**UNITEDSTATESSECURITIES 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** |
|------------|---------------------------------------------------------------------------------------------------|

** **

**Forthe quarterly period ended March 31, 2004**

 

**OR**

 

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

 

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**Commissionfile number 000-23195**

 

**TIERTECHNOLOGIES, INC.**

(Exact name of Registrant asspecified in its charter)

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

 

**10780Parkridge Blvd., 4th FloorReston, Virgnia  20191**

(Address of principal executiveoffices)

**2001N. Main Street, Suite 500Walnut Creek, CA 94596**

(Former address of principalexecutive offices)

 

**(571)382-1090**

(Registrant’s telephone number,including area code)

 

Indicate by check mark whether the Registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Actof 1934 during the preceding 12 months (or for such shorter period that theRegistrant was required to file such reports) and (2) has been subject to suchfiling requirements for the past 90 days. 

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

 

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

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

 

As of April 30, 2004, the number of shares outstanding of theRegistrant’s Class A Common Stock was 880,000 and the number of sharesoutstanding of the Registrant’s Class B Common Stock was 17,988,466.

 

 

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**TIERTECHNOLOGIES, INC.**

 

**FORM10-Q**

 

**TABLEOF CONTENTS**

 
| **Part I—FINANCIAL INFORMATION** |
|---------------------------------------|
|                                  |   |   |
| Item 1.                               | Condensed Consolidated Financial Statements (unaudited) |   |
|                                  |   |   |
|                                  | Condensed  Consolidated Balance Sheets as of March 31, 2004 and September 30,  2003. |   |
|                                  |   |   |
|                                  | Condensed Consolidated Statements of  Operations for the three and six months ended March 31, 2004 and 2003. |   |
|                                  |   |   |
|                                  | Condensed Consolidated Statements of Cash  Flows for the six months ended March 31, 2004 and 2003 |   |
|                                  |   |   |
|                                  | Notes to Condensed Consolidated Financial  Statements. |   |
|                                  |   |   |
| Item 2.                               | Management’s Discussion and Analysis of  Financial Condition and Results of Operations. |   |
|                                  |   |   |
| Item 3.                               | Quantitative and Qualitative Disclosures  About Market Risk. |   |
|                                  |   |   |
| Item 4.                               | Controls and Procedures. |   |
|                                  |   |   |
| **Part II-OTHER INFORMATION**         |
|                                  |   |   |
| Item 1.                               | Legal Proceedings |   |
|                                  |   |   |
| Item 4.                               | Submission of Matters to a Vote of Security  Holders |   |
|                                  |   |   |
| Item 6.                               | Exhibits and Reports on Form 8-K. |   |
|                                  |   |   |
| Signatures.                           |   |

 

**Private SecuritiesLitigation Reform Act Safe Harbor Statement**

 

Certain statements contained in this report, including statementsregarding the development of and demand for our services and our markets,anticipated trends in various expenses, expected costs of legal proceedings andother statements that are not historical facts, are forward-looking statementswithin the meaning of the federal securities laws. These forward-lookingstatements relate to future events or our future financial and/or operatingperformance and can generally be identified as such because the context of thestatement will include words such as “may”, “will”, “intends”, “plans”,“believes”, “anticipates”, “expects”, “estimates”, “shows”, “predicts”,“potential”, “continue”, or “opportunity”, the negative of these words or wordsof similar import. 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 28, that couldcause actual results to differ materially from those anticipated as of the dateof this report.

 

2

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**PART I.  FINANCIAL INFORMATION**

 

**ITEM 1.  FINANCIAL STATEMENTS**

 

**TIERTECHNOLOGIES, INC.**

 

**CONDENSED CONSOLIDATED BALANCESHEETS**

**(unaudited)**

**(inthousands)**

 
|                                                                               |   | **March 31,  2004** |       | **September 30,  2003** |       |
|------------------------------------------------------------------------------------|--------|--------------------------|------------|------------------------------|------------|
| **ASSETS**                                                                         |   |                     | ** ** |                         | ** ** |
|                                                                               |   |                     |       |                         |       |
| **Current assets:**                                                                |   |                     | ** ** |                         | ** ** |
| Cash and cash equivalents.                                                         |   | $                        | 49,706     |                         | $          | 26,178 |   |
| Short-term investments.                                                            |   | 1,000                    |       | 5,492                        |       |
| Accounts receivable, net.                                                          |   | 13,718                   |       | 20,024                       |       |
| Unbilled receivables                                                               |   | 4,500                    |       | 7,872                        |       |
| Assets of discontinued operations                                                  |   | 689                      |       | 3,550                        |       |
| Prepaid expenses and other current assets.                                         |   | 2,616                    |       | 4,602                        |       |
| Total current assets.                                                              |   | 72,229                   |       | 67,718                       |       |
| Equipment and software, net.                                                       |   | 4,459                    |       | 5,422                        |       |
| Notes and accrued interest receivable from  related parties, less current portion. |   | 2,273                    |       | 2,152                        |       |
| Goodwill                                                                           |   | 29,625                   |       | 29,625                       |       |
| Other acquired intangible assets, net.                                             |   | 23,329                   |       | 24,832                       |       |
| Long-term investments                                                              |   | 23,675                   |       | 24,883                       |       |
| Restricted investments                                                             |   | 7,675                    |       | 7,707                        |       |
| Non-current assets of discontinued  operations                                     |   | —                   |       | 760                          |       |
| Other assets.                                                                      |   | 2,534                    |       | 1,875                        |       |
| Total assets.                                                                      |   | $                        | 165,799    |                         | $          | 164,974 |   |
|                                                                               |   |                     |       |                         |       |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                      |   |                     |       |                         |       |
|                                                                               |   |                     |       |                         |       |
| **Current liabilities:**                                                           |   |                     |       |                         |       |
| Accounts payable.                                                                  |   | $                        | 949        |                         | $          | 2,087 |   |
| Accrued liabilities.                                                               |   | 9,130                    |       | 8,476                        |       |
| Accrued subcontractor expenses.                                                    |   | 3,493                    |       | 5,494                        |       |
| Accrued compensation and related  liabilities.                                     |   | 3,864                    |       | 3,654                        |       |
| Income taxes payable                                                               |   | 4,546                    |       | —                       |       |
| Deferred revenue                                                                   |   | 3,350                    |       | 3,299                        |       |
| Liabilities of discontinued operations                                             |   | 529                      |       | 2,043                        |       |
| Current portion of long-term debt.                                                 |   | 120                      |       | 150                          |       |
| Total current liabilities.                                                         |   | 25,981                   |       | 25,203                       |       |
| Long-term debt, less current portion.                                              |   | 138                      |       | 195                          |       |
| Non-current liabilities of discontinued  operations                                |   | 62                       |       | 432                          |       |
| Other liabilities.                                                                 |   | 1,388                    |       | 994                          |       |
| Total liabilities.                                                                 |   | 27,569                   |       | 26,824                       |       |
|                                                                               |   |                     |       |                         |       |
| Commitments and contingencies                                                      |   |                     |       |                         |       |
|                                                                               |   |                     |       |                         |       |
| **Shareholders’ equity:**                                                     |   |                     |       |                         |       |
| Common stock, no par value.                                                        |   | 165,920                  |       | 164,742                      |       |
| Notes receivable from shareholders.                                                |   | (1,773                   | )          | (1,773                       | )          |
| Accumulated other comprehensive loss.                                              |   | (124                     | )          | (350                         | )          |
| Accumulated deficit.                                                               |   | (25,793                  | )          | (24,469                      | )          |
| Total shareholders’ equity.                                                   |   | 138,230                  |       | 138,150                      |       |
| Total liabilities and shareholders’ equity                                    |   | $                        | 165,799    |                         | $          | 164,974 |   |

 

See Notes to Condensed Consolidated FinancialStatements

 

3

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**TIERTECHNOLOGIES, INC.**

 

#### **CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

**(unaudited)**

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

 
|                                                                |   | **Three months Ended  March 31,** |   | **Six Months Ended  March 31,** |   |
|---------------------------------------------------------------------|--------|----------------------------------------|--------|--------------------------------------|--------|
|                                                                |   | **2004**                               |   | **2003**                             |   | **2004** |   | **2003** |   |
| Net revenues                                                        |   | $                                      | 29,659 |                                 | $      | 30,165 |   | $ | 56,169 |   | $ | 59,252 |   |
| Costs and expenses:                                                 |   |                                   |   |                                 |   |   |   |   |   |
| Direct costs                                                        |   | 19,399                                 |   | 19,750                               |   | 37,367 |   | 38,315 |   |
| Selling and marketing                                               |   | 1,756                                  |   | 1,413                                |   | 3,133 |   | 2,854 |   |
| General and administrative                                          |   | 6,293                                  |   | 5,431                                |   | 12,593 |   | 11,210 |   |
| Restructuring charges                                               |   | 5                                      |   | —                               |   | 1,261 |   | — |   |
| Depreciation and amortization                                       |   | 1,107                                  |   | 1,388                                |   | 2,238 |   | 2,765 |   |
| Income (loss) from continuing operations                            |   | 1,099                                  |   | 2,183                                |   | (423 | ) | 4,108 |   |
| Interest income (expense), net                                      |   | 293                                    |   | 296                                  |   | 570 |   | 674 |   |
| Income from continuing operations before  income taxes              |   | 1,392                                  |   | 2,479                                |   | 147 |   | 4,782 |   |
| Provision for income taxes                                          |   | 35                                     |   | 955                                  |   | 70 |   | 1,793 |   |
| Income from continuing operations, net of  income taxes             |   | 1,357                                  |   | 1,524                                |   | 77 |   | 2,989 |   |
| Income (loss) from of discontinued  operations, net of income taxes |   | 164                                    |   | 57                                   |   | (1,401 | ) | 316 |   |
| Net income (loss)                                                   |   | $                                      | 1,521  |                                 | $      | 1,581 |   | $ | (1,324 | ) | $ | 3,305 |   |
|                                                                |   |                                   |   |                                 |   |   |   |   |   |
| Income from continuing operations, net of  income taxes:            |   |                                   |   |                                 |   |   |   |   |   |
| Per basic share                                                     |   | $                                      | 0.07   |                                 | $      | 0.08 |   | $ | — |   | $ | 0.16 |   |
| Per diluted share                                                   |   | $                                      | 0.07   |                                 | $      | 0.08 |   | $ | — |   | $ | 0.15 |   |
|                                                                |   |                                   |   |                                 |   |   |   |   |   |
| Income (loss) from discontinued operations,  net of income taxes:   |   |                                   |   |                                 |   |   |   |   |   |
| Per basic share                                                     |   | $                                      | 0.01   |                                 | $      | **—** |   | $ | (0.07 | ) | $ | 0.02 |   |
| Per diluted share                                                   |   | $                                      | 0.01   |                                 | $      | — |   | $ | (0.07 | ) | $ | 0.02 |   |
|                                                                |   |                                   |   |                                 |   |   |   |   |   |
| Net income (loss):                                                  |   |                                   |   |                                 |   |   |   |   |   |
| Per basic share                                                     |   | $                                      | 0.08   |                                 | $      | 0.08 |   | $ | (0.07 | ) | $ | 0.17 |   |
| Per diluted share                                                   |   | $                                      | 0.08   |                                 | $      | 0.08 |   | $ | (0.07 | ) | $ | 0.17 |   |
|                                                                |   |                                   |   |                                 |   |   |   |   |   |
| Shares used in computing basic income  (loss) per share             |   | 18,808                                 |   | 18,834                               |   | 18,755 |   | 18,944 |   |
| Shares used in computing diluted income  (loss) per share           |   | 19,217                                 |   | 19,355                               |   | 19,083 |   | 19,580 |   |

 

See Notes to Condensed Consolidated FinancialStatements

 

4

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**TIERTECHNOLOGIES, INC.**

 

#### **CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(unaudited)**

**(inthousands)**

 
|                                                                                                                                                       |   | **Six Months  Ended  March 31,** |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------|--------|
|                                                                                                                                                       |   | **2004**                              |   | **2003** |   |
| **Operating activities**                                                                                                                                   |   |                                  |   |   |   |
| Income from continuing operations, net of  income taxes                                                                                                    |   | $                                     | 77     |   | $ | 2,989 |   |
| Adjustments to reconcile income from  continuing operations, net of income taxes to net cash from continuing  operations provided by operating activities: |   |                                  |   |   |   |
| Asset impairment charge                                                                                                                                    |   | 135                                   |   | — |   |
| Depreciation and amortization                                                                                                                              |   | 3,287                                 |   | 3,847 |   |
| Provision for doubtful accounts                                                                                                                            |   | 272                                   |   | 366 |   |
| Tax benefit of stock options exercised                                                                                                                     |   | —                                |   | 196 |   |
| Forgiveness of notes receivable from  employees                                                                                                            |   | 8                                     |   | 27 |   |
| Change in operating assets and liabilities,  net of effects of business combinations:                                                                      |   |                                  |   |   |   |
| Accounts receivable                                                                                                                                        |   | 8,581                                 |   | (5,926 | ) |
| Prepaid expenses and other assets                                                                                                                          |   | (210                                  | )      | 565 |   |
| Accounts payable and accrued liabilities                                                                                                                   |   | 5,040                                 |   | (1,932 | ) |
| Deferred revenue                                                                                                                                           |   | 51                                    |   | 521 |   |
| Net cash from continuing operations provided  by operating activities                                                                                      |   | 17,241                                |   | 653 |   |
|                                                                                                                                                       |   |                                  |   |   |   |
| **Investing activities**                                                                                                                                   |   |                                  |   |   |   |
| Purchase of equipment and software                                                                                                                         |   | (908                                  | )      | (995 | ) |
| Notes and accrued interest receivable from  related parties                                                                                                |   | (171                                  | )      | (135 | ) |
| Repayments on notes and accrued interest receivable  from related parties                                                                                  |   | 34                                    |   | 14 |   |
| Business combinations, net of cash acquired                                                                                                                |   | —                                |   | 151 |   |
| Purchases of available-for-sale securities                                                                                                                 |   | (10,358                               | )      | (19,298 | ) |
| Sales of available-for-sale securities                                                                                                                     |   | —                                |   | 5,989 |   |
| Maturities of available-for-sale securities                                                                                                                |   | 16,032                                |   | 15,533 |   |
| Other assets                                                                                                                                               |   | 26                                    |   | — |   |
| Net cash from continuing operations  provided by investing activities                                                                                      |   | 4,655                                 |   | 1,259 |   |
|                                                                                                                                                       |   |                                  |   |   |   |
| **Financing activities**                                                                                                                                   |   |                                  |   |   |   |
| Net proceeds from issuance of Class B  common stock                                                                                                   |   | 1,177                                 |   | 1,028 |   |
| Repurchase of Class B common stock                                                                                                                         |   | —                                |   | (6,665 | ) |
| Payments on capital lease obligations and  other financing arrangements                                                                                    |   | (87                                   | )      | (344 | ) |
| Net cash from continuing operations  provided by (used in) financing activities                                                                            |   | 1,090                                 |   | (5,981 | ) |
| Net cash provided by (used in) continuing  operations                                                                                                      |   | 22,986                                |   | (4,069 | ) |
| Net cash provided by discontinued  operations                                                                                                              |   | 542                                   |   | 142 |   |
| Net increase (decrease) in cash and cash  equivalents                                                                                                      |   | 23,528                                |   | (3,927 | ) |
| Cash and cash equivalents at beginning of  period                                                                                                          |   | 26,178                                |   | 40,609 |   |
| Cash and cash equivalents at end of period                                                                                                                 |   | $                                     | 49,706 |   | $ | 36,682 |   |
|                                                                                                                                                       |   |                                  |   |   |   |
| **Supplemental  disclosures of cash flow information**                                                                                                     |   |                                  |   |   |   |
| Cash paid during the period for:                                                                                                                           |   |                                  |   |   |   |
| Interest                                                                                                                                                   |   | $                                     | 28     |   | $ | 31 |   |
| Income taxes paid (refunded), net                                                                                                                          |   | $                                     | (6,939 | ) | $ | 2,393 |   |
|                                                                                                                                                       |   |                                  |   |   |   |
| **Supplemental disclosures  of non-cash transactions**                                                                                                     |   |                                  |   |   |   |
| Equipment acquired under capital lease  obligations and other financing arrangements                                                                       |   | $                                     | — |   | $ | 68 |   |

 

**See Notes to Condensed Consolidated FinancialStatements**

 

5

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**TIERTECHNOLOGIES, INC.**

 

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(unaudited)**

 

**NOTE 1—BASIS OFPRESENTATION**

 

The accompanying condensed consolidatedfinancial statements of Tier Technologies, Inc. (‘‘Tier’’ or the ‘‘Company’’)include the accounts of the Company and its wholly owned subsidiaries. Allsignificant intercompany transactions and balances have been eliminated inconsolidation. In the opinion of management, the condensed consolidatedfinancial statements reflect all normal and recurring adjustments which arenecessary for a fair presentation of the Company’s financial position, resultsof operations and cash flows as of the dates and for the periods presented. Thecondensed consolidated financial statements have been prepared in accordancewith generally accepted accounting principles for interim financialinformation. Consequently, these statements do not include all the disclosuresnormally required by generally accepted accounting principles for annualfinancial statements nor those normally made in the Company’s Annual Report onForm 10-K. Accordingly, reference should be made to the Company’s Form 10-Kfiled on December 19, 2003 and other reports the Company has filed withthe Securities and Exchange Commission for additional disclosures, including asummary of the Company’s accounting policies, which have not materiallychanged. The consolidated results of operations for the six months endedMarch 31, 2004 are not necessarily indicative of results that may beexpected for the fiscal year ending September 30, 2004 or any futureperiod, and the Company makes no representations related thereto.

 

The preparation of financial statements inconformity with generally accepted accounting principles requires management tomake certain estimates and assumptions that affect the reported amounts ofassets and liabilities, disclosures of contingent assets and liabilities andthe 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 reclassifications have been made to theprior period financial statements to conform to the current periodpresentation.

 

 

###### **NOTE 2—REVENUE RECOGNITION**

 

The Company derives net revenues from three principal deliveryofferings:  transaction and paymentprocessing, systems design and integration, and maintenance and supportservices.  Net revenues include softwarelicense revenues and reimbursements from clients for out-of-pocketexpenses.  Neither software license norreimbursements revenues were greater than 10% of total net revenues for each periodincluded in 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 includes revenuesrecorded at the Company’s child support payment processing centers and OfficialPayments Corporation (“OPC”), the Company’s wholly–owned subsidiary, and arebased upon a per-transaction fee or a percentage of the dollar amountprocessed.  Revenues are recognized eachmonth based on the number of transactions performed and dollar amount processedin that month after the Company has received a signed contract, the price pertransaction or fee percentage is fixed according to the contract, andcollectibility is reasonably assured. The Company assesses the probability ofcollection based upon the client’s financial condition and prior paymenthistory.  For OPC, transaction fees aregenerally borne by the consumer utilizing our services, not the governmentalentity. OPC receives real-time authorization for credit and debit cardtransactions which ensures availability of cardholder funds for payment.

 

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

 

6

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License and services revenues for contracts involving significantmodification, customization or services which are essential to thefunctionality of the software are recognized over the period of eachengagement, using the percentage-of-completion method of Statement of Position81-1 “Accounting for the Performance of Construction Type and CertainProduction Type Contracts.” The ratio of costs incurred to total estimatedproject costs is used as the measure of progress towards completion.  Due to the long-term nature of thesecontracts, estimates of total project costs are subject to changes over thecontract term. A provision for a loss contract on an engagement is made in theperiod in which the loss becomes probable and can be reasonably estimated.  If the loss cannot be reasonably estimated,a zero profit methodology is applied to the contract whereby the amount ofrevenue recognized is limited to the amount of costs until such time, as thetotal loss can be estimated. Advance payments from clients and amounts billedto clients in excess of revenue recognized are recorded as deferred revenue.Amounts recognized as revenue in advance of contractual billing are recorded asunbilled receivables. Revenues recognized under the percentage-of-completionmethod were $5,951,000 and $14,716,000 for the six months ended March 31,2004 and 2003, respectively.

 

Where costs are incurred related to an unapproved change order, thecosts are deferred until the change order is approved provided that the Companybelieves it is probable that the cost will be recovered through a change in thecontract price. Included in prepaid and other assets at March 31, 2004 andSeptember 30, 2003, respectively, were $0 and $34,000 of deferred costsrelated to change orders not yet approved.

 

Revenues from software license fees not requiring significantmodification are recognized in accordance with Statement of Position 97-2,“Software Revenue Recognition.”**Revenuesfrom license fees are recognized when persuasive evidence of an agreementexists, delivery of the software has occurred, no significant Companyobligations with regard to implementation or integration exist, the fee isfixed or determinable and collectibility is probable. Arrangements for whichthe fees are not deemed probable for collection are recognized upon cashcollection.  Arrangements for which thefees are not deemed fixed or determinable are recognized on the earlier of thedue date or when payment is received. Revenues from software license fees not requiring significantmodification were $126,000 and $39,000 for the six months ended March 31,2004 and 2003, respectively.

 

For license arrangements with multiple obligations (for example,undelivered maintenance and support), the Company allocates revenues to eachcomponent of the arrangement using the residual value method of accountingbased on the fair value of the undelivered elements, which is specific to theCompany.  Fair value for the maintenanceand support obligations for software licenses is based upon the specific saleof renewals to customers or upon renewal rates quoted in the contracts.

 

Under the terms of its license agreements, the Company does not offerreturn rights or price protection. Therefore, no provisions have been made for sales returns.  For its proprietary software, the Companyoffers routine, short-term warranties that its software will operate free ofmaterial defects and in conformity with written documentation.  Under these agreements, if the Company hasan active maintenance agreement with the customer, the Company accounts for anyobligation in conformity with Statement of Financial Accounting Standards No.5, “Accounting for Contingencies.”  Ifthe Company does not have a maintenance contract in place, the warranty isconsidered implied maintenance and the Company defers the amount of revenuesconsistent with the fair value of other maintenance and support obligations.

 

*Maintenance and Support Services –*TheCompany provides ongoing maintenance and support services.**Maintenance revenue is deferred andrecognized on a straight-line basis as services revenue over the life of therelated contract, which is typically one year. Non-essential support services, including training and consulting, arealso typically provided on a time and materials basis and revenue is recognizedas the services are performed. Revenue is recognized after a contract is signedwhich indicates a fixed or determinable price and the Company believes, basedupon its assessment of the customer’s financial condition, that collection isreasonably assured.

 

7

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*Multiple Elements Arrangements –*The Company has several engagements that provide a combination of services fromseveral delivery offerings as part of the overall project.  For these multiple element arrangements, theCompany allocates revenue to each element based on the fair value of thedelivery offering.  In establishing fairvalue, the Company uses prices charged on similar contracts.  For multiple element arrangements enteredinto beginning July 1, 2003, we have followed the provisions of EmergingIssues Task Force Issue 00-21, “Revenue Arrangements with MultipleDeliverables” (EITF 00-21).  For thesemultiple element arrangements, the Company accounts for each unit of thecontract as a separate unit when each unit provides value to the customer on astand-alone basis and there is objective evidence of the fair value of thestand-alone unit.  The implementation ofEITF 00-21 did not have a material effect on the Company’s recognition ofrevenue.

 

**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 March 31, 2004, noclient comprised more than 10% of total net revenues and for the three months endedMarch 31, 2003, revenues from two clients totaled approximately $3,344,000and $3,021,000, which represented 11.1% and 10.0%, respectively, of total netrevenues.  For the six months endedMarch 31, 2004, revenues from one client totaled approximately $5,692,000,which represented 10.1% of total net revenues. For the six months endedMarch 31, 2003, revenues from one client totaled approximately $6,579,000which represented 11.1% of total net revenues.

 

The Company’s contracts with government agencies typically include atermination for convenience clause.  Thetermination for convenience clause provides the agency with the right toterminate a contract, in whole or in part, for any reason deemed to be in thepublic’s best interest.  Each contracthas specific remedies under a termination for convenience that generallyprovide a settlement claim which includes costs relating or allocable to theterminated contract, including settlement expenses and a reasonable profit. TheCompany’s contracts with government agencies also typically provide fortermination for cause when either party endangers the performance in thecontract.

 

The Company has several large accounts receivable and unbilledreceivable balances, and any dispute, early contract termination or othercollection issues could have a material adverse impact on its financialcondition and results of operations. Unbilled receivables were $4,500,000 and $7,872,000 at March 31,2004 and September 30, 2003, respectively.  Amounts will become billable upon completion of projectmilestones or customer acceptance. The entire unbilled receivables balance asof March 31, 2004 and September 30, 2003 was expected to becomebillable within one year.   Unbilled receivablesfor two clients accounted for 45.3% and 33.7%, respectively, of total unbilledreceivables at March 31, 2004. Total accounts receivable and unbilledreceivables for these two clients accounted for 17.7% and 9.7%, respectively,of total net accounts receivable and unbilled receivables at March 31,2004.  Unbilled receivables for threeclients accounted for 44.2%, 25.0% and 20.3%, respectively, of total unbilledreceivables at September 30, 2003. Total accounts receivable and unbilledreceivables for these three clients accounted for 20.1%, 16.3% and 7.2%,respectively, of total net accounts receivable and unbilled receivables atSeptember 30, 2003.

 

On August 25, 2003, the Company received a notice of terminationfor default of a significant contract with the California Public EmployeesRetirement System (“CalPERS”). The Company recorded $12,831,000 inSeptember 2003 as a revenue reversal on this loss contract for amountsunbilled and uncollected as of the date of termination. From inception throughJune 30, 2003, the Company had recorded revenue under thepercentage-of-completion method of $20,340,000 under the terms of the contractand collected  $7,508,000 in cashincluding $985,000 in July 2003. The Company filed a lawsuit to overturnthe termination of the contract for default and to recover all uncollectedunbilled receivables, delay, disruption and interference costs, attorneys feesand other costs associated with the contract. (See Note 13.) The Company alsowrote-off $532,000 in deferred costs in September 2003 related to changeorders that were being negotiated at June 30, 2003. No revenue wasrecognized in connection with this contract for the six months endedMarch 31, 2004.

 

8

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Included in accounts receivable and other assets at March 31, 2004was approximately $1,818,000, which represented balances billed but not paid byclients under retainage provisions in the contracts, of which approximately$6,000 was expected to be collected within one year,  $430,000 was expected to be collected within two years,$1,379,000 was expected to be collected within three years and $3,000 wasexpected to be collected within five years. Included in accounts receivable andother assets at September 30, 2003 was approximately $1,448,000 ofretainage of which approximately $461,000 was expected to be collected withinone year, $430,000 was expected to be collected within two years and $557,000was expected to be collected within three years.

 

**NOTE 4—LONG-TERMINVESTMENTS**

 

Investments with maturities greater than 12 months as of the balancesheet date are classified as long-term investments.  These long-term investments are categorized by the Company asavailable-for-sale and are recorded at amounts that approximate fair valuebased on quoted market prices and are primarily comprised of state and localmunicipalities’ debt readily traded on over-the-counter markets.  Unrealized gains and losses on theseinvestments were not material and there were no other-than-temporary impairmentsto these investments.

 

Restricted investments were approximately $7,675,000 and $7,707,000 atMarch 31, 2004 and September 30, 2003, respectively, and were pledgedin connection with performance bonds and real estate operating leases and willbe restricted for the terms of the project performance periods and leaseperiods, the latest of which is estimated to be through June 2005.

 

**NOTE 5—BANK LINES OFCREDIT**

 

At March 31, 2004, the Company had a $15.0 million revolvingcredit facility, all of which may be used for letters of credit.  The credit facility has a maturity date ofJanuary 31, 2005.  The creditfacility is collateralized by first priority liens and security interests inthe Company’s assets. Interest is based on either the adjusted LIBOR rate plus2.5% or the lender’s announced prime rate plus 0.25%, at the Company’s option,and is payable monthly.  As ofMarch 31, 2004, there were no outstanding borrowings or standby letters ofcredit.  Among other provisions, thecredit facility requires the Company to maintain certain minimum financialratios. As of March 31, 2004, the Company was in compliance with all ofthe financial ratios of the credit facility.

 

In addition to the credit facility noted above, the Company had lettersof credit totaling approximately $3,396,000, which were collateralized bycertain securities in the Company’s long-term investment portfolio atMarch 31, 2004.  Also, theCompany’s subsidiary, OPC, had a letter of credit outstanding in the amount ofapproximately $138,000 collateralized by a certificate of deposit.  These letters of credit were issued tosecure performance bonds and to meet various facility lease requirements.

 

**NOTE 6—GOODWILL ANDOTHER ACQUIRED INTANGIBLE ASSETS**

 

As of October 1, 2002, the Company adopted Statement of FinancialAccounting Standard No. 142 (“SFAS 142”), “Goodwill and Other IntangibleAssets” and ceased amortizing goodwill. The Company completed initialimpairment tests in accordance with SFAS 142 in the first quarter of fiscalyear 2003.  Results of the initialimpairment tests did not indicate any impairment loss.  Impairment tests involve the use ofestimates related to the fair market values of the business operations withwhich goodwill is associated.  Losses,if any, resulting from the annual impairment tests will be reflected inoperating income in the statement of operations. During the fourth quarter offiscal year 2003, the Company decided to shut down the U.S. Commercial Servicessegment and the United Kingdom Operations segment and accordingly recorded arestructuring charge of $17,646,000 to write-off substantially all of theassociated goodwill.  As ofSeptember 30, 2003, the remaining fair market value of the goodwillassociated with these segments totaled $457,000. The fair market value wasdetermined by estimating the expected margin on the remaining contracts inthese segments.

 

9

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During the six months ended March 31, 2004, the Company wrote-offthe remaining $457,000 of goodwill associated with the U.S. Commercial Servicessegment in discontinued operations as a result of the fulfillment of theremaining contracts in the quarter ended December 31, 2003.  In the fourth quarter of fiscal year 2003,the Company performed its annual impairment test to determine if the goodwillassociated with its remaining segments was impaired.  The results did not indicate any impairment loss for theremaining segments.

 

Other acquired intangible assets, net, consisted of the following atMarch 31, 2004 and September 30, 2003 (in thousands):

 
|                                   |   |                     |   | **March 31,  2004** |   | **September 30,  2003**  |   |
|----------------------------------------|--------|--------------------------|--------|--------------------------|--------|-------------------------------|--------|
|                                   |   | **Amortization  Period** |   | **Gross**                |   | **Accumulated  Amortization** |   | **Net** |   | **Gross** |   | **Accumulated  Amortization** |   | **Net** |   |
|                                   |   |                     |   |                     |   | **(in thousands)**            |   |   |   |   |   | **(in thousands)** |   |   |   |
| Client  relationships                  |   | 10 years                 |   | $                        | 24,400 |                          | $      | (4,067 | ) | $ | 20,333 |   | $ | 24,400 |   | $ | (2,847 | ) | $ | 21,553 |   |
| Tradename                              |   | 10 years                 |   | 3,200                    |   | (533                          | )      | 2,667 |   | 3,200 |   | (373 | ) | 2,827 |   |
| Technology                             |   | 3 years                  |   | 740                      |   | (411                          | )      | 329 |   | 740 |   | (288 | ) | 452 |   |
| Acquired  contracts                    |   | 12 months                |   | 500                      |   | (500                          | )      | — |   | 500 |   | (500 | ) | 3⁄4 |   |
| Other  acquired intangible assets, net |   |                     |   | $                        | 28,840 |                          | $      | (5,511 | ) | $ | 23,329 |   | $ | 28,840 |   | $ | (4,008 | ) | $ | 24,832 |   |

 

The changes in the carrying amount ofgoodwill for the six months ended March 31, 2004 are as follows (inthousands):

 
|                                   |   | **Government  Business  Process  Outsourcing** |   | **Government  Systems  Integration** |   | **Official  Payments** |   | **Total** |   |
|----------------------------------------|--------|------------------------------------------------|--------|--------------------------------------|--------|------------------------|--------|-----------|--------|
| Balance as  of September 30, 2003 |   | $                                              | 5,298  |                                 | $      | 9,721                  |   | $         | 14,606 |   | $ | 29,625 |   |
| Activity                               |   | —                                         |   | —                               |   | —                 |   | —    |   |
| Balance as  of March 31, 2004     |   | $                                              | 5,298  |                                 | $      | 9,721                  |   | $         | 14,606 |   | $ | 29,625 |   |

 

**NOTE 7 —  SHAREHOLDERS’ EQUITY**

 

**Pro Forma Impact ofEmployee Stock Options**

 

In December 2002, the Financial Accounting Standards Board(“FASB”) issued Statement of Financial Accounting Standards No. 148 (“SFAS148”), “Accounting for Stock-Based Compensation Costs – Transition and Disclosure,”which provides alternative methods of transition for an entity that voluntarilychanges to the fair value-based method of accounting for stock-basedcompensation.  SFAS 148 also requiresadditional disclosures about the effects on reported net income of an entity’saccounting policy with respect to stock-based compensation.  The Company accounts for employee stockoptions in accordance with Accounting Principles Board Opinion No. 25(“APB 25”), “Accounting for Stock Issued to Employees” and provides thedisclosure required in Statement of Financial Accounting Standards No. 123(“SFAS 123”), “Accounting for Stock-Based Compensation.” Stock optionsissued to non-employees are accounted for in accordance with Emerging IssuesTask Force Issue No. 96-18, “Accounting for Equity Instruments That AreIssued to Other Than Employees for Acquiring, or in Conjunction with Selling,Goods or Services.”  The Company adoptedthe disclosure provisions of SFAS 148 in January 2003.

 

10

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

 
|                                                                              |   | **Three  Months Ended  March 31,**          |   | **Six Months  Ended  March 31,** |   |
|-----------------------------------------------------------------------------------|--------|--------------------------------------------------|--------|---------------------------------------|--------|
|                                                                              |   | **2004**                                         |   | **2003**                              |   | **2004** |   | **2003** |   |
|                                                                              |   | **(in  thousands,  except per share data)** |   |
| Net income (loss), as  reported                                                   |   | $                                                | 1,521  |                                  | $      | 1,581 |   | $ | (1,324 | ) | $ | 3,305 |   |
| Deduct: Pro forma employee compensation costrelated to stock options, net  of tax |   | 1,057                                            |   | 691                                   |   | 1,216 |   | 1,598 |   |
| Pro forma net income (loss)                                                       |   | $                                                | 464    |                                  | $      | 890 |   | $ | (2,540 | ) | $ | 1,707 |   |
|                                                                              |   |                                             |   |                                  |   |   |   |   |   |
| Net income (loss) per basic share:                                                |   |                                             |   |                                  |   |   |   |   |   |
| As reported                                                                       |   | $                                                | 0.08   |                                  | $      | 0.08 |   | $ | (0.07 | ) | $ | 0.17 |   |
| Pro forma                                                                         |   | $                                                | 0.02   |                                  | $      | 0.05 |   | $ | (0.14 | ) | $ | 0.09 |   |
|                                                                              |   |                                             |   |                                  |   |   |   |   |   |
| Net income (loss) per diluted share:                                              |   |                                             |   |                                  |   |   |   |   |   |
| As reported                                                                       |   | $                                                | 0.08   |                                  | $      | 0.08 |   | $ | (0.07 | ) | $ | 0.17 |   |
| Pro forma                                                                         |   | $                                                | 0.02   |                                  | $      | 0.05 |   | $ | (0.13 | ) | $ | 0.09 |   |

 

**NOTE8 —  INCOME (LOSS) PER SHARE**

 

The following table sets forth the computation of basic and dilutedincome (loss) per share:

 
|                                                                                                                |   | **Three Months Ended  March 31,**     |       | **Six Months Ended  March 31,** |       |
|---------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------|------------|--------------------------------------|------------|
|                                                                                                                |   | **2004**                                   |       | **2003**                             |       | **2004** |   | **2003** |   |
|                                                                                                                |   | **(in  thousands, except per share data)** |       |
| Numerator:                                                                                                          |   |                                       | ** ** |                                 | ** ** |   | ** ** |   | ** ** |
| Income from  continuing operations, net of  income taxes                                                            |   | $                                          | 1,357      |                                 | $          | 1,524 |   | $ | 77 |   | $ | 2,989 |   |
| Income (loss)  from discontinued operation, net of  income taxes                                                    |   | 164                                        |       | 57                                   |       | (1,401 | ) | 316 |   |
| Net income  (loss)                                                                                                  |   | $                                          | 1,521      |                                 | $          | 1,581 |   | $ | (1,324 | ) | $ | 3,305 |   |
| Denominator  for basic income (loss) per share-  weighted average common shares outstanding                         |   | 18,808                                     |       | 18,834                               |       | 18,755 |   | 18,944 |   |
| Effects of  dilutive securities:                                                                                    |   |                                       |       |                                 |       |   |   |   |   |
| Common stock  options                                                                                               |   | 409                                        |       | 521                                  |       | 328 |   | 636 |   |
| Denominator  for diluted income (loss) per share-  adjusted weighted average common shares and  assumed conversions |   | 19,217                                     |       | 19,355                               |       | 19,083 |   | 19,580 |   |
| Income from  continuing operations, net of income taxes:                                                            |   |                                       |       |                                 |       |   |   |   |   |
| Per basic  share                                                                                                    |   | $                                          | 0.07       |                                 | $          | 0.08 |   | $ | — |   | $ | 0.16 |   |
| Per diluted  share                                                                                                  |   | $                                          | 0.07       |                                 | $          | 0.08 |   | $ | — |   | $ | 0.15 |   |
| Income (loss)  from discontinued operation, net of income taxes:                                                    |   |                                       |       |                                 |       |   |   |   |   |
| Per basic  share                                                                                                    |   | $                                          | 0.01       |                                 | $          | — |   | $ | (0.07 | ) | $ | 0.02 |   |
| Per diluted  share                                                                                                  |   | $                                          | 0.01       |                                 | $          | — |   | $ | (0.07 | ) | $ | 0.02 |   |
| Net income  (loss):                                                                                                 |   |                                       |       |                                 |       |   |   |   |   |
| Per basic  share                                                                                                    |   | $                                          | 0.08       |                                 | $          | 0.08 |   | $ | (0.07 | ) | $ | 0.17 |   |
| Per diluted share                                                                                                   |   | $                                          | 0.08       |                                 | $          | 0.08 |   | $ | (0.07 | ) | $ | 0.17 |   |

 

11

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For the three and six months ended March 31, 2004, options topurchase approximately 1,960,000 and 2,209,000 shares of Class B common stock,respectively, at prices ranging from $10.88 to $20.70 per share and $9.19 to$20.70 per share, respectively, were outstanding but were not included in thecomputation of diluted income (loss) per share because the options’ exerciseprices were greater than the average market price of the shares for thisperiod.  For the three and six monthsended March 31, 2003, options to purchase approximately 1,373,000 and995,000 shares of Class B common stock, respectively, at prices ranging from$13.75 to $20.70 per share and $15.19 to $20.70 per share, respectively, wereoutstanding but were not included in the computation of diluted income pershare because the options’ exercise prices were greater than the average marketprice of the shares for this period.

 

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

 

The Company’s comprehensive income (loss) was as follows: 

 
|                                                             |   | **Three  Months Ended  March 31,** |   | **Six Months  Ended  March 31,** |   |
|------------------------------------------------------------------|--------|-----------------------------------------|--------|---------------------------------------|--------|
|                                                             |   | **2004**                                |   | **2003**                              |   | **2004** |   | **2003** |   |
|                                                             |   | **(in  thousands)**                     |   |
| Net income (loss).                                               |   | $                                       | 1,521  |                                  | $      | 1,581 |   | $ | (1,324 | ) | $ | 3,305 |   |
| Net change in unrealized gain on  available-for-sale investments |   | 112                                     |   | (32                                   | )      | (26 | ) | 16 |   |
| Foreign currency translation adjustments                         |   | 21                                      |   | (46                                   | )      | 254 |   | (136 | ) |
| Comprehensive income (loss).                                     |   | $                                       | 1,654  |                                  | $      | 1,503 |   | $ | (1,096 | ) | $ | 3,185 |   |

 

**NOTE 10—SEGMENTINFORMATION**

 

Following the restructuring in the fourth quarter of fiscal 2003, theCompany has been managed through three reportable segments: Government BusinessProcess Outsourcing (“Government BPO”), Government Systems Integration(“Government SI”) and OPC.  Accordingly,the prior year amounts have been reclassified to conform to the current yearpresentation. The Government BPO segment provides transaction processingservices. The Government SI segment provides systems integration, licensing andmaintenance services.  The OPC segmentprovides transaction and payment processing services.  The Company evaluates the performance of its operating segmentsbased on net revenue and direct costs, while other operating costs areevaluated on a geographical basis. Accordingly, the Company does not include selling and marketingexpenses, general and administrative expenses, depreciation and amortizationexpense not attributable to state child support payment processing centers,interest income (expense), other income (expense) and income tax expense insegment profitability.  The table belowpresents financial information for the three reportable segments:

 
|                                        |   | **Government  BPO** |   | **Government  SI** |   | **OPC** |   | **Total** |   |
|---------------------------------------------|--------|---------------------|--------|--------------------|--------|---------|--------|-----------|--------|
|                                        |   | **(in thousands)**  |   |
| **Three Months Ended March 31, 2004:** |   |                |   |               |   |    |   |      |   |
| Net revenues                                |   | $                   | 11,899 |               | $      | 9,808   |   | $         | 7,952  |   | $ | 29,659 |   |
| Direct costs                                |   | 7,537               |   | 6,574              |   | 5,288   |   | 19,399    |   |
|                                        |   |                |   |               |   |    |   |      |   |
| **Three Months Ended March 31, 2003**  |   |                |   |               |   |    |   |      |   |
| Net revenues                                |   | 12,032              |   | 11,556             |   | $       | 6,577  |      | 30,165 |   |
| Direct costs                                |   | 7,072               |   | 8,156              |   | 4,522   |   | 19,750    |   |
|                                        |   |                |   |               |   |    |   |      |   |
| **Six Months Ended March 31, 2004:**   |   |                |   |               |   |    |   |      |   |
| Net revenues                                |   | 23,010              |   | 17,533             |   | 15,626  |   | 56,169    |   |
| Direct costs                                |   | 15,291              |   | 11,889             |   | 10,187  |   | 37,367    |   |
|                                        |   |                |   |               |   |    |   |      |   |
| **Six Months Ended March 31, 2003:**   |   |                |   |               |   |    |   |      |   |
| Net revenues                                |   | 23,854              |   | 22,696             |   | 12,702  |   | 59,252    |   |
| Direct costs                                |   | 13,831              |   | 15,991             |   | 8,493   |   | 38,315    |   |
|                                             |        |                     |        |                    |        |         |        |           |        |  |  |  |  |

 

12

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**NOTE 11—RESTRUCTURING**

 

During the fourth quarter of fiscal year 2003, the Company initiated astrategic review of its business units. This review was completed in the fourth quarter of fiscal year 2003 andthe Company decided to renew its focus on its core Government Servicesbusinesses while exiting 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 chargewas comprised of $18,197,000 of goodwill, intangible and tangible assetimpairment charges, $882,000 related to the closure of several offices (net ofestimated sublease 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 approximately20 employees were terminated during the three months ended September 30,2003 and the remaining employees were terminated during the three months endedDecember 31, 2003. Additional goodwill and asset impairment charges ofapproximately $887,000 were incurred for the six months ended March 31,2004, of which approximately $135,000 was included in restructuring charges andapproximately $752,000 was included in loss from discontinued operations.  Additional severance of approximately $1.7million was incurred for the six months ended March 31, 2004, of whichapproximately $903,000 resulted from the signing of a termination agreementwith the Company’s former Chief Executive Officer and was included inrestructuring charges and approximately $830,000 was included in loss from discontinuedoperations.  Additional severancecharges estimated at $552,000 are expected to be incurred in the third quarterof fiscal 2004.  The additionalseverance charge represents an estimate of the non-cash charge for themodification of the former Chief Executive Officer’s stock options terms,determined based on the price of the Company’s Class B common stock onApril 1, 2004.  Also included inrestructuring charges for the six months ended March 31, 2004 was $223,000related to estimated closure costs for one additional office (net of estimatedsublease income of $75,000).

 

As a result of the acquisition of OPC in July 2002, the Companyassumed certain liabilities for restructuring costs that OPC had previouslyrecognized in connection with the involuntary termination of employees and theconsolidation of facilities (net of estimated sublease income of $295,000). Theassumed severance liability included severance for 27 individuals and theclosing of certain office space.

 

At September 30, 2003, the Company had restructuring liabilitiestotaling $2,330,000 of which $656,000 was recorded in accrued liabilities,$668,000 was recorded in other long-term liabilities and $1,006,000 wasrecorded in liabilities of discontinued operations.  The following is a summary of the restructuring liabilities fromSeptember 30, 2002 through September 30, 2003 (in thousands):

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

 

At March 31, 2004, the Company had restructuring liabilitiestotaling $2,273,000, of which $985,000 was recorded in accrued liabilities,$857,000 was recorded in non-current other liabilities, $369,000 was includedin current liabilities of discontinued operations and $62,000 was recorded innon-current liabilities of discontinued operations. Approximately $614,000 ofthe non-current restructuring liability is expected to be paid in fiscal year2005 and the balance is expected to be paid in fiscal year 2006. The followingis a summary of the restructuring liabilities from September 30, 2003 toMarch 31, 2004 (in thousands):

 

13

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|                                             |   | **Liability  as of  September 30,  2003** |   | **Additions/  (Reductions)** |   | **Cash  Payments** |   | **Liability  as of  March 31,  2004** |   |
|--------------------------------------------------|--------|------------------------------------------------|--------|------------------------------|--------|--------------------|--------|--------------------------------------------|--------|
| Severance – OPC                             |   | $                                              | 1,133  |                         | $      | —             |   | $                                          | (246   | ) | $ | 887 |   |
| Facilities closure – OPC                    |   | 137                                            |   | 3⁄4                       |   | (40                | )      | 97                                         |   |
| Severance - fiscal 2003 plan                     |   | 3⁄4                                         |   | 903                          |   | (228               | )      | 675                                        |   |
| Facilities closure – fiscal 2003 plan       |   | 53                                             |   | 249                          |   | (119               | )      | 183                                        |   |
| Severance - discontinued operations              |   | 178                                            |   | 827                          |   | (965               | )      | 40                                         |   |
| Facilities closure – discontinuedoperations |   | 829                                            |   | (212                         | )      | (226               | )      | 391                                        |   |
|                                             |   | $                                              | 2,330  |                         | $      | 1,767              |   | $                                          | (1,824 | ) | $ | 2,273 |   |

 

**NOTE 12 —DISCONTINUED OPERATIONS**

 

During the quarter endedSeptember 30, 2003, the Company completed a strategic review of allbusiness units and began a restructuring plan which included exiting the U.S.Commercial Services segment and the United Kingdom Operations segment. Duringthe quarter ended December 31, 2003, the Company completed therestructuring and abandoned those businesses. Accordingly, the financial position, results of operations and cashflows of the U.S. Commercial Services and United Kingdom Operations segmentshave been reported as discontinued operations for each period presented.  The discontinued operations activity for thethree and six months ended March 31, 2004 included a reduction in theestimated facility closure charges as a result of renegotiating more favorablelease-buyout terms for one of the facilities. The discontinued operations activity for the three and six months endedMarch 31, 2003 represented the historical results of operations of thesediscontinued businesses.  AtMarch 31, 2004, the Company had net assets of discontinued operations ofapproximately $98,000 comprised of cash, accounts receivable, prepaid expenses,restructuring liabilities, and accounts payable and other accrued liabilities.

 

The operating results of thediscontinued operations are as follows:

 
|                                                             |   | **Three  Months Ended  March 31,** |   | **Six Months  Ended  March 31,** |   |
|------------------------------------------------------------------|--------|-----------------------------------------|--------|---------------------------------------|--------|
|                                                             |   | **2004**                                |   | **2003**                              |   | **2004** |   | **2003** |   |
|                                                             |   | **(in thousands)**                      |   |
|                                                             |   |                                    |   |                                  |   |   |   |   |   |
| Net revenues                                                     |   | $                                       | 56     |                                  | $      | 3,063 |   | $ | 1,727 |   | $ | 6,171 |   |
| Income (loss) from discontinued operations, net of  income taxes |   | $                                       | 164    |                                  | $      | 57 |   | $ | (1,401 | ) | $ | 316 |   |

 

**NOTE 13 -  LEGAL PROCEEDINGS**

 

In January 2004, the Company was served with a complaint filed byProfessional Services & Resources, Inc. (“PSRI”) in the Circuit Court inCole County, Missouri (*Professional Services & Resources, Inc. vs. TierTechnologies, Inc.,*Case No. 04CV323189).  PSRI alleged that the Company breached the subcontract agreementbetween the parties by hiring an employee of PSRI.  PSRI claimed damages of $100,000 for violation of the agreement,punitive damages, and attorney fees and costs associated with the action.  This matter was settled in March 2004and the Company recorded a charge for $27,000 in the six months endedMarch 31, 2004.

 

In December 2003, a complaint was filed in the U.S. District Courtfor the Northern District of California against the Company, its formerchairman of the board who formerly was its chief executive officer, anotherexecutive officer who formerly was its chief financial officer and a formerexecutive officer.  *Sperling v. Tier Technologies, Inc. et al*,case no. C03-05509VRW.  The complaintwas brought as a purported shareholder class action under Sections 10(b) and20(a)

 

14

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of the Securities Exchange Act of 1934 and Rule 10b-5 promulgatedthereunder and sought unspecified monetary damages on behalf of the shareholderclass.  The court dismissed thiscomplaint without prejudice in December 2003.

 

Also, in December 2003, a complaint was filed by a shareholder asa putative derivative action in California Superior Court for Contra CostaCounty. *Scala V. Bildner et al,*case no. C03-03077*.* Thederivative complaint named the same three officers, another current officer,some of the Company’s current directors and two former directors as defendantsand alleged breach of fiduciary duty, abuse of control, gross mismanagement,waste of corporate assets, unjust enrichment and violations of the CaliforniaCorporations Code.  The court dismissedthis complaint without prejudice in March 2004.

 

In November 2003, the Company filed a lawsuit in CaliforniaSuperior Court, Sacramento County, against CalPERS to overturn CalPERS’decision to terminate the contract relating to the Company’s systems integrationproject for CalPERS for default and to recover added costs associated with thatproject.  The Company seeks to recoverdamages and project delay, disruption and interference costs on the project.  In December 2003, CalPERS filed across-complaint against the Company and made a claim against the performancebond for this contract.  The parties areundertaking discovery and the Company intends to vigorously pursue its claimsand to defend against CalPERS’ cross-complaint.

 

In June 2003, the Company announced thatit had received a subpoena from a grand jury in the Southern District of NewYork to produce certain documents pursuant to an investigation involving thechild support payment processing industry by the United States Department ofJustice (“DOJ”), Antitrust Division. The Company has fully cooperated, and intends to continue to cooperatefully, with the subpoena and with the DOJ’s investigation.  On November 20, 2003, the DOJ grantedconditional amnesty to the Company pursuant to the Antitrust Division’sCorporate Leniency Policy. Consequently, the DOJ will not bring any criminal charges against theCompany, its officers, directors and employees, as long as the Companycontinues to comply with the Corporate Leniency Policy, which requires, amongother things, the Company’s full cooperation in the investigation andrestitution payments if it is determined that parties were injured as a resultof impermissible anti-competitive conduct. During the six months endedMarch 31, 2004, we incurred approximately $321,000 of legal costs tocomply with the subpoena which includes approximately $211,000 cost incurredunder indemnification agreements partially offset by a claim payment receivedfrom our insurance carrier for approximately $227,000.  Due to the preliminary nature of thegovernment’s inquiry, we are not able to assess the full impact on ourfinancial condition and results of operations.

 

In May 2003, we received a notice of demand for arbitration inconnection with a dispute over payments related to an acquisition.  This matter was settled and the Companyrecorded a charge of approximately $104,000 in the six months endedMarch 31, 2004.

 

**NOTE 14 -  SUBSEQUENT EVENTS**

 

In April 2004, the Company announcedthat it would be consolidating its Walnut Creek, California and Reston,Virginia offices by June 30, 2004. As part of the office consolidation, the Company will relocate theaccounting, financial planning, information technology, legal, human resourcesand facilities corporate functions to the Reston office and will close theWalnut Creek office.  The Companybelieves that the office consolidation will improve the efficiency of itsworkforce and reduce its cost structure. The Company anticipates that some members of the staff now resident inWalnut Creek will relocate to the Reston office as part of the officeconsolidation and that the Company will hire new staff for the Reston office toperform functions formerly carried out in Walnut Creek.  The Company estimates that it will incurrestructuring and other related pre-tax charges totaling approximately $3.5million in connection with the office consolidation.  The estimated charge is comprised of approximately $211,000 inseverance payments to employees who do not relocate to the Reston office, $2.2million in facility closure costs, net of estimated sublease income of$999,000, and $1.1 million in other charges related to the officeconsolidation.  The Company estimatesthat $3.2 million of these charges will be recorded in the quarter ending June 30,2004 and the remaining balance will be recorded in the quarter endingSeptember 30, 2004.

 

In April 2004, the Company acquired fromPublicBuy.net LLC, an e-procurement software solution and related assets thatstreamline the purchasing process for public procurement officials for $1.2million in cash.    The Company intendsto license this software as part of its suite of financial management softwareofferings.

 

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**ITEM2.****  MANAGEMENT’S****DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS**

 

**Overview**

 

We are a provider of transaction and paymentprocessing and packaged software and systems implementation services forfederal, state and local government clients. We combine our understanding of enterprise-wide systems with domainknowledge to formulate, evaluate and implement solutions that allow clients torapidly channel emerging technologies into their business operations. Ourworkforce, composed of employees, independent contractors and subcontractors,decreased to 754 on March 31, 2004 from 800 on March 31, 2003primarily due to the restructuring and discontinued operations.

 

Infiscal year 2003, we operated our business through four strategic businessunits:  U.S. Government Services, U.S.Commercial Services, OPC and United Kingdom Operations.  In the fourth quarter of fiscal year2003, we completed a strategic review of all business units and began arestructuring plan which renewed our focus on our core Government Servicesbusinesses while exiting other unprofitable or marginal business operations. As of December 31, 2003, we had exited the United Kingdom segment,the U.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 (“Government BPO”) business unit and the Government SystemsIntegration (“Government SI”) business unit. We intend to increase ourinvestment in business development in these areas to support future revenuegrowth.  Our Government BPOsegment includes our child support payment processing contracts, our health andhuman services consulting business, a District of Columbia child supportenforcement project and the Financial Institution Data Match contracts. Weexpect to see significant proposal activity in the child support paymentprocessing market over the next six months as we believe approximately fivestates intend to issue new requests for proposals. Our Government SI segmentincludes our pension contracts, unemployment insurance contracts, financialmanagement systems (“FMS”) contracts, our e-government contracts and the Stateof Missouri contracts.  We have shiftedour systems integration model from custom developed solutions to implementationand modification 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.

 

We derive net revenues primarily from transaction and paymentprocessing, systems design and integration, and maintenance and supportservices.  We bill clients on a  per-transaction basis, a fixed price basisor a time and materials basis.  Werecognize net revenues from transaction-based contracts based on fees chargedon a per-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 anddeterminable, collection is probable and vendor specific objective evidenceexists to determine the value of any undeliverable elements of thearrangement.  We recognize fixed pricenet revenues for other projects as services are provided and accepted by ourclients, if applicable.  We recognizetime and materials net revenues as we perform services and incur expenses. Netrevenues from software maintenance contracts are recognized ratably over theterm of the contract, typically one year. During the six months ended March 31, 2004, we generated 18.0% ofour net revenues on a fixed price basis and 62.8% of our net revenues on aper-transaction basis. We believe that the percentage of total net revenuesattributable to fixed price and per-transaction based contracts will continueto be significant. Substantially all of our contracts are terminable by theclient following limited notice and without significant penalty to the client.From time to time, in the regular course of our business, we negotiate themodification, termination, renewal or transition of time and materials, fixedprice and per-transaction based contracts that may involve an adjustment to thescope, duration or nature of  theproject, billing rates or price.  If wesignificantly overestimate the volume for transaction-based contracts orunderestimate the resources, costs or time required for fixed price orper-transaction based contracts, our financial condition and results ofoperations would be materially and adversely affected. Unsatisfactoryperformance of services or proprietary software or unanticipated difficultiesor delays in completing projects may result in client dissatisfaction and areduction in payment to us, termination of a contract, or payment of damages orpenalties by us as a result of litigation or otherwise, which could have a materialadverse effect upon our business, financial condition and results ofoperations.

 

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We have derived a significant portion of our net revenues from a smallnumber of large clients. For some of these clients, we perform a number ofdifferent projects pursuant to multiple contracts or purchase orders. For thesix months ended March 31, 2004, revenues from the State of Missouriaccounted for 10.1% of our total net revenues. We anticipate that a substantialportion of our net revenues will continue to be derived from a small numberof  large clients. The completion,cancellation or significant reduction in the scope of a large project wouldhave a material adverse effect on our business, financial condition and resultsof operations. In addition, we perform child support payment processingservices for three different state governments as a subcontractor to ACS Stateand Local Solutions, Inc. (“ACS”).  Forthe six months ended March 31, 2004, work performed under these threesubcontracts accounted for 13.6% of total net revenues.

 

Personnel, facility and depreciation and amortization expensesrepresent a significant percentage of our operating expenses and are relativelyfixed in advance of any particular quarter. We manage our personnel utilizationrates by carefully monitoring our needs and anticipating personnel increasesbased on specific project requirements. To the extent net revenues do notincrease at a rate commensurate with these additional expenses, our results ofoperations 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, financialcondition and results of operations would be materially and adversely affected.

 

From October 1, 2001 through March 31, 2004, we made threeacquisitions for a total cost of approximately $79.7 million using cash. Wealso incurred $1.0 million in cumulative compensation charges related tobusiness combinations and $1.3 million in cumulative business combinationintegration charges resulting from these acquisitions. Generally, we recordcontingent payments as additional goodwill at the time the payment can bedetermined beyond a reasonable doubt. If a contingent payment is based, inpart, on a seller’s continuing employment with us, the payments are recorded ascompensation expense under U.S. generally accepted accounting principles overthe vesting period when the amount is deemed probable.

 

In April 2004, we announced our intention to consolidate ourWalnut Creek, California and Reston, Virginia offices by June 30,2004.  As part of the officeconsolidation, we will relocate the accounting, financial planning, informationtechnology, legal, human resources and facilities corporate functions to theReston office and will close the Walnut Creek office.  We believe that the office consolidation will improve the efficiencyof our workforce and reduce our cost structure.  We anticipate that some members of the staff now resident inWalnut Creek will relocate to the Reston office as part of the officeconsolidation.  We estimate that we willincur restructuring and other related pre-tax charges totaling approximately$3.5 million in connection with the office consolidation.  The estimated charge is comprised ofapproximately $211,000 in severance payments to employees who do not relocateto the Reston office, $2.2 million in facility closure costs, net of estimatedsublease income of $999,000, and $1.1 million in other charges related to theoffice consolidation.  We estimate that$3.2 million of these charges will be recorded in the quarter endingJune 30, 2004 and the remaining balance will be recorded in the quarterending September 30, 2004.

 

# **Critical Accounting Policies and Estimates**

 

The discussion and analysis of our financial condition and results ofoperations are based upon our consolidated financial statements, which havebeen 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 our estimates, including thoserelated to revenue recognition, cost, collectibility of receivables, goodwilland intangible assets, income taxes, restructuring obligations and discontinuedoperations.  We base our estimates onhistorical experience and on various other assumptions that are believed to bereasonable under the circumstances.  Such experience and assumptions form the basis of judgments about thecarrying values of assets and liabilities that are not readily apparent fromother sources.  Actual results maydiffer from these estimates under different assumptions or conditions.

 

We believe the following critical accounting policies and the relatedjudgments and estimates significantly affect the preparation of ourconsolidated 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 

 

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presentation from the point of commitment to the point of actual disposalof the operations. During the quarter ended September 30, 2003, wecompleted a plan to exit the operations of our U.S. Commercial Servicessegment, our United Kingdom Operations segment and the Justice and PublicSafety and Strategies divisions within the U.S. Government Servicessegment.  Effective October 1,2003, the U.S. Government Services segment was split into  our Government BPO and Government SIsegments. During the quarter ended December 31, 2003, we exited the U.S.Commercial Services and United Kingdom Operations segments and the financialposition, results of the operations and cash flows of these components arereported as discontinued operations for each period in this report.  We must use our judgment to determinewhether particular operations are considered a component of the entity and whenthe operations have been disposed.

 

*Revenue Recognition.*  Certain judgments affect the application ofour revenue policy.  Our OPC andGovernment BPO segments generate transaction and payment processing revenues.Net revenues from transaction and payment processing contracts are generallyrecognized based on fees charged on a per-transaction basis or fees charged asa percentage 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 U.S. Government Services segment is approximately three years plus optionalclient renewals averaging approximately two and one-half years.  We use our historical experience andmathematical models to estimate transaction volumes.  We monitor volumes of transactions on a monthly basis.  Any significant variance from the estimatednumber of transactions or average transaction dollars processed couldsignificantly impact the resulting revenues and operating profit.  For example, our monthly transactions volumesat our child support payment processing centers varied between 107% and 93%from the average monthly volume during fiscal year 2003.  If the volume of transactions processed atall child support payment processing centers decreased 10% from the volumeprocessed during fiscal year 2003, our transaction processing revenues wouldhave decreased approximately $2.9 million. Additionally, if the average volumeof dollars processed by OPC for each payment type decreased 10% from theaverage volume processed by OPC for each payment type during fiscal year 2003,our transaction and payment processing revenues would have decreased byapproximately $3.7 million.

 

For OPC’s electronic payment transactions, we use judgment andhistorical experience to estimate sales returns and allowances attributable tocredit card reversals and chargebacks in determining net revenues. Whenestimating these reserves, we analyze historical trends, our specific customerexperience and current economic conditions. Within our OPC segment, on-linepayment processing revenues are generated by consumer payments.  Before OPC processes payment transactions,each consumer must agree to pay us a processing fee by making the appropriateselection on our web site or telephone system. Credit card reversal and chargebacks of convenience fees were $89,000and $61,000 or 0.6% and 0.5% of OPC net revenues for the six months endedMarch 31, 2004 and 2003, respectively.

 

Our Government SI segment generates systems design and integrationrevenues. Net license and services revenues from contracts involvingsignificant modification, customization or services which are essential to thefunctionality of the software are recognized using the percentage-of-completionmethod of accounting based upon the ratio of costs incurred to total estimatedproject costs.  The total estimated costis calculated using financial models and is based on our historical experienceand expected project time and effort. Any significant changes in total estimated costs could significantlyimpact the recognition of net revenue. We monitor the costs incurred and evaluate variances between budgetedand actual costs in our fixed price contracts on a monthly basis.  To the extent there are changes in the totalestimated costs, we adjust the percentage of revenues recognized.  For example, if the total estimated costs ofeach of our percentage-of-completion contracts in process as ofSeptember 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$126,000 and $39,000 for the six months ended March 31, 2004 and 2003,respectively.

 

Our Government SI segment also generates maintenance and supportservices revenues.  Net revenues fromsoftware 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 $8.8 million and $8.1 million for the six months endedMarch 31, 2004 and 2003, respectively.

 

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Generally our government contracts are subject to “fiscal funding”clauses, which entitle the client, in the event of budgetary constraints, toreduce or eliminate the services we are to provide, with a correspondingreduction in the fee the client must pay under the terms and conditions of theoriginal contract.  Net revenues arerecognized under such contracts only when we consider the likelihood ofcancellation of funding to be remote. For OPC, the consumer generally bears the transaction fee, not thegovernment entity, so OPC contracts are not generally subject to fiscal fundingissues.  For the six months endedMarch 31, 2004 and 2003, revenues recognized under contracts subject tofiscal funding clauses were 72.2% and 78.6%, respectively, of total netrevenues.

 

For all our segments, the amount and timing of our net revenue isdifficult to predict, and any shortfall in net revenue or delay in recognizingnet revenue could cause our operating results to vary significantly fromquarter to quarter and could result in future operating losses.

 

*Cost and Volume Estimates.*  For our transaction and payment processing,we establish the per-transaction fee or transaction fee percentage in ourclient contracts based on estimated future costs and estimates of transactionand dollar volume over the life of the contract.  Included in our cost estimates for certain child support paymentprocessing contracts are estimates regarding misapplied payments and paymentsthat are rejected due to insufficient funds to the extent we are to bear thesecosts. Actual misapplied payments and amounts for insufficient funds checks areheld as receivables until collected or written off, as deemed appropriate.  Included in our OPC 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 six months endedMarch 31, 2004 and 2003, expenses incurred by us related to misappliedpayments and insufficient funds checks were $660,000 and $329,000,respectively.

 

We recognize fixed price net revenues for our systems design andintegration projects using the percentage-of-completion method, based upon theratio of costs incurred to total estimated project costs.  Any significant changes in total estimatedproject costs could significantly affect our operating profit.

 

*Collectibility of Receivables.*  A considerable amount of judgment isrequired to assess the ultimate realization of receivables, including assessingthe probability 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 are rejecteddue to insufficient funds, and a sales return and allowance provision forreversals and chargebacks from consumers who use our credit or debit cardpayment services.  At March 31,2004 and September 30, 2003, the combined balance of the allowance accountswas $2.1 million and $1.8 million, respectively.   There is no assurance that we will not need to record increasesto these balances in the future.  Wehave several large accounts receivable and unbilled receivable balances, andany dispute, early contract termination or other collection issues could have amaterial adverse impact on our financial condition and results ofoperations.  For example, during thefourth quarter of fiscal year 2003, CalPERS terminated our systems integrationcontract. We subsequently filed a lawsuit seeking to recover costs anddamages.  As a result, we recorded acharge against revenues of $12.8 million to write down the total value ofunbilled receivables from CalPERS.  AtMarch 31, 2004, $8.1 million of our accounts receivable and $4.1 millionof our unbilled receivables balances were balances owed by seven clients foramounts greater than $1.0 million each.

 

*Goodwill and Other Intangible Assets.*  Consideration paid in connection withacquisitions is required to be allocated to the acquired assets, includingidentifiable intangible assets, and liabilities acquired.  Acquired assets and liabilities are recordedbased on our estimate of fair value, which requires significant judgment withrespect to future cash flows and discount rates.  We utilize historical experience as well as external specialiststo estimate fair value.  For intangibleassets, we are required to estimate the useful life of the asset or determineif it has an indefinite useful life.  Weuse our judgment to evaluate potential indicators of impairment of goodwill andother intangible assets.  Our judgmentsregarding the existence of impairment indicators are based on marketconditions, operational performance of our acquired businesses andidentification of reporting units. Future events could cause us to conclude that impairment indicatorsexist and that goodwill and other intangible assets associated with ouracquired businesses are impaired. Beginning October 1, 2002, we adopted Statement of Financial AccountingStandards No. 142 (“SFAS 142”) “Goodwill and Other Intangible Assets.”  Accordingly, our goodwill and otherintangible assets that have an indefinite useful life are not amortized butinstead are reviewed at least annually for impairment.  During the quarter ended March 31,2003, we completed the initial impairment test and the results did not indicateany impairment loss.  Impairment testsinvolve 

 

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the use of estimates related to the fair market value of the businessoperations with which goodwill is associated. During the fourth quarter of fiscal year 2003, we decided to shut downthe U.S. Commercial Services segment and the United Kingdom Operations segmentand accordingly recorded a  charge of$17.6 million to write down goodwill to its fair value as determined bycalculating the expected cash flows from the remaining contractual obligationsof those segments.  As ofSeptember 30, 2003, the remaining goodwill associated with these segments totaled$457,000.  This goodwill value waswritten off during the quarter ended December 31, 2003.  In the fourth quarter of fiscal year 2003,we performed our annual impairment test to determine if the remaining goodwillassociated with our continuing segments was impaired. Our estimate of fairvalue did not indicate any impairment. The fair market value of the remaining segments was determined usingforecasted future cash flows.  Thosecash flows were forecasted using significant assumptions including: futurerevenues and expenses, future growth rates and discount rates.  These growth rates are consistent with ourplans and experience.  If the discountrate used in these valuation models increased by 1%, the calculated fair valuewould decrease by 4.5%.

 

*Income Taxes.*  We are required to estimate our income taxesin each of the jurisdictions in which we operate as part of the process ofpreparing our consolidated financial statements.  This process involves estimating our actual current taxliability, including assessing temporary differences resulting from differingtax treatment of items, such as the difference in amortizable lives forintangible assets for tax and accounting purposes.  These differences result in deferred tax assets andliabilities.  At March 31, 2004 andSeptember 30, 2003, we had a net deferred tax asset of $23.2 million,comprised of net operating loss carryforwards, foreign tax credit carryforwardsand other deductible temporary differences, against which we are carrying a$23.2 million valuation allowance. Statement of Financial Accounting StandardsNo. 109 (“SFAS 109”) “Accounting for Income Taxes” requires that the deferredtax assets be reduced by a valuation allowance if, based on the weight ofavailable evidence, it is more likely than not that some portion or all of therecorded 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 valuation allowance until sufficientpositive evidence exists to support reversal of the valuation allowance.  Our income tax expense recorded in thefuture will be reduced to the extent of offsetting decreases in our valuationallowance.  In addition, the calculationof tax liabilities involves significant judgment in estimating the impact ofuncertainties in the application of complex tax laws.  Although we believe that our estimates are reasonable, resolutionof these uncertainties in a manner inconsistent with management’s expectationscould have a material impact on the Company’s financial position and cashflows.

 

*Determination of Restructuring Obligations*.  During the fourth quarter of fiscal 2003, werecorded a restructuring charge related to plans and actions taken to exitbusinesses, terminate employees and consolidate facilities.  During the quarter ended December 31,2003, we exited the former U.S. Commercial Services and United Kingdom segmentsand the financial position, results of operations and cash flows of thesebusinesses are reported as discontinued operations for each period.   Also, as a result of our acquisition of OPCin July 2002, we assumed certain liabilities for restructuring costs thatOPC had previously recognized in connection with the termination of employeesand the consolidation of facilities.  The restructuring liability forconsolidation of facilities is the estimated net obligation payable onabandoned office facilities.  Theestimated net obligation includes the gross obligation payable under existinglease agreements through estimated disposition dates, estimated costs ofabandonment or lease transfer, as offset by estimated sublease income.  Tothe extent we are unable to sublease or otherwise dispose of the facilities onthe dates estimated, or the estimated sublease income or estimated costs differfrom our estimates, the restructuring liability may requireadjustment.  As of March 31, 2004, we have sublet all thefacilities for which we have estimated sublease income.  At March 31, 2004 andSeptember 30, 2003, we had restructuring liabilities totalingapproximately $2.3 million for each period.

 

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**Results of Operations**

 

The following table summarizes our operating results as a percentage ofnet revenues for each of the periods indicated:

 
|                                                    |   | **Three  Months Ended  March 31,** |       | **Six Months  Ended  March 31,** |       |
|---------------------------------------------------------|--------|-----------------------------------------|------------|---------------------------------------|------------|
|                                                    |   | **2004**                                |       | **2003**                              |       | **2004** |   | **2003** |   |
|                                                    |   |                                    | ** ** |                                  | ** ** |   | ** ** |   | ** ** |
| Net revenues                                            |   | 100.0                                   | %          | 100.0                                 | %          | 100.0 | % | 100.0 | % |
| Costs and expenses:                                     |   |                                    |       |                                  |       |   |   |   |   |
| Direct costs                                            |   | 65.4                                    |       | 65.5                                  |       | 66.5 |   | 64.7 |   |
| Selling and marketing                                   |   | 5.9                                     |       | 4.7                                   |       | 5.6 |   | 4.8 |   |
| General and administrative                              |   | 21.2                                    |       | 18.0                                  |       | 22.4 |   | 18.9 |   |
| Restructuring charges                                   |   | —                                  |       | —                                |       | 2.3 |   | — |   |
| Depreciation and amortization                           |   | 3.8                                     |       | 4.6                                   |       | 4.0 |   | 4.7 |   |
| Income (loss) from continuing operations                |   | 3.7                                     |       | 7.2                                   |       | (0.8 | ) | 6.9 |   |
| Interest income (expense), net                          |   | 1.0                                     |       | 1.0                                   |       | 1.0 |   | 1.1 |   |
| Income from continuing operations before  income taxes  |   | 4.7                                     |       | 8.2                                   |       | 0.2 |   | 8.0 |   |
| Provision for income taxes                              |   | 0.1                                     |       | 3.2                                   |       | 0.1 |   | 3.0 |   |
| Income from continuing operations, net of  income taxes |   | 4.6                                     | %          | 5.0                                   | %          | 0.1 | % | 5.0 | % |

 

**Three Months EndedMarch 31, 2004 and March 31, 2003**

 

*Net Revenues.* We generate net revenues primarily from transaction and paymentprocessing services, software development services, and software license andmaintenance fees. The Government BPO segment provides systems design andintegration and transaction and payment processing services to federal, stateand local government entities in the United States. The Government SI segmentprovides systems design and integration services to state and local governmententities in the United States.  The OPCsegment provides transaction and payment processing services to clientsprimarily in the public sector. Net revenues decreased 1.7% to $29.7 millionfor the three months ended March 31, 2004 from $30.2 million in the threemonths ended March 31, 2003. This decrease resulted primarily from adecrease in  Government BPO net revenuesof approximately $133,000 and a decrease in Government SI net revenues ofapproximately $1.7 million, partially offset by an increase in OPC net revenuesof approximately $1.4 million.  Thefollowing table presents the net revenues for each of the three reportablesegments for the three months ended March 31, 2004 and 2003:

 

|           |   | **Three  months ended  March 31,** |   |
|----------------|--------|-----------------------------------------|--------|
|           |   | **2004**                                |   | **2003** |   |
|           |   | **(in thousands)**                      |   |
|           |   |                                    |   |   |   |
| Government BPO |   | $                                       | 11,899 |   | $ | 12,032 |   |
| Government SI  |   | 9,808                                   |   | 11,556 |   |
| OPC            |   | 7,952                                   |   | 6,577 |   |
| Total          |   | $                                       | 29,659 |   | $ | 30,165 |   |

 

The $133,000 decrease in Government BPO net revenues resulted primarilyfrom the winding down of one project that is expected to be completed in May2004. The $1.7 million decrease in Government SI net revenues resultedprimarily from a $3.3 million decrease in revenues from CalPERS as a result ofthe termination of the project due to a dispute with CalPERS, partially offset by increased revenue on onepension project begun in fiscal 2003 and growth in new practice areas,including unemployment insurance and e-Government, not included in the prioryear.  The $1.4 million increase in OPCnet revenues resulted primarily from an increase in adoption rates of OPCservices and the addition of new government clients and payment types.

 

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The following table presents net revenues for the three months endedMarch 31, 2004 and 2003 by delivery offering:

 

|                               |   | **Three  months ended  March 31,** |   |
|------------------------------------|--------|-----------------------------------------|--------|
|                               |   | **2004**                                |   | **2003** |   |
|                               |   | **(in thousands)**                      |   |
|                               |   |                                    |   |   |   |
| Transaction and payment processing |   | $                                       | 18,811 |   | $ | 17,486 |   |
| Systems design and integration     |   | 5,325                                   |   | 7,695 |   |
| Maintenance and support services   |   | 4,598                                   |   | 4,391 |   |
| Other                              |   | 925                                     |   | 593 |   |
| Total                              |   | $                                       | 29,659 |   | $ | 30,165 |   |

 

Net revenues from transaction and payment processing services increased7.6% to $18.8 million in the three months ended March 31, 2004 compared to$17.5 million in the three months ended March 31, 2003 primarily as aresult of the $1.4 million increase in OPC net revenues.  Net revenues from systems design andintegration services decreased 30.8% to $5.3 million in the three months endedMarch 31, 2004 compared to $7.7 million in the three months ended March 31,2003 primarily due to a $3.3 million reduction in revenues from CalPERS as aresult of the termination of the CalPERS contract, partially offset byincreased revenue on one pension project begun in fiscal 2003 and growth in newpractice areas, including unemployment insurance and e-Government, not includedin the prior year.  Net revenues frommaintenance and support services increased 4.7%  to $4.6 million in the three months ended March 31, 2004compared to $4.4 million in the three months ended March 31, 2003primarily as a result of increased revenues from one of our large clients.   Net revenues from other services increased56.0% to $925,000 in the three months ended March 31, 2004 compared to $593,000in the three months ended March 31, 2003.

 

Net revenues include reimbursements from clients for out-of-pocketexpenses.  Reimbursement and softwarelicense net revenues for each period represented were less than 10% of totalnet revenues for the respective period. We expect reimbursement revenues to increase in absolute dollars infuture periods primarily due to new contracts and future anticipated contractsprimarily in our child support payment processing operations.

 

*Direct Costs.*   Direct costs consist primarily of those costs directlyattributable to providing service to a client, including employee salaries andincentive compensation, independent contractor and subcontractor costs,employee benefits, payroll taxes, travel-related expenditures, amortization ofintellectual property, amortization and depreciation of any project-relatedequipment, hardware or software purchases, and the cost of hardware, softwareor equipment sold to clients.  For statechild support payment processing center operations, direct costs also includefacility, depreciation and amortization expense and direct overhead costs.  For OPC, direct costs consist primarily ofcredit and debit card discount fees, processing fees, telecommunication costsand other third party costs.  Directcosts include $518,000 of depreciation and amortization for the three monthsended March 31, 2004 and $568,000 for the three months endedMarch 31, 2003.  In total, directcosts decreased 1.8% to $19.4 million for the three months ended March 31,2004 from $19.8 million for the three months ended March 31, 2003.  This decrease resulted primarily from thedecrease in headcount resulting fromthe restructuring.

 

*Selling and Marketing.  *Sellingand marketing expenses consist primarily of personnel costs, sales commissions,advertising and marketing expenditures, and travel-related expenditures.Selling and marketing expenses increased 24.3% to $1.8 million for the threemonths ended March 31, 2004 from $1.4 million for the three months endedMarch 31, 2003.  As a percentage ofnet revenues, selling and marketing expenses increased to 5.9% for the threemonths ended March 31, 2004 from 4.7% for the three months endedMarch 31, 2003.  The increase inselling and marketing expenses for the three months ended March 31, 2004resulted primarily from increased advertising expenses as a result ofproduction costs for a new television commercial to advertise for OPC’supcoming tax season.  We expect sellingand marketing expenses for fiscal year 2004 to increase in absolute dollarscompared to fiscal year 2003 as a result of our investment in businessdevelopment.  We expect sales andmarketing expenses to fluctuate from quarter to quarter due to items such asincreased advertising and marketing expense as OPC prepares for theApril 15th 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, 

 

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client implementation, client service and customer service departments,staffing, accounting and finance, legal, facilities and information systems, aswell as business insurance costs, facility costs and professional fees relatedto legal, audit, tax, external financial reporting and investor relationsmatters. General and administrative expenses increased 15.9% to $6.3 millionfor the three months ended March 31, 2004 from $5.4 million for the threemonths ended March 31, 2003. As a percentage of net revenues, general andadministrative expenses increased to 21.2% for the three months endedMarch 31, 2004 from 18.0% for the three months ended March 31, 2003.The increase in general and administrative expenses resulted primarily from legaland other costs incurred related to the CalPERS terminated contract, increasedlegal fees related to the dismissed shareholder lawsuits, and increasedaccounting and other fees related to compliance with the Sarbanes-Oxley Act,partially offset by a decrease in OPC transition costs and the insurancereimbursement of DOJ legal fees.  Weexpect general and administrative expenses will increase in absolute dollarsfor fiscal year 2004 compared to fiscal year 2003 as a result of increasedinsurance premiums for directors and officers liability insurance, costs tocomply with the Sarbanes-Oxley Act, additional costs related to the terminatedCalPERS contract and the consolidation of our Walnut Creek and Reston offices.

 

*Restructuringcharges.***  **Restructuring charges were $5,000 and $0 forthe three months ended March 31, 2004 and 2003.  The restructuring charge for the three months endedMarch 31, 2004 represents a change in the estimate of facility closurecharges.  We expect to incuradditional charges of approximately $552,000 for the remainder of fiscal year2004 as a result of additional severance due to the modification of our formerChief Executive Officer’s stock options based on the price of our Class Bcommon stock on April 1, 2004.  Wealso expect to incur restructuring charges totaling approximately $2.4 millionin connection with the office consolidation. The estimated charge is comprised of approximately $211,000 in severancepayments to employees who do not relocate to the Reston office and $2.2 millionin facility closure costs, net of estimated sublease income of $999,000.

 

*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 20.2% to  $1.1 million for the three months endedMarch 31, 2004 from $1.4 million for the three months ended March 31,2003. As a percentage of net revenues, depreciation and amortization decreasedto 3.8% for the three months ended March 31, 2004 from 4.6% for the threemonths ended March 31, 2003.  Thedecrease in depreciation and amortization resulted primarily from decreasedcapital expenditures.

 

*Interest Income  (Expense), Net.*   Net interest income decreased 1.0% to$293,000 for the three months ended March 31, 2004 from $296,000 for thethree months ended March 31, 2003. This decrease was primarily attributable to lower investment balancesand lower interest rates in the current year.

 

*Provision  for Income Taxes.* The provision for income taxes was $35,000for the three months ended March 31, 2004 and $955,000 for the threemonths ended March 31, 2003.  Theprovision for income taxes for the three months ended March 31, 2004represents the expected minimum state tax payments.  No tax benefit on the net loss was recorded due to the fullvaluation allowance on our net deferred tax assets.  Our effective tax rate was 38.5% for the three months endedMarch 31, 2003.  The effective taxrate in the upcoming quarters and for the year ending September 30, 2004may vary due to a variety of factors, including, but not limited to, therelative income contribution by tax jurisdiction, changes in statutory taxrates, the amount of tax exempt interest income generated during the year, theability to utilize foreign tax credits and foreign net operating losses, andany non-deductible items related to acquisitions or other nonrecurring charges.We will continue to monitor the effective tax rate on a quarterly basis.

 

*Discontinuedoperations.*   The income from discontinued operations,net of income taxes was $164,000 and $57,000 for the three months endedMarch 31, 2004 and 2003, respectively. The income from discontinued operations for the three months endedMarch 31, 2004 resulted primarily from a reduction in the estimatedfacility closure charges as a result of renegotiating more favorablelease-buyout terms for one of the facilities. The income from discontinued operations for the three months endedMarch 31, 2003, net of income taxes represents the historical operatingresults of our discontinued U.S. Commercial Services and United Kingdomsegments.

 

**Six Months EndedMarch 31, 2004 and March 31, 2003**

 

*Net Revenues.* Net revenues decreased 5.2% to $56.2 million for the six months endedMarch 31, 2004 from $59.3 million in the six months ended March 31,2003. This decrease resulted primarily from a decrease in Government BPO netrevenues of approximately $844,000 and a decrease in Government SI net revenuesof 

 

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approximately $5.2 million, partially offset by an increase in OPC netrevenues of approximately $2.9 million. The following table presents the net revenues for each of the threereportable segments for the six months ended March 31, 2004 and 2003:

 

|           |   | **Six months  ended  March 31,** |   |
|----------------|--------|---------------------------------------|--------|
|           |   | **2004**                              |   | **2003** |   |
|           |   | **(in thousands)**                    |   |
|           |   |                                  |   |   |   |
| Government BPO |   | $                                     | 23,010 |   | $ | 23,854 |   |
| Government SI  |   | 17,533                                |   | 22,696 |   |
| OPC            |   | 15,626                                |   | 12,702 |   |
| Total          |   | $                                     | 56,169 |   | $ | 59,252 |   |

 

The $844,000 decrease in Government BPO net revenues resulted primarilyfrom the winding down of one project that is expected to be completed in May2004. The $5.2 million decrease in Government SI net revenues resultedprimarily from a $6.6 million decrease in revenues from CalPERS as a result ofthe termination of the project due to a dispute with CalPERS, partially offset by increased revenue on onepension project begun in fiscal 2003 and growth in new practice areas,including unemployment insurance and e-Government, not included in the prioryear.  The $2.9 million increase in OPCnet revenues resulted primarily from an increase in adoption rates of OPCservices and the addition of new government clients and payment types.

 

The following table presents net revenues for the six months endedMarch 31, 2004 and 2003 by delivery offering:

 

|                               |   | **Six months  ended  March 31,** |   |
|------------------------------------|--------|---------------------------------------|--------|
|                               |   | **2004**                              |   | **2003** |   |
|                               |   | **(in thousands)**                    |   |
|                               |   |                                  |   |   |   |
| Transaction and payment processing |   | $                                     | 37,137 |   | $ | 33,696 |   |
| Systems design and integration     |   | 9,033                                 |   | 16,394 |   |
| Maintenance and support services   |   | 8,806                                 |   | 8,079 |   |
| Other                              |   | 1,193                                 |   | 1,083 |   |
| Total                              |   | $                                     | 56,169 |   | $ | 59,252 |   |

 

Net revenues from transaction and payment processing services increased10.2% to $37.1 million in the six months ended March 31, 2004 compared to$33.7 million in the six months ended March 31, 2003 primarily as a resultof the $2.9 million increase in OPC net revenues as well as approximately $1.4million in net revenues from one new child support payment processing contract inour Government BPO segment, partially offset by a $962,000 decrease in revenuesfrom the loss of one child support payment processing center contract.  Net revenues from systems design andintegration services decreased 44.9% to $9.0 million in the six months endedMarch 31, 2004 compared to $16.4 million in the six months endedMarch 31, 2003 primarily due to a $6.6 million reduction in revenues fromCalPERS as a result of the termination of the CalPERS contract and decreasedrevenues of $1.3 million due to the winding down of one project that isexpected to be completed in May 2004. Net revenues from maintenance and support services increased 9.0% to$8.8 million in the six months ended March 31, 2004 compared to $8.1million in the six months ended March 31, 2003 primarily as a result ofincreased revenues from one of our large clients.   Net revenues from other services increased 10.2% to $1.2 millionin the six months ended March 31, 2004 compared to $1.1 million in the sixmonths ended March 31, 2003.

 

Reimbursement and software license net revenues for each periodrepresented were less than 10% of total net revenues for the respectiveperiod.  We expect reimbursementrevenues to increase in absolute dollars in future periods primarily due to newcontracts and future anticipated contracts primarily in our child supportpayment processing operations.

 

*Direct Costs.*   Direct costs decreased 2.5% to $37.4 million for the six monthsended March 31, 2004 from $38.3 million for the six months endedMarch 31, 2003.  This decreaseresulted primarily from the decrease in 

 

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headcount as a result of the restructuring.**Direct costs include $1.0million of depreciation and amortization for the six months endedMarch 31, 2004 and $1.1 million for the six months ended March 31,2003.

 

*Selling and Marketing.  *Sellingand marketing expenses increased 9.8% to $3.1 million for the six months endedMarch 31, 2004 from $2.9 million for the six months ended March 31,2003.  As a percentage of net revenues,selling and marketing expenses increased to 5.6% for the six months endedMarch 31, 2004 from 4.8% for the six months ended March 31,2003.  The increase in selling andmarketing expenses for the six months ended March 31, 2004 resultedprimarily from increased advertising expenses for OPC.  We expect selling and marketing expenses forfiscal year 2004 to increase in absolute dollars compared to fiscal year 2003as a result of our investment in business development.  We expect sales and marketing expenses tofluctuate from quarter to quarter due to items such as increased advertisingand marketing expense as OPC prepares for the April 15th taxseason.

 

*General and Administrative.*   General and administrative expensesincreased 12.3% to $12.6 million for the six months ended March 31, 2004from $11.2 million for the six months ended March 31, 2003. As apercentage of net revenues, general and administrative expenses increased to22.4% for the six months ended March 31, 2004 from 18.9% for the sixmonths ended March 31, 2003. The increase in general and administrativeexpenses resulted primarily from legal and other costs incurred of $692,000related to the terminated CalPERS contract, increased legal fees related to thedismissed shareholder lawsuits, and increased accounting and other fees relatedto compliance with the Sarbanes-Oxley Act, partially offset by a decrease inOPC transition costs and the insurance reimbursement of DOJ legal fees.  We expect general and administrative expenseswill increase in absolute dollars for fiscal year 2004 compared to fiscal year2003 as a result of increased insurance premiums for directors and officersliability insurance and costs to comply with the Sarbanes-Oxley Act.

 

*Restructuringcharges.   *The following table presents therestructuring charges for the six months ended March 31, 2004 and 2003:

 

|                                                |   | **Six months  ended  March 31,** |   |
|-----------------------------------------------------|--------|---------------------------------------|--------|
|                                                |   | **2004**                              |   | **2003** |   |
|                                                |   | **(in thousands)**                    |   |
|                                                |   |                                  |   |   |   |
| Assets impairment charge                            |   | $                                     | 135    |   | $ | — |   |
| Severance charge resulting from restructuring       |   | 903                                   |   | 3⁄4 |   |
| Office closure charge resulting from  restructuring |   | 223                                   |   | 3⁄4 |   |
| Total                                               |   | $                                     | 1,261  |   | $ | 3⁄4 |   |

 

During the six months ended March 31, 2004, we recorded assetimpairment charges of $135,000 resulting from assets written off due to anoffice closure.   The severance chargeof $903,000 represents additional severance costs resulting from the signing ofa termination agreement with our former Chief Executive Officer.  The office closure charge of $223,000represents costs incurred for the closure of one office (net of estimatedsublease income of $75,000).  We expectto incur additional charges of approximately $552,000 for the remainder offiscal year 2004 as a result of additional severance due to the modification ofour former Chief Executive Officer’s stock options based on the price of ourClass B common stock on April 1, 2004. We also expect to incur restructuring charges totaling approximately$2.4 million in connection with the office consolidation.  The estimated charge is comprised of approximately$211,000 in severance payments to employees who do not relocate to the Restonoffice and $2.2 million in facility closure costs, net of estimated subleaseincome of $999,000.

 

*Depreciation and Amortization.*   Depreciation and amortization decreased19.1% to  $2.2 million for the sixmonths ended March 31, 2004 from $2.8 million for the six months endedMarch 31, 2003. As a percentage of net revenues, depreciation andamortization decreased to 4.0% for the six months ended March 31, 2004from 4.7% for the six months ended March 31, 2003.  The decrease in depreciation andamortization resulted primarily from decreased capital expenditures.

 

*Interest Income  (Expense), Net.*   Net interest income decreased 15.4% to$570,000 for the six months ended March 31, 2004 compared to net interestincome of $674,000 for the six months ended March 31, 2003.  This decrease was primarily attributable tolower investment balances and lower interest rates in the current year.

 

*Provision  for Income Taxes.* The provision for income taxes was $70,000for the six months ended March 31, 2004 and $1.8 million for the sixmonths ended March 31, 2003.  Theprovision for income taxes for the six months ended March 31, 2004represents the expected minimum state tax payments.  No tax benefit on the net loss was 

 

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recorded due to the full valuation allowance on our net deferred taxassets.  Our effective tax rate was37.5% for the six months ended March 31, 2003.  The effective tax rate in the upcoming quarters and for the yearending September 30, 2004 may vary due to a variety of factors, including,but not limited to, the relative income contribution by tax jurisdiction,changes in statutory tax rates, the amount of tax exempt interest incomegenerated during the year, the ability to utilize foreign tax credits andforeign net operating losses, and any non-deductible items related toacquisitions or other nonrecurring charges. We will continue to monitor theeffective tax rate on a quarterly basis.

 

*Discontinuedoperations.*   The loss from discontinued operations, netof income taxes was $1.4 million for the six months ended March 31, 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 discontinued operations, net ofincome taxes was $316,000 for the six months ended March 31, 2003 andrepresents the historical results of operations of the discontinued segments.

 

**Liquidity and CapitalResources**

 

Our principal capital requirement is to fund working capital to supportour growth, including potential future acquisitions and potential contingentpayments due to prior acquisitions.  Wemaintain a $15.0 million revolving credit facility that expires onJanuary 31, 2005, of which $15.0 million may be used for letters ofcredit.  The credit facility bearsinterest at the adjusted LIBOR rate plus 2.5% or the lender’s announced primerate plus 0.25%, at our option. The credit facility is collateralized by firstpriority liens and security interests in our assets. The credit facilitycontains certain restrictive covenants including, but not limited to,limitations on the amount of loans we may extend to officers and employees, thepayment of dividends, the repurchase of common stock and the incurrence ofadditional debt.  The credit facilityrequires the  maintenance of certainfinancial covenants, including a minimum quarterly net income requirement,minimum tangible net worth, a minimum ratio of debt to tangible net worth and aminimum ratio of liquid assets to current liabilities.  As of March 31, 2004, we were incompliance with all the covenants of the credit facility.

 

In addition to the credit facility mentioned above, we had letters ofcredit totaling approximately $3,396,000, which were collateralized by certainsecurities in our long-term investment portfolio at March 31, 2004.  Furthermore, our subsidiary, OPC, had aletter of credit outstanding in the amount of approximately $138,000 secured bya certificate of deposit.  These lettersof credit were issued to secure performance bonds and to meet various facilitylease requirements.

 

Net cash from continuing operations provided by operating activitieswas $17.2 million and $653,000 in the six months ended March 31, 2004 and2003, respectively. The increase in net cash from continuing operationsprovided by operating activities is largely attributable to the receipt ofapproximately $6.9 million of income tax refunds and  increased accounts receivable collections.

 

Net cash from continuing operations provided by investing activitieswas $4.7 million and $1.3 million in the six months ended March 31, 2004and 2003, respectively. The increase in net cash from continuing operationsused in investing activities is primarily attributable to the maturity ofinvestments in the six months ended March 31, 2004.

 

Capital expenditures, including equipment and software acquired underfinancing arrangements but excluding assets acquired or leased through businesscombinations, were approximately $908,000 in the six months endedMarch 31, 2004 and $1.1 million in the six months ended March 31, 2003.  We anticipate that in fiscal year 2004, wewill have capital expenditures similar to fiscal year 2003 related to, amongother things, purchases of computer equipment to enhance our operations andsupport our growth, as well as potential expenditures related to new officeleases and the establishment or expansion of child support payment processingand other transaction processing centers.

 

Net cash from continuing operations provided by financing activitiestotaled $1.1 million in the six months ended March 31, 2004 as compared tonet cash used in financing activities of $6.0 million in the six months ended March 31, 2003.  The net cash from continuing operationsprovided by financing activities for the six months ended March 31, 2004resulted primarily from the exercise of employee stock options.  The net cash used in financing activitiesfor the six months ended March 31, 2003 resulted primarily from therepurchase of shares of our Class B common stock.

 

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We expect to generate cash flows from operating activities over thelong-term; however, we may experience significant fluctuations from quarter toquarter resulting from the timing of the billing and collection of largeproject milestones, particularly for our pension software systemsprojects.  We anticipate that ourexisting capital resources, including our cash balances, cash that weanticipate will be provided by operating activities and our available creditfacilities, 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 capital resources depend on numerousfactors, including potential acquisitions; contingent payments earned; new andexisting contract requirements; the timing of the receipt of accountsreceivable, including unbilled receivables; legal costs incurred to comply withthe DOJ investigation; legal costs incurred arising out of our dispute withCalPERS; the timing and ability to sell investment securities held in ourportfolio without a loss of principal; our ability to draw on our bank facilityand employee growth.  To the extent thatour existing capital resources are insufficient to meet our capitalrequirements, we will have to raise additional funds. There can be no assurancethat additional funding, if necessary, will be available on favorable terms, ifat all.  The raising of additional capitalmay dilute our shareholders’ ownership in us.

 

During the fourth quarter of fiscal 2003, we initiated a strategicreview of our business units.  Thisreview was completed in the fourth quarter of fiscal 2003, and we decided torenew our focus on our core Government Services businesses while exitingunprofitable or marginal business operations. As a result of this review, we recorded restructuring charges ofapproximately $19.8 million during the quarter 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 the closure of several offices (net of estimated subleaseincome of $115,000) and $707,000 of severance related to the termination ofemployees in the exited businesses, of which $529,000 was paid in fiscal year2003.  The restructuring plan includedthe termination of approximately 50 employees, of which approximately 20employees were terminated in the three months ended September 30, 2003 andthe remaining employees were terminated in the three months endedDecember 31, 2003. Additional goodwill and intangible asset impairmentcharges of approximately $887,000 were incurred for the six months endedMarch 31, 2004, of which approximately $135,000 was included in restructuringand other charges and approximately $752,000 was included in loss fromdiscontinued operations.  Additionalseverance of $1.7 million, of which approximately $903,000 resulted from thesigning of a termination agreement with our former chief executive officer andwas included in restructuring and other charges and approximately $830,000 wasincluded in loss from discontinued operations. Also included in restructuring and other charges for the six monthsended March 31, 2004 was $223,000 related to estimated closure costs forone additional office (net of estimated sublease income of $75,000).  As a result of the restructuring, we expectsalary costs to be reduced by approximately $6.3 million and facility costs tobe reduced by approximately $475,000 in fiscal year 2004.

 

As a result of the acquisition of OPC in July 2002, we assumedcertain liabilities for restructuring costs that OPC had previously recognizedin connection with the involuntary termination of employees of $2.7 million andthe consolidation of facilities of $546,000 (net of estimated sublease incomeof $295,000). The assumed severance liability included severance for 27individuals and the closing of certain office space.

 

During the six months ended March 31, 2004, we made total cashpayments of $1.4 million for severance and $385,000 for facilities. Additionalseverance charges of approximately $552,000 are expected to be incurred in thethird quarter of fiscal 2004.  Theadditional severance charge represents an estimate of the non-cash charge forthe modification of our former Chief Executive Officer’s stock options termsbased on the price of our Class B common stock on April 1, 2004.

 

In April 2004, we announced our intention to consolidate ourWalnut Creek, California and Reston, Virginia offices by June 30,2004.  As part of the officeconsolidation, we will relocate the accounting, financial planning, informationtechnology, legal, human resources and facilities corporate functions to the Restonoffice and will close the Walnut Creek office. We believe that the office consolidation will improve the efficiency ofour workforce and reduce our cost structure. We anticipate that some members of the staff now resident in WalnutCreek will relocate to the Reston office as part of the office consolidationand we will hire new staff for the Reston office to perform functions formerlycarried out in Walnut Creek. We estimate that we will incur a one-timerestructuring and other related pre-tax charges of $3.5 million in connectionwith the office consolidation. The estimated charge is comprised ofapproximately $211,000 in severance payments to employees who do not relocateto the Reston office, $2.2 million in facility closure costs, net of estimatedsublease income of $999,000, and $1.1 million in other charges related to theoffice consolidation.  The Companyestimates that $3.2 million of these charges will be recorded in the quarterending June 30, 2004 and the remaining balance will be recorded in the quarterending September 30, 2004.

 

Due to the current economic climate, the performance bond market hassubstantially changed, resulting in reduced availability of bonds, increasedcash collateral requirements and increased premiums.  Some of our government contracts require a performance bond andfuture requests for proposal may also require a performance bond.  Our inability to obtain performance bonds,increased costs to obtain such bonds or a requirement to pledge significantcash collateral in 

 

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order to obtain such bonds would adversely affect our business and ourcapacity to obtain additional contracts. Increased premiums or a claim made against a performance bond couldadversely affect our earnings and cash flow and impair our ability to bid forfuture contracts.

 

**Disclosures About Contractual Obligations andCommercial Commitments as of March 31, 2004**

 

As of March 31, 2004, we had not entered into any derivativetransactions and we had the following obligations and commitments to make futurepayments under contracts, contractual obligations and commercial commitments(in thousands):

 
|                             |   | **Payments  due by period** |   |
|----------------------------------|--------|-----------------------------|--------|
| **Contractual Cash Obligations** |   | **Total**                   |   | **Less than  1 year** |   | **2 –3 years** |   | **4 –5 years** |   | **After 5  years** |   |
| Debt, including interest         |   | $                           | 179    |   | $ | 138 |   | $ | 41 |   | $ | — |   | $ | — |   |
| Operating leases                 |   | 7,415                       |   | 2,985 |   | 3,040 |   | 1,251 |   | 139 |   |
| Restructuring liability          |   | 2,273                       |   | 1,354 |   | 919 |   | — |   | — |   |
| Total                            |   | $                           | 9,867  |   | $ | 4,477 |   | $ | 4,000 |   | $ | 1,251 |   | $ | 139 |   |

 
|                             |   | **Amount of  commitment expiration per period** |   |
|----------------------------------|--------|-------------------------------------------------|--------|
| **Other Commercial Commitments** |   | **Total  amounts  committed**                   |   | **Less than  1 year** |   | **2 – 3  years** |   | **4 –5 years** |   | **After 5  years** |   |
| Standby letters of credit        |   | $                                               | 3,534  |   | $ | 3,000 |   | $ | 289 |   | $ | — |   | $ | 245 |   |
| Performance bonds                |   | 36,450                                          |   | 31,719 |   | 4,731 |   | — |   | — |   |
| Total                            |   | $                                               | 39,984 |   | $ | 34,719 |   | $ | 5,020 |   | $ | — |   | $ | 245 |   |

 

**Factors That MayAffect Future Results**

 

The following factors and other risk factors could cause our actualresults to differ materially from those contained in forward-looking statementsin this Form 10-Q.

 

**Our quarterly net revenues,operating results and cash flows are volatile, may fluctuate significantly fromquarter to quarter and may be difficult to forecast, which may cause the marketprice of our Class B common stock to decline.**

 

Our net revenues, operating results and cash flows are subject tosignificant variation from quarter to quarter due to a number of factors, manyof which are outside our control.  Amongother 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 OPC’s payment processing center operations;

 

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•                  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; and

 

•                  estimates madefor restructuring liabilities.

 

The timing and realization of opportunities in our sales pipeline makethe timing and variability of net revenues difficult to forecast. A highpercentage of our operating expenses, particularly personnel, facility anddepreciation and amortization, are fixed in advance. Because of the variabilityof our quarterly operating results, we believe that period-to-periodcomparisons of our operating results are not necessarily meaningful, should notbe relied upon as indications of future performance and may result involatility and declines in the price of our Class B common stock. In addition,our operating results may from time to time fall below the expectations ofanalysts and investors. If so, the market price of our Class B commonstock may decline significantly.

 

As discussed in Note 6 to our Condensed Consolidated FinancialStatements, 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 withwhich goodwill is associated.  If we donot meet 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 offiscal year 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.  No additional impairment resulted.  At March 31, 2004, we had goodwill of $29.6 million andother intangibles of $23.3 million.  Anyresulting impairment loss could have a material adverse impact on our financialcondition and results of operations.

 

**We rely on smallnumbers of projects, customers and target markets for significant portions ofour net revenues, and our operating results and cash flows may declinesignificantly if we cannot keep or replace these projects or clients or ifconditions in our target markets deteriorate.**

 

We have derived, and believe that we willcontinue to derive, a significant portion of our net revenues from a limitednumber of clients. The completion or cancellation of a large project or asignificant reduction in its scope would significantly reduce our net revenuesand cash flows. Most of our contracts are terminable by the client followinglimited notice and without significant penalty to the client. If any of ourlarge clients or prime contractors terminates its relationship with us, we willlose a significant portion of our net revenues and cash flows. In the fourthfiscal quarter of 

 

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fiscal 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 six months ended March 31, 2004,our top ten clients represented 56.5% of our total net revenues and the Stateof Missouri accounted for 10.1% of our total net revenues. Revenues fromfederal taxpayers accounted for 23.0% of OPC’s net revenues.  The existing contract with the IRS allowsthe IRS to terminate OPC’s services at any time for any or no reason. Eventhough our net revenues are not funded by the IRS, the loss of the IRS as aclient, or a decrease in IRS-related transactions because of increasedcompetition from another IRS-authorized service provider, would result in areduction in our net revenues and cash flows.

 

We currently perform services for threedifferent state governments as a subcontractor to ACS. For the six months endedMarch 31, 2004, work performed under these three subcontracts accountedfor 13.6% of total net revenues. The volume of work performed for specificclients or prime contractors is likely to vary from period to period, and aclient or prime contractor in one period may not use our services in asubsequent period. For example, although our agreement with ACS contemplatedthat we would jointly pursue a request for proposal for child supportprocessing for the state of California, the two companies have mutually decidednot to pursue this proposal jointly. We intend to pursue the opportunity withanother partner.  As a result of thedecision to pursue the opportunity with another partner, we cannot predict ifthis will affect the three subcontracts under our existing relationship withACS or the future revenue associated with those subcontracts.  The loss of revenues from those subcontractscould adversely affect future operating results and cash flows.

 

As a result of our focus in specific markets,economic and other conditions that affect the companies and government agenciesin these markets could also result in a reduction in our net revenues and cashflows. Because we derive a significant portion of our net revenues from alimited number of clients, we have several large accounts receivable andunbilled receivable balances. At March 31, 2004, unbilled receivables fortwo clients accounted for 45.3% and 33.7% of total unbilled receivables. AtMarch 31, 2004, total accounts receivable and unbilled receivables, forthese two clients accounted for 17.7% and 9.7%, respectively, of total netaccounts receivable and unbilled receivables. Any dispute, early contracttermination or other collection issues could have a material adverse impact onour 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.

 

**Our operating resultsmay be adversely affected if we fail to accurately estimate the resourcesnecessary to meet our obligations under fixed price contracts or the volume oftransactions or transaction dollars processed under our transaction-basedcontracts.**

 

Underestimating the resources, costs or time required for a fixed priceproject or a transaction-based contract or overestimating the expected volumeof transactions or transaction dollars processed under a transaction-basedcontract would cause our costs under fixed price contracts to be greater thanexpected and our fees under transaction-based contracts to be less thanexpected, and our related profit, if any, to be less. Under fixed pricecontracts, we generally receive our fee if we meet specified deliverables suchas 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 thefactors upon which we base our contract pricing, or we are unable tosuccessfully obtain change orders, we may incur losses on those contracts or beunable to complete our performance obligations. During the quarter ended March 31, 2004, 18.0% of our netrevenues were generated on a fixed price basis and 62.8% 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 economic climate couldadversely affect our net revenues and cash flows.**

 

There are some parts of our business that experience increasing pricingpressures from competitors as well as from clients facing pressure to controlcosts.  We continue to see clientsreduce or defer their expenditures or defer the start of work alreadycontracted.  Some of our competitors arecapable of operating at significant losses for extended periods of 

 

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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 to competitive pressures, welower the prices of our products and services. If we are unable to reduce our costs or improve operating efficiencieswhen we offer such lower prices, our net revenues and margins will be adverselyaffected.

 

OPC’s net revenues are generated primarily based on convenience feescharged as a percentage of dollars processed for income taxes and otherpayments.  Income taxes are dependent onthe amount of income earned by taxpaying citizens and the prevailing taxrates.  A decline in economic conditionscould reduce the per capita income of citizens, and thus reduce the amount ofincome tax payments consumers remit to government entities, which may reduceOPC’s revenues from convenience fees.  Areduction in income tax rates may also reduce the amount of income tax paymentsconsumers remit to government entities, which may reduce OPC’s revenues fromconvenience fees. In addition, a decline in the economy may result in areduction in consumer spending, particularly for non-essential goods andservices, which may result in a reduction in consumers’ use of OPC’s services.  If the economy declines, our results ofoperations and cash flows could be adversely affected.

 

**We depend ongovernment agencies for our net revenues and the loss or decline of existing orfuture government agency funding would adversely affect our net revenues andcash flows.**

 

For the six months ended March 31, 2004, approximately 38.3% ofour net revenues were derived from federally mandated and primarily federallyfunded child support transaction processing services fees and approximately27.8% of our net revenues were derived from convenience fees earned by OPC withrespect to payments made by constituents to government agencies.  The balance of our net revenues was derivedfrom other services provided to government agencies.  Some of these net revenues, particularly our FMS and State ofMissouri contracts, may be subject to state and local government agencyspending fluctuations. These government agencies may be subject to budget cuts,budgetary constraints, a reduction or discontinuation of funding or changes inthe political or regulatory environment that may cause government agencies toterminate projects, divert funds or delay implementation. These governmentagencies may terminate most of these contracts at any time without cause.  In addition, revisions to or repeals ofmandated statutes and regulations, including changes to the timing of requiredcompliance, may cause government agencies to divert funds. A significantreduction in funds available for government agencies to purchase professionalservices or business solutions would significantly reduce our net revenues andcash flows. The loss of a major government client, or any significant reductionor delay in orders by that client, would also significantly reduce our netrevenues and cash flows. Additionally, government contracts are generallysubject 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 is continuing toevolve, it is difficult to evaluate OPC’s business.**

 

At the end of July 2002, we acquired OPC, which has a history oflosses. Although OPC has cumulatively increased revenues since the acquisitionand has reduced certain operating expenses as we integrated this acquisition,there can be no assurance that OPC will attain and maintain profitability inthe future.

 

The use of credit and debit cards and electronic checks to makepayments to government agencies is still relatively new and evolving.  To date, OPC’s business has consistedprimarily of providing credit and debit card payment options for the payment offederal and state personal income taxes, real estate and personal propertytaxes, 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. There can be no assurances that we will be able to develop new OPCrelationships or maintain existing OPC relationships, and the failure to do socould have a material and adverse effect on our business, operating results andfinancial condition.  In addition, ifconsumers are not receptive to paying a convenience fee, if card associationschange their rules and do not allow us to charge the convenience fees, or if creditor debit card issuers eliminate or reduce the value of rewards obtained undertheir respective rewards programs, demand for 

 

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OPC’s services will decline or fail to grow, which would have a materialand adverse effect on our business, operating results and financial condition.OPC is charged processing fees by its credit/debit card partners and financialinstitutions for processing payments. The processing fees OPC is charged can bechanged with little or no notice. Any increase in the fees charged to OPC mayhave a material adverse impact on our business, operating results and financialconditions.

 

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

 

Demand for OPC’s services would also be adversely impacted by a declinein the use of the Internet.  Factorsthat could reduce the level of Internet usage or electronic commerce includethe actual or perceived lack of security or privacy of information, trafficcongestion or other Internet access delays, excessive government regulation,increases in access costs, or the unavailability of cost-effective high speedservice.

 

**The litigation with CalPERS will negativelyaffect our operating results and cash flows.**

 

In November 2003, we filed a lawsuit in California Superior Court,Sacramento County, against CalPERS to overturn CalPERS’ decision to terminatethe contract for default and to recover added costs associated with our systemsintegration project for the contributions reporting system.  We seek to recover damages and projectdelay, disruption and interference costs on the project. CalPERS terminated thecontract for default after we sought to recover added costs due toCalPERS-caused delays, disruption and interference. There is no guarantee thatwe will be successful in our lawsuit against CalPERS or that we will recoverthe damages we seek.  CalPERS filed acounter-claim against us.  Due to therisks and uncertainty inherent in any litigation, there is the possibility thatCalPERS could prevail against the Company. In this litigation, the prevailing party will be entitled to theirattorneys’ fees.  Accordingly, there isthe possibility that if we are found liable to CalPERS, we would be required topay their damages, which could be substantial, and their attorneys’ fees, aswell as our own.  The costs oflitigation can be substantial and the process can be lengthy andunpredictable.  There may be claims madeagainst us by subcontractors or other third parties. CalPERS made a claimagainst our performance bond.  Under theterms of our indemnity agreement with the surety that provided the performancebond, we are obligated to reimburse the surety for their investigation expensesin this matter.  An ongoing dispute witha former client could negatively impact our ability to secure additional contractsand business for other clients.  Management may be required to devote substantial time to thelitigation process which may result in the diversion of their time andattention from other revenue-generating activities.

 

**An investigationinvolving the child support payment processing industry may negatively affectour business and operating results.**

 

In June 2003, we announced that we had received a subpoena from agrand jury in the Southern District of New York to produce certain documentspursuant to an investigation involving the child support payment processingindustry by the Antitrust Division of the DOJ. We have fully cooperated, andintend to continue to cooperate fully, with the subpoena and with the DOJ’sinvestigation. On November 20, 2003, the DOJ granted us conditional amnestypursuant to the Antitrust Division’s Corporate Leniency Policy. Consequently,the DOJ will not bring any criminal charges against us and our officers,directors and employees, as long as we continue to comply with the CorporateLeniency Policy, which requires, among other things, our full cooperation inthe investigation and restitution payments if it is determined that partieswere injured as a result of impermissible anticompetitive conduct. During thesix months ended March 31, 2004, we incurred approximately $321,000 oflegal costs to comply with the subpoena which includes approximately $211,000cost incurred under directors and officers indemnification agreements,partially offset by a claim payment received from our insurance carrier forapproximately $227,000. We anticipate that we will incur an additional $250,000in the remainder of fiscal year 2004 as we continue to cooperate with theinvestigation. Such expenses, any restitution payments that we are required tomake and any negative publicity in connection with the investigation could havea material adverse effect on our financial condition, results of operations andbusiness.

 

**Because we sometimeswork with third parties and/or use third party software in providing productsand services to clients, our reputation, operating results and competitivenesscould be adversely affected by those third parties.**

 

We frequently join with other organizations to bid and perform anengagement.  In these engagements, wemay engage subcontractors or we may act as a subcontractor to the primecontractor of the engagement. We also use third party software or technologyproviders to jointly bid and perform engagements. Our ability to service someof our clients 

 

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depends to a large extent on our use of various software programs thatwe license from a small number of primary software vendors. In thesesituations, we depend on the software, resources and technology of these thirdparties in order to perform work under the engagement. Failure of third partiesto meet their contractual obligations or other actions or failures attributableto these third parties or their products or to the prime contractor orsubcontractor could adversely impact a project, damage our reputation andadversely affect our ability to attract new business. In addition, theinability to negotiate terms of a contract with a third party, the refusal orinability of these third parties to permit continued use of their software,services or technology by us, our inability to gain access to software that hasbeen placed in escrow by third parties, or the discontinuance or termination bythe client or prime contractor of our services or the services of a keysubcontractor, would harm our operating results and the competitiveness of ourproducts and services and may adversely affect our ability to serve newclients.  If we are unable to meet ourcontractual requirements with our clients, we could be subjected to claims byour clients.

 

OPC relies on a third party co-location facility for its primary datacenter 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 becomesubject to other lawsuits that could result in material liabilities to us orcause us to incur material costs.**

 

Any failure in a client’s system or failure to meet a materialdeliverable could result in a claim against us for substantial damages,regardless of our responsibility for such failure. We cannot guarantee that thedisclaimers, limitations of warranty, limitations of liability and otherprovisions set forth in our contracts will be enforceable or will otherwiseprotect us from liability for damages. Any claim by a shareholder or derivativeaction brought by a shareholder could result in a material liability to us. Ourinsurance, which includes coverage for errors or omissions and directors andofficers liability, may not continue to be available on reasonable terms or insufficient amounts to cover one or more claims, and the insurer may disclaimcoverage as to any future claim. The successful assertion of one or more claimsagainst us that exceed available insurance coverage or changes in insurancepolicies, including premium increases or the imposition of large deductible orco-insurance requirements, would adversely affect our business.

 

**We have completednumerous acquisitions and may complete others, which could increase our costsor be disruptive.**

 

One component of our business strategy is to expand our presence in newor existing markets by acquiring additional businesses. From October 1,2001 through March 31, 2004,we acquired three businesses using cash, with some of those acquisitionsalso involving assumed liabilities and contingent payments. Acquisitionsinvolve a number of special risks, including:

 

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

 

•                  diversion ofmanagement’s attention;

 

•                  failure toretain key personnel;

 

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

 

•                  increasedgeneral and administrative expenses;

 

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

 

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

 

•                  assumption ofunknown liabilities;

 

•                  the potentiallydilutive issuance of our common stock, the use of significant amounts of cashor the incurrence of substantial amounts of debt; and

 

•                  otherunanticipated events or circumstances.

 

We may not be able to identify, acquire or profitably manage 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.

 

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**Our markets arehighly competitive, and our business and prospects will be adversely affectedif we do not compete effectively for any reason.**

 

The information technology, transaction processing and consultingservices 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 in the informationtechnology and consulting services markets include:

 

•                  reputation;

 

•                  projectmanagement expertise;

 

•                  industryexpertise;

 

•                  speed ofdevelopment and implementations;

 

•                  technicalexpertise;

 

•                  competitivepricing; and

 

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

 

We believe that our ability to compete also depends in part on a numberof competitive factors outside our control,

including:

 

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

 

•                  the ownership bycompetitors of software used by potential clients;

 

•                  the price atwhich others offer comparable services;

 

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

 

•                  the extent ofour competitors’ responsiveness to client needs.

 

If we do not compete effectively on one or more of these competitivefactors, our business and our ability to execute our business strategy will beimpaired.

 

**Our failure todeliver error-free products and services could result in reduced payments,significant financial liability or additional costs to us, as well as negativepublicity.**

 

Many of our engagements involve projects that are critical to theoperations of our clients’ businesses and provide benefits that may bedifficult to quantify. The failure by us, or by third parties on an engagementin which we are a subcontractor, to meet a client’s expectations in theperformance of the engagement could damage our reputation and adversely affectour ability to attract new business. We have undertaken, and may in the futureundertake, 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.

 

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

 

**If we are unable toobtain adequate insurance coverage or sufficient performance bonds for anyreason, our business will be adversely affected.**

 

We maintain insurance to cover a variety of different business risks including,but not limited to, errors and omissions, directors and officers, generalliability and workers’ compensation policies. There can be no assurance that wecan maintain the same scope and amount of insurance coverage on reasonableterms or obtain such insurance at all. Our inability to renew policies or maintain the same level of coveragewould adversely affect our business and increase our risk exposure.  Any claims against our policies may impactour ability to obtain such insurance on reasonable terms, if at all.  Increased premiums or a claim made against apolicy could adversely affect our earnings and cash flow and impair our abilityto bid for future contracts.

 

We have undertaken, and may in the future undertake, projects thatrequire us to obtain a performance bond from a licensed surety and post theperformance bond with the client.  Therecan be no assurance that such performance bonds will continue to be availableon reasonable terms, if at all.  Ourinability to obtain performance bonds or a reduction in our bonding capacitywould 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.

 

**Our business willsuffer if we are unable to attract, successfully integrate and retain qualifiedpersonnel and key employees.**

 

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

 

We also recently announced our intention to consolidate our existingoffices in Walnut Creek, California and Reston, Virginia.  Some of the employees in our Walnut Creekoffice may not wish to relocate to Reston and may elect to terminate theiremployment with us as a result.  Inaddition, we may face difficulties integrating employees from our Walnut Creekoffice into our Reston office.  The lossof the services of any key employee could significantly disrupt our operations.In addition, if one or more of our key employees resigns to join a competitoror to form a competing company, the loss of such personnel and any resultingloss of existing or potential clients to any such competitor could adverselyaffect our competitive position and operating results.

 

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**Our Class Bcommon stock price and trading volume have been and could continue to bevolatile, which could result in substantial losses for investors in ourClass B common stock.**

 

Our Class B common stock price and trading volume have been andcould continue to be volatile. These price fluctuations may be rapid and severeand may leave investors little time to react. Factors that affect the marketprice 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 fiscal2003;

 

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

 

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

 

•                  changes inearnings estimates by securities analysts or us; and

 

•                  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 productswe provide compete in markets that are rapidly changing and we must develop,acquire and introduce new products and technologies to grow our net revenuesand remain competitive.**

 

The markets for products we provide are characterized by rapidtechnological 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 marketingnew products or product enhancements on a timely and cost effective basis, orat all, and our new products and product enhancements may not adequately meetthe requirements of the marketplace or achieve market acceptance.  If we are unable, for technological or otherreasons, to develop and introduce new products or enhancements of existingproducts in a timely manner in response to changing market conditions or clientrequirements, or if new products or new versions of existing products do notachieve market acceptance, our business would be seriously harmed.  In addition, our ability to develop newproducts and product enhancements is dependent upon the products of othersoftware vendors.  If the products ofsuch vendors have design defects or flaws, or if such products are unexpectedlydelayed in their introduction, our business could be seriously harmed.  Software products as complex as thoseoffered by us may contain undetected defects or errors when first introduced oras new versions are released.  Althoughwe have not experienced significant adverse effects resulting from softwareerrors, we cannot be certain that, despite testing by us and our clients,defects or errors will not be found in new products or enhancements aftergeneral release, resulting in loss of or delay in market acceptance, whichcould seriously harm our business.

 

**We could suffer material losses if oursystems or operations fail or are disrupted.**

 

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

 

**If we fail to adapt our business to changesin economic or business conditions, our business may be adversely affected.**

 

Personnel, facility and depreciation and amortization expensesrepresent a significant percentage of our operating expenses and are relativelyfixed in advance of any particular quarter. We manage our personnel utilizationrates by carefully monitoring our needs and anticipating personnel increasesbased on specific project requirements. To the extent 

 

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net revenues do not increase at a rate commensurate with theseadditional expenses, our results of operations could be materially andadversely affected.  If we fail to alignour operating expenses with prevailing economic or business conditions, ouroperating results and financial condition could be adversely affected.

 

A constraint in OPC’s capacity to process transactions could impair thequality and availability of OPC’s service. Capacity constraints may cause unanticipated system disruptions, impairquality and lower the level of service. Although we believe that OPC has sufficiently expanded its systemcapacity to accommodate anticipated future growth, there are no assurances thatOPC will not suffer capacity constraints caused by sharp increases in the useof its services.  Due to the largenumber of tax payments made in March and April, there is an increased riskthat OPC will suffer a capacity constraint during that period, which could havean adverse effect on our business, operating results and financial condition.

 

**If OPC’s clients or credit/debit card issuerscease to publicize OPC’s services or adversely change the manner in which OPC’sservices are promoted, consumer use of its services may slow, and we may suffera large increase in advertising costs.**

 

Currently, OPC’s government clients and credit/debit card issuersprovide a significant portion of the publicity for its services, without anycharge to OPC.  If clients orcredit/debit card issuers cease to publicize OPC’s services, or charge OPC forthis publicity, advertising costs will increase substantially, resulting in amaterial and adverse effect on our business, operating results and financialcondition. While OPC endeavors in its client agreements to require such clientsto undertake such advertising activities, many of the clients and payment cardissuers have no obligation to continue to provide this publicity, and there areno assurances that they will continue to do so.  In addition, the clients may publicize other services, includingthose of its competitors.  For example,the IRS’s tax year 2002 Form 1040 instruction booklet listed OPC’s name beforea competitor’s name in regard to providers of electronic credit/debit cardpayment services, whereas for the 2003 tax year (i.e., filing due date ofApril 15, 2004), OPC’s name was listed second.

 

In addition, OPC advertises in conjunctionwith its credit/debit card partners under co-operative advertising programs. IfOPC’s credit/debit card partners fail to contribute to the co-operativeadvertising programs, OPC’s ability to advertise may be impacted.

 

**If we are unable to protect our intellectualproperty and proprietary rights, our business could be adversely affected.**

 

The steps we take to protect our intellectual property rights may beinadequate to avoid the loss or misappropriation of that information, or todetect unauthorized use of such information. We rely on a combination of tradesecrets, nondisclosure agreements, licensing agreements and other contractualarrangements, and copyright and trademark laws to protect our intellectualproperty rights. We also enter into non-disclosure agreements with ouremployees, subcontractors and the parties we team with for contracts andgenerally require that our clients enter into such agreements. We also controland limit access to our proprietary information.

 

We have proprietary software that is licensed to clients pursuant tolicensing agreements and other contractual arrangements. We utilizeintellectual property laws, including copyright and trademark laws, to protectour proprietary rights. Issues relating to the ownership of, and rights to use,software and application frameworks can be complicated, and there can be noassurance that disputes will not arise that affect our ability to resell orreuse such software and application frameworks. A portion of our business alsoinvolves 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 the future that maynot be successfully defended. The loss or misappropriation of our intellectualproperty or the unsuccessful defense of any claim of infringement could preventor delay our providing our products and services, cause us to become liable forsubstantial damages, or force us to enter into royalty or licensing agreements.

 

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**Compliance with changing regulation ofcorporate governance and public disclosure may result in additional expenses.**

 

Changing laws, regulations and standards relating to corporategovernance and public disclosure, including the Sarbanes-Oxley Act of 2002, newSEC regulations and Nasdaq Stock Market rules, are creating uncertainty forcompanies such as ours. To maintain high standards of corporate governance andpublic disclosure, we intend to invest all reasonably necessary resources tocomply with evolving standards.  Thisinvestment may result in increased general and administrative expenses foroutside services and a diversion of management time and attention fromrevenue-generating activities.

 

**Control of our company by our former chairmanof the board could make it difficult for another company to acquire us andcould depress the price of our Class B common stock.**

 

Concentration of voting control could have the effect of delaying orpreventing a change in control of us and may affect the market price of ourClass B common stock.  The votingpower held by Mr. James L. Bildner, our former chairman of the board andformer chief executive officer, in Class A and Class B common stock ownedby Mr. Bildner and vested options to acquire Class B common stockheld by Mr. Bildner represented 34.4% of our total common stock votingpower outstanding at March 31, 2004. As a result, Mr. Bildner may beable to control the outcome of all corporate actions requiring shareholderapproval, including changes in our equity incentive plan, the election of amajority of our directors, proxy contests, mergers, tender offers, or othertransactions that could give holders of our Class B common stock theopportunity to realize a premium over the then-prevailing market price fortheir shares of Class B common stock.

 

**Our issuance of preferred stock could make itdifficult for another company to acquire us, which could depress the price ofour Class B common stock.**

 

Our board of directors has the authority to issue preferred stock andto determine the preferences, limitations and relative rights of shares ofpreferred stock and to fix the number of shares constituting any series and thedesignation of such series, without any further vote or action by ourshareholders. The preferred stock could be issued with voting, liquidation,dividend and other rights superior to the rights of our Class B commonstock. The potential issuance of preferred stock may delay or prevent a changein control of us, discourage bids for the Class B common stock at apremium over the market price and adversely affect the market price and thevoting and other rights of the holders of our Class B common stock.

 

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**ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK**

 

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

 

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

 

We have conducted operations in the United Kingdom through aU.S.-incorporated subsidiary. Net revenues from these operations are typicallydenominated in British Pounds and Euros and are included in net income (loss)from discontinued operations for the six months ended March 31, 2004 and2003. Near-term changes in exchange rates may have a material impact on ourfuture income (loss) from discontinued operations, fair values or cash flows aswe liquidate the remaining assets and liabilities in the United Kingdom.  We have not engaged in foreign currencyhedging transactions during the six months ended March 31, 2004. There canbe no assurance that a sudden and significant decline in the value of theBritish Pound or Euro would not have a material adverse effect on our financialcondition and results of operations.

 

**Interestrate sensitivity**

 

We maintain a portfolio of cash equivalents and investments in avariety of securities, including certificates of deposit, money market fundsand government and non-government debt securities. These available-for-salesecurities are subject to interest rate risk and may fall in value if marketinterest rates increase. If market interest rates increase immediately anduniformly by 10 percentage points from levels at March 31, 2004, the fairvalue of the portfolio would decline by $3,577,000. We anticipate having theability to hold our fixed income investments until maturity, and therefore donot expect our operating results or cash flows to be affected to anysignificant degree by the effect of a sudden change in market interest rates onour securities portfolio.

 

**ITEM 4.  CONTROLS AND PROCEDURES**

 

Our chief executive officer and chief financial officer performed anevaluation of our disclosure controls and procedures (as defined in Rules13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the“Exchange Act”)) as of the end of the period covered by this report.  Based on the evaluation, the chief executiveofficer and chief financial officer concluded that our disclosure controls andprocedures were effective and sufficient as of the end of the period covered bythis report to ensure that the information required to be disclosed in thereports that we file under the Exchange Act is recorded, processed, summarized,and reported within the time periods specified in the SEC’s rules and forms.

 

There were no significant changes in ourinternal control over financial reporting during the quarter endedMarch 31, 2004.  We are not awareof any significant change in any other factors that significantly affected ourinternal control over financial reporting during the quarter endedMarch 31, 2004.

 

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**PART II.   OTHER INFORMATION**

 

**ITEM 1.  LEGAL PROCEEDINGS**

 

In May 2003, we received a notice of demand for arbitration inconnection with a dispute over payments related to an acquisition.  The claim was for an amount not less than$700,000 plus interest, attorneys’ fees and associated costs.  This matter was settled and a charge ofapproximately $104,000 was recorded in the six months ended March 31,2004.

 

In June 2003, we announced that we had received a subpoena from agrand jury in the Southern District of New York to produce certain documentspursuant to an investigation involving the child support payment processingindustry by the Antitrust Division of the DOJ. We have fully cooperated, and intend to continue to cooperate fully,with the subpoena and with the DOJ’s investigation.  On November 20, 2003, the DOJ granted conditional amnesty tothe Company pursuant to the Antitrust Division’s Corporate Leniency Policy.  Consequently, the DOJ will not bring anycriminal charges against the Company and our officers, directors and employees,as long as we continue to comply with the Corporate Leniency Policy, whichrequires, among other things, our full cooperation in the investigation andrestitution payments if it is determined that parties were injured as a resultof impermissible anti-competitive conduct. We have not recorded any liabilityfor such payments as any liability is not probable or estimable at this time.During fiscal 2003, we incurred approximately $1.3 million of legal costs tocomply with the investigation, which includes approximately $305,000 paid underofficers and directors indemnification agreements, and we expect to incurapproximately an additional $250,000 in the remainder of fiscal year 2004.

 

In November 2003, we filed a lawsuit in California Superior Court,Sacramento County, *Tier Technologies, Inc. vState of California, through its agency, California Public Employees RetirementSystem, C.A. No. 03AS06220*, to overturn CalPERS’ decision toterminate the contract relating to our systems integration project for CalPERSfor default and to recover added costs associated with that project.  We seek to recover damages and projectdelay, disruption and interference costs on the project.  In December 2003, CalPERS filed across-complaint against us and made a claim against our performance bond forthis contract.  The parties areundertaking discovery and we intend to vigorously pursue our claims and todefend against CalPERS’ cross-complaint. We expect to incur costs of approximately $850,000 in the remainder offiscal year 2004 related to this matter.

 

In December 2003, a complaint was filed in the U.S. District Courtfor the Northern District of California against us, our former chairman of the boardwho formerly was our chief executive officer, another executive officer whoformerly was our chief financial officer and a former executive officer.  *Sperlingv. Tier Technologies, Inc. et al*, case no. C03-05509VRW.  The complaint was brought as a purportedshareholder class action under Sections 10(b) and 20(a) of the SecuritiesExchange Act of 1934 and Rule 10b-5 promulgated thereunder and soughtunspecified monetary damages on behalf of the shareholder class.  The court dismissed this complaint withoutprejudice in December 2003.

 

Also, in December 2003, a complaint was filed by a shareholder asa putative derivative action in California Superior Court for Contra CostaCounty, *Scala v. Bildner et al*,case no. C03-03077.  The derivativecomplaint named the same three officers, another current officer, some of ourcurrent directors and two former directors as defendants and alleged breach offiduciary duty, abuse of control, gross mismanagement, waste of corporateassets, unjust enrichment and violations of the California CorporationsCode.  The court dismissed thiscomplaint without prejudice in March 2004.

 

In January 2004, we were served with a complaint filed byProfessional Services & Resources, Inc. (PSRI) in the Circuit Court in ColeCounty, Missouri (*Professional Services & Resources, Inc. vs. Tier Technologies,Inc.,*Case No. 04CV323189). PSRI alleged that we breached the subcontract agreement between theparties by hiring an employee of PSRI. PSRI claimed damages of $100,000 for violation of the agreement,punitive damages, and attorney fees and costs associated with the action.  We settled this matter in March 2004and have recorded a charge for $27,000 in the six months ended March 31,2004.

 

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**ITEM 4. SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS**

 

The following proposals were adopted by the margins indicated at Tier’sAnnual Meeting of Shareholders held on January 28, 2004.

 
| **Proposal** |                                                                                                                                                              | **Voted  For** |       | **Votes****Withheld** |    | **Abstentions** |   |
|--------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|----------------|------------|-----------------------|---------|-----------------|--------|
| 1.           | To elect a  Board of Directors to hold office until the next Annual Meeting of  Shareholders or until their respective successors have been elected or  approved: |           |       |                  |    |            |   |   |
|         |                                                                                                                                                              |           |       |                  |    |            |   |
|         |                                                                                                                                                              |           |       |                  |    |            |   |
|         | - James L. Bildner                                                                                                                                                |           |       |                  |    |            |   |   |
|         | - Charles W. Berger                                                                                                                                               |           | 26,105,580 |                  | 68,763  |            | — |   |
|         | - Samuel Cabot III (a)                                                                                                                                            |           | 25,630,565 |                  | 543,778 |            | — |   |
|         | - Ronald L. Rossetti (a)                                                                                                                                          |           | 16,829,834 |                  | 544,509 |            | — |   |
|         | - Morgan P. Guenther                                                                                                                                              |           | 17,306,431 |                  | 67,912  |            | — |   |
|         | - T. Michael Scott                                                                                                                                                |           | 17,306,431 |                  | 67,912  |            | — |   |
|         | - James R. Weaver                                                                                                                                                 |           | 25,629,510 |                  | 544,833 |            | — |   |
|         |                                                                                                                                                              |           | 17,305,302 |                  | 69,041  |            | — |   |
| 2.           | To ratify the selection of PricewaterhouseCoopers LLP as independent  aud itors of the Company for its fiscal year ending September 30, 2004                 |           |       |                  |    |            |   |   |
|         |                                                                                                                                                              |           |       |                  |    |            |
|         | 26,165,593                                                                                                                                                        |           | 7,850      |                  | 900     |            |

 

(a)           ClassB Director

 

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

 

(a)*Exhibits.*

 
| **Exhibit  Number** |   | **Description**                                                                                                                                                |
|---------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.41               |   | Employment Agreement dated July 2, 2003 by and between the  Company and Mr. Jeff McCandless.                                                              |
|                |   |                                                                                                                                                           |
| 31.1                |   | Certification of Chief Executive Officer pursuant to Rules 13a-14(a)  and 15d-14(a) promulgated under the Securities Exchange Act of 1934, as  amended.        |
|                |   |                                                                                                                                                           |
| 31.2                |   | Certification of Chief Financial Officer pursuant to Rules 13a-14(a)  and 15d-14(a) promulgated under the Securities Exchange Act of 1934, as  amended.        |
|                |   |                                                                                                                                                           |
| 32.1                |   | Certification of Chief Executive Officer pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |
|                |   |                                                                                                                                                           |
| 32.2                |   | Certification of Chief Financial Officer pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002  |

 

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* Management contract or compensatory planrequired to be filed as an exhibit to this report.

 

(b) *Reports on Form 8-K.*

 

Current Report on Form 8-K, furnishedJanuary 28, 2004, pursuant to Items 7 and 12.  Reference is made to the press release of the Company issuedJanuary 28, 2004, announcing the Company’s financial results for thequarter ended December 31, 2003.

 

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**SIGNATURES**

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.

 

 
|                | TIER TECHNOLOGIES, INC. |
|---------------------|-------------------------|
|                |                    |
|                |                    |
| Dated: May 11, 2004 |                    |
|                |                    |
|                |                    |
|                | By:                     | /s/ Jeffrey A. McCandless |
|                |                    | **Jeffrey A. McCandless** |
|                |                    | **Chief Financial Officer** |
|                |                    | **(Principal Financial and Accounting Officer)** |

 

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