** **

**Securities and Exchange Commission********Washington, D.C. 20549**

**FORM 10-Q**

 
| **(Mark  One)**                                        |                                                                                          |
|--------------------------------------------------------|-----------------------------------------------------------------------------------------------|
|                                                   |                                                                                          |
| ý                                                 | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15d OF THE SECURITIES EXCHANGE ACT OF 1934**    |
|                                                   |                                                                                          |
| **For  the quarterly period ended September 30, 2003** |
|                                                   |
| o                                                      | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

** **

**Forthe transition period from                  to                  **

 

**Commissionfile number 0-21705**

 

**SANCHEZCOMPUTER ASSOCIATES, INC.******(Exact Name ofRegistrant as Specified in Its Charter)

 

| **Pennsylvania**  (State or other Jurisdiction of  Incorporation or Organization)   |   | **23-2161560**  (I.R.S. Employer Identification No.) |
|-------------------------------------------------------------------------------------|--------|------------------------------------------------------|
|                                                                                |   |                                                 |
| **40  Valley Stream Parkway, Malvern PA**  (Address of Principal Executive Offices) |   | **19355**  (Zip Code)                                |
|                                                                                |   |                                                 |
| **www.sanchez.com**(Company’s Web site)                                        |   |                                                 |

 

Registrant’sTelephone Number, Including Area Code: **(610)296-8877**

 

**N/A**

FormerName, Former Address and Former Fiscal Year, if Changed Since Last Report

 

Indicate bycheck mark whether the registrant: (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.   Yes ý   No o

 

Indicate by check mark whether the registrantis an accelerated filer (as defined in Rule 12b-2 of theAct).   Yes o   No ý

 

As of October 31, 2003, there were 26,921,551 outstanding shares of theissuer’s Common Stock, no par value.

 

 

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**SANCHEZCOMPUTER ASSOCIATES, INC.INDEX TO FORM 10-QFOR THE QUARTER ENDED SEPTEMBER 30, 2003**
| **PART I:  FINANCIAL INFORMATION** |
|----------------------------------------------|
|                                         |   |   |
| ITEM 1:                                      | FINANCIAL STATEMENTS |   |
|                                         |   |   |
|                                         | CONSOLIDATED BALANCE SHEETS  September 30, 2003 (Unaudited) and December 31, 2002 |   |
|                                         |   |   |
|                                         | CONSOLIDATED STATEMENTS OF  OPERATIONS (Unaudited)  Three and nine months ended September 30, 2003 and 2002 |   |
|                                         |   |   |
|                                         | CONSOLIDATED STATEMENTS OF CASH  FLOWS (Unaudited)  Nine months ended September 30, 2003 and 2002 |   |
|                                         |   |   |
|                                         | NOTES TO CONSOLIDATED FINANCIAL  STATEMENTS (Unaudited) |   |
|                                         |   |   |
| 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  6:                                     | EXHIBITS  AND REPORTS ON FORM 8-K |   |
|                                         |   |   |
| SIGNATURE                                    |   |

 

2

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**Sanchez Computer Associates, Inc.Consolidated Balance Sheets(in thousands, except per share amounts)**

 
|                                                                                                                     |   | **September 30,** |    | **December 31,** |   |
|--------------------------------------------------------------------------------------------------------------------------|--------|-------------------|---------|------------------|--------|
|                                                                                                                     |   | **2003**          |    | **2002**         |   |
|                                                                                                                     |   | **(unaudited)**   |    |             |   |
| **ASSETS**                                                                                                               |   |              |    |             |   |
| Current assets                                                                                                           |   |              |    |             |   |
| Cash and cash  equivalents                                                                                               |   | $                 | 27,994  |             | $      | 32,717 |   |
| Accounts  receivables, less allowances ($325 and $979)                                                                   |   | 14,233            |    | 12,993           |   |
| Contracts in  process                                                                                                    |   | 3,742             |    | 4,851            |   |
| Income tax refund  receivable                                                                                            |   | 2,380             |    | 1,619            |   |
| Deferred income  taxes                                                                                                   |   | 2,661             |    | 2,661            |   |
| Prepaid and  other current assets                                                                                        |   | 2,617             |    | 2,812            |   |
| Deferred  expenses                                                                                                       |   | 10,723            |    | 8,343            |   |
| Total current  assets                                                                                                    |   | 64,350            |    | 65,996           |   |
|                                                                                                                     |   |              |    |             |   |
| Property and  equipment                                                                                                  |   |              |    |             |   |
| Equipment                                                                                                                |   | 18,544            |    | 16,532           |   |
| Furniture and  fixtures                                                                                                  |   | 2,663             |    | 2,674            |   |
| Leasehold  improvements                                                                                                  |   | 3,169             |    | 3,148            |   |
|                                                                                                                     |   | 24,376            |    | 22,354           |   |
| Accumulated  depreciation and amortization                                                                               |   | (19,514           | )       | (16,826          | )      |
| Net property and  equipment                                                                                              |   | 4,862             |    | 5,528            |   |
|                                                                                                                     |   |              |    |             |   |
| Goodwill                                                                                                                 |   | 22,142            |    | 23,896           |   |
| Deferred  expenses                                                                                                       |   | 5,183             |    | 11,496           |   |
| Amortizable  intangible assets, net                                                                                      |   | 3,494             |    | 8,454            |   |
| Deferred income  taxes                                                                                                   |   | 2,895             |    | 2,895            |   |
| Other  non-current assets                                                                                                |   | 2,536             |    | 2,832            |   |
| Total assets                                                                                                             |   | $                 | 105,462 |             | $      | 121,097 |   |
|                                                                                                                     |   |              |    |             |   |
| **LIABILITIES AND SHAREHOLDERS’  EQUITY**                                                                           |   |              |    |             |   |
| Current  liabilities                                                                                                     |   |              |    |             |   |
| Accounts payable                                                                                                         |   | $                 | 4,726   |             | $      | 3,771 |   |
| Accrued expenses                                                                                                         |   | 7,007             |    | 9,617            |   |
| Deferred revenue                                                                                                         |   | 24,867            |    | 22,804           |   |
| Total current  liabilities                                                                                               |   | 36,600            |    | 36,192           |   |
| Deferred revenue                                                                                                         |   | 6,990             |    | 18,150           |   |
| Minority interest                                                                                                        |   | 190               |    | 209              |   |
| Total  liabilities                                                                                                       |   | 43,780            |    | 54,551           |   |
|                                                                                                                     |   |              |    |             |   |
| Shareholders’  equity                                                                                               |   |              |    |             |   |
| Common stock  stated value of $.01 per share, 75,000 shares authorized, 26,918 and 26,689  shares issued and outstanding |   | 269               |    | 267              |   |
| Additional  paid-in capital                                                                                              |   | 49,371            |    | 48,794           |   |
| Retained  earnings                                                                                                       |   | 9,094             |    | 18,575           |   |
| Accumulated  comprehensive income (loss)                                                                                 |   | 2,948             |    | (1,090           | )      |
| Total  shareholders’ equity                                                                                         |   | 61,682            |    | 66,546           |   |
| Total  liabilities and shareholders’ equity                                                                         |   | $                 | 105,462 |             | $      | 121,097 |   |

See notesto consolidated financial statements

3

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**Sanchez Computer Associates, Inc.Consolidated Statements ofOperations(in thousands, except per share amounts)(unaudited)**

 
|                                                     |   | **Three  Months Ended****September  30,** |   | **Nine  Months Ended****September  30,** |   |
|----------------------------------------------------------|--------|-------------------------------------------|--------|------------------------------------------|--------|
|                                                     |   | **2003**                                  |   | **2002**                                 |   | **2003** |   | **2002** |   |
| Revenues                                                 |   |                                      |   |                                     |   |   |   |   |   |
| Products                                                 |   | $                                         | 7,112  |                                     | $      | 4,132 |   | $ | 19,073 |   | $ | 10,813 |   |
| Services                                                 |   | 7,264                                     |   | 10,232                                   |   | 20,560 |   | 25,102 |   |
| Processing                                               |   | 4,557                                     |   | 4,743                                    |   | 13,837 |   | 13,835 |   |
| Software  maintenance and other                          |   | 5,015                                     |   | 4,546                                    |   | 15,295 |   | 12,689 |   |
| Customer  reimbursements                                 |   | 1,211                                     |   | 1,562                                    |   | 3,439 |   | 4,434 |   |
| Total revenues                                           |   | 25,159                                    |   | 25,215                                   |   | 72,204 |   | 66,873 |   |
|                                                     |   |                                      |   |                                     |   |   |   |   |   |
| Operating  expenses                                      |   |                                      |   |                                     |   |   |   |   |   |
| Product  development                                     |   | 5,666                                     |   | 4,483                                    |   | 16,120 |   | 11,377 |   |
| Product support                                          |   | 1,629                                     |   | 1,652                                    |   | 4,903 |   | 4,417 |   |
| Services                                                 |   | 5,955                                     |   | 5,541                                    |   | 16,678 |   | 14,695 |   |
| Processing                                               |   | 4,358                                     |   | 4,154                                    |   | 12,099 |   | 12,302 |   |
| Sales and  marketing                                     |   | 3,123                                     |   | 2,933                                    |   | 9,948 |   | 9,295 |   |
| General,  administrative and other                       |   | 3,155                                     |   | 2,696                                    |   | 8,840 |   | 8,234 |   |
| Customer reimbursement  expense                          |   | 1,211                                     |   | 1,562                                    |   | 3,439 |   | 4,434 |   |
| Impairment  charge                                       |   | 9,500                                     |   | —                                   |   | 9,500 |   | — |   |
| Restructuring  charge                                    |   | —                                    |   | 752                                      |   | 316 |   | 752 |   |
| Total operating  expenses                                |   | 34,597                                    |   | 23,773                                   |   | 81,843 |   | 65,506 |   |
|                                                     |   |                                      |   |                                     |   |   |   |   |   |
| Earnings (loss)  from operations                         |   | (9,438                                    | )      | 1,442                                    |   | (9,639 | ) | 1,367 |   |
| Interest income,  net                                    |   | 67                                        |   | 147                                      |   | 219 |   | 889 |   |
| Gain on  investment                                      |   | —                                    |   | —                                   |   | 156 |   | — |   |
| Foreign exchange  income (loss)                          |   | 12                                        |   | 134                                      |   | (194 | ) | 134 |   |
| Earnings (loss)  before income taxes                     |   | (9,359                                    | )      | 1,723                                    |   | (9,458 | ) | 2,390 |   |
| Income tax provision                                     |   | 74                                        |   | 409                                      |   | 23 |   | 629 |   |
| Net earnings  (loss)                                     |   | $                                         | (9,433 | )                                        | $      | 1,314 |   | $ | (9,481 | ) | $ | 1,761 |   |
|                                                     |   |                                      |   |                                     |   |   |   |   |   |
| Basic and  diluted earnings (loss) per share             |   | $                                         | (0.35  | )                                        | $      | 0.05 |   | $ | (0.35 | ) | $ | 0.07 |   |
|                                                     |   |                                      |   |                                     |   |   |   |   |   |
| Weighted-average  common shares outstanding              |   | 26,893                                    |   | 26,503                                   |   | 26,816 |   | 26,202 |   |
|                                                     |   |                                      |   |                                     |   |   |   |   |   |
| Weighted-average  common and dilutive shares outstanding |   | 26,893                                    |   | 26,817                                   |   | 26,816 |   | 26,482 |   |

See notes to consolidated financial statements

4

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**Sanchez Computer Associates, Inc.Consolidated Statements of Cash Flows(in thousands)(unaudited)**

** **
|                                                                                            |   | **Nine  Months Ended  September 30,** |   |
|-------------------------------------------------------------------------------------------------|--------|---------------------------------------|--------|
|                                                                                            |   | **2003**                              |   | **2002** |   |
| Cash flows from operating activities                                                            |   |                                  |   |   |   |
| Net earnings (loss)                                                                             |   | $                                     | (9,481 | ) | $ | 1,761 |   |
| Adjustments to reconcile net earnings (loss) to cash provided (used)  by operating activities   |   |                                  |   |   |   |
| Depreciation and amortization                                                                   |   | 3,633                                 |   | 3,709 |   |
| Impairment charge                                                                               |   | 9,500                                 |   | — |   |
| Changes in operating assets and liabilities                                                     |   |                                  |   |   |   |
| Accounts receivable                                                                             |   | (1,059                                | )      | 3,123 |   |
| Contracts in process                                                                            |   | 1,112                                 |   | (3,130 | ) |
| Income tax refund receivable/payable                                                            |   | (1,003                                | )      | 131 |   |
| Prepaid and other current assets                                                                |   | 822                                   |   | (1,824 | ) |
| Accounts payable and accrued expenses                                                           |   | (1,775                                | )      | (3,653 | ) |
| Provision for doubtful accounts receivable                                                      |   | —                                |   | 1,100 |   |
| Deferred revenue                                                                                |   | (8,970                                | )      | 10,799 |   |
| Deferred expenses                                                                               |   | 3,910                                 |   | (2,600 | ) |
| Other                                                                                           |   | (50                                   | )      | — |   |
| Net cash provided (used) by operating activities                                                |   | (3,361                                | )      | 9,416 |   |
|                                                                                            |   |                                  |   |   |   |
| Cash flows from investing activities                                                            |   |                                  |   |   |   |
| Investments                                                                                     |   | (75                                   | )      | (500 | ) |
| Capital expenditures                                                                            |   | (2,022                                | )      | (1,334 | ) |
| Acquisition of Spectra, net of cash acquired of $1,849 and including  transaction costs of $514 |   | —                                |   | (25,671 | ) |
| Net cash used by investing activities                                                           |   | (2,097                                | )      | (27,505 | ) |
|                                                                                            |   |                                  |   |   |   |
| Cash flows from financing activities                                                            |   |                                  |   |   |   |
| Exercise of stock options                                                                       |   | 180                                   |   | 37 |   |
| Proceeds from the issuance of shares under the employee stock  purchase plan                    |   | 345                                   |   | 577 |   |
| Net cash provided by financing activities                                                       |   | 525                                   |   | 614 |   |
|                                                                                            |   |                                  |   |   |   |
| Net decrease in cash and cash equivalents                                                       |   | (4,933                                | )      | (17,475 | ) |
| Effect of foreign exchange on cash                                                              |   | 210                                   |   | (77 | ) |
| Cash and cash equivalents at beginning of period                                                |   | 32,717                                |   | 40,955 |   |
| Cash and cash equivalents at end of period                                                      |   | $                                     | 27,994 |   | $ | 23,403 |   |
|                                                                                            |   |                                  |   |   |   |
| Supplemental cash flow information                                                              |   |                                  |   |   |   |
| Interest paid                                                                                   |   | $                                     | — |   | $ | — |   |
| Income taxes paid                                                                               |   | $                                     | 810    |   | $ | 716 |   |
|                                                                                            |   |                                  |   |   |   |

See notesto consolidated financial statements

5

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**Sanchez Computer Associates, Inc. Notes to Unaudited Consolidated Financial Statements**

 

**(A.)****                           ****Basis of Presentation**

 

The accompanyingconsolidated financial statements of Sanchez Computer Associates, Inc. (Sanchezor the Company) include the accounts of all of the Company’s majority ownedsubsidiaries.  All significantintercompany transactions and balances have been eliminated inconsolidation.  Certain prior periodamounts have been reclassified to conform with the current periodpresentation.  In the opinion ofmanagement, the consolidated financial statements reflect all normal andrecurring adjustments which are necessary for a fair presentation of theCompany’s financial position, results of operations, and cash flows as of thedates and for the periods presented. The consolidated financial statements have been prepared in accordancewith accounting principles generally accepted in the United States for interimfinancial information.  Consequently,these statements do not include all of the disclosures normally required bygenerally accepted accounting principles for annual financial statements northose normally made in the Company’s Annual Report on Form 10-K.  Accordingly, reference should be made to theCompany’s Annual Report on Form 10-K for additional disclosures, including asummary of the Company’s critical accounting policies, which have not changedsince our latest Annual Report on Form 10-K as of December 31, 2002.  The consolidated results of operations forthe three and nine months ended September 30, 2003 are not necessarilyindicative of results for the full year.

 

**(B.)****                           ****Geographic Segments**

 

Revenue derived fromcustomers in various geographic regions is as follows (in thousands):

 
|                |   | **Three  months ended** |   | **Nine  months ended** |
|---------------------|--------|-------------------------|--------|------------------------|
|                |   | **September  30,**      |   | **September  30,**     |
|                |   | **2003**                |   | **2002**               |   | **2003** |   | **2002** |
| U.S. and  Caribbean |   | $                       | 12,930 |                   | $ | 14,975 |   | $ | 36,451 |   | $ | 42,686 |
| Canada              |   | 3,913                   |   | 4,398                  |   | 12,179 |   | 6,154 |
| Europe              |   | 4,546                   |   | 4,673                  |   | 14,127 |   | 16,457 |
| Other               |   | 3,770                   |   | 1,169                  |   | 9,447 |   | 1,576 |
| Total               |   | $                       | 25,159 |                   | $ | 25,215 |   | $ | 72,204 |   | $ | 66,873 |

** **

**(C.)****                           ****Business Segments**

 

Previously, our segmentsincluded Sanchez’s software licensing business, the Sanchez Data Systems, Inc.(SDSI) outsourcing business and the Wealth Management Division, which wascreated following the Company’s acquisition of Spectra Securities Software,Inc. (Spectra) in July 2002.  Beginning withthe first quarter of 2003, the Company organized into divisions and initiatedsegment reporting based on those divisions. Sanchez’s new divisional segments are Banking Solutions, WealthManagement, Outsourcing, and Global Services. In addition, a Corporate Support group was created to support theseoperating divisions.  The Companyevaluates the performance of its segments and allocates resources to themaccordingly.  Customer reimbursementrevenue and expenses are the same amount and, therefore, have no net effect onoperating earnings.  Customerreimbursement revenues and expenses are not allocated to the individualoperating divisions.  The Companycombines assets, liabilities and shareholders’ equity into one consolidatedbalance sheet and does not measure the performance of its divisions based uponbalance sheet accounts.  It is notpractical at this time to restate segment data for prior periods to conform to theCompany’s new segment reporting.  Wewill continue to also present segment information under the previous formatuntil comparative information about segments under the new format isavailable.  The tables below summarizethe Company’s segments as they are currently measured as well as how they werepreviously reported in 2002.

6

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The table belowsummarizes information about the new business segments (in thousands):

 
|                            |   | **Three  months ended** |   | **Nine  months ended**  |   |
|---------------------------------|--------|-------------------------|--------|-------------------------|--------|
|                            |   | **September  30, 2003** |   | **September  30, 2003** |   |
| Revenues                        |   |                    |   |                    |   |
| Banking Solutions               |   | $                       | 10,312 |                    | $      | 27,895 |   |
| Wealth Management               |   | 2,367                   |   | 8,026                   |   |
| Outsourcing                     |   | 5,652                   |   | 17,457                  |   |
| Global Services                 |   | 5,617                   |   | 15,387                  |   |
| Total segment revenue           |   | 23,948                  |   | 68,765                  |   |
| Customer reimbursements         |   | 1,211                   |   | 3,439                   |   |
| Total revenues                  |   | $                       | 25,159 |                    | $      | 72,204 |   |
|                            |   |                    |   |                    |   |
| Earnings (loss) from operations |   |                    |   |                    |   |
| Banking Solutions               |   | $                       | 2,671  |                    | $      | 5,801 |   |
| Wealth Management               |   | (10,831                 | )      | (12,083                 | )      |
| Outsourcing                     |   | (944                    | )      | (1,564                  | )      |
| Global Services                 |   | (334                    | )      | (1,793                  | )      |
| Total loss from operations      |   | $                       | (9,438 | )                       | $      | (9,639 | ) |

 

Thetable below summarizes informationabout the business segments in the previous format (in thousands):

 
|                                  |   | **Three  months ended  September 30,** |   | **Nine  months ended  September 30,** |   |
|---------------------------------------|--------|----------------------------------------|--------|---------------------------------------|--------|
|                                  |   | **2003**                               |   | **2002**                              |   | **2003** |   | **2002** |   |
| Revenues                              |   |                                   |   |                                  |   |   |   |   |   |
| Sanchez                               |   | $                                      | 13,499 |                                  | $      | 8,606 |   | $ | 36,815 |   | $ | 26,934 |   |
| SDSI                                  |   | 9,289                                  |   | 12,690                                |   | 27,354 |   | 36,020 |   |
| Wealth Management                     |   | 2,371                                  |   | 3,919                                 |   | 8,035 |   | 3,919 |   |
| Total Revenues                        |   | $                                      | 25,159 |                                  | $      | 25,215 |   | $ | 72,204 |   | $ | 66,873 |   |
|                                  |   |                                   |   |                                  |   |   |   |   |   |
| Earnings (loss) from operations       |   |                                   |   |                                  |   |   |   |   |   |
| Sanchez                               |   | $                                      | 473    |                                  | $      | (833 | ) | $ | 94 |   | $ | (1,553 | ) |
| SDSI                                  |   | (83                                    | )      | 2,097                                 |   | 875 |   | 2,742 |   |
| Wealth Management                     |   | (9,828                                 | )      | 178                                   |   | (10,608 | ) | 178 |   |
| Total earnings (loss) from operations |   | $                                      | (9,438 | )                                     | $      | 1,442 |   | $ | (9,639 | ) | $ | 1,367 |   |
|                                       |        |                                        |        |                                       |        |  |  |  |  |  |  |  |  |  |  |  |

 
|              |   | **September  30,** |    | **December  31,** |   |
|-------------------|--------|--------------------|---------|-------------------|--------|
|              |   | **2003**           |    | **2002**          |   |
| Assets            |   |               |    |              |   |
| Sanchez           |   | $                  | 91,128  |              | $      | 97,438 |   |
| SDSI              |   | 26,116             |    | 41,000            |   |
| Wealth Management |   | 26,994             |    | 38,655            |   |
| Eliminations      |   | (38,776            | )       | (55,996           | )      |
| Total assets      |   | $                  | 105,462 |              | $      | 121,097 |   |

 

7

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**(D.)****                           ****Earnings Per Share**

 

Basicearnings (loss) per share has been calculated as net earnings (loss) divided byweighted-average common sharesoutstanding, while diluted earnings (loss) per share has been computed as netearnings (loss) dividedby weighted-average common and diluted shares outstanding, which includes thedilutive effect of stock options.  The following table provides a reconciliation of weighted-averagecommon shares outstanding to weighted-average common and diluted sharesoutstanding (in thousands):

 
|                                                         |   | **Three  months ended** |   | **Nine  months ended** |   |
|--------------------------------------------------------------|--------|-------------------------|--------|------------------------|--------|
|                                                         |   | **September  30,**      |   | **September  30,**     |   |
|                                                         |   | **2003**                |   | **2002**               |   | **2003** |   | **2002** |   |
| Weighted-average shares outstanding                          |   | 26,893                  |   | 26,503                 |   | 26,816 |   | 26,202 |   |
| Dilutive effect of options                                   |   | —                  |   | 314                    |   | — |   | 280 |   |
| Total weighted average common and diluted shares outstanding |   | 26,893                  |   | 26,817                 |   | 26,816 |   | 26,482 |   |

 

At September 30, 2003, total potentiallydilutive common stock equivalents include options to purchase 6,664,668 sharesof common stock.  As of September 30,2002, total potentially dilutive common stock equivalents included options topurchase 6,130,824 shares of common stock.  All potentially dilutive common stock equivalents were excluded from thecalculations of net loss per share for the three and nine months ended September 30, 2003, astheir effect is anti-dilutive as a result of the net loss incurred for theperiods.

 

**(E.)****                             ****Stock-****Based****Compensation**

 

InDecember 2002, Statement of Financial Accounting Standards (SFAS) No. 148,“Accounting for Stock-Based Compensation—Transition and Disclosure,” wasissued.  SFAS No. 148 amended SFAS No.123, “Accounting for Stock-Based Compensation,” to provide alternative methodsof transition for a voluntary change to the fair-value based method ofaccounting for stock-based employee compensation.  In addition, SFAS No. 148 amended the disclosure requirements of SFAS No.123 related to the disclosure about the method of accounting for stock-basedemployee compensation and the effect of the method used on reportedresults.  The disclosure provisions ofSFAS No. 148 are applicable to interim or annual periods that end afterDecember 15, 2002, and, as such, have been incorporated below.  SFAS No. 123, as amended by SFAS No. 148,permits companies to (i) recognize as expense the fair value of stock-basedawards, or (ii) continue to apply the provisions of Accounting Principles Board(APB) Opinion No. 25, “Accounting For Stock Issued to Employees,” and relatedinterpretations, and provide pro forma net earnings (loss) and earnings (loss)per share disclosures for employee stock option grants as if the fair-valuebased method defined in SFAS No. 123 had been applied.  The Company continues to apply theprovisions of APB Opinion No. 25 and provide the pro forma disclosures inaccordance with the provisions of SFAS No. 123 and SFAS No. 148 to its stockoption plans.  Had compensation cost forthe Company’s stock option plans been determined based upon the fair value ofthe options at the date of grant, as prescribed under SFAS No. 123, theCompany’s net earnings (loss) and basic and diluted net earnings (loss) pershare would have been adjusted to the following pro forma amounts (inthousands, except per share amounts):

 
|                                                                                                                                     |   |        |   | **Three  months ended** |    | **Nine  months ended** |   |
|------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------|--------|-------------------------|---------|------------------------|--------|
|                                                                                                                                     |   |        |   | **September  30,**      |    | **September  30,**     |   |
|                                                                                                                                     |   |        |   | **2003**                |    | **2002**               |   | **2003** |   | **2002** |   |
| Net earnings (loss)                                                                                                                      |   | As reported |   | $                       | (9,433  | )                      | $      | 1,314 |   | $ | (9,481 | ) | $ | 1,761 |   |
| Deduct:  Total stock-based  employee compensation expense determined under the fair-value based methods  for all awards, net of tax |   |        |   | (682                    | )       | (1,145                 | )      | (2,249 | ) | (3,342 | ) |
|                                                                                                                                     |   | Pro forma   |   | $                       | (10,115 | )                      | $      | 169 |   | $ | (11,730 | ) | $ | (1,581 | ) |
|                                                                                                                                     |   |        |   |                    |    |                   |   |   |   |   |   |
| Basic and diluted earnings (loss) per share                                                                                              |   | As reported |   | $                       | (0.35   | )                      | $      | 0.05 |   | $ | (0.35 | ) | $ | 0.07 |   |
|                                                                                                                                     |   | Pro forma   |   | $                       | (0.38   | )                      | $      | 0.01 |   | $ | (0.44 | ) | $ | (0.06 | ) |
|                                                                                                                                          |        |             |        |                         |         |                        |        |  |  |  |  |  |  |  |  |  |  |  |

 

8

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**(F.)****                             ****Goodwill****and Intangible Assets**

 

Inaccordance with SFAS No. 142, “Goodwill and Other Intangibles,” the Company nolonger amortizes goodwill but instead performs an annual test to determine ifthe Company’s goodwill is impaired. During the third fiscal quarter of 2003, the Company performed itsannual assessment of goodwill associated with its Wealth Management ReportingUnit (Reporting Unit).  The Companyengaged an external valuation specialist to assist in this assessment.  The market approach was used to measure thefair value of the Reporting Unit.  Thisapproach derives market multiples from recent transactions or offerings ofcompanies with similar operations as the Reporting Unit.  Market multiples of publicly tradedcompanies that were deemed comparable to the Company were also used in theanalysis.  Based upon this analysis, theCompany determined that the carrying value of the Reporting Unit exceeded itsfair value.   The identification of animpairment necessitated the preparation of a SFAS No. 142, Level 2 analysis toquantify the amount of the goodwill impairment.  During this analysis, the Company determined that there alsocould be an impairment to certain amortizable intangible assets associated withthe Reporting Unit, primarily the customer relationships and acquiredtechnology.  As a result, the Companyperformed an impairment analysis of the long-lived assets in accordance withSFAS No. 144, “Accounting for the Impairment or Disposal of Long-LivedAssets.”  As a result of this analysis,the Company determined that the carrying value of the Reporting Unit’slong-lived assets exceeded the undiscounted cash flows expected to be generatedby such assets over their remaining useful life.  Accordingly, the Company recorded an impairment charge ofapproximately $5.5 million to write down the long-lived assets to their fairvalue.  The fair value of thelong-lived assets was primarily determined using the income approach.  The income approach measures the value of anasset by calculating the present value of its future economic benefits.  These benefits can include revenues, costsavings, tax deductions, and proceeds from its disposition.  Value indications are developed bydiscounting expected cash flows to their present value at a rate of return thatincorporates the risk-free rate for the use of funds, trends within theindustry, and risks associated with particular investments of similar type andquality as of the valuation date.  TheCompany then determined the fair value of the goodwill associated with theReporting Unit in accordance with SFAS No. 142, resulting in an impairmentcharge related to goodwill of approximately $4.0 million.  The total impairment to goodwill and certainamortizable intangible assets of the Reporting Unit for the quarter endedSeptember 30, 2003 was $9.5 million and appears on the Consolidated Statementsof  Operations as Impairment charge.

 

Basedon the carrying value of amortizable intangible assets as ofSeptember 30, 2003, remaining amortization is expected to be approximately$166,000 for the remainder of fiscal 2003, $589,000 in fiscal 2004, $515,000 infiscal 2005 and $515,000 in fiscal 2006 and $1.7 million in years 2007 through2012.

 

**(G.)****                           ****Recent AccountingPronouncements**

** **

InJanuary 2003, the Financial Accounting Standards Board issued Interpretation No. 46, “Consolidation of VariableInterest Entities,” which addresses the consolidation by businessenterprises of variable interest entities as defined in theInterpretation.  Interpretation No. 46requires that its provisions are effective immediately for all arrangementsentered into after January 31, 2003. For those arrangements entered into prior to January 31, 2003, theInterpretation 46 provisions are required to be adopted at the beginning of thefirst interim or annual period beginning after December 15, 2003.  The Company does not expect that theprovisions of Interpretation No. 46 will have a material impact on theCompany’s results of operations or financial position.

 

**(H.)****                           ****Related****Party Transactions**

 

OnJuly 3, 2002, in connection with the acquisition of Spectra, the Company loanedMr. John McLeod, President of the Company’s Wealth Management Division,approximately $314,000.  This loan issecured by a pledge of 100,000 shares of Sanchez common stock.  The loan contains an interest rate asprescribed by the Canadian Customs and Revenue Agency (Base Rate).  This rate is adjusted quarterlyto the extent such Base Rate changes. At September 30, 2003 the Base Rate was 4%.  The loan has a term of three years commencing July 3, 2002 withsix semi-annual payments, the first of which was due on January 3, 2003.  In July 2003, Mr. McLeod made the second ofhis six semi-annual payments.

 

During2001, the Company loaned $130,000 to Mr. Todd Pittman, the Company’s ChiefFinancial Officer, for the purchase of Company stock.  The three-year loan, for which Mr. Pittman is personally liable,is secured by the Company stock purchased by Mr. Pittman, and bears interest ata rate of 4.63% per annum.  Mr. Pittmanhad a balance, including interest, of approximately $118,000 as of September30, 2003.

 

9

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Inaccordance with the Sarbanes-Oxley Act of 2002, the Company has adopted apolicy not to grant any new loans or materially modify or extend any existingloans to officers or directors of the Company and the audit committee mustreview and approve any related party transactions involving officers ordirectors.

 

**(I.)****                                ****Comprehensive****Income**

 

Comprehensive income (loss) consists of net earnings(loss), adjusted for other increases and decreases affecting shareholders’equity that are excluded from the determination of net earnings (loss).  The calculation of comprehensive income(loss) for the three and nine months ended September 30, 2003 and 2002 is asfollows (in thousands):

 
|                                     |   | **Three  months ended  September 30,** |   | **Nine  months ended  September 30,** |   |
|------------------------------------------|--------|----------------------------------------|--------|---------------------------------------|--------|
|                                     |   | **2003**                               |   | **2002**                              |   | **2003** |   | **2002** |   |
| Net earnings  (loss)                     |   | $                                      | (9,433 | )                                     | $      | 1,314 |   | $ | (9,481 | ) | $ | 1,761 |   |
| Cumulative translation adjustments       |   | (197                                   | )      | (1,095                                | )      | 4,089 |   | (1,095 | ) |
| Unrealized loss on marketable securities |   | (23                                    | )      | —                                |   | (23 | ) | — |   |
| Comprehensive income (loss)              |   | $                                      | (9,653 | )                                     | $      | 219 |   | $ | (5,415 | ) | $ | 666 |   |

 

**(J.)****                             ****Subsequent****Events**

 

OnOctober 17, 2003, the Company announced that it has begun implementing plans toreduce the Company’s cost base by approximately $8.0 million.  The cost reductions are targeted forcompletion by the end of the year.  TheCompany expects to achieve these cost savings primarily through a reduction inits workforce and broad-based salary reductions.  The Company expects to take a restructuring charge ofapproximately $1.3 million in the fourth quarter of 2003 related to suchactions.

 

10

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**ITEM 2**.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS

** **

**Overview**

** **

**Sanchez Computer Associates, Inc. (Sanchez or the Company) is publiclytraded on the Nasdaq Stock Exchange under the symbol SCAI.  The Company is aninternational provider in developing and marketing scalable and integratedsoftware and services that provide banking, customer integration, brokerage,wealth management and outsourcing solutions used by approximately 400 financialinstitutions in 22 countries.  Sanchez’scorporate headquarters is located in Malvern, Pennsylvania.  The Company’s outsourcing data andoperations service center is located in Seven Fields, Pennsylvania.  Sanchez also maintains offices in Toronto,Canada; San Ramon, California; Sydney, Australia; New York, New York;Amsterdam, the Netherlands; and Warsaw, Poland.**

** **

**Divisional Organization**

** **

**Beginning with the first quarter of 2003, Sanchez organizedinto divisions and initiated new segment reporting based on thosedivisions.  Sanchez’s divisionalsegments are Banking Solutions, Wealth Management, Outsourcing and GlobalServices.  In addition, a CorporateSupport group was created to support these operating divisions.  Each division has individual profit and lossresponsibilities and is responsible for advancing the Company’s objective to bethe industry’s leading “value innovator.” Whether through software products, methodologies, services, customsoftware enhancements or solutions consulting engagements, each division istasked to significantly lower clients’ ongoing operations and technology costs,reduce their technology risk, and improve their enterprise customermanagement.  The divisions were createdto provide the innovation and focus necessary to assist clients in achievingtheir business plans.  The Companybelieves this additional focus for all of its products and services will helpthe Company pursue new and previously under-served revenue opportunities.  In addition, it is believed the divisionswill allow the Company to respond more quickly and with greater flexibility toa wider variety of******clientrequirements and needs.  The Companymarkets internationally and prospects for sales opportunities with institutionsin need of one or more of the following solutions: a bank line of businessmigration; a retail banking legacy system replacement; customer enterpriseintegration; bank outsourcing; or a wealth management solution.

** **

*SanchezBanking Solutions Division*

TheBanking Solutions Division **develops and supports** the Sanchez suite ofintegrated banking software products. The division licenses the**se**banking products to financial institutions to run in-house or alternatively, on an outsourced basis.  The Banking Solutions Division derives itsrevenues from **licenses of** software products, productenhancements and software maintenance**fees,** aswell as from other miscellaneous fees.

*SanchezWealth Management Division*

The Wealth Management Division is responsible for thedevelopment, maintenance and services associated with Sanchez WealthwareTM.  Wealthware is an integrated wealthmanagement software solution that helps financial institutions manage investorassets online.  Wealthware aggregatescustomer data to provide a single, customer-centric perspective and providesthe desktop tools to analyze portfolios, make informed investment decisions andexecute transactions.  The WealthManagement Division derives its revenues primarily from license, service andmaintenance fees on its Wealth Management product.

* *

*Sanchez Outsourcing Division*

 

Sanchezalso uses its integrated banking platform as the basis for offering a completeoutsourced direct banking solution called Sanchez e-PROFILE®. The Sanchez Outsourcing Divisionadministers the Sanchez e-PROFILE solution by offering an integrated end-to-end operationsand technology platform.  This outsourced platformenables institutions to offer comprehensive on-line financial services to theircustomers.  This solution integratesproducts and services from **what the Company believes are**the industry’s“best-in-class” vendors, including Sanchez products, and manages them under asingle, outsourced operating umbrella.  The solution also provides theCompany with a distribution channel for the suite of Sanchez products, relatedtechnologies and services.  At September30, 2003, there were nine clients processing accounts at the Company’s data andoperations service center.  TheOutsourcing Division’s revenues are primarily generated from processing andservices fees.

11

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*SanchezGlobal Services Division*

TheGlobal Services Division provides project management, training, systemimplementation, solution integration, custom interfaces to third-party orin-house legacy applications, data conversion, integrated testing, customsoftware, custom output (reports, statements, notices), custom componentapplication, localization, and version upgrade services to our banking customers.  While supporting the other operating units, the Global ServicesDivision also markets its services directly to existing and prospectiveclients.

**Revenue Generation**

TheCompany’s divisions generate revenue by assessing fees on software products,services, processing and maintenance. Fees assessed on software products include software license and productenhancement fees.  Typically, fees forsoftware license contracts are paid in stages upon the completion of defineddeliverables or certain dates.  Forlicenses sold for in-house solutions, i.e., operated by the institutions, theCompany recognizes revenue from fees **under**either the percentage-of-completion contract accounting method, or where applicable, when therequirements ofAICPA Statement of Position 97-2 “Software Revenue Recognition” are met.  Financial institutions selecting anoutsourced banking solution can purchase product licenses upfront, or in lieuof upfront license fees, institutions can opt to spread the license andaccompanying maintenance fees on a per account/per month basis over the life ofthe processing contract.  Assessment ofper account/per month fees begins after the client goes live, i.e., clientbegins processing its customers’ accounts on the outsourced platform with thesolution.  Software product fees andimplementation fees generated from outsourced solutions, along with theirassociated costs, are largely deferred during the implementation phase of anoutsourced project in accordance with Staff Accounting Bulletin No. **101,**“Revenue Recognition in Financial Statements” **(SAB 101)**.  Once an outsourced solution goes live, thedeferred product and services revenue and costs are recognized over theexpected life of the processing arrangement. Other service revenue is generally recognized when the services areperformed or on the percentage-of-completion method, depending on the contractterms and accounting for the other elements of the arrangement.  Processing fees consist primarily of monthlyand account-based fees for servicing, **as well as**transactionfees associated with transaction volumes for a specified period.  Under the outsourcing model, when a clientinstitution’s customer account base grows, and the institution exceeds theminimum account processing levels, outsourcing revenue can increase.  For both in-house and outsourced licensecontracts, maintenance fees are normally billed annually in advance andrecognized as revenue ratably during the specified maintenance period.  The Company also recognizes reimbursableclient expenses as revenue in accordance with Emerging Issues Task Force IssueNo.  01-14, “Income StatementCharacterization of Reimbursement Received for ‘Out-of-Pocket’ ExpensesIncurred” (EITF 01-14), which requires that the reimbursement received forout-of-pocket expenses be classified as revenues and not as cost reductions.

12

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# **Results ofOperations**

        The following table sets forth, for theperiods indicated, selected statement of operations data: 

 
|                                      |   | **Three  Months Ended** |   | **Nine  Months Ended** |   |
|-------------------------------------------|--------|-------------------------|--------|------------------------|--------|
| **Dollars in  thousands**                 |   | **September  30,**      |   | **September  30,**     |   |
|                                      |   | **2003**                |   | **2002**               |   | **2003** |   | **2002** |   |
| Revenues                                  |   |                    |   |                   |   |   |   |   |   |
| Products                                  |   | $                       | 7,112  |                   | $      | 4,132 |   | $ | 19,073 |   | $ | 10,813 |   |
| Services                                  |   | 7,264                   |   | 10,232                 |   | 20,560 |   | 25,102 |   |
| Processing                                |   | 4,557                   |   | 4,743                  |   | 13,837 |   | 13,835 |   |
| Software maintenance and other            |   | 5,015                   |   | 4,546                  |   | 15,295 |   | 12,689 |   |
| Customer reimbursements                   |   | 1,211                   |   | 1,562                  |   | 3,439 |   | 4,434 |   |
| Total revenues                            |   | $                       | 25,159 |                   | $      | 25,215 |   | $ | 72,204 |   | $ | 66,873 |   |
|                                      |   |                    |   |                   |   |   |   |   |   |
| Percentage Relationship to Total Revenues |   |                    |   |                   |   |   |   |   |   |
| Revenues                                  |   |                    |   |                   |   |   |   |   |   |
| Products                                  |   | 28.3                    | %      | 16.4                   | %      | 26.4 | % | 16.2 | % |
| Services                                  |   | 28.9                    |   | 40.6                   |   | 28.5 |   | 37.5 |   |
| Processing                                |   | 18.1                    |   | 18.8                   |   | 19.2 |   | 20.7 |   |
| Software maintenance and other            |   | 19.9                    |   | 18.0                   |   | 21.2 |   | 19.0 |   |
| Customer reimbursements                   |   | 4.8                     |   | 6.2                    |   | 4.7 |   | 6.6 |   |
| Total revenues                            |   | 100.0                   |   | 100.0                  |   | 100.0 |   | 100.0 |   |
|                                      |   |                    |   |                   |   |   |   |   |   |
| Operating expenses                        |   |                    |   |                   |   |   |   |   |   |
| Product development                       |   | 22.5                    |   | 17.8                   |   | 22.3 |   | 17.0 |   |
| Product support                           |   | 6.5                     |   | 6.6                    |   | 6.8 |   | 6.6 |   |
| Services                                  |   | 23.7                    |   | 22.0                   |   | 23.1 |   | 22.0 |   |
| Processing                                |   | 17.3                    |   | 16.4                   |   | 16.7 |   | 18.4 |   |
| Sales and marketing                       |   | 12.4                    |   | 11.6                   |   | 13.8 |   | 13.9 |   |
| General, administrative and other         |   | 12.5                    |   | 10.7                   |   | 12.2 |   | 12.3 |   |
| Customer reimbursement expense            |   | 4.8                     |   | 6.2                    |   | 4.8 |   | 6.7 |   |
| Impairment charge                         |   | 37.8                    |   | —                 |   | 13.2 |   | — |   |
| Restructuring charge                      |   | —                  |   | 3.0                    |   | 0.4 |   | 1.1 |   |
| Total operating expenses                  |   | 137.5                   |   | 94.3                   |   | 113.3 |   | 98.0 |   |
|                                      |   |                    |   |                   |   |   |   |   |   |
| Earnings (loss) from operations           |   | (37.5                   | )      | 5.7                    |   | (13.3 | ) | 2.0 |   |
| Interest income, net                      |   | 0.3                     |   | 0.6                    |   | 0.3 |   | 1.4 |   |
| Gain on investment                        |   | —                  |   | —                 |   | 0.2 |   | — |   |
| Foreign exchange income (loss)            |   | —                  |   | 0.5                    |   | (0.3 | ) | 0.2 |   |
| Earnings (loss) before income taxes       |   | (37.2                   | )      | 6.8                    |   | (13.1 | ) | 3.6 |   |
| Income tax provision                      |   | 0.3                     |   | 1.6                    |   | — |   | 1.0 |   |
| Net earnings (loss)                       |   | (37.5                   | )%     | 5.2                    | %      | (13.1 | )% | 2.6 | % |
|                                      |   |                    |   |                   |   |   |   |   |   |

# ** **

13

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**ThreeMonths Ended September 30, 2003 Compared to Three Months Ended September 30,2002**

 

REVENUES

 

        Total revenues decreased by $56,000 in the third quarter of2003 as compared to the third quarter of 2002.

 

        Product revenue increased by $3.0 million, or 72%, from thethird quarter of 2002 to the third quarter of 2003.  Product revenues increased primarily as a result of licenserevenue that was recognized for projects currently being implemented withcustomers in Canada and Thailand.  Inaddition, the recognition of revenue from several license expansions fromclients who are expanding their use of the Company’s software and the accretionof previously deferred product revenues from a significant U.S. outsourcingcustomer also contributed to the increase in product revenues.

 

        Service revenues decreased by $3.0 million, or 29%, in thequarter ended September 30, 2003, as compared to the quarter ended September30, 2002.  Included in service revenuesa year ago was the one-time settlement of $2.9 million from a receivable with aformer client.  Other service revenuesreported for the quarter were driven by two on-going implementation projects,as well as on-going projects within the Company’s installed banking andbrokerage customer base and the accretion of previously deferred servicerevenues.

 

        Processing revenues decreased by $186,000, or 4%, in thethird quarter of 2003 as compared to the third quarter of 2002.  The decrease in processing revenues isprimarily reflective of the discontinuance of processing services from a clientin the second quarter of 2003 and a reduction in services provided to anotherclient during the past year.  Thesedecreases were partially offset by the additional processing revenue generatedas a result of a significant U.S. customer launching its offering earlier inthe year.

 

        Software maintenance and other revenues increased by$469,000, or 10%, from the third quarter of 2002 to the third quarter of2003.  The increase is attributable tomaintenance fees from new clients and the maintenance fees associated withlicense expansions from existing clients.

 

        Customer reimbursement revenues decreased by $351,000, or23%, in the quarter ended September 30, 2003, as compared to the quarter endedSeptember 30, 2002.  The primary reasonfor the decrease can be attributed to less reimbursable expenses incurred as aresult of fewer implementation projects in the third quarter of 2003 ascompared to the third quarter of 2002.

 

OPERATING EXPENSES

 

*       *Product development expensesincreased $1.2 million, or 26%, in the third quarter of 2003 compared to thesame period in 2002, primarily due to the increased usage of externalconsulting resources.  Also contributingto the increase were higher compensation, benefit, occupancy and variousallocated overhead costs.

 

        Product support expensesdecreased $23,000, or 1%, in the third quarter of 2003 compared to the thirdquarter of 2002.  This decrease isprimarily due to lower third-party maintenance costs as a result of theCompany’s efforts to transfer certain maintenance work from third partyresources to in-house resources.

 

        Service expenses increasedby $414,000, or 8%, during the quarter ended September 30, 2003, as compared tothe quarter ended September 30, 2002.  The primary reason for the increase inservice expenses is due to less deferral of expenses related to theimplementation of the outsourcing solution.  Service margins in the third quarter of 2003 were 18%, comparedto 46% in the third quarter of 2002. The primary reasons for the drop in service margins were lowerutilization rates of internal resources and lower margins related to revenuesfrom certain outsourcing clients that are being recognized over the estimatedcustomer life when compared to the quarter ended September 30, 2002.

 

        Processing expensesincreased $204,000, or 5%, in the third quarter of 2003 as compared to2002.  This increase is partiallyattributable to an increase in internal resources working on our processingclients as well as the incremental costs associated with an additional clienton the processing platform.  Theseincreases were partially offset by lower third party processing fees as someclients reduced their services.

 

        Sales and marketingexpenses increased by $190,000, or 6%, in the second quarter of 2003 comparedto the same quarter in 2002.  Expenseswere up primarily due to an increase in external marketing spending.

 

14

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*       *General, administrative andother expenses increased by $459,000, or 17%, in the quarter ended September30, 2003, compared to the quarter ended September 30, 2002.  The increase includes higher compensationand benefits as well as higher insurance, recruitment, external legal and otherprofessional fees.

 

        Customer reimbursement expenses decreased by $351,000, or23%, in the quarter ended September 30, 2003, as compared to the quarter endedSeptember 30, 2002.  The primary reasonfor the decrease can be attributed to less reimbursable expenses incurred as aresult of fewer implementation projects in the third quarter of 2003 ascompared to the third quarter of 2002.

 

*       *During thequarter ended September 30, 2003, the Company recorded an impairment charge of$9.5 million.  During the third quarterthe Company performed an assessment of the goodwill associated with theCompany’s Wealth Management Division. The Company engaged an external valuation specialist to assist in thisassessment.  Based upon this assessment,the Company determined that the carrying value of the Reporting Unit exceededits fair value.  Whileperforming the goodwill realizability analysis, the Company determined thatthere also was an impairment to certain amortizable intangible assetsassociated with the Reporting Unit, primarily the customer relationships andacquired technology, resulting in an impairment charge of approximately $5.5million to write down the asset group to its fair value.  The Companythen determined the fair value of the goodwill associated with the ReportingUnit in accordance with SFAS No. 142, resulting in an impairment charge relatedto goodwill of approximately $4.0 million.

 

OTHER INCOME, EXPENSE AND TAXES

 

        Interest income for thequarter ended September 30, 2003 decreased $80,000, or 54%, compared to thequarter ended September 30, 2002, primarily due to lower interest rates in2003.

 

        The Company’s effectivetax rate in the third quarter of 2003 was 1% of earnings compared to 24% in thethird quarter of 2002.  The reason forthe change is primarily due to the impairment charge related to the WealthManagement Reporting Unit, which is not deductible for income tax purposes andthe recording of a valuation allowance against deferred taxes in Canada.

 

**Nine MonthsEnded September 30, 2003, Compared to Nine Months Ended September 30, 2002**

 

REVENUES

 

        Total revenues increased by $5.3 million, or 8%, in the ninemonths ended September 30, 2003, as compared to the nine months ended September30, 2002.

 

        Product revenues increased by $8.3 million, or 76%, from thenine months ended September 30, 2002 to the nine months ended September 30,2003.  The increase in product revenueis primarily attributable to the license revenue realized from two of theCompany’s major implementation projects in Canada and Thailand.  In addition, the recognition of severallicense expansions from clients who are expanding their use of the Company’ssoftware and the accretion of previously deferred product revenues from asignificant U.S. customer also contributed to the increase in productrevenues.  Also contributing to theincrease in product revenues was the revenue associated with the acquisition ofour Wealth Management Division in July 2002.

 

        Service revenues decreased by $4.5 million, or 18%, in thenine months ended September 30, 2003, as compared to the nine months endedSeptember 30, 2002.  Included in servicerevenues during the nine months ended September 30, 2002 was $3.2 million in revenue related to afavorable arbitration ruling in respect to a dispute with1stWebbankdirect.  Also during the firstnine months of 2002, the Company settled an outstanding receivable with aformer client and as a result recognized $2.9 million in related servicesrevenues. Partially offsetting the decrease in service revenues was the revenueassociated with the acquisition of our Wealth Management Division in July2002.  Service revenues reported for thecurrent year were driven by two on-going implementation projects, as well ason-going projects within the Company’s installed banking and brokerage customerbase and the accretion of previously deferred service revenues.

 

        Processing revenues increased by $2,000 in the nine monthsended September 30, 2003, as compared to the nine months ended September 30,2002.  Processing revenues increasedonly slightly as a result of a majority of clients remaining within theirmonthly minimum processing volumes. During the nine months ended September 30, 2003, Juniper Bankdiscontinued processing on the outsourcing platform.  The revenue generated from this client was immaterial for thenine months ended September 30, 2003.

 

15

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        Software maintenance and other revenues increased $2.6million, or 21%, from the nine months ended September 30, 2002 to the ninemonths ended September 30, 2003.  Theincrease can be primarily attributed to the commencement of maintenance for asignificant U.S. customer in mid-2002, the start of maintenance at a client inThailand as well as the one-time termination fee from a U.S. customerrecognized in the nine months ended September 30, 2003.  Also contributing to the increase inmaintenance and other revenues was the revenue associated with the acquisitionof our Wealth Management Division in July 2002.

 

        Customer reimbursement revenues decreased $995,000, or 22%,in the nine months ended September 30, 2003, as compared to the nine monthsended September 30, 2002.  The primaryreason for the decrease can be attributed to less travel required forimplementation projects in the nine months ended September 30, 2003 as comparedto the nine months ended September 30, 2002.

 

OPERATING EXPENSES

 

*       *Product development expensesincreased $4.7 million, or 42%, in the first nine months of 2003 compared tothe nine months ended September 30, 2002, primarily due to the costs associatedwith our Wealth Management Division, which was acquired in July 2002.  Contributing to the net increase was anincrease in the net amortization of previously deferred license costs forclients using the outsourced solution in 2003 compared to 2002 as well ashigher outside consulting expenses resulting from an increase in externalresources.

 

*       *Product support expensesincreased by $486,000, or 11%, for the nine months ended September 30, 2003,primarily due to the costs associated with our Wealth Management Division,which was acquired in July 2002. Partially offsetting this increase was lower third party support fees asthe Company has begun to handle more support matters with its own resources.

 

        Service expenses increasedby $2.0 million, or 14%, during the nine months ended September 30, 2003, ascompared to the nine months ended September 30, 2002.  Theprimary reason for the increase in service expenses is due to less deferral ofexpenses related to the implementation of the outsourcing solution as well asthe costs associated with the Wealth Management Division.  Service margins for the ninemonths ended September 30, 2003, were 19%, compared to 42% in the nine monthsended September 30, 2002.  The primarycauses for the drop in the service margin were lower utilization rates ofinternal resources and lower margins related to certain outsourcing projectsthat are being recognized over the estimated customer life when compared to thesame period ended September 30, 2002.

 

        Processing expensesdecreased $203,000, or 2%, in the first nine months of 2003, as compared to thesame period in 2002.  This decrease isattributable to lower third party processing fees and maintenance costs relatedto outside vendors.  The addition of theWealth Management Division partially offset these reductions.  The gross margin relative to processing was13% during the nine months ended September 30, 2003, as compared to 11% duringthe same period in 2002.

 

*       *Sales and marketing expensesincreased by $653,000, or 7%, in the nine months ended September 30, 2003,compared to 2002.  This increase isprimarily due to the addition of the Wealth Management Division expenses.  This was partially offset by lowercommissions paid to third party partners as well as lower travel expenses.

 

        General, administrativeand other expenses increased by $606,000, or 7%, in 2003 primarily due to theWealth Management Division expenses. These were partially offset by a decrease in bad debt and legal expensein the first nine months of 2003 compared to the same period in 2002.

 

        Customer reimbursement expense decreased $995,000, or 22%, inthe nine months ended September 30, 2003, as compared to the nine months endedSeptember 30, 2002.  The primary reasonfor the decrease can be attributed to less travel required for implementationprojects in the nine months ended September 30, 2003, as compared to the ninemonths ended September 30, 2002.

 

        During the nine monthsended September 30, 2003, the Company recorded an impairment charge of $9.5million.  During the third quarter theCompany performed an assessment of the goodwill associated with the Company’sWealth Management Division.  The Companyengaged an external valuation specialist to assist in this assessment.  Based upon this assessment, the Companydetermined that the carrying value of the Reporting Unit exceeded its fairvalue.  While performing thegoodwill realizability analysis, the Company determined that there also was animpairment to certain amortizable intangible assets associated with theReporting Unit, primarily the customer relationships and acquired technology,resulting in an impairment charge of approximately $5.5 million to write downthe asset group to its fair value.  The Companythen determined the fair value of the goodwill associated with the ReportingUnit in accordance with SFAS No. 142, resulting in an impairment charge relatedto goodwill

 

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of approximately $4.0 million.

 

        During the nine monthsended September 30, 2003, the Company incurred restructuring costs primarilyrelated to its relocation of its European headquarters from Chester, U.K. toAmsterdam, the Netherlands. Restructuring charges recorded in connection with these actions totaledapproximately $316,000, which consisted primarily of severance relatedpayments.

 

OTHER INCOME, EXPENSE AND TAXES

 

        Interest income for thenine months ended September 30, 2003, decreased $670,000 or 75% compared to thesame period in 2002.  Interest income in2002 included interest received related to the settlement of an outstandingreceivable with a former client.  Alsocontributing to the decrease are lower interest rates in 2003 and lower cashreserves following the acquisition of Spectra Software in July 2002.

 

        During 2003’s first ninemonths, the Company recognized a net gain of $156,000 on the settlement of aninvestment in a partner company in Poland.

 

        The Company incurred aforeign exchange loss of $194,000 during the first nine months of 2003,primarily as a result of a weakening U.S. dollar against the Canadiandollar.  The Company’s foreign exchangeexposure is primarily related to intercompany activity that was not designatedas permanent in the first quarter of 2003.

 

        The Company’s effectivetax rate in the first nine months of 2003 was 0% of earnings compared to 33% inthe same period of 2002.  The reason forthis decrease is primarily due to the impairment charge related to the WealthManagement Reporting Unit, which is not deductible for income tax purposes.

 

**Liquidity and Capital Resources**

 

Cash and cash equivalents were $28.0 million atSeptember 30, 2003, a decrease of $4.7 million from December 31, 2002.  Cash used by operating activities for thenine months ended September 30, 2003, was $3.4 million compared to cashprovided by operating activities of $9.4 million for the comparable 2002period.  Contributing to the use of cashby operating activities was an increase in the net amortization of deferredrevenues and expenses during the nine months ended September 30, 2003 comparedto the same period in 2002.  Thisincrease in net amortization is primarily attributable to fewer implementationprojects related to outsourcing clients where associated revenues and directcosts were deferred.  During the firstnine months of 2003, the Company used $2.0 million for the purchase of propertyand equipment, while financing activities contributed $525,000 of cash duringthe nine months ended September 30, 2003, principally fromthe proceeds from the employee stock purchase plan.

 

The Company currently anticipates that cash generatedfrom operations and existing cash balances will be sufficient to satisfy itsoperating and capital cash needs for the foreseeable future and, at a minimum,through the next year.  Should theCompany’s business expand more rapidly than expected, the Company has a line ofcredit of $20 million available for its use. The Company’s line of credit is secured with the Company’s primarybanker and has a term of three years which expires on July 2, 2006.  Outstanding amounts shall bear an interestrate per annum from one of the following two options; (1) a Base Rate optionthat is equal to the Bank’s prime rate or one quarter of one (.25)percentage point above the Federal Funds Rate, (2) a LIBOR Rate Option equal to the sum of (i) LIBORplus (ii) 150 basis points (the “LIBOR-Based Rate”).  At thecurrent time the Company has not drawn on this line of credit and has no debtoutstanding.

 

The Company believes thatits business is generally not seasonal; however, the Company has historicallyexperienced, and can be expected to continue to experience, a certain degree ofvariability in its quarterly revenue, earnings and cash flow patterns.  This variability is typically driven bysignificant events, which directly impact the recognition and billing ofproject-related revenues.  Examples ofsuch events include the timing of new business contract closings and the initiationof product and service fee revenue recognition, one-time payments from existingclients relative to license expansion rights (required to process a greaternumber of customer accounts or expand the number of permitted users) andcompletion of implementation project rollouts and the related revenuerecognition.  Because a high percentageof the Company’s expenses are relatively fixed, a variation in the timing ofthe initiation or the completion of client projects, particularly at or nearthe end of any quarter, can cause significant variations in operating resultsfrom quarter to quarter.  The Companybelieves that over the course of time the ongoing monthly revenue streamassociated with the outsourcing operations will contribute toward more predictablequarter-to-quarter revenues.

 

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**Recent Accounting Pronouncements**

In January 2003, the FASBissued Interpretation No. 46, “Consolidation of Variable Interest Entities,”which addresses the consolidation by business enterprises of variable interestentities as defined in the Interpretation. Interpretation No. 46 requires that its provisions are effectiveimmediately for all arrangements entered into after January 31, 2003.  For those arrangements entered into prior toJanuary 31, 2003, Interpretation No. 46 provisions are required to be adoptedat the beginning of the first interim or annual period beginning after December15, 2003.  The Company does not expect thatthe provisions of Interpretation No. 46 will have a material impact on theCompany’s results of operations or financial position.

**Forward-looking Statements**

        Certain matters discussed in this Form 10-Q contain“forward-looking statements” within the meaning of Section 27A of theSecurities Act of 1933 and Section 21E of the Securities Exchange Act of 1934,including, but not limited to, statements concerning the Company’s revenues,expenses and earnings, future operating and financial performance, growthrates, acquisition opportunities, and other similar forecasts andexpectations.  The words “anticipate,”“estimate,” “believe,” “expect,” “intend,” “plan,” “project” and variations ofthese words and similar expressions are intended to identify forward-lookingstatements.  Forward-looking statementsare based on operating budgets, forecasts, beliefs and assumptions ofmanagement and, as such, are subject to risks and uncertainties and are notguarantees of future performance. Actual outcomes could differ materially from those expressed in any suchforward-looking statement due to a variety of factors in addition to thosespecifically identified herein.  Thesefactors include, without limitation, the timely and successfulintegration of new businesses and products of recently acquired companies andthe risks associated with acquisitions, changes in or interpretations of taxlaws, treaties, or regulations, governmental and public policy changes,business and economic conditions, currency fluctuations, challenges the Companymay face as it expands its international operations, the development of themarkets or new business areas that the Company is targeting, demand forproducts and services in the financial services industry, the extent to whichthe Internet will be used for financial services and products, the potentiallyadverse impact of consolidation in the financial services industry, timing ofcontracts and long sales cycles, competition among technology companies servingour industry, renewal of material contracts with clients, potential delays in,or cancellation of, the implementation of products and services, undetectedsoftware errors or failures found in new products, the potentially adverseeffect of business interruptions beyond the Company’s control, such as securitybreaches and future acts of terrorism, maintaining good relationships with keystrategic partners, the Company’s ability to attract, hire, and retain skilledand knowledgeable employees, success of the Company’s business model, changesin and availability of capital requirements, the Company’s ability to protectits intellectual property rights, and outcomes of pending and futurelitigation.  In addition, the Company’soperating results may fluctuate significantly and the Company may not be ableto maintain historical growth rates or meet anticipated growth levels.  The Company’s stock price fluctuates and maycontinue to be volatile.  The Companyhas investments in other companies, which are inherently risky.  These risks, as well as risks identified inthe Company’s other SEC filings and public announcements, may impact futureresults.  The Company undertakes noduty to publicly update any forward-looking statements, whether as a result ofnew information, future events or otherwise.

 

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

**Interest Rate Risk**

        TheCompany’s exposure to market risk for changes in interest rates relatesprimarily to the Company’s cash equivalents. The Company does not have any derivative financial instruments in itsportfolio.  The Company is averse toprincipal loss and ensures the safety and preservation of its invested funds bylimiting default risk, market risk and reinvestment risk.  The Company does not expect any material losswith respect to its cash equivalents.

**Foreign Currency Risk**

The Company does not useforeign exchange forward contracts. Substantially all of the Company’s U.S. based operations contract inU.S. dollars.  For the Company’s foreignsubsidiaries, the Company generally matches local currency revenues with localcurrency costs.  The Company does havecertain inter-company relationships that may create foreign exchange gains orlosses.

 

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

 

**Evaluation of Disclosure Controls and Procedures**

 

**The Company’s Chief Executive Officer and Chief FinancialOfficer have evaluated the effectiveness of the design and operation of itsdisclosure controls and procedures as of September 30, 2003, and based on theirevaluation, the Chief Executive Officer and Chief Financial Officer haveconcluded that these disclosure controls and procedures are effective.**

** **

**The evaluation referred to above did not identify anychanges in the Company’s internal control over financial reporting thatoccurred during the quarter ended September 30, 2003 that has materiallyaffected, or is reasonably likely to materially affect, the Company’s internalcontrol over financial reporting.**

 

**AuditProcess and Auditors**

 

Under the Sarbanes-OxleyAct, auditors are prohibited from providing non-audit services to audit clientswithout the advance approval of the audit committee.  The Audit Committee has also put in place a procedure forapproval of the permitted non-audit services by one of three Audit Committeemembers in between meetings, subject to subsequent ratification by the fullAudit Committee.

 

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**PART II—OTHER INFORMATION**

**ITEM6****:  EXHIBITS ANDREPORTS ON FORM8-K**

a)              Exhibit 31.1.   Section 302 CEO Certification.

b)             Exhibit 31.2.   Section 302 CFO Certification.

c)              Exhibit 32.1.   CEO-CFO Certification pursuant to 18 U.S.C.Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of2002.

No otherapplicable items.

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**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 

| SANCHEZ COMPUTER ASSOCIATES, INC.                    |
|------------------------------------------------------|
|                                                 |
| /s/  TODD A. PITTMAN                            |
| Todd A. Pittman                                      |
| *Senior Vice President and Chief  Financial Officer* |

 

Dated: November 14, 2003

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