**UNITED STATES**

**SECURITIES 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 June 30, 2004** |
|                                             |       |                                                                                          |
| **OR**                                           |
|                                             |       |                                                                                          |
| **o**                                            | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** | ** ** |

 

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**Commission file****number 000-23195**

 

**TIER TECHNOLOGIES, INC.**

(Exact name of Registrant as specified in its charter)

 

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

 

**10780Parkridge Blvd., 4th Floor**

**Reston,Virginia 20191**

(Address of principal executive offices)

 

**Notapplicable**

(Former name, former address, and former fiscal year, if changed sincelast report)

 

**(571)382-1090**

(Registrant’s telephone number, including area code)

 

Indicate by check markwhether the Registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the Registrant was required to filesuch reports) and (2) has been subject to such filing requirements for the past90 days. 

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

 

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

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

 

As of July 30, 2004, thenumber of shares outstanding of the Registrant’s Class ACommon Stock was 160,000 and the number of shares outstanding of the Registrant’sClass B Common Stock was 19,182,491.

 

 

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**TIERTECHNOLOGIES, INC.**

 

**FORM 10-Q**

 

**TABLE OFCONTENTS**

 
| ** **                            | ** **                                                                                                    | **Page** |
|---------------------------------------|---------------------------------------------------------------------------------------------------------------|----------|
|                                  | ** **                                                                                                    |     |
| **Part I—FINANCIAL INFORMATION** |                                                                                                          |
|                                  |                                                                                                          |     |
| Item 1.                               | Condensed Consolidated Financial Statements  (unaudited)                                                      |     |
|                                  |                                                                                                          |     |
|                                  | Condensed Consolidated Balance Sheets as of June  30, 2004 and September 30, 2003.                            | 3        |
|                                  |                                                                                                          |     |
|                                  | Condensed  Consolidated Statements of Operations for the three and nine months ended  June 30, 2004 and 2003. | 4        |
|                                  |                                                                                                          |     |
|                                  | Condensed  Consolidated Statements of Cash Flows for the nine months ended June 30, 2004  and 2003            | 5        |
|                                  |                                                                                                          |     |
|                                  | Notes  to Condensed Consolidated Financial Statements.                                                        | 6        |
|                                  |                                                                                                          |     |
| Item 2.                               | Management’s Discussion and Analysis of  Financial Condition and Results of Operations.                  | 18       |
|                                  |                                                                                                          |     |
| Item 3.                               | Quantitative and Qualitative Disclosures About  Market Risk.                                                  | 42       |
|                                  |                                                                                                          |     |
| Item 4.                               | Controls and Procedures.                                                                                      | 42       |
|                                  |                                                                                                          |     |
| **Part II—OTHER INFORMATION**    | ** **                                                                                                    |
|                                  |                                                                                                          |     |
| Item 1.                               | Legal Proceedings                                                                                             | 43       |
|                                  |                                                                                                          |     |
| Item 6.                               | Exhibits and Reports on Form  8-K.                                                                            | 44       |
|                                  |                                                                                                          |     |
| Signature                             | 45                                                                                                            |

 

**Private Securities LitigationReform Act Safe Harbor Statement**

 

Certainstatements contained in this report, including statements regarding thedevelopment of and demand for our services and our markets, anticipated trendsin various expenses, expected costs of legal proceedings and other statementsthat are not historical facts, are forward-looking statements within the meaningof the federal securities laws. These forward-looking statements relate tofuture events or our future financial and/or operating performance and cangenerally be identified as such because the context of the statement willinclude 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-looking statements are subject to risks anduncertainties, including the risks and uncertainties described and referred tounder “Factors That May Affect Future Results” beginning on page 31, that could cause actual results to differ materiallyfrom those anticipated as of the date of this report.

 

2

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**PART I****.   FINANCIAL INFORMATION**

 

**ITEM 1****.****   FINANCIAL STATEMENTS**

 

**TIERTECHNOLOGIES, INC.**

 

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

**(unaudited)**

**(in thousands)**

** **
| ** **                                                                        | ** ** | **June 30,  2004** | ** ** | **September 30,  2003** | ** ** |
|-----------------------------------------------------------------------------------|------------|--------------------|------------|-------------------------|------------|
| **ASSETS**                                                                        |       |               |       |                    |       |
|                                                                              |       |               |       |                    |       |
| **Current assets:**                                                               |       |               |       |                    |       |
| Cash  and cash equivalents                                                        |       | $                  | 32,929     |                    | $          | 26,178 |   |
| Short-term  investments                                                           |       | 4,199              |       | 5,492                   |       |
| Accounts  receivable, net                                                         |       | 19,503             |       | 20,024                  |       |
| Unbilled  receivables                                                             |       | 2,753              |       | 7,872                   |       |
| Assets  of discontinued operations                                                |       | 682                |       | 3,550                   |       |
| Prepaid  expenses and other current assets                                        |       | 4,350              |       | 4,602                   |       |
| Total  current assets                                                             |       | 64,416             |       | 67,718                  |       |
| Equipment  and software, net                                                      |       | 6,656              |       | 5,422                   |       |
| Notes  and accrued interest receivable from related parties, less current portion |       | 2,339              |       | 2,152                   |       |
| Goodwill                                                                          |       | 43,115             |       | 29,625                  |       |
| Other  acquired intangible assets, net                                            |       | 29,720             |       | 24,832                  |       |
| Long-term  investments                                                            |       | 22,346             |       | 24,883                  |       |
| Restricted  investments                                                           |       | 7,540              |       | 7,707                   |       |
| Non-current  assets of discontinued operations                                    |       | —             |       | 760                     |       |
| Other  assets                                                                     |       | 3,084              |       | 1,875                   |       |
| Total  assets                                                                     |       | $                  | 179,216    |                    | $          | 164,974 |   |
|                                                                              |       |               |       |                    |       |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                    |       |               |       |                    |       |
|                                                                              |       |               |       |                    |       |
| **Current liabilities:**                                                          |       |               |       |                    |       |
| Accounts  payable                                                                 |       | $                  | 1,993      |                    | $          | 2,087 |   |
| Accrued  liabilities                                                              |       | 10,370             |       | 8,476                   |       |
| Accrued  subcontractor expenses                                                   |       | 5,121              |       | 5,494                   |       |
| Accrued  compensation and related liabilities                                     |       | 4,751              |       | 3,654                   |       |
| Income  taxes payable                                                             |       | 4,410              |       | —                  |       |
| Deferred  revenue                                                                 |       | 3,413              |       | 3,299                   |       |
| Liabilities  of discontinued operations                                           |       | 307                |       | 2,043                   |       |
| Current  portion of long-term debt                                                |       | 114                |       | 150                     |       |
| Total  current liabilities                                                        |       | 30,479             |       | 25,203                  |       |
| Long-term  debt, less current portion                                             |       | 118                |       | 195                     |       |
| Non-current  liabilities of discontinued operations                               |       | 12                 |       | 432                     |       |
| Other  liabilities                                                                |       | 4,023              |       | 994                     |       |
| Total  liabilities                                                                |       | 34,632             |       | 26,824                  |       |
|                                                                              |       |               |       |                    |       |
| Commitments  and contingencies                                                    |       |               |       |                    |       |
|                                                                              |       |               |       |                    |       |
| **Shareholders’ equity:**                                                    |       |               |       |                    |       |
| Common  stock, no par value                                                       |       | 171,567            |       | 164,742                 |       |
| Notes  receivable from shareholders                                               |       | (1,773             | )          | (1,773                  | )          |
| Accumulated  other comprehensive loss                                             |       | (330               | )          | (350                    | )          |
| Accumulated  deficit                                                              |       | (24,880            | )          | (24,469                 | )          |
| Total  shareholders’ equity                                                  |       | 144,584            |       | 138,150                 |       |
| Total  liabilities and shareholders’ equity                                  |       | $                  | 179,216    |                    | $          | 164,974 |   |

 

See Notes toCondensed Consolidated Financial Statements

 

3

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**TIER TECHNOLOGIES, INC.**

 

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

**(unaudited)**

**(in thousands, except pershare data)**

 
| ** **                                                        | ** ** | **Three Months Ended  June 30,** | ** ** | **Nine Months Ended  June 30,** | ** ** |
|-------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                        | ** ** | **2004**                         | ** ** | **2003**                        | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net  revenues                                                     |       | $                                | 40,733     |                            | $          | 42,719 |   | $ | 96,902 |   | $ | 101,970 |   |
| Costs  and expenses:                                              |       |                             |       |                            |       |   |   |   |   |
| Direct  costs                                                     |       | 28,111                           |       | 30,878                          |       | 65,479 |   | 69,193 |   |
| Selling  and marketing                                            |       | 2,003                            |       | 1,540                           |       | 5,136 |   | 4,394 |   |
| General  and administrative                                       |       | 6,951                            |       | 5,756                           |       | 19,543 |   | 16,966 |   |
| Restructuring  charges                                            |       | 1,847                            |       | —                          |       | 3,108 |   | — |   |
| Depreciation  and amortization                                    |       | 1,160                            |       | 1,258                           |       | 3,398 |   | 4,022 |   |
| Income  from continuing operations                                |       | 661                              |       | 3,287                           |       | 238 |   | 7,395 |   |
| Interest  income (expense), net                                   |       | 305                              |       | 250                             |       | 875 |   | 924 |   |
| Income  from continuing operations before income taxes            |       | 966                              |       | 3,537                           |       | 1,113 |   | 8,319 |   |
| Provision  for income taxes                                       |       | 35                               |       | 1,352                           |       | 105 |   | 3,145 |   |
| Income  from continuing operations, net of income taxes           |       | 931                              |       | 2,185                           |       | 1,008 |   | 5,174 |   |
| Income  (loss) from discontinued operations, net of income taxes  |       | (17                              | )          | (58                             | )          | (1,418 | ) | 258 |   |
| Net  income (loss)                                                |       | $                                | 914        |                            | $          | 2,127 |   | $ | (410 | ) | $ | 5,432 |   |
|                                                              |       |                             |       |                            |       |   |   |   |   |
| Income  from continuing operations, net of income taxes:          |       |                             |       |                            |       |   |   |   |   |
| Per  basic share                                                  |       | $                                | 0.05       |                            | $          | 0.12 |   | $ | 0.05 |   | $ | 0.27 |   |
| Per  diluted share                                                |       | $                                | 0.05       |                            | $          | 0.12 |   | $ | 0.05 |   | $ | 0.27 |   |
|                                                              |       |                             |       |                            |       |   |   |   |   |
| Income  (loss) from discontinued operations, net of income taxes: |       |                             |       |                            |       |   |   |   |   |
| Per  basic share                                                  |       | $                                | —     |                            | $          | — |   | $ | (0.08 | ) | $ | 0.01 |   |
| Per  diluted share                                                |       | $                                | —     |                            | $          | — |   | $ | (0.07 | ) | $ | 0.01 |   |
|                                                              |       |                             |       |                            |       |   |   |   |   |
| Net  income (loss):                                               |       |                             |       |                            |       |   |   |   |   |
| Per  basic share                                                  |       | $                                | 0.05       |                            | $          | 0.11 |   | $ | (0.02 | ) | $ | 0.29 |   |
| Per  diluted share                                                |       | $                                | 0.05       |                            | $          | 0.11 |   | $ | (0.02 | ) | $ | 0.28 |   |
|                                                              |       |                             |       |                            |       |   |   |   |   |
| Shares  used in computing basic income (loss) per share           |       | 19,030                           |       | 18,600                          |       | 18,846 |   | 18,829 |   |
| Shares  used in computing diluted income (loss) per share         |       | 19,513                           |       | 18,821                          |       | 19,229 |   | 19,343 |   |

 

See Notes to Condensed Consolidated FinancialStatements

 

4

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**TIERTECHNOLOGIES, INC.**

 

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

**(unaudited)**

**(in thousands)**

** **
| ** **                                                                                                                                                 | ** ** | **Nine Months Ended  June 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                                                                 | ** ** | **2004**                        | ** ** | **2003** | ** ** |
| **Operating activities**                                                                                                                                   |       |                            |       |   |   |
| Income from continuing operations, net of income  taxes                                                                                                    |       | $                               | 1,008      |   | $ | 5,174 |   |
| Adjustments to reconcile income from continuing  operations, net of income taxes to net cash from continuing operations  provided by operating activities: |       |                            |       |   |   |
| Asset impairment charge                                                                                                                                    |       | 571                             |       | — |   |
| Depreciation and amortization                                                                                                                              |       | 5,081                           |       | 5,657 |   |
| Provision for doubtful accounts                                                                                                                            |       | 482                             |       | 578 |   |
| Tax benefit of stock options exercised                                                                                                                     |       | —                          |       | 200 |   |
| Stock options revision charge                                                                                                                              |       | 552                             |       | — |   |
| Forgiveness of notes receivable from employees                                                                                                             |       | 8                               |       | 40 |   |
| Change in operating assets and liabilities, net of  effects of business combinations:                                                                      |       |                            |       |   |   |
| Accounts receivable                                                                                                                                        |       | 4,891                           |       | (5,520 | ) |
| Prepaid expenses and other assets                                                                                                                          |       | (806                            | )          | (431 | ) |
| Accounts payable and accrued liabilities                                                                                                                   |       | 8,692                           |       | (899 | ) |
| Deferred revenue                                                                                                                                           |       | (906                            | )          | (256 | ) |
| Net cash from continuing operations provided by  operating activities                                                                                      |       | 19,573                          |       | 4,543 |   |
|                                                                                                                                                       |       |                            |       |   |   |
| **Investing activities**                                                                                                                                   |       |                            |       |   |   |
| Purchase of equipment and software                                                                                                                         |       | (2,605                          | )          | (1,407 | ) |
| Notes and accrued interest receivable from related  parties                                                                                                |       | (259                            | )          | (201 | ) |
| Repayments on notes and accrued interest receivable  from related parties                                                                                  |       | 62                              |       | 15 |   |
| Business combinations, net of cash acquired                                                                                                                |       | (15,613                         | )          | 286 |   |
| Purchases of available-for-sale securities                                                                                                                 |       | (16,593                         | )          | (24,803 | ) |
| Sales of available-for-sale securities                                                                                                                     |       | —                          |       | 5,989 |   |
| Maturities of available-for-sale securities                                                                                                                |       | 20,198                          |       | 17,431 |   |
| Other assets                                                                                                                                               |       | 27                              |       | (2 | ) |
| Net cash from continuing operations used in  investing activities                                                                                          |       | (14,783                         | )          | (2,692 | ) |
|                                                                                                                                                       |       |                            |       |   |   |
| **Financing activities**                                                                                                                                   |       |                            |       |   |   |
| Borrowings under bank line  of credit                                                                                                                      |       | 2,200                           |       | — |   |
| Repayment under bank line  of credit                                                                                                                       |       | (2,200                          | )          | — |   |
| Net proceeds from issuance of Class B common  stock                                                                                                   |       | 1,826                           |       | 1,400 |   |
| Repurchase of Class B common stock                                                                                                                         |       | —                          |       | (6,665 | ) |
| Payments on capital lease obligations and other  financing arrangements                                                                                    |       | (113                            | )          | (412 | ) |
| Net cash from continuing operations provided by  (used in) financing activities                                                                            |       | 1,713                           |       | (5,677 | ) |
| Net cash provided by (used in) continuing operations                                                                                                       |       | 6,503                           |       | (3,826 | ) |
| Net cash provided by (used in) discontinued  operations                                                                                                    |       | 248                             |       | (1,450 | ) |
| Net increase (decrease) in cash and cash equivalents                                                                                                       |       | 6,751                           |       | (5,276 | ) |
| Cash and cash equivalents at beginning of period                                                                                                           |       | 26,178                          |       | 40,609 |   |
| Cash and cash equivalents at end of period                                                                                                                 |       | $                               | 32,929     |   | $ | 35,333 |   |
|                                                                                                                                                       |       |                            |       |   |   |
| **Supplemental disclosures of cash  flow information**                                                                                                     |       |                            |       |   |   |
| Cash paid during the period for:                                                                                                                           |       |                            |       |   |   |
| Interest                                                                                                                                                   |       | $                               | 37         |   | $ | 44 |   |
| Income taxes paid (refunded), net                                                                                                                          |       | $                               | (7,022     | ) | $ | 2,680 |   |
|                                                                                                                                                       |       |                            |       |   |   |
| **Supplemental disclosures of  non-cash transactions**                                                                                                     |       |                            |       |   |   |
| Equipment acquired under capital lease obligations  and other financing arrangements                                                                       |       | $                               | —     |   | $ | 68 |   |
| Conversion of Class A common stock to Class B common  stock                                                                                                |       | $                               | 761        |   | $ | — |   |
| Class B common stock issued in business combination                                                                                                        |       | $                               | 4,447      |   | $ | — |   |

** **

See Notes toCondensed Consolidated Financial Statements

 

5

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**TIERTECHNOLOGIES, INC.**

** **

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(unaudited)**

 

**NOTE 1—BASIS OF PRESENTATION**

 

The accompanyingcondensed consolidated financial statements of Tier Technologies, Inc.(‘‘Tier’’ or the ‘‘Company’’) include the accounts of the Company and itswholly owned subsidiaries. All significant intercompany transactions andbalances have been eliminated in consolidation. In the opinion of management,the condensed consolidated financial statements reflect all normal andrecurring 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 financialstatements have been prepared in accordance with generally accepted accountingprinciples for interim financial information. Consequently, these statements donot include all the disclosures normally required by generally acceptedaccounting principles for annual financial statements nor those normally madein the Company’s Annual Report on Form 10-K. Accordingly, reference should bemade to the Company’s Form 10-K filed on December 19, 2003 and other reportsthe Company has filed with the Securities and Exchange Commission foradditional disclosures, including a summary of the Company’s accountingpolicies, which have not materially changed. The consolidated results of operationsfor the nine months ended June 30, 2004 are not necessarily indicative ofresults that may be expected for the fiscal year ending September 30, 2004 orany future period, and the Company makes no representations related thereto.

 

The preparation of financialstatements in conformity with generally accepted accounting principles requiresmanagement to make certain estimates and assumptions that affect the reportedamounts of assets and liabilities, disclosures of contingent assets andliabilities and the results of operations during the reporting period.  Although management believes that theestimates and assumptions used in preparing the accompanying condensedconsolidated financial statements and related notes are reasonable in light ofknown facts and circumstances, actual results could differ materially fromthose estimates.

 

Certain reclassificationshave been made to the prior period financial statements to conform to thecurrent period presentation.

 

 

###### **NOTE 2—REVENUE RECOGNITION**

 

The Company derives netrevenues from three principal delivery offerings:  transaction and payment processing, systemsdesign and integration, and maintenance and support services.  Net revenues include software licenserevenues and 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”) 104, *RevenueRecognition.* Transaction processing revenues include revenuesrecorded at the Company’s child support payment processing centers and therevenues of the Company’s Electronic Payment Processing (“EPP”) segment.  The EPP segment includes revenues from twowholly-owned subsidiaries of the Company: all revenues from Official Payments Corporation (“OPC”) and theelectronic processing revenues of EPOS Corporation (“EPOS”), an Alabama corporation acquiredeffective June 1, 2004.  These revenuesare based upon a per-transaction fee or a percentage of the dollar amountprocessed and 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. TheCompany assesses the probability of collection based upon the client’sfinancial condition and prior payment history. For EPP, transaction fees are generally borne by the consumer utilizingour services, not the governmental or other entity. EPP receives real-timeauthorization for credit and debit card transactions, which ensuresavailability of cardholder funds for payment. Revenues for EPOS are included only from the date of acquisition.

** **

*SystemsDesign and Integration -*Systems design and integrationincludes software application license revenues and software development andsystems integration service revenues to develop applications to enhance ourclients’ operating functionality.

** **

6

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License and services 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 aloss contract on an engagement is made in the period in which the loss becomesprobable and can be reasonably estimated. If the loss cannot be reasonably estimated, a zero profit methodology isapplied to the contract whereby the amount of revenue recognized is limited tothe amount of costs until such time, as the total loss can be estimated.Advance payments from clients and amounts billed to clients in excess ofrevenue recognized are recorded as deferred revenue. Amounts recognized asrevenue in advance of contractual billing are recorded as unbilled receivables.Revenues recognized under the percentage-of-completion method were $9,743,000and $22,022,000 for the nine months ended June 30, 2004 and 2003, respectively.

 

Where costs areincurred related to an unapproved change order, the costs are deferred untilthe change order is approved provided that the Company believes it is probablethat the cost will be recovered through a change in the contract price.Included in prepaid and other assets at June 30, 2004 and September 30, 2003were $0 and $34,000, respectively, of deferred costs related to change ordersnot 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 the fees are not deemed probable forcollection are recognized upon cash collection. Arrangements for which the fees are not deemed fixed or determinable arerecognized on the earlier of the due date or when payment is received.  Revenues from software license fees notrequiring significant modification were $370,000 and $56,000 for the ninemonths ended June 30, 2004 and 2003, 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 the terms ofits license agreements, the Company does not offer return rights or priceprotection.  Therefore, no provisionshave been made for sales returns.  Forits proprietary software, the Company offers routine, short-term warranties thatits software will operate free of material defects and in conformity withwritten documentation.  Under theseagreements, if the Company has an active maintenance agreement with thecustomer, the Company accounts for any obligation in conformity with Statementof Financial Accounting Standards No. 5, “Accounting for Contingencies.”  If the Company does not have a maintenancecontract in place, the warranty is considered implied maintenance and theCompany defers the amount of revenues consistent with the fair value of othermaintenance and support obligations.

 

*Maintenanceand Support Services –*The Company provides ongoingmaintenance 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 recognizedafter a contract is signed which indicates a fixed or determinable price andthe Company believes, based upon its assessment of the customer’s financialcondition that collection is reasonably assured.

 

***Multiple Elements Arrangements –*** TheCompany has several engagements that provide a combination of services fromseveral delivery offerings as part of the overall project.  For these multiple element arrangements, theCompany

** **

**7**

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** **

**allocates**revenue to each element based on the fair value of the delivery offering.  In establishing fair value, the Company usesprices charged on similar contracts.  Formultiple element arrangements entered into beginning July 1, 2003, the Companyhas followed the provisions of Emerging Issues Task Force Issue 00-21, “RevenueArrangements with Multiple Deliverables” (EITF 00-21).  For these multiple element arrangements, theCompany accounts for each unit of the contract as a separate unit when eachunit provides value to the customer on a stand-alone basis and there isobjective evidence of the fair value of the stand-alone unit.  The implementation of EITF 00-21 did not havea material effect on the Company’s recognition of revenue.

 

 

**NOTE 3—****CUSTOMER CONCENTRATION AND RISK**

 

The Company derives a significant portion of its net revenues from alimited number of clients. For the three months ended June 30, 2004 and 2003,revenue from one client totaled approximately $9,713,000 and $12,246,000,respectively, which represented 23.8% and 28.7%, respectively, of total netrevenues.  In both comparative threemonth periods, the revenues from this client represented the highestconcentration in any quarter during the respective fiscal years.  For the nine months ended June 30, 2004 and2003, revenues from the same client totaled approximately $13,303,000 and$15,637,000, respectively, which represented 13.7% and 15.3%, respectively, oftotal 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 best interest.  Each contract has specific remedies under atermination for convenience that generally provide a settlement claim whichincludes costs relating or allocable to the terminated contract, includingsettlement expenses and a reasonable profit. The Company’s contracts withgovernment agencies also typically provide for termination for cause wheneither party endangers 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 ofoperations.  Unbilled receivables were$2,753,000 and $7,872,000 at June 30, 2004 and September 30, 2003,respectively.  Amounts will becomebillable upon completion of project milestones or customer acceptance. Theentire unbilled receivables balance as of June 30, 2004 and September 30, 2003was expected to become billable within one year.   At June 30, 2004, two clients accounted for52.6% and 35.6% of total unbilled receivables and 8.4% and 23.7%, of total netaccounts receivable and unbilled receivables. An additional client accounted for 11.7% of total net accountsreceivable and unbilled receivables at June 30, 2004.  At September 30, 2003, three clientsaccounted for 44.2%, 25.0% and 20.3% of total unbilled receivables and 20.1%,16.3% and 7.2% of total net accounts receivable and unbilled receivables.

 

**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 in September 2003 as a revenue reversal onthis loss contract for amounts unbilled and uncollected as of the date oftermination. The Company also wrote-off $532,000 in deferred costs in September2003 related to change orders that were being negotiated at June 30, 2003.  From inception through June 30, 2003, theCompany had recorded revenue under the percentage-of-completion method of$20,340,000 under the terms of the contract and collected $7,508,000 in cashincluding $985,000 in July 2003. No revenues were recognized in connection withthis contract for the nine months ended June 30, 2004.  The Company filed a lawsuit to overturn thetermination of the contract for default and to recover all uncollected unbilledreceivables, delay, disruption and interference costs, attorneys’ fees andother costs associated with the contract. On August 4, 2004, the Company and CalPERS reached an agreement in ajudicially supervised settlement conference before the Sacramento SuperiorCourt wherein CalPERS withdrew the termination for default and the partiesrescinded the contract.  The parties alsomutually released each other from any and all claims arising out of thecontract.  The parties are in the processof preparing a written settlement agreement  (See Note 14).**

 

8

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** **

Included in other assets at June 30, 2004 was approximately $2,395,000,which represented balances billed but not paid by clients under retainageprovisions in the contracts, of which approximately $2,358,000 was expected tobe collected within two years, and $37,000 was expected to be collected withinfour years. Included in accounts receivable and other assets at September 30, 2003was approximately $1,448,000 of retainage of which approximately $461,000 wasexpected to be collected within one year, $430,000 was expected to be collectedwithin two years and $557,000 was expected to be collected within three years**.**

** **

**NOTE4—LONG-TERM INVESTMENTS**

 

Investments withmaturities greater than 12 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 were approximately **$**7,540,000and $7,707,000 at June 30, 2004 and September 30, 2003, respectively, and werepledged in connection with performance bonds and real estate operating leasesand will be restricted for the terms of the project performance periods andlease periods, the latest of which is estimated to be through June 2005.

 

**NOTE 5—BANK LINES OF CREDIT**

 

At June 30, 2004,the Company had a $15,000,000 revolving credit facility, all of which may beused for letters of credit.  The creditfacility has a maturity date of January 31, 2005.  The credit facility is collateralized byfirst priority liens and security interests in the Company’s assets. Interestis based on either the adjusted LIBOR rate plus 2.25% or the lender’s announcedprime rate at the Company’s option, and is payable monthly.  As of June 30, 2004, there was approximately$985,000 of standby letters of credit outstanding under this facility.  Among other provisions, the credit facilityrequires the Company to maintain certain minimum financial ratios. As of June30, 2004, the Company was in compliance with all of the financial ratios of thecredit facility.

 

One of the standby letters of credit outstanding underthe credit facility was issued in April 2004 in the amount of $935,000, and wasused to guarantee the performance bond of a third party required by a projectcontract that is anticipated to be completed in August 2005.  In conjunction with this guarantee, the Companyentered into an indemnification agreement with the third party which pledges tohold harmless, indemnify and make the Company whole from and against any andall amounts actually claimed or withdrawn as well as other businessconsideration.  In accordance withFinancial Accounting Standards Board (“FASB”) Interpretation No. 45 (“FIN 45”),“Guarantor’s Accounting and Disclosure Requirements for Guarantees, IncludingIndirect Guarantees of Indebtedness of Others”, the Company recorded aliability for the fair value of $935,000 in accrued liabilities and an equalreceivable in prepaid expenses and other current assets.  The recorded amounts will be eliminated ifthe Company is released from the risk upon expiration or settlement of theobligation.

 

In addition to the letters of credit issued under thecredit facility, the Company had letters of credit totaling approximately$3,151,000, which were collateralized by certain securities in the Company’slong-term investment portfolio at June 30, 2004.  Also, the Company’s subsidiary, OPC, had aletter of credit outstanding in the amount of approximately $138,000collateralized by a certificate of deposit. The majority of these letters of credit were issued to secure performancebonds and to meet various facility lease requirements.

 

9

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**NOTE6—GOODWILL AND OTHER ACQUIRED INTANGIBLE ASSETS**

 

**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 initial impairment tests in accordance withSFAS 142 in the first quarter of fiscal year 2003.  Results of the initial impairment tests didnot indicate any impairment loss. Impairment tests involve the use of estimates related to the fair marketvalues of the business operations with which goodwill is associated.  Losses, if any, resulting from the annualimpairment tests will be reflected in operating income in the statement of operations.During the fourth quarter of fiscal year 2003, the Company decided to shut downthe U.S. Commercial Services segment and the United Kingdom Operations segmentand accordingly recorded a restructuring charge of $17,646,000 to write-offsubstantially all of the associated goodwill. As of September 30, 2003, the remaining fair market value of thegoodwill associated with these segments totaled $457,000. The fair market valuewas determined by estimating the expected margin on the remaining contracts inthese segments.**

 

**During thenine months ended June 30, 2004, the Company wrote-off the remaining $457,000of goodwill associated with the U.S. Commercial Services segment indiscontinued operations as a result of the fulfillment of the remaining contractsin the quarter ended December 31, 2003. In the fourth quarter of fiscal year 2003, the Company performed itsannual impairment test to determine if the goodwill associated with itsremaining segments was impaired.  Theresults did not indicate any impairment loss for the remaining segments.**

 

Other acquiredintangible assets, net, consisted of the following at June 30, 2004 andSeptember 30, 2003 (in thousands):

 
| ** **                                   | ** ** | **Amortization  Period** | ** **                    | **June 30,  2004** | ** ** | **September 30,  2003** | ** ** |
|----------------------------------------------|------------|--------------------------|-------------------------------|--------------------|------------|-------------------------|------------|
| ** **                                   | **Gross**  | ** **               | **Accumulated  Amortization** | ** **         | **Net**    | ** **              | **Gross**  | ** ** | **Accumulated  Amortization** | ** ** | **Net** | ** ** |
|                                         |       |                     |                          |               |       |                    |       |   |   |   |   |   |   |   |   |
| Client relationships                         |       | 10 years                 |                          | $                  | 24,400     |                    | $          | (4,677 | ) | $ | 19,723 |   | $ | 24,400 |   | $ | (2,847 | ) | $ | 21,553 |   |
| Tradename                                    |       | 10 years                 |                          | 3,200              |       | (613                    | )          | 2,587 |   | 3,200 |   | (373 | ) | 2,827 |   |
| Technology                                   |       | 3 years                  |                          | 740                |       | (473                    | )          | 267 |   | 740 |   | (288 | ) | 452 |   |
| Acquired assets, related to EPOS acquisition |       | 5 years                  |                          | 7,206              |       | (120                    | )          | 7,086 |   | — |   | — |   | — |   |
| Acquired contracts                           |       | 12 months                |                          | 575                |       | (518                    | )          | 57 |   | 500 |   | (500 | ) | — |   |
| Total                                        |       |                     |                          | $                  | 36,121     |                    | $          | (6,401 | ) | $ | 29,720 |   | $ | 28,840 |   | $ | (4,008 | ) | $ | 24,832 |   |

 

The changes in the carrying amount of goodwill for the nine months endedJune 30, 2004 are as follows (in thousands):

 
| ** **                        | ** ** | **Government  Business  Process  Outsourcing** | ** ** | **Package  Software and  Systems  Integration** | ** ** | **Electronic  Payment  Processing** | ** ** | **Total** | ** ** |
|-----------------------------------|------------|------------------------------------------------|------------|-------------------------------------------------|------------|-------------------------------------|------------|-----------|------------|
| Balance  as of September 30, 2003 |       | $                                              | 5,298      |                                            | $          | 9,721                               |       | $         | 14,606     |   | $ | 29,625 |   |
| Activity                          |       | —                                         |       | 13,490                                          |       | —                              |       | 13,490    |       |
| Balance  as of June 30, 2004      |       | $                                              | 5,298      |                                            | $          | 23,211                              |       | $         | 14,606     |   | $ | 43,115 |   |

 

The Company is in the process of obtaining a formal valuation for theEPOS acquisition and has preliminarily estimated goodwill of $13,490,000 andintangible assets of $7,206,000 with an average amortization period of fiveyears.

 

10

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**NOTE 7 — SHAREHOLDERS’ EQUITY**

 

**Pro Forma Impact of EmployeeStock Options**

 

In December 2002,the Financial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards No. 148 (“SFAS 148”), “Accounting for Stock-BasedCompensation Costs – Transition and Disclosure,” which provides alternativemethods of transition for an entity that voluntarily changes to the fairvalue-based method of accounting for stock-based compensation.  SFAS 148 also requires additional disclosuresabout the effects on reported net income of an entity’s accounting policy withrespect to stock-based compensation.  TheCompany accounts for employee stock options in accordance with AccountingPrinciples Board Opinion No. 25 (“APB 25”), “Accounting for Stock Issuedto Employees” and provides the disclosure required in Statement of FinancialAccounting Standards No. 123 (“SFAS 123”), “Accounting forStock-Based Compensation.” Stock options issued to non-employees are accountedfor in accordance with Emerging Issues Task Force Issue No. 96-18,“Accounting for Equity Instruments That Are Issued to Other Than Employees forAcquiring, or in Conjunction with Selling, Goods or Services.”  The Company adopted the disclosure provisionsof SFAS 148 in January 2003.

 

The following table illustrates the effect on netincome (loss) and net income (loss) per share if the Company would have appliedthe fair value recognition provisions of SFAS 123 to stock-based compensation:

 
| ** **                                                                               | ** ** | **Three Months Ended   June 30,**          | ** ** | **Nine Months Ended  June 30,** | ** ** |
|------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                               | ** ** | **2004**                                   | ** ** | **2003**                        | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                               | ** ** | **(in  thousands, except per share data)** | ** ** |
| Net income (loss), as reported                                                           |       | $                                          | 914        |                            | $          | 2,127 |   | $ | (410 | ) | $ | 5,432 |   |
| Deduct:  Pro forma employee compensation cost  related to stock options, net of tax |       | 962                                        |       | 596                             |       | 2,214 |   | 2,193 |   |
| Pro  forma net income (loss)                                                             |       | $                                          | (48        | )                               | $          | 1,531 |   | $ | (2,624 | ) | $ | 3,239 |   |
|                                                                                     |       |                                       |       |                            |       |   |   |   |   |
| Net  income (loss) per basic share:                                                      |       |                                       |       |                            |       |   |   |   |   |
| As  reported                                                                             |       | $                                          | 0.05       |                            | $          | 0.11 |   | $ | (0.02 | ) | $ | 0.29 |   |
| Pro  forma                                                                               |       | $                                          | —     |                            | $          | 0.08 |   | $ | (0.14 | ) | $ | 0.17 |   |
|                                                                                     |       |                                       |       |                            |       |   |   |   |   |
| Net  income (loss) per diluted share:                                                    |       |                                       |       |                            |       |   |   |   |   |
| As  reported                                                                             |       | $                                          | 0.05       |                            | $          | 0.11 |   | $ | (0.02 | ) | $ | 0.28 |   |
| Pro  forma                                                                               |       | $                                          | —     |                            | $          | 0.08 |   | $ | (0.14 | ) | $ | 0.17 |   |

 

11

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**NOTE 8 —INCOME (LOSS) PER SHARE**

 

The following table sets forth the computation ofbasic and diluted income (loss) per share:

 
| ** **                                                                                                               | ** ** | **Three Months Ended  June 30,**          | ** ** | **Nine Months Ended  June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|---------------------------------|------------|
| **2004**                                                                                                                 | ** ** | **2003**                                  | ** ** | **2004**                        | ** ** | **2003** | ** ** |
| ** **                                                                                                               | ** ** | **(in thousands, except per share data)** | ** ** |
| Numerator:                                                                                                               |       |                                      |       |                            |       |   |   |   |   |
| Income from continuing operations, net of  income taxes                                                             |       | $                                         | 931        |                            | $          | 2,185 |   | $ | 1,008 |   | $ | 5,174 |   |
| Income (loss) from discontinued operation, net of  income taxes                                                          |       | (17                                       | )          | (58                             | )          | (1,418 | ) | 258 |   |
| Net income (loss)                                                                                                        |       | $                                         | 914        |                            | $          | 2,127 |   | $ | (410 | ) | $ | 5,432 |   |
| Denominator for basic income (loss) per share-weighted  average common shares outstanding                                |       | 19,030                                    |       | 18,600                          |       | 18,846 |   | 18,829 |   |
| Effects of dilutive securities:                                                                                          |       |                                      |       |                            |       |   |   |   |   |
| Common stock options                                                                                                     |       | 483                                       |       | 221                             |       | 383 |   | 514 |   |
| Denominator for diluted income (loss) per share-  adjusted weighted average common shares  and  assumed conversions |       | 19,513                                    |       | 18,821                          |       | 19,229 |   | 19,343 |   |
| Income from continuing operations, net of income  taxes:                                                                 |       |                                      |       |                            |       |   |   |   |   |
| Per basic share                                                                                                          |       | $                                         | 0.05       |                            | $          | 0.12 |   | $ | 0.05 |   | $ | 0.27 |   |
| Per diluted share                                                                                                        |       | $                                         | 0.05       |                            | $          | 0.12 |   | $ | 0.05 |   | $ | 0.27 |   |
| Income (loss) from discontinued operation, net of  income taxes:                                                         |       |                                      |       |                            |       |   |   |   |   |
| Per basic share                                                                                                          |       | $                                         | —     |                            | $          | — |   | $ | (0.08 | ) | $ | 0.01 |   |
| Per diluted share                                                                                                        |       | $                                         | —     |                            | $          | — |   | $ | (0.07 | ) | $ | 0.01 |   |
| Net income (loss):                                                                                                       |       |                                      |       |                            |       |   |   |   |   |
| Per basic share                                                                                                          |       | $                                         | 0.05       |                            | $          | 0.11 |   | $ | (0.02 | ) | $ | 0.29 |   |
| Per diluted share                                                                                                        |       | $                                         | 0.05       |                            | $          | 0.11 |   | $ | (0.02 | ) | $ | 0.28 |   |

 

For the three and nine months ended June 30, 2004,options to purchase approximately 1,753,000 and 2,051,000 shares of Class Bcommon stock, respectively, at prices ranging from $10.88 to $20.70 per shareand $10.20 to $20.70 per share, respectively, were outstandingbut were not included in the computation of diluted income (loss) per sharebecause the options’ exercise prices were greater than the average market priceof the shares for this period.  For thethree and nine months ended June 30, 2003, options to purchase approximately1,801,000 and 1,331,000 shares of Class B common stock, respectively, at pricesranging from $8.53 to $20.70 per share and $13.75 to $20.70 per share,respectively, were outstanding but were not included in the computation ofdiluted income per share because the options’ exercise prices were greater thanthe average market price of the shares for this period.

 

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

 

The Company’s comprehensiveincome (loss) was as follows:

 
| ** **                                                       | ** ** | **Three Months Ended  June 30,** | ** ** | **Nine Months Ended  June 30,** | ** ** |
|------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                       | ** ** | **2004**                         | ** ** | **2003**                        | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                       | ** ** | **(in thousands)**               |
| Net  income (loss)                                               |       | $                                | 914        |                            | $          | 2,127 |   | $ | (410 | ) | $ | 5,432 |   |
| Net  change in unrealized gain on available for-sale investments |       | (197                             | )          | (33                             | )          | (224 | ) | (17 | ) |
| Foreign  currency translation adjustment.                        |       | (10                              | )          | 102                             |       | 244 |   | (34 | ) |
| Comprehensive  income (loss)                                     |       | $                                | 707        |                            | $          | 2,196 |   | $ | (390 | ) | $ | 5,381 |   |

** **

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** **

**NOTE 10—ACQUISITIONS**

 

All acquisitions have been accounted for using thepurchase method of accounting.  Theinitial purchase price for each acquisition described below includes cash paid, stock issued at the date of acquisition and estimatedacquisition costs. Beginning October 1, 2002, the Company adopted SFAS 142, “Goodwilland other Intangible Assets,” and no longer amortizes goodwill and indefinitelived intangible assets. Under SFAS 142, goodwill and indefinite livedintangible assets are reviewed at least annually for impairment.  Separable intangible assets that have finiteuseful lives continue to be amortized over their useful lives.

 

Effective June 1, 2004, the Company purchased all ofthe outstanding stock of EPOS Corporation (“EPOS”), aAlabama corporation that supplies interactive voice response communication andelectronic transaction processing technologies. The total purchase price was approximately $20,060,000 and was comprisedof approximately $15,613,000 in cash and 402,422 shares of Class B common stockvalued at approximately $4,447,000, based on the closing price of Class Bcommon stock on June 1, 2004.  The cashpayment of $15,613,000 includes payments directly to EPOS lenders ofapproximately $7,544,000 and estimated acquisition costs of approximately$811,000.  The estimated identifiableintangible assets total $7,206,000 and are being amortized over fiveyears.  Total estimated goodwill of$13,490,000 was preliminarily allocated to the Package Software and SystemsIntegration (“PSSI”) segment.  Thepreliminary value assigned to intangible assets and goodwill are based uponmanagement’s estimates as the Company is awaiting the finalization ofappraisals and other studies before the identification and valuation of assetscan be complete, which is expected in the fourth quarter of fiscal year 2004.  The Company does not expect to deductgoodwill arising from this transaction for income tax purposes.

 

Manyrequests for proposals issued in the child support payment processing andunemployment insurance practices require interactive voice response communicationcapabilities, such as those provided by EPOS. Additionally, EPOS has established electronic payment processingcapabilities and clients in the secondary education and utilities verticalindustries that broaden the Company’s overall capabilities and clientbase.  The Company has establishedstrategic, operational business, financial, and valuation criteria that it usesto evaluate potential acquisitions and believes that these criteria, includingvaluation, are in line with market conditions.

 

The total purchase pricepaid was preliminarily allocated to the assets acquired and liabilities assumedas follows (in thousands):

 
| Accounts  receivable                       |   | $      | 1,139  |   |
|--------------------------------------------|--------|--------|--------|--------|
| Prepaid  expenses and other current assets |   | 1,014  |   |
| Equipment  and software                    |   | 1,838  |   |
| Other  assets                              |   | 37     |   |
| Accounts  payable and accrued expenses     |   | (1,473 | )      |
| Deferred  revenue                          |   | (1,020 | )      |
| Deferred  income tax liability             |   | (2,162 | )      |
| Other  long-term liability                 |   | (9     | )      |
| Other  acquired intangible assets          |   | 7,206  |   |
| Goodwill                                   |   | 13,490 |   |
|                                       |   |   |   |
| Total  consideration                       |   | $      | 20,060 |   |

 

13

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The followingunaudited pro forma summary presents consolidated information as if theacquisition of EPOS had occurred as of October 1, 2002.  This pro forma summary is provided forinformation purposes only and is based on historical information afterincluding the impact of certain adjustments such as increased estimatedamortization expense due to the preliminary recording of intangibleassets.  These pro forma results do notnecessarily reflect actual results that would have occurred nor is itnecessarily indicative of future results of operations of the combined entities(in thousands, except per share data):

 
| ** **                                                    | ** ** | **Nine  months ended  June 30, 2004** | ** ** | **Nine  months ended  June 30, 2003** | ** ** |
|---------------------------------------------------------------|------------|---------------------------------------|------------|---------------------------------------|------------|
|                                                          |       |                                  |       |                                  |       |
| Net  revenues                                                 |       | $                                     | 107,851    |                                  | $          | 110,282 |   |
|                                                          |       |                                  |       |                                  |       |
| Net  income (loss)                                            |       | $                                     | (961       | )                                     | $          | 4,991 |   |
|                                                          |       |                                  |       |                                  |       |
| Basic  net income (loss) per share                            |       | $                                     | (0.05      | )                                     | $          | 0.26 |   |
| Diluted  net income (loss) per share                          |       | $                                     | (0.05      | )                                     | $          | 0.25 |   |
|                                                          |       |                                  |       |                                  |       |
| Shares  used in computing basic net income (loss) per share   |       | 19,206                                |       | 19,232                                |       |
| Shares  used in computing diluted net income (loss) per share |       | 19,588                                |       | 19,745                                |       |

 

**In April 2004, the Companyacquired from PublicBuy.net LLC an e-procurement software solution and relatedassets that streamline the purchasing process for public procurement officialsfor approximately $1,259,000 in cash, including $66,000 in estimatedtransaction costs.  The total purchaseprice was allocated to intangible assets for $75,000, which arebeing amortized over 12 months, and software for $1,184,000.  The Company intends to license this softwareas part of its suite of financial management software offerings.**

 

**NOTE 11—SEGMENT INFORMATION**

 

Following therestructuring in the fourth quarter of fiscal year 2003, the Company has beenmanaged through three reportable segments: Government Business ProcessOutsourcing (“GBPO”), Government Systems Integration (“Government SI”) andOPC.  Accordingly, the prior year amountshave been reclassified to conform to the current year presentation.  In connection with the acquisition of EPOS,the Company renamed two of its segments; consequently, the three reportablesegments are now as follows:  GBPO,Package Software and Systems Integration (“PSSI”), formerly known as GovernmentSI, and Electronic Payment Processing (“EPP”), formerly known as OPC.  The GBPO segment provides transactionprocessing services. The PSSI segment provides systems integration, licensingand maintenance services.  The EPPsegment provides transaction and payment processing services.  The Company evaluates the performance of itsoperating segments based on net revenues and direct costs, while otheroperating costs are evaluated on a geographical basis.  Accordingly, the Company does not includeselling and marketing expenses, general and administrative expenses,depreciation and amortization expense not attributable to state child supportpayment processing centers, interest income (expense), other income (expense)and income tax expense in segment profitability.  The table below presents financialinformation for the three reportable segments:

 
| ** **                            | ** ** | **GBPO**            | ** ** | **PSSI** | ** ** | **EPP** | ** ** | **Total** | ** ** |
|---------------------------------------|------------|---------------------|------------|----------|------------|---------|------------|-----------|------------|
| ** **                            | ** ** | **(in  thousands)** | ** ** |
| **Three Months Ended June 30, 2004:** |       |                |       |     |       |    |       |      |       |
| Net revenues                          |       | $                   | 11,777     |     | $          | 12,147  |       | $         | 16,809     |   | $ | 40,733 |   |
| Direct costs                          |       | 7,310               |       | 8,098    |       | 12,703  |       | 28,111    |       |
|                                  |       |                |       |     |       |    |       |      |       |
| **Three Months Ended June 30, 2003**  |       |                |       |     |       |    |       |      |       |
| Net revenues                          |       | 12,524              |       | 11,970   |       | 18,225  |       | 42,719    |       |
| Direct costs                          |       | 8,245               |       | 8,561    |       | 14,072  |       | 30,878    |       |
|                                  |       |                |       |     |       |    |       |      |       |
| **Nine Months Ended June 30, 2004:**  |       |                |       |     |       |    |       |      |       |
| Net revenues                          |       | 34,787              |       | 29,680   |       | 32,435  |       | 96,902    |       |
| Direct costs                          |       | 22,602              |       | 19,986   |       | 22,891  |       | 65,479    |       |
|                                  |       |                |       |     |       |    |       |      |       |
| **Nine Months Ended June 30, 2003:**  |       |                |       |     |       |    |       |      |       |
| Net revenues                          |       | 36,377              |       | 34,666   |       | 30,927  |       | 101,970   |       |
| Direct costs                          |       | 22,076              |       | 24,552   |       | 22,565  |       | 69,193    |       |
|                                       |            |                     |            |          |            |         |            |           |            |  |  |  |  |

 

14

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**NOTE12—RESTRUCTURING**

 

Duringthe fourth quarter of fiscal year 2003, the Company initiated a strategicreview of its business units.  Thisreview was completed in the fourth quarter of fiscal year 2003 and the Companydecided to renew its focus on its core Government Services businesses whileexiting unprofitable or marginal business operations.  As a result of this review, the Companyrecorded a charge of approximately $19,786,000 during the three months endedSeptember 30, 2003.  This charge wascomprised of $18,197,000 of goodwill, intangible and tangible asset impairmentcharges, $882,000 related to the closure of several offices (net of estimatedsublease income of $115,000) and $707,000 of severance related to thetermination of employees in the exited businesses. The restructuring planincluded the termination of approximately 50 employees, of which approximately     20 employees were terminated during thethree months ended September 30, 2003 and the remaining employees wereterminated during the three months ended December 31, 2003.  Goodwill and asset impairment charges ofapproximately $1,323,000 were incurred for the nine months ended June 30, 2004,of which approximately $571,000 was included in restructuring charges andapproximately $752,000 was included in loss from discontinued operations.  Severance of approximately $2,291,000 wasincurred for the nine months ended June 30, 2004, of which approximately$1,461,000 primarily resulted from the signing of a termination agreement withthe Company’s former chief executive officer and was included in restructuringcharges and approximately $830,000 was included in loss from discontinuedoperations.  Also included in restructuringcharges for the nine months ended June 30, 2004 was an additional****$1**,**076,000 comprised of $222,000 related toestimated facility closure costs for one additional office and $854,000 for theclosure of our Walnut Creek, California office (net of estimated subleaseincome of $1,544,000).

 

Asa result of the acquisition of OPC in July 2002, the Company assumed certainliabilities for restructuring costs that OPC had previously recognized inconnection with the involuntary termination of employees and the consolidationof facilities (net of estimated sublease income of $295,000). The assumedseverance liability included severance for 27 individuals and the closing ofcertain office space.

 

InJune 2004, the Company completed the consolidation of its Walnut Creek,California and Reston, Virginia offices. As part of the office consolidation, the Company relocated theaccounting, financial planning, information technology, legal, human resourcesand facilities corporate functions to the Reston office and closed the WalnutCreek office.  The Company believes thatthe office consolidation will improve the efficiency of its workforce, reduceits cost structure, assist in developing a consistent corporate culture andstreamline the overall back office operations. As anticipated, some members of the staff formerly resident in WalnutCreek have relocated to the Reston office as part of the office consolidation,and the Company has hired new staff for the Reston office to perform functionsformerly carried out in Walnut Creek. The Company estimates that it will incur restructuring and other relatedpre-tax charges totaling approximately $2,800,000 in connection with the officeconsolidation.  The estimated charges arecomprised of approximately $385,000 in severance payments for employees who donot relocate to the Reston office, $1,290,000 in asset impairment charges andfacility closure costs, net of estimated sublease income of $1,488,000, andapproximately $1,125,000 in other charges related to the office consolidation.  The Company recorded approximately $1,552,000(net of estimated sublease income of $1,488,000) of these charges in the threemonths ended June 30, 2004 comprised of $436,000 in asset impairment charges,$854,000 in facility closure costs and $262,000 in other charges related to theoffice consolidation. The Company expects the remaining charges to be recordedin the three months ending September 30, 2004.

 

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AtSeptember 30, 2003, the Company had restructuring liabilities totaling $2,330,000of which $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  – continuing operations            |       | —                                   |       | 280                          |       | (280               | )          | —                                   |       |
| Facilities  closure – continuing operations   |       | —                                   |       | 53                           |       | —             |       | 53                                       |       |
| Severance  – discontinued operations.         |       | —                                   |       | 427                          |       | (249               | )          | 178                                      |       |
| Facilities  closure – discontinued operations |       | —                                   |       | 829                          |       | —             |       | 829                                      |       |
|                                               |       | $                                        | 2,767      |                         | $          | 1,536              |       | $                                        | (1,973     | ) | $ | 2,330 |   |

 

AtJune 30, 2004, the Company had restructuring liabilities totaling $2,772,000,of which $1,460,000 was recorded in accrued liabilities, $1,162,000 wasrecorded in non-current other liabilities, $138,000 was included in currentliabilities of discontinued operations and $12,000 was recorded in non-currentliabilities of discontinued operations. Approximately $266,000 of thenon-current restructuring liability is expected to be paid in fiscal year 2005,approximately $507,000 in fiscal year 2006, approximately $222,000 in fiscalyear 2007, and the balance is expected to be paid in fiscal year 2008. Thefollowing is a summary of the restructuring liabilities from September 30, 2003to June 30, 2004 (in thousands): 

 
| ** **                                         | ** ** | **Liability as of  September 30,  2003** | ** ** | **Additions/  (Reductions)** | ** ** | **Cash  Payments** | ** ** | **Liability as of  June 30,  2004** | ** ** |
|----------------------------------------------------|------------|------------------------------------------|------------|------------------------------|------------|--------------------|------------|-------------------------------------|------------|
| Severance  – OPC                              |       | $                                        | 1,133      |                         | $          | —             |       | $                                   | (345       | ) | $ | 788 |   |
| Facilities  closure – OPC                     |       | 137                                      |       | —                       |       | (66                | )          | 71                                  |       |
| Severance  – continuing operations            |       | —                                   |       | 1,099                        |       | (495               | )          | 604                                 |       |
| Facilities  closure – continuing operations   |       | 53                                       |       | 1,260                        |       | (154               | )          | 1,159                               |       |
| Severance  – discontinued operations.         |       | 178                                      |       | 827                          |       | (965               | )          | 40                                  |       |
| Facilities  closure – discontinued operations |       | 829                                      |       | (420                         | )          | (299               | )          | 110                                 |       |
|                                               |       | $                                        | 2,330      |                         | $          | 2,766              |       | $                                   | (2,324     | ) | $ | 2,772 |   |

 

**NOTE 13 —DISCONTINUED OPERATIONS**

 

During the quarter ended September 30, 2003, the Company completed astrategic review of all business units and began a restructuring plan whichincluded exiting the U.S. Commercial Services segment and the United KingdomOperations segment. During the quarter ended December 31, 2003, the Companycompleted 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.  The discontinuedoperations activity for the three and nine months ended June 30, 2004 includeda reduction in the estimated facility closure charges as a result ofrenegotiating more favorable lease-buyout terms for one of the facilities.  The revenues for the three months ended June30, 2004 of $53,000 resulted from a project on which the Company had completedits efforts as of December 31, 2003 but had a task which was subsequentlyperformed by a subcontractor with no margin derived by the Company.  The discontinued operations activity for thethree and nine months ended June 30, 2003 represented the historical results ofoperations of these discontinued businesses.

 

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At June 30, 2004, the Company had net assets of discontinued operationsof approximately $363,000 comprised of cash, accounts receivable, prepaidexpenses, restructuring liabilities, and accounts payable and other accruedliabilities.

 

The operating results of the discontinued operations were as follows:

** **
| ** **                                                       | ** ** | **Three Months Ended  June 30,** | ** ** | **Nine Months Ended  June 30,** | ** ** |
|------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                       | ** ** | **2004**                         | ** ** | **2003**                        | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                       | ** ** | **(in  thousands)**              | ** ** |
|                                                             |       |                             |       |                            |       |   |   |   |   |
| Net  revenues                                                    |       | $                                | 53         |                            | $          | 2,808 |   | $ | 1,780 |   | $ | 8,979 |   |
| Income  (loss) from discontinued operations, net of income taxes |       | $                                | (17        | )                               | $          | (58 | ) | $ | (1,418 | ) | $ | 258 |   |

 

**NOTE 14 - LEGAL PROCEEDINGS**

** **

In November 2003,the Company filed a lawsuit in California Superior Court, Sacramento County,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 sought 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.  On August 4,2004, the Company and CalPERS reached an agreement in a judicially supervisedsettlement conference before the Sacramento Superior Court wherein CalPERSwithdrew the termination for default and the parties rescinded the contract.  The parties released each other from any andall claims arising out of the contracts. The parties are in the process of preparing a written settlementagreement.

 

In June 2003, the Company announced that it hadreceived a subpoena from a grand jury in the Southern District of New York toproduce certain documents pursuant to an investigation involving the childsupport payment processing industry by the United States Department of Justice(“DOJ”), Antitrust Division.  The Companyhas fully cooperated, and intends to continue to cooperate fully, with thesubpoena and with the DOJ’s investigation. On November 20, 2003, the DOJ granted conditional amnesty to the Companypursuant to the Antitrust Division’s Corporate Leniency Policy.  Consequently, the DOJ will not bring anycriminal charges against the Company, its officers, directors and employees, aslong as the Company continues to comply with the Corporate Leniency Policy,which requires, among other things, the Company’s full cooperation in theinvestigation and restitution payments if it is determined that parties wereinjured as a result of impermissible anti-competitive conduct. During the ninemonths ended June 30, 2004, the Company incurred approximately $456,000 oflegal costs to comply with the subpoena which includes approximately $211,000cost incurred under indemnification agreements partially offset by a claimpayment received from the Company’s insurance carrier for approximately$227,000.  Due to the preliminary natureof the government’s inquiry, the Company is not able to assess the full impacton our financial condition and results of operations.

 

**NOTE 15 – SUBSEQUENT EVENT**

 

**In connectionwith the planned integration of EPOS and OPC, the Company estimates that itwill incur in the three months ended September 30, 2004 approximately$1,000,000 related to severance for OPC’s former chief operating officer andother integration charges.**

** **

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**ITEM 2**.           MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS

** **

**Overview**

 

We are a provider of transaction and paymentprocessing and packaged software and systems implementation services primarilyfor federal, state and local government and other public sector clients.  We combine our understanding ofenterprise-wide systems with domain knowledge to formulate, evaluate andimplement solutions that allow clients to rapidly channel emerging technologiesinto their business operations. Our workforce, composed of employees,independent contractors and subcontractors, increased to 849 on June 30,2004 from 804 on June 30, 2003 primarily due to our acquisition of EPOS inJune 2004.

 

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 business operations. As of December 31, 2003, we had exited the United Kingdom segment, theU.S. Commercial Services segment, and the Justice & Public Safety andStrategies 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 (“GBPO”) business unit and the Government SystemsIntegration (“Government SI”) business unit. In connection with our acquisition of EPOS, we renamed our Government SIbusiness unit as Package Software and Systems Integration (“PSSI”) and the OPCsegment as Electronic Payment Processing (“EPP”).  Our GBPO segment includes our child supportpayment processing contracts, our health and human services consultingbusiness, a District of Columbia child support enforcement project and theFinancial Institution Data Match contracts. We expect to see significantproposal activity in the child support payment processing market over the nextsix months as we believe approximately three states intend to issue newrequests for proposals. Our PSSI segment includes our pension contracts,unemployment insurance contracts, financial management systems (“FMS”) contracts,our e-government contracts, the State of Missouri contracts and the EPOSinteractive voice response license, hardware sales, services and maintenancecontracts.  We have shifted our systemsintegration model from custom developed solutions to implementation andmodification of packaged software. We believe this strategy of implementingpre-existing software applications that include customizations to meet ourparticular clients’ needs will combine the potential for greater profitabilitywith less risk compared to our earlier strategy of building a system based upona set of functional requirements.  OurEPP segment includes OPC and the electronic payment processing contracts ofEPOS.

 

**We derive net revenues primarilyfrom transaction and payment processing, systems design and integration, andmaintenance and support services.  Webill clients on a per-transaction basis, a fixed price basis or a time andmaterials basis.  We recognize netrevenues from transaction-based contracts based on fees charged on aper-transaction basis or fees charged as a percentage of dollarsprocessed.  We recognize net revenuesfrom software licenses that include significant implementation or customizationservices on the percentage-of-completion method of accounting based upon theratio of costs incurred to total estimated project costs.  We recognize net revenues from softwarelicenses that do not include significant implementation or customizationservices upon delivery to the licensee when the fees are fixed and determinable,collection is probable and vendor specific objective evidence exists todetermine the value of any undeliverable elements of the arrangement.  We recognize fixed price net revenues forother projects as services are provided and accepted by our clients, ifapplicable.  We recognize time andmaterials net revenues as we perform services and incur expenses. Net revenuesfrom software maintenance contracts are recognized ratably over the term of thecontract, typically one year.  During thenine months ended June 30, 2004, we generated**17.8% of our net revenues on a fixed price basis and                            64.4% of our net revenues on a per-transaction basis. Webelieve that the percentage of total net revenues attributable to fixed priceand per-transaction based contracts will continue to be significant.Substantially all of our contracts are terminable by the client followinglimited notice and without significant penalty to the client. From time totime, in the regular course of our business, we negotiate the modification,termination, renewal or transition of time and materials, fixed price andper-transaction based contracts that may involve an adjustment to the scope,duration or nature of the project, billing rates or price.  If we significantly overestimate the volume fortransaction-based contracts or underestimate the resources, costs or timerequired for fixed price or per-transaction based contracts, our financialcondition and results of operations would be materially and adversely affected.Unsatisfactory performance of services or proprietary software or unanticipateddifficulties or delays in completing projects may result in clientdissatisfaction and a reduction in payment to us, termination of a contract, orpayment of damages or penalties by us as a

 

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**result of litigation or otherwise, which could have amaterial adverse effect upon our business, financial condition and results ofoperations.**

** **

**We have derived a significant portion of our netrevenues from a small number of large clients. For some of these clients, weperform a number of different projects pursuant to multiple contracts orpurchase orders. For the nine months ended June 30, 2004, revenues fromthe Internal Revenue Service contract accounted for 13.7% of our total netrevenues. In addition, we performed child support payment processing servicesfor three different state governments as a subcontractor to ACS State and LocalSolutions, Inc. (“ACS”) during the nine months ended June 30, 2004 whichaccounted for 12.2% of total net revenues. In June 2004, we were notified by ACS of its decision not to renewone of our subcontracts effective June 30, 2004.  This subcontract accounted for approximately5.6% of total net revenues for the nine months ended June 30, 2004.  We anticipate that a substantial portion ofour net revenues will continue to be derived from a small number of largeclients. The completion, cancellation or significant reduction in the scope ofa large project would have a material adverse effect on our business, financialcondition and results of operations.**

** **

Personnel, facility and depreciation and amortizationexpenses represent a significant percentage of our operating expenses and arerelatively fixed in advance of any particular quarter. We manage our personnelutilization rates by carefully monitoring our needs and anticipating personnelincreases based on specific project requirements. To the extent net revenues donot increase at a rate commensurate with these additional expenses, our resultsof operations could be materially and adversely affected. In addition, to theextent that we are unable to hire and retain salaried employees to staff new orexisting client engagements or retain hourly employees or contractors, our business,financial condition and results of operations would be materially and adverselyaffected.

 

From October 1, 2001 through June 30, 2004,we made four acquisitions for a total cost of approximately $99.8 million usingcash and Class B common stock. We also incurred $1.0 million in cumulativecompensation charges related to business combinations and $1.3 million incumulative business combination integration charges resulting from theseacquisitions. Generally, we record contingent payments as additional goodwillat the time the payment can be determined beyond a reasonable doubt. If acontingent payment is based, in part, on a seller’s continuing employment withus, the payments are recorded as compensation expense under U.S. generallyaccepted accounting principles over the vesting period when the amount isdeemed probable.

 

In June 2004, we completed the consolidation ofour Walnut Creek, California and Reston, Virginia offices.  As part of the office consolidation, werelocated the accounting, financial planning, information technology, legal,human resources and facilities corporate functions to the Reston office andclosed the Walnut Creek office.  Webelieve that the office consolidation will improve the efficiency of ourworkforce, reduce our cost structure, assist in developing a consistentcorporate culture and streamline the overall back office operations.  As anticipated, some members of the staffformerly resident in Walnut Creek have relocated to the Reston office as partof the office consolidation, and we hired new staff for the Reston office toperform functions formerly carried out in Walnut Creek.  We estimate that we will incur restructuringand other related pre-tax charges totaling approximately $2.8 million inconnection with the office consolidation. The estimated charges are comprised of approximately $385,000 inseverance payments for employees who did not relocate to the Reston office,$1.3 million in facility closure costs, net of estimated sublease income of$1.5 million and approximately $1.2 million in other charges related to theoffice consolidation.  We recordedapproximately $1.6 million (net of estimated sublease income of $1.5 million)of these charges in the three months ended June 30, 2004 and expect theremaining charges to be recorded in the three months ending September 30,2004.

 

# **Critical Accounting Policies and Estimates**

# ** **

The discussion and analysis of our financial conditionand results of operations are based upon our consolidated financial statements,which have been prepared in accordance with U.S. generally accepted accountingprinciples.  The preparation of thesefinancial statements requires us to make estimates and judgments that affectour reported assets, liabilities, net revenues and expenses, and our relateddisclosure of contingent assets and liabilities.  On an ongoing basis, we evaluate ourestimates, including those related to revenue recognition, cost, collectibilityof receivables, goodwill and intangible assets, income taxes, restructuringobligations and discontinued operations. We base our estimates on historical experience and on various otherassumptions that are believed to be reasonable under the circumstances.   Such experience and assumptions form thebasis of judgments about the carrying values of assets and liabilities that arenot readily apparent from other sources. Actual results may differ from these estimates under differentassumptions or conditions.

 

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We believe the following critical accounting policiesand the related judgments and estimates significantly affect the preparation ofour consolidated financial statements:

 

*Basis of Presentation.*  During the year ended September 30,2003, we adopted SFAS 144, “Accounting for the Impairment and Disposal of LongLived Assets” which broadened the presentation of discontinued operations fromthe disposal of a segment to the disposal of a component of the entity.  SFAS 144 also changed the timing of presentationfrom the point of commitment to the point of actual disposal of the operations.During the quarter ended September 30, 2003, we completed a plan to exitthe operations of our U.S. Commercial Services segment, our United KingdomOperations segment and the Justice and Public Safety and Strategies divisionswithin the U.S. Government Services segment. Effective October 1, 2003, the U.S. Government Services segment wassplit into our GBPO and Government SI, now PSSI, segments. During the quarter endedDecember 31, 2003, we exited the U.S. Commercial Services and UnitedKingdom Operations segments and the financial position, results of theoperations and cash flows of these components are reported as discontinuedoperations for each period in this report. We must use our judgment to determine whether particular operations areconsidered a component of the entity and when the operations have beendisposed.

 

*Revenue Recognition.*  Certain judgments affect the application ofour revenue policy.  Our EPP and GBPOsegments generate transaction and payment processing revenues. Net revenuesfrom transaction and payment processing contracts are generally recognizedbased on fees charged on a per-transaction basis or fees charged as apercentage of total dollars processed. We establish the per-transaction fee or transaction fee percentage inour contracts based on estimated future costs and the estimate of transactionvolume over the life of the contract. The estimated average length of the transaction processing contracts inour GBPO segment is approximately three years plus optional client renewalsaveraging approximately two and one-half years. We use our historical experience and mathematical models to estimatetransaction volumes.  We monitortransaction volume on a monthly basis. Any significant variance from the estimated number of transactions oraverage transaction dollars processed could significantly impact the resultingrevenues and operating profit.  Forexample, our monthly transaction volume at our child support payment processingcenters varied between 107% and 93% from the average monthly volume duringfiscal year 2003.  If the volume oftransactions 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 average volume of dollars processed by OPC foreach payment type decreased 10% from the average volume processed by OPC foreach payment type during fiscal year 2003, our transaction and paymentprocessing revenues would have decreased by approximately $3.7 million.

 

For EPP segment electronic payment transactions, weuse judgment and historical experience to estimate sales returns and allowancesattributable to credit card reversals and chargebacks in determining netrevenues. When estimating these reserves, we analyze historical trends, ourspecific customer experience and current economic conditions. Within our EPPsegment, on-line payment processing revenues are nearly always generated byconsumer payments.  Before our EPPsegment processes payment transactions, each consumer must agree to pay us aprocessing fee by making the appropriate selection on our web site or telephonesystem.  Credit card reversal and chargebacksof convenience fees were $155,000 and $92,000 or 0.5% and 0.3% of EPP segmentnet revenues for the nine months ended June 30, 2004 and 2003,respectively.

 

Our PSSI segment generates systems design andintegration revenues. Net license and services revenues from contractsinvolving significant modification, customization or services which areessential 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 evaluatevariances between budgeted and actual costs in our fixed price contracts on amonthly basis.  To the extent there arechanges in 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 not requiring significant modification were$370,000 and $56,000 for the nine months ended June 30, 2004 and 2003,respectively.

 

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Our PSSI segment also generates maintenance andsupport services revenues.  Net revenuesfrom software maintenance contracts are recognized ratably over the term of thecontract, typically one year. Non-essential support services, including training and consulting, arealso provided on a time and materials basis. Revenue is recognized as the services are performed.  Maintenance and non-essential supportservices revenues were $14.2 million and $12.7 million for the nine monthsended June 30, 2004 and 2003, respectively.

 

Generally our government contracts are subject to“fiscal funding” clauses, which entitle the client, in the event of budgetaryconstraints, to reduce or eliminate the services we are to provide, with acorresponding reduction in the fee the client must pay under the terms andconditions of the original contract.  Netrevenues are recognized under such contracts only when we consider the likelihoodof cancellation of funding to be remote. Within the EPP segment the consumergenerally bears the transaction fee, not the government entity, so EPP segmentcontracts are not generally subject to fiscal funding issues.  For the nine months ended June 30, 2004and 2003, revenues recognized under contracts subject to fiscal funding clauseswere 66.5% and 69.7%, respectively, of total net revenues.

 

For all our segments, the amount and timing of our netrevenue is difficult to predict, and any shortfall in net revenue or delay inrecognizing net revenue could cause our operating results to vary significantlyfrom quarter to quarter and could result in future operating losses.

 

*Cost and Volume Estimates.*  For our transaction and payment processingbusiness, we establish the per-transaction fee or transaction fee percentage inour client contracts based on estimated future costs and estimates oftransaction and dollar volume over the life of the contract.  Included in our cost estimates for certainchild support payment processing contracts are estimates regarding misappliedpayments and payments that are rejected due to insufficient funds to the extentwe are to bear these costs. Actual misapplied payments and amounts forinsufficient funds checks are held as receivables until collected or writtenoff, as deemed appropriate. Included in our EPP segment cost estimates areprocessing fees that are subject to change with limited or no notice.  We use our judgment and review historicaltrends, our specific experience and current economic conditions in order toestimate these costs.  Any significantvariance from our estimates could significantly impact our operatingprofit.  For the nine months endedJune 30, 2004 and 2003, expenses incurred by us related to misappliedpayments and insufficient funds checks were $978,000 and $415,000,respectively.

 

**We recognize fixed price net revenues for oursystems design and integration projects using the percentage-of-completionmethod, based upon the ratio of costs incurred to total estimated projectcosts.  Any significant changes in totalestimated project costs could significantly affect our operating profit.**

** **

*Collectibility of Receivables.*  A considerable amount of judgment is requiredto assess the ultimate realization of receivables, including assessing theprobability of collection and the current credit worthiness of ourclients.  Probability of collection isbased upon the assessment of the client’s financial condition through thereview 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. Wemaintain an allowance for doubtful accounts for accounts receivable balances,including receivables resulting from misapplied payments and payments that arerejected due to insufficient funds, and a sales return and allowance provisionfor reversals and chargebacks from consumers who use our credit or debit cardpayment services.  At June 30, 2004and September 30, 2003, the combined balance of the allowance accounts was$2.6 million and $1.8 million, respectively.  There is no assurance that we will not need to record increases to thesebalances in the future.  We have severallarge accounts receivable and unbilled receivable balances, and any dispute,early contract termination or other collection issues could have a materialadverse impact on our financial condition and results of operations.  For example, during the fourth quarter offiscal year 2003, CalPERS terminated our systems integration contract. Wesubsequently filed a lawsuit seeking to recover costs and damages.  As a result, we recorded a charge againstrevenues of $12.8 million to write down the total value of unbilled receivablesfrom CalPERS.  On August 4, 2004, wereached an agreement with CalPERS in a judicially supervised settlementconference before the Sacramento Superior Court wherein CalPERS withdrew thetermination for default and the parties rescinded the contract.  The parties also released each other from anyand all claims arising out of the contracts. The parties are in the process of preparing a written settlementagreement.  At June 30, 2004, $11.1million of our accounts receivable and $2.5 million of our unbilled receivablesbalances were balances owed by seven clients for amounts greater than $1.0million each.

 

*Goodwill and Other IntangibleAssets.*  Considerationpaid in connection with acquisitions is required to be allocated to theacquired assets, including identifiable intangible assets, and liabilitiesacquired.  Acquired assets andliabilities are recorded based on our estimate of fair value, which requiressignificant judgment with respect to future cash flows and discount rates.  We utilize historical experience as well asexternal specialists to estimate fair value. For

 

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intangible assets, we are required to estimate the useful life of theasset or determine if it has an indefinite useful life.  We use our judgment to evaluate potentialindicators of impairment of goodwill and other intangible assets.  Our judgments regarding the existence ofimpairment indicators are based on market conditions, operational performanceof our acquired businesses and identification of reporting units.  Future events could cause us to conclude thatimpairment indicators exist and that goodwill and other intangible assetsassociated with our acquired businesses are impaired.  Beginning October 1, 2002, we adoptedStatement of Financial Accounting Standards No. 142 (“SFAS 142”) “Goodwill andOther Intangible Assets.”  Accordingly,our goodwill and other intangible assets that have an indefinite useful lifeare not amortized but instead are reviewed at least annually forimpairment.  During the quarter endedDecember 31, 2002, we completed the initial impairment test and theresults did not indicate any impairment loss. Impairment tests involve the use of estimates related to the fair marketvalue of the business operations with which goodwill is associated.  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 charge of $17.6million to write down goodwill to its fair value as determined by calculatingthe expected cash flows from the remaining contractual obligations of thosesegments.  As of September 30, 2003,the remaining goodwill associated with these segments totaled $457,000.  This goodwill value was written off duringthe quarter ended December 31, 2003. In the fourth quarter of fiscal year 2003, we performed our annualimpairment test to determine if the remaining goodwill associated with ourcontinuing segments was impaired. Our estimate of fair value did not indicateany impairment.  The fair market value ofthe remaining segments 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 valuationmodels increased by 1%, the calculated fair value would have decreased 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 actualcurrent tax liability, including assessing temporary differences resulting fromdiffering tax treatment of items, such as the difference in amortizable livesfor intangible assets for tax and accounting purposes.  These differences result in deferred taxassets and liabilities.  At June 30,2004 and September 30, 2003, we had a net deferred tax asset of $23.2million, comprised of net operating loss carryforwards, foreign tax creditcarryforwards and other deductible temporary differences, against which we arecarrying a $23.2 million valuation allowance. Statement of Financial AccountingStandards No. 109 (“SFAS 109”) “Accounting for Income Taxes” requires that thedeferred tax assets be reduced by a valuation allowance if, based on the weightof available evidence, it is more likely than not that some portion or all ofthe recorded deferred tax assets will not be realized in future periods.  In evaluating our ability to recover ourdeferred tax assets we consider all available positive and negative evidenceincluding our past operating results, the existence of cumulative losses in themost recent fiscal years and our forecast of future taxable income.  In determining future taxable income, we areresponsible for assumptions utilized including the amount of federal and statepre-tax operating income, the reversal of temporary differences and theimplementation of feasible and prudent tax planning strategies.  These assumptions require significantjudgment about the forecasts of future taxable income and are consistent withthe plans and estimates we are using to manage the underlying businesses.  Management concluded to establish a fullvaluation 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 tax expenserecorded in the future will be reduced to the extent of offsetting decreases inour valuation allowance.  In addition,the calculation of tax liabilities involves significant judgment in estimatingthe impact of uncertainties in the application of complex tax laws.  Although we believe that our estimates arereasonable, resolution of these uncertainties in a manner inconsistent withmanagement’s expectations could have a material impact on the Company’sfinancial position and cash flows.

 

*Determination of RestructuringObligations*.  Duringthe fourth quarter of fiscal year 2003, we recorded a restructuring chargerelated to plans and actions taken to exit businesses, terminate employees andconsolidate facilities.  During thequarter ended December 31, 2003, we exited the former U.S. CommercialServices and United Kingdom segments and the financial position, results ofoperations and cash flows of these businesses are reported as discontinuedoperations for each period.   Also, as aresult of our acquisition of OPC in July 2002, we assumed certainliabilities for restructuring costs that OPC had previously recognized inconnection with the termination of employees and the consolidation offacilities.  During the quarter endedJune 30, 2004, we relocated the accounting, financial planning,information technology, legal, human resources and facilities corporatefunctions to Reston, Virginia and closed the Walnut Creek, Californiaoffice.  We have recorded restructuringcharges related to this office consolidation. The restructuring liability for consolidation of facilities is theestimated net obligation payable on abandoned office facilities.  The estimated net obligation includes thegross obligation payable under existing lease agreements through estimateddisposition dates, estimated costs of abandonment or lease transfer, as offsetby estimated sublease income.  To the extent we are unable to sublease orotherwise dispose of the facilities on the dates estimated, or the estimatedsublease income or estimated costs 

 

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differ from our estimates, the restructuring liability may requireadjustment.  The estimated sublease income was calculated based onexecuted subleases.  At June 30,2004 and September 30, 2003, we had restructuring liabilities totalingapproximately $2.8 million and $2.3 million, respectively.

 

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**Results of Operations**

 

The following table summarizes our operating resultsas a percentage of net revenues for each of the periods indicated:

 
| ** **                                              | ** ** | **Three Months Ended  June 30,** | ** ** | **Nine Months Ended  June 30,** | ** ** |
|---------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                              | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                    |       |                                  |       |                                 |       |   |   |   |   |
| Net revenues                                            |       | 100.0                                 | %          | 100.0                                | %          | 100.0 | % | 100.0 | % |
| Costs and expenses:                                     |       |                                  |       |                                 |       |   |   |   |   |
| Direct costs                                            |       | 69.0                                  |       | 72.3                                 |       | 67.6 |   | 67.9 |   |
| Selling and marketing                                   |       | 4.9                                   |       | 3.6                                  |       | 5.3 |   | 4.3 |   |
| General and administrative                              |       | 17.1                                  |       | 13.5                                 |       | 20.2 |   | 16.6 |   |
| Restructuring charges                                   |       | 4.5                                   |       | —                               |       | 3.2 |   | — |   |
| Depreciation and amortization                           |       | 2.9                                   |       | 2.9                                  |       | 3.5 |   | 3.9 |   |
| Income from continuing operations                       |       | 1.6                                   |       | 7.7                                  |       | 0.2 |   | 7.3 |   |
| Interest income (expense), net                          |       | 0.8                                   |       | 0.6                                  |       | 0.9 |   | 0.9 |   |
| Income from continuing operations before income  taxes  |       | 2.4                                   |       | 8.3                                  |       | 1.1 |   | 8.2 |   |
| Provision for income taxes                              |       | 0.1                                   |       | 3.2                                  |       | 0.1 |   | 3.1 |   |
| Income from continuing operations, net of income  taxes |       | 2.3                                   | %          | 5.1                                  | %          | 1.0 | % | 5.1 | % |

 

**Three Months Ended June 30, 2004 andJune 30, 2003**

 

*Net Revenues.*  We generate net revenues primarily fromtransaction and payment processing services, software development services, andsoftware license and maintenance fees. The GBPO segment provides systems designand integration and transaction and payment processing services to federal,state and local government entities in the United States. The PSSI segmentprovides systems design and integration services to state and local governmentand other public sector entities in the United States.  The EPP segment provides transaction andpayment processing services to clients primarily in the public sector. Netrevenues decreased 4.6% to $40.7 million for the three months endedJune 30, 2004 from $42.7 million in the three months ended June 30,2003. This decrease resulted primarily from a decrease in GBPO net revenues ofapproximately $747,000 and a decrease in EPP segment net revenues ofapproximately $1.4 million partially offset by an increase in PSSI net revenuesof approximately $177,000.  The followingtable presents the net revenues for each of the three reportable segments forthe three months ended June 30, 2004 and 2003:

 

| ** ** | ** ** | **Three months ended  June 30,** | ** ** |
|------------|------------|---------------------------------------|------------|
| ** ** | ** ** | **2004**                              | ** ** | **2003** | ** ** |
| ** ** | ** ** | **(in thousands)**                    | ** ** |
|       |       |                                  |       |   |   |
| GBPO       |       | $                                     | 11,777     |   | $ | 12,524 |   |
| PSSI       |       | 12,147                                |       | 11,970 |   |
| EPP        |       | 16,809                                |       | 18,225 |   |
| Total      |       | $                                     | 40,733     |   | $ | 42,719 |   |

 

The $747,000 decrease in GBPO net revenues resultedprimarily from the discontinuance of a contract that ended in fiscal year 2003which generated $538,000 in revenues during the three months ended June 30,2003.  The $177,000 increase in PSSI netrevenues resulted from increases of $473,000 in the State of Missouri practice,$1.4 million in the emerging practices industry including unemploymentinsurance and E-government, and revenues of $1.3 million from EPOS partiallyoffset by a $2.8 million reduction in revenues from CalPERS as a result of thetermination of the project.  The $1.4million decrease in EPP net revenues resulted primarily from a decrease infederal tax dollars processed for the tax season of $2.5 million partiallyoffset by increased revenues of $775,000 from an increase in adoption rates ofOPC services and revenues of approximately $220,000 from EPOS.

 

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The following table presents net revenues for thethree months ended June 30, 2004 and 2003 by delivery offering:

 

| ** **                         | ** ** | **Three months ended  June 30,** | ** ** |
|------------------------------------|------------|---------------------------------------|------------|
| ** **                         | ** ** | **2004**                              | ** ** | **2003** | ** ** |
| ** **                         | ** ** | **(in thousands)**                    | ** ** |
|                               |       |                                  |       |   |   |
| Transaction and payment processing |       | $                                     | 27,867     |   | $ | 29,550 |   |
| Systems design and integration     |       | 5,568                                 |       | 8,033 |   |
| Maintenance and support services   |       | 5,401                                 |       | 4,615 |   |
| Product sales and other services   |       | 1,897                                 |       | 521 |   |
| Total                              |       | $                                     | 40,733     |   | $ | 42,719 |   |

 

Net revenues from transaction and payment processingservices decreased 5.7% to $27.9 million in the three months endedJune 30, 2004 compared to $29.6 million in the three months endedJune 30, 2003 primarily as a result of the $1.4 million decrease in EPPnet revenues.  Net revenues from systemsdesign and integration services decreased 30.7% to $5.6 million in the threemonths ended June 30, 2004 compared to $8.0 million in the three monthsended June 30, 2003 primarily due to a $2.8 million reduction in revenuesfrom CalPERS as a result of the termination of the CalPERS contract.  Net revenues from maintenance and supportservices increased 17.0% to $5.4 million in the three months endedJune 30, 2004 compared to $4.6 million in the three months endedJune 30, 2003 primarily as a result of increased revenues of $776,000 fromour State of Missouri practice and revenues from EPOS of approximately$353,000.   Net revenues from productsales and other services increased 264.1% to $1.9 million in the three monthsended June 30, 2004 compared to $521,000 in the three months endedJune 30, 2003 primarily as a result of growth in new practice areas,including web portal services, of $492,000 and product sales revenues from EPOSof $908,000 both during the three months ended June 30, 2004.

 

Net revenues include reimbursements from clients forout-of-pocket expenses.  Reimbursementand software license net revenues for each period represented were less than10% of total net revenues for the respective period.  Reimbursement revenues may increase inabsolute dollars in future periods if we are successful in winning newcontracts in our child support payment processing operations.

 

*Direct Costs.*   Direct costs consist primarily of thosecosts directly attributable to providing service to a client, includingemployee salaries and incentive compensation, independent contractor andsubcontractor costs, employee benefits, payroll taxes, travel-relatedexpenditures, amortization of intellectual property, amortization anddepreciation of any project-related equipment, hardware or software purchases,and the cost of hardware, software or equipment sold to clients.  For state child support payment processingcenter operations, direct costs also include facility, depreciation andamortization expense and direct overhead costs. For EPP, direct costs consist primarily of credit and debit carddiscount fees, processing fees, telecommunication costs and other third partycosts.  Direct costs included $634,000 ofdepreciation and amortization for the three months ended June 30, 2004 and$552,000 for the three months ended June 30, 2003.  In total, direct costs decreased 9.0% to$28.1 million for the three months ended June 30, 2004 from $30.9 million forthe three months ended June 30, 2003. This decrease resulted primarily from the decrease in headcount of 83 resulting from therestructuring and the termination of the CalPERS contract, which was partiallyoffset by the addition of 40 employees with the acquisition of EPOS effectiveJune 1, 2004.

 

*Selling and Marketing.  *Selling and marketingexpenses consist primarily of personnel costs, sales commissions, advertisingand marketing expenditures, and travel-related expenditures. Selling andmarketing expenses increased 30.1% to $2.0 million for the three months endedJune 30, 2004 from $1.5 million for the three months ended June 30,2003.  As a percentage of net revenues,selling and marketing expenses increased to 4.9% for the three months endedJune 30, 2004 from 3.6% for the three months ended June 30,2003.  The increase in selling andmarketing expenses for the three months ended June 30, 2004 resultedprimarily from increased advertising and marketing expenses in connection withthe April 15th federal tax season.  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 for the April 15th federal tax season.

 

*General and Administrative.*   General and administrative expenses consistprimarily of personnel costs related to general management and administrativefunctions, human resources, resource management, OPC’s engineering, clientimplementation, client service and customer service departments, staffing,accounting and finance, legal, facilities and information systems, as well asbusiness insurance costs, facility costs and professional fees related to

 

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legal, audit, tax, external financial reporting and investor relationsmatters. General and administrative expenses increased 20.8% to $7.0 millionfor the three months ended June 30, 2004 from $5.8 million for the threemonths ended June 30, 2003. As a percentage of net revenues, general andadministrative expenses increased to 17.1% for the three months endedJune 30, 2004 from 13.5% for the three months ended June 30, 2003. Theincrease in general and administrative expenses resulted primarily from$448,000 in expenses related to the consolidation of our Walnut Creek andReston offices, $412,000 in legal and other costs incurred related to theterminated CalPERS contract and $241,000 in increased accounting and other feesrelated to compliance with the Sarbanes-Oxley Act.  We expect general and administrative expenseswill increase in absolute dollars for fiscal year 2004 compared to fiscal year2003 as a result of costs to comply with the Sarbanes-Oxley Act, additionalcosts related to the terminated CalPERS contract and the consolidation of ourWalnut Creek and Reston offices.

 

*Restructuringcharges.***  **The following table presents therestructuring charges for the three months ended June 30, 2004 and 2003:

 

 

| ** **                                         | ** ** | **Three months ended  June 30,** | ** ** |
|----------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                         | ** ** | **2004**                              | ** ** | **2003** | ** ** |
| ** **                                         | ** ** | **(in thousands)**                    | ** ** |
|                                               |       |                                  |       |   |   |
| Assets impairment charge                           |       | $                                     | 436        |   | $ | — |   |
| Severance charge resulting from restructuring      |       | 558                                   |       | 3⁄4 |   |
| Office closure charge resulting from restructuring |       | 853                                   |       | — |   |
| Total                                              |       | $                                     | 1,847      |   | $ | — |   |

 

During the three months ended June 30, 2004, werecorded asset impairment charges of $436,000 resulting from assets written offdue to the closure of our Walnut Creek office. The severance charge of $558,000 represented severance costs due to themodification of our former chief executive officer’s stock options based on theprice of our Class B common stock on April 1, 2004.  The office closure charge of $853,000represented costs incurred for the closure of the Walnut Creek office.  We also expect to incur in the three monthsending September 30, 2004, additional severance payments totalingapproximately $385,000 for employees who do not relocate to the Reston officein connection with the office consolidation.

 

*Depreciation and Amortization.*   Depreciation and amortization consistsprimarily of expenses associated with depreciation of equipment and leaseholdimprovements and amortization of other intangible assets resulting fromacquisitions and other intellectual property not directly attributable toclient projects. Project-related depreciation and amortization is included indirect costs.  For OPC, no depreciationand amortization expense is included in direct costs.  Depreciation and amortization decreased 7.8%to $1.2 million for the three months ended June 30, 2004 from $1.3 millionfor the three months ended June 30, 2003. As a percentage of net revenues,depreciation and amortization remained constant at 2.9% for the three monthsended June 30, 2004 as compared to the three months ended June 30,2003.  The decrease in depreciation andamortization in absolute dollars resulted primarily from assets that becamefully depreciated or amortized.

 

*Interest Income (Expense), Net.*   Net interest income increased 22.0% to$305,000 for the three months ended June 30, 2004 from $250,000 for thethree months ended June 30, 2003. This increase was primarily attributable to higher interest rates due toa shift to higher yield investments in the current quarter as well as higheraverage cash balance.

 

*Provision for Income Taxes.* The provision for income taxes was $35,000 forthe three months ended June 30, 2004 and $1.4 million for the three monthsended June 30, 2003.  The provisionfor income taxes for the three months ended June 30, 2004 represented theexpected minimum state tax payments.  Noadditional tax provision on the pre-tax income for the three months endedJune 30, 2004 was recorded due to the pre-tax loss for the nine monthsended June 30, 2004.  In addition,no tax benefit on the pre-tax loss for the nine months ended June 30, 2004was recorded due to the full valuation allowance on our net deferred taxassets.  Our effective tax rate was 38.2%for the three months ended June 30, 2003. The effective tax rate in the upcoming quarters and for the year endingSeptember 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 generated duringthe year, the ability to utilize foreign tax

 

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credits and foreign net operating losses, and any non-deductible itemsrelated to acquisitions or other nonrecurring charges. We will continue tomonitor the effective tax rate on a quarterly basis.

 

*Discontinuedoperations.*   The loss from discontinued operations, netof income taxes, was $17,000 and $58,000 for the three months endedJune 30, 2004 and 2003, respectively. The loss from discontinued operations for the three months endedJune 30, 2004 resulted primarily from miscellaneous closing expenses.  The loss from discontinued operations for thethree months ended June 30, 2003, net of income taxes represents thehistorical operating results of our discontinued U.S. Commercial Services andUnited Kingdom segments.

 

**Nine Months Ended June 30, 2004 andJune 30, 2003**

 

*Net Revenues.*  Net revenues decreased 5.0% to $96.9 millionfor the nine months ended June 30, 2004 from $102.0 million in the ninemonths ended June 30, 2003. This decrease resulted primarily from adecrease in GBPO net revenues of approximately $1.6 million and a decrease inPSSI net revenues of approximately $5.0 million, partially offset by anincrease in EPP net revenues of approximately $1.5 million.  The following table presents the net revenuesfor each of the three reportable segments for the nine months endedJune 30, 2004 and 2003:

 

| ** ** | ** ** | **Nine months ended  June 30,** | ** ** |
|------------|------------|--------------------------------------|------------|
| ** ** | ** ** | **2004**                             | ** ** | **2003** | ** ** |
| ** ** | ** ** | **(in thousands)**                   | ** ** |
|       |       |                                 |       |   |   |
| GBPO       |       | $                                    | 34,787     |   | $ | 36,377 |   |
| PSSI       |       | 29,680                               |       | 34,666 |   |
| EPP        |       | 32,435                               |       | 30,927 |   |
| Total      |       | $                                    | 96,902     |   | $ | 101,970 |   |

 

The $1.6 million decrease in GBPO net revenuesresulted primarily from the discontinuance of a contract that ended in fiscalyear 2003 which generated $1.5 million in revenues during the nine months endedJune 30, 2003.  The $5.0 million decreasein PSSI net revenues resulted primarily from a $9.4 million decrease inrevenues from CalPERS, as a result of the termination of the project due to adispute with CalPERS, partially offset by increased revenues of $400,000 in ourState of Missouri practice, increased revenues of $2.0 million in our pensionpractice, growth in emerging practices of $3.1 million, including unemploymentinsurance and e-Government practices and revenues of $1.2 million from EPOS.The $1.5 million increase in EPP net revenues resulted primarily from anincrease in adoption rates of OPC services with increased revenue of $3.6million partially offset by a decrease in revenues generated from federal tax dollarsprocessed of $2.3 million.

 

The following table presents net revenues for the ninemonths ended June 30, 2004 and 2003 by delivery offering:

 

| ** **                         | ** ** | **Nine months ended  June 30,** | ** ** |
|------------------------------------|------------|--------------------------------------|------------|
| ** **                         | ** ** | **2004**                             | ** ** | **2003** | ** ** |
| ** **                         | ** ** | **(in thousands)**                   | ** ** |
|                               |       |                                 |       |   |   |
| Transaction and payment processing |       | $                                    | 65,004     |   | $ | 63,246 |   |
| Systems design and integration     |       | 14,601                               |       | 24,426 |   |
| Maintenance and support services   |       | 14,207                               |       | 12,694 |   |
| Product sales and other services   |       | 3,090                                |       | 1,604 |   |
| Total                              |       | $                                    | 96,902     |   | $ | 101,970 |   |

 

Net revenues from transaction and payment processingservices increased 2.8% to $65.0 million in the nine months ended June 30,2004 compared to $63.2 million in the nine months ended June 30, 2003primarily as a result of the $1.5 million increase in EPP net revenues.  Net revenues from systems design andintegration services decreased 40.2% to $14.6 million in the nine months endedJune 30, 2004 compared to $24.4 million in the nine months endedJune 30, 2003 primarily due to a $9.4 million reduction in revenues fromCalPERS as a result of the termination of the CalPERS contract.   Net revenues from maintenance and supportservices increased 11.9% to $14.2 million in the nine months endedJune 30, 2004 compared to $12.7 million in the nine months ended June 30,2003 primarily as a result of increased

 

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revenues of $2.0 million from our State of Missouri practice.   Net revenues from product sales and otherservices increased 92.8% to $3.1 million in the nine months ended June 30,2004 compared to $1.6 million in the nine months ended June 30, 2003primarily due to increased growth in new practice areas, including web portalservices revenues, of $915,000 and product sales revenues of $908,000 from EPOSboth during the nine months ended June 30, 2004.

 

Reimbursement and software license net revenues foreach period represented were less than 10% of total net revenues for therespective period.  Reimbursementrevenues may increase in absolute dollars in future periods if we aresuccessful in winning new contracts in our child support payment processingoperations.

 

*Direct Costs.*   Direct costs decreased 5.4% to $65.5 millionfor the nine months ended June 30, 2004 from $69.2 million for the ninemonths ended June 30, 2003.  Thisdecrease resulted primarily from the decrease in headcount as a result of therestructuring and the termination of the CalPERS contract.**Directcosts include $1.7 million of depreciation and amortization for the nine monthsended June 30, 2004 and $1.6 million for the nine months endedJune 30, 2003.

 

*Selling and Marketing.  *Selling and marketingexpenses increased 16.9% to $5.1 million for the nine months endedJune 30, 2004 from $4.4 million for the nine months ended June 30,2003.  As a percentage of net revenues,selling and marketing expenses increased to 5.3% for the nine months endedJune 30, 2004 from 4.3% for the nine months ended June 30, 2003.  The increase in selling and marketingexpenses for the nine months ended June 30, 2004 resulted primarily fromincreased advertising expenses for OPC. We expect selling and marketing expenses for fiscal year 2004 toincrease in absolute dollars compared to fiscal year 2003 as a result of ourinvestment in business development.  Weexpect sales and marketing expenses to fluctuate from quarter to quarter due toitems such as increased advertising and marketing expense for the April 15thfederal tax season.

 

*General and Administrative.*   General and administrative expensesincreased 15.2% to $19.5 million for the nine months ended June 30, 2004from $17.0 million for the nine months ended June 30, 2003. As apercentage of net revenues, general and administrative expenses increased to20.2% for the nine months ended June 30, 2004 from 16.6% for the ninemonths ended June 30, 2003. The increase in general and administrativeexpenses resulted primarily from $1.3 million in legal and other costs incurredrelated to the terminated CalPERS contract and the shareholder lawsuits thatwere dismissed in December 2003 and March 2004. We expect general and administrative expenses will increase in absolutedollars for fiscal year 2004 compared to fiscal year 2003 as a result of thelegal cost and costs to comply with the Sarbanes-Oxley Act.

 

*Restructuringcharges. *The following table presents the restructuringcharges for the nine months ended June 30, 2004 and 2003:

 

| ** **                                         | ** ** | **Nine months ended  June 30,** | ** ** |
|----------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                         | ** ** | **2004**                             | ** ** | **2003** | ** ** |
| ** **                                         | ** ** | **(in thousands)**                   | ** ** |
|                                               |       |                                 |       |   |   |
| Assets impairment charge                           |       | $                                    | 571        |   | $ | — |   |
| Severance charge resulting from restructuring      |       | 1,461                                |       | — |   |
| Office closure charge resulting from restructuring |       | 1,076                                |       | — |   |
| Total                                              |       | $                                    | 3,108      |   | $ | — |   |

 

During the nine months ended June 30, 2004, werecorded asset impairment charges of $571,000 resulting from assets written offdue to the closure of two offices.   Theseverance charge of $1.5 million represented severance costs resulting from thesigning of a termination agreement with our former chief executive officerincluding a charge due to the modification of his stock options based on theprice of our Class B common stock on April 1, 2004.  The office closure charge of $1.1 millionrepresented costs incurred for the closure of two offices (net of estimatedsublease income of $1.5 million).  Wealso expect to incur in the three months ending September 30, 2004,additional restructuring charges totaling approximately $385,000 in connectionwith the office consolidation in severance payments for employees who did notrelocate to the Reston office.

 

*Depreciation and Amortization.*   Depreciation and amortization decreased15.5% to $3.4 million for the nine months ended June 30, 2004 from $4.0million for the nine months ended June 30, 2003. As a percentage of netrevenues, depreciation and amortization decreased to 3.5% for the nine monthsended June 30, 2004 from 3.9% for the nine months ended June 30,2003.  The decrease in depreciation andamortization resulted primarily from

 

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decreased capital expenditures in the first six months of the fiscalyear and assets that became fully depreciated or amortized.

 

*Interest Income (Expense), Net.*   Net interest income decreased 5.3% to$875,000 for the nine months ended June 30, 2004 compared to net interestincome of $924,000 for the nine months ended June 30, 2003.  This decrease was primarily attributable tolower investment balances and lower interest rates during the first six monthsof the current year.

 

*Provision for Income Taxes.* The provision for income taxes was $105,000for the nine months ended June 30, 2004 and $3.1 million for the ninemonths ended June 30, 2003.  Theprovision for income taxes for the nine months ended June 30, 2004represents the expected minimum state tax payments.  No tax benefit on the net loss for the ninemonths ended June 30, 2004 was recorded due to the full valuationallowance on our net deferred tax assets. Our effective tax rate was 37.8% for the nine months ended June 30,2003.  The effective tax rate in the upcomingquarters and for the year ending September 30, 2004 may vary due to avariety of factors, including, but not limited to, the relative incomecontribution by tax jurisdiction, changes in statutory tax rates, the amount oftax exempt interest income generated during the year, the ability to utilizeforeign tax credits and foreign net operating losses, and any non-deductibleitems related to acquisitions or other nonrecurring charges. We will continueto monitor the effective tax rate on a quarterly basis.

 

*Discontinuedoperations.*   The loss from discontinued operations, netof income taxes was $1.4 million for the nine months ended June 30, 2004and 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 discontinuedoperations, net of income taxes was $258,000 for the nine months endedJune 30, 2003 and represents the historical results of operations of thediscontinued segments.

 

**Liquidity and Capital Resources**

 

Our principal capital requirement is to fund workingcapital to support our growth, including potential future acquisitions andpotential contingent payments due to prior acquisitions.  We maintain a $15.0 million revolving creditfacility that expires on January 31, 2005, of which $15.0 million may beused for letters of credit.  The creditfacility bears interest at the adjusted LIBOR rate plus 2.25% or the lender’sannounced prime rate at our option. As of June 30, 2004, there wasapproximately $985,000 of standby letters of credit outstanding under thisfacility.  The credit facility iscollateralized by first priority liens and security interests in our assets.The credit facility contains certain restrictive covenants including, but notlimited to, limitations on the amount of loans we may extend to officers andemployees, the payment of dividends, the repurchase of common stock and theincurrence of additional debt.  Thecredit facility requires the maintenance of certain financial covenants, includinga minimum quarterly net income requirement, minimum tangible net worth, aminimum ratio of debt to tangible net worth and a minimum ratio of liquidassets to current liabilities.  As ofJune 30, 2004, we were in compliance with all the covenants of the creditfacility.

 

In April 2004, we issued a letter of credit inthe amount of $935,000, which was used to guarantee the performance bond of athird party required by a project contract that is anticipated to be completedin August 2005.  In conjunction withthis guarantee, we entered into an indemnification agreement with the thirdparty which pledges to hold harmless, indemnify and make us whole from andagainst any and all amounts actually claimed or withdrawn and other businessrelated consideration.  In accordancewith FIN 45, we recorded a liability for the fair value of $935,000 in accruedliabilities and an equal receivable in prepaid expenses and other currentassets.  The recorded amounts will beeliminated if we are released from the risk upon expiration or settlement ofthe obligation.

 

In addition to the letters of credit issued under thecredit facility mentioned above, we had letters of credit totalingapproximately $3,151,000, which were collateralized by certain securities inour long-term investment portfolio at June 30, 2004.  Furthermore, OPC had a letter of creditoutstanding in the amount of approximately $138,000 secured by a certificate ofdeposit.  The majority of these lettersof credit were issued to secure performance bonds and to meet various facilitylease requirements.

 

Net cash from continuing operations provided byoperating activities was $19.6 million and $4.5 million in the nine monthsended June 30, 2004 and 2003, respectively. The increase in net cash fromcontinuing operations

 

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provided by operating activities is largely attributable to the receiptof approximately $7.0 million of income tax refunds and increased accountsreceivable collections partially offset by a decrease in deferred revenue.

 

Net cash from continuing operations used in investingactivities was $14.8 million and $2.7 million in the nine months endedJune 30, 2004 and 2003, respectively. The increase in net cash fromcontinuing operations used in investing activities is primarily attributable toour purchase of EPOS effective June 1, 2004.

 

Capital expenditures, including equipment and softwareacquired under financing arrangements but excluding assets acquired or leasedthrough business combinations, were approximately $2.6 million in the ninemonths ended June 30, 2004 and $1.5 million in the nine months endedJune 30, 2003.  We anticipate thatin fiscal year 2004, we will have increased capital expenditures compared tofiscal year 2003 resulting from among other things, purchases of computerequipment to enhance our operations and support our growth, expendituresrelated to new office leases and the purchase of software from PublicBuy.net,LLC for approximately $1.2 million in the nine months ended June 30, 2004.

 

Net cash from continuing operations provided byfinancing activities totaled $1.7 million in the nine months endedJune 30, 2004 as compared to net cash used in financing activities of $5.7million in the nine months ended June 30, 2003.  The net cash from continuing operationsprovided by financing activities for the nine months ended June 30, 2004resulted primarily from the exercise of employee stock options.  The net cash used in financing activities forthe nine months ended June 30, 2003 resulted primarily from the repurchaseof shares of our Class B common stock.

 

We expect to generate cash flows from operatingactivities over the long-term; however, we may experience significantfluctuations from quarter to quarter resulting from the timing of the billingand collection of large project milestones, particularly for our pensionsoftware systems projects.  We anticipatethat our existing capital resources, including our cash balances, cash that weanticipate will be provided by operating activities and our available creditfacility will be adequate to fund our operations for at least the next 12months. There can be no assurance that changes will not occur that wouldconsume 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; remaining legal costsincurred arising out of our formal dispute with CalPERS; the timing and abilityto sell investment securities held in our portfolio without a loss ofprincipal; our ability to draw on our bank facility and employee growth.  To the extent that our existing capitalresources are insufficient to meet our capital requirements, we will have toraise additional funds. There can be no assurance that additional funding, ifnecessary, will be available on favorable terms, if at all.  The raising of additional capital may diluteour shareholders’ ownership in us.

 

**During the fourth quarter of fiscal 2003, weinitiated a strategic review of our business units.  This review was completed in the fourth quarterof fiscal year 2003, and we decided to renew our focus on our core GovernmentServices 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. This restructuring charge was comprised of $18.2 million of goodwill,intangible and tangible asset impairment charges, $882,000 related to theclosure of several offices (net of estimated sublease income of $115,000) and$707,000 of severance related to the termination of employees in the exitedbusinesses, of which $529,000 was paid in fiscal year 2003.  The restructuring plan included thetermination of approximately 50 employees, of which approximately 20 employeeswere terminated in the three months ended September 30, 2003 and theremaining employees were terminated in the three months ended December 31,2003. Additional goodwill and intangible asset impairment charges ofapproximately $1.3 million were incurred for the nine months endedJune 30, 2004, of which approximately $571,000 was included inrestructuring charges and approximately $752,000 was included in loss fromdiscontinued operations.  Additional severanceof $2.3 million, of which approximately $1.5 million resulted from the signingof a termination agreement with our former chief executive officer, wasincluded in restructuring and other charges and approximately $830,000 wasincluded in loss from discontinued operations. Also included in restructuring charges for the nine months endedJune 30, 2004 was $1.1 million related to estimated closure costs for oneadditional office and the consolidation of our Walnut Creek, California andReston, Virginia offices (net of estimated sublease income of $1.5million).  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 of the acquisition of OPC inJuly 2002, we assumed certain liabilities for restructuring costs that OPChad previously recognized in connection with the involuntary termination ofemployees of $2.7 million and the**

 

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**consolidation of facilities of $546,000 (net ofestimated sublease income of $295,000). The assumed severance liabilityincluded severance for 27 individuals and the closing of certain office space.**

** **

**During the nine months ended June 30, 2004, wemade restructuring cost cash payments of $1.8 million for severance and$519,000 for facilities.**

** **

In June 2004, we completed the consolidation ofour Walnut Creek, California and Reston, Virginia offices.  As part of the office consolidation, werelocated the accounting, financial planning, information technology, legal,human resources and facilities corporate functions to the Reston office andclosed the Walnut Creek office.  Webelieve that the office consolidation will improve the efficiency of our workforce,reduce our cost structure, assist in developing a consistent corporate cultureand streamline the overall back office operations.  As anticipated, some members of the staffformerly resident in Walnut Creek relocated to the Reston office as part of theoffice consolidation. We estimate that we will incur a one-time restructuringand other related pre-tax charges of $2.8 million in connection with the officeconsolidation. The estimated charges are comprised of approximately $385,000 inseverance payments for employees who do not relocate to the Reston office, $1.3million in asset impairment charges and facility closure costs, net ofestimated sublease income of $1.5 million, and approximately $1.1 million inother charges related to the office consolidation.  We recorded approximately $1.6 million (netof estimated sublease income of $1.5 million) of these charges in the threemonths ended June 30, 2004 comprised of $436,000 in asset impairmentcharges, $854,000 in facility closure costs and $262,000 in other chargesrelated to the office consolidation.  Weexpect the remaining charges to be recorded in the three months endingSeptember 30, 2004.

 

**Due to the current economic climate, the performancebond market has substantially changed, resulting in reduced availability ofbonds, increased cash collateral requirements and increased premiums.  Some of our government contracts require aperformance bond and future requests for proposal may also require aperformance bond.  Our inability toobtain performance bonds, increased costs to obtain such bonds or a requirementto pledge significant cash collateral in order to obtain such bonds wouldadversely affect our business and our capacity to obtain additionalcontracts.  Increased premiums or a claimmade against a performance bond could adversely affect our earnings and cashflow and impair our ability to bid for future contracts.**

 

**Disclosures About ContractualObligations and Commercial Commitments as of June 30, 2004**

 

As of June 30, 2004, we had not entered into anyderivative transactions and we had the following obligations and commitments tomake future payments under contracts, contractual obligations and commercialcommitments (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         |       | $                          | 261        |   | $ | 140 |   | $ | 121 |   | $ | — |   | $ | — |   |
| Operating leases                 |       | 11,162                     |       | 3,665 |   | 4,132 |   | 2,609 |   | 756 |   |
| Restructuring liability          |       | 2,772                      |       | 1,598 |   | 936 |   | 238 |   | — |   |
| Total                            |       | $                          | 14,195     |   | $ | 5,403 |   | $ | 5,189 |   | $ | 2,847 |   | $ | 756 |   |

 
| ** **                       | ** ** | **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        |       | $                                              | 4,274      |   | $ | 138 |   | $ | 4,086 |   | $ | — |   | $ | 50 |   |
| Performance bonds                |       | 34,885                                         |       | 32,719 |   | 2,166 |   | — |   | — |   |
| Total                            |       | $                                              | 39,159     |   | $ | 32,857 |   | $ | 6,252 |   | $ | — |   | $ | 50 |   |

 

**Factors That May Affect Future Results**

 

The following factors and other risk factors couldcause our actual results to differ materially from those contained in forward-lookingstatements in this Form 10-Q.

 

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**Our quarterly net revenues, operating results andcash flows are volatile, may fluctuate significantly from quarter to quarterand may be difficult to forecast, which may cause the market price of ourClass B common stock to decline.**

 

Our net revenues, operating results and cash flows aresubject to significant variation from quarter to quarter due to a number offactors, many of which are outside our control. Among other things, these factors 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 our EPP segment payment processing 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 andreal estate and personal property tax payments may be made annually orsemi-annually in many 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;

 

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

 

•                  legal expensesincurred in complying with the DOJ investigation and our disputes with CalPERS;

 

•                  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;

 

•                  the integrationof acquisitions, including EPOS, without disruption to our other businessactivities; and

 

•                  estimates madefor restructuring liabilities.

 

The timing and realization of opportunities in oursales pipeline make the timing and variability of net revenues difficult toforecast. A high percentage of our operating expenses, particularly personnel,facility and depreciation and amortization, are relatively fixed in advance.Because of the variability of our quarterly operating results, we believe thatperiod-to-period comparisons of our operating results are not necessarilymeaningful, should not be relied upon as indications of future performance andmay result in volatility and declines in the price of our Class B commonstock. In

 

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addition, our operating results may from time to time fall below theexpectations of analysts and investors. If so, the market price of ourClass B common stock may decline significantly.

 

As discussed in Note 6 to our Condensed ConsolidatedFinancial Statements, we adopted SFAS 142 as of October 1, 2002.  This standard requires that goodwill nolonger be amortized, and instead, be tested for impairment on a periodicbasis.  Impairment tests involve the useof estimates related to the fair market value of the business operations with whichgoodwill is associated.  If we do notmeet our long-term forecasts, or if the trading price of our Class B commonstock does not improve, we could be required to record impairment chargesrelated to goodwill and other intangible assets, which could adversely affectour financial results. During the fourth quarter of fiscal year 2003, wedecided to shut down our U.S. Commercial Services segment and our UnitedKingdom Operations segment and accordingly recorded a restructuring charge towrite-off substantially all of the associated goodwill totaling $17.6million.  In the fourth quarter of fiscalyear 2003, we performed our annual impairment test to determine if theremaining goodwill associated with our remaining segments was impaired. Theresults did not indicate any impairment loss. In addition, other acquired intangible assets are tested for impairmentwhenever an event or circumstance indicates the carrying value of otheracquired intangible assets may not be recoverable.  As of June 30, 2004, there have been noevents or circumstances that indicate any additional impairment.  At June 30, 2004, we had goodwill of$43.1 million and other intangibles of $29.7 million.  Any resulting impairment loss could have amaterial adverse impact on our financial condition and results of operations.

 

**We rely on small numbers ofprojects, customers and target markets for significant portions of our netrevenues, and our operating results and cash flows may decline significantly ifwe cannot keep or replace these projects or clients or if conditions in ourtarget markets deteriorate.**

** **

We have derived, and believethat we will continue to derive, a significant portion of our net revenues froma limited number of clients. The completion or cancellation of a large projector a significant reduction in its scope would significantly reduce our netrevenues and cash flows. Most of our contracts are terminable by the clientfollowing limited notice and without significant penalty to the client. If anyof our large clients or prime contractors terminates its relationship with us,we will lose a significant portion of our net revenues and cash flows. In thefourth fiscal quarter of fiscal year 2003, CalPERS terminated our systemsintegration contract, and as a result we recorded an adjustment to revenue ofapproximately $12.8 million to write down the total value of our unbilledreceivable from CalPERS.

 

For the nine months endedJune 30, 2004, our top ten clients represented 59.8% of our total netrevenues and the Internal Revenue Service (“IRS”) contract accounted for 13.7%of our total net revenues. Revenues from federal taxpayers accounted for 41.0%of OPC’s net revenues.  The existingcontract with the IRS allows the IRS to terminate OPC’s services at any timefor any or no reason. Even though our net revenues are not funded by the IRS,the loss of the IRS as a client, or a decrease in IRS-related transactionsbecause of increased competition from another IRS-authorized service provider,would result in a reduction in our net revenues and cash flows.

 

During the nine months endedJune 30, 2004, we performed services for three different state governmentsas a subcontractor to ACS accounting for 12.2% of total net revenues.  In June 2004, we were notified by ACS ofits decision not to renew our subcontract on its Ohio child support contracteffective June 30, 2004.  For thenine months ended June 30, 2004, the revenues from the Ohio subcontractaccounted for approximately 5.6% of total revenues. The volume of workperformed for specific clients or prime contractors is likely to vary fromperiod to period, and a client or prime contractor in one period may not useour services in a subsequent period.  Wecannot predict if ACS’s decision will affect the other two subcontracts underour existing relationship with ACS or the future revenue associated with thosesubcontracts.  The remaining twosubcontracts have base contract renewal dates of June 30, 2006 and May 31,2007.  The loss of revenues from thosesubcontracts could adversely affect future operating results and cash flows.

 

As a result of our focus inspecific markets, economic and other conditions that affect the companies andgovernment agencies in these markets could also result in a reduction in ournet revenues and cash flows. Because we derive a significant portion of our netrevenues from a limited number of clients, we have several large accountsreceivable and unbilled receivable balances. At June 30, 2004, unbilledreceivables for two clients accounted for 52.6% and 35.6% of total unbilledreceivables. At June 30, 2004, total accounts receivable and unbilledreceivables, for these two clients accounted for 8.4% and 23.7%, respectively,of total net accounts receivable and unbilled receivables. Any dispute, earlycontract termination or other collection issues could have a material adverseimpact on our financial condition and results of operations. The imposition ofsignificant penalties for our failure to meet scheduled delivery requirementscould also have a material adverse effect on us.

 

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**Our operating results may be adversely affected ifwe fail to accurately estimate the resources necessary to meet our obligationsunder fixed price contracts or the volume of transactions or transactiondollars processed under our transaction-based contracts.**

 

Underestimating the resources, costs or time requiredfor a fixed price project or a transaction-based contract or overestimating theexpected volume of transactions or transaction dollars processed under atransaction-based contract would cause our costs under fixed price contracts tobe greater than expected and our fees under transaction-based contracts to beless than expected, and our related profit, if any, to be less. Under fixedprice contracts, we generally receive our fee if we meet specified deliverablessuch as completing certain components of a system installation. Fortransaction-based contracts, we receive our fee on a per-transaction basis oras a percentage of dollars processed, such as the number of child supportpayments processed or tax dollars processed. To earn a profit on thesecontracts, we rely upon accurately estimating costs involved and assessing theprobability of meeting the specified objectives or realizing the expectednumber or average dollar amounts of transactions within the contracted timeperiod. A failure by a client to adequately disclose in their request forproposal their existing systems, current interfaces, complete functionalrequirements and historical payment and transaction volumes could result in ourunderestimating the work required to complete a project.  If we fail to estimate accurately the factorsupon which we base our contract pricing, or we are unable to successfullyobtain change orders, we may incur losses on those contracts or be unable tocomplete our performance obligations. During the quarter ended June 30, 2004, 17.8% of our netrevenues were generated on a fixed price basis and 64.4% of our net revenueswere generated from transaction-based contracts. We believe that the percentageof net revenues attributable to fixed price and transaction-based contractswill continue to be significant for the foreseeable future.

 

**A decline in the economicclimate could adversely affect our net revenues and cash flows.**

** **

There are some parts of our business that experienceincreasing pricing pressures from competitors as well as from clients facingpressure to control costs.  We continueto see clients reduce or defer their expenditures or defer the start of workalready contracted.  Some of ourcompetitors are capable of operating at significant losses for extended periodsof time, increasing pricing pressure on our products and services.  If we do not maintain competitive pricing,the demand for our products and services, as well as our market share, maydecline, having an adverse effect on our business.  From time to time, in responding tocompetitive pressures, we lower the prices of our products and services.  If we are unable to reduce our costs orimprove operating efficiencies when we offer such lower prices, our netrevenues and margins will be adversely affected.

 

OPC’s net revenues are generated primarily based onconvenience fees charged as a percentage of dollars processed for income taxesand other payments.  Income taxes aredependent on the amount of income earned by taxpaying citizens and theprevailing tax rates.  A decline ineconomic conditions could reduce the per capita income of citizens, and thusreduce the amount of income tax payments consumers remit to governmententities, which may reduce OPC’s revenues from convenience fees.  A reduction in income tax rates may alsoreduce the amount of income tax payments consumers remit to governmententities, which may reduce OPC’s revenues from convenience fees. In addition, adecline in the economy may result in a reduction in consumer spending,particularly for non-essential goods and services, which may result in areduction in consumers’ use of OPC’s services. If the economy declines, our results of operations and cash flows couldbe 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 nine months ended**June 30, 2004, approximately 33.6% of our net revenueswere derived from federally mandated and primarily federally funded childsupport transaction processing services fees and approximately 33.5% of our netrevenues were derived from convenience fees earned by our EPP segment withrespect to payments made by constituents primarily to government agencies.  The balance of our net revenues was derivedfrom other services provided to government agencies.  Some of these net revenues, particularly ourFMS and State of Missouri contracts, may be subject to state and localgovernment agency spending fluctuations. These government agencies may besubject to budget cuts, budgetary constraints, a reduction or discontinuationof funding or changes in the political or regulatory environment that may causegovernment agencies to terminate projects, divert funds or delayimplementation. 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 funds available for government agencies topurchase professional services or business solutions would significantly reduceour net revenues and cash flows. The loss of a

 

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**major government client, or any significantreduction or delay in orders by that client, would also significantly reduceour net revenues and cash flows. Additionally, government contracts aregenerally subject to audits and investigations by government agencies.  If the results of these audits orinvestigations are negative, our reputation could be damaged, contracts couldbe terminated or significant penalties could be assessed.  If a contract is terminated for any reason,our ability to fully recover certain amounts may be impaired resulting in amaterial adverse impact on our financial condition and results of operations.**

** **

**Because OPC’s business model iscontinuing to evolve, it is difficult to evaluate OPC’s business.**

 

At the end of July 2002, we acquired OPC, whichhas a history of losses. Although OPC has cumulatively increased revenues sincethe acquisition and has reduced certain operating expenses as we integratedthis acquisition, there can be no assurance that OPC will attain and maintainprofitability in the future.

 

The use of credit and debit cards and electronicchecks to make payments to government agencies is still relatively new andevolving.  To date, OPC’s business hasconsisted primarily of providing credit and debit card payment options for thepayment of federal and state personal income taxes, real estate and personalproperty taxes, business taxes and fines for traffic violations and parkingcitations.  Payment by electronic checkis an additional payment option that OPC has implemented for electronictransactions.  Because OPC has only alimited operating history under our management, it is difficult to evaluate itsbusiness and prospects and the risks, expenses and difficulties that we mayface in implementing OPC’s business model. OPC’s business model is based onconsumers’ willingness to pay a convenience fee (in addition to their requiredgovernment or other payment) for the use of OPC’s credit or debit card andelectronic check payment option.  Oursuccess with respect to OPC will depend on maintaining OPC’s relationship withthe IRS and on maintaining existing, and developing additional relationshipswith state and local government agencies, especially state taxing authorities,and their respective constituents.  Therecan be no assurances that we will be able to develop new OPC relationships ormaintain existing OPC relationships, and the failure to do so could have amaterial and adverse effect on our business, operating results and financialcondition.  In addition, if consumers arenot receptive to paying a convenience fee, if card associations change theirrules and do not allow us to charge the convenience fees, or if credit or debitcard issuers eliminate or reduce the value of rewards obtained under theirrespective rewards programs, demand for OPC’s services will decline or fail togrow, which would have a material and adverse effect on our business, operatingresults and financial condition. OPC is charged processing fees by itscredit/debit card partners and financial institutions for processing payments.The processing fees OPC is charged can be changed with little or no notice. Anyincrease in the fees charged to OPC may have a material adverse impact on ourbusiness, operating results and financial conditions.

 

Currently, OPC processes credit and debit cardpayments on behalf of VISA issuing banks for certain tax payments under a VISAtax pilot program that was created in March 2002.  The tax pilot program is scheduled to end inDecember 2004.  If VISA does notextend the tax pilot program or make it a permanent program, OPC would belimited in its ability to accept VISA cards and this limitation could have amaterial adverse impact on our financial condition and results of operations.

 

Demand for OPC’s services would also be adverselyimpacted by a decline in the use of the Internet.  Factors that could reduce the level ofInternet usage or electronic commerce include the actual or perceived lack ofsecurity or privacy of information, traffic congestion or other Internet accessdelays, excessive government regulation, increases in access costs, or theunavailability of cost-effective high speed service.

 

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**An investigation involvingthe child support payment processing industry may negatively affect ourbusiness and operating results.**

** **

In June 2003, we announced that we had received asubpoena from a grand jury in the Southern District of New York to producecertain documents pursuant to an investigation involving the child supportpayment processing industry by the Antitrust Division of the DOJ. We have fullycooperated, and intend to continue to cooperate fully, with the subpoena andwith the DOJ’s investigation. On November 20, 2003, the DOJ granted usconditional amnesty pursuant to the Antitrust Division’s Corporate LeniencyPolicy. Consequently, the DOJ will not bring any criminal charges against usand 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 the nine months ended June 30, 2004, weincurred approximately $456,000 of legal costs to comply with the subpoenawhich includes cost of approximately $211,000 incurred under directors andofficers indemnification agreements, partially offset by a claim paymentreceived from our insurance carrier for approximately $227,000.  We anticipate that we will incur up to anadditional $300,000 in the remainder of fiscal year 2004 as we continue tocooperate 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 frequently join with other organizations to bid andperform an engagement.  In theseengagements, we may engage subcontractors or we may act as a subcontractor tothe prime contractor of the engagement. We also use third party software ortechnology providers to jointly bid and perform engagements. Our ability toservice some of our clients depends to a large extent on our use of varioussoftware programs that we license from a small number of primary softwarevendors. In these situations, we depend on the software, resources andtechnology of these third parties in order to perform work under theengagement. Failure of third parties to meet their contractual obligations orother actions or failures attributable to these third parties or their productsor to the prime contractor or subcontractor could adversely impact a project,damage our reputation and adversely affect our ability to attract new business.In addition, the inability to negotiate terms of a contract with a third party,the refusal or inability of these third parties to permit continued use oftheir software, services or technology by us, our inability to gain access tosoftware that has been placed in escrow by third parties, or the discontinuanceor termination by the client or prime contractor of our services or theservices of a key subcontractor, would harm our operating results and thecompetitiveness of our products and services and may adversely affect ourability to serve new clients.  If we areunable to meet our contractual requirements with our clients, we could besubjected to claims by our clients.

 

**OPC relies on a third party co-location facility forits primary data center and utilizes third party processors to complete paymenttransactions.  Failure by these thirdparties to satisfactorily perform services may adversely affect our operatingresults and our reputation.**

** **

**We could become subject to other lawsuits thatcould result in material liabilities to us or cause us to incur material costs.**

 

Any failure in a client’s system or failure to meet amaterial deliverable could result in a claim against us for substantialdamages, regardless of our responsibility for such failure. We cannot guaranteethat the disclaimers, limitations of warranty, limitations of liability andother provisions set forth in our contracts will be enforceable or willotherwise protect us from liability for damages. Any claim by a shareholder orderivative action brought by a shareholder could result in a material liabilityto 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 assertionof one or more claims against us that exceed available insurance coverage orchanges in insurance policies, including premium increases or the imposition oflarge deductible or co-insurance requirements, would adversely affect ourbusiness.

 

**We have completed numerousacquisitions and may complete others, which could increase our costs or bedisruptive.**

** **

One component of our business strategy is to expandour presence in new or existing markets by acquiring additional businesses.From October 1, 2001 through June 30,2004, we acquired four businesses using cash and Class B

 

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common stock, with some of those acquisitions also involving assumedliabilities and contingent payments. Acquisitions involve a number of specialrisks, 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 additionalbusinesses or integrate successfully any acquired businesses withoutsubstantial expense, delay or other operational or financial problems. Withoutadditional acquisitions, we are unlikely to maintain historical growth rates.

 

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

 

The information technology, transaction processing andconsulting services markets are highly competitive and are served by numerousinternational, national and local firms. We may not be able to competeeffectively in these markets. Market participants include systems consultingand integration firms, including international consulting firms and relatedentities, the internal information systems groups of our prospective clients,professional services companies, hardware and application software vendors, anddivisions of large integrated technology companies and outsourcing companies.Many of these competitors have significantly greater financial, technical andmarketing resources, generate greater net revenues and have greater namerecognition than we do. In addition, there are relatively low barriers to entryinto the information technology and consulting services markets, and we havefaced, and expect to continue to face, additional competition from new entrantsinto the information technology and consulting services markets.

 

We believe that the principal competitive factors inthe information technology and consulting services markets include:

 

•                     reputation;

 

•                     project management expertise;

 

•                     industry expertise;

 

•                     speed of development andimplementations;

 

•                     technical expertise;

 

•                     competitive pricing; and

 

•                     the ability to deliver results ona fixed price basis, a transaction basis and a time and materials basis.

 

We believe that our ability to compete also depends inpart on a number of competitive factors outside our control, including:

 

•                     the ability of our clients orcompetitors to hire, retain and motivate project managers and other seniortechnical staff;

 

•                     the ownership by competitors ofsoftware used by potential clients;

 

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•                     the price at which others offercomparable services;

 

•                     the ability of our clients toperform the services themselves; and

 

•                     the extent of our competitors’responsiveness to client needs.

 

If we do not compete effectively on one or more ofthese competitive factors, our business and our ability to execute our businessstrategy will be impaired.

 

**Our failure to deliver error-free products andservices could result in reduced payments, significant financial liability oradditional costs to us, as well as negative publicity.**

 

Many of our engagements involve projects that arecritical to the operations of our clients’ businesses and provide benefits thatmay be difficult to quantify. The failure by us, or by third parties on anengagement in which we are a subcontractor, to meet a client’s expectations inthe performance of the engagement could damage our reputation and adverselyaffect our ability to attract new business. We have undertaken, and may in thefuture undertake, projects in which we guarantee performance based upon definedoperating specifications or guaranteed delivery dates. We also have undertaken,and may in the future undertake, projects that require us to obtain aperformance bond from a licensed surety and to post the performance bond withthe client. Unsatisfactory performance or unanticipated difficulties or delaysin completing 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.

 

Our EPP segment’s electronic payment services and ourchild support payment processing services are designed to provide paymentmanagement functions and, in the case of certain of our child support paymentprocessing contracts, serve to limit our clients’ risk of fraud or loss ineffecting transactions with their constituents. As electronic services become more critical to our clients, we may besubjected to claims or fines regarding our alleged liability for the processingof fraudulent or erroneous transactions. Our services depend on hardware,software and supporting infrastructure that is internally developed, purchasedand/or licensed from third parties. Although we conduct extensive testing, software may contain defects orprogramming errors, or may not properly interface with third party systems,particularly when first introduced or when new versions are released.  In addition, we may experience disruptions inservice from third-party providers. To the extent that defects or errors areundetected by us in the future or cannot be resolved satisfactorily or in atimely manner once detected, our business could suffer.  If one or more liability claims were broughtagainst us, even if unsuccessful, their defense would likely be time consuming,costly and potentially damaging to our reputation.  Any such liability or claim could have amaterial and adverse effect on our business, operating results and financialcondition.

 

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

 

We maintain insurance to cover a variety of differentbusiness risks including, but not limited to, errors and omissions, directorsand officers, general liability and workers’ compensation policies. There canbe no assurance that we can maintain the same scope and amount of insurancecoverage on reasonable terms or obtain such insurance at all.  Our inability to renew policies or maintainthe same level of coverage would adversely affect our business and increase ourrisk exposure.  Any claims against ourpolicies may impact our ability to obtain such insurance on reasonable terms,if at all.  Increased premiums or a claimmade against a policy could adversely affect our earnings and cash flow andimpair our ability to bid for future contracts.

 

We have undertaken, and may in the future undertake,projects that require us to obtain a performance bond from a licensed suretyand post the performance bond with the client. There can be no assurance that such performance bonds will continue tobe available on reasonable terms, if at all. Our inability to obtain performance bonds or a reduction in our bondingcapacity would adversely affect our business and our capacity to obtain additionalcontracts. Increased premiums or a claim made against a performance bond couldadversely affect our earnings and cash flow and limit our ability to bid forfuture contracts.

 

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

 

If we are unable to attract, retain, train, manage andmotivate skilled employees, particularly project managers and other seniortechnical personnel, our ability to adequately manage and staff our existingprojects and to bid for or obtain new projects could be impaired, which wouldadversely affect our business and its growth. The failure of our employees toachieve expected levels of performance could adversely affect our business.There is significant competition for employees with the skills required toperform the services we offer. In particular, qualified project managers andsenior technical and professional staff are in great demand worldwide. Inaddition, we require that many of our employees travel to client sites toperform services on our behalf, which may make a position with us lessattractive to potential employees. We may not be able to identify andsuccessfully recruit and integrate a sufficient number of skilled employeesinto our operations, which would harm our business and its growth. Our successalso depends upon the continued services of a number of key employees,including our chief executive officer and the leaders of our strategic businessunits. Any of our employees may terminate their employment at any time.

 

In June 2004, we completed the consolidation ofour offices in Walnut Creek, California and Reston, Virginia.  Some of the employees in our Walnut Creekoffice did not relocate to Reston and elected to terminate their employmentwith us as a result.  In addition, we mayface difficulties integrating employees from our Walnut Creek office and newlyhired employees into our Reston office. The loss of the services of any key employee could significantly disruptour operations. In addition, if one or more of our key employees resigns tojoin a competitor or to form a competing company, the loss of suchpersonnel and any resulting loss of existing or potential clients to any suchcompetitor could adversely affect our competitive position and operatingresults.

 

**Our Class B common stock price and tradingvolume have been and could continue to be volatile, which could result insubstantial losses for investors in our Class B common stock.**

 

Our Class B common stock price and trading volumehave been and could continue to be volatile. These price fluctuations may berapid and severe and may leave investors little time to react. Factors thataffect the market price of our Class 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 fiscal year2003 and the consolidation of the Walnut Creek and Reston offices during secondhalf of fiscal year 2004;

 

•                  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

 

•                  general economicand political conditions such as recessions and acts of war or terrorism.

 

Fluctuations in the price of our Class B common stock couldcontribute to investors losing all or part of 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 markets for products we provide are characterizedby rapid technological change, changes in client demands and evolving industrystandards.  As a result, our futuresuccess will continue to depend upon our ability to develop new products orproduct enhancements that address the future needs of our target markets and torespond to these changing standards and practices.  We may not be successful in developing,introducing and marketing new products or product enhancements on a timely andcost effective basis, or at all, and our new products and product enhancementsmay not adequately meet the requirements of the marketplace or achieve marketacceptance.  If we are unable, for technologicalor other reasons, to develop and introduce new products or enhancements ofexisting products in a timely manner in response to changing market conditionsor client requirements, or if new products or new versions of existing productsdo not achieve market acceptance, our business would be seriously harmed.  In addition, our ability to develop newproducts and product enhancements is dependent upon the products of othersoftware vendors.  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 those offeredby us may contain undetected defects or errors particularly when firstintroduced or as new versions are released. Although we have not experienced significant adverse effects resultingfrom software errors, we cannot be certain that, despite testing by us and ourclients, defects or

 

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errors will not be found in new products or enhancements after generalrelease, resulting in loss of or delay in market acceptance, which couldseriously harm our business.

 

**We could suffer material losses ifour systems or operations fail or are disrupted.**

 

Any system failure, including network, software orhardware failure or operations disruptions, whether caused by us, a third partyservice provider, unauthorized intruders and hackers, computer viruses, naturaldisasters, power shortage, capacity constraints, health epidemics or terroristattacks, could cause interruptions, delays in our business, loss of data ordamage to our reputation.  Any systemfailure in our EPP segment business, particularly during income tax season,could have a material adverse impact on our reputation, results of operationsand financial condition. In addition, if our mail, communications or utilitiesare disrupted or fail, our operations, including our child support transactionprocessing, could be suspended or interrupted, we could incur contractualpenalties and our business could be harmed. Our property insurance and businessinterruption insurance may not be adequate to compensate us for all losses thatmay occur as a result of any system or operational failure or disruption.

 

**If we fail to adapt ourbusiness to changes in economic or business conditions, our business may beadversely affected.**

** **

Personnel, facility and depreciation and amortizationexpenses represent a significant percentage of our operating expenses and arerelatively fixed in advance of any particular quarter. We manage our personnelutilization rates by carefully monitoring our needs and anticipating personnelincreases based on specific project requirements. To the extent net revenues donot increase at a rate commensurate with these additional expenses, our resultsof operations could be materially and adversely affected.  If we fail to align our operating expenseswith prevailing economic or business conditions, our operating results andfinancial condition could be adversely affected.

 

A constraint in our EPP segment’s capacity to processtransactions could impair the quality and availability of service.  Capacity constraints may cause unanticipatedsystem disruptions, impair quality and lower the level of service.  Although we believe that the EPP segment hassufficient capacity to accommodate anticipated future growth, there are noassurances that the EPP segment will not suffer capacity constraints caused bysharp increases in the use of its services. Due to the large number of tax payments made in March and April,there is an increased risk that the EPP segment will suffer a capacityconstraint during that period, which could have an adverse effect on ourbusiness, operating results and financial condition.

 

**If our EPP segment’s clients orcredit/debit card issuers cease to publicize our services or adversely changethe manner in which our services are promoted, consumer use of our services mayslow, and we may suffer a large increase in advertising costs.**

 

**Currently, our EPP segment’s clients and credit/debitcard issuers provide a significant portion of the publicity for our services,without any charge to us.  If clients orcredit/debit card issuers cease to publicize our services, or charge us forthis publicity, advertising costs will increase substantially, resulting in amaterial and adverse effect on our business, operating results and financialcondition. While the EPP segment endeavors in its client agreements to requiresuch clients to undertake such advertising activities, many of the clients andpayment card issuers have no obligation to continue to provide this publicity,and there are no assurances that they will continue to do so.  In addition, the clients may publicize otherservices, including those of competitors. For example, the IRS’s tax year 2002 Form 1040 instruction bookletlisted OPC’s name before a competitor’s name in regard to providers ofelectronic credit/debit card payment services, whereas for the 2003 tax yearOPC’s name was listed second.**

** **

**In addition, OPC advertises in conjunction with itscredit/debit card partners under co-operative advertising programs. If OPC’scredit/debit card partners fail to contribute to the co-operative advertisingprograms, OPC’s ability to advertise may be impacted.**

** **

**If we are unable toprotect our intellectual property and proprietary rights, our business could beadversely affected.**

** **

The steps we take to protect our intellectual propertyrights may be inadequate to avoid the loss or misappropriation of thatinformation, or to detect unauthorized use of such information. We rely on acombination of trade secrets, nondisclosure agreements, licensing agreementsand other contractual arrangements, and copyright and trademark laws to protectour intellectual property rights. We also enter into non-disclosure agreementswith our employees,

 

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subcontractors and the parties we team with for contracts and generallyrequire that our clients enter into such agreements. We also control and limitaccess to our proprietary information.

 

We have proprietary software that is licensed toclients pursuant to licensing agreements and other contractual arrangements. Weutilize intellectual property laws, including copyright and trademark laws, toprotect our proprietary rights. Issues relating to the ownership of, and rightsto use, software and application frameworks can be complicated, and there canbe no assurance that disputes will not arise that affect our ability to resellor reuse such software and application frameworks. A portion of our businessalso involves the development of software applications for specific clientengagements or the customization of an existing software product for a specificclient. Ownership of the developed software and the customizations to theexisting software are the subject of negotiation with each particular clientand is typically assigned to the client. We also develop software applicationframeworks and may retain ownership or marketing rights to these applicationframeworks, which may be adapted through further customization for futureclient projects. Some of our clients have prohibited us from marketing thesoftware and application frameworks developed specifically for them for aspecified period of time or to specified third parties, and others may demandsimilar or other restrictions in the future.

 

Infringement claims may be asserted against us in thefuture that may not be successfully defended. The loss or misappropriation ofour intellectual property or the unsuccessful defense of any claim ofinfringement could prevent or delay our providing our products and services,cause us to become liable for substantial damages, or force us to enter intoroyalty or licensing agreements.

 

**Compliance with changingregulation of corporate governance and public disclosure may result inadditional expenses.**

** **

**Changing laws, regulations and standards relating tocorporate governance and public disclosure, including the Sarbanes-Oxley Act of2002, new SEC regulations and Nasdaq Stock Market rules, are creatinguncertainty for companies such as ours. To maintain high standards of corporategovernance and public disclosure, we intend to invest all reasonably necessaryresources to comply with evolving standards. This investment may result in increased general and administrativeexpenses for outside services and a diversion of management time and attentionfrom revenue-generating activities.**

** **

**Control of our company by our formerchairman of the board could make it difficult for another company to acquire usand could depress the price of our Class B common stock.**

 

Concentration of voting control could have the effectof delaying or preventing a change in control of us and may affect the marketprice of our Class B common stock. The voting power held by Mr. James L. Bildner, our former chairman ofthe board and former chief executive officer, in Class A and Class Bcommon stock owned by Mr. Bildner and vested options to acquire Class Bcommon stock held by Mr. Bildner represented 13.8% of our total commonstock voting power outstanding at June 30, 2004. As a result,Mr. Bildner may be able to control the outcome of all corporate actionsrequiring shareholder approval, including changes in our equity incentive plan,the election of a majority of our directors, proxy contests, mergers, tenderoffers, or other transactions that could give holders of our Class Bcommon stock the opportunity to realize a premium over the then-prevailingmarket price for their shares of Class B common stock.

 

**Our issuance of preferredstock could make it difficult for another company to acquire us, which coulddepress the price of our Class B common stock.**

** **

**Our board of directors has the authority to issuepreferred stock and to determine the preferences, limitations and relativerights of shares of preferred stock and to fix the number of sharesconstituting any series and the designation of such series, without any furthervote or action by our shareholders. The preferred stock could be issued withvoting, liquidation, dividend and other rights superior to the rights of ourClass B common stock. The potential issuance of preferred stock may delayor prevent a change in control of us, discourage bids for the Class Bcommon stock at a premium over the market price and adversely affect the marketprice and the voting and other rights of the holders of our Class B commonstock.**

 

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**ITEM 3****.   QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

 

Market risk represents the risk of loss that mayimpact our financial position, results of operations or cash flows due toadverse changes in market prices and rates. We are exposed to market riskbecause of changes in foreign currency exchange rates as measured against theU.S. dollar and currencies used by our discontinued operation in the UnitedKingdom.

 

###### **Foreign currency exchange rate risk**

###### ** **

We have conducted operations in the United Kingdomthrough a U.S.-incorporated subsidiary. Net revenues from these operations havebeen typically denominated in British Pounds and Euros and are included in netincome (loss) from discontinued operations for the nine months endedJune 30, 2004 and 2003. Near-term changes in 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 inthe United Kingdom.  We have not engagedin foreign currency hedging transactions during the nine months endedJune 30, 2004. There can be no assurance that a sudden and significantdecline in the value of the British Pound or Euro would not have a materialadverse effect on our financial condition and results of operations.

 

**Interestrate sensitivity**

 

We maintain a portfolio of cash equivalents andinvestments in a variety of securities, including certificates of deposit,money market funds and government and non-government debt securities. Theseavailable-for-sale securities are subject to interest rate risk and may fall invalue if market interest rates increase. If market interest rates increaseimmediately and uniformly by 10 percentage points from levels at June 30,2004, the fair value of the portfolio would decline by $2.6 million.  We anticipate having the ability to hold ourfixed income investments until maturity, and therefore do not expect ouroperating results or cash flows to be affected to any significant degree by theeffect of a sudden change in market interest rates on our securities portfolio.

 

**ITEM 4****.   CONTROLS AND PROCEDURES**

 

Our chief executive officer and chief financialofficer performed an evaluation of our disclosure controls and procedures (asdefined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of1934, as amended (the “Exchange Act”)) as of the end of the period covered bythis report.  Based on the evaluation,the chief executive officer and chief financial officer concluded that ourdisclosure controls and procedures were effective and sufficient as of the endof the period covered by this report to ensure that the information required tobe disclosed in the reports that we file under the Exchange Act is recorded,processed, summarized, and reported within the time periods specified in theSEC’s rules and forms.

 

There were no significantchanges in our internal control over financial reporting during the quarterended June 30, 2004.  We are notaware of any significant change in any other factors that significantlyaffected our internal control over financial reporting during the quarter endedJune 30, 2004.

 

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

 

**ITEM 1.   LEGAL PROCEEDINGS**

 

In June 2003, we announced that we had received asubpoena from a grand jury in the Southern District of New York to producecertain documents pursuant to an investigation involving the child supportpayment processing industry by the Antitrust Division of the DOJ.  We have fully cooperated, and intend tocontinue 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 theAntitrust Division’s Corporate Leniency Policy. Consequently, the DOJ will not bring any criminal charges against theCompany and our officers, directors and employees, as long as we continue tocomply with the Corporate Leniency Policy, which requires, among other things,our full cooperation in the investigation and restitution payments if it isdetermined that parties were injured as a result of impermissible anti-competitiveconduct. We have not recorded any liability for such payments as any liabilityis not probable or estimable at this time. During fiscal year 2003, we incurredapproximately $1.3 million of legal costs to comply with the investigation,which includes approximately $305,000 paid under officers and directorsindemnification agreements.  During thenine months ended June 30, 2004, we incurred approximately $456,000 oflegal costs to comply with the subpoena which included costs of approximately$211,000 incurred under indemnification agreements partially offset by a claimpayment received from our insurance carrier for approximately $227,000.  We expect to incur cost of up to anadditional $300,000 during the remainder of fiscal year 2004.

 

In November 2003, we filed a lawsuit inCalifornia Superior Court, Sacramento County, *TierTechnologies, Inc. v State of California, through its agency, California PublicEmployees Retirement System, C.A. No. 03AS06220*, to overturnCalPERS’ decision to terminate the contract relating to our systems integrationproject for CalPERS for default and to recover added costs associated with thatproject.  We sought to recover damagesand project delay, disruption and interference costs on the project.   CalPERS filed a cross-complaint against usand made a claim against our performance bond for this contract.  On August 4, 2004, we reached agreementwith CalPERS in a judicially supervised settlement conference before theSacramento Superior Court wherein CalPERS withdrew the termination for defaultand the parties rescinded the contract. The parties also released each other from any and all claims arising outof the contract.  The parties are in theprocess of preparing a written settlement agreement.  We expect to incur costs of approximately$325,000 in the remainder of the fiscal year related to this matter.

 

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**ITEM 6.   EXHIBITS AND REPORTS ON FORM 8-K**

 

(a)          *Exhibits.*

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                                                                                                                  |
|---------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **          | ** ** | ** **                                                                                                                                                                                                       |
| 10.42               |       | Pledge Agreement between the Company and James L.  Bildner, dated April 1, 2004.                                                                                                                            |
|                |       |                                                                                                                                                                                                             |
| 10.43               |       | First Amendment to the Pledge Agreement between the  Company and James L. Bildner, dated June 14, 2004.                                                                                                     |
|                |       |                                                                                                                                                                                                             |
| 10.44               |       | First Amendment to the Second Amended and Restated  Pledge Agreement between the Company and James L. Bildner, dated  June 14, 2004.                                                                        |
|                |       |                                                                                                                                                                                                             |
| 10.45               |       | First Amendment to the Third Amended and Restated  Pledge Agreement between the Company and James L. Bildner, dated  June 14, 2004.                                                                         |
|                |       |                                                                                                                                                                                                             |
| 10.46               |       | Agreement and Plan of Merger among the Company,  Baker Acquisition Corporation, EPOS Corporation, the individuals named  herein, and Michael A. Lawler, as Shareholder Representative, dated  June 1, 2004. |
|                |       |                                                                                                                                                                                                             |
| 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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(b) *Reports on Form 8-K.*

 

Current Report on Form 8-K, furnished April 30,2004, pursuant to Items 7 and 12. Reference is made to the press release of the Company issuedApril 29, 2004, announcing the Company’s financial results for the quarterended March 31, 2004.

 

Current Report on Form 8-K, filed on June 4,2004, pursuant to Item 5.  Reference ismade to the press release of the Company issued June 1, 2004 announcingthat the Company had signed an agreement to acquire all of the issued andoutstanding shares of EPOS Corporation, an Alabama company.

 

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**SIGNATURE**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 
|                        | TIER TECHNOLOGIES, INC. |
|-----------------------------|-------------------------|
|                        |                    |
| Dated: August 16, 2004 |                    |
|                        |                    |
|                        |                    |
|                        | By:                     | /s/ Jeffrey A. McCandless |   |
|                        |                    | **Jeffrey A. McCandless** | ** ** |
|                        |                    | **Chief Financial Officer** |   |
|                        |                    | **(Principal Financial and Accounting Officer)** |   |
|                             |                         |  |  |  |

 

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