##### Table of Contents



SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

þ Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended June 30, 2003

or

o Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from ______________to______________

Commission File Number: 1-11905

National Processing, Inc.
(Exact name of Registrant as specified in its charter)

Ohio
    
    61-1303983(State or other jurisdiction
    
    (I.R.S. Employer Identification No.)of incorporation or organization)1231 Durrett LaneLouisville, Kentucky
    
    40213-2008(Address of principal executive offices)
    
    (Zip Code)


(502) 315-2000
(Registrants telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES X NO

Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). YES X NO

The number of shares outstanding of the Registrants Common Stock as of July
31, 2003 was 52,432,877.





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TABLE OF CONTENTS



|                               |                                                                                               |                                                           |  |  |  |  |  | 
|------------------------------ | --------------------------------------------------------------------------------------------- | --------------------------------------------------------- |  |  |  |  |  | 
|Part I. Financial Information 
|                               | Item 1. Consolidated Financial Statements (unaudited)                                        
|                               |                                                                                               | Consolidated Balance Sheets                              
|                               |                                                                                               | Consolidated Statements of Income                        
|                               |                                                                                               | Consolidated Statement of Changes in Shareholders Equity
|                               |                                                                                               | Consolidated Statements of Cash Flows                    
|                               |                                                                                               | Notes to 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 (None)                                                             
|                               | Item 2. Changes in Securities and Use of Proceeds (None)                                     
|                               | Item 3. Defaults Upon Senior Securities (None)                                               
|                               | Item 4. Submission of Matters to a Vote of Security Holders                                  
|                               | Item 5. Other Information (None)                                                             
|                               | Item 6. Exhibits and Reports on Form 8-K:                                                    
|SIGNATURES                    
|EX-3.1(II) Code of Regulations
|EX-10.23 Guarantee            
|EX-31.1 CEO 302 Cert.         
|EX-31.2 CFO 302 Cert.         
|EX-32.1 CEO 906 Cert.         
|EX-32.2 CFO 906 Cert.         



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##### Table of Contents



NATIONAL PROCESSING, INC.

INDEX

Part I. Financial InformationPage No.Item 1. Consolidated Financial Statements (unaudited)Consolidated Balance Sheets  June 30, 2003,
December 31, 2002, and June 30, 2002
    
    
    3Consolidated Statements of Income  Three and Six
Months Ended June 30, 2003 and 2002
    
    
    4Consolidated Statement of Changes in Shareholders
Equity  Six Months Ended June 30, 2003
    
    
    5Consolidated Statements of Cash Flows -
Six Months Ended June 30, 2003 and 2002
    
    
    6Notes to Consolidated Financial Statements
    
    
    7Item 2. Managements Discussion and Analysis of
Financial Condition and Results of Operations
    
    
    16Item 3. Quantitative and Qualitative Disclosures About
Market Risk
    
    
    27Item 4. Controls and Procedures
    
    
    28Part II. Other InformationItem 1. Legal Proceedings (None)
    
    
    29Item 2. Changes in Securities and Use of Proceeds (None)
    
    
    29Item 3. Defaults Upon Senior Securities (None)
    
    
    29Item 4. Submission of Matters to a Vote of Security Holders
    
    
    29Item 5. Other Information (None)
    
    
    29Item 6. Exhibits and Reports on Form 8-K
    
    
    29Signatures
    
    
    31


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National Processing, Inc.
Consolidated Balance Sheets
Unaudited
(Dollars in thousands)

June 30
    
    December 31
    
    June 302003
    
    2002
    
    2002AssetsCurrent assets:Cash and cash equivalents
    
    $
    214,806
    
    
    $
    185,513
    
    
    $
    182,679Accounts receivable  trade
    
    
    113,456
    
    
    
    152,132
    
    
    
    108,003Deferred tax assets
    
    
    1,396
    
    
    
    2,113
    
    
    
    2,904Other current assets
    
    
    9,606
    
    
    
    7,287
    
    
    
    6,929Total current assets
    
    
    339,264
    
    
    
    347,045
    
    
    
    300,515Property and equipment:Furniture and equipment
    
    
    51,641
    
    
    
    51,253
    
    
    
    55,301Building and leasehold improvements
    
    
    12,153
    
    
    
    11,835
    
    
    
    10,842Software
    
    
    39,702
    
    
    
    37,666
    
    
    
    35,922Property leased from affiliate
    
    
    4,173
    
    
    
    4,173
    
    
    
    4,173Land and improvements
    
    
    442
    
    
    
    442
    
    
    
    442108,111
    
    
    
    105,369
    
    
    
    106,680Less: Accumulated depreciation and amortization
    
    
    56,843
    
    
    
    51,662
    
    
    
    52,015Property and equipment, net
    
    
    51,268
    
    
    
    53,707
    
    
    
    54,665Other assets:Goodwill
    
    
    115,195
    
    
    
    91,227
    
    
    
    91,227Other intangible assets, net of accumulated amortization of $25,129, $21,470
and $17,946 at June 30, 2003, December 31, 2002, and
June 30, 2002, respectively
    
    
    48,070
    
    
    
    41,990
    
    
    
    41,614Deferred tax assets
    
    
    10,444
    
    
    
    12,231
    
    
    
    12,801Other assets
    
    
    4,061
    
    
    
    4,304
    
    
    
    3,421Total other assets
    
    
    177,770
    
    
    
    149,752
    
    
    
    149,063Total assets
    
    $
    568,302
    
    
    $
    550,504
    
    
    $
    504,243Liabilities and shareholders equityCurrent liabilities:Accounts payable  trade
    
    $
    23,612
    
    
    $
    23,006
    
    
    $
    21,533Accrued bankcard assessments
    
    
    24,562
    
    
    
    27,645
    
    
    
    25,459Accrued compensation and benefits
    
    
    2,583
    
    
    
    3,321
    
    
    
    3,086Income tax payable
    
    
    11,606
    
    
    
    17,211
    
    
    
    9,905Other accrued liabilities
    
    
    25,130
    
    
    
    18,744
    
    
    
    12,081Total current liabilities
    
    
    87,493
    
    
    
    89,927
    
    
    
    72,064Obligations under capital leases
    
    
    2,093
    
    
    
    1,732
    
    
    
    1,797Minority interest
    
    
    1,247
    
    
    
    2,462
    
    
    
    2,040Total liabilities
    
    
    90,833
    
    
    
    94,121
    
    
    
    75,901Shareholders equity:Preferred stock, without par value; 5,000,000 shares authorized; no shares
issued or outstanding
    
    
    
    
    
    
    
    
    
    
    Common stock, without par value; 95,000,000 shares authorized; 52,245,178,
52,093,945, and 52,040,701 issued and outstanding at
June 30, 2003, December 31, 2002, and June 30, 2002, respectively
    
    
    1
    
    
    
    1
    
    
    
    1Contributed capital
    
    
    200,120
    
    
    
    198,728
    
    
    
    197,570Unearned compensation
    
    
    (230
    )
    
    
    (311
    )
    
    
    (364
    )Retained earnings
    
    
    277,578
    
    
    
    257,965
    
    
    
    231,135Total shareholders equity
    
    
    477,469
    
    
    
    456,383
    
    
    
    428,342Total liabilities and shareholders equity
    
    $
    568,302
    
    
    $
    550,504
    
    
    $
    504,243


See notes to consolidated financial statements

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National Processing, Inc.
Consolidated Statements of Income
Unaudited
(In thousands, except per share amounts)

Three Months Ended
    
    Six Months EndedJune 30
    
    June 302003
    
    2002
    
    2003
    
    2002Revenue
    
    $
    113,614
    
    
    $
    112,664
    
    
    $
    219,568
    
    
    $
    222,609Operating expenses
    
    
    83,172
    
    
    
    80,859
    
    
    
    165,924
    
    
    
    163,163General and administrative expenses
    
    
    5,748
    
    
    
    4,082
    
    
    
    10,054
    
    
    
    8,684Depreciation and amortization
    
    
    5,044
    
    
    
    4,456
    
    
    
    10,011
    
    
    
    8,479Impairment, restructuring, and related expenses
    
    
    1,273
    
    
    
    1,650
    
    
    
    1,273
    
    
    
    1,650Operating profit
    
    
    18,377
    
    
    
    21,617
    
    
    
    32,306
    
    
    
    40,633Net interest income
    
    
    830
    
    
    
    1,069
    
    
    
    1,672
    
    
    
    2,104Income before provision for income taxes
and minority interest
    
    
    19,207
    
    
    
    22,686
    
    
    
    33,978
    
    
    
    42,737Provision for income taxes
    
    
    7,444
    
    
    
    9,861
    
    
    
    13,139
    
    
    
    17,277Income before minority interest
    
    
    11,763
    
    
    
    12,825
    
    
    
    20,839
    
    
    
    25,460Minority interest
    
    
    697
    
    
    
    626
    
    
    
    1,226
    
    
    
    1,213Net income
    
    $
    11,066
    
    
    $
    12,199
    
    
    $
    19,613
    
    
    $
    24,247Basic net income per common share
    
    $
    0.21
    
    
    $
    0.23
    
    
    $
    0.38
    
    
    $
    0.47Diluted net income per common share
    
    $
    0.21
    
    
    $
    0.23
    
    
    $
    0.37
    
    
    $
    0.46


See notes to consolidated financial statements

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National Processing, Inc.
Consolidated Statement of Changes in Shareholders Equity
Unaudited
(In thousands, except share amounts)

Common
    
    Common
    
    Contributed
    
    Unearned
    
    RetainedShares
    
    Stock
    
    Capital
    
    Compensation
    
    Earnings
    
    TotalBalance at January 1, 2003
    
    
    52,093,945
    
    
    $
    1
    
    
    $
    198,728
    
    
    $
    (311
    )
    
    $
    257,965
    
    
    $
    456,383Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    19,613
    
    
    
    19,613Issuance of common shares under stock-based
compensation plans, including related
tax effects
    
    
    151,233
    
    
    
    
    
    
    
    1,392
    
    
    
    81
    
    
    
    
    
    
    
    1,473Balance at June 30, 2003
    
    
    52,245,178
    
    
    $
    1
    
    
    $
    200,120
    
    
    $
    (230
    )
    
    $
    277,578
    
    
    $
    477,469


See notes to consolidated financial statements

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National Processing, Inc.
Consolidated Statements of Cash Flows
Unaudited
(In thousands)

Six Months EndedJune 302003
    
    2002Operating ActivitiesNet income
    
    $
    19,613
    
    
    $
    24,247Items not requiring cash currently:Depreciation and amortization
    
    
    10,011
    
    
    
    8,479Restructuring, divestiture and impairment charges
    
    
    1,273
    
    
    
    1,650Deferred income taxes
    
    
    2,504
    
    
    
    904Loss on disposition of fixed assets
    
    
    33
    
    
    
    180Minority interest
    
    
    1,226
    
    
    
    1,213Change in current assets and liabilities:Accounts receivable  trade
    
    
    41,989
    
    
    
    55,641Accounts payable  trade
    
    
    (1,601
    )
    
    
    2,453Accrued bankcard assessments
    
    
    (3,188
    )
    
    
    (2,654
    )Income taxes payable
    
    
    (5,382
    )
    
    
    2,830Other current assets/liabilities
    
    
    (409
    )
    
    
    (6,124
    )Other, net
    
    
    7
    
    
    
    (139
    )Net cash provided by operating activities
    
    
    66,076
    
    
    
    88,680Investing ActivitiesCapital expenditures
    
    
    (3,408
    )
    
    
    (10,559
    )Acquisitions, net of cash received
    
    
    (32,356
    )
    
    
    Net cash used in investing activities
    
    
    (35,764
    )
    
    
    (10,559
    )Financing ActivitiesPrincipal payments under capital lease obligations
    
    
    (65
    )
    
    
    (65
    )Distribution to minority shareholder
    
    
    (2,441
    )
    
    
    Issuance of common stock under stock-based compensation plans
    
    
    1,487
    
    
    
    3,366Net cash (used in) provided by financing activities
    
    
    (1,019
    )
    
    
    3,301Net increase in cash and cash equivalents
    
    
    29,293
    
    
    
    81,422Cash and cash equivalents, beginning of period
    
    
    185,513
    
    
    
    101,257Cash and cash equivalents, end of period
    
    $
    214,806
    
    
    $
    182,679Supplemental cash flow information:Taxes paid
    
    $
    16,244
    
    
    $
    13,819


See notes to consolidated financial statements

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National Processing, Inc.
Notes to Consolidated Financial Statements
Unaudited



|1. |  | ORGANIZATION AND BUSINESS
|-- |  | -------------------------

Organization

National Processing, Inc. and its subsidiaries (the Company) are
providers of electronic payment processing services headquartered in
Louisville, Kentucky. The Company is 85% owned by National City
Corporation (National City), a financial holding company headquartered
in Cleveland, Ohio.

Business

The Company currently operates two business segments, Merchant Card
Services and Payment Services. Merchant Card Services authorizes,
processes, and performs financial settlement and reporting of card
transactions, including credit and debit card transactions. Merchant Card
Services provides services to merchant locations primarily in the United
States and represents approximately 96% of the Companys revenue.

Payment Services provides financial settlement and reporting
solutions to large and mid-size corporate customers in the travel and
healthcare industries. Payment Services settles 100% of domestic airline
tickets issued by travel agencies and settled through the Airlines
Reporting Corporation. Payment Services also settles commission payments
for car rental companies, cruise line operators, and hotels. In the
healthcare industry, Payment Services provides financial settlement and
reporting to healthcare organizations such as insurance companies, managed
care organizations, and self-insured organizations. Payment Services
represents approximately 4% of the Companys revenue. Payment Services
does not meet the materiality thresholds for separate disclosures of
segment information as defined in Statement of Financial Accounting
Standards (SFAS) 131, Disclosures about Segments of an Enterprise and
Related Information. As a result, these Notes to Consolidated Financial
Statements do not include segment disclosures.

Sponsorship Agreement

The Company and National City Bank of Kentucky (NCBK), a wholly
owned subsidiary of National City, are parties to a sponsorship agreement
(the Sponsorship Agreement) whereby the Company acts as NCBKs sole
agent for the purposes of providing electronic data authorization and
capture, reporting, settlement, and clearing services for merchants who
participate in Visa® and MasterCard® programs. The Company, along with
other nonbank processors, must be sponsored by a financial institution
that is a member of the Visa® and MasterCard® associations. NCBK is a
member of such associations and acts as the Companys primary sponsor.

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|2. |  | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
|-- |  | ------------------------------------------

The consolidated financial statements include the accounts of
National Processing, Inc. and its subsidiaries, including a 70% ownership
interest in ABN AMRO Merchant Services, LLC (AAMS). The results of
operations of AAMS are included in the consolidated financial statements,
and the 30% minority ownership interest has been accounted for as a
minority interest. All significant intercompany transactions and balances
have been eliminated in consolidation. The accounting and reporting
policies of the Company conform with accounting principles generally
accepted in the United States. Certain 2002 amounts have been
reclassified to conform with the 2003 presentation.

Financial statements prepared in accordance with accounting
principles generally accepted in the United States require the use of
estimates and assumptions by management that affect the reported amounts
of revenue and expenses, assets and liabilities, and the disclosure
requirements for contingent assets and liabilities during and at the date
of the financial statements. Consequently, actual results could differ
from those estimates.

For the interim periods presented, management believes the unaudited
consolidated financial statements reflect all adjustments of a normal
recurring nature and disclosures which are necessary for a fair
presentation of the results for the interim periods presented. The
results of operations for the interim periods are not necessarily
indicative of the results that may be expected for the full year or any
other interim period.

The Company experiences seasonality in its businesses and typically
realizes higher revenue from increased transaction volume in the summer
and holiday months. Accounts receivable is generally highest in the
fourth quarter, as December is typically the highest volume month due to
holiday sales.

Although the consolidated balance sheet at December 31, 2002 has been
derived from the audited consolidated financial statements at that date,
the accompanying interim consolidated financial statements do not include
all of the information and footnotes required by accounting principles
generally accepted in the United States. These interim financial
statements should be read in conjunction with the Companys 2002 Annual
Report on Form 10-K.

Revenue Recognition

The Company recognizes revenue as services are performed, recording
revenue net of certain costs not controlled by the Company, primarily
interchange and debit network fees. Interchange and debit network fees
for the three months ended June 30, 2003 and 2002 were $611 million and
$622 million, respectively. For the six months ended June 30, 2003 and
2002, interchange and debit network fees were $1.182 billion and $1.184
billion, respectively.

The Company records assessments charged by credit card associations
as operating expense in the Consolidated Statements of Income, as the
Company is the primary obligor of these costs. Assessment expense for
each of the three months ended June 30, 2003 and 2002 was $33.0 million
and $34.2 million, respectively. For the six months ended June 30, 2003
and 2002, assessment expense was $64.2 million and $65.4 million,
respectively.

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Stock-Based Compensation

The Company has various stock-based compensation plans that allow for
the granting of stock to eligible employees and directors. Prior to
January 1, 2003, the Company accounted for these plans under the
recognition and measurement principles of Accounting Principles Board
(APB) Opinion No. 25, Accounting for Stock Issued to Employees, and
related interpretations. Compensation expense for employee stock options
was not recognized if the exercise price of the option equaled or exceeded
the market price of the stock on the date of grant. Compensation expense
for restricted share awards is recognized ratably over the period of
service, generally the restricted period, based on the fair value of the
stock on the date of grant. Effective January 1, 2003, the Company
adopted the fair value method of recording stock options under the
transitional guidance of SFAS 148, Accounting for Stock-Based Compensation
 Transition and Disclosure. Compensation expense for employee stock
options granted after January 1, 2003 are recognized in the Consolidated
Financial Statements under the fair value method.

The following table illustrates the effect on net income and earnings
per share if the Company had applied the fair value recognition provisions
of SFAS 123, Accounting for Stock-Based Compensation, to employee options
for all periods. For purposes of providing the pro forma disclosures
required under SFAS 123, the fair value of stock options granted were
estimated at the date of grant using a Black-Scholes option pricing model.
The Black-Scholes option pricing model was originally developed for use in
estimating the fair value of traded options, which have different
characteristics than the Companys employee stock options. The model is
also sensitive to changes in the subjective assumptions, which can
materially affect the fair value estimate. As a result, management
believes the Black-Scholes model may not necessarily provide a reliable
single measure of the fair value of employee stock options.

(in thousands, except share amounts)
    
    Three Months Ended
    
    Six Months EndedJune 30
    
    June 302003
    
    2002
    
    2003
    
    2002Net income, as reported
    
    $
    11,066
    
    
    $
    12,199
    
    
    $
    19,613
    
    
    $
    24,247Add: Stock option expense included in net income
under fair value based method, net of
related tax effects
    
    
    5
    
    
    
    
    
    
    
    5
    
    
    
    Deduct: Total stock option expense determined
under fair value based method, net of
related tax effects
    
    
    (1,795
    )
    
    
    (1,894
    )
    
    
    (3,766
    )
    
    
    (3,380
    )Pro forma net income
    
    $
    9,276
    
    
    $
    10,305
    
    
    $
    15,852
    
    
    $
    20,867Earnings per share:Basic  as reported
    
    $
    0.21
    
    
    $
    0.23
    
    
    $
    0.38
    
    
    $
    0.47Basic  pro forma
    
    $
    0.18
    
    
    $
    0.20
    
    
    $
    0.30
    
    
    $
    0.40Diluted  as reported
    
    $
    0.21
    
    
    $
    0.23
    
    
    $
    0.37
    
    
    $
    0.46Diluted  pro forma
    
    $
    0.18
    
    
    $
    0.20
    
    
    $
    0.30
    
    
    $
    0.40


The following weighted-average assumptions were used in the
option-pricing model for stock options issued in each of the respective
years:

2003
    
    2002
    
    2001
    
    2000Risk free interest rate
    
    2.6%
    
    3.6%
    
    5.5%
    
    5.0%Expected option life
    
    4 years
    
    4 years
    
    7 years
    
    7 yearsExpected dividend yield
    
    0%
    
    0%
    
    0%
    
    0%Volatility factor
    
    .473
    
    .485
    
    .495
    
    .479Weighted average grant date fair value of options
    
    $6.38
    
    $11.45
    
    $15.14
    
    $6.36


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|3. |  | RECENT ACCOUNTING PRONOUNCEMENTS
|-- |  | --------------------------------

Accounting for Exit or Disposal Activities

SFAS 146, Accounting for Costs Associated with Exit or Disposal
Activities, was issued in June 2002 and addresses financial accounting and
reporting for costs associated with exit or disposal activities and
nullified Emerging Issues Task Force (EITF) Issue No. 94-3, Liability
Recognition for Certain Employee Termination Benefits and Other Costs to
Exit an Activity (including Certain Costs Incurred in a Restructuring).
SFAS 146 requires a liability for a cost associated with an exit or
disposal activity be recognized when the liability is incurred. Under
EITF 94-3, a liability for an exit cost was recognized at the date of the
entitys commitment to an exit plan. The provisions of SFAS 146 became
effective for the Company January 1, 2003 and have not had a material
impact on the Companys results of operations, financial position, or
liquidity.

Accounting for Stock-Based Compensation

In December 2002, the Financial Accounting Standards Board (FASB)
issued SFAS 148, Accounting for Stock-Based Compensation  Transition and
Disclosure, which provides guidance on how to transition from the
intrinsic value method of accounting for stock-based employee compensation
under APB 25 to SFAS 123s fair value method of accounting, if a company
so elects.

Effective January 1, 2003, the Company adopted the fair value method
of recording stock options under SFAS 123. In accordance with the
transitional guidance of SFAS 148, the fair value method of accounting for
stock options will be applied prospectively to awards granted subsequent
to December 31, 2002. As permitted, options granted prior to January 1,
2003 will continue to be accounted for under APB 25, and the proforma
impact of accounting for these options at fair value will continue to be
disclosed in the Consolidated Financial Statements until the last of those
options vest in 2005.

As the cost of anticipated future option awards is phased in over a
four-year period, the annual impact will rise assuming options are granted
in future years at a similar level and under similar market conditions to
2002. The actual impact per diluted share may vary in the event the fair
value or the number of options granted increases or decreases from the
current estimate, or if the current accounting guidance changes. The
Company uses the Black-Scholes model to estimate option values. The
Black-Scholes option pricing model was originally developed for use in
estimating the fair value of traded options, which have different
characteristics from the Companys employee stock options. The model is
also sensitive to changes in subjective assumptions, which can materially
affect the fair value estimate.

Accounting for Guarantees

In November 2002, the FASB issued Interpretation No. 45 (FIN 45),
Guarantors Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others.FIN 45 requires
additional recognition and disclosure by a guarantor in its financial
statements about its obligations under certain guarantees.

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The Companys contingent obligation to honor chargebacks under
merchant contracts is considered a performance guarantee under FIN 45.
Performance guarantees are contracts that contingently require the
guarantor to make payments to the guaranteed party based on another
entitys failure to perform under an obligating agreement. Performance
guarantees are subject to both the recognition and disclosure requirements
of FIN 45. The disclosure requirements of FIN 45 were effective for the
Company as of December 31, 2002. The required disclosures are included in
Note 6 to the Consolidated Financial Statements. The recognition
requirements of FIN 45 were adopted January 1, 2003 for new guarantees
entered into after such date and did not have a material impact on the
Companys financial position or results of operations.

Consolidation of Variable Interest Entities

In January 2003, the FASB issued FASB Interpretation No. 46 (FIN
46), Consolidation of Variable Interest Entities. FIN 46 provides
guidance on how to identify a variable interest entity (VIE) and determine
when the assets, liabilities, noncontrolling interests, and results of
operations of a VIE are to be included in an entitys consolidated
financial statements. A VIE exists when either the total equity investment
at risk is not sufficient to permit the entity to finance its activities
by itself, or the equity investors lack one of three characteristics
associated with owning a controlling financial interest. Those
characteristics include the direct or indirect ability to make decisions
about an entitys activities through voting rights or similar rights, the
obligation to absorb the expected losses of an entity if they occur, and
the right to receive the expected residual returns of the entity if they
occur.

FIN 46 was effective immediately for new entities created or acquired
after February 1, 2003 and became effective on July 1, 2003, for entities
in which the Company had a variable interest prior to February 1, 2003.
The provisions of FIN 46 have not had a material impact on the Companys
results of operations, financial position or liquidity through June 30,
2003. Further, the Company believes that the future provisions of FIN 46
will not have a material impact on the Companys results of operations,
financial position or liquidity.



|4. |  | ACQUISITIONS
|-- |  | ------------

On June 9, 2003, the Company acquired Bridgeview Payment Solutions,
Inc. (BPS) from Bridgeview Bank and Trust Company for $32.4 million in
cash. The preliminary allocation of the purchase price increased the
Companys goodwill by approximately $24 million. The remainder of the
purchase price was primarily allocated to merchant contracts, which are
included in other intangible assets on the Consolidated Balance Sheets and
are being amortized on a straight-line basis over 5 years. The results of
operations for BPS have been included in the Consolidated Financial
Statements since the date of acquisition. Incremental revenue as a result
of this acquisition was $1.2 million for the quarter ended June 30, 2003.

On July 3, 2002, the Company acquired a portfolio of processing
contracts for $2.7 million in cash, which was recorded as an intangible
asset. The terms of the agreement also include future payments to the
seller for a portion of the revenue derived from these contracts for a
specified period plus an additional one-time payment of up to $1.0 million
in the third quarter of 2003. Under the terms of the agreement, the
Company provides front-end authorization services for approximately 50,000
merchant locations. Prior to the acquisition, the Company was already

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providing settlement services for these merchants.



|5. |  | IMPAIRMENT, RESTRUCTURING, AND UNUSUAL ITEMS
|-- |  | --------------------------------------------

In May 2003, the Company implemented various initiatives focused on
improving the long-term profitability of the Company. In connection with
these initiatives, the Company eliminated 48 information technology
positions which resulted in severance for approximately 30 employees. The
Company also incurred a loss on the sale of 14 regional sales offices.
The remaining obligations for these initiatives are included in other
accrued liabilities on the Consolidated Balance Sheet. A rollforward of
the liability for severance and related expenses related to these
initiatives is presented in the table below.

(in thousands)
    
    Six Months EndedJune 30, 2003Beginning balance
    
    $
    Severance and related charges
    
    
    1,273Payments and adjustments
    
    
    (134
    )Ending balance
    
    $
    1,139


In May 2002, the Company announced plans to close its remaining
operations in Juarez, Mexico. The work performed in Mexico has been
relocated to existing facilities in the United States. The Company
recorded a pre-tax restructuring charge of $1.7 million ($2.4 million
after-tax) in the second quarter of 2002 related to severance costs for
approximately 120 employees, building and equipment write-downs, and
related items. The after-tax charge exceeded the pre-tax amount due to
additional tax provisions required for nondeductible losses and dividends
from foreign subsidiaries. As of June 30, 2003, the Company had $0.5
million remaining in accrued liabilities for future obligations related to
this closure.



|6. |  | COMMITMENTS AND CONTINGENCIES
|-- |  | -----------------------------

Under the rules of Visa® and MasterCard®, when a merchant processor
acquires card transactions, it has certain contingent liabilities for the
transactions processed. This contingent liability arises in the event of
a billing dispute between the merchant and a cardholder that is ultimately
resolved in the cardholders favor. In such a case, the transaction is
charged back to the merchant and the disputed amount is credited or
otherwise refunded to the cardholder. If the Company is unable to collect
this amount from the merchants account, and if the merchant refuses or is
unable to reimburse the Company for the chargeback due to liquidation or
other reasons, the Company will bear the loss for the amount of the refund
paid to the cardholder.

A cardholder, through its issuing bank, generally has until the later
of up to four months after the date a transaction is processed or the
delivery of the product or service to present a chargeback to the Company
as the merchant processor. Management believes the maximum potential
exposure for chargebacks would not exceed the total amount of merchant
transactions processed through Visa® and MasterCard® for the last four
months, plus any outstanding delayed-delivery transactions and unresolved
chargebacks in the process of resolution. For the period from March
through June 2003, this amount totaled approximately $49 billion. At June
30, 2003, the Company had $3.2 million of unresolved chargebacks that were
in process of resolution.

For the three months ended June 30, 2003 and 2002, the Company
processed $36.0 million and $38.4 million, respectively, in chargebacks
presented by issuing banks. For the six months ended

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June 30, 2003 and
2002, the Company processed $76.2 million and $87.0 million, respectively,
in chargebacks presented by issuing banks. Actual losses recorded for
the three months ended June 30, 2003 and 2002 were $0.8 million and $1.0 million,
respectively. Actual losses recorded for the six months ended June 30,
2003 and 2002 were $1.8 million and $2.3 million, respectively. The
Company accrues for probable losses based on historical experience and at
June 30, 2003 had $1.1 million recorded in other accrued liabilities for
expected losses.

In most cases, a contingent liability for chargebacks is unlikely to
arise, as most products or services are delivered when purchased, and
credits are issued on returned items. Where the product or service is not
provided, however, until some time after the purchase
(delayed-delivery), the potential for this contingent liability
increases. For the six months ended June 30, 2003, the Company processed
approximately $7.4 billion of merchant transactions related to
delayed-delivery purchases.

The Company currently processes card transactions for two of the
largest airlines in the United States. In May 2002, the Company announced
its decision to discontinue processing debit and credit card transactions
for the airline industry. The Company will honor its existing contractual
obligations to the two airlines it currently serves but does not intend to
renew such contracts when their current terms expire. The contracts
currently in effect have expiration dates of April 2004 and November 2005.
One of the two continuing airline merchants, United Airlines, Inc., is
currently operating under Chapter 11 protection. In the event of
liquidation of United Airlines or the Companys other airline customer,
the Company could become financially responsible for refunding tickets
purchased through Visa® and MasterCard® under the chargeback rules of
those associations. At June 30, 2003, the estimated dollar value of
tickets purchased, but as yet unflown, under continuing merchant
processing contracts, was approximately $931 million, of which
approximately $490 million pertained to United Airlines. Based upon
available information, these amounts represent managements best estimate
of its maximum potential chargeback exposure related to its continuing
airline customers. As of June 30, 2003, the Company held no significant
collateral under these contracts.

During the second quarter of 2003, the Companys obligation to
process card transactions for two other airline merchants, including U.S.
Airways Group, Inc., ceased with these merchants transitioning to new
processors. At June 30, 2003, the estimated dollar value of tickets
purchased, but as yet unflown, under these concluding contracts was
approximately $151 million. This amount represents managements best
estimate of its maximum potential chargeback exposure under these
concluded contracts. As of June 30, 2003, the Company held cash
collateral of $9.0 million and third-party indemnifications of $125
million against this remaining chargeback exposure.

Based on current conditions in the airline industry and other
information currently available to the Company, management believes the
risk of a material loss under the chargeback rules has increased since
December 31, 2002 but is not probable at this time.

MasterCard® Guarantee

On May 16, 2003, the Company provided a financial guarantee relating
to NCBKs obligations with MasterCard®. The agreement guarantees the
payment of NCBKs membership obligations pursuant to its license agreement
with MasterCard®, the Bylaws and Rules of MasterCard®, and all regulations
and policies of MasterCard® should NCBK default or fail to meet its
obligations of

13Table of Contents

membership. The Companys primary risk under this
guarantee is related to potential chargebacks; however, the Company
believes its exposure to a material loss under the guarantee is not
probable at this time. The Company processes all transactions received
from MasterCard® by NCBK under the
exclusive terms of the Sponsorship Agreement.

Visa® Guarantee

On August 6, 2002, the Company provided a financial guarantee
relating to NCBKs membership obligations with Visa®. The agreement
guarantees the payment of NCBKs membership obligations pursuant to the
Visa® Certificate of Incorporation and Amendments, Bylaws, rules, policies
and operating rules should NCBK default or fail to meet its obligations of
membership including NCBKs obligations to pay any Visa® member attendant
to NCBKs membership in Visa®, and Visas expenses incurred in payment of
such obligations on NCBKs behalf or otherwise because of NCBKs failure
to meet such obligations. The Companys primary risk under this guarantee
is related to potential chargebacks; however, the Company believes its
exposure to a material loss under the guarantee is not probable at this
time. The Company processes all transactions received from Visa® by NCBK
under the exclusive terms of the Sponsorship Agreement.

Litigation

In the normal course of business, the Company is involved in
litigation from time to time. In the opinion of management, the ultimate
liability, if any, arising from this litigation is not expected to have a
material adverse effect on the Companys financial condition, results of
operations, or liquidity.



|7. |  | NET INCOME PER COMMON SHARE
|-- |  | ---------------------------

The calculation of net income per common share follows (in
thousands, except per share amounts):

Three Months Ended
    
    Six Months EndedJune 30
    
    June 302003
    
    2002
    
    2003
    
    2002BASICNet income
    
    $
    11,066
    
    
    $
    12,199
    
    
    $
    19,613
    
    
    $
    24,247Average common shares outstanding
    
    
    52,213
    
    
    
    52,010
    
    
    
    52,168
    
    
    
    51,935Net income per common share  basic
    
    $
    0.21
    
    
    $
    0.23
    
    
    $
    0.38
    
    
    $
    0.47DILUTEDNet income
    
    $
    11,066
    
    
    $
    12,199
    
    
    $
    19,613
    
    
    $
    24,247Average common shares outstanding
    
    
    52,213
    
    
    
    52,010
    
    
    
    52,168
    
    
    
    51,935Dilutive effect of stock options
    
    
    239
    
    
    
    714
    
    
    
    209
    
    
    
    690Average common shares outstanding  diluted
    
    
    52,452
    
    
    
    52,724
    
    
    
    52,377
    
    
    
    52,625Net income per common share  diluted
    
    $
    0.21
    
    
    $
    0.23
    
    
    $
    0.37
    
    
    $
    0.46


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|8. |  | TRANSACTIONS WITH AFFILIATES
|-- |  | ----------------------------

The Company leases certain facilities from NCBK, a wholly owned
subsidiary of National City, under long-term agreements classified as
Property Leased from Affiliate in the accompanying Consolidated Balance
Sheets. The Company has paid $0.1 million, including interest, under this
lease for each of the six months ended June 30, 2003 and 2002.

Substantially all of the Companys cash and cash equivalents are held
at NCBK and other National City banking subsidiaries. The majority of the
interest income and earnings on customer balances included in the
Consolidated Statements of Income are derived from accounts held at NCBK
and other National City banking subsidiaries.

The Company receives certain administrative services, such as
internal audit and legal services, from National City and its affiliates.
The Company also uses NCBK and other National City subsidiaries for the
majority of its banking services. Charges for these services are included
in general and administrative expenses and totaled $0.8 million and $1.6
million for the quarter and six months ended June 30, 2003 respectively.
For the quarter and six months ended June 30, 2002, charges for these
services totaled $0.5 million and $1.0 million, respectively. As of June
30, 2003, $0.1 million was due to National City. As of December 31, 2002
and June 30, 2002, no amounts were due to or from National City.

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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations

The following should be read in conjunction with the Companys 2002 Annual
Report on Form 10-K, and subsequent filings with the Securities and Exchange
Commission.

Critical Accounting Policies

General

The Companys consolidated financial statements are prepared in accordance
with accounting principles generally accepted in the United States.
Application of these principles requires management to make estimates,
assumptions, and judgments that affect the amounts reported in the financial
statements and accompanying notes. These estimates, assumptions, and judgments
are based on information available as of the date of the financial statements;
accordingly, as this information changes, the financial statements could
reflect different estimates, assumptions, and judgments. Certain policies
inherently have greater reliance on the use of estimates, assumptions, and
judgments and as such have greater possibility of producing results that could
be materially different than originally reported.

Income Taxes

The Company is included in the consolidated federal income tax return of
National City. National City allocates income taxes to the Company as if it
were a stand-alone tax paying entity. Deferred tax assets and liabilities are
recognized, as certain items are required to be treated differently for
financial statement purposes versus how they are treated for tax purposes.

Management judgments and estimates are required in determining the income
tax provision as well as the balances of deferred tax assets and liabilities.
As of June 30, 2003, the Company had net deferred tax assets of $11.8 million.
The Company records a valuation allowance to reduce deferred tax assets when it
is more likely than not that certain amounts will not be realized. The Company
considers projected future taxable income and tax planning strategies in
assessing the need for a valuation allowance. Should the Company determine in
the future that all or part of its net deferred tax asset is unrealizable, an
adjustment to the deferred tax asset would be charged to income in the period
such determination was made. Management provides reserves when it is likely
that a taxing authority may take a sustainable position on a matter contrary to
the Companys position.

Long-Lived Assets

Long-lived assets, consisting primarily of property and equipment,
goodwill, and other intangible assets, comprise a significant portion of the
Companys total assets.

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Property and equipment, net of accumulated depreciation and amortization,
totaled $51.3 million as of June 30, 2003, which represented 9% of total
assets. Useful lives of property and equipment (which includes internal-use
software) are estimated in order to determine the amount of depreciation
expense to be recorded during each reporting period. The useful lives are
estimated at the time the assets are acquired based on historical experience
with similar assets and current business plans. Based on future events and
changes in business plans, the useful lives assigned to these assets may need
to be shortened, resulting in the recognition of increased depreciation expense
in future periods. These changes could also result in the recognition of an
immediate impairment charge to reflect the write-down in the value of the
assets. Alternatively, assets may ultimately be used by the Company for longer
than their assigned depreciable lives.

Internal-use software is a component of property and equipment. The
Company capitalizes certain costs incurred to develop or obtain internal-use
software in accordance with Statement of Position 98-1, Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use. The Company
capitalizes costs once the preliminary project stage has been completed,
management has approved funding for the project, and it is probable the project
will be completed and the software will be used for its intended use.
Capitalized software development and purchased software are recorded at cost.
Commencing the month following project completion, these costs are amortized on
a straight-line basis over the estimated useful life of the software, ranging
from three to ten years. Software development costs may become impaired due to
technological obsolescence of the project or where development efforts are
abandoned due to changes in business plans. For purposes of depreciation and
impairment, capitalized costs are treated in the same manner as other property
and equipment.

Goodwill and other intangible assets, net of accumulated amortization,
totaled $163.3 million as of June 30, 2003, which represented 29% of total
assets. The Company determines amortization periods for intangible assets
based on estimated future cash flows. The Company analyzes goodwill and other
intangible assets for impairment on an annual basis or more frequently if
events or circumstances warrant. In assessing the recoverability of goodwill
and intangible assets, the Company makes estimates regarding future cash flows
and assumptions about other factors to determine the fair value. Changes in
estimates or the related assumptions may cause the Company to record impairment
charges for the related assets.

Chargebacks and Other Contingencies

The Company records reserves for chargebacks and contingent liabilities
when such amounts are deemed to be probable and estimable in accordance with
Statement of Financial Accounting Standards (SFAS) 5, Accounting for
Contingencies. The required reserves may change in the future due to new
developments including, but not limited to, changes in litigation or increased
chargeback exposure as the result of merchant insolvency, liquidation, or other
reasons. The required reserves are reviewed periodically to determine if
adjustments are required. (See Note 6 to the accompanying Consolidated
Financial Statements.)

Components of Revenue and Expense

Revenue

Merchant Card Services represents approximately 96% of the Companys
revenue. Payment Services represents approximately 4% of the Companys
revenue.

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Approximately 95% of Merchant Card Services revenue is derived from
processing contracts with
merchants for the authorization, processing, and settlement of credit and
debit card transactions. Processing fee revenue is earned either on a per
transaction basis or discount basis, which is a percent of dollar volume
processed. Merchant contracts generally have terms ranging from three to five
years. Processing fee revenue is recorded in the period the related
transaction is processed and is recorded net of interchange fees charged by the
credit card associations and fees charged by debit networks. Interchange and
debit network fees for the three months ended June 30, 2003 and 2002 were $611
million and $622 million respectively. For the six months ended June 30, 2003
and 2002, interchange and debit network fees were $1.182 billion and $1.184
billion, respectively. The decrease in interchange and debit network in 2003
compared to 2002 is attributed to lower dollar processing volume primarily as a
result of the Companys decision to exit processing for airline merchants. The
remainder of Merchant Card Services revenue is derived from sources other than
processing fees, including equipment and supply sales, equipment repair fees,
application and installation fees, and third-party commissions.

Approximately 50% of Payment Services revenue is earned from an exclusive
long-term contract with the Airlines Reporting Corporation under which the
Company is compensated on a cost-plus basis. The remainder of Payment
Services revenue is derived from other non-card based electronic settlement
products. Revenue is recorded in the period services are provided.

A portion of total consolidated revenue is derived from earnings on
customer cash balances, which are maintained by National City pursuant to
contractual terms. For the three months ended June 30, 2003 and 2002, earnings
on customer balances were $0.6 million and $0.9 million, respectively. For the
six months ended June 30, 2003 and 2002, earnings on customer balances were
$1.1 million and $2.0 million, respectively.

Expense

Bankcard assessments are liabilities to Visa® and MasterCard® that
originate from the Companys agreements with these agencies. Bankcard
assessment expense is the largest component of operating expense and amounted
to $33.0 million and $34.2 million for the three months ended June 30, 2003 and
2002. Assessment expense for the six months ended June 30, 2002 and 2001 was
$64.2 million and $65.4 million, respectively. Operating expense also includes
costs of providing services to customers including wages and personnel costs,
authorization fees, commissions paid to independent sales organizations, and
data processing costs.

General and administrative expense includes corporate management and
administrative expense as well as fees for certain administrative services,
such as internal audit and legal services, from National City and its
affiliates.

Results of Operations

The Companys operating results are presented below in the manner in which
they are viewed by management. Certain prior year amounts have been
reclassified to conform with the 2003 presentation.

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Three Months Ended June 30, 2003 Compared to Three Months Ended June 30, 2002

(Dollars in thousands)% Change from Prior2003
    
    2002
    
    YearRevenue
    
    $
    113,614
    
    
    $
    112,664
    
    
    
    1Operating expenses
    
    
    83,172
    
    
    
    80,859
    
    
    
    3General and administrative expenses
    
    
    5,748
    
    
    
    4,082
    
    
    
    41Depreciation and amortization
    
    
    5,044
    
    
    
    4,456
    
    
    
    13Impairment, restructuring and related
expenses
    
    
    1,273
    
    
    
    1,650
    
    
    
    (23
    )Operating profit
    
    
    18,377
    
    
    
    21,617
    
    
    
    (15
    )Net interest income
    
    
    830
    
    
    
    1,069
    
    
    
    (22
    )Income before taxes and minority interest
    
    
    19,207
    
    
    
    22,686
    
    
    
    (15
    )Provision for income taxes
    
    
    7,444
    
    
    
    9,861
    
    
    
    (25
    )Net income before minority interest
    
    
    11,763
    
    
    
    12,825
    
    
    
    (8
    )Minority interest
    
    
    697
    
    
    
    626
    
    
    
    11Net income
    
    $
    11,066
    
    
    $
    12,199
    
    
    
    (9
    )


Revenue for the three months ended June 30, 2003 increased 1% to $113.6
million from $112.7 million in 2002.

Merchant Card Services revenue was $109.6 million for the quarter, up 2%
from second quarter 2002 revenue of $107.6 million. Merchant Card Services
transaction volume processed for the three months ended June 30, 2003 increased
8% to 1.03 billion transactions from 955 million transactions in 2002.
Merchant Card Services dollar volume processed for the three months ended June
30, 2003 decreased 2% to $42.2 billion from $42.9 billion in 2002. The
increase in transaction volume is primarily due to growth in existing national
customers and the addition of new regional merchants. The dollar volume
processed has trailed transaction growth primarily as a result of the Companys
initiative to exit merchant processing for airlines, which have a large average
ticket per transaction. Revenue also trailed transaction volume growth due to
price compression in the national merchant base.

Revenue from Payment Services was $4.0 million for the quarter, down 20%
from second quarter of 2002 revenue of $5.0 million. This decrease was due to
lower paper-based transactions from the Companys Airlines Reporting
Corporation Contract.

Operating expenses for the three months ended June 30, 2003 increased 3%
to $83.2 million from $80.9 million in 2002 due primarily to increased
transaction volume in Merchant Card Services.

General and administrative expenses increased by 41% to $5.8 million for
the three months ended June 30, 2003 from $4.1 million in 2002 due to increased
legal expenses associated with the Companys airline contracts, increased
banking and administrative fees for services performed by National City, and
increases for annual incentive compensation programs.

Depreciation and amortization increased 13% to $5.0 million for the three
months ended June 30, 2003 from $4.5 million in 2002 due to additional
depreciation from a new data center added in the third quarter of 2002.

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In May 2003, the Company implemented various initiatives focused on
improving the long-term profitability of the Company. In connection with these
initiatives, the Company eliminated 48 information technology positions which
resulted in severance for 30 employees. The Company also incurred a loss on
the sale of 14 regional sales offices. The Company recorded a charge of $1.3
million in the second quarter of 2003 related to these initiatives. As of June
30, 2003, the Company had $1.1 million remaining in accrued liabilities related
to these charges.

In May 2002, the Company announced plans to close its remaining operations
in Juarez, Mexico. The work performed in Mexico has been relocated to existing
facilities in the United States. The Company recorded a restructuring charge
of $1.7 million in the second quarter of 2002 related to severance costs for
approximately 120 employees, building and equipment write-downs, and related
items. As of June 30, 2003, the Company had $0.5 million remaining in accrued
liabilities for future obligations related to this closure.

Operating profit margin as a percentage of revenue decreased to 16% for
the three months ended June 30, 2003 from 19% in 2002 due to the items
discussed above.

Net interest income earned on the Companys cash and cash equivalents for
the three months ended June 30, 2003 was $0.8 million, down 22% from $1.1
million in the 2002 second quarter due to lower average interest rates in 2003,
offset partially by higher balances.

The overall effective tax rate for the second quarter of 2003 was 38.8%
compared to 43.5% for the same quarter a year ago. The decrease in the
effective tax rate was due to additional provisions in the second quarter of
2002 related to exiting foreign operations.

For the three months ended June 30, 2003, minority interest was $0.7
million, up 11% from $0.6 million in the second quarter of 2002. This increase
is due to higher earnings from AAMS, which is 70% owned by National Processing.

Net income decreased 9% to $11.1 million for the three months ended June
30, 2003 from $12.2 million in 2002 due to the items discussed above.

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Six Months Ended June 30, 2003 Compared to Six Months Ended June 30, 2002

% Change from Prior2003
    
    2002
    
    YearRevenue
    
    $
    219,568
    
    
    $
    222,609
    
    
    
    (1
    )Operating expenses
    
    
    165,924
    
    
    
    163,163
    
    
    
    2General and administrative expenses
    
    
    10,054
    
    
    
    8,684
    
    
    
    16Depreciation and amortization
    
    
    10,011
    
    
    
    8,479
    
    
    
    18Impairment, restructuring and related
expenses
    
    
    1,273
    
    
    
    1,650
    
    
    
    (23
    )Operating profit
    
    
    32,306
    
    
    
    40,633
    
    
    
    (20
    )Net interest income
    
    
    1,672
    
    
    
    2,104
    
    
    
    (21
    )Income before taxes and minority interest
    
    
    33,978
    
    
    
    42,737
    
    
    
    (20
    )Provision for income taxes
    
    
    13,139
    
    
    
    17,277
    
    
    
    (24
    )Net income before minority interest
    
    
    20,839
    
    
    
    25,460
    
    
    
    (18
    )Minority interest
    
    
    1,226
    
    
    
    1,213
    
    
    
    1Net income
    
    $
    19,613
    
    
    $
    24,247
    
    
    
    (19
    )


Revenue for the six months ended June 30, 2003 decreased 1% to $219.6
million from $222.6 million in 2002.

Merchant Card Services revenue was $211.5 million for the six months ended
June 30, 2003, compared to $212.2 million in 2002. Merchant Card Services
transaction volume processed for the six months ended June 30, 2003 increased
8% to 1.982 billion transactions from 1.836 billion transactions in 2002.
Merchant Card Services dollar volume processed for the six months ended June
30, 2003 was $81.6 billion compared to $82.0 billion in 2002. The increase in
transaction volume is primarily due to growth in existing national customers
and the addition of new regional merchants. The dollar volume processed has
trailed transaction growth primarily as a result of the Companys initiative to
exit merchant processing for airlines, which have a large average ticket per
transaction. Revenue also trailed transaction volume growth due to price
compression in the national merchant base and the Companys decision to exit
the airline industry.

Revenue from Payment Services was $8.1 million for the six months ended
June 30, 2003, down 22% from 2002 revenue of $10.4 million. This decrease was
due to lower paper-based transactions from the Companys Airlines Reporting
Corporation Contract.

Operating expenses for the six months ended June 30, 2003 increased 2% to
$165.9 million from $163.2 million in 2002 due primarily to increased
transaction volume in Merchant Card Services.

General and administrative expenses increased by 16% to $10.1 for the six
months ended June 30, 2003 from $8.7 million in 2002 due primarily to increased
legal expenses associated with the Companys airline contracts and increased
banking and administrative fees for services performed by National City.

Depreciation and amortization increased 18% to $10.0 million for the six
months ended June 30, 2003 from $8.5 million in 2002 due to additional
depreciation from a new web-based merchant accounting and reporting system
added in the second quarter of 2002 and a new data center added in the third
quarter of 2002.

In May 2003, the Company implemented various initiatives focused on
improving the long-term profitability of the Company. In connection with these
initiatives, the Company eliminated 48 information technology positions which
resulted in severance for 30 employees. The Company also incurred a loss on
the sale of 14 regional sales offices. The Company recorded a charge of $1.3
million in the second quarter

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of 2003 related to these initiatives. As of June
30, 2003, the Company had $1.1 million remaining in
accrued liabilities related to these charges.

In May 2002, the Company announced plans to close its remaining operations
in Juarez, Mexico. The work performed in Mexico has been relocated to existing
facilities in the United States. The Company recorded a restructuring charge
of $1.7 million in the second quarter of 2002 related to severance costs for
approximately 120 employees, building and equipment write-downs, and related
items. As of June 30, 2003, the Company had $0.5 million remaining in accrued
liabilities for future obligations related to this closure.

Operating profit margin as a percentage of revenue decreased to 15% for
the six months ended June 30, 2003 from 18% in 2002 due to the items discussed
above.

Net interest income earned on the Companys cash and cash equivalents for
the six months ended June 30, 2003 was $1.7 million, down 21% from $2.1 million
for the six months ended June 30, 2002 due to lower average interest rates in
2003, offset partially by higher balances.

The overall effective tax rate for the six months ended June 30, 2003 was
38.7% compared to 40.4% for the same period a year ago. The decrease is due to
additional provisions in 2002 related to exiting foreign operations.

For the six months ended June 30, 2003 and 2002, minority interest was
$1.2 million. Minority interest is based on earnings from AAMS, which is 70%
owned by National Processing.

Net income decreased 19% to $19.6 million for the six months ended June
30, 2003 from $24.2 million in 2002 due to the items discussed above.

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Forward-Looking Results of Operations

Airlines

The Company currently processes card transactions for two of the largest
airlines in the United States. In May 2002, the Company announced its decision
to discontinue processing debit and credit card transactions for the airline
industry. The Company will honor its existing contractual obligations to the
two airlines it currently serves but does not intend to renew such contracts
when their current terms expire. The contracts currently in effect have
expiration dates of April 2004 and November 2005. One of the two continuing
airline merchants, United Airlines, Inc., is currently operating under Chapter
11 protection. In the event of liquidation of United Airlines or the Companys
other airline customer, the Company could become financially responsible for
refunding tickets purchased through Visa® and MasterCard® under the chargeback
rules of those associations. At June 30, 2003, the dollar value of tickets
purchased, but as yet unflown, under continuing merchant processing contracts,
was approximately $931 million, of which approximately $490 million pertained
to United Airlines. Based upon available information, these amounts represent
managements best estimate of its maximum potential chargeback exposure related
to its continuing airline customers. As of June 30, 2003, the Company held no
significant collateral under these contracts.

During the second quarter of 2003, the Companys obligation to process
card transactions for two other airline merchants, including U.S. Airways
Group, Inc., ceased with these merchants transitioning to new processors. At
June 30, 2003, the dollar value of tickets purchased, but as yet unflown, under
these concluding contracts was approximately $151 million. This amount
represents managements best estimate of its maximum potential chargeback
exposure under these concluded contracts. As of June 30, 2003, the Company
held cash collateral of $9.0 million and third-party indemnifications of $125
million against this remaining chargeback exposure.

Based on current conditions in the airline industry and other information
currently available to the Company, management believes the risk of a material
loss under the chargeback rules has increased since December 31, 2002 but is
not probable at this time.

Additional Factors

The Company is dependent on overall consumer spending trends. The Company
is also currently experiencing increased pricing pressure in competing for new
national merchants and in retaining the existing base of national merchants.
These factors may impact the Companys future revenue and operating profits.

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Recent Accounting Pronouncements

Accounting for Exit or Disposal Activities

SFAS 146, Accounting for Costs Associated with Exit or Disposal
Activities,was issued in June 2002 and addresses financial accounting and
reporting for costs associated with exit or disposal activities and nullified
Emerging Issues Task Force (EITF) Issue No. 94-3, Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring).SFAS 146 requires a
liability for a cost associated with an exit or disposal activity be recognized
when the liability is incurred. Under EITF 94-3, a liability for an exit cost
was recognized at the date of the entitys commitment to an exit plan. The
provisions of SFAS 146 became effective for the Company January 1, 2003 and
have not had a material impact on the Companys results of operations,
financial position, or liquidity.

Accounting for Stock-Based Compensation

In December 2002, the FASB issued SFAS 148, Accounting for Stock-Based
Compensation  Transition and Disclosure, which provides guidance on how to
transition from the intrinsic value method of accounting for stock-based
employee compensation under APB 25 to SFAS 123s fair value method of
accounting, if a company so elects.

Effective January 1, 2003, the Company adopted the fair value method of
recording stock options under SFAS 123. In accordance with the transitional
guidance of SFAS 148, the fair value method of accounting for stock options
will be applied prospectively to awards granted subsequent to December 31,
2002. As permitted, options granted prior to January 1, 2003, will continue to
be accounted for under APB 25, and the proforma impact of accounting for these
options at fair value will continue to be disclosed in the Consolidated
Financial Statements until the last of those options vest in 2005.

As the cost of anticipated future option awards is phased in over a
four-year period, the annual impact will rise assuming options are granted in
future years at a similar level and under similar market conditions to 2002.
The actual impact per diluted share may vary in the event the fair value or the
number of options granted increases or decreases from the current estimate, or
if the current accounting guidance changes. The Company uses the Black-Scholes
model to estimate option values. The Black-Scholes option pricing model was
originally developed for use in estimating the fair value of traded options,
which have different characteristics from the Companys employee stock options.
The model is also sensitive to changes in subjective assumptions, which can
materially affect the fair value estimate.

Accounting for Guarantees

In November 2002, the FASB issued Interpretation No. 45 (FIN 45),
Guarantors Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others.FIN 45 requires additional
recognition and disclosure by a guarantor in its financial statements about its
obligations under certain guarantees.

The Companys contingent obligation to honor chargebacks under merchant
contracts is considered a performance guarantee under FIN 45. Performance
guarantees are contracts that contingently require the guarantor to make
payments to the guaranteed party based on another entitys failure to perform
under an

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obligating agreement. Performance guarantees are subject to both the
recognition and disclosure
requirements of FIN 45. The disclosure requirements of FIN 45 were
effective for the Company as of December 31, 2002. The required disclosures
are included in Note 6 to the Consolidated Financial Statements. The
recognition requirements of FIN 45 were adopted January 1, 2003 for new
guarantees entered into after such date and did not have a material impact on
the Companys financial position or results of operations.

Consolidation of Variable Interest Entities

In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46),
Consolidation of Variable Interest Entities. FIN 46 provides guidance on how to
identify a variable interest entity (VIE) and determine when the assets,
liabilities, noncontrolling interests, and results of operations of a VIE are
to be included in an entitys consolidated financial statements. A VIE exists
when either the total equity investment at risk is not sufficient to permit the
entity to finance its activities by itself, or the equity investors lack one of
three characteristics associated with owning a controlling financial interest.
Those characteristics include the direct or indirect ability to make decisions
about an entitys activities through voting rights or similar rights, the
obligation to absorb the expected losses of an entity if they occur, and the
right to receive the expected residual returns of the entity if they occur.

FIN 46 was effective immediately for new entities created or acquired
after February 1, 2003 and became effective on July 1, 2003, for entities in
which the Company had a variable interest prior to February 1, 2003. The
provisions of FIN 46 have not had a material impact on the Companys results of
operations, financial position or liquidity through June 30, 2003. Further,
the Company believes that the future provisions of FIN 46 will not have a
material impact on the Companys results of operations, financial position or
liquidity.

Seasonality

The Company experiences seasonality in its businesses and typically
realizes higher revenue from increased transaction volume in the summer and
holiday months. Accounts receivable is generally highest in the fourth
quarter, as December is typically the highest volume month due to holiday
sales.

Liquidity and Capital Resources

The Companys primary uses of capital resources include capital
expenditures, working capital, and acquisitions. Future business acquisitions
may be funded through current liquidity, borrowed funds, and/or issuances of
common stock.

The Companys capital expenditures include amounts for computer hardware,
external and internally developed software, and improvements to operating
facilities. During the six months ended June 30, 2003 and 2002, the Companys
capital expenditures totaled $3.4 million and $10.6 million, respectively. The
decline in capital expenditures is due to two large capital investments in 2002
- a new web-based merchant accounting and reporting system and a new data
center. Such expenditures were financed from operating cash flow, which
totaled $66.1 million and $88.7 million for the six months ended June 30, 2003
and 2002, respectively. The decrease in operating cash flow is due to lower
income and the timing of working capital items, including accounts receivable,
accounts payable, and income tax payments.

On June 9, 2003, the Company acquired Bridgeview Payment Solutions, Inc.
from Bridgeview Bank and

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Trust Company for $32.4 million in cash.

On July 3, 2002, the Company acquired a portfolio of processing contracts
$2.7 million in cash. The terms of the agreement also include future payments
to the seller for a portion of the revenue derived from these contracts for a
specified period plus an additional one-time payment of up to $1.0 million in
the third quarter of 2003.

In March 2003, the Company paid $2.4 million to the minority shareholder
of AAMS. This payment represents the prorata share of earnings due to the
minority shareholder for the year ended December 31, 2002.

As the Company does not carry significant amounts of inventory and
historically has experienced short collection periods for its accounts
receivable, it does not require substantial working capital to support revenue
growth. Working capital requirements will vary depending upon future
acquisition activity. Increases in working capital needs and future capital
expenditures are expected to be financed through operating cash flow and
current cash balances.

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Forward-Looking Statements

The section entitled Managements Discussion and Analysis of Financial
Condition and Results of Operations contains forward-looking statements.
Forward-looking statements give current expectations or forecasts of future
events and are not guarantees of future performance. Forward-looking
statements may be identified by the use of words such as may, will,
intend, expect, believe, anticipate, plan, estimate, project,
target, forecast, seek and other similar words used in connection with
any discussion of future operating or financial performance. The
forward-looking statements are based on managements expectations that involve
a number of risks and uncertainties, and, although management believes the
expectations reflected in such forward-looking statements are reasonable,
actual results may differ materially from those expressed or implied in such
statements. Risks and uncertainties that could cause actual results to differ
materially include, without limitation, the Companys ability to execute its
business plans; changes in general economic conditions in the United States and
other relevant economies; changes in consumer spending habits; changes in the
growth rate of the card processing industry from recent years; ability to
execute the Companys acquisition strategy; successful integration of
acquisitions; consolidation in the banking, card processing or electronic
payment settlement industries; consolidation of major customers or industries
serviced; industry competition; renewal of major customer relationships;
changes in interest rates; governmental and economic stability in foreign
countries in which the Company operates; litigation or changes in existing
litigation, chargebacks, customer bankruptcy, claims and assessments; reliance
on third party processing relationships; changes in banking regulations;
changes in credit card association rules, regulations or operations; changes in
other laws or regulations that impact the Companys business; changes in
accounting policies and procedures as may be required due to new accounting
pronouncements of the Financial Accounting Standards Board or other regulatory
agencies; technological changes; timely and successful implementation of future
processing systems projects; financial or other business impacts due to systems
infiltrations; and successful business continuity plans. Additional
information concerning factors that could cause actual results to differ
materially from those expressed or implied in the forward-looking statements is
available in the Companys Annual Report on Form 10-K for the year ended
December 31, 2002 and subsequent filings with the Securities and Exchange
Commission. You are advised to consult any further disclosures the Company
makes on related subjects in the Companys Forms 10-Q, 8-K and 10-K reports
filed with the Commission. Copies of the Companys filings with the Commission
are available at no cost on the Commissions web site at www.sec.gov or on the
Companys web site at www.npc.net.




Item 3. Quantitative and Qualitative Disclosures About Market Risk

Derivative Instruments

The Company does not use derivative instruments.

Market Risk of Financial Instruments

The Companys primary market risk exposure with regard to financial
instruments is to changes in interest rates. As of June 30, 2003, the Company
had $215 million in cash and cash equivalents. For the first six months of
2003, NCBK also held an average of approximately $285 million of customer cash
balances. The Company retains the incremental interest earned on certain of
these funds above what is contractually due to the customers. Interest earned
on customer cash balances is included as a component of revenue.

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Because of the short-term nature of these instruments, a sudden change in
market interest rates would not
impact the fair value of these instruments. The Companys earnings,
however, are impacted by changes in interest rates, with respect to interest on
the Companys cash and cash equivalents and on customer funds maintained by
NCBK. At June 30, 2003, a hypothetical 100 basis point increase in short-term
interest rates would result in an increase of approximately $4 million in
annual pre-tax income. A hypothetical 100 basis point decrease in short-term
interest rates would result in a decrease of approximately $4 million in annual
pre-tax income.




Item 4. Controls and Procedures

As of June 30, 2003, an evaluation was performed under the supervision and
with the participation of the Companys management, including the Chairman and
Chief Executive Officer (CEO) and the Chief Financial Officer (CFO), of the
effectiveness of the design and operation of the Companys disclosure controls
and procedures. Based on that evaluation, the Companys management, including
the CEO and CFO, concluded the Companys disclosure controls and procedures as
of June 30, 2003 were effective in ensuring information required to be
disclosed in this Quarterly Report on Form 10-Q was recorded, processed,
summarized and reported on a timely basis. There have been no changes in the
Companys internal control over financial reporting that occurred during the
quarter ended June 30, 2003 that have materially affected, or are reasonably
likely to materially affect, the Companys internal control over financial
reporting.

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Part II -    Other Information




Item 1. Legal Proceedings (None)




Item 2. Changes in Securities and Use of Proceeds (None)




Item 3. Defaults Upon Senior Securities (None)




Item 4. Submission of Matters to a Vote of Security Holders

On May 16, 2003, at the Annual Shareholders Meeting of the Company, the
shareholders took the following actions:



|1. |  | Elected as directors all nominees designated in the proxy statement dated March 28, 2003 as follows:
|-- |  | ----------------------------------------------------------------------------------------------------

Number of VotesFor
    
    WithheldPaul G. Clark
    
    
    51,028,274
    
    
    
    0Jeffrey P. Gotschall
    
    
    51,471,546
    
    
    
    0Jeffrey D. Kelly
    
    
    51,029,124
    
    
    
    0J. Armando Ramirez
    
    
    51,028,274
    
    
    
    0




| |  | Directors whose terms continued after the Annual Shareholders Meeting
include: Aureliano Gonzalez-Baz, Jon L. Gorney, Preston B. Heller, Jr., and
Robert G. Siefers.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------



|2. |  | Approved the amendment to the National Processing, Inc. Code of
Regulations: 50,319,539 votes cast for, 1,385,843 votes cast against, and
37,981 votes abstained.
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------



|3. |  | Approved the Audit Committees selection of Ernst & Young LLP as
independent auditor for the Company for 2003: 51,431,846 votes cast for,
304,839 votes cast against, and 6,678 votes abstained.
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




Item 5. Other Information (None)




Item 6. Exhibits and Reports on Form 8-K:

The exhibits filed as part of the Form 10-Q for the quarter ended
June 30, 2003 are accessible at no cost on the Companys website at
www.npc.net or through the Securities and Exchange Commissions website at
www.sec.gov. Copies of the exhibits may be requested at a cost of $0.30
per page from National Processings investor relations department.

EXHIBIT
    
    DESCRIPTIONNUMBER3.1 (i)
    
    Amended Articles of Incorporation of the Company. (A)3.1(ii)
    
    Code of Regulations, Amended and Restated, as adopted and
in effect on May 16, 2003, of the Company. (Filed as Exhibit 3.1
(ii))4.1
    
    Specimen Certification for the Common Stock, without par value, of the Company. (B)4.2
    
    Registration Rights Agreement between the Company and National
City Corporation, dated July 16, 1996. (B)10.1
    
    Absolute Net Ground Lease by and between Preston Manor, Inc.
and Allied Stores Corporation, dated January 16, 1969. (A)


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10.2
    
    Second Amendment to Lease by and between William G. Earley,
Plaza Centers, Inc. and First National Bank of
Louisville, dated April 15, 1986. (A)10.3
    
    Sponsorship Agreement between NPC and National City Bank of Kentucky, dated June 30, 1996. (B)10.4
    
    Administrative Services Agreement between NPC and National City Corporation, dated July 15, 1996.(B)10.5
    
    Tax Sharing Agreement between the Company and National City Corporation, dated July 17, 1996. (B)10.6
    
    Employment Agreement and Undertaking of Confidentiality between
the Company and Mark Pyke dated March 4, 1996. (Incorporated herein
by reference to Exhibit 10.19 to the Companys Annual Report on Form
10-K for the year ended December 31, 2002) **10.7
    
    Employment Agreement and Undertaking of Confidentiality between
National Processing Company and Thomas A. Wimsett dated December 12,
1997. (Incorporated herein by reference to Exhibit 10.21 to the
Companys Quarterly Report on Form 10-Q for the quarter ended
September 30, 2002) **10.8
    
    Separation Agreement, Release and Waiver between National
Processing, Inc. and Thomas A. Wimsett dated September 29, 2002.
(Incorporated herein by reference to Exhibit 10.22 to the Companys
Quarterly Report on Form 10-Q for the quarter ended September 30,
2002) **10.9
    
    Visa® U.S.A. Inc. Guaranty between National Processing, Inc.
and Visa® U.S.A. Inc. dated August 6, 2002. (Incorporated herein by
reference to Exhibit 10.23 to the Companys Quarterly Report on Form
10-Q for the quarter ended September 30, 2002)10.10
    
    National Processing, Inc. 2000 Stock Option Plan.
(Incorporated herein by reference to Exhibit 10.28 to the Companys
Annual Report on Form 10-K for the year ended December 31, 2002) **10.11
    
    National Processing Company 1996 Stock Option Plan.
(Incorporated herein by reference to Exhibit 10.29 to the Companys
Annual Report on Form 10-K for the year ended December 31, 2002) **10.12
    
    Nonemployee Directors Stock Option Plan and Form of Stock
Option Agreement. (B) **10.13
    
    National Processing Company Short-Term Incentive Compensation
Plan for Senior Executives, effective February 1, 2003.
(Incorporated herein by reference to Exhibit 10.31 to the Companys
Annual Report on Form 10-K for the year ended December 31, 2002) **10.14
    
    National Processing Company Long-Term Incentive Compensation
Plan for Senior Officers, as amended and restated effective February
1, 2003. (Incorporated herein by reference to Exhibit 10.32 to the
Companys Annual Report on Form 10-K for the year ended December 31,
2002) **10.15
    
    Amendment to Building Lease between National City Bank of
Kentucky and NPC, dated July 3, 1996. (B)10.16
    
    Form of Severance Agreement between the Company and certain
Senior Vice Presidents. (Incorporated herein by reference to Exhibit
10.37 to the Companys Quarterly Report on Form 10-Q for the quarter
ended September 30, 2002) **10.17
    
    Form of Severance Agreement between the Company and certain
Executive Vice Presidents. (Incorporated herein by reference to
Exhibit 10.38 to the Companys Quarterly Report on Form 10-Q for the
quarter ended September 30, 2002) **10.18
    
    Employment Agreement and Undertaking of Confidentiality
between the Company and David Fountain dated October 27, 1998.
(Incorporated herein by reference to Exhibit 10.39 to the Companys
Quarterly Report on Form 10-Q for the quarter ended September 30,
2002) **10.19
    
    National Processing, Inc. 2001 Restricted Stock Plan.
(Incorporated herein by reference to Exhibit A to National
Processing, Inc.s Proxy Statement on Form 14A #001-11905, dated
March 31, 2001) **10.20
    
    National Processing, Inc.s U.S. Asset Purchase Agreement,
dated July 11, 2001. (Incorporated herein by reference to Exhibit
10.42 to the Companys Quarterly Report on Form 10-Q for the quarter
ended June 30, 2001)10.21
    
    National Processing, Inc.s Mexico Asset Purchase Agreement,
dated July 11, 2001. (Incorporated herein by reference to Exhibit
10.43 to the Companys Quarterly Report on Form 10-Q for the quarter
ended June 30, 2001)10.22
    
    National Processing, Inc.s Stock Purchase Agreement, dated
July 11, 2001. (Incorporated herein by reference to Exhibit 10.44 to
the Companys Quarterly Report on Form 10-Q for the quarter ended
June 30, 2001)10.23
    
    Guarantee between National Processing, Inc. and MasterCard®
International Incorporated dated May 16, 2003. (Filed as Exhibit
10.23)14
    
    Senior Financial Officers Code of Ethics (Incorporated herein
by reference to Exhibit 99.1 to the Companys Annual Report on Form
10-K for the year ended December 31, 2002)31.1
    
    Chief Executive Officer 302 Certification dated August 8, 2003
for National Processing, Inc.s Quarterly Report on Form 10-Q for the
quarter ended June 30, 2003. (Filed as Exhibit 31.1)31.2
    
    Chief Financial Officer 302 Certification dated August 8, 2003
for National Processing, Inc.s Quarterly Report on Form 10-Q for the
quarter ended June 30, 2003. (Filed as Exhibit 31.2)32.1
    
    Chief Executive Officer 906 Certification dated August 8, 2003
for National Processing, Inc.s Quarterly Report on Form 10-Q for
quarter ended June 30, 2003. (Filed as Exhibit 32.1)32.2
    
    Chief Financial Officer 906 Certification dated August 8, 2003
for National Processing,
Inc.s Quarterly Report on Form 10-Q for quarter ended June 30,
2003. (Filed as Exhibit 32.2)


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(A)
    
    Exhibit is incorporated herein by reference to the applicable
exhibit in the Companys Registration Statement on Form S-1
(Registration No. 333-05507) filed on June 7, 1996.(B)
    
    Exhibit is incorporated herein by reference to the applicable
exhibit in the Companys Amendment No. 1 to Form S-1 Registration
Statement (Registration No. 333-05507) filed on July 18, 1996.**
    
    Represents a management contract or compensatory plan required
to be filed pursuant to Item 14 of Form 10-K.




|b. |  | Reports on Form 8-K
|-- |  | -------------------

April 16, 2003: On April 16, 2003, the Company issued a news release
reporting earnings and including a financial summary for the quarter ended
March 31, 2003.

June 6, 2003: On June 6, 2003, the Company issued a news release
announcing its wholly-owned subsidiary, National Processing Company, LLC,
entered into a stock purchase agreement to acquire Bridgeview Payment
Solutions, Inc.

June 11, 2003: On June 9, 2003, the Companys wholly-owned
subsidiary, National Processing Company, LLC, announced that it acquired
Bridgeview Payment Solutions, Inc. through a stock purchase agreement
dated June 5, 2003.

July 16, 2003: On July 16, 2003, the Company issued a news release
reporting earnings and including a financial summary for the quarter and
six months ended June 30, 2003.




SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934,
the Company has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

NATIONAL PROCESSING, INC.Date:
    
    August 8, 2003
    
    By:  /s/ Jon L. Gorney
Jon L. Gorney
Chairman and Chief Executive Officer
(Duly Authorized Signer)By:  /s/ David E. Fountain
David E. Fountain
Senior Vice President and Chief Financial Officer
(Principal Financial Officer)


31