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UNITED STATES

FORM 10-K

For the transition period from                to                

NATIONAL PROCESSING, INC.

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

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

National Processing, Inc. Common Stock, No Par Value

      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      No     

      Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.     

      The aggregate market value of the voting stock held by non-affiliates of the Registrant as of January 31, 2001 was $129,418,036. The market value calculation was determined using the closing sale price of the Registrant’s common stock on January 31, 2001, as reported on the New York Stock Exchange.

      The number of shares outstanding of the Registrant’s Common Stock as of January 31, 2001 was 50,941,460.

Documents Incorporated by Reference:

      Portion’s of the Registrant’s Proxy Statement (to be dated approximately March 28, 2001) are incorporated by reference into Item 10, Directors and Executive Officers of the Registrant; Item 11, Executive Compensation; Item 12, Security Ownership of Certain Beneficial Owners and Management; and Item 13, Certain Relationships and Related Transactions, of Part III.

Table of Contents

TABLE OF CONTENTS

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PART I

Item 1.  Business

      National Processing, Inc. (the “Company” or “Registrant”), through its wholly-owned operating subsidiaries which are collectively referred to as National Processing Company (“NPC”), operates two business segments — Merchant Card Services and Corporate Outsourcing Solutions.

      Merchant Card Services authorizes, processes and performs financial settlement of card transactions including credit, debit and electronic benefits transfer (“EBT”). Merchant Card Services provides services to virtually every industry that accepts cards for payment settlement and represented approximately 74% of the Company’s revenue in 2000. Merchant Card Services currently provides services to over 500,000 merchant locations primarily in the United States.

      Corporate Outsourcing Solutions provides a variety of financial and administrative processing solutions to large corporate customers, primarily in three industries: travel, healthcare and financial services. These solutions include financial settlement, image scanning, data capture, storage and retrieval, and value-added customer reporting. Corporate Outsourcing Solutions represented approximately 26% of the Company’s revenue in 2000 and had processing locations in the United States, Mexico and the Caribbean.

      The Company is an Ohio corporation that is 87% owned by National City Corporation, a financial holding company headquartered in Cleveland, Ohio (“National City”). The Company maintains operations, employees and contracts substantially independent of National City’s other operating subsidiaries. The Company and National City are parties to agreements pursuant to which National City and its subsidiaries provide the Company, and the Company provides National City and its subsidiaries, certain administrative support, operations, and processing services. The Company is also a party to a tax sharing agreement and a registration rights agreement with National City.

      See Segment Reporting, Note M to the Consolidated Financial Statements, for additional financial disclosures of the Company’s operating segments and foreign operations.

Industry Overview

  Merchant Card Services

      The merchant card processing industry provides retailers and other merchants with card-based payment authorization, capture, settlement, exception processing and other related services. The industry has enjoyed significant growth over the last ten years due to wider merchant acceptance of card-based settlement products and increased consumer usage of card-based payment services.

      NPC provides a diversified product mix to meet a wide range of customer needs, including:

	•	Processing of all credit card types
	•	Authorization and settlement
	•	Chargeback prevention and handling
	•	Point of Sale (POS) hardware and software
	•	On-line/off-line debit card acquiring
	•	Electronic Benefits Transfer (EBT)
	•	Customized reporting formats/data management
	•	Call-center services
	•	E-commerce solutions

      NPC provides services to a wide array of customers in virtually every industry, including retailers, supermarkets, restaurants, petroleum and convenience stores, airlines, hospitality and e-commerce. NPC is the second largest provider of merchant card processing services in the United States. In 2000, NPC processed 2.8 billion transactions (including approximately one out of every six Visa® and MasterCard® transactions in

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      The merchant card processing market is generally divided into two markets: national and regional merchants including smaller “mom and pop” merchants. Since 1997, NPC has deployed a dual strategy focused on growing both markets. On December 31, 1999, the Company increased its market share of regional merchants by acquiring a merchant processing portfolio from Heartland Payment Systems LLC. In 2000, approximately 56% of merchant card processing revenue was from regional merchants.

      On January 8, 2001, the Company further expanded its market share of regional merchants by acquiring the merchant services business units from several National City affiliates.

      Merchant Card Services revenue was $317.9 million which represented approximately 74% of the Company’s revenue in 2000. Total transaction volume increased by 26% to 2.8 billion in 2000. Total dollar settlement volume increased by 22% to $127 billion in 2000.

      Merchant Card Services uses various sales and marketing channels for both its national and regional customers. The Company employs approximately 300 sales representatives who focus on direct marketing channels. In addition, the Company sells its services through approximately 575 third-party relationships such as independent sales offices and community banks.

      The merchant card processing market is extremely competitive, which results in pricing pressure and creates the need for continuous improvement in technology both to satisfy customer demands and to reduce operating costs. The costs to meet merchant requirements for improved service and satisfy the demand for additional technology-driven applications combined with the scale-driven nature of the industry have made it difficult for small-scale transaction processors to remain competitive and has led to consolidation in the industry. NPC competes in this industry by focusing on lowering the merchant’s “total cost of card acceptance”, which includes minimizing interchange and processing fees assessed by third parties. NPC also focuses on providing superior products and outstanding service.

      According to published industry sources, the five largest card processors handle over 70% of the transaction and dollar volume in the United States. The remaining market is highly fragmented among smaller merchant service providers. As a result, the transaction processing industry will likely continue to undergo consolidation.

  Corporate Outsourcing Solutions

      The business process outsourcing industry provides a variety of financial and administrative processing solutions to large corporate customers. These solutions include financial settlement, image scanning, data capture, storage and retrieval, and value-added customer reporting. Corporate Outsourcing Solutions revenue was $109.4 million which represented approximately 26% of the Company’s revenue in 2000. Corporate Outsourcing Solutions currently focuses on three industries: travel, healthcare and financial services.

      In the travel industry, the Company provides a variety of outsourcing services to airlines, hotels, travel agents, cruise lines and car rental companies. NPC performs image scanning and data capture, storage and retrieval services for major airlines in the United States. The Company, through an exclusive long-term “cost-plus” contract with the Airlines Reporting Corporation (“ARC”), provides payment settlement services for all airline tickets sold by travel agents in the United States. In addition, NPC provides an industry-wide global payment system for consolidating and processing business to business commission payments for all car rental companies as well as for the hotel, cruise line and airline industries. These services are provided primarily in the Company’s Mexico and United States locations.

      In the healthcare industry, the Company provides image scanning and data capture, storage and retrieval services for many of the nation’s largest healthcare insurers. NPC uses high-speed digital communication networks, image scanning technology, and offshore data entry facilities to process healthcare claims for these insurers. These services are provided primarily in the Company’s Caribbean locations.

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      NPC services the financial services industry by providing data capture, application processing, mailroom and other services for the largest credit card issuers and financial institutions in the United States. These services are primarily performed in the Company’s Mexican and Caribbean locations.

      During 2000, a non-cash pre-tax impairment charge of $7.1 million was recorded for goodwill and fixed assets related to a small product line within the Corporate Outsourcing Solutions segment. In the fourth quarter of 2000, the Company received a contract cancellation notice from its largest customer for this product line. At that time, management decided to divest or exit the product line and recorded impairment charges of $6.7 million for goodwill and $0.4 million for fixed assets. This charge totaled $4.6 million after-tax or $0.09 per share. This product line contributed $5.7 million of revenue and $2.0 million in operating profit in 2000 and is expected to be exited in the first half of 2001.

      The business process outsourcing industry experiences considerable competition in the marketplace, which has resulted in additional focus on economies of scale. In addition to competition, the cost of advancing technology and customer demand for a broad product line have caused consolidation among transaction processing providers. NPC competes in this industry by focusing on price, quality and customer service.

Regulation

      As a result of National City’s ownership in the Company and as long as National City has a controlling interest, the Company is subject to banking laws, regulations and orders (collectively, the “Banking Laws”). For example, the Company is subject to the supervision and examination by the Board of Governors of the Federal Reserve System (“FRB”), one of the principal regulatory bodies having jurisdiction over National City.

      The FRB reviews acquisitions and new businesses to be engaged in by the Company, and the FRB’s written approval is required for the Company to consummate an acquisition. Pursuant to the Bank Holding Act, the Company shall not engage in any activity, or own, control, or have the power to vote more than 5% of any class of voting security of any company engaged in any activity (i) for which the Bank Holding Act requires a bank holding company to receive prior approval from the FRB without such approval having been obtained, or (ii) that would cause the Company or any affiliate of the Company to violate any regulation, administrative order, or court order made pursuant to the Bank Holding Act. If at any time it is determined that any activity conducted by the Company or any subsidiary does not comply with the requirements of the Bank Holding Act, the Company is required to take all reasonable steps to cease such activity, or to divest any ownership or control position. If National City is unable to obtain the necessary consent or approval for any business activity substantially different from those business activities the Company currently conducts, then the Company may not engage in any of those new business activities or proceed with the contemplated acquisition of a business that would engage in such new activities. The Company does not believe, however, that either the Banking Laws or the Bank Holding Act will impede the manner in which the Company conducts its business or its product and service offerings, although there can be no assurance that the Banking Laws or Bank Holding Act will not have such an effect.

      The Company is also subject to various other federal, state, local and foreign laws, orders and regulations applicable to the Company’s operations in the jurisdictions where it conducts business. Where applicable, regulators and other persons are authorized to seek remedies against entities such as the Company for violations of such laws.

      Through National City Bank of Kentucky, (“NCBK”), which serves as a member bank for the Company, the Company is registered with VISA® and MasterCard® as a certified processor and member service provider. As a result, the Company must adhere to the standards of the VISA® and MasterCard® credit card associations or risk suspension or termination of its designation and/or status. There can be no assurance that (i) VISA® and MasterCard® will maintain the Company’s registrations; (ii) the current VISA® and MasterCard® rules allowing the Company and other non-bank transaction processors to market and provide transaction processing services will remain in effect; or (iii) VISA® and MasterCard® will continue to interpret their rules as they have done in the past, which may have an impact on the Company’s business operations. NCBK is a wholly-owned subsidiary of National City.

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Employees

      As of December 31, 2000, the Company and its subsidiaries had approximately 7,000 full-time and part-time employees.

      Corporate Outsourcing Solutions has significant production operations in international locations, including Juarez, Mexico, the Dominican Republic, and Jamaica. As of December 31, 2000, international operations employed approximately 75% of the Company’s employees.

Seasonality

      The Company experiences seasonality in certain businesses and typically realizes higher revenue in the third and fourth calendar quarters reflecting increased transaction volume in the summer and holiday months.

Item 2.  Properties

      The Company leases its processing facility in Louisville, Kentucky, consisting of approximately 223,000 square feet, from National City Bank of Kentucky. (See Transactions with Affiliates, Note E to Consolidated Financial Statements). The Company’s lease for the Louisville processing facility expires on February 28, 2019. The Company’s Juarez operation owns four properties totaling 225,000 square feet. The Company’s other processing facilities have varying lease expiration terms and range in size from 10,000 square feet to 75,000 square feet and are located throughout the United States, Dominican Republic, Jamaica, and Mexico. The Company’s 33 marketing and sales offices have varying lease expiration terms and range in size from 100 square feet to 4,400 square feet and are located throughout the United States. All properties leased and owned by the Company are in good repair and suitable condition for the purposes for which they are used. The Company periodically reviews its overall facility needs in order to add or delete capacity based on the needs of its individual product lines.

Item 3.  Legal Proceedings

      Various legal actions arising in the ordinary course of business are pending against the Company. None of the litigation pending against the Company, individually or collectively, in the opinion of management, is expected to have a material adverse effect on the Company’s financial condition, results of operations or liquidity.

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

      None.

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PART II

Item 5.  Market for the Registrant’s Common Equity and Related Shareholder Matters

      The Company’s common stock is traded on the New York Stock Exchange under the symbol NAP. The quarterly high and low trade price and the final day’s closing price of the Company’s common stock for each of the quarterly periods in 2000 and 1999 were:

      The number of holders of record of the Company’s common stock as of January 31, 2001 was 64. The Company believes it has significantly more than 64 beneficial holders of its common stock.

      The Company has never declared or paid cash dividends on its common stock and has no plans to pay cash dividends in the foreseeable future. The declaration and payment of cash dividends on the Company’s common stock is at the discretion of the Company’s Board of Directors, and any decision to declare a dividend will be based on a number of factors, including, but not limited to, earnings, financial condition, borrowing covenants and other factors deemed relevant.

      The name and address of the Company’s common stock transfer agent and registrar is National City Bank (a wholly-owned subsidiary of National City), Corporate Trust Operations, P.O. Box 92301, Locator 5352, Cleveland, Ohio, 44139-0900, (800.622.6757).

      Investors or analysts requiring further information should contact:

	David E. Fountain
	Chief Financial Officer
	1231 Durrett Lane
	Louisville, KY 40213-2008
	(502.315.3311)

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Item 6.  Selected Financial Data

      The following data should be read in conjunction with the Consolidated Financial Statements and related notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in Item 7.

(1)

This financial data includes the impact of the following acquisitions during the periods presented: on February 4, 1997, the Company acquired NTA, Inc., a freight payment processing company; on June 18, 1997, the Company acquired the operating assets and liabilities of InTraCon, Inc., a freight payment processing company; on June 20, 1997, the Company acquired the operating assets and liabilities of MRS Jamaica, Inc., a healthcare claim form processing company; on September 30, 1997, the Company acquired Caribbean Data Services, Ltd., a data processing company; on October 24, 1997, the Company acquired 79.6% of the outstanding shares of FA Holdings, Inc., a debit and credit card processor; (the Company acquired the remaining outstanding shares of FA Holdings, Inc. on January 2, 1998); on January 15, 1998, the Company acquired JBH Travel Audit Inc., a commission collections company which audits commissions payable to travel agencies; on December 31, 1999, the Company acquired a regional merchant processing portfolio from Heartland Payment Systems LLC. Each of these transactions were accounted for as purchases; accordingly, the results of operations are included in the consolidated statements of operations from the respective acquisition dates.

Effective April 1, 1999, the Company sold its Freight and Payables business lines. Effective June 1, 1999, the Company sold its Check Acceptance and Remittance business lines.

(2)

Included in net income (loss) are certain nonrecurring items summarized as follows: for 2000, $8.6 million ($5.6 million after-tax) of impairment and site consolidation expenses; for 1999, $71.7 million (also $71.7 million after-tax) of impairment, restructuring and related expenses; for 1998, $1.4 million ($0.8 million after-tax) of net gains related to contract terminations; for 1997, $13.3 million ($8.1 million after-tax) of impairment, restructuring and related expenses; for 1996, $3.9 million ($2.3 million after-tax) of gain related to a contract termination.

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Components of Revenue and Expenses

      Revenue. The Company’s Merchant Card Services revenue is primarily derived from fees paid by merchants for the authorization, processing and settlement of credit and debit card transactions. Fees are generated either on a per transaction basis or on a “discount” basis which is a percent of dollar volume processed. Revenue is recorded net of interchange fees charged by the credit card associations as such costs are not controlled by the Company.

      Corporate Outsourcing Solutions revenue is generated from a variety of financial and administrative processing solutions provided to customers. These solutions include financial settlement, image scanning, data capture, storage and retrieval, and value-added customer reporting. A portion of Corporate Outsourcing Solutions revenue is derived from an exclusive long-term contract with Airlines Reporting Corporation under which the Company is compensated on a “cost-plus” basis.

      A small portion of revenue is derived from earnings on customer cash balances, which are maintained pursuant to contract terms.

      Expenses. Expenses include costs of providing services to customers including wages and personnel costs, assessment fees, authorization fees, data processing costs, and general and administrative expenses.

Results of Operations

      The Company’s operating results are presented below in the manner in which they are viewed by management. The Company divested certain business units during 1999 in order to focus on its core business lines. Accordingly, the segment results presented below segregate the operating performance for the remaining core business lines, versus those that were divested. The segment operating profits as shown below exclude certain nonrecurring items. Certain prior year amounts have been reclassified to conform with the 2000 presentation.

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Year Ended December 31, 2000 Compared to Year Ended December 31, 1999

NM — Not meaningful

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  Merchant Card Services

      Revenue for 2000 increased 20% to $317.9 million from $264.5 million in 1999. Transaction volume processed increased by 26% to 2.8 billion in 2000 from 2.2 billion in 1999. Dollar volume processed increased 22% to $127 billion in 2000 from $104 billion in 1999. Volume growth resulted from new customer accounts, including the acquisition of a merchant processing portfolio from Heartland Payment Systems LLC on December 31, 1999, and increased volume from existing accounts.

      Expenses increased 14% to $263.5 million in 2000 from $231.7 million in 1999 primarily due to customer base expansion and increased volumes. Operating margins as a percentage of revenue increased to 17% in 2000 from 12% in 1999, primarily due to increased revenue from higher-margin regional merchants, economies of scale from increased volumes and cost savings initiatives. In addition, 1999 contained testing and remediation expenses for Year 2000 that did not recur in 2000. Due primarily to the factors listed above, operating profits increased 66% to $54.4 million in 2000 from $32.8 million in 1999.

  Corporate Outsourcing Solutions

      Revenue was $109.4 million in 2000 compared to $109.2 million in 1999. The Company generated additional revenue due to volume growth in the healthcare product line and price increases in certain of the travel product lines. However, these revenue increases were mostly offset by anticipated volume decreases in other product lines due primarily to continuing conversion from paper to electronic ticketing and reporting in the airline industry, which reduced the demand for the Company’s data capture services.

      Operating expenses were $93.0 million in 2000 down slightly from $93.4 million in 1999 due to cost savings initiatives and product line mix changes. Operating margins as a percentage of revenue increased to 15% in 2000 from 14% in 1999. Operating profits increased 4% to $16.4 million in 2000 from $15.8 million in 1999.

  Divested Business Lines

      Divested business lines are comprised of the Remittance, Payables, Freight and Check Acceptance business lines that were sold by the Company in the first half of 1999. Operating loss for the divested business lines was $1.1 million for the year ended December 31, 1999.

  Net Interest Income

      Net interest income increased to $8.3 million in 2000 from $4.5 million in 1999 due to increased level of cash and investments as well as rising interest rates during 2000 compared to 1999. The increased levels of cash and investments were due primarily to the receipt of sale proceeds from the business lines that were divested in the first half of 1999, as well as cash flow from operations.

  Nonrecurring Items

      During 2000, a pre-tax charge of $1.5 million was recorded for site consolidation initiatives. The charge totaled $1.0 million after-tax, or $0.02 per share. At December 31, 2000, the Company had $0.4 million remaining relating primarily to future lease payments recorded in other accrued liabilities.

      During 2000, a non-cash pre-tax impairment charge of $7.1 million was recorded for goodwill and fixed assets related to a small product line within the Corporate Outsourcing Solutions segment. In the fourth quarter of 2000, the Company received a contract cancellation notice from its largest customer for this product line. At that time, management decided to divest or exit the product line and recorded impairment charges of $6.7 million for goodwill and $0.4 million for fixed assets. This charge totaled $4.6 million after-tax or $0.09 per share. This product line contributed $5.7 million of revenue and $2.0 million of operating profit in 2000 and is expected to be exited in the first half of 2001.

      During 1999, the Company recorded restructuring charges of $2.2 million, including $1.9 million for severance expense for approximately 540 employees and $0.3 million for other costs. These charges related to

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      During 1999, the Company committed to a formal plan to dispose of its Freight, Payables, Remittance and Check Acceptance business lines and recorded pre-tax impairment losses and associated expenses of $69.5 million related to the sale and wind-down of these business lines. The charges decreased 1999 net income and earnings per share by $69.9 million and $1.38, respectively. Effective April 1, 1999, the Company sold its Freight and Payables business lines for $18.3 million. Effective June 1, 1999, the Company sold its Remittance and Check Acceptance business lines for $44.3 million. At December 31, 2000, the Company had $0.8 million remaining related to the final obligations of these dispositions recorded in other accrued liabilities. The remaining obligations are primarily for future severance payments and legal matters.

  Provision for Income Taxes

      Excluding the impact of nonrecurring items, the effective tax rate was 38.0% for 2000, compared to 33.9% for 1999. Pre-tax income for 1999 included a larger percentage of foreign income which was taxed at lower rates. In 2000, there was an increase in U.S. income, versus foreign income, which is additionally subject to state and local taxation. The increase in the effective tax rate for 2000 was partially offset by $1.1 million due to a reduction in the valuation allowance for state net operating loss carryforwards.

      The overall effective rate for 1999 included the effect of the write-off of $65.7 million of nondeductible goodwill related to the divested business lines.

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Year Ended December 31, 1999 Compared to Year Ended December 31, 1998