003 and 2002 |   |
|                           |   |                                                                                                    |   |
|                           |   | Notes to Condensed Consolidated Financial  Statements                                                   |   |
|                           |   |                                                                                                    |   |
| Item 2.                        |   | Management’s Discussion and Analysis of  Financial Condition and Results of Operations             |   |
|                           |   |                                                                                                    |   |
| Item 3.                        |   | Quantitative and Qualitative Disclosures  About Market Risk                                             |   |
|                           |   |                                                                                                    |   |
| Item 4.                        |   | Controls and Procedures                                                                                 |   |
|                           |   |                                                                                                    |   |
| **Part  II-OTHER INFORMATION** |
|                           |   |                                                                                                    |   |
| Item 1.                        |   | Legal Proceedings                                                                                       |   |
|                           |   |                                                                                                    |   |
| Item 6.                        |   | Exhibits and Reports on Form 8-K                                                                        |   |
|                           |   |                                                                                                    |   |
| Signatures                     |   |

 

**Private Securities Litigation Reform Act SafeHarbor Statement**

 

Certain statements contained inthis report, including statements regarding the development of and demand forour services and our markets, anticipated trends in various expenses, expectedcosts of legal proceedings and other statements that are not historical facts,are forward-looking statements within the meaning of the federal securitieslaws.  These forward-looking statementsrelate to future events or our future financial and/or operating performanceand can generally be identified as such because the context of the statementwill include words such as “may”, “will”, “intends”, “plans”, “believes”,“anticipates”, “expects”, “estimates”, “shows”, “predicts”, “potential”,“continue”, or “opportunity”, the negative of these words or words of similarimport.  These forward-lookingstatements are subject to risks and uncertainties, including the risks anduncertainties described and referred to under “Factors That May Affect FutureResults” beginning on page 26, that could cause actual results to differmaterially from those anticipated as of the date of this report.

 

2

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**PART I****.   FINANCIALINFORMATION**

 

**ITEM1****.****                   FINANCIALSTATEMENTS**

 

**TIER TECHNOLOGIES,INC.**

 

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

**(unaudited)**

**(in thousands)**

** **
|                                                                              |   | **December  31,  2003** |       | **September  30,  2003** |       |
|-----------------------------------------------------------------------------------|--------|-------------------------|------------|--------------------------|------------|
| **ASSETS**                                                                        |   |                    | ** ** |                     | ** ** |
|                                                                              |   |                    |       |                     |       |
| **Current assets:**                                                               |   |                    | ** ** |                     | ** ** |
| Cash and cash equivalents                                                         |   | $                       | 36,224     |                     | $          | 26,178 |   |
| Short-term investments                                                            |   | 4,078                   |       | 5,492                    |       |
| Accounts receivable, net                                                          |   | 18,547                  |       | 20,024                   |       |
| Unbilled receivables                                                              |   | 3,001                   |       | 7,872                    |       |
| Assets of discontinued operations                                                 |   | 1,107                   |       | 3,550                    |       |
| Prepaid expenses and other current assets                                         |   | 2,446                   |       | 4,602                    |       |
| Total current assets                                                              |   | 65,403                  |       | 67,718                   |       |
| Equipment and software, net                                                       |   | 4,829                   |       | 5,422                    |       |
| Notes and accrued interest receivable from  related parties, less current portion |   | 2,206                   |       | 2,152                    |       |
| Goodwill                                                                          |   | 29,625                  |       | 29,625                   |       |
| Other acquired intangible assets, net                                             |   | 24,080                  |       | 24,832                   |       |
| Long-term investments                                                             |   | 28,641                  |       | 24,883                   |       |
| Restricted investments                                                            |   | 7,707                   |       | 7,707                    |       |
| Non-current assets of discontinued  operations                                    |   | —                  |       | 760                      |       |
| Other assets.                                                                     |   | 2,574                   |       | 1,875                    |       |
| Total assets                                                                      |   | $                       | 165,065    |                     | $          | 164,974 |   |
|                                                                              |   |                    |       |                     |       |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                     |   |                    |       |                     |       |
|                                                                              |   |                    |       |                     |       |
| **Current liabilities:**                                                          |   |                    |       |                     |       |
| Accounts payable                                                                  |   | $                       | 1,226      |                     | $          | 2,087 |   |
| Accrued liabilities                                                               |   | 8,923                   |       | 8,476                    |       |
| Accrued subcontractor expenses                                                    |   | 4,298                   |       | 5,494                    |       |
| Accrued compensation and related  liabilities                                     |   | 3,369                   |       | 3,654                    |       |
| Income taxes payable                                                              |   | 4,077                   |       | —                   |       |
| Deferred revenue                                                                  |   | 3,764                   |       | 3,299                    |       |
| Liabilities of discontinued operations                                            |   | 1,330                   |       | 2,043                    |       |
| Other current liabilities                                                         |   | 131                     |       | 150                      |       |
| Total current liabilities                                                         |   | 27,118                  |       | 25,203                   |       |
| Long-term debt, less current portion                                              |   | 162                     |       | 195                      |       |
| Non-current liabilities of discontinued  operations                               |   | 348                     |       | 432                      |       |
| Other liabilities                                                                 |   | 1,398                   |       | 994                      |       |
| Total liabilities                                                                 |   | 29,026                  |       | 26,824                   |       |
|                                                                              |   |                    |       |                     |       |
| Commitments and contingencies                                                     |   |                    |       |                     |       |
|                                                                              |   |                    |       |                     |       |
| **Shareholders’ equity:**                                                    |   |                    |       |                     |       |
| Common stock, no par value                                                        |   | 165,383                 |       | 164,742                  |       |
| Notes receivable from shareholders                                                |   | (1,773                  | )          | (1,773                   | )          |
| Accumulated other comprehensive loss                                              |   | (257                    | )          | (350                     | )          |
| Accumulated deficit                                                               |   | (27,314                 | )          | (24,469                  | )          |
| Total shareholders’ equity                                                   |   | 136,039                 |       | 138,150                  |       |
| Total liabilities and shareholders’ equity                                   |   | $                       | 165,065    |                     | $          | 164,974 |   |

 

See Notes to Condensed Consolidated Financial Statements

 

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**TIER TECHNOLOGIES,INC.**

 

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

**(unaudited)**

**(in thousands, exceptper share data)**

** **
|                                                                |   | **Three  Months Ended  December 31,** |   |
|---------------------------------------------------------------------|--------|---------------------------------------|--------|
|                                                                |   | **2003**                              |   | **2002** |   |
| Net revenues                                                        |   | $                                     | 26,510 |   | $ | 29,087 |   |
| Costs and expenses:                                                 |   |                                  |   |   |   |
| Direct costs                                                        |   | 17,968                                |   | 18,565 |   |
| Selling and marketing                                               |   | 1,377                                 |   | 1,441 |   |
| General and administrative                                          |   | 5,484                                 |   | 5,374 |   |
| Restructuring and other charges                                     |   | 2,072                                 |   | 405 |   |
| Depreciation and amortization                                       |   | 1,131                                 |   | 1,377 |   |
| Income (loss) from continuing operations                            |   | (1,522                                | )      | 1,925 |   |
| Interest income (expense), net                                      |   | 277                                   |   | 378 |   |
| Income (loss) from continuing operations  before income taxes       |   | (1,245                                | )      | 2,303 |   |
| Provision for income taxes                                          |   | 35                                    |   | 838 |   |
| Income (loss)  from continuing operations, net of income taxes |   | (1,280                                | )      | 1,465 |   |
| Income (loss) from discontinued operations,  net of income taxes    |   | (1,565                                | )      | 259 |   |
| Net income (loss)                                                   |   | $                                     | (2,845 | ) | $ | 1,724 |   |
|                                                                |   |                                  |   |   |   |
| Income (loss) from continuing operations,  net of income taxes:     |   |                                  |   |   |   |
| Per basic share                                                     |   | $                                     | (0.07  | ) | $ | 0.08 |   |
| Per diluted share                                                   |   | $                                     | (0.07  | ) | $ | 0.07 |   |
|                                                                |   |                                  |   |   |   |
| Income (loss) from discontinued operations,  net of income taxes:   |   |                                  |   |   |   |
| Per basic share                                                     |   | $                                     | (0.08  | ) | $ | 0.01 |   |
| Per diluted share                                                   |   | $                                     | (0.08  | ) | $ | 0.01 |   |
|                                                                |   |                                  |   |   |   |
| Net income (loss):                                                  |   |                                  |   |   |   |
| Per basic share                                                     |   | $                                     | (0.15  | ) | $ | 0.09 |   |
| Per diluted share                                                   |   | $                                     | (0.15  | ) | $ | 0.09 |   |
|                                                                |   |                                  |   |   |   |
| Shares used in computing basic income  (loss) per share             |   | 18,702                                |   | 19,052 |   |
| Shares used in computing diluted income  (loss) per share           |   | 18,702                                |   | 19,815 |   |

 

See Notes to Condensed Consolidated Financial Statements

 

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**TIER TECHNOLOGIES,INC.**

 

#### **CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(unaudited)**

**(in thousands)**

 
|                                                                                                                                                                               |   | **Three  Months Ended  December 31,** |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------|--------|
|                                                                                                                                                                               |   | **2003**                              |   | **2002** |   |
| **Operating activities**                                                                                                                                                           |   |                                  |   |   |   |
| Income (loss) from continuing operations,  net of income taxes                                                                                                                     |   | (1,280                                | )      | $ | 1,465 |   |
| Adjustments to reconcile income (loss) from  continuing operations, net of income taxes to net cash from continuing  operations provided by (used in)   operating activities: |   |                                  |   |   |   |
| Asset impairment charge                                                                                                                                                            |   | 135                                   |   | — |   |
| Depreciation and amortization                                                                                                                                                      |   | 1,662                                 |   | 1,891 |   |
| Provision for doubtful accounts                                                                                                                                                    |   | 26                                    |   | 296 |   |
| Tax benefit of stock options exercised                                                                                                                                             |   | —                                |   | 135 |   |
| Forgiveness of notes receivable from  employees                                                                                                                                    |   | 8                                     |   | 14 |   |
| Change in operating assets and liabilities,  net of effects of business combinations:                                                                                              |   |                                  |   |   |   |
| Accounts receivable                                                                                                                                                                |   | 5,533                                 |   | (5,423 | ) |
| Prepaid expenses and other assets                                                                                                                                                  |   | (132                                  | )      | (1,031 | ) |
| Accounts payable and accrued liabilities                                                                                                                                           |   | 4,961                                 |   | (1,624 | ) |
| Deferred revenue                                                                                                                                                                   |   | 465                                   |   | 727 |   |
| Net cash from continuing operations  provided by (used in) operating activities                                                                                                    |   | 11,378                                |   | (3,550 | ) |
|                                                                                                                                                                               |   |                                  |   |   |   |
| **Investing activities**                                                                                                                                                           |   |                                  |   |   |   |
| Purchase of equipment and software                                                                                                                                                 |   | (409                                  | )      | (787 | ) |
| Notes and accrued interest receivable from  related parties                                                                                                                        |   | (70                                   | )      | (64 | ) |
| Repayments on notes and accrued interest receivable  from related parties                                                                                                          |   | 11                                    |   | 13 |   |
| Business combinations, net of cash acquired                                                                                                                                        |   | —                                |   | (31 | ) |
| Purchases of available-for-sale securities                                                                                                                                         |   | (5,200                                | )      | (17,297 | ) |
| Maturities of available-for-sale securities                                                                                                                                        |   | 2,717                                 |   | 12,089 |   |
| Net cash from continuing operations used in  investing activities                                                                                                                  |   | (2,951                                | )      | (6,077 | ) |
|                                                                                                                                                                               |   |                                  |   |   |   |
| **Financing activities**                                                                                                                                                           |   |                                  |   |   |   |
| Net proceeds from issuance of Class B  common stock                                                                                                                           |   | 641                                   |   | 592 |   |
| Payments on capital lease obligations and  other financing arrangements                                                                                                            |   | (52                                   | )      | (165 | ) |
| Net cash from continuing operations  provided by financing activities                                                                                                              |   | 589                                   |   | 427 |   |
| Net cash provided by (used in) continuing  operations                                                                                                                              |   | 9,016                                 |   | (9,200 | ) |
| Net cash provided by discontinued  operations                                                                                                                                      |   | 1,030                                 |   | 1,149 |   |
| Net increase (decrease) in cash and cash  equivalents                                                                                                                              |   | 10,046                                |   | (8,051 | ) |
| Cash and cash equivalents at beginning of  period                                                                                                                                  |   | 26,178                                |   | 40,609 |   |
| Cash and cash equivalents at end of period                                                                                                                                         |   | $                                     | 36,224 |   | $ | 32,558 |   |
|                                                                                                                                                                               |   |                                  |   |   |   |
| **Supplemental disclosures of cash flow  information**                                                                                                                             |   |                                  |   |   |   |
| Cash paid during the period for:                                                                                                                                                   |   |                                  |   |   |   |
| Interest                                                                                                                                                                           |   | $                                     | 15     |   | $ | 19 |   |
| Income taxes paid (refunded), net                                                                                                                                                  |   | $                                     | (6,482 | ) | $ | 1,858 |   |
|                                                                                                                                                                               |   |                                  |   |   |   |
| **Supplemental disclosures of non-cash  transactions**                                                                                                                             |   |                                  |   |   |   |
| Equipment acquired under capital lease  obligations and other financing arrangements                                                                                               |   | $                                     | — |   | $ | 58 |   |

 

See Notes to Condensed Consolidated Financial Statements

 

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**TIER TECHNOLOGIES,INC.**

 

**NOTES****TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(unaudited)**

 

**NOTE 1—BASIS OF PRESENTATION**

 

Theaccompanying condensed consolidated financial statements of Tier Technologies,Inc. (“Tier” or the “Company”) include the accounts of the Company and itswholly owned subsidiaries.  Allsignificant intercompany transactions and balances have been eliminated inconsolidation.  In the opinion ofmanagement, the condensed consolidated financial statements reflect all normaland recurring adjustments which are necessary for a fair presentation of theCompany’s financial position, results of operations and cash flows as of thedates and for the periods presented. The condensed consolidated financial statements have been prepared inaccordance with generally accepted accounting principles for interim financialinformation.  Consequently, thesestatements do not include all the disclosures normally required by generallyaccepted accounting principles for annual financial statements nor thosenormally made in the Company’s Annual Report on Form 10-K.  Accordingly, reference should be made to theCompany’s Form 10-K filed on December 19, 2003 and other reports the Companyhas filed with the Securities and Exchange Commission for additionaldisclosures, including a summary of the Company’s accounting policies, whichhave not materially changed.  The consolidatedresults of operations for the three months ended December 31, 2003 are notnecessarily indicative of results that may be expected for the fiscal yearending September 30, 2004 or any future period, and the Company makes norepresentations related thereto.

 

Thepreparation of financial statements in conformity with generally acceptedaccounting principles requires management to make certain estimates andassumptions that affect the reported amounts of assets and liabilities,disclosures of contingent assets and liabilities and the results of operationsduring the reporting period.  Althoughmanagement believes that the estimates and assumptions used in preparing theaccompanying condensed consolidated financial statements and related notes arereasonable in light of known facts and circumstances, actual results coulddiffer materially from those estimates.

 

Certainreclassifications have been made to the prior period financial statements toconform to the current period presentation, including the presentation ofdiscontinued operations.

 

**NOTE 2—REVENUE RECOGNITION**

 

The Companyderives net revenues from three principal delivery offerings:  transaction and payment processing, systemsdesign and integration, and maintenance and support services.  Net revenues include software license revenuesand reimbursements from clients for out-of-pocket expenses.  Neither software license nor reimbursementsrevenues were greater than 10% of total net revenues for each period includedin these condensed consolidated financial statements.

 

*Transaction and Payment Processing*–Transaction and payment processing revenues are recorded in accordance withStaff Accounting Bulletin (“SAB”) 101, *RevenueRecognition.* Transactionprocessing revenues includes revenues recorded at the Company’s child supportpayment processing centers and Official Payments Corporation (“OPC”), theCompany’s wholly–owned subsidiary and are based upon a per-transaction fee or apercentage of the dollar amount processed. Revenues are recognized each month based on the number of transactionsperformed and dollar amount processed in that month after the Company hasreceived a signed contract, the price per transaction or fee percentage isfixed according to the contract, and collectibility is reasonably assured.  The Company assesses the probability ofcollection based upon the client’s financial condition and prior paymenthistory.  For OPC, transaction fees aregenerally borne by the consumer utilizing our services, not the governmentalentity.  OPC receives real-timeauthorization for credit and debit card transactions which ensures availabilityof cardholder funds for payment.

 

*Systems Design and Integration -*Systemsdesign and integration includes software application license revenues andsoftware development and systems integration service revenues to developapplications to enhance our clients’ operating functionality.

 

6

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License andservices revenues for contracts involving significant modification,customization or services which are essential to the functionality of thesoftware are recognized over the period of each engagement, using thepercentage-of-completion method of Statement of Position 81-1 “Accounting forthe Performance of Construction Type and Certain Production Type Contracts.”The ratio of costs incurred to total estimated project costs is used as themeasure of progress towards completion. Due to the long-term nature of these contracts, estimates of totalproject costs are subject to changes over the contract term.  A provision for a loss contract on anengagement is made in the period in which the loss becomes probable and can bereasonably estimated.  If the losscannot be reasonably estimated, a zero profit methodology is applied to thecontract whereby the amount of revenue recognized is limited to the amount ofcosts until such time, as the total loss can be estimated.  Advance payments from clients and amountsbilled to clients in excess of revenue recognized are recorded as deferredrevenue.  Amounts recognized as revenuein advance of contractual billing are recorded as unbilled receivables.  Revenues recognized under thepercentage-of-completion method were $2,411,000 and $7,771,000 for the threemonths ended December 31, 2003 and 2002, respectively.

 

Where costsare incurred related to an unapproved change order, the costs are deferreduntil the change order is approved provided that the Company believes it isprobable that the cost will be recovered through a change in the contractprice.  Included in prepaid and otherassets at December 31, 2003 and September 30, 2003, respectively, were $0 and$34,000 of deferred costs related to change orders not yet approved.

 

Revenues fromsoftware license fees not requiring significant modification are recognized inaccordance with Statement of Position 97-2, “Software Revenue Recognition.”**Revenues from license fees are recognizedwhen persuasive evidence of an agreement exists, delivery of the software hasoccurred, no significant Company obligations with regard to implementation orintegration exist, the fee is fixed or determinable and collectibility isprobable.  Arrangements for which thefees are not deemed probable for collection are recognized upon cashcollection.  Arrangements for which thefees are not deemed fixed or determinable are recognized on the earlier of thedue date or when payment is received. Revenues from software license fees not requiring significantmodification were $53,000 and $20,000 for the three months ended December 31,2003 and 2002, respectively.

 

For licensearrangements with multiple obligations (for example, undelivered maintenanceand support), the Company allocates revenues to each component of thearrangement using the residual value method of accounting based on the fairvalue of the undelivered elements, which is specific to the Company.  Fair value for the maintenance and supportobligations for software licenses is based upon the specific sale of renewalsto customers or upon renewal rates quoted in the contracts.

 

Under theterms of its license agreements, the Company does not offer return rights orprice protection.  Therefore, noprovisions have been made for sales returns. For its proprietary software, the Company offers routine, short-termwarranties that its software will operate free of material defects and inconformity with written documentation. Under these agreements, if the Company has an active maintenanceagreement with the customer, the Company accounts for any obligation in conformitywith Statement of Financial Accounting Standards No. 5, “Accounting forContingencies.”  If the Company does nothave a maintenance contract in place, the warranty is considered impliedmaintenance and the Company defers the amount of revenues consistent with thefair value of other maintenance and support obligations.

 

*Maintenance and Support Services –*TheCompany provides ongoing maintenance and support services. * *Maintenancerevenue is deferred and recognized on a straight-line basis as services revenueover the life of the related contract, which is typically one year.  Non-essential support services, includingtraining and consulting, are also typically provided on a time and materialsbasis and revenue is recognized as the services are performed.  Revenue is recognized after a contract issigned which indicates a fixed or determinable price and the Company believes,based upon its assessment of the customer’s financial condition, thatcollection is reasonably assured.

 

7

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*Multiple Elements Arrangements –*The Company has several engagements that provide a combination of services fromseveral delivery offerings as part of the overall project.  For these multiple element arrangements, theCompany allocates revenue to each element based on the fair value of thedelivery offering.  In establishing fairvalue, the Company uses prices charged on similar contracts.

 

**NOTE 3—CUSTOMER CONCENTRATION AND RISK**

 

The Companyderives a significant portion of its net revenues from a limited number of clients.  For the three months ended December 31,2003, revenues from one client totaled approximately $2,744,000, whichrepresented 10.4% of total net revenues. For the three months ended December 31, 2002, revenues from one clienttotaled approximately $3,234,000 which represented 11.1% of total net revenues.

 

The Company’scontracts with government agencies typically include a termination forconvenience clause.  The termination forconvenience clause provides the agency with the right to terminate a contract,in whole or in part, for any reason deemed to be in the public’s bestinterest.  Each contract has specificremedies under a termination for convenience and the remedy generally providesa settlement claim which includes costs relating or allocable to the terminatedcontract, including settlement expenses and a reasonable profit.  The Company’s contracts with governmentagencies also typically provide for termination for cause when either partyendangers the performance in the contract.

 

The Company hasseveral large accounts receivable and unbilled receivable balances, and anydispute, early contract termination or other collection issues could have amaterial adverse impact on its financial condition and results of operations.  Unbilled receivables were $3,001,000 and$7,872,000 at December 31, 2003 and September 30, 2003, respectively.  Amounts will become billable upon completionof project milestones or customer acceptance. Unbilled receivables for two clients accounted for 43.5% and 31.5%,respectively, of total unbilled receivables at December 31, 2003.  Total accounts receivable and unbilledreceivables for these two clients accounted for 7.4% and 9.6%, respectively, oftotal net accounts receivable and unbilled receivables at December 31, 2003.  Unbilled receivables for three clientsaccounted for 44.2%, 25.0% and 20.3%, respectively, of total unbilledreceivables at September 30, 2003. Total accounts receivable and unbilled receivables for these threeclients accounted for 20.1%, 16.3% and 7.2%, respectively, of total netaccounts receivable and unbilled receivables at September 30, 2003.

 

On August 25,2003, the Company received a notice of termination for default of a significantcontract with the California Public Employees Retirement System (“CalPERS”).  The Company recorded $12,831,000 inSeptember 2003 as a revenue reversal on this loss contract for amounts unbilledand uncollected as of the date of termination. From inception through June 30, 2003, the Company had recorded revenueunder the percentage-of-completion method of $20,340,000 under the terms of thecontract and collected  $7,508,000 incash including $985,000 in July 2003. The Company filed a lawsuit to overturn the termination of the contractfor default and to recover all uncollected unbilled receivables, delay,disruption and interference costs, attorneys fees and other costs associatedwith the contract. (See Note 13.)  TheCompany also wrote-off $532,000 in deferred costs in September 2003 related tochange orders that were being negotiated at June 30, 2003.  No revenue was recognized in connection withthis contract for the three months ended December 31, 2003.

 

Included inaccounts receivable and other assets at December 31, 2003 was approximately$1,782,000, which represented balances billed but not paid by clients underretainage provisions in the contracts, of which approximately $6,000 wasexpected to be collected within one year, $430,000 was expected to be collected within two years and $1,346,000was expected to be collected within three years.  Included in accounts receivable and other assets at September 30,2003 was approximately $1,448,000 of retainage of which approximately $461,000was expected to be collected within one year, $430,000 was expected to becollected within two years and $557,000 was expected to be collected withinthree years.

 

8

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**NOTE 4—LONG-TERM INVESTMENTS**

 

Investmentswith maturities greater than twelve months as of the balance sheet date are classifiedas long-term investments.  Theselong-term investments are categorized by the Company as available-for-sale andare recorded at amounts that approximate fair value based on quoted marketprices and are primarily comprised of state and local municipalities’ debtreadily traded on over-the-counter markets. Unrealized gains and losses on these investments were not material andthere were no other-than-temporary impairments to these investments.

 

Restrictedinvestments at December 31, 2003 and September 30, 2003 were approximately$7,707,000 and were pledged in connection with performance bonds and realestate operating leases and will be restricted for the terms of the projectperformance periods and lease periods, the latest of which is estimated to bethrough June 2005.

 

**NOTE 5—BANK LINES OF CREDIT**

 

At December31, 2003, the Company had a $15.0 million revolving credit facility, all ofwhich may be used for letters of credit. The credit facility has a maturity date of January 31, 2005.  The credit facility is collateralized byfirst priority liens and security interests in the Company’s assets.  Interest is based on either the adjustedLIBOR rate plus 2.5% or the lender’s announced prime rate plus 0.25%, at theCompany’s option, and is payable monthly. As of December 31, 2003, there were no outstanding borrowings or standbyletters of credit.  Among otherprovisions, the credit facility requires the Company to maintain certainminimum financial ratios.  As ofDecember 31, 2003, the Company was in compliance with all of the financialratios of the credit facility.

 

At December31, 2003, the Company also had a $2.5 million non-revolving line of credit forfinancing capital expenditures that may be drawn upon until January 29,2004.  Principal payments must be madein 36 equal monthly payments commencing February 29, 2004.  This credit facility has a maturity date ofJanuary 31, 2007.  Interest is based oneither the LIBOR rate plus 2.75% or the lender’s announced prime rate plus0.5%, at the Company’s option and is payable monthly.  As of December 31, 2003, the Company had no borrowings under thisline of credit.

 

In addition tothe credit facilities noted above, the Company had letters of credit totalingapproximately $3,346,000, which were collateralized by certain securities inthe Company’s long-term investment portfolio at December 31, 2003.  Also, the Company’s subsidiary, OPC had aletter of credit outstanding in the amount of approximately $138,000 collateralizedby a certificate of deposit.  Theseletters of credit were issued to secure performance bonds and to meet variousfacility lease requirements.

 

**NOTE 6—GOODWILL AND OTHER ACQUIRED INTANGIBLEASSETS**

 

As of October1, 2002, the Company adopted Statement of Financial Accounting Standard No. 142(“SFAS 142”), “Goodwill and Other Intangible Assets” and ceased amortizinggoodwill.  The Company completed initialimpairment tests in accordance with SFAS 142 in the first quarter of fiscalyear 2003.  Results of the initialimpairment tests did not indicate any impairment loss.  Impairment tests involve the use ofestimates related to the fair market values of the business operations withwhich goodwill is associated.  Losses,if any, resulting from the annual impairment tests will be reflected in operatingincome in the statement of operations. During the fourth quarter of fiscal year 2003, the Company decided toshut down the U.S. Commercial Services segment and the United KingdomOperations segment and accordingly recorded a restructuring charge of $17,646,000to write-off substantially all of the associated goodwill.  As of September 30, 2003, the remaininggoodwill associated with these segments totaled $457,000, representing its fairmarket value.  The fair market value wasdetermined by estimating the expected margin on the remaining contracts inthese segments.  During the three monthsended December 31, 2003, the Company wrote-off the remaining $457,000 ofgoodwill associated with the U.S. Commercial Services segment.  In the fourth quarter of fiscal year 2003,the Company performed its annual impairment test to determine if the goodwillassociated with its remaining segments was impaired.  The results did not indicate any impairment loss for theremaining segments.

 

9

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Other acquiredintangible assets, net, consisted of the following at December 31, 2003 andSeptember 30, 2003:

 
|                                   |   |                     |   | **December  31,  2003** |   | **September  30,  2003**      |   |
|----------------------------------------|--------|--------------------------|--------|-------------------------|--------|-------------------------------|--------|
|                                   |   | **Amortization  Period** |   | **Gross**               |   | **Accumulated  Amortization** |   | **Net** |   | **Gross** |   | **Accumulated  Amortization** |   | **Net** |   |
|                                   |   |                     |   | **(in thousands)**      |   | **(in thousands)**            |   |
| Client relationships                   |   | 10 years                 |   | $                       | 24,400 |                          | $      | (3,457 | ) | $ | 20,943 |   | $ | 24,400 |   | $ | (2,847 | ) | $ | 21,553 |   |
| Trademarks                             |   | 3 years                  |   | 3,200                   |   | (453                          | )      | 2,747 |   | 3,200 |   | (373 | ) | 2,827 |   |
| Technology                             |   | 10 years                 |   | 740                     |   | (350                          | )      | 390 |   | 740 |   | (288 | ) | 452 |   |
| Acquired contracts                     |   | 12 months                |   | 500                     |   | (500                          | )      | — |   | 500 |   | (500 | ) | 3⁄4 |   |
| Other acquired intangible  assets, net |   |                     |   | $                       | 28,840 |                          | $      | (4,760 | ) | $ | 24,080 |   | $ | 28,840 |   | $ | (4,008 | ) | $ | 24,832 |   |

 

The changes in the carrying amount of goodwill for the three monthsended December 31, 2003 are as follows (in thousands):

 
|                              |   | **Government****Business  Process  Outsourcing** |   | **Government****Systems  Integration** |   | **Official****Payments** |   | **Total** |   |
|-----------------------------------|--------|--------------------------------------------------|--------|----------------------------------------|--------|--------------------------|--------|-----------|--------|
| Balance as of September 30,  2003 |   | $                                                | 5,298  |                                   | $      | 9,721                    |   | $         | 14,606 |   | $ | 29,625 |   |
| Activity                          |   | —                                           |   | —                                 |   | —                   |   | —    |   |
| Balance as of December 31, 2003   |   | $                                                | 5,298  |                                   | $      | 9,721                    |   | $         | 14,606 |   | $ | 29,625 |   |

 

**NOTE 7 — SHAREHOLDERS’ EQUITY**

 

**Pro Forma Impact of Employee Stock Options**

 

In December2002, the Financial Accounting Standards Board (“FASB”) issued Statement ofFinancial Accounting Standards No. 148 (“SFAS 148”), “Accounting forStock-Based Compensation Costs – Transition and Disclosure,” which providesalternative methods of transition for an entity that voluntarily changes to thefair value-based method of accounting for stock-based compensation.  SFAS 148 also requires additionaldisclosures about the effects on reported net income of an entity’s accountingpolicy with respect to stock-based compensation.  The Company accounts for employee stock options in accordancewith Accounting Principles Board Opinion No. 25, (“APB 25”), “Accountingfor Stock Issued to Employees” and provides the disclosure required inStatement of Financial Accounting Standards No. 123 (“SFAS 123”),“Accounting for Stock-Based Compensation.” Stock options issued tonon-employees are accounted for in accordance with Emerging Issues Task ForceIssue No. 96-18, “Accounting for Equity Instruments That Are Issued toOther Than Employees for Acquiring, or in Conjunction with Selling, Goods orServices.”  The Company adopted thedisclosure provisions of SFAS 148 in January 2003.

 

10

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The followingtable illustrates the effect on net income (loss) and net income (loss) pershare if the Company would have applied the fair value recognition provisionsof SFAS 123 to stock-based compensation:

 
|                                                                                                                              |   | **Three Months Ended****December 31,**    |   |
|-----------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------|--------|
|                                                                                                                              |   | **2003**                                  |   | **2002** |   |
|                                                                                                                              |   | **(in thousands, except per share data)** |   |
| Net income (loss), as reported                                                                                                    |   | $                                         | (2,845 | ) | $ | 1,724 |   |
| Deduct:   Total stock-based compensation expense determined under fair  value-based method for all awards, net of tax effect |   | 159                                       |   | 907 |   |
| Pro forma net income (loss)                                                                                                       |   | $                                         | (3,004 | ) | $ | 817 |   |
|                                                                                                                              |   |                                      |   |   |   |
| Net income (loss) per basic share:                                                                                                |   |                                      |   |   |   |
| As reported                                                                                                                       |   | $                                         | (0.15  | ) | $ | 0.09 |   |
| Pro forma                                                                                                                         |   | $                                         | (0.16  | ) | $ | 0.04 |   |
|                                                                                                                              |   |                                      |   |   |   |
| Net income (loss) per diluted share:                                                                                              |   |                                      |   |   |   |
| As reported                                                                                                                       |   | $                                         | (0.15  | ) | $ | 0.09 |   |
| Pro forma                                                                                                                         |   | $                                         | (0.16  | ) | $ | 0.04 |   |

 

**NOTE 8 — INCOME (LOSS) PER SHARE**

 

The followingtable sets forth the computation of basic and diluted income (loss) per share:

 
|                                                                                                              |   | **Three Months Ended****December 31,**     |   |
|-------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------|--------|
|                                                                                                              |   | **2003**                                   |   | **2002** |   |
|                                                                                                              |   | **(in  thousands, except per share data)** |   |
| Numerator:                                                                                                        |   |                                       |   |   |   |
| Income (loss) from continuing  operations, net of income taxes                                                    |   | $                                          | (1,280 | ) | $ | 1,465 |   |
| Income (loss) from discontinued  operations, net of income taxes                                                  |   | (1,565                                     | )      | 259 |   |
| Net income (loss)                                                                                                 |   | $                                          | (2,845 | ) | $ | 1,724 |   |
| Denominator for basic income  (loss) per share-weighted average  common shares outstanding                        |   | 18,702                                     |   | 19,052 |   |
| Effects of dilutive securities:                                                                                   |   |                                       |   |   |   |
| Common stock options                                                                                              |   | —                                     |   | 763 |   |
| Denominator for diluted income  (loss) per share-adjusted weighted  average common shares and assumed conversions |   | $                                          | 18,702 |   | 19,815 |   |
| Income (loss) from continuing  operations, net of income taxes:                                                   |   |                                       |   |   |   |
| Per basic share                                                                                                   |   | $                                          | (0.07  | ) | $ | 0.08 |   |
| Per diluted share                                                                                                 |   | $                                          | (0.07  | ) | $ | 0.07 |   |
| Income (loss) from discontinued  operations, net of income taxes:                                                 |   |                                       |   |   |   |
| Per basic share                                                                                                   |   | $                                          | (0.08  | ) | $ | 0.01 |   |
| Per diluted share                                                                                                 |   | $                                          | (0.08  | ) | $ | 0.01 |   |
| Net income (loss):                                                                                                |   |                                       |   |   |   |
| Per basic share                                                                                                   |   | $                                          | (0.15  | ) | $ | 0.09 |   |
| Per diluted share                                                                                                 |   | $                                          | (0.15  | ) | $ | 0.09 |   |

 

11

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Options topurchase approximately 1,546,000 shares of Class B common stock at pricesranging from $8.66 to $20.70 per share were outstanding at December 31, 2003,but were not included in the computation of diluted income (loss) per share forthe three months ended December 31, 2003 because the options’ exercise priceswere greater than the average market price of the shares for the period.  In addition, potential common stock ofapproximately 210,000 shares were also excluded from the calculation of dilutedincome (loss) per share at December 31, 2003, since their effect would havebeen anti-dilutive.  Options to purchaseapproximately 598,000 shares of Class B common stock at prices ranging from$16.90 to $20.70 per share were outstanding at December 31, 2002, but were notincluded in the computation of diluted income per share for the three monthsended December 31, 2002 because the options’ exercise prices were greater thanthe average market price of the shares for the period.

 

**NOTE 9—COMPREHENSIVE INCOME (LOSS)**

 

The Company’scomprehensive income (loss) was as follows: 

 
|                                                             |   | **Three  Months Ended  December 31,** |   |
|------------------------------------------------------------------|--------|---------------------------------------|--------|
|                                                             |   | **2003**                              |   | **2002** |   |
|                                                             |   | **(in  thousands)**                   |   |
| Net income (loss).                                               |   | $                                     | (2,845 | ) | $ | 1,724 |   |
| Net change in unrealized gain on  available-for-sale investments |   | (140                                  | )      | 48 |   |
| Foreign currency translation adjustment.                         |   | 233                                   |   | (91 | ) |
| Comprehensive income (loss).                                     |   | $                                     | (2,752 | ) | $ | 1,681 |   |

 

**NOTE 10—SEGMENT INFORMATION**

 

As a result ofthe restructuring, beginning October 2003, the Company is managed through threereportable segments: Government Business Process Outsourcing (“GovernmentBPO”), Government Systems Integration (“Government SI”) and OPC.  The Government BPO segment provides transactionprocessing services.  The Government SIsegment provides systems integration, licensing and maintenance services.  The OPC segment provides transaction andpayment processing services.  TheCompany evaluates the performance of its operating segments based on netrevenue and direct costs, while other operating costs are evaluated on ageographical basis.  Accordingly, theCompany does not include selling and marketing expenses, general andadministrative expenses, depreciation and amortization expense not attributableto state child support payment processing centers, interest income (expense),other income (expense) and income tax expense in segment profitability.  The table below presents financial informationfor the three reportable segments:

 
|                                      |   | **Government  BPO** |       | **Government  SI** |   | **OPC** |   | **Total** |   |
|-------------------------------------------|--------|---------------------|------------|--------------------|--------|---------|--------|-----------|--------|
|                                      |   | **(in thousands)**  | ** ** |
| **Three Months Ended December 31, 2003:** |   |                |       |               |   |    |   |      |   |
| Net revenues                              |   | $                   | 11,111     |               | $      | 7,725   |   | $         | 7,674  |   | $ | 26,510 |   |
| Direct costs                              |   | 7,755               |       | 5,314              |   | 4,899   |   | 17,968    |   |
|                                      |   |                |       |               |   |    |   |      |   |
| **Three Months Ended December 31, 2002:** |   |                |       |               |   |    |   |      |   |
| Net revenues                              |   | $                   | 11,822     |               | $      | 11,140  |   | $         | 6,125  |   | $ | 29,087 |   |
| Direct costs                              |   | 6,759               |       | 7,836              |   | 3,970   |   | 18,565    |   |

 

12

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**NOTE 11—RESTRUCTURING**

 

During thefourth quarter of fiscal year 2003, the Company initiated a strategic review ofits business units.  This review wascompleted in the fourth quarter of fiscal year 2003 and the Company decided torenew its focus on its core Government Services businesses while exitingunprofitable or marginal business operations. As a result of this review, the Company recorded charges ofapproximately $19,786,000 during the three months ended September 30,2003.  This charge was comprised of$18,197,000 of goodwill, intangible and tangible asset impairment charges,$882,000 related to the closure of several offices (net of estimated subleaseincome of $115,000) and $707,000 of severance related to the termination ofemployees in the exited businesses.  Therestructuring plan included the termination of approximately 50 employees, ofwhich approximately 20 employees were terminated during the three months endedSeptember 30, 2003 and the remaining employees were terminated during the threemonths ended December 31, 2003. Additional goodwill and asset impairment charges of approximately$887,000 were incurred for the three months ended December 31, 2003, of whichapproximately $135,000 is included in restructuring and other charges andapproximately $752,000 were included in loss from discontinued operations.  Additional severance of approximately $1.7million was incurred for the three months ended December 31, 2003, of whichapproximately $903,000 resulted from the signing of a termination agreementwith the Company’s former Chief Executive Officer and was included inrestructuring and other charges and approximately $830,000 was included in lossfrom discontinued operations. Additional severance charges estimated at $350,000 are expected to beincurred in the second quarter of fiscal 2004. The additional severance chargerepresents an estimate of the non-cash charge for the contingent modificationof the Company's former Chief Executive Officer's stock options terms. Theactual charge will be determined based on the price of the Company's Class Bcommon stock on the date the options terms are modified. Also included inrestructuring and other charges for the three months ended December 31, 2003was $218,000 related to estimated closure costs for one additional office (netof estimated sublease income of $75,000).

 

As a result ofthe acquisition of OPC in July 2002, the Company assumed certain liabilitiesfor restructuring costs that OPC had previously recognized in connection withthe involuntary termination of employees and the consolidation of facilities(net of estimated sublease income of $295,000).  The assumed severance liability included severance for 27individuals and the closing of certain office space.

 

At September30, 2003, the Company had restructuring liabilities totaling $2,330,000 ofwhich $656,000 was recorded in accrued liabilities, $668,000 was recorded inother long-term liabilities and $1,006,000 was recorded in liabilities ofdiscontinued operations.  The followingis a summary of the restructuring liabilities from September 30, 2002 throughSeptember 30, 2003 (in thousands):

 
|                                               |   | **Liability  as of  September 30,  2002** |   | **Additions/  (Reductions)** |   | **Cash  Payments** |   | **Liability  as of  September 30,  2003** |   |
|----------------------------------------------------|--------|-------------------------------------------|--------|------------------------------|--------|--------------------|--------|-------------------------------------------|--------|
| Severance – OPC                               |   | $                                         | 2,254  |                         | $      | (38                | )      | $                                         | (1,083 | ) | $ | 1,133 |   |
| Facilities closure – OPC                      |   | 513                                       |   | (15                          | )      | (361               | )      | 137                                       |   |
| Severance – fiscal 2003 plan                  |   | 3⁄4                                    |   | 280                          |   | (280               | )      | —                                    |   |
| Facilities closure – fiscal 2003 plan         |   | 3⁄4                                    |   | 53                           |   | 3⁄4             |   | 53                                        |   |
| Severance – Discontinued operations.          |   | 3⁄4                                    |   | 427                          |   | (249               | )      | 178                                       |   |
| Facilities closure – discontinued  operations |   | 3⁄4                                    |   | 829                          |   | 3⁄4             |   | 829                                       |   |
|                                               |   | $                                         | 2,767  |                         | $      | 1,536              |   | $                                         | (1,973 | ) | $ | 2,330 |   |

 

At December31, 2003, the Company had restructuring liabilities totaling $2,925,000, ofwhich $1,016,000 was recorded in accrued liabilities, $998,000 was recorded inother non-current liabilities, $563,000 was included in current liabilities ofdiscontinued operations and $348,000 was recorded in non-current liabilities ofdiscontinued operations.  Approximately$998,000 of the non-current restructuring liability is expected to be paid infiscal year 2005 and the balance is expected to be paid in fiscal year2006.  The following is a summary of therestructuring liabilities from September 30, 2003 to December 31, 2003 (inthousands):

 

13

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|                                               |   | **Liability  as of  September 30,  2003** |   | **Additions/  (Reductions)** |   | **Cash  Payments** |   | **Liability  as of  December 31,  2003** |   |
|----------------------------------------------------|--------|-------------------------------------------|--------|------------------------------|--------|--------------------|--------|------------------------------------------|--------|
| Severance – OPC                               |   | $                                         | 1,133  |                         | $      | —             |   | $                                        | (120   | ) | $ | 1,013 |   |
| Facilities closure – OPC                      |   | 137                                       |   | 3⁄4                       |   | (20                | )      | 117                                      |   |
| Severance – fiscal 2003 plan                  |   | 3⁄4                                    |   | 903                          |   | (228               | )      | 675                                      |   |
| Facilities closure – fiscal 2003 plan         |   | 53                                        |   | 218                          |   | (62                | )      | 209                                      |   |
| Severance – Discontinued operations.          |   | 178                                       |   | 830                          |   | (835               | )      | 173                                      |   |
| Facilities closure – discontinued  operations |   | 829                                       |   | 20                           |   | (111               | )      | 738                                      |   |
|                                               |   | $                                         | 2,330  |                         | $      | 1,971              |   | $                                        | (1,376 | ) | $ | 2,925 |   |

 

**12.****      ****NOTE 12 — DISCONTINUED OPERATIONS**

 

During the quarterended September 30, 2003, the Company completed a strategic review of allbusiness units and began a restructuring plan which included exiting the U.S.Commercial Services segment and the United Kingdom Operations segment.  During the quarter ended December 31, 2003,the Company completed the restructuring and abandoned those businesses.  Accordingly, the financial position, resultsof operations and cash flows of the U.S. Commercial Services and United KingdomOperations segments have been reported as discontinued operations for eachperiod presented.  At December 31, 2003,the Company had net liabilities of discontinued operations of approximately$571,000 comprised of accounts receivable, prepaid expenses, fixed assets,restructuring liabilities, accrued compensation and related liabilities andaccounts payable and other accrued liabilities.

 

The operatingresults of the discontinued operations are as follows:

 
|                                                             |   | **Three  Months Ended  December 31,** |       |
|------------------------------------------------------------------|--------|---------------------------------------|------------|
|                                                             |   | **2003**                              |       | **2002** |   |
|                                                             |   | **(in thousands)**                    | ** ** |
|                                                             |   |                                  |       |   |   |
| Net revenues                                                     |   | $                                     | 1,671      |   | $ | 3,104 |   |
| Income (loss) from discontinued operations,  net of income taxes |   | $                                     | (1,565     | ) | $ | 259 |   |

 

**13.  LEGALPROCEEDINGS**

 

In December2003, a complaint was filed in the U.S. District Court for the NorthernDistrict of California against the Company, its chairman of the board whoformerly was its chief executive officer, another executive officer whoformerly was its chief financial officer and a former executive officer.  *Sperlingv. Tier Technologies, Inc. et al*, case no. C03-05509VRW.  The complaint has been brought as apurported shareholder class action under Sections 10(b) and 20(a) of theSecurities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder and seeksunspecified monetary damages on behalf of the shareholder class.  In general, the complaint alleges that theCompany misrepresented its financial performance during the fiscal years 2002and 2003 to inflate the value of its stock. The Company has not been served with a copy of this complaint.  Since the filing of the complaint in federalcourt, the Company has been served with a copy of a complaint filed by ashareholder as a putative derivative action in California Superior Court forContra Costa County.  The derivativecomplaint names the same three officers, another current officer, some of theCompany’s current directors and two former directors as defendants and allegesbreach of fiduciary duty, abuse of control, gross mismanagement, waste ofcorporate assets, unjust enrichment and violations of the CaliforniaCorporations Code.  The Company believesthat the allegations in these complaints are without merit and intends tovigorously defend these lawsuits.  Thelawsuits have been tendered to the Company’s insurance carriers.

 

14

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In November2003, the Company filed a lawsuit in California Superior Court, SacramentoCounty, against CalPERS to overturn CalPERS’ decision to terminate the contractrelating to the Company’s systems integration project for CalPERS for defaultand to recover added costs associated with that project.  The Company seeks to recover damages andproject delay, disruption and interference costs on the project.  In December 2003, CalPERS filed across-complaint against the Company and made a claim against the performancebond for this contract.  The parties areundertaking discovery and the Company intends to vigorously pursue its claimsand to defend against CalPERS’ cross-complaint.

 

In June 2003,the Company announced that it had received a subpoena from a grand jury in theSouthern District of New York to produce certain documents pursuant to aninvestigation involving the child support payment processing industry by theUnited States Department of Justice (“DOJ”), Antitrust Division.  The Company has fully cooperated, andintends to continue to cooperate fully, with the subpoena and with the DOJ’sinvestigation.  On November 20, 2003,the DOJ granted conditional amnesty to the Company pursuant to the AntitrustDivision’s Corporate Leniency Policy. Consequently, the DOJ will not bring any criminal charges against theCompany, its officers, directors and employees, as long as the Companycontinues to comply with the Corporate Leniency Policy, which requires, amongother things, our full cooperation in the investigation and restitutionpayments if it is determined that parties were injured as a result ofimpermissible anti-competitive conduct. During the three months ended December 31, 2003, we incurredapproximately $516,000 of legal costs to comply with the subpoena whichincludes approximately $232,000 paid under indemnification agreements.  Due to the preliminary nature of thegovernment’s inquiry, we are not able to assess the full impact on ourfinancial condition and results of operations.

 

In May 2003,we received a notice of demand for arbitration in connection with a disputeover payments related to an acquisition. The claim is for an amount not less than $700,000 plus interest,attorneys’ fees and associated costs. This matter was settled and the Company recorded a charge ofapproximately $104,000 in the three months ended December 31, 2003.

 

**14.  RECENTACCOUNTING PRONOUNCEMENTS**

 

In May 2003,the FASB issued Statement of Financial Accounting Standards No. 150(“SFAS 150”), “Accounting for Certain Financial Instruments withCharacteristics of both Liabilities and Equity.” SFAS 150 establishesstandards for classifying and measuring as liabilities certain financialinstruments that embody obligations of the issuer and have characteristics ofboth liabilities and equity. SFAS 150 represents a significant change in practice in theaccounting for a number of financial instruments, including mandatoryredeemable equity instruments and certain equity derivatives that frequentlyare used in connection with share repurchase programs.  SFAS 150 is effective for all financialinstruments created or modified after May 31, 2003, and for all otherinstruments as of September 1, 2003. We have not used such instruments in our share repurchase program, andthe adoption of this statement did not have a material effect on the Company'sconsolidated financial position, results of operations or cash flows.

 

**15.  SUBSEQUENTEVENT**

 

In January2004, the Company was served with a complaint filed by Professional Services& Resources, Inc. (PSRI) in the Circuit Court in Cole County, Missouri (*ProfessionalServices & Resources, Inc. vs. Tier Technologies, Inc.,*Case No.04CV323189).  PSRI alleges that Tierbreached the subcontract agreement between the parties by hiring an employee ofPSRI.  PSRI claims damages of $100,000for violation of the agreement, punitive damages, and attorney fees and costsassociated with the action.  The Companybelieves the allegations in the complaint are without merit and intends tovigorously defend the lawsuit.

 

15

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**ITEM 2****.****                   MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**Overview**

 

We are aprovider of transaction and payment processing and packaged software andsystems implementation services for federal, state and local governmentclients.  We combine our understandingof enterprise-wide systems with domain knowledge to formulate, evaluate andimplement solutions that allow clients to rapidly channel emerging technologiesinto their business operations.  Ourworkforce, composed of employees, independent contractors and subcontractors,decreased to 724 on December 31, 2003 from 838 on December 31, 2002 primarilydue to the restructuring and discontinued operations.

 

In fiscal year 2003, weoperated our business through four strategic business units:  U.S. Government Services, U.S. CommercialServices, OPC and United Kingdom Operations. In the fourth quarter of fiscal year 2003, we completed a strategicreview of all business units and began a restructuring plan which renewed ourfocus on our core Government Services businesses while exiting otherunprofitable or marginal businessoperations.  As of December 31, 2003, wehad exited the United Kingdom segment, the U.S. Commercial Services segment,and the Justice & Public Safety and Strategies divisions of our former U.S.Government Services business unit.  Thefinancial position, results of operations and cash flows for the U.S.Commercial Services and United Kingdom segments are reported as discontinuedoperations for each period in this report. We also created two new business units from our U.S. Government Servicesbusiness unit:  the Government BusinessProcess Outsourcing ("Government BPO") business unit and theGovernment Systems Integration (“Government SI”) business unit.  We intend to increase our investment inbusiness development in these areas to support future revenue growth.  Our Government BPO segment includesour child support payment processing contracts, our health and human servicesconsulting business, a District of Columbia child support enforcement projectand the Financial Institution Data Match contracts. We expect to seesignificant proposal activity in the child support payment processing marketover the next six months as we believe approximately seven states intend toissue new requests for proposals. Our Government SI segment includes ourpension contracts, unemployment insurance contracts, financial managementsystems (“FMS”) contracts, our e-government contracts and the state of Missouricontracts.  We have shifted our systemsintegration model from custom developed solutions to implementation andmodification of packaged software. We believe this strategy of implementing pre-existingsoftware applications that include customizations to meet our particularclients’ needs will combine the potential for greater profitability with lessrisk compared to our earlier strategy of building systems from scratch.

 

We derive net revenues primarily from transaction and paymentprocessing, systems design and integration, and maintenance and supportservices.  We bill clients on aper-transaction basis, a fixed price basis or a time and materials basis.  We recognize net revenues from transaction-basedcontracts based on fees charged on a per-transaction basis or fees charged as apercentage of dollars processed.  Werecognize net revenues from software licenses that include significantimplementation or customization services on the percentage-of-completion methodof accounting based upon the ratio of costs incurred to total estimated projectcosts.  We recognize net revenues fromsoftware licenses that do not include significant implementation or customizationservices upon delivery to the licensee when the fees are fixed anddeterminable, collection is probable and vendor specific objective evidenceexists to determine the value of any undeliverable elements of thearrangement.  We recognize fixed pricenet revenues for other projects as services are provided and accepted by ourclients, if applicable.  We recognizetime and materials net revenues as we perform services and incur expenses.  Net revenues from software maintenancecontracts are recognized ratably over the term of the contract, typically oneyear.  During the three months endedDecember 31, 2003, we generated 16.6% of our net revenues on a fixed pricebasis and 65.3% of our net revenues on a per-transaction basis.  We believe that the percentage of total netrevenues attributable to fixed price and per-transaction based contracts willcontinue to be significant. Substantially all of our contracts are terminable by the clientfollowing limited notice and without significant penalty to the client.  From time to time, in the regular course ofour business, we negotiate the modification, termination, renewal or transitionof time and materials, fixed price and per-transaction based contracts that mayinvolve an adjustment to the scope, duration or nature of the project, billingrates or price.  If we significantlyoverestimate the volume for transaction-based contracts or underestimate theresources, costs or time required for fixed price or per-transaction basedcontracts, our financial condition and results of operations would be materiallyand adversely affected.  Unsatisfactoryperformance of services or proprietary software or unanticipated difficultiesor delays in completing projects may result in client dissatisfaction and areduction in payment to us, termination of a contract, or payment of damages orpenalties by us as a result of litigation or otherwise, which could have amaterial adverse effect upon our business, financial condition and results ofoperations.

 

We havederived a significant portion of our net revenues from a small number of largeclients.  For some of these clients, weperform a number of different projects pursuant to multiple contracts orpurchase orders.  For the three monthsended December 31, 2003, revenues from the State of Missouri accounted for 10.4%of our total net revenues.  Weanticipate that a substantial portion of our net revenues will continue to bederived from a small number of large clients. The completion, cancellation or significant reduction in the scope of alarge project would have a material adverse effect on our business, financialcondition and results of operations.  Inaddition, we perform child support payment processing services for threedifferent state governments as a subcontractor to ACS State and LocalSolutions, Inc. (“ACS”).  For the threemonths ended December 31, 2003, work performed under these three subcontractsaccounted for 14.3% of total net revenues.

 

Personnel,facility and depreciation and amortization expenses represent a significantpercentage of our operating expenses and are relatively fixed in advance of anyparticular quarter.  We manage ourpersonnel utilization rates by carefully monitoring our needs and anticipatingpersonnel increases based on specific project requirements.  To the extent net revenues do not increaseat a rate commensurate with these additional expenses, our results ofoperations could be materially and adversely affected.  In addition, to the extent that we areunable to hire and retain salaried employees to staff new or existing clientengagements or retain hourly employees or contractors, our business, financialcondition and results of operations would be materially and adversely affected.

 

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From October1, 2001 through December 31, 2003, we made three acquisitions for a total costof approximately $79.7 million using cash. We also incurred $1.0 million in cumulative compensation charges relatedto business combinations and $1.3 million in cumulative business combinationintegration charges resulting from these acquisitions.  Generally, we record contingent payments asadditional goodwill at the time the payment can be determined beyond areasonable doubt.  If a contingentpayment is based, in part, on a seller’s continuing employment with us, thepayments are recorded as compensation expense under U.S. generally acceptedaccounting principles over the vesting period when the amount is deemedprobable.

 

 

 

**Critical Accounting Policies and Estimates**

 

The discussionand analysis of our financial condition and results of operations are basedupon our consolidated financial statements, which have been prepared inaccordance with U.S. generally accepted accounting principles.  The preparation of these financialstatements requires us to make estimates and judgments that affect our reportedassets, liabilities, net revenues and expenses, and our related disclosure ofcontingent assets and liabilities.  Onan on-going basis, we evaluate our estimates, including those related torevenue recognition, cost, collectibility of receivables, goodwill andintangible assets, income taxes, restructuring obligations and discontinuedoperations.  We base our estimates onhistorical experience and on various other assumptions that are believed to bereasonable under the circumstances. Such experience and assumptions form the basis of judgments about thecarrying values of assets and liabilities that are not readily apparent fromother sources.  Actual results maydiffer from these estimates under different assumptions or conditions.

 

We believe thefollowing critical accounting policies and the related judgments and estimatessignificantly affect the preparation of our consolidated financial statements:

 

*Basis of Presentation.*  During the year ended September 30, 2003, weadopted SFAS 144, “Accounting for the Impairment and Disposal of Long livedAssets” which broadened the presentation of discontinued operations from thedisposal of a segment to the disposal of a component of the entity.  SFAS 144 also changed the timing ofpresentation from the point of commitment to the point of actual disposal ofthe operations.  During the quarterended September 30, 2003, we completed a plan to exit the operations of ourU.S. Commercial Services segment, our United Kingdom Operations segment and theJustice and Public Safety and Strategies divisions within the U.S. GovernmentServices segment.  Effective October 1,2003, the U.S. Government Services segment was split into Government BPO andGovernment SI.  During the quarter endedDecember 31, 2003, we exited the U.S. Commercial Services and United KingdomOperations segments and the financial position, results of the operations andcash flows of these components are reported as discontinued operations for eachperiod in this report.  We must use ourjudgment to determine whether particular operations are considered a componentof the entity and when the operations have been disposed.

 

*Revenue Recognition.*  Certain judgments affect the application ofour revenue policy.  Our OPC andGovernment BPO segments generate transaction and payment processingrevenues.  Net revenues from transactionand payment processing contracts are generally recognized based on fees chargedon a per-transaction basis or fees charged as a percentage of total dollarsprocessed.  We establish theper-transaction fee or transaction fee percentage in our contracts based onestimated future costs and the estimate of transaction volume over the life ofthe contract.  We use our historicalexperience and mathematical models to estimate transaction volumes.  We monitor volumes of transactions on amonthly basis.  Any significant variancefrom the estimated number of transactions or average transaction dollarsprocessed could significantly impact the resulting revenues and operatingprofit.  For example, our monthlytransactions volumes at our

 

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child support paymentprocessing centers varied between 107% and 93% from the average monthly volumeduring fiscal year 2003.  If the volumeof transactions processed at all child support payment processing centersdecreased 10% from the volume processed during fiscal year 2003, ourtransaction processing revenues would have decreased approximately $2.9million.  Additionally, if the averagevolume of dollars processed by OPC for each payment type decreased 10% from theaverage volume processed by OPC for each payment type during fiscal year 2003,our transaction and payment processing revenues would have decreased by approximately$3.7 million.

 

For OPC’selectronic payment transactions, we use judgment and historical experience toestimate sales returns and allowances attributable to credit card reversals andchargebacks in determining net revenues. When estimating these reserves, we analyze historical trends, ourspecific customer experience and current economic conditions.  Credit card reversal and chargebacks ofconvenience fees were $44,000 or 0.6% of total OPC revenues for the threemonths ended December 31, 2003.

 

Our GovernmentSI segment generates systems design and integration revenues.  Net license and services revenues fromcontracts involving significant modification, customization or services whichare essential to the functionality of the software are recognized using thepercentage-of-completion method of accounting based upon the ratio of costsincurred to total estimated project costs. The total estimated cost is calculated using financial models and isbased on our historical experience and expected project time and effort.  Any significant changes in total estimatedcosts could significantly impact the recognition of net revenue.  We monitor the costs incurred and evaluate variancesbetween budgeted and actual costs in our fixed price contracts on a monthlybasis.  To the extent there are changesin the total estimated costs, we adjust the percentage of revenuesrecognized.  For example, if the totalestimated costs of each of our percentage-of-completion contracts in process asof September 30, 2003 increased 10%, our fixed price revenues for the yearended September 30, 2003 would have decreased by $4.3 million.  Provided the arrangement does not requiresignificant implementation or customization of the software, software licensenet revenue is recognized when there is persuasive evidence of an arrangement,the fee is fixed or determinable, collectibility is probable and delivery tothe client has occurred.  We use ourjudgment to determine when implementation or customization is significant.  Revenues for software license fees notrequiring significant modification were $53,000 and $20,000 for the threemonths ended December 31, 2003 and 2002, respectively.

 

Our GovernmentSI segment also generates maintenance and support services revenues.  Net revenues from software maintenancecontracts are recognized ratably over the term of the contract, typically oneyear.  Non-essential support services,including training and consulting, are also provided on a time and materialsbasis.  Revenue is recognized as theservices are performed.  Maintenance andnon-essential support services revenues were $4.2 million and $3.7 million forthe three months ended December 31, 2003 and 2002, respectively.

 

Generally ourgovernment contracts are subject to “fiscal funding” clauses, which entitle theclient, in the event of budgetary constraints, to reduce or eliminate theservices we are to provide, with a corresponding reduction in the fee theclient must pay.  Net revenues are recognizedunder such contracts only when we consider the likelihood of cancellation offunding to be remote.  For OPC, theconsumer generally bears the transaction fee, not the government entity, so OPCcontracts are not generally subject to fiscal funding issues.  For the three months ended December 31,2003, revenues recognized under contracts subject to fiscal funding clauseswere 71.1% of total net revenues.

 

For all oursegments, the amount and timing of our net revenue is difficult to predict, andany shortfall in net revenue or delay in recognizing net revenue could causeour operating results to vary significantly from quarter to quarter and couldresult in future operating losses.

 

*Cost and Volume Estimates.*  For our transaction and payment processing,we establish the per-transaction fee or transaction fee percentage in ourclient contracts based on estimated future costs and estimates of transactionand dollar volume over the life of the contract.  Included in our cost estimates for certain child support paymentprocessing contracts are estimates regarding misapplied payments and paymentsthat are rejected due to insufficient funds to the extent we are to bear thesecosts.  Included in our OPC costestimates are processing fees that are subject to change with limited or nonotice.  We use our judgment and reviewhistorical trends, our specific experience and current economic conditions inorder to estimate these costs.  Anysignificant variance from our estimates could significantly impact ouroperating profit.  For the three monthsended December 31, 2003, expenses incurred by us related to misapplied paymentsand insufficient funds checks were $321,000.

 

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We recognizefixed price net revenues for our systems design and integration projects usingthe percentage-of-completion method, based upon the ratio of costs incurred tototal estimated project costs.  Anysignificant changes in total estimated project costs could significantly affectour operating profit.

 

Collectibilityof Receivables.  A considerable amountof judgment is required to assess the ultimate realization of receivables,including assessing the probability of collection and the current creditworthiness of our clients.  Probabilityof collection is based upon the assessment of the client’s financial conditionthrough the review of its current financial statements or credit reports.  For follow-on sales to existing clients,prior payment history is also used to evaluate probability of collection.  We maintain an allowance for doubtfulaccounts for accounts receivable balances, including receivables resulting frommisapplied payments and payments that are rejected due to insufficient funds,and a sales return and allowance provision for reversals and chargebacks fromconsumers who use our credit or debit card payment services.  At December 31, 2003 and September 30, 2003,the combined balance of the allowance accounts was $1.8 million for eachperiod.  There is no assurance that wewill not need to record increases to these balances in the future.  We have several large accounts receivableand unbilled receivable balances, and any dispute, early contract terminationor other collection issues could have a material adverse impact on ourfinancial condition and results of operations. For example, during the fourth quarter of fiscal year 2003, CalPERSterminated our systems integration contract. We subsequently filed a lawsuit seeking to recover costs anddamages.  As a result, we recorded acharge against revenues of $12.8 million to write down the total value ofunbilled receivables from CalPERS.  AtDecember 31, 2003, $12.3 million of our accounts receivable and $4.4 million ofour unbilled receivables balances were balances owed by seven clients foramounts greater than $1.0 million each.

 

*Goodwill and Other Intangible Assets.*  Consideration paid in connection withacquisitions is required to be allocated to the acquired assets, includingidentifiable intangible assets, and liabilities acquired.  Acquired assets and liabilities are recordedbased on our estimate of fair value, which requires significant judgment withrespect to future cash flows and discount rates.  We utilize historical experience as well as external specialiststo estimate fair value.  For intangibleassets, we are required to estimate the useful life of the asset or determineif it has an indefinite useful life.  Weuse our judgment to evaluate potential indicators of impairment of goodwill andother intangible assets.  Our judgmentsregarding the existence of impairment indicators are based on marketconditions, operational performance of our acquired businesses andidentification of reporting units. Future events could cause us to conclude that impairment indicatorsexist and that goodwill and other intangible assets associated with ouracquired businesses are impaired. Beginning October 1, 2002, we adopted Statement of Financial AccountingStandards No. 142 (“SFAS 142”) “Goodwill and Other Intangible Assets.”  Accordingly, our goodwill and otherintangible assets that have an indefinite useful life are not amortized butinstead are reviewed at least annually for impairment.  During the quarter ended December 31, 2002,we completed the initial impairment test and the results did not indicate anyimpairment loss.  Impairment testsinvolve the use of estimates related to the fair market value of the businessoperations with which goodwill is associated. During the fourth quarter of fiscal year 2003, we decided to shut downthe U.S. Commercial Services segment and the United Kingdom Operations segmentand accordingly recorded a charge of $17.6 million to write down goodwill toits fair value as determined by calculating the expected cash flows from theremaining contractual obligations of those segments.  As of September 30, 2003, the remaining goodwill associated withthese segments total $457,000.  Thisgoodwill value was written off during the quarter ended December 31, 2003.  In the fourth quarter of fiscal year 2003,we performed our annual impairment test to determine if the remaining goodwillassociated with our continuing segments was impaired.  Our estimate of fair value did not indicate any impairment.  The fair market value of the remainingsegments was determined using forecasted future cash flows.  Those cash flows were forecasted usingsignificant assumptions including: future revenues and expenses, future growthrates and discount rates.  These growthrates are consistent with our plans and experience.  If the discount rate used in these valuation models increased by1%, the calculated fair value would decrease by 4.5%.

 

*Income Taxes.*  We are required to estimate our income taxesin each of the jurisdictions in which we operate as part of the process ofpreparing our consolidated financial statements.  This process involves estimating our actual current taxliability, including assessing temporary differences resulting from differingtax treatment of items, such as the difference in amortizable lives forintangible assets for tax and accounting purposes.  These differences result in deferred tax assets andliabilities.  At December 31, 2003 andSeptember 30, 2003, we had a net deferred tax asset of $23.2 million, comprisedof net operating loss carryforwards, foreign tax credit carryforwards and otherdeductible temporary differences, against which we are carrying a $23.2 millionvaluation allowance.  Statement ofFinancial Accounting Standards No. 109 (“SFAS 109”) “Accounting for IncomeTaxes” requires that the deferred tax assets be reduced by a

 

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valuation allowance if, basedon the weight of available evidence, it is more likely than not that someportion or all of the recorded deferred tax assets will not be realized infuture periods.  In evaluating our abilityto recover our deferred tax assets we consider all available positive andnegative evidence including our past operating results, the existence ofcumulative losses in the most recent fiscal years and our forecast of futuretaxable income.  In determining futuretaxable income, we are responsible for assumptions utilized including theamount of federal and state pre-tax operating income, the reversal of temporarydifferences and the implementation of feasible and prudent tax planningstrategies.  These assumptions requiresignificant judgment about the forecasts of future taxable income and areconsistent with the plans and estimates we are using to manage the underlyingbusinesses.  Management concluded toestablish a full valuation allowance as of September 30, 2003.  We intend to maintain this valuationallowance until sufficient positive evidence exists to support reversal of thevaluation allowance.  Our income taxexpense recorded in the future will be reduced to the extent of offsettingdecreases in our valuation allowance. In addition, the calculation of tax liabilities involves significantjudgment in estimating the impact of uncertainties in the application ofcomplex tax laws. Although we believe that our estimates are reasonable,resolution of these uncertainties in a manner inconsistent with management'sexpectations could have a material impact on the Company's financial positionand cash flows.

 

*Determination of Restructuring Obligations*.  During the fourth quarter of fiscal 2003, werecorded a restructuring charge related to plans and actions taken to exitbusinesses, terminate employees and consolidate facilities.  During the quarter ended December 31, 2003,we exited the former U.S. Commercial Services and United Kingdom segments andthe financial position, results of operations and cash flows of thesebusinesses are reported as discontinued operations for each period.  Also, as a result of our acquisition of OPCin July 2002, we assumed certain liabilities for restructuring costs that OPChad previously recognized in connection with the termination of employees andthe consolidation of facilities.  The restructuring liability forconsolidation of facilities is the estimated net obligation payable onabandoned office facilities.  The estimatednet obligation includes the gross obligation payable under existing leaseagreements through estimated disposition dates, estimated costs of abandonmentor lease transfer, as offset by estimated sublease income.  To the extentwe are unable to sublease or otherwise dispose of the facilities on the datesestimated, or the estimated sublease income or estimated costs differ from ourestimates, the restructuring liability may require adjustment.  Forexample, if we do not obtain a sublease for the facilities that are not alreadysubleased as of December 31, 2003, our restructuring liability forconsolidation of facilities would increase by approximately $32,000.  At December 31, 2003 and September 30, 2003we had restructuring liabilities totaling $2.9 million and $2.3 million,respectively.

 

**Results of Operations**

 

The followingtable summarizes our operating results as a percentage of net revenues for eachof the periods indicated:

 
|                                                           |   | **Three  Months Ended  December 31,** |       |
|----------------------------------------------------------------|--------|---------------------------------------|------------|
|                                                           |   | **2003**                              |       | **2002** |   |
|                                                           |   |                                  | ** ** |   | ** ** |
| Net revenues                                                   |   | 100.0                                 | %          | 100.0 | % |
| Costs and expenses:                                            |   |                                  |       |   |   |
| Direct costs                                                   |   | 67.8                                  |       | 63.8 |   |
| Selling and marketing                                          |   | 5.2                                   |       | 5.0 |   |
| General and administrative                                     |   | 20.7                                  |       | 18.5 |   |
| Restructuring and other charges                                |   | 7.8                                   |       | 1.4 |   |
| Depreciation and amortization                                  |   | 4.2                                   |       | 4.7 |   |
| Income (loss) from continuing operations                       |   | (5.7                                  | )          | 6.6 |   |
| Interest income (expense), net                                 |   | 1.0                                   |       | 1.3 |   |
| Income (loss) from continuing operations  before income taxes  |   | (4.7                                  | )          | 7.9 |   |
| Provision for income taxes                                     |   | 0.1                                   |       | 2.9 |   |
| Income (loss) from continuing operations,  net of income taxes |   | (4.8                                  | )%         | 5.0 | % |

 

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**Three Months Ended December 31, 2003 andDecember 31, 2002**

 

*Net Revenues.*  We generate net revenues primarily fromtransaction and payment processing services, software development services, andsoftware license and maintenance fees. The Government BPO segment provides systems design and integration andtransaction and payment processing services to federal, state and localgovernment entities in the United States. The Government SI segment provides systems design and integrationservices to state and local government entities in the United States.  The OPC segment provides transaction andpayment processing services to clients primarily in the public sector.  Net revenues decreased 8.9% to $26.5 millionfor the three months ended December 31, 2003 from $29.1 million in the threemonths ended December 31, 2002.  Thisdecrease resulted primarily from a decrease in Government BPO net revenues ofapproximately $711,000 and a decrease in Government SI net revenues ofapproximately $3.4 million, partially offset by an increase in OPC net revenuesof approximately $1.5 million.  Thefollowing table presents the net revenues for each of the three reportablesegments for the three months ended December 31, 2003 and 2002:

 

|           |   | **Three  months ended  December 31,** |   |
|----------------|--------|---------------------------------------|--------|
|           |   | **2003**                              |   | **2002** |   |
|           |   | **(in thousands)**                    |   |
|           |   |                                  |   |   |   |
| Government BPO |   | $                                     | 11,111 |   | $ | 11,822 |   |
| Government SI  |   | 7,725                                 |   | 11,140 |   |
| OPC            |   | 7,674                                 |   | 6,125 |   |
| Total          |   | $                                     | 26,510 |   | $ | 29,087 |   |

 

The $711,000decrease in Government BPO net revenues resulted primarily from the windingdown of one project that is expected to be completed in May 2004.  The $3.4 million decrease in Government SInet revenues resulted primarily from a $3.2 million decrease in revenues fromCalPERS as a result of the termination of the project due to a dispute withCalPERS.  The $1.5 million increase inOPC net revenues resulted primarily from an increase in adoption rates of OPCservices and the addition of new government clients and payment types.

 

The followingtable presents net revenues for the three months ended December 31, 2003 and2002 by delivery offering:

 

|                               |   | **Three  months ended  December 31,** |   |
|------------------------------------|--------|--------------------------------------------|--------|
|                               |   | **2003**                                   |   | **2002** |   |
|                               |   | **(in thousands)**                         |   |
|                               |   |                                       |   |   |   |
| Transaction and payment processing |   | $                                          | 18,326 |   | $ | 16,210 |   |
| Systems design and integration     |   | 3,708                                      |   | 8,699 |   |
| Maintenance and support services   |   | 4,208                                      |   | 3,688 |   |
| Other                              |   | 268                                        |   | 490 |   |
| Total                              |   | $                                          | 26,510 |   | $ | 29,087 |   |

 

Net revenuesfrom transaction and payment processing services increased 13.1% in the threemonths ended December 31, 2003 compared to the three months ended December 31,2002 primarily as a result of the $1.5 million increase in OPC net revenues aswell as approximately $1.2 million in net revenues from one new child supportpayment processing contract in our Government BPO segment, partially offset bya $450,000 decrease in revenues from the loss of one child support paymentprocessing center contract.  Netrevenues from systems design and integration services decreased 57.4% in thethree months ended December 31, 2003 compared to the three months endedDecember 31, 2002 primarily due to a $3.2 million reduction in revenues fromCalPERS as a result of the termination of the CalPERS contract and decreasedrevenues of $1.1 million due to the winding down of one project that isexpected to be completed in May 2004. Net revenues from maintenance and support services increased 14.1% inthe three months ended December 31, 2003 compared to the three months endedDecember 31, 2002 primarily as a result of increased revenues

 

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from one of our largeclients.  Net revenues from otherservices, which declined 45.3% in the three months ended December 31, 2003compared to the three months ended December 31, 2002, were affected by areduction in client IT spending.

 

Net revenuesinclude reimbursements from clients for out-of-pocket expenses.  Reimbursement and software license netrevenues for each period represented were less than 10% of total net revenuesfor the respective period.  We expectreimbursement revenues to increase in absolute dollars in future periodsprimarily due to new contracts and future anticipated contracts primarily inour child support payment processing operations.

 

*DirectCosts.   *Direct costs consist primarilyof those costs directly attributable to providing service to a client,including employee salaries and incentive compensation, independent contractorand subcontractor costs, employee benefits, payroll taxes, travel-related expenditures,amortization of intellectual property, amortization and depreciation of anyproject-related equipment, hardware or software purchases, and the cost ofhardware, software or equipment sold to clients.  For state child support payment processing center operations,direct costs also include facility, depreciation and amortization expense anddirect overhead costs.  For OPC, directcosts consist primarily of credit and debit card discount fees, processingfees, telecommunication costs and other third party costs.  Direct costs include $531,000 ofdepreciation and amortization for the three months ended December 31, 2003 and$514,000 for the three months ended December 31, 2002.  In total, direct costs decreased 3.2% to$18.0 million for the three months ended December 31, 2003 from $18.6 millionfor the three months ended December 31, 2002. This decrease resulted primarily from the decrease in net revenues.

 

*Selling and Marketing.     *Sellingand marketing expenses consist primarily of personnel costs, sales commissions,advertising and marketing expenditures, and travel-related expenditures.  Selling and marketing expenses were $1.4million for the three months ended December 31, 2003 and 2002.  As a percentage of net revenues, selling andmarketing expenses increased to 5.2% for the three months ended December 31,2003 from 5.0% for the three months ended December 31, 2002.  We expect selling and marketing expenses forfiscal year 2004 to increase in absolute dollars compared to fiscal year 2003as a result of our investment in business development.  We expect sales and marketing expenses tofluctuate from quarter to quarter due to items such as increased advertisingand marketing expense as OPC prepares for the April 15th tax season.

 

*General and Administrative.   *Generaland administrative expenses consist primarily of personnel costs related togeneral management and administrative functions, human resources, resourcemanagement, OPC’s engineering, client implementation, client service andcustomer service departments, staffing, accounting and finance, legal,facilities and information systems, as well as business insurance costs,facility costs and professional fees related to legal, audit, tax, externalfinancial reporting and investor relations matters.  General and administrative expenses increased 2.0% to $5.5million for the three months ended December 31, 2003 from $5.4 million for thethree months ended December 31, 2002. As a percentage of net revenues, general and administrative expensesincreased to 20.7% for the three months ended December 31, 2003 from 18.5% forthe three months ended December 31, 2002. We expect general and administrative expenses will increase in absolutedollars for fiscal year 2004 compared to fiscal year 2003 as a result ofincreased insurance premiums for directors and officers liability insurance andcosts to comply with the Sarbanes-Oxley Act.

 

*Restructuring andother charges.***     **The following table presents the restructuring and other charges for the three monthsended December 31, 2003 and 2002:

 

|                                                |   | **Three  months ended  December 31,** |   |
|-----------------------------------------------------|--------|--------------------------------------------|--------|
|                                                |   | **2003**                                   |   | **2002** |   |
|                                                |   | **(in thousands)**                         |   |
|                                                |   |                                       |   |   |   |
| Assets impairment charge                            |   | $                                          | 135    |   | $ | — |   |
| Indirect costs associated with terminated  contract |   | 300                                        |   | 3⁄4 |   |
| Severance charge resulting from restructuring       |   | 903                                        |   | 3⁄4 |   |
| Office closure charge resulting from  restructuring |   | 218                                        |   | 3⁄4 |   |
| Business combination integration                    |   | 3⁄4                                     |   | 405 |   |
| Other charges                                       |   | 516                                        |   | 3⁄4 |   |
| Total                                               |   | $                                          | 2,072  |   | $ | 405 |   |

 

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During thethree months ended December 31, 2003, we recorded asset impairment charges of$135,000 resulting from assets written off due to an office closure.  We also recorded $300,000 of indirect costsassociated with terminated contract which includes legal and other costs relatedto the terminated CalPERS contract.  Theseverance charge of $903,000 represents additional severance costs resultingfrom the signing of a termination agreement with our former Chief ExecutiveOfficer.  The office closure charge of$218,000 represents costs incurred for the closure of one office (net ofestimated sublease income of $75,000). Other charges of $516,000 represent legal and other costs incurred tocomply with the DOJ subpoena.  We expectto incur additional charges of approximately $2.1 million for the remainder offiscal year 2004 as a result of additional severance due to the contingentmodification of our former Chief Executive Officer’s stock option terms  (the actual charge will be determined basedon the price of our Class B common stock on the date the options terms aremodified), additional costs incurred as a result of the CalPERS dispute andlegal costs to comply with the DOJ subpoena.

 

*Depreciation andAmortization.* Depreciation and amortization consists primarily of expenses associatedwith depreciation of equipment and leasehold improvements and amortization ofother intangible assets resulting from acquisitions and other intellectualproperty not directly attributable to client projects.  Project-related depreciation and amortizationis included in direct costs.  For OPC,no depreciation and amortization expense is included in direct costs.  Depreciation and amortization decreased17.9% to  $1.1 million for the threemonths ended December 31, 2003 from $1.4 million for the three months endedDecember 31, 2002.  As a percentage ofnet revenues, depreciation and amortization decreased to 4.2% for the threemonths ended December 31, 2003 from 4.7% for the three months ended December31, 2002.  The decrease in depreciationand amortization resulted primarily from decreased capital expenditures.

 

*Interest Income  (Expense), Net.*  Net interest income decreased 26.7% to$277,000 for the three months ended December 31, 2003 compared to net interestincome of $378,000 for the three months ended December 31, 2002.  This decrease was primarily attributable tolower investment balances and lower interest rates in the current year.

 

*Provision for IncomeTaxes.* Theprovision for income taxes was $35,000 for the three months ended December 31, 2003and $838,000 for the three months ended December 31, 2002.  The provision for income taxes for the threemonths ended December 31, 2003 represents the expected minimum state taxpayments.  No tax benefit on the netloss was recorded due to the full valuation allowance on our net deferred taxassets.  Our effective tax rate was36.4% for the three months ended December 31, 2002.  The effective tax rate in the upcoming quarters and for the yearending September 30, 2004 may vary due to a variety of factors, including, butnot limited to, the relative income contribution by tax jurisdiction, changesin statutory tax rates, the amount of tax exempt interest income generatedduring the year, the ability to utilize foreign tax credits and foreign netoperating losses, and any non-deductible items related to acquisitions or othernonrecurring charges.  We will continueto monitor the effective tax rate on a quarterly basis.

 

*Discontinuedoperations.*  The loss from discontinued operations, netof income taxes was $1.6 million for the three months ended December 31, 2003and represents the historical operating results of our U.S. Commercial Servicesand United Kingdom segments and the asset impairment and restructuring chargesrecorded as a result of discontinuing these segments.  The income from operations of discontinued operations, net ofincome taxes was $259,000 for the three months ended December 31, 2002 andrepresents the historical results of operations of the discontinued segments.

 

**Liquidity and Capital Resources**

 

Our principalcapital requirement is to fund working capital to support our growth, includingpotential future acquisitions and potential contingent payments due to prioracquisitions.  We maintain a $15.0million revolving credit facility that expires on January 31, 2005, of which$15.0 million may be used for letters of credit.  The credit facility bears interest at the adjusted LIBOR rateplus 2.5% or the lender’s announced prime rate plus 0.25%, at our option.  The credit facility is collateralized byfirst priority liens and security interests in our assets.  The credit facility contains certainrestrictive covenants including, but not limited to, limitations on the amountof loans we may extend to officers and employees, the payment of dividends, therepurchase of common stock and the incurrence of additional debt.  The credit facility requires the maintenanceof certain financial covenants, including a minimum quarterly net incomerequirement, minimum tangible net worth, a minimum ratio of debt to tangiblenet worth and a minimum ratio of liquid assets to current liabilities.  As of December 31, 2003, we were incompliance with all the covenants of the credit facility.

 

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At December31, 2003, we also had a $2.5 million non-revolving line of credit for financingcapital expenditures that may be drawn upon until January 29, 2004.  Principal payments must be made in 36 equalmonthly payments commencing February 29, 2004. This credit facility has a maturity date of January 31, 2007.  Interest is based on either the LIBOR rateplus 2.75% or the lender’s announced prime rate plus 0.5%, at our option and ispayable monthly.  As of December 31,2003, we had no borrowings under this line of credit.

 

In addition tothe credit facilities mentioned above, we had letters of credit totalingapproximately $3,346,000, which were collateralized by certain securities inour long-term investment portfolio at December 31, 2003.  Furthermore, our subsidiary, OPC, had aletter of credit outstanding in the amount of approximately $138,000 secured bya certificate of deposit.  These lettersof credit were issued to secure performance bonds and to meet various facilitylease requirements.

 

Net cash fromcontinuing operations provided by operating activities was $11.4 million in thethree months ended December 31, 2003 as compared to net cash from continuingoperations used in operating activities of $3.6 million in the three monthsended December 31, 2002.  The increasein net cash from continuing operations provided by operating activities islargely attributable to the receipt of approximately $6.5 million of income taxrefunds and increased accounts receivable collections.

 

Net cash fromcontinuing operations used in investing activities was $3.0 million and $6.1million in the three months ended December 31, 2003 and 2002,respectively.  The decrease in net cashfrom continuing operations used in investing activities is primarilyattributable to decreased investment activity in the three months endedDecember 31, 2003.

 

Capitalexpenditures, including equipment and software acquired under financingarrangements but excluding assets acquired or leased through businesscombinations, were approximately $409,000 in the three months ended December31, 2003 and $845,000 in the three months ended December 31, 2002.  We anticipate that in fiscal year 2004, wewill have capital expenditures similar to fiscal year 2003 related to, among otherthings, purchases of computer equipment to enhance our operations and supportour growth, as well as potential expenditures related to new office leases andthe establishment or expansion of child support payment processing and othertransaction processing centers.

 

Net cash fromcontinuing operations provided by financing activities totaled $589,000 in thethree months ended December 31, 2003 and $427,000 in the three months endedDecember 31, 2002.  The net cash fromcontinuing operations provided by financing activities for the three monthsended December 31, 2003 and 2002 resulted primarily from the exercise ofemployee stock options.

 

We expect togenerate cash flows from operating activities over the long-term; however, wemay experience significant fluctuations from quarter to quarter resulting fromthe timing of the billing and collection of large project milestones,particularly for our pension software systems projects.  We anticipate that our existing capitalresources, including our cash balances, cash that we anticipate will be providedby operating activities and our available credit facilities, will be adequateto fund our operations for at least the next 12 months.  There can be no assurance that changes willnot occur that would consume available capital resources before such time.  Our capital requirements and capitalresources depend on numerous factors, including potential acquisitions;contingent payments earned; new and existing contract requirements; the timingof the receipt of accounts receivable, including unbilled receivables; legalcosts incurred to comply with the DOJ investigation; legal costs incurredarising out of our dispute with CalPERS and to defend against the shareholderlitigation in federal and state courts; our ability to draw on our bankfacility and employee growth.  To theextent that our existing capital resources are insufficient to meet our capitalrequirements, we will have to raise additional funds.  There can be no assurance that additional funding, if necessary,will be available on favorable terms, if at all.  The raising of additional capital may dilute our shareholders’ownership in us.

 

During thefourth quarter of fiscal 2003, we initiated a strategic review of our businessunits.  This review was completed in thefourth quarter of fiscal 2003, and we decided to renew our focus on our coreGovernment Services businesses while exiting unprofitable or marginal businessoperations.  As a result of this review,we recorded restructuring charges of approximately $19.8 million during thequarter ended September 30, 2003.  Thisrestructuring charge was comprised of $18.2 million of goodwill, intangible andtangible asset impairment charges, $882,000 related to the closure of severaloffices (net of estimated sublease income of $115,000) and $707,000 of severancerelated to the termination of employees in the exited businesses, of which$529,000 was paid in fiscal year 2003. The restructuring

 

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plan included the terminationof approximately 50 employees, of which approximately 20 employees wereterminated in the three months ended September 30, 2003 and the remainingemployees were terminated in the three months ended December 31, 2003.  Additional goodwill and intangible assetimpairment charges of approximately $887,000 were incurred for the three monthsended December 31, 2003, of which approximately $135,000 was included inrestructuring and other charges and approximately $752,000 was included in lossfrom discontinued operations, and additional severance of $1.7 million, ofwhich approximately $903,000 is included in restructuring and other charges andapproximately $830,000 is included in loss from discontinued operations.  Also included in restructuring and othercharges for the three months ended December 31, 2003 was $218,000 related toestimated closure costs for one additional office (net of estimated subleaseincome of $75,000).  As a result of therestructuring, we expect salary costs to be reduced by approximately $6.3million and facility costs to be reduced by approximately $475,000 in fiscalyear 2004.

 

As a result ofthe acquisition of OPC in July 2002, we assumed certain liabilities forrestructuring costs that OPC had previously recognized in connection with theinvoluntary termination of employees of $2.7 million and the consolidation offacilities of $546,000 (net of estimated sublease income of $295,000).  The assumed severance liability includedseverance for 27 individuals and the closing of certain office space.

 

During thethree months ended December 31, 2003, we made total cash payments of $1.2million for severance and $193,000 for facilities.  Additional severance charges of approximately $350,000 areexpected to be incurred in the second quarter of fiscal 2004.  The additional severance charge representsan estimate of the non-cash charge for the contingent modification of ourformer Chief Executive Officer’s stock options terms.  The actual charge will be determined based on the price of ourClass B common stock on the date the options terms are modified.

 

Due to thecurrent economic climate, the performance bond market has substantiallychanged, resulting in reduced availability of bonds, increased cash collateralrequirements and increased premiums. Some of our government contracts require a performance bond and futurerequests for proposal may also require a performance bond.  Our inability to obtain performance bonds,increased costs to obtain such bonds or a requirement to pledge significantcash collateral in order to obtain such bonds would adversely affect ourbusiness and our capacity to obtain additional contracts.  Increased premiums or a claim made against aperformance bond could adversely affect our earnings and cash flow and impairour ability to bid for future contracts.

 

**DisclosuresAbout Contractual Obligations And Commercial Commitments as of December 31,2003**

 

As of December31, 2003, we had not entered into any derivative transactions and we had thefollowing obligations and commitments to make future payments under contracts,contractual obligations and commercial commitments (in thousands):

 
|                             |   | **Payments due by period** |   |
|----------------------------------|--------|----------------------------|--------|
| **Contractual Cash Obligations** |   | **Total**                  |   | **Less than  1 year** |   | **2 – 3  years** |   | **4 – 5  years** |   | **After 5  years** |   |
| Debt, including interest         |   | $                          | 337    |   | $ | 158 |   | $ | 179 |   | $ | — |   | $ | — |   |
| Operating leases                 |   | 9,739                      |   | 3,398 |   | 4,132 |   | 1,967 |   | 242 |   |
| Restructuring liability          |   | 2,925                      |   | 1,579 |   | 1,346 |   | — |   | — |   |
| Total                            |   | $                          | 13,001 |   | $ | 5,135 |   | $ | 5,657 |   | $ | 1,967 |   | $ | 242 |   |

 
|                             |   | **Amount of commitment expiration per period** |   |
|----------------------------------|--------|------------------------------------------------|--------|
| **Other Commercial Commitments** |   | **Total  amounts  committed**                  |   | **Less than  1 year** |   | **2 – 3  years** |   | **4 – 5  years** |   | **After 5  years** |   |
| Standby letters of credit        |   | $                                              | 3,484  |   | $ | 3,000 |   | $ | 289 |   | $ | — |   | $ | 195 |   |
| Performance bonds                |   | 36,450                                         |   | 31,719 |   | 4,731 |   | — |   | — |   |
| Total                            |   | $                                              | 39,934 |   | $ | 34,719 |   | $ | 5,020 |   | $ | — |   | $ | 195 |   |

 

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**Recent Accounting Standards**

 

In May 2003,the FASB issued Statement of Financial Accounting Standards No. 150(“SFAS 150”), “Accounting for Certain Financial Instruments withCharacteristics of both Liabilities and Equity.” SFAS 150 establishesstandards for classifying and measuring as liabilities certain financialinstruments that embody obligations of the issuer and have characteristics ofboth liabilities and equity. SFAS 150 represents a significant change in practice in theaccounting for a number of financial instruments, including mandatoryredeemable equity instruments and certain equity derivatives that frequentlyare used in connection with share repurchase programs.  SFAS 150 is effective for all financialinstruments created or modified after May 31, 2003, and to otherinstruments as of September 1, 2003. We have not used such instruments in our share repurchase program, andthe adoption of this statement did not have a material effect on ourconsolidated financial position, results of operations or cash flows.

 

**Factors That May Affect Future Results**

 

The followingfactors and other risk factors could cause our actual results to differmaterially from those contained in forward-looking statements in this Form10-Q.

 

**Our quarterly net revenues, operating resultsand cash flows are volatile, may fluctuate significantly from quarter toquarter and may be difficult to forecast, which may cause the market price ofour Class B common stock to decline.**

 

Our netrevenues, operating results and cash flows are subject to significant variationfrom quarter to quarter due to a number of factors, many of which are outsideour control.  Among other things, thesefactors include:

 

•                  the number, sizeand scope of projects in which we are engaged;

 

•                  the accuracy ofestimated resources and costs required to complete our fixed price contracts;

 

•                  dependency onour technology and credit/debit card partners;

 

•                  the adequacy ofprovisions for losses, including provisions for accounts receivable, unbilledreceivables and other receivables;

 

•                  economicconditions in the markets we serve;

 

•                  demand for ourservices generated by strategic partnerships and certain prime contractors;

 

•                  revenuesrecognized and costs incurred on projects before we have the right to invoiceand ultimately collect cash from our clients;

 

•                  the accuracy ofestimated transaction volume and transaction dollars processed in computingtransaction net revenues from our child support payment processing centeroperations and OPC’s payment processing center operations;

 

•                  our consultantutilization rates and the number of billable days in a particular quarter whichmay be significantly impacted by increased vacations and public holidays;

 

•                  the seasonalityof OPC’s business, due primarily to the fact that the majority of federal andstate personal income tax payments are made in March and April and real estateand personal property tax payments may be made annually or semi-annually inmany jurisdictions;

 

•                  changes toprocessing fees charged to OPC by its credit/debit card partners and financialinstitutions for processing payment transactions;

 

•                  the contractualterms and degree of completion of projects;

 

•                  any delays orcosts incurred in connection with, or early termination of, a project;

 

•                  our ability tostaff projects with salaried employees versus hourly employees, hourlyindependent contractors and sub-contractors;

 

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•                  the amount andtiming of costs related to our sales and marketing and other initiatives;

 

•                  legal expensesincurred in complying with the DOJ investigation, our dispute with CalPERS andshareholder litigation in federal and state courts;

 

•                  variability ofsoftware license fee revenue in a particular quarter;

 

•                  start-up costsincurred in connection with the initiation of large projects;

 

•                  any assessmentof potential penalties or contingent obligations in connection with a projector legal claim; and

 

•                  estimates madefor restructuring liabilities.

 

The timing andrealization of opportunities in our sales pipeline make the timing andvariability of net revenues difficult to forecast.  A high percentage of our operating expenses, particularlypersonnel, facility and depreciation and amortization, are fixed inadvance.  Because of the variability ofour quarterly operating results, we believe that period-to-period comparisonsof our operating results are not necessarily meaningful, should not be reliedupon as indications of future performance and may result in volatility anddeclines in the price of our Class B common stock.  In addition, our operating results may fromtime to time fall below the expectations of analysts and investors.  If so, the market price of our Class Bcommon stock may decline significantly.

 

As discussedin Note 6 to our Condensed Consolidated Financial Statements, we adopted SFAS142 as of October 1, 2002.  Thisstandard requires that goodwill no longer be amortized, and instead, be testedfor impairment on a periodic basis. Impairment tests involve the use of estimates related to the fair marketvalue of the business operations with which goodwill is associated.  If we do not meet our long-term forecasts,or if the trading price of our Class B common stock does not improve, we couldbe required to record impairment charges related to goodwill and otherintangible assets, which could adversely affect our financial results.  During the fourth quarter of fiscal year2003, we decided to shut down the U.S. Commercial Services segment and theUnited Kingdom Operations segment and accordingly recorded a restructuringcharge to write-off substantially all of the associated goodwill totaling $17.6million.  In the fourth quarter offiscal year 2003, we performed our annual impairment test to determine if theremaining goodwill associated with our remaining segments was impaired.  The results did not indicate any impairmentloss.  In addition, other acquiredintangible assets are tested for impairment whenever an event or circumstanceindicates the carrying value of other acquired intangible assets may not berecoverable.  No additional impairmentresulted.  At December 31, 2003, we hadgoodwill of $29.6 million and other intangibles of $24.1 million.  Any resulting impairment loss could have amaterial adverse impact on our financial condition and results of operations.

 

**We rely on small numbers of projects,customers and target markets for significant portions of our net revenues, andour operating results and cash flows may decline significantly if we cannotkeep or replace these projects or clients or if conditions in our targetmarkets deteriorate.**

 

We have derived, and believe that we will continue to derive, asignificant portion of our net revenues from a limited number of clients.  The completion or cancellation of a largeproject or a significant reduction in its scope would significantly reduce ournet revenues and cash flows.  Most of ourcontracts are terminable by the client following limited notice and without significantpenalty to the client.  If any of ourlarge clients or prime contractors terminates its relationship with us, we willlose a significant portion of our net revenues and cash flows.  In the fourth fiscal quarter of fiscal 2003,CalPERS terminated our systems integration contract, and as a result werecorded an adjustment to revenue of approximately $12.8 million to write downthe total value of our unbilled receivable from CalPERS.

 

For the three months ended December 31, 2003, our top ten clientsrepresented 56.2% of our total net revenues and the State of Missouri accountedfor 10.4% of our total net revenues. Revenues from IRS taxpayers accounted for 17.2% of OPC’s net revenues.  The existing contract with the IRS allowsthe IRS to terminate OPC’s services at any time for any or no reason.  Even though our net revenues are not fundedby the IRS, the loss of the IRS as a client, or a decrease in IRS-relatedtransactions because of increased competition from another IRS-authorizedservice provider, would result in a reduction in our net revenues and cashflows.

 

We currently perform services for three different state governments asa subcontractor to ACS.  For the threemonths ended December 31, 2003, work performed under these three subcontracts accountedfor 14.3% of total net

 

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revenues.  The volume of work performed for specificclients or prime contractors is likely to vary from period to period, and aclient or prime contractor in one period may not use our services in asubsequent period.  For example,although our agreement with ACS contemplated that we would jointly pursue arequest for proposal for child support processing for the state of California,the two companies have mutually decided not to pursue this proposaljointly.  We intend to pursue theopportunity with another partner.  As aresult of the decision to pursue the opportunity with another partner, wecannot predict if this will affect the three subcontracts under our existing relationshipwith ACS or the future revenue associated with those subcontracts.  The loss of revenues from those subcontractscould adversely affect future operating results and cash flows.

 

As a result of our focus in specific markets, economic and other conditionsthat affect the companies and government agencies in these markets could alsoresult in a reduction in our net revenues and cash flows.  Because we derive a significant portion ofour net revenues from a limited number of clients, we have several largeaccounts receivable and unbilled receivable balances.  At December 31, 2003, unbilled receivables for two clientsaccounted for 43.5% and 31.5% of total unbilled receivables.  At December 31, 2003, total accountsreceivable and unbilled receivables, for these two clients accounted for 7.4%and 9.6%, respectively, of total net accounts receivable and unbilledreceivables.  Any dispute, earlycontract termination or other collection issues could have a material adverseimpact on our financial condition and results of operations.  The imposition of significant penalties forour failure to meet scheduled delivery requirements could also have a materialadverse effect on us.

 

**Our operating results may be adverselyaffected if we fail to accurately estimate the resources necessary to meet ourobligations under fixed price contracts or the volume of transactions ortransaction dollars processed under our transaction-based contracts.**

 

Underestimatingthe resources, costs or time required for a fixed price project or atransaction-based contract or overestimating the expected volume oftransactions or transaction dollars processed under a transaction-basedcontract would cause our costs under fixed price contracts to be greater thanexpected and our fees under transaction-based contracts to be less thanexpected, and our related profit, if any, to be less.  Under fixed price contracts, we generally receive our fee if wemeet specified deliverables such as completing certain components of a systeminstallation.  For transaction-basedcontracts, we receive our fee on a per-transaction basis or as a percentage ofdollars processed, such as the number of child support payments processed ortax dollars processed.  To earn a profiton these contracts, we rely upon accurately estimating costs involved andassessing the probability of meeting the specified objectives or realizing theexpected number or average dollar amounts of transactions within the contractedtime period.  A failure by a client toadequately disclose in their request for proposal their existing systems,current interfaces, complete functional requirements and historical payment andtransaction volumes could result in our underestimating the work required tocomplete a project.  If we fail toestimate accurately the factors upon which we base our contract pricing, or weare unable to successfully obtain change orders, we may incur losses on thosecontracts or be unable to complete our performance obligations.  During the quarter ended December 31, 2003, 16.6% of our netrevenues were generated on a fixed price basis and 65.3% of our net revenueswere generated from transaction-based contracts.  We believe that the percentage of net revenues attributable tofixed price and transaction-based contracts will continue to be significant forthe foreseeable future.

 

**Adecline in the economic climate could adversely affect our net revenues andcash flows.**

 

There are someparts of our business that experience increasing pricing pressures fromcompetitors as well as from clients facing pressure to control costs.  We continue to see clients reduce or defertheir expenditures or defer the start of work already contracted.  Some of our competitors are capable ofoperating at significant losses for extended periods of time, increasingpricing pressure on our products and services. If we do not maintain competitive pricing, the demand for our productsand services, as well as our market share, may decline, having an adverseeffect on our business.  From time totime, in responding to competitive pressures, we lower the prices of ourproducts and services.  If we are unableto reduce our costs or improve operating efficiencies when we offer such lowerprices, our net revenues and margins will be adversely affected.

 

OPC’s netrevenues are generated primarily based on convenience fees charged as apercentage of dollars processed for income taxes and other payments.  Income taxes are dependent on the amount ofincome earned by taxpaying citizens and the prevailing tax rates.  A decline in economic conditions couldreduce the per capita income of citizens, and thus reduce the amount of incometax payments consumers remit to government entities, which may reduce OPC’s

 

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revenues from conveniencefees.  A reduction in income tax ratesmay also reduce the amount of income tax payments consumers remit to governmententities, which may reduce OPC’s revenues from convenience fees.  In addition, a decline in the economy mayresult in a reduction in consumer spending, particularly for non-essentialgoods and services, which may result in a reduction in consumers’ use of OPC’sservices.  If the economy declines, ourresults of operations and cash flows could be adversely affected.

 

**We depend on government agencies for our netrevenues and the loss or decline of existing or future government agencyfunding would adversely affect our net revenues and cash flows.**

 

For the threemonths ended December 31, 2003, approximately 40.2% of our net revenues werederived from federally mandated and primarily federally funded child supporttransaction processing services fees and approximately 28.9% of our netrevenues were derived from convenience fees earned by OPC with respect topayments made by constituents to government agencies.   The balance of our net revenues were derived from other servicesprovided to government agencies. Some of these net revenues, particularly ourFMS and State of Missouri contracts, may be subject to state and local governmentagency spending fluctuations.  Thesegovernment agencies may be subject to budget cuts, budgetary constraints, areduction or discontinuation of funding or changes in the political orregulatory environment that may cause government agencies to terminateprojects, divert funds or delay implementation.  These government agencies may terminate most of these contractsat any time without cause.  In addition,revisions to or repeals of mandated statutes and regulations, including changesto the timing of required compliance, may cause government agencies to divertfunds.  A significant reduction in fundsavailable for government agencies to purchase professional services or businesssolutions would significantly reduce our net revenues and cash flows.  The loss of a major government client, orany significant reduction or delay in orders by that client, would alsosignificantly reduce our net revenues and cash flows.  Additionally, government contracts are generally subject toaudits and investigations by government agencies.  If the results of these audits or investigations are negative,our reputation could be damaged, contracts could be terminated or significantpenalties could be assessed.  If acontract is terminated for any reason, our ability to fully recover certainamounts may be impaired resulting in a material adverse impact on our financialcondition and results of operations.

 

**Thelitigation with CalPERS will negatively affect our operating results and cashflows.**

 

In November2003, we filed a lawsuit in California Superior Court, Sacramento County,against CalPERS to overturn CalPERS’ decision to terminate the contract fordefault and to recover added costs associated with our systems integrationproject for the contributions reporting system.  We seek to recover damages and project delay, disruption andinterference costs on the project. CalPERS terminated the contract for default after we sought to recoveradded costs due to CalPERS-caused delays, disruption and interference.  There is no guarantee that we will besuccessful in our lawsuit against CalPERS or that we will recover the damageswe seek.  CalPERS filed a counter-claimagainst us.  Due to the risks and uncertaintyinherent in any litigation, there is the possibility that CalPERS could prevailagainst the Company.  In thislitigation, the prevailing party will be entitled to their attorneys fees.  Accordingly, there is the possibility thatif we are found liable to CalPERS, we would be required to pay their damages,which could be substantial, and their attorneys’ fees, as well as our own.  The costs of litigation can be substantialand the process can be lengthy and unpredictable.  There may be claims made against us by subcontractors or otherthird parties.  CalPERS made a claimagainst our performance bond.  Under theterms of our indemnity agreement with the surety that provided the performancebond, we are obligated to reimburse the surety for their investigation expensesin this matter.  An ongoing dispute witha former client could negatively impact our ability to secure additionalcontracts and business for other clients. Management may be required to devote substantial time to the litigationprocess which may result in the diversion of their time and attention fromother revenue-generating activities.

 

**An investigation involving the child supportpayment processing industry may negatively affect our business and operatingresults.**

 

In June 2003,we announced that we had received a subpoena from a grand jury in the SouthernDistrict of New York to produce certain documents pursuant to an investigationinvolving the child support payment processing industry by the AntitrustDivision of the DOJ.  We have fullycooperated, and intend to continue to cooperate fully, with the subpoena and withthe DOJ’s investigation.  OnNovember 20, 2003, the DOJ granted us conditional amnesty pursuant to theAntitrust Division’s Corporate Leniency Policy.  Consequently, the DOJ will not bring any criminal charges againstus and our officers, directors and employees, as long as we continue to complywith the Corporate Leniency Policy, which requires, among other things, ourfull cooperation in the investigation and restitution payments if it isdetermined that parties were injured as a result of impermissibleanticompetitive conduct.  During thethree months ended December 31, 2003, we incurred approximately $516,000 oflegal costs to comply with the subpoena which includes approximately $232,000paid under directors and officers indemnification agreements.  We anticipate that we will incur anadditional

 

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$1.5 million in fiscal year2004 as we continue to cooperate with the investigation.  Such expenses, any restitution payments thatwe are required to make and any negative publicity in connection with theinvestigation could have a material adverse effect on our financial condition,results of operations and business.

 

**Because we sometimes work with third partiesand/or use third party software in providing products and services to clients,our reputation, operating results and competitiveness could be adverselyaffected by those third parties.**

 

We frequentlyjoin with other organizations to bid and perform an engagement.  In these engagements, we may engagesubcontractors or we may act as a subcontractor to the prime contractor of theengagement.  We also use third partysoftware or technology providers to jointly bid and perform engagements.  Our ability to service some of our clientsdepends to a large extent on our use of various software programs that welicense from a small number of primary software vendors.  In these situations, we depend on thesoftware, resources and technology of these third parties in order to performwork under the engagement.  Failure ofthird parties to meet their contractual obligations or other actions orfailures attributable to these third parties or their products or to the primecontractor or subcontractor could adversely impact a project, damage ourreputation and adversely affect our ability to attract new business.  In addition, the inability to negotiateterms of a contract with a third party, the refusal or inability of these thirdparties to permit continued use of their software, services or technology byus, our inability to gain access to software that has been placed in escrow bythird parties, or the discontinuance or termination by the client or primecontractor of our services or the services of a key subcontractor, would harmour operating results and the competitiveness of our products and services andmay adversely affect our ability to serve new clients.  If we are unable to meet our contractualrequirements with our clients, we could be subjected to claims by our clients.

 

OPC relies ona third party co-location facility for its primary data center and utilizesthird party processors to complete payment transactions.  Failure by these third parties tosatisfactorily perform services may adversely affect our operating results andour reputation.

 

**Weand certain of our officers and directors have been named as defendants inrecently initiated securities litigation that could result in substantial costsand divert management’s attention and resources.**

 

We are awareof a lawsuit in which we, our chairman of the board who formerly was our chiefexecutive officer, another executive officer who formerly was our chieffinancial officer and a former executive officer, are alleged to have violatedfederal securities laws relating to alleged misrepresentations regarding ourfinancial performance during fiscal years 2002 and 2003.  In December 2003, we were served withanother complaint filed by a shareholder as a putative derivative action instate court against the same three officers, another current officer, some ofour current directors and two former directors.  The derivative complaint alleges breach of fiduciary duty, abuseof control, gross mismanagement, waste of corporate assets, unjust enrichmentand violations of the California Corporations Code.  We believe that the claims in these lawsuits are without merit,and we intend to engage in a vigorous defense of such claims.  If we are not successful in our defense ofsuch claims, we could be forced to make significant payments to ourshareholders and their lawyers, and such payments could have a material adverseeffect on our business, financial condition, results of operations and cashflows if not covered by our insurance. Even if such claims are not successful, the litigation could result insubstantial costs and divert management’s attention and resources, which couldhave an adverse effect on our business and could impact our ability to obtainfuture directors and officers insurance coverage at a reasonable premium orsuccessfully obtain such coverage at all.

 

**We could become subject to other lawsuitsthat could result in material liabilities to us or cause us to incur materialcosts.**

 

Any failure ina client’s system or failure to meet a material deliverable could result in aclaim against us for substantial damages, regardless of our responsibility forsuch failure.  We cannot guarantee thatthe disclaimers, limitations of warranty, limitations of liability and otherprovisions set forth in our contracts will be enforceable or will otherwiseprotect us from liability for damages. Any claim by a shareholder or derivative action brought by a shareholdercould result in a material liability to us. Our insurance, which includes coverage for errors or omissions anddirectors and officers liability, may not continue to be available onreasonable terms or in sufficient amounts to cover one or more claims, and theinsurer may disclaim coverage as to any future claim.  The successful assertion of one or more claims against us that exceedavailable insurance coverage or changes in insurance policies, includingpremium increases or the imposition of large deductible or co-insurancerequirements, would adversely affect our business.

 

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**We have completed numerous acquisitions andmay complete others, which could increase our costs or be disruptive.**

 

One componentof our business strategy is to expand our presence in new or existing marketsby acquiring additional businesses. From October 1, 2001 through December 31, 2003, we acquiredthree businesses using cash, with some of those acquisitions alsoinvolving assumed liabilities and contingent payments. Acquisitions involve anumber of special risks, including:

 

•                  failure torealize the value of the acquired assets, businesses or projects;

 

•                  diversion ofmanagement’s attention;

 

•                  failure toretain key personnel;

 

•                  entrance intomarkets in which we have limited or no prior experience;

 

•                  increasedgeneral and administrative expenses;

 

•                  clientdissatisfaction or performance problems with acquired assets, businesses orprojects;

 

•                  write-offs dueto impairment of goodwill and other intangible assets and other charges againstearnings;

 

•                  assumption ofunknown liabilities;

 

•                  the potentiallydilutive issuance of our common stock, the use of significant amounts of cashor the

incurrence of substantial amounts of debt;and

 

•                  otherunanticipated events or circumstances.

 

We may not be able to identify,acquire or profitably manage additional businesses or integrate successfullyany acquired businesses without substantial expense, delay or other operationalor financial problems. Without additional acquisitions, we are unlikely tomaintain historical growth rates.

 

**Our markets are highly competitive, and ourbusiness and prospects will be adversely affected if we do not competeeffectively for any reason.**

 

Theinformation technology, transaction processing and consulting services marketsare highly competitive and are served by numerous international, national andlocal firms. We may not be able to compete effectively in these markets. Marketparticipants include systems consulting and integration firms, includinginternational consulting firms and related entities, the internal informationsystems groups of our prospective clients, professional services companies,hardware and application software vendors, and divisions of large integratedtechnology companies and outsourcing companies. Many of these competitors havesignificantly greater financial, technical and marketing resources, generategreater net revenues and have greater name recognition than we do. In addition,there are relatively low barriers to entry into the information technology andconsulting services markets, and we have faced, and expect to continue to face,additional competition from new entrants into the information technology andconsulting services markets.

 

We believethat the principal competitive factors in the information technology andconsulting services markets include:

 

•                  reputation;

 

•                  projectmanagement expertise;

 

•                  industryexpertise;

 

•                  speed ofdevelopment and implementations;

 

•                  technicalexpertise;

 

•                  competitivepricing; and

 

•                  the ability todeliver results on a fixed price and transaction basis as well as a time andmaterials basis.

 

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We believethat our ability to compete also depends in part on a number of competitivefactors outside our control,

including:

 

•                  the ability ofour clients or competitors to hire, retain and motivate project managers andother senior technical staff;

 

•                  the ownership bycompetitors of software used by potential clients;

 

•                  the price atwhich others offer comparable services;

 

•                  the ability ofour clients to perform the services themselves; and

 

•                  the extent ofour competitors’ responsiveness to client needs.

 

If we do notcompete effectively on one or more of these competitive factors, our businessand our ability to execute our business strategy will be impaired.

 

**Our failure to deliver error-free productsand services could result in reduced payments, significant financial liabilityor additional costs to us, as well as negative publicity.**

 

Many of ourengagements involve projects that are critical to the operations of ourclients’ businesses and provide benefits that may be difficult to quantify. Thefailure by us, or by third parties on an engagement in which we are asubcontractor, to meet a client’s expectations in the performance of theengagement could damage our reputation and adversely affect our ability to attractnew business. We have undertaken, and may in the future undertake, projects inwhich we guarantee performance based upon defined operating specifications orguaranteed delivery dates. We also have undertaken, and may in the futureundertake, projects that require us to obtain a performance bond from alicensed surety and to post the performance bond with the client.Unsatisfactory performance or unanticipated difficulties or delays incompleting such projects may result in termination of the contract, clientdissatisfaction and a reduction in payment to us, payment of material penaltiesor material damages by us as a result of litigation or otherwise, or claims bya client against the performance bond posted by us. In addition, unanticipateddelays could necessitate the use of more resources than we initially budgetedfor a particular project, which could increase our costs for that project.

 

OPC’selectronic payment services and our child support payment processing servicesare designed to provide payment management functions and, in the case ofcertain of our child support payment processing contracts, serve to limit ourclients’ risk of fraud or loss in effecting transactions with theirconstituents.  As electronic servicesbecome more critical to our clients, we may be subjected to claims or finesregarding our alleged liability for the processing of fraudulent or erroneoustransactions. Our services depend on hardware, software and supportinginfrastructure that is internally developed, purchased and/or licensed fromthird parties.  Although we conductextensive testing, software may contain defects or programming errors, or maynot properly interface with third party systems, particularly when firstintroduced or when new versions are released. In addition, we may experience disruptions in service from third-partyproviders. To the extent that defects or errors are undetected by us in thefuture or cannot be resolved satisfactorily or in a timely manner oncedetected, our business could suffer.  Ifone or more liability claims were brought against us, even if unsuccessful,their defense would likely be time consuming, costly and potentially damagingto our reputation.  Any such liabilityor claim could have a material and adverse effect on our business, operatingresults and financial condition.

 

**BecauseOPC’s business model is continuing to evolve, it is difficult to evaluate OPC’sbusiness.**

 

At the end ofJuly 2002, we acquired OPC, which has a history of losses. Although OPC hascumulatively increased revenues since the acquisition and has reduced certainoperating expenses as we integrated this acquisition, there can be no assurancethat OPC will attain and maintain profitability in the future.

 

The use ofcredit and debit cards and electronic checks to make payments to governmentagencies is still relatively new and evolving. To date, OPC’s business has consisted primarily of providing credit anddebit card payment options for the payment of federal and state personal incometaxes, real estate and personal property taxes, business taxes and fines fortraffic violations and parking citations. Payment by electronic check is an additional payment option that OPC hasimplemented for electronic transactions. Because OPC has only a limited operating history under Tier’smanagement, it is difficult to evaluate its business and prospects and therisks, expenses and difficulties that we may face

 

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in implementing OPC’s businessmodel. OPC’s business model is based on consumers’ willingness to pay aconvenience fee (in addition to their required government or other payment) forthe use of OPC’s credit or debit card and electronic check payment option.  Our success with respect to OPC will dependon maintaining OPC’s relationship with the IRS and on maintaining existing, anddeveloping additional relationships with state and local government agencies,especially state taxing authorities, and their respective constituents.  There can be no assurances that we will beable to develop new OPC relationships or maintain existing OPC relationships,and the failure to do so could have a material and adverse effect on ourbusiness, operating results and financial condition.  In addition, if consumers are not receptive to paying aconvenience fee, if card associations change their rules and do not allow us tocharge the convenience fees, or if credit or debit card issuers eliminate orreduce the value of rewards obtained under their respective rewards programs,demand for OPC’s services will decline or fail to grow, which would have amaterial and adverse effect on our business, operating results and financialcondition. OPC is charged processing fees by its credit/debit card partners andfinancial institutions for processing payments. The processing fees OPC ischarged can be changed with little or no notice. Any increase in the feescharged to OPC may have a material adverse impact on our business, operatingresults and financial conditions.

 

Currently, OPC processes credit and debit card payments on behalf ofVISA issuing banks for certain tax payments under a VISA tax pilot program thatwas created in March 2002.  The taxpilot program is scheduled to end in December 2004.  If VISA does not extend the tax pilot program or make it apermanent program, OPC would be limited in its ability to accept VISA cards andthis could have a material adverse impact on our financial condition andresults of operations.

 

Demand forOPC’s services would also be adversely impacted by a decline in the use of theInternet.  Factors that could reduce thelevel of Internet usage or electronic commerce include the actual or perceivedlack of security or privacy of information, traffic congestion or otherInternet access delays, excessive government regulation, increases in accesscosts, or the unavailability of cost-effective high speed service.

 

**If we are unable to obtain adequate insurancecoverage or sufficient performance bonds for any reason, our business will beadversely affected.**

 

We maintaininsurance to cover a variety of different business risks including, but notlimited to, errors and omissions, directors and officers, general liability andworkers’ compensation policies. There can be no assurance that we can maintainthe same scope and amount of insurance coverage on reasonable terms or obtainsuch insurance at all.  Our inability torenew policies or maintain the same level of coverage would adversely affectour business and increase our risk exposure. Any claims against our policies may impact our ability to obtain suchinsurance on reasonable terms, if at all. Increased premiums or a claim made against a policy could adverselyaffect our earnings and cash flow and impair our ability to bid for futurecontracts.

 

We haveundertaken, and may in the future undertake, projects that require us to obtaina performance bond from a licensed surety and post the performance bond withthe client.  There can be no assurancethat such performance bonds will continue to be available on reasonable terms,if at all.  Our inability to obtainperformance bonds or a reduction in our bonding capacity would adversely affectour business and our capacity to obtain additional contracts. Increasedpremiums or a claim made against a performance bond could adversely affect ourearnings and cash flow and limit our ability to bid for future contracts.

 

**Our business will suffer if we are unable toattract, successfully integrate and retain qualified personnel and keyemployees.**

 

If we areunable to attract, retain, train, manage and motivate skilled employees,particularly project managers and other senior technical personnel, our abilityto adequately manage and staff our existing projects and to bid for or obtainnew projects could be impaired, which would adversely affect our business andits growth. The failure of our employees to achieve expected levels ofperformance could adversely affect our business. There is significantcompetition for employees with the skills required to perform the services weoffer. In particular, qualified project managers and senior technical andprofessional staff are in great demand worldwide. In addition, we require thatmany of our employees travel to client sites to perform services on our behalf,which may make a position with us less attractive to potential employees. Wemay not be able to identify and successfully recruit and integrate a sufficientnumber of skilled employees into our operations, which would harm our businessand its growth. Our success also depends upon the continued services of anumber of key employees, including our chief executive officer and the leadersof our strategic

 

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business units. Any of ouremployees may terminate their employment at any time. The loss of the servicesof any key employee could significantly disrupt our operations. In addition, ifone or more of our key employees resigns to join a competitor or to form acompeting company, the loss of such personnel and any resulting loss of existingor potential clients to any such competitor could adversely affect ourcompetitive position and operating results.

 

**Our Class B common stock price andtrading volume have been and could continue to be volatile, which could resultin substantial losses for investors in our Class B common stock.**

 

OurClass B common stock price and trading volume have been and could continueto be volatile. These price fluctuations may be rapid and severe and may leaveinvestors little time to react. Factors that affect the market price of ourClass B common stock include:

 

•                  quarterlyvariations in operating results;

 

•                  developmentswith respect to specific projects, such as our contract dispute with CalPERS;

 

•                  developments inour organization, such as our restructuring in the fourth quarter of fiscal2003;

 

•                  announcements oftechnological innovations or new products or services by us or our competitors;

 

•                   generalconditions in the information technology industry or the industries in whichour clients compete;

 

•                   changes inearnings estimates by securities analysts or us; and

 

•                   generaleconomic and political conditions such as recessions and acts of war orterrorism.

 

Fluctuations in the price ofour Class B common stock could contribute to investors losing all or partof their investment.

 

**The software products we provide compete inmarkets that are rapidly changing and we must develop, acquire and introducenew products and technologies to grow our net revenues and remain competitive.**

 

The marketsfor products we provide are characterized by rapid technological change,changes in client demands and evolving industry standards.  As a result, our future success willcontinue to depend upon our ability to develop new products or productenhancements that address the future needs of our target markets and to respondto these changing standards and practices. We may not be successful in developing, introducing and marketing newproducts or product enhancements on a timely and cost effective basis, or atall, and our new products and product enhancements may not adequately meet therequirements of the marketplace or achieve market acceptance.  If we are unable, for technological or otherreasons, to develop and introduce new products or enhancements of existingproducts in a timely manner in response to changing market conditions or clientrequirements, or if new products or new versions of existing products do notachieve market acceptance, our business would be seriously harmed.  In addition, our ability to develop new productsand product enhancements is dependent upon the products of other softwarevendors.  If the products of suchvendors have design defects or flaws, or if such products are unexpectedlydelayed in their introduction, our business could be seriously harmed.  Software products as complex as thoseoffered by us may contain undetected defects or errors when first introduced oras new versions are released.  Althoughwe have not experienced significant adverse effects resulting from softwareerrors, we cannot be certain that, despite testing by us and our clients,defects or errors will not be found in new products or enhancements aftergeneral release, resulting in loss of or delay in market acceptance, whichcould seriously harm our business.

 

**Wecould suffer material losses if our systems or operations fail or aredisrupted.**

 

Any system failure, including network, software or hardware failure oroperations disruptions, whether caused by us, a third party service provider,unauthorized intruders and hackers, computer viruses, natural disasters, powershortage, capacity constraints, health epidemics or terrorist attacks, couldcause interruptions, delays in our business, loss of data or damage to ourreputation.  Any system failure in ourOPC business, particularly during income tax season, could have a materialadverse impact on our reputation, results of operations and financialcondition. In addition, if our mail, communications or utilities are disruptedor fail, our operations, including our child support transaction processing,could be suspended or interrupted, we could incur contractual penalties and ourbusiness could be harmed. Our property insurance and business interruptioninsurance may not be adequate to compensate us for all losses that may occur asa result of any system or operational failure or disruption.

 

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**Ifwe fail to adapt our business to changes in economic or business conditions,our business may be adversely affected.**

 

Personnel,facility and depreciation and amortization expenses represent a significantpercentage of our operating expenses and are relatively fixed in advance of anyparticular quarter. We manage our personnel utilization rates by carefullymonitoring our needs and anticipating personnel increases based on specificproject requirements. To the extent net revenues do not increase at a ratecommensurate with these additional expenses, our results of operations could bematerially and adversely affected.  Ifwe fail to align our operating expenses with prevailing economic or businessconditions, our operating results and financial condition could be adverselyaffected.

 

A constraintin OPC’s capacity to process transactions could impair the quality andavailability of OPC’s service.  Capacityconstraints may cause unanticipated system disruptions, impair quality andlower the level of service.  Although webelieve that OPC has sufficiently expanded its system capacity to accommodateanticipated future growth, there are no assurances that OPC will not suffercapacity constraints caused by sharp increases in the use of its services.  Due to the large number of tax payments madein March and April, there is an increased risk that OPC will suffer a capacityconstraint during that period, which could have an adverse effect on ourbusiness, operating results and financial condition.

 

**IfOPC’s clients or credit/debit card issuers cease to publicize OPC’s services oradversely change the manner in which OPC’s services are promoted, consumer useof its services may slow, and we may suffer a large increase in advertisingcosts.**

 

Currently,OPC’s government clients and credit/debit card issuers provide a significantportion of the publicity for its services, without any charge to OPC.  If clients cease to publicize OPC’sservices, or charge OPC for this publicity, advertising costs will increasesubstantially, resulting in a material and adverse effect on our business,operating results and financial condition. While OPC endeavors in its clientagreements to require such clients to undertake such advertising activities,many of the clients and payment card issuers have no obligation to continue toprovide this publicity, and there are no assurances that they will continue todo so.  In addition, the clients maypublicize other services, including those of its competitors.  For example, the IRS’s tax year 2002 Form1040 instruction booklet listed OPC’s name before a competitor’s name in regardto providers of electronic credit/debit card payment services, whereas for the2003 tax year (i.e., filing due date of April 15, 2004), OPC’s name will belisted second.

 

In addition,OPC advertises in conjunction with its credit/debit card partners underco-operative advertising programs. If OPC’s credit/debit card partners fail tocontribute to the co-operative advertising programs, OPC’s ability to advertisemay be impacted.

 

**Ifwe are unable to protect our intellectual property and proprietary rights, ourbusiness could be adversely affected.**

 

The steps wetake to protect our intellectual property rights may be inadequate to avoid theloss or misappropriation of that information, or to detect unauthorized use ofsuch information. We rely on a combination of trade secrets, nondisclosureagreements, licensing agreements and other contractual arrangements, andcopyright and trademark laws to protect our intellectual property rights. Wealso enter into non-disclosure agreements with our employees, subcontractorsand the parties we team with for contracts and generally require that ourclients enter into such agreements. We also control and limit access to ourproprietary information.

 

We haveproprietary software that is licensed to clients pursuant to licensingagreements and other contractual arrangements. We utilize intellectual propertylaws, including copyright and trademark laws, to protect our proprietaryrights. Issues relating to the ownership of, and rights to use, software andapplication frameworks can be complicated, and there can be no assurance thatdisputes will not arise that affect our ability to resell or reuse suchsoftware and application frameworks. A portion of our business also involvesthe development of software applications for specific client engagements or thecustomization of an existing software product for a specific client. Ownershipof the developed software and the customizations to the existing software arethe subject of negotiation with each particular client and is typicallyassigned to the client. We also develop software application frameworks, andmay retain ownership or marketing rights to these application frameworks, whichmay be adapted through further customization for future client

 

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projects. Some of our clientshave prohibited us from marketing the software and application frameworksdeveloped specifically for them for a specified period of time or to specifiedthird parties, and others may demand similar or other restrictions in thefuture.

 

Infringementclaims may be asserted against us in the future that may not be successfullydefended. The loss or misappropriation of our intellectual property or theunsuccessful defense of any claim of infringement could prevent or delay ourproviding our products and services, cause us to become liable for substantialdamages, or force us to enter into royalty or licensing agreements.

 

**Compliancewith changing regulation of corporate governance and public disclosure mayresult in additional expenses.**

 

Changing laws,regulations and standards relating to corporate governance and publicdisclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations andNasdaq Stock Market rules, are creating uncertainty for companies such as ours.To maintain high standards of corporate governance and public disclosure, weintend to invest all reasonably necessary resources to comply with evolvingstandards.  This investment may resultin increased general and administrative expenses for outside services and adiversion of management time and attention from revenue-generating activities.

 

**Controlof our company by our chairman of the board could make it difficult for anothercompany to acquire us and could depress the price of our Class B commonstock.**

 

Concentrationof voting control could have the effect of delaying or preventing a change incontrol of us and may affect the market price of our Class B commonstock.  The voting power held by Mr.James L. Bildner, our chairman of the board and former chief executiveofficer, in Class A and Class B common stock owned by Mr. Bildner andvested options to acquire Class B common stock held by Mr. Bildnerrepresented 34.4% of our total common stock voting power outstanding atDecember 31, 2003. As a result, Mr. Bildner may be able to control the outcomeof all corporate actions requiring shareholder approval, including changes inour equity incentive plan, the election of a majority of our directors, proxycontests, mergers, tender offers, or other transactions that could give holdersof our Class B common stock the opportunity to realize a premium over thethen-prevailing market price for their shares of Class B common stock.

 

**Ourissuance of preferred stock could make it difficult for another company toacquire us, which could depress the price of our Class B common stock.**

 

Our board ofdirectors has the authority to issue preferred stock and to determine thepreferences, limitations and relative rights of shares of preferred stock andto fix the number of shares constituting any series and the designation of suchseries, without any further vote or action by our shareholders. The preferredstock could be issued with voting, liquidation, dividend and other rightssuperior to the rights of our Class B common stock. The potential issuanceof preferred stock may delay or prevent a change in control of us, discouragebids for the Class B common stock at a premium over the market price andadversely affect the market price and the voting and other rights of theholders of our Class B common stock.

 

**ITEM3****.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

Market risk represents the risk of loss that may impact our financialposition, results of operations or cash flows due to adverse changes in marketprices and rates. We are exposed to market risk because of changes in foreigncurrency exchange rates as measured against the U.S. dollar and currencies usedby our discontinued operation in the United Kingdom.

 

###### **Foreigncurrency exchange rate risk**

 

We haveconducted operations in the United Kingdom through a U.S.-incorporatedsubsidiary. Net revenues from these operations are typically denominated inBritish Pounds and Euros and are included in net income (loss) fromdiscontinued operations for the three months ended December 31, 2003 and 2002.Near-term changes in

 

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exchange rates may have amaterial impact on our future income (loss) from discontinued operations, fairvalues or cash flows as we liquidate the remaining assets and liabilities in theUnited Kingdom.  We have not engaged inforeign currency hedging transactions during the three months ended December31, 2003. There can be no assurance that a sudden and significant decline inthe value of the British Pound or Euro would not have a material adverse effecton our financial condition and results of operations.

 

**Interest rate sensitivity**

 

We maintain aportfolio of cash equivalents and investments in a variety of securities,including certificates of deposit, money market funds and government andnon-government debt securities. These available-for-sale securities are subjectto interest rate risk and may fall in value if market interest rates increase.If market interest rates increase immediately and uniformly by 10 percentagepoints from levels at December 31, 2003, the fair value of the portfolio woulddecline by $2,992,000. We anticipate having the ability to hold our fixedincome investments until maturity, and therefore do not expect our operatingresults or cash flows to be affected to any significant degree by the effect ofa sudden change in market interest rates on our securities portfolio.

 

**ITEM4****.   CONTROLSAND PROCEDURES**

 

Our chiefexecutive officer and chief financial officer performed an evaluation of ourdisclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as ofthe end of the period covered by this report. Based on the evaluation, the chief executive officer and chief financialofficer concluded that our disclosure controls and procedures were effectiveand sufficient as of the end of the period covered by this report to ensurethat the information required to be disclosed in the reports that we file underthe Exchange Act is recorded, processed, summarized, and reported within thetime periods specified in the SEC’s rules and forms.

 

There were no significant changes in our internal control overfinancial reporting during the quarter ended December 31, 2003.  We are not aware of any significant changein any other factors that significantly affected our internal control overfinancial reporting during the quarter ended December 31, 2003.

 

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**PART II****.   OTHER INFORMATION**

 

**ITEM 1.   LEGAL PROCEEDINGS**

 

In May 2003,we received a notice of demand for arbitration in connection with a disputeover payments related to an acquisition. The claim was for an amount not less than $700,000 plus interest,attorneys’ fees and associated costs.  Thismatter was settled and a charge of approximately $104,000 was recorded in thethree months ended December 31, 2003.

 

In June 2003, we announcedthat we had received a subpoena from a grand jury in the Southern District ofNew York to produce certain documents pursuant to an investigation involvingthe child support payment processing industry by the United States Departmentof Justice (“DOJ”), Antitrust Division. We have fully cooperated, and intend to continue to cooperate fully,with the subpoena and with the DOJ’s investigation.  On November 20, 2003, the DOJ granted conditional amnesty to theCompany pursuant to the Antitrust Division’s Corporate Leniency Policy.  Consequently, the DOJ will not bring anycriminal charges against the Company and our officers, directors and employees,as long as we continue to comply with the Corporate Leniency Policy, whichrequires, among other things, our full cooperation in the investigation andrestitution payments if it is determined that parties were injured as a resultof impermissible anti-competitive conduct. We have not recorded any liabilityfor such payments as any liability is not probable or estimable at this time.During fiscal 2003, we incurred approximately $1.3 million of legal costs tocomply with the investigation, which includes approximately $305,000 paid underofficers and directors indemnification agreements, and we expect to incurapproximately an additional $1.5 million in fiscal year 2004.

 

In November2003, we filed a lawsuit in California Superior Court, Sacramento County, *Tier Technologies, Inc. v State of California,through its agency, California Public Employees Retirement System, C.A. No.03AS06220*, to overturn CalPERS’ decision to terminate the contractrelating to our systems integration project for CalPERS for default and torecover added costs associated with that project.  We seek to recover damages and project delay, disruption andinterference costs on the project.  InDecember 2003, CalPERS filed a cross-complaint against us and made a claimagainst our performance bond for this contract.  The parties are undertaking discovery and we intend to vigorouslypursue our claims and to defend against CalPERS’ cross-complaint.  We expect to incur costs of approximately$1.5 million in fiscal year 2004 related to this matter.

 

In December 2003, acomplaint was filed in the U.S. District Court for the Northern District ofCalifornia against us, our chairman of the board who formerly was our chiefexecutive officer, another executive officer who formerly was our chieffinancial officer and a former executive officer.  *Sperling v. Tier Technologies,Inc. et al*, case no. C03-05509VRW. The complaint has been brought as a purported shareholder class actionunder Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule10b-5 promulgated thereunder and seeks unspecified monetary damages on behalfof the shareholder class.  In general,the complaint alleges that we misrepresented our financial performance duringthe fiscal years 2002 and 2003 to inflate the value of our stock.  We have not been served with thiscomplaint.  Since the filing of thecomplaint in federal court, we have been served with a complaint filed by ashareholder as a putative derivative action in California Superior Court forContra Costa County, *Scala v. Bildner et al*,case no. C03-03077.  The derivativecomplaint names the same three officers, another current officer, some of ourcurrent directors and two former directors as defendants and alleges breach offiduciary duty, abuse of control, gross mismanagement, waste of corporateassets, unjust enrichment and violations of the California CorporationsCode.  We believe that the allegationsin these complaints are without merit and intend to vigorously defend these lawsuits.  The lawsuits have been tendered to ourinsurance carriers.

 

In January2004, we were served with a complaint filed by Professional Services &Resources, Inc. (PSRI) in the Circuit Court in Cole County, Missouri (*ProfessionalServices & Resources, Inc. vs. Tier Technologies, Inc.,*Case No.04CV323189).  PSRI alleges that webreached the subcontract agreement between the parties by hiring an employee ofPSRI.  PSRI claims damages of $100,000for violation of the agreement, punitive damages, and attorney fees and costsassociated with the action.  We believethe allegations in the complaint are without merit and we intend to vigorouslydefend the lawsuit.

 

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**ITEM6****.   EXHIBITSAND REPORTS ON FORM 8-K**

 

(a)*Exhibits.*

* *
| **Exhibit Number** |   | **Description**                                                                                                                                         |
|--------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.39              |   | Termination  Agreement dated October 14, 2003 by and between the Company and James L.  Bildner*                                                         |
|               |   |                                                                                                                                                    |
| 10.40              |   | Separation  Agreement dated December 12, 2003 by and between the Company and Harry  Wiggins.*                                                           |
|               |   |                                                                                                                                                    |
| 31.1               |   | Certification  of Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a)  promulgated under the Securities Exchange Act of 1934, as amended. |
|               |   |                                                                                                                                                    |
| 31.2               |   | Certification  of Chief Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) promulgated  under the Securities Exchange Act of 1934, as amended. |
|               |   |                                                                                                                                                    |
| 32.1               |   | Certification  of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.    |
|               |   |                                                                                                                                                    |
| 32.2               |   | Certification  of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002     |

 

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* Management contract or compensatory plan required to be filed as anexhibit to this report.

 

(b) *Reportson Form 8-K.*

 

Current Report on Form 8-K, filed November 10, 2003, pursuant to Items5 and 12.  Reference is made to thepress releases of the Company issued November 10, 2003, announcing 1) theCompany’s fourth quarter and year end results, 2) the closure of certainbusiness operations and 3) the filing of a lawsuit by the Company.

 

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**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 theundersigned thereunto duly authorized.

 

 
|                      | TIER  TECHNOLOGIES, INC.                         |
|---------------------------|--------------------------------------------------|
|                      |                                             |
| Dated:  February 13, 2004 |                                             |
|                      |                                             |
|                      | By:                                              |    /s/  JEFFREY A. MCCANDLESS |
|                      | **Jeffrey A. McCandless**                        |
|                      | **Chief Financial Officer**                      |
|                      | **(Principal Financial and Accounting Officer)** |

 

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