NATIONAL PROCESSING INC - 10-K Annual Report

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 ü 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. ü

Indicate by check mark whether the registrant is an accelerated filer (as defined by Rule 12b-2 of the Act). Yes ü No .

The aggregate market value of the voting stock held by non-affiliates of the Registrant as of June 30, 2003 was $126,370,919. The market value calculation was determined using the closing sale price of the Registrant’s common stock on June 30, 2003, as reported on the New York Stock Exchange.

The number of shares outstanding of the Registrant’s Common Stock as of February 27, 2004 was 53,141,342.

Portions of the Registrant’s Proxy Statement (to be dated approximately March 19, 2004) 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; Item 13, Certain Relationships and Related Transactions, of Part III; and Item 14, Principal Accountant Fees and Services.

National Processing, Inc. and its subsidiaries (the “Company”) are providers of electronic payment processing services. National Processing, Inc. was incorporated in 1996 as an Ohio corporation and is 84% owned by National City Corporation (“National City”), a financial holding company headquartered in Cleveland, Ohio. The Company’s primary operating subsidiary, National Processing Company, LLC, is located in Louisville, Kentucky. The Company and National City are parties to agreements pursuant to which the Company outsources a portion of certain functions to National City including information technology services, tax services, human resource services, internal audit and legal services. The Company is also a party to a tax-sharing agreement and a registration rights agreement with National City.

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 represented 97%, 96%, and 85% of the Company’s revenue in 2003, 2002, and 2001, respectively.

Payment Services was formerly a component of the Company’s Corporate Outsourcing Solutions segment. This segment was renamed Payment Services in 2001 after the sale of the Business Process Outsourcing (“BPO”) unit, which was also formerly a component of the Company’s Corporate Outsourcing Solutions segment. 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 represented 3%, 4%, and 6% of the Company’s revenue in 2003, 2002, and 2001, respectively.

During 2001, the Company divested its BPO business and exited its Denver collections business, which collectively represented 9% of the Company’s revenue in 2001.

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, the Notes to Consolidated Financial Statements do not include segment disclosures.

The merchant card processing industry provides retailers and other merchants with card-based payment authorization, capture, settlement and reporting, 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 payment products and increased consumer usage of card-based payment services.

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


	•	Processing of all credit card types

	•	Authorization and settlement accounting


	•	Merchant reporting

	•	Chargeback prevention and handling

	•	Point of Sale (POS) hardware and software

	•	On-line and off-line debit card acquiring

	•	Electronic Benefits Transfer processing (EBT)

	•	Customized reporting formats and data management

	•	Call-center services

	•	E-commerce solutions

The Company provides services to a wide array of customers in virtually every industry, including retailers, supermarkets, quick service and full service restaurants, petroleum and convenience stores, hospitality, and e-commerce. NPC is the second largest provider of merchant card processing services in the United States. In 2003, NPC processed 4.3 billion transactions, including approximately one out of every five Visa® and MasterCard ® transactions in the United States.

The merchant card processing market can generally be divided into two markets: 1) national merchants and 2) regional merchants, including small single-location merchants. Since 1997, the Company 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 contract portfolio from Heartland Payment Systems LLC. The Company further expanded its market share of regional merchants by acquiring the merchant services business units from several National City banking subsidiaries on January 8, 2001, a 70% ownership interest in ABN AMRO Merchant Services, LLC (“AAMS”) on June 28, 2001, and Bridgeview Payment Solutions, Inc. (“BPS”) on June 9, 2003.

Merchant Card Services revenue was $464.5 million in 2003, which represented 97% of the Company’s revenue. Total transaction volume increased by 11% to 4.3 billion in 2003. Total dollar settlement volume increased by 5% to $177 billion in 2003.

Merchant Card Services uses various sales and marketing channels for both its national and regional customers. The Company employs approximately 150 commission only sales representatives who focus on direct marketing channels. In addition, the Company sells its services through approximately 1,100 third-party relationships such as independent sales offices and community banks who, in most cases, represent National Processing exclusively.

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 increased costs to meet merchant requirements for regulatory compliance, 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. National Processing 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.

According to published industry sources, the ten largest card processors handle approximately 90% 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.

travel and healthcare industries. Payment Services revenue was $15.6 million in 2003, which represented 3% of the Company’s revenue. Payment Services settled $64 billion of payments in 2003.

In the travel industry, Payment Services provides financial settlement and reporting to airlines, hotels, travel agents, cruise lines, and car rental companies. Through an exclusive long-term “cost-plus” contract with the Airlines Reporting Corporation (“ARC”), Payment Services settles 100% of domestic airline tickets issued by travel agencies and settled through the Airlines Reporting Corporation. In addition, NPC provides an industry-wide global payment system for consolidating and processing business-to-business commission payments for virtually all United States based car rental companies as well as for the hotel and cruise line industries. During 2001, these services were performed in both the Company’s Mexican and United States locations. In 2002 and 2003, these services were performed solely in the Company’s United States locations.

Competition for the Payment Services segment varies based on the individual product lines. The Company currently has an exclusive long-term contract with ARC to provide payment settlement for all airline tickets sold by travel agents in the United States. The other Payment Services product lines experience competition in the marketplace. NPC competes in this industry by focusing on price, quality, and customer service.

In 2001, the Company divested its BPO business and exited its Denver collections business, which were components of the former Corporate Outsourcing Solutions segment. Revenue from these divested businesses was $41.2 million, which represented 9% of the Company’s revenue in 2001. The sale of the BPO business unit to Affiliated Computer Services (“ACS”) was completed on August 29, 2001, for $43.0 million in cash ($41.3 million after transaction-related expenses). The Company recorded charges of $3.9 million ($4.6 million after-tax) related to the BPO divestiture. These charges consisted of a loss of $3.3 million ($4.2 million after-tax) on the sale of the business and a $0.6 million charge ($0.4 million after-tax) for severance costs related to organizational restructuring actions taken to reduce support costs associated with the BPO unit.

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 Company 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 Company Act requires a 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 Company 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 Company 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 Company 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 Company Act will not have such an effect.

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.

On July 30, 2002, the Senate and the House of Representatives of the United States (Congress) enacted the Sarbanes-Oxley Act of 2002, a statute that addresses, among other issues, corporate governance, auditing and accounting, executive compensation and enhanced and timely disclosure of corporate information. The New York Stock Exchange also proposed corporate governance rules that were approved by the Securities and Exchange Commission. These changes are intended to allow shareholders to more easily and efficiently monitor the performance of companies and directors.

Effective August 29, 2002, as directed by Section 302(a) of the Sarbanes-Oxley Act, the Company’s chief executive officer and chief financial officer are each required to certify that the Company’s quarterly and annual reports do not contain any untrue statement of a material fact. The rules have several requirements, including having these officers certify that: they are responsible for establishing, maintaining and regularly evaluating the effectiveness of the Company’s internal controls; they have made certain disclosures to the Company’s auditors and the audit committee of the board of directors about the Company’s internal controls; and they have included information in the Company’s quarterly and annual reports about their evaluation and whether there have been significant changes in the Company’s internal controls or in other factors that could significantly affect internal controls subsequent to the evaluation.

On November 14, 2002, the Board of Directors of National Processing approved a series of actions to strengthen and improve its corporate governance practices. Included in those actions was the adoption of a new Code of Ethics, a Code of Ethics for Senior Financial Officers, Corporate Governance Guidelines and new charters for the Audit and Compensation Committees. More information on National Processing’s Corporate Governance is available on the National Processing web site at www.npc.net.

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.

The Company and NCBK 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.

The Company retains full responsibility for performance of Merchant Card Services, except for certain obligations or responsibilities of NCBK pursuant to the Sponsorship Agreement. The Sponsorship Agreement provides that the Company will comply with (1) all Visa® and MasterCard ® bylaws, manuals and operating regulations and other written materials as they from time to time are amended which bind or apply to NCBK as a member of Visa® and MasterCard ® with respect to Merchant Card Services or to the Company as a third party processor, (2) all agreements between merchants and NCBK with respect to Merchant Card Services, and (3) all applicable federal or state laws and regulations. Under the Sponsorship Agreement, the Company will receive all fees, discounts and other amounts payable by merchants for Merchant Card Services and will bear the expenses of maintaining facilities necessary to provide such services. Certain indemnification provisions are also contained in the Sponsorship Agreement, under which the Company will indemnify NCBK

against losses, claims or other amounts in accordance with the terms of the Sponsorship Agreement. See Note 13 to the Consolidated Financial Statements.

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 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.

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 material loss under the guarantee is not probable at this time. National Processing processes all transactions received from Visa® by NCBK under the exclusive terms of the Sponsorship Agreement.

As of December 31, 2003, the Company had approximately 1,700 full-time and part-time employees.

The Company experiences seasonality in certain businesses and typically realizes higher revenue in the third and fourth quarters and lower revenue in the first quarter, reflecting 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.

All reports filed electronically by National Processing, Inc. with the United States Securities and Exchange Commission (SEC), including the annual report on Form 10-K, quarterly reports on Form 10-Q and current event reports on Form 8-K, as well as any amendments to those reports, are accessible at no cost on the Company’s web site at www.npc.net. These filings are also available on the SEC’s web site at www.sec.gov.

The Company leases its main processing facility in Louisville, Kentucky, consisting of approximately 224,000 square feet, from NCBK. See Transactions with Affiliates, Note 7 to the Consolidated Financial Statements. The Company’s lease for the Louisville processing facility expires on February 28, 2019. The Company’s other U.S. facilities have varying lease expiration terms and range in size from 5,000 square feet to 16,000 square feet. The Company also has 20 marketing and sales offices, which have varying lease expiration terms and range in size from 100 square feet to 4,600 square feet and are located throughout the United States. As of December 31, 2003, the Company owned one idle processing facility in Juarez, Mexico, consisting of 50,000 square feet, which was sold subsequent to year end. 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.

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 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 2003 and 2002 were as follows:

Securities authorized for issuance under equity compensation plans are summarized in the following table. See Note 12 to the Consolidated Financial Statements for a description of the plans.

The number of holders of record of the Company’s common stock as of February 27, 2004 was 111. The Company believes it has significantly more than 111 beneficial holders of its common stock.

The Company has never declared or paid cash dividends on its common stock. 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, and other factors deemed relevant.

The name and address of the Company’s common stock transfer agent and registrar is National City Bank, Corporate Trust Operations, P.O. Box 92301, Locator 5352, Cleveland, Ohio, 44193-0900, (800.622.6757).

Investors or analysts requiring a copy of this annual report on Form 10-K or further information should contact:


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

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.

loss on the sale of 14 regional sales offices; for 2002, $1.7 million ($2.4 million after-tax) of site consolidation expenses and $3.2 million ($1.9 million after-tax) related to a separation agreement with the former CEO; for 2001, $3.9 million ($4.6 million after-tax) of restructuring and divestiture expenses; 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.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

National Processing’s revenue is primarily derived from processing contracts with merchants for the authorization, processing and settlement of credit and debit card transactions. Business volumes tend to be influenced by overall consumer spending trends as well as competitive conditions within the marketplace. During 2003, U.S. consumers continued to substitute card-based payments for cash and checks. As a result, transactions and dollar volume processed increased 11% and 5%, respectively, over 2002 levels.

In 2003, the Company experienced strong growth from regional and small business merchant accounts. Conversely, the merchant processing industry has experienced a sustained period of lower market pricing for large national merchants, which decreased the Company’s overall profit margins. Negative pricing trends are expected to continue in the future as these merchant contracts renew at lower market pricing levels.

The Company expects consumer preference for card-based payments to continue to grow in 2004, which will lead to higher processing volumes. Additionally, in 2004 the Company will focus on continued expansion into higher margin regional merchant accounts, while also focusing on new product development and managing its cost structure to offset the expected impact of lower margins on national merchant contracts.

Approximately 95% of Merchant Card Services revenue is derived from processing contracts with merchants for 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 that the related transaction is processed and is recorded net of interchange fees charged by the credit card associations and fees charged by debit networks. For the years ended December 31, 2003, 2002, and 2001, interchange and debit network fees were $2.5 billion, $2.4 billion, and $2.2 billion, respectively. The increase in interchange and debit network fees is attributed to increased processing volumes. 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 40% 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 NCBK pursuant to contractual terms. For the years ended December 31, 2003, 2002, and 2001, earnings on customer balances were $2.2 million, $4.3 million, and $8.3 million, respectively.

Bankcard assessments are liabilities to MasterCard ® and Visa® that originate from the Company’s agreements with these agencies. Bankcard assessments expense is the largest component of operating expense and, for the years ended December 31, 2003, 2002, and 2001, was $139.8 million, $134.9 million, and $126.1 million, respectively. The increase in assessments expense is attributed to increased processing volumes. 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 management and administrative expenses as well as fees for certain administrative services provided by National City and its affiliates.

Merchant Card Services revenue was $464.5 million for 2003, up 7% from 2002 revenue of $434.9 million. Merchant Card Services transaction volume processed for 2003 increased 11% to 4.3 billion transactions from 3.9 billion transactions in 2002. Merchant Card Services dollar volume processed for 2003 increased 5% to $177 billion from $169 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. Merchant Card Services revenue for 2003 as compared to 2002 period was higher due primarily to the increased transaction and dollar volumes, additional revenue resulting from the acquisition of Bridgeview Payment Solutions, and the favorable benefit of rate changes implemented by Visa® and MasterCard ® . These favorable factors were partially offset by the negative impacts of price compression in the national merchant base and the Company’s decision to exit merchant processing for the airline industry.

Revenue from Payment Services was $15.6 million for 2003, down 24% from 2002 revenue of $20.4 million. This decrease was due primarily to lower revenue from the Company’s Airlines Reporting Corporation contract.

Operating expenses for 2003 increased 7% to $353.9 million from $330.5 million in 2002 due primarily to increased transaction volume in Merchant Card Services.

General and administrative expenses decreased by 1% to $22.8 million for 2003 from $23.1 million in 2002. The year 2002 included $3.2 million of expenses related to a separation agreement with the Company’s former CEO, which did not occur in 2003. In 2003, however, the Company incurred higher expenses associated primarily with equity based compensation. See Note 12 to the Consolidated Financial Statements.

Depreciation and amortization increased 15% to $21.3 million for 2003 from $18.5 million in 2002 due primarily to a web-based merchant accounting and reporting system and a new data center that started depreciating in the second and third quarters of 2002 and additional amortization expense for the merchant portfolio acquired as part of the June 2003 acquisition of Bridgeview Payment Solutions, Inc.

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 consolidated certain technology functions 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 December 31, 2003, the Company had $0.6 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 December 31, 2003, the Company had $0.3 million remaining in accrued liabilities for future obligations related to this closure.

Operating profit margin as a percentage of revenue decreased to 17% for 2003 from 18% in 2002 due to the items discussed above.

Net interest income earned on the Company’s cash and cash equivalents for 2003 was $3.0 million, down 31% from $4.4 million in 2002 due to lower average interest rates in 2003, offset partially by higher balances.

The overall effective tax rate for 2003 was 38.6%, compared to 37.7% in 2002. The increase in the effective tax rate was due primarily to the realization of $1.0 million of foreign tax credits in 2002 which had not previously been recognized due to uncertainty.

For the year ended December 31, 2003, minority interest was $2.8 million, up 12% from $2.5 million in 2002. This increase is due to higher earnings from AAMS, which is 70% owned by National Processing.

Net income decreased 5% to $48.8 million for 2003 from $51.1 million in 2002 due to the items discussed above.

Revenue for 2002 decreased 4% to $455.4 million from $473.3 million in 2001, primarily as a result of the BPO divestiture, discussed below.

Merchant Card Services revenue was $434.9 million, up 8% from $402.0 million in 2001. Merchant Card Services transaction volume processed increased 11% to 3.9 billion transactions in 2002 from 3.5 billion transactions in 2001. Merchant Card Services dollar volume increased 9% to $169 billion compared to $156 billion in 2001. The increase in transaction volume was primarily due to growth in existing national customers, the addition of new regional merchants and continued expansion into new markets. These favorable factors were partially offset by the negative impacts of price compression in the national merchant base.

Revenue from Payment Services was $20.4 million in 2002, down 32% from 2001 revenue of $30.1 million. This decrease was due to lower revenue from the Company’s Airlines Reporting Corporation contract and lower earnings on customer balances due to lower average interest rates in 2002. The revenue decrease was partially offset by increased pricing in the Company’s commission settlement product.

Operating expenses for the year ended December 31, 2002 decreased 4% to $330.5 million from $343.8 million in 2001 due primarily to the divestiture of the Company’s Business Process Outsourcing business, which was partially offset by increased operating expenses in Merchant Card Services resulting from higher volumes.

General and administrative expenses increased by 1% to $23.1 million for the year ended December 31, 2002 from $22.8 million in 2001 due primarily to changes in estimates for certain non-income related taxes offset by lower expenses as a result of the BPO divestiture.

Depreciation and amortization decreased 9% to $18.5 million for the year ended December 31, 2002 from $20.3 million in 2001. The year ended December 31, 2001 included $2.7 million of goodwill amortization expense that did not recur in 2002 due to the adoption of new accounting standards. This decrease was partially offset by additional depreciation in 2002 due to the addition of a new web-based merchant accounting and reporting system and the addition of a new data center.

In 2001, the Company divested its Business Process Outsourcing (“BPO”) business and discontinued its Denver collections business, which were components of the former Corporate Outsourcing Solutions segment. The Denver collections business was discontinued on March 30, 2001. The sale of the BPO unit to Affiliated Computer Services (“ACS”) was completed on August 29, 2001 for $43.0 million in cash ($41.3 million after transaction-related expenses). For the year ended December 31, 2001, these business units had revenue of $41.2 million. Operating profit (loss) for the divested and discontinued business units, which includes a $3.9 million loss on the sale of the BPO unit in 2001, was $(0.3) million for the year ended December 31, 2001.

During 2001, the Company recorded a net pre-tax charge of $3.9 million ($4.6 million after-tax) related to the BPO divestiture. The after-tax charge exceeded the pre-tax amount due to additional provisions required for nondeductible losses, repatriation of previously untaxed earnings in foreign countries, and dividends from foreign subsidiaries. As of December 31, 2003, the Company had $0.2 million remaining in accrued liabilities related to final obligations associated with the BPO divestiture.

Operating profit margin as a percentage of revenue increased to 18% for the year ended December 31, 2002 from 17% in 2001 due to the items discussed above.

Net interest income earned on the Company’s cash and cash equivalents for the year ended December 31, 2002 was $4.4 million, down 36% from $6.9 million for 2001 due to lower average interest rates in 2002.

The overall effective tax rate was 37.7% in 2002 compared to 40.1% in 2001. The decrease in the effective tax rate was due to a $1.0 million foreign tax credit recorded in 2002, which had not previously been recognized due to uncertainty. The 2001 period also included the additional tax provisions related to the BPO divestiture discussed above.

For the year ended December 31, 2002, minority interest was $2.5 million compared to $0.8 million for 2001. The increase is due to higher earnings from AAMS. National Processing acquired a 70% ownership interest in AAMS on June 28, 2001.

Net income decreased 3% to $51.1 million for 2002 from $52.7 million in 2001 due to the items discussed above.

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 December 31, 2003, the dollar value of tickets purchased, but as yet unflown, under continuing merchant processing contracts, was approximately $786 million, of which approximately $464 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 December 31, 2003, the Company held no significant collateral under these contracts.

concluding contracts was approximately $5 million. This amount represents management’s best estimate of its maximum potential chargeback exposure under these concluded contracts. As of December 31, 2003, the Company held cash collateral of $1 million and third-party indemnifications of $110 million against this remaining chargeback exposure.

In November 2003, Congress passed the Federal Aviation Administration Reauthorization Act. This legislation included an extension of the airline ticket re-accommodation provision, which requires airlines to honor tickets through November 2004 for other airlines that may suspend, interrupt or discontinue services due to insolvency or liquidation.

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 is unlikely.

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 national merchants. These factors may affect the Company’s future revenue and operating profits.

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.

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 December 31, 2003, the Company had net deferred tax assets of $15.9 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 appears probable that a taxing authority may take a sustainable position on a matter contrary to the Company’s position. Based on existing levels of pre-tax earnings, management believes that the Company will generate future taxable income above minimum amounts required to realize its deferred tax 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.

Property and equipment, net of accumulated depreciation and amortization, totaled $50.7 million as of December 31, 2003, which represented 8% of total assets. Useful lives of property and equipment (which includes internal use software) are estimated in order to determine the amount of depreciation and amortization 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 and amortization expense in future periods. These changes could also result in the recognition of an immediate impairment charge to reflect the write-down in value of the assets. See Note 3 to the Consolidated Financial Statements. 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 that the project will be completed and that 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 $158.6 million as of December 31, 2003, which represented 26% of total assets. 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 must make 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. See Note 3 to the Consolidated Financial Statements.

The Company records reserves for chargebacks and other contingent liabilities when such amounts are deemed to be probable and estimable in accordance with 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 13 to the Consolidated Financial Statements.

In June 2001, the Financial Accounting Standards Board issued SFAS 141, Business Combinations, and SFAS 142, Goodwill and Other Intangible Assets. SFAS 141 requires business combinations initiated after June 30, 2001 to be accounted for using the purchase method of accounting and broadens the criteria for recording intangible assets separate from goodwill. Under the provisions of SFAS 142, goodwill and certain other intangible assets, which do not possess finite useful lives, are no longer to be amortized over the estimated life but rather are tested at least annually for impairment based on specific guidance provided in the new standard. Intangible assets determined to have finite lives continue to be amortized over their estimated useful lives and also continue to be subject to impairment testing.

impairment was required to be recorded as a result of these tests. The Company currently does not have any other indefinite-lived intangible assets on its balance sheet. There have not been any material categorical reclassifications or adjustments to the useful lives of finite-lived intangible assets as a result of adopting the new standard.

If the non-amortization provisions of SFAS 142 had been adopted effective January 1, 2000, goodwill amortization expense, which is primarily nondeductible for income tax purposes, would have been reduced by $2.7 million for year ended December 31, 2001. For the year ended December 31, 2001, proforma net income would have been $55.0 million, or $1.06 per diluted share, versus reported net income of $52.7 million, or $1.01 per diluted share.

The Company’s amortizable intangible assets as of December 31, 2003 related almost exclusively to acquired merchant portfolios. These costs are amortized on a straight-line basis over periods ranging from 5 to 10 years. Amortization expense for years ended December 31, 2003, 2002 and 2001 were $8.7 million, $6.9 million and $5.6 million, respectively. The estimated annual amortization expense for existing intangible assets for each of the next five years is as follows: 2004 — $9.7 million; 2005, 2006, and 2007 — $7.8 million, and 2008 — $3.3 million.

In general, application of the new provisions may result in more income statement volatility due to the potential periodic recognition of impairment losses, which are likely to vary in amount and regularity, for goodwill and other indefinite-lived intangible assets, versus reducing those assets through the recognition of recurring, consistent amortization amounts.

SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets,was issued in October 2001 and addresses how and when to measure impairment on long-lived assets and how to account for long-lived assets that an entity plans to dispose of either through sale, abandonment, exchange, or distribution to owners. The new provisions supersede SFAS 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of, which addressed asset impairment, and certain provisions of Accounting Principals Board (“APB”) Opinion 30, Reporting the Results of Operations — Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, related to reporting the effects of the disposal of a business segment and requires expected future operating losses from discontinued operations to be recorded in the period in which the losses are incurred rather than the measurement date. Under SFAS 144, more dispositions may qualify for discontinued operations treatment in the income statement. The provisions of SFAS 144 became effective for the Company on January 1, 2002 and have not had a material impact on the Company’s financial position, results of operations, or liquidity.

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 nullifies 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 Restructuring). SFAS 146 requires that 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 is recognized at the date of the entity’s commitment to an exit plan. The provisions of SFAS 146 became effective for the Company on January 1, 2003 and have not had a material impact on the Company’s financial position, results of operations, or liquidity.

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, Accounting for Stock Issued to Employees,

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 was applied prospectively to awards granted subsequent to December 31, 2002. As permitted, options granted prior to January 1, 2003, continue to be accounted for under APB Opinion 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. The actual impact per diluted share may vary in the event the fair value or the number of options granted increase or decrease, 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.

In May 2003, the FASB issued SFAS 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. This statement establishes standards for classifying and measuring certain financial instruments that embody obligations of the issuer and have characteristics of both liabilities and equity. The provisions of SFAS 150 became effective for the Company on June 1, 2003 for any new qualifying financial instruments that were subsequently entered into or modified. The provisions of SFAS 150 for all other qualifying instruments within its scope became effective as of July 1, 2003. The adoption of this standard did not have a material impact on financial position, results of operations, or liquidity. In December 2003, the FASB deferred for an indefinite period the application of the guidance in SFAS 150 to noncontrolling interests that are classified as equity in the financial statements of a subsidiary but would be classified as a liability in the parent’s financial statements under SFAS 150. Management continues to evaluate the applicability of SFAS 150 to such entities and believes it would not have a material impact, if any, to financial position, results of operations, or liquidity.

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 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 13 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, results of operations, or liquidity.

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.

In December 2003, the FASB reissued FIN 46 with certain modifications and clarifications. Application of this guidance was effective for interests in certain VIE’s commonly referred to as special-purpose entities (“SPEs”) as of December 31, 2003. Application for all other types of entities is required for periods ending after March 15, 2004, unless previously applied. The provisions of FIN 46 are not anticipated to have a material impact on the Company’s financial position, results of operations, or liquidity.

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 2003, the Company’s capital expenditures totaled $9.3 million. Such expenditures were financed from operating cash flow, which for 2003 totaled $92.2 million. Capital expenditures and operating cash flow for 2002 were $16.3 million and $100.8 million, respectively. Operating cash flow decreased in 2003 due primarily to the timing of certain working capital items. The Company expects capital expenditures for 2004 to be comparable to 2003, which will be principally used to enhance merchant card processing capabilities.

On January 8, 2001, the Company acquired the merchant services business units from several National City banking subsidiaries for $44.0 million in cash. See Note 4 to the Consolidated Financial Statements.

On June 28, 2001, the Company acquired a 70% ownership interest in AAMS for $48.5 million in cash. See Note 4 to the Consolidated Financial Statements.

On August 29, 2001, the Company completed the sale of the BPO unit to Affiliated Computer Services, Inc. for $43.0 million cash ($41.3 million after transaction-related expenses). See Note 5 to the Consolidated Financial Statements.

On July 3, 2002, the Company acquired processing contracts from a key strategic partner for $2.7 million cash. Pursuant to the terms of the agreement, an additional $1.0 million was paid on August 5, 2003 related to these contracts. 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. See Note 4 to the Consolidated Financial Statements.

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.

On June 9, 2003, the Company acquired Bridgeview Payment Solutions, Inc. from Bridgeview Bank and Trust Company for $32.4 million in cash.

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 are expected to be financed through operating cash flow and current cash balances.

See also the sections entitled Chargeback and Market Uncertainties and Contractual Obligations, Commitments and Contingent Liabilities for other items that may impact the Company’s liquidity and capital resources.

The following table presents, as of December 31, 2003, the Company’s significant fixed and determinable contractual obligations by payment date. The payment amounts represent those amounts contractually due to the recipient. Further discussion of the nature of each obligation is included in the referenced note to the consolidated financial statements.

The Company’s operating lease obligations represent short and long-term lease and rental payments for offices, facilities and equipment. Capital lease obligations primarily represent a long-term lease for the Company’s main operating facility. Processing minimums represent minimum obligations under agreements to purchase outsourced authorization and settlement services.

The Company may also have liabilities under certain contractual agreements contingent upon the occurrence of certain events. A discussion of significant contractual arrangements under which the Company may be held contingently liable, including guarantee arrangements, is included in Note 13 to the Consolidated Financial Statements.

The annual report on Form 10-K 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. 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.

The Company’s primary market risk exposure with regard to financial instruments is to changes in interest rates. As of December 31, 2003, the Company had $247 million in cash and cash equivalents. For the year ended December 31, 2003, NCBK also held an average of approximately $245 million of customer cash balances. The Company retains 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.

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 affected by changes in interest rates, with respect to interest on the Company’s cash and cash equivalents as well as on customer funds maintained by NCBK. At December 31, 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 based on cash balances for 2003. 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 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

As of December 31, 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 December 31, 2003 were effective in ensuring information required to be disclosed in this Annual Report on Form 10-K 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 year ended December 31, 2003 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

An executive officer will serve until his successor is chosen and qualified. There is no family relationship between any of the executive officers.

Mr. Gorney was appointed Chairman and Chief Executive Officer in September 2002. Mr. Gorney has served as an Executive Vice President of National City Corporation from 1993 to the present, with responsibility for National City’s overall technology and operations functions.

Mr. Pyke was appointed Chief Operating Officer in October 2001. Mr. Pyke previously served as Executive Vice President – Merchant Card Services from October 1999 to October 2001 and was a Senior Vice President of the Merchant Card Services division from 1998 to 1999.

Mr. Martin was appointed as Executive Vice President — Merchant Card Services in January 2000. Mr. Martin previously served as President of Client Merchant Services for First Data Corporation in 1998.

Mr. Robins was appointed Executive Vice President — Business Development in November 2000. Mr. Robins was employed by Visa U.S.A. from 1996 to 2000 serving as Executive Vice President of Market Development and Acceptance.

Mr. Cory was appointed Executive Vice President — Information Technology and Operations in April 2003. Mr. Cory was employed by National City Corporation serving as Executive Vice President — Consumer Loan Services from 2001 to 2003 and Senior Vice President — Card Services from 1999 to 2001.

Mr. Fountain was appointed Chief Financial Officer in October 1999. Mr. Fountain was appointed interim Chief Financial Officer in July 1999 and served as Senior Vice President — Chief Accounting Officer from 1998 to 1999.

Mr. Lanham was appointed Chief Accounting Officer in May 2000. Mr. Lanham joined the Company in November 1999 as Vice President — Corporate Controller. From 1996 to 1999, Mr. Lanham was employed by Arthur Andersen, serving as a manager in the firm’s Audit and Business Advisory division.

The other information required by Item 10 is incorporated by reference from the Company’s Definitive Proxy Statement to be dated approximately March 19, 2004.

Incorporated by reference from the Company’s Definitive Proxy Statement to be dated approximately March 19, 2004.

Omitted due to inapplicability or because required information is shown in the Company’s Consolidated Financial Statements or notes thereto.

The exhibits filed as part of the 2003 Form 10-K are accessible at no cost on the Company’s web site at www.npc.net or through the United States Securities and Exchange Commission’s web site at www.sec.gov. Copies of the exhibits may be requested at a cost of $.30 per page from National Processing’s investor relations department.


(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.

October 16, 2003: On October 16, 2003, the Company issued a news release reporting earnings and including a financial summary for the quarter and nine months ended September 30, 2003.

January 15, 2004: On January 15, 2004, the Company issued a news release reporting earnings and including a financial summary for the fourth quarter and year ended December 31, 2003.

Pursuant to the requirements of Section 13 or 15(d) 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, on March 11, 2004.

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons in the capacities and on the dates indicated.


*	The undersigned by signing his name hereto, does sign and execute the Annual Report on Form 10-K for fiscal year 2003 pursuant to the Power of Attorney executed by the above named Directors of the Company and which have been filed with the Securities Exchange Commission on behalf of such directors.

We have audited the accompanying consolidated balance sheets of National Processing, Inc. and subsidiaries (a majority owned subsidiary of National City Corporation) as of December 31, 2003 and 2002, and the related consolidated statements of income, changes in shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2003. These financial statements are the responsibility of National Processing, Inc.’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of National Processing, Inc. and subsidiaries at December 31, 2003 and 2002, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States.

As discussed in Note 3 to the financial statements, in 2002 the Company changed its method of accounting for goodwill.

National Processing, Inc. and subsidiaries (the “Company”) are providers of electronic payment processing services. The Company is 84% owned by National City Corporation (“National City”), a financial holding company headquartered in Cleveland, Ohio. The Company’s primary operating subsidiary, National Processing Company, LLC is located in Louisville, Kentucky.

The Company and National City are parties to a registration rights agreement whereby National City has the right to require the Company to use its best efforts to register under the Securities Act of 1933, as amended, all or a portion of the issued and outstanding common stock held by National City. National City also has the right to participate, or “piggy-back”, in equity offerings initiated by the Company, subject to a reduction of the size of the offering on the advice of the managing underwriter.

The Company 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 represented 97% of the Company’s revenue in 2003.

Payment Services was formerly an operating unit within the Company’s Corporate Outsourcing Solutions segment. This segment was renamed Payment Services in 2001 after the sale of the Business Process Outsourcing (“BPO”) unit, which was also formerly a component of the Company’s Corporate Outsourcing Solutions segment. 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 represented 3% of the Company’s revenue in 2003. 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.

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.

will receive all fees, discounts and other amounts payable by merchants for Merchant Card Services and will bear the expenses of maintaining facilities necessary to provide such services. Certain indemnification provisions are also contained in the Sponsorship Agreement, under which the Company will indemnify NCBK against losses, claims or other amounts in accordance with the terms of the Sponsorship Agreement.

The Consolidated Financial Statements include the accounts of National Processing, Inc. and its subsidiaries. On June 28, 2001, the Company acquired a 70% ownership interest in ABN AMRO Merchant Services, LLC (“AAMS”) from ABN AMRO North America, Inc. and it subsidiaries (“AANA”). See Note 4. Since the date of its acquisition, the results of operations of AAMS have been included in the Consolidated Financial Statements of the Company and AANA’s 30% 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.

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.

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. For the years ended December 31, 2003, 2002, and 2001, interchange and debit network fees were $2.5 billion, $2.4 billion, and $2.2 billion, respectively.

Cash equivalents consist of highly liquid bank overnight repurchase agreements, which are readily convertible to cash. The carrying amount of these balances approximates fair value.

Property and equipment is stated at cost and depreciated on a straight-line basis over the estimated useful life or term of the related lease, whichever is shorter. Maintenance and repairs are expensed as incurred, while improvements that extend the useful life of the related asset are capitalized and depreciated over the remaining life of the related asset.

The Company capitalizes certain costs incurred to develop or obtain internal-use software. For purposes of amortization and impairment, capitalized costs are treated in the same manner as other long-lived assets. To be considered as internal-use software, the software is either acquired, internally developed, or modified solely to meet the Company’s internal needs with no plans to market the software externally. Project costs that are considered research and development costs are expensed as incurred. Capitalized software development

and purchased software costs 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.

Upon the sale or disposal of property or equipment, the cost and accumulated depreciation accounts are adjusted accordingly and any gain or loss is recognized.

Other intangible assets are composed primarily of acquired merchant portfolios which represent costs allocated to customer contracts acquired through acquisitions. These costs are amortized on a straight-line basis over periods ranging from 5 to 10 years.

Operating results of companies acquired in purchase transactions are included in the consolidated statements of operations from their respective acquisition dates. The excess of the purchase price over the net assets acquired (goodwill) is tested at least annually for impairment based on specific guidance provided in SFAS 142, Goodwill and Other Intangible Assets. The Company performed annual impairment tests in 2002 and 2003. No impairment was required to be recorded as a result of these tests.

Effective January 1, 2002, the Company adopted SFAS 142. See Note 3 for further discussion of the impact of this new accounting pronouncement on the Company’s Consolidated Financial Statements.

Effective January 1, 2002, the Company adopted SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which changed the way asset impairment is measured. Long-lived assets to be held and those to be disposed of and certain intangibles are evaluated for impairment using the guidance provided by SFAS 144. See Note 3 for further discussion of the impact of this new accounting pronouncement on the Company’s Consolidated Financial Statements.

Liabilities to MasterCard ® and Visa® originating from the Company’s agreements with these agencies, as an authorized processor, are accrued and settled on a monthly and quarterly basis, respectively.

The Company records assessments charged by credit card associations as expense as the Company is the primary obligor of these costs. For the years ended December 31, 2003, 2002, and 2001, assessments expense was $139.8 million, $134.9 million, and $126.1 million, respectively.

The Company is included in the consolidated federal income tax return of National City. National City allocates income taxes to its subsidiaries on a separate return basis. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying

amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized as income or expense in the period that includes the enactment date.

The Company has various stock-based compensation plans that allow for the granting of stock to eligible employees and directors. See Note 12. Prior to January 1, 2003, the Company accounted for those plans under the recognition and measurement principles of Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. Under APB 25, compensation expense for employee stock options is not recognized if the exercise price of the option equaled or exceeded the market price 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. 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.

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 stock-based employee awards 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.

The following weighted-average assumptions were used in the option-pricing model:

Certain prior year amounts have been reclassified to conform with the 2003 presentation. Reclassifications had no effect on previously reported net income or equity.

In June 2001, the Financial Accounting Standards Board (“FASB”) issued SFAS 141, Business Combinations, and SFAS 142, Goodwill and Other Intangible Assets. SFAS 141 requires business combinations initiated after June 30, 2001 to be accounted for using the purchase method of accounting and broadens the criteria for recording intangible assets separate from goodwill. Under the provisions of SFAS 142, goodwill and certain other intangible assets, which do not possess finite useful lives, are no longer to be amortized into net income over an estimated life but rather are tested at least annually for impairment based on specific guidance provided in the new standard. Intangible assets determined to have finite lives continue to be amortized over their estimated useful lives and also continue to be subject to impairment testing.

The provisions of SFAS 142 were adopted by the Company as required effective January 1, 2002. As part of adopting the provisions of SFAS 142, a transitional impairment test was applied to all goodwill during the quarter ended March 31, 2002. The Company also performed annual impairment tests in 2002 and 2003. No impairment was required to be recorded as a result of these tests. The Company currently does not have any other indefinite-lived intangible assets on its balance sheet. There have not been any material categorical reclassifications or adjustments to the useful lives of finite-lived intangible assets as a result of adopting the new standard.

If the non-amortization provisions of SFAS 142 had been adopted effective January 1, 2001, goodwill amortization expense, which is primarily nondeductible for income tax purposes, would have been reduced by $2.7 million for year ended December 31, 2001. For the year ended December 31, 2001, proforma net income would have been $55.0 million, or $1.06 per diluted share, versus reported net income of $52.7 million, or $1.01 per diluted share.

The Company’s amortizable intangible assets as of December 31, 2003 related almost exclusively to acquired merchant portfolios. These costs are amortized on a straight-line basis over periods ranging from 5 to 10 years. Amortization expense for the years ended December 31, 2003, 2002, and 2001 was $8.7 million, $6.9 million, and $5.6 million, respectively. The estimated annual amortization expense for existing intangible assets for each of the next five years is as follows: 2004 — $9.7 million; 2005, 2006, and 2007 — 7.8, and 2008 — $3.3 million.

In general, application of the new provisions may result in more income statement volatility due to potential periodic recognition of impairment losses, which are likely to vary in amount and regularity, for goodwill and other indefinite-lived intangible assets, versus reducing those assets through the recognition of recurring, consistent amortization amounts.

SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets, was issued in October 2001 and addresses how and when to measure impairment on long-lived assets and how to account for long-lived assets that an entity plans to dispose of either through sale, abandonment, exchange, or distribution to owners. The statement’s provisions supersede SFAS 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of, which addressed asset impairment, and certain provisions of APB 30, Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, related to reporting the effects of the disposal of a business segment and requires expected future operating losses from discontinued operations to be recorded in the period in which the losses are incurred rather than the measurement date. Under SFAS 144, more dispositions may qualify for discontinued operations treatment in the income statement. The provisions of SFAS 144 became effective for the Company January 1, 2002 and have not had a material impact on the Company’s financial position, results of operations, or liquidity.

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 nullifies 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 that 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 is recognized at the date of the entity’s commitment to an exit plan. The provisions of SFAS 146 become effective for the Company January 1, 2003 and have not had a material impact on the Company’s financial position, results of operations, or liquidity.

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, Accounting for Stock Issued to Employees, to SFAS 123’s fair value method of accounting, if a company so elects.

In May 2003, the FASB issued SFAS 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. This statement establishes standards for classifying and measuring certain financial instruments that embody obligations of the issuer and have characteristics of both liabilities and equity. The provisions of SFAS 150 became effective for the Company on June 1, 2003 for any new qualifying financial instruments that were subsequently entered into or modified. The provisions of SFAS 150 for all other qualifying instruments within its scope became effective as of July 1, 2003. The adoption of this standard did not have a material impact on financial position, results of operations, or liquidity. In December 2003, the FASB deferred for an indefinite period the application of the guidance in SFAS 150 to noncontrolling interests that are classified as equity in the financial statements of a subsidiary but would be classified as a liability in the parent’s financial statements under SFAS 150. Management continues to evaluate the applicability of SFAS 150 to such entities and believes it would not have a material impact, if any, to financial position, results of operations, or liquidity.

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 13. 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, results of operations, or liquidity.

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.

In December 2003, the FASB reissued FIN 46 with certain modifications and clarifications. Application of this guidance was effective for interests in certain VIE’s commonly referred to as special-purpose entities (“SPEs”) as of December 31, 2003. Application for all other types of entities is required for periods ending after March 31, 2004, unless previously applied. The provisions of FIN 46 are not anticipated to have a material impact on the Company’s financial position, results of operations, or liquidity.

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 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 $12.2 million for year ended December 31, 2003.

On July 3, 2002, the Company acquired processing contracts from a key strategic partner for $2.7 million in cash, which was recorded, as an intangible asset. Pursuant to the terms of the agreement, an additional $1.0 million was paid on August 5, 2003 related to these contracts, which also was recorded as an intangible asset. These intangible assets are being amortized on a straight-line basis over 10 years. 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. Under the terms of the agreement, the Company obtained the right to provide front-end authorization services for approximately 50,000 merchant locations. Prior to the acquisition, the Company was already providing settlement services for these merchants.

On June 28, 2001, the Company acquired a 70% ownership interest in AAMS from AANA for $48.5 million in cash. Under the terms of the agreement, the Company provides AAMS with all merchant processing services including both authorization and settlement of all card-based transactions. The acquisition, accounted for as a purchase, increased the Company’s goodwill by approximately $27 million. The remainder of the purchase price was allocated to other indentifiable intangibles, primarily acquired merchant contracts, which are being amortized on a straight-line basis over 10 years. Since the date of its acquisition, the results of operations of AAMS have been included in the Consolidated Financial Statements and AANA’s 30% ownership interest has been accounted for as a minority interest. AAMS is an LLC that is treated as a partnership for federal income tax purposes.

On January 8, 2001, the Company purchased the merchant services business units from several of National City’s banking subsidiaries for $44.0 million in cash. This acquisition included merchant contracts and additional sales personnel. The Company also assumed responsibility for all merchant processing sales efforts throughout National City’s 1,200 branch network via an exclusive multi-year marketing agreement. The Company had previously provided the authorization and settlement processing for these merchants via a third party processing contract with National City’s subsidiary banks. The acquisition was accounted for as a transaction among entities under common control and was recorded at National City’s historical cost bases. The excess of the cash paid over the historical cost bases was recorded as a reduction in shareholder’s equity, net of income taxes of $15.4 million. The results of operations of the National City merchant services business units have been included in the consolidated financial statements since the date of acquisition.

In 2001, the Company divested its BPO (“Business Process Outsourcing”) business and discontinued its Denver collections business, which were components of the former Corporate Outsourcing Solutions segment. The Denver collections business was discontinued on March 30, 2001. The sale of the BPO unit to Affiliated Computer Services (“ACS”) was completed on August 29, 2001 for $43.0 million in cash ($41.3 million after transaction-related expenses). For the year ended December 31, 2001, the divested and discontinued business units had revenue of $41.2 million. Operating profit (loss) for the divested and discontinued business units, which included $3.9 million of charges related to the divestiture, was $(0.3) million for the year ended December 31, 2001.

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 consolidated certain technology functions, which resulted in severance for 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 charges incurred in connection with these initiatives is presented in the table below. The remaining obligations as of December 31, 2003 represent future payments for severance and lease commitments extending through August 15, 2005.

In 2002, the Company recorded $3.2 million ($1.9 million after-tax) of expenses related to a separation agreement with the former CEO. This amount was included in general and administrative expense in the accompanying financial statements. As of December 31, 2003, the Company had $1.0 million remaining in accrued liabilities for future obligations related to this agreement.

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 exceeds the pre-tax amount due to additional tax provisions required for nondeductible losses and dividends from foreign subsidiaries. As of December 31, 2003, the Company had $0.3 million remaining in accrued liabilities for future obligations related to this closure.

During 2001, the Company recorded net pre-tax charges of $3.9 million ($4.6 million after-tax) related to the BPO divestiture. The after-tax charges exceed the pre-tax amounts due to additional provisions required for nondeductible losses, repatriation of previously untaxed earnings in foreign countries, and dividends from foreign subsidiaries. These charges consisted of a loss of $3.3 million ($4.3 million after-tax) on the sale of the business and a $0.6 million charge ($0.4 million after-tax) for severance costs related to organizational restructuring actions taken to reduce support costs associated with the BPO unit. As of December 31, 2003 the Company had $0.2 million remaining in accrued liabilities related to the final obligations associated with the BPO divestiture.

The Company leases certain facilities from NCBK, a wholly owned subsidiary of National City, under long-term agreements classified as “Obligations Under Capital Leases” in the accompanying balance sheets. Future minimum payments under this lease, which expires in 2019, are $2.6 million, including interest of $1.0 million. Future minimum payments under these leases, including interest, for the next five years are $0.2 million per year.

Substantially all of the Company’s cash and cash equivalents are held by NCBK and other National City subsidiaries. The majority of 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 subsidiaries.

The Company and National City are parties to agreements pursuant to which the Company outsources a portion of certain functions to National City including information technology services, tax services, human resource services, internal audit and legal services, from National City and its affiliates. The Company also utilizes NCBK and other National City subsidiaries for the majority of its banking services. Charges for these services totaled $4.7 million, $2.0 million, and $1.6 million in 2003, 2002, and 2001, respectively.

On January 8, 2001, the Company acquired the merchant services business units from several National City banking subsidiaries for $44.0 million, which was paid in cash at closing. See Note 4.

The Company leases various offices, facilities, and equipment under noncancellable lease agreements with expiration dates through 2019. During the normal course of business, most of these leases will be renewed or replaced by other leases. Future minimum rental payments under these leases are $1.3 million in 2004, $1.0 million in 2005, $0.9 million in 2006, $0.9 million in 2007, $0.6 million in 2008 and $3.8 million thereafter. Rent expense under operating leases was $2.5 million, $2.5 million, and $2.9 million in 2003, 2002, and 2001, respectively.

The temporary differences that gave rise to deferred tax assets and liabilities at December 31 are as follows (in thousands):

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 appears probable that a taxing authority may take a sustainable position on a matter contrary to the Company’s position. Based on existing levels of pre-tax earnings, management believes that the Company will generate future taxable income above minimum amounts required to realize its deferred tax assets.

The reconciliation of the Company’s income tax provisions and the amounts computed by applying the U.S. statutory income tax rate to income before taxes is as follows (in thousands):

For 2003, 2002 and 2001, income tax benefits of $3.0 million, $1.4 million and $4.6 million respectively, were received related to the exercise of nonqualified employee stock options. This benefit is recorded directly to shareholders’ equity.

As of December 31, 2003, the Company had no state net operating loss carryforwards for income tax purposes available to offset future taxable income in the related states. All net operating losses were utilized by December 31, 2003.

The Company offers a 401(k) savings plan to all employees who meet certain age and eligibility requirements. The plan is funded by employee contributions and discretionary matching contributions by the Company. The Company recognized $2.2 million, $2.2 million, and $2.1 million in matching contribution expense during 2003, 2002, and 2001, respectively.

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

Diluted net income per common share takes into consideration the proforma dilution assuming certain unvested restricted stock and unexercised stock option awards were converted or exercised into common shares. For the years ended December 31, 2003, 2002, and 2001, options to purchase 2,466,386, 2,467,768, and 1,428,352 shares of common stock, respectively, were outstanding but not included in the computation of diluted net income per share because their inclusion would have had an anti-dilutive effect.

The Company maintains various stock option and restricted stock plans. These plans provide for the granting of stock options and restricted shares to eligible employees and directors. All of the Company’s stock option and restricted stock plans were approved by the stockholders.

The stock option plans under which options may currently be granted authorize the issuance to officers, directors and key employees of up to 9,200,000 options to purchase shares of common stock at the fair value of the common stock on the date of grant. These options generally become exercisable 33% annually beginning one year from the date of grant and expire not later than ten years from the date of grant.

Compensation expense was recognized in 2003, 2002, and 2001, related to the fair value of options for former employees in situations where vesting continued upon a change in employee status. The Company recognized $0.8 million, $1.0 million, and $0.8 million of compensation expense for these employees in 2003, 2002, and 2001, respectively.

The Company’s restricted stock plan provides for the issuance of up to 500,000 shares of common stock to officers and key employees. In general, the restrictions on shares granted expire within a four-year period. The Company recognizes compensation expense over the restricted period. The grant date fair value of the restricted share awards granted in 2003, 2002, and 2001 was $20.27, $27.92, and $24.18, respectively. The Company recognized $0.3 million, $0.1 million, and $0.2 million of compensation expense in 2003, 2002, and 2001, respectively, related to these restricted stock awards. As of December 31, 2003, 166,100 shares of restricted stock were outstanding.

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

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 last four months of 2003, this amount totaled approximately $56 billion. At December 31, 2003, the Company had $6 million of unresolved chargebacks that were in process of resolution.

During 2003, 2002, and 2001, the Company processed $151 million, $163 million, and $168 million, respectively, in chargebacks presented by issuing banks. Actual losses recorded for 2003, 2002, and 2001 were $3 million, $3 million, and $4 million, respectively. The Company accrues for probable losses based on historical experience and at December 31, 2003 and 2002, had $1.3 million and $1.5 million, respectively, 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. In 2003, the Company processed approximately $13 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 December 31, 2003, the estimated dollar value of tickets purchased, but as yet unflown, under continuing merchant processing contracts, was approximately $786 million, of which approximately $464 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 December 31, 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 December 31, 2003, the estimated dollar value of tickets purchased, but as yet unflown, under these concluding contracts was approximately $5 million. This amount represents management’s best estimate of its maximum potential chargeback exposure under these concluded contracts. As of December 31, 2003, the Company held cash collateral of $1 million and third-party indemnifications of $110 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 is unlikely.

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.

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.

Selected quarterly data for 2003 and 2002 are as follows (in thousands, except per share amounts):

The above financial data for 2003 includes a second quarter charge of $1.3 million ($0.8 million after-tax) related to the consolidation of technology functions and a loss on the sale of 14 regional sales offices.

The above financial data for 2002 includes certain charges. The second quarter of 2002 includes a charge of $1.7 million ($2.4 million after-tax) for severance costs, building and equipment write-downs and other items related to the closure of operations in Juarez, Mexico. The third quarter of 2002 includes a charge of $3.4 million ($2.0 million after-tax) related to a separation agreement with the former CEO.


[X]		ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2003
OR
[ ]		TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934


Ohio (State or other jurisdiction of incorporation or organization)		61-1303983 (I.R.S. Employer Identification No.)

1900 East Ninth Street Cleveland, Ohio (Address of principal executive offices)		44114-3484 (Zip Code)


		Page

PART I

Item 1.	Business		3

Item 2.	Properties		7

Item 3.	Legal Proceedings		8

Item 4.	Submission of Matters to a Vote of Security Holders		8
PART II

Item 5.	Market for Registrant’s Common Equity and Related Shareholder Matters		8

Item 6.	Selected Financial Data		9

Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		10

Item 7A.	Quantitative and Qualitative Disclosures About Market Risk		21

Item 8.	Financial Statements and Supplementary Data		21

Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure		21

Item 9A.	Controls and Procedures		21
PART III

Item 10.	Directors and Executive Officers of the Registrant		21

Item 11.	Executive Compensation		22

Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters		22

Item 13.	Certain Relationships and Related Transactions		22

Item 14.	Principal Accountant Fees and Services		22
PART IV

Item 15.	Exhibits, Financial Statement Schedules and Reports on Form 8-K		23
	Signatures		26
Exhibit 10.13
Exhibit 10.16
Exhibit 21.1
Exhibit 23.1
Exhibit 24.1
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2
Exhibit 99.1


	High		Low		Close

Year Ended December 31, 2003
First Quarter	$	16.25	$	12.85	$	13.92
Second Quarter		17.37		13.60		16.08
Third Quarter		21.80		15.29		19.32
Fourth Quarter		24.53		19.40		23.55
Year Ended December 31, 2002
First Quarter	$	32.68	$	22.78	$	28.58
Second Quarter		30.28		24.80		25.80
Third Quarter		27.50		16.95		16.99
Fourth Quarter		16.60		11.50		16.05


			Weighted-		Shares
	Shares to Be Issued		Average Option		Available for
Plan Category	Upon Exercise		Exercise Price		Future Grants

Plans approved by shareholders		3,105,208	$	24.08		4,083,224
Plan not approved by shareholders		—		—		—

Total		3,105,208	$	24.08		4,083,224



	Year Ended December 31,

	2003		2002		2001		2000		1999


	(in millions, except per share data)
Income Statement Data: (1)
Revenue	$	480.1	$	455.4	$	473.3	$	427.3	$	431.0
Net Income (Loss) (2)(3)		48.8		51.1		52.7		43.4		(37.4	)
Basic Net Income (Loss) Per Share		0.93		0.98		1.03		0.85		(0.74	)
Diluted Net Income (Loss) Per Share		0.93		0.97		1.01		0.85		(0.74	)
Average Shares Outstanding — Basic		52.5		52.0		51.4		50.8		50.7
Average Shares Outstanding — Diluted		52.6		52.5		52.0		51.0		50.7

Balance Sheet Data: (1)
Working Capital	$	298.0	$	257.1	$	199.7	$	184.2	$	124.4
Goodwill		115.3		91.2		91.2		79.4		88.4
Total Assets		622.0		550.5		478.3		435.4		402.3
Long-Term Obligations		1.9		1.7		1.9		3.2		6.0
Total Liabilities		100.2		94.1		78.3		73.9		85.9
Shareholders’ Equity		521.8		456.4		400.0		361.6		316.4


(1)		This financial data includes the impact of the following acquisitions during the periods presented: on December 31, 1999, the Company acquired a regional merchant processing portfolio from Heartland Payment Systems LLC; on June 28, 2001, the Company acquired a 70% ownership interest in ABN AMRO Merchant Services, LLC; on June 9, 2003, the Company acquired Bridgeview Payment Solutions, Inc. from Bridgeview Bank and Trust Company. 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. On January 8, 2001, the Company purchased the merchant services business units from several of National City’s banking subsidiaries. This acquisition was accounted for as a transaction among entities under common control and was recorded at the historical cost bases of National City. The results of operations of the National City Merchant Services business units have been included in the consolidated financial statements since the date of acquisition.

		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. Effective August 29, 2000, the Company sold its Springfield remittance operation. Effective March 30, 2001, the Company discontinued its Denver collections business. Effective August 29, 2001, the Company sold its Business Process Outsourcing business.

(2)		Included in net income (loss) are certain items summarized as follows: for 2003, $1.3 million ($0.8 million after-tax) of restructuring charges related to the consolidation of technology functions and a


(3)		The Company adopted the non-amortization provisions of Statement of Financial Accounting Standards (SFAS) 142, Goodwill and Other Intangible Assets, on January 1, 2002. If SFAS 142 had been adopted effective January 1, 1999, proforma net income (loss) would have been $55.0 million, $45.5 million, and $(34.7) million for the years ended December 31, 2001, 2000, and 1999, respectively.


					% Change
					from Prior
	2003		2002		Year


	(Dollars in thousands)
Revenue	$	480,098	$	455,376		5
Operating expenses		353,915		330,518		7
General and administrative expenses		22,845		23,142		(1	)
Depreciation and amortization		21,256		18,542		15
Impairment, restructuring and related expenses		1,273		1,650		(23	)

Operating profit		80,809		81,524		(1	)
Net interest income		3,024		4,410		(31	)

Income before provision for income taxes and minority interest		83,833		85,934		(2	)
Provision for income taxes		32,321		32,396		—

Net income before minority interest		51,512		53,538		(4	)
Minority interest		2,751		2,461		12

Net income	$	48,761	$	51,077		(5	)


	Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity



			Payments Due In

	Note		One Year		One to		Three to		Over
	Reference		or Less		Three Years		Five Years		Five Years		Total
(In Millions)
Operating Leases		8	$	1.3	$	1.9	$	1.5	$	3.8	$	8.5
Capital Lease		7		0.3		0.5		0.3		1.4		2.5
Processing Minimums		—		11.4		23.2		6.8		—		41.4
Other		—		0.3		—		—		—		0.3


Name	Age		Position

Jon L. Gorney		53	Chairman and Chief Executive Officer
Mark D. Pyke		43	Executive Vice President — Chief Operating Officer
Norman M. Martin		60	Executive Vice President — Merchant Card Services
Robert C. Robins		62	Executive Vice President — Business Development
Steven C. Cory		54	Executive Vice President — Information Technology and Operations
David E. Fountain		43	Senior Vice President — Chief Financial Officer
Kelly L. Lanham		34	Senior Vice President — Chief Accounting Officer


Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters


Item 13.	Certain Relationships and Related Transactions


Item 15.	Exhibits, Financial Statement Schedules and Reports on Form 8-K


	Organization


	Business


	Merchant Card Services


	Payment Services


	Page Number
Description	in Report

Report of Ernst & Young LLP, Independent Auditors		F-1
Consolidated Balance Sheets as of December 31, 2003 and 2002		F-2
Consolidated Statements of Income for each of the three years in the period ended December 31, 2003		F-3
Consolidated Statements of Changes in Shareholders’ Equity for each of the three years in the period ended December 31, 2003		F-4
Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 2003		F-5
Notes to Consolidated Financial Statements		F-6


Exhibit
Number			Description

	3.1	(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. (Incorporated herein by reference to Exhibit 3.1 (ii) to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2003)
	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)
	4.3		Amended Articles of Incorporation of the Company related to the capital stock of the Company and shareholders’ rights. (A)
	4.4		Code of Regulations, Amended and Restated, as adopted and in effect on May 16, 2003, of the Company as related to the capital stock of the Company and shareholders’ rights. (Incorporated herein by reference to Exhibit 3.1 (ii) to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2003)
	10.1		Absolute Net Ground Lease by and between Preston Manor, Inc. and Allied Stores Corporation, dated January 16, 1969. (A)
	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)


Signature	Title	Date

/s/ JON L. GORNEY Jon L. Gorney	Chief Executive Officer and Director (Principal Executive Officer)		March 11, 2004

/s/ DAVID E. FOUNTAIN David E. Fountain	Senior Vice President and Chief Financial Officer (Principal Financial Officer)		March 11, 2004

/s/ KELLY L. LANHAM Kelly L. Lanham	Senior Vice President and Chief Accounting Officer (Principal Accounting Officer)		March 11, 2004

/s/ PAUL G. CLARK Paul G. Clark	Director		March 11, 2004	*

/s/ JEFFREY D. KELLY Jeffrey D. Kelly	Director		March 11, 2004	*

Aureliano Gonzalez-Baz	Director		March 11, 2004

/s/ JEFFREY P. GOTSCHALL Jeffrey P. Gotschall	Director		March 11, 2004	*

Preston B. Heller, Jr.	Director		March 11, 2004	*

/s/ J. ARMANDO RAMIREZ J. Armando Ramirez	Director		March 11, 2004	*



		December 31,

		2003			2002


		(Dollars in thousands)
Assets
Current assets:
	Cash and cash equivalents	$	246,957		$	185,513
	Accounts receivable-trade		136,346			152,132
	Deferred tax assets		2,775			2,113
	Other current assets		7,402			7,287

Total current assets			393,480			347,045
Property and equipment:
	Furniture and equipment		50,324			51,253
	Building and leasehold improvements		12,490			11,835
	Software		40,034			37,666
	Property leased under capital leases		4,599			4,173
	Land and improvements		442			442

			107,889			105,369
	Accumulated depreciation and amortization		(57,238	)		(51,662	)

			50,651			53,707
Other assets:
	Goodwill		115,306			91,227
	Other intangible assets, net of accumulated amortization of $30,187 in 2003 and $21,470 in 2002		43,312			41,990
	Deferred tax assets		13,117			12,231
	Other assets		6,108			4,304

Total other assets			177,843			149,752

Total assets		$	621,974		$	550,504

Liabilities and shareholders’ equity
Current liabilities:
	Accounts payable-trade	$	26,426		$	23,006
	Accrued bankcard assessments		33,335			27,645
	Accrued compensation and benefits		3,725			3,321
	Income taxes payable		11,693			17,211
	Other accrued liabilities		20,295			18,744

Total current liabilities			95,474			89,927
Obligations under capital leases			1,945			1,732
Minority interest			2,772			2,462

Total liabilities			100,191			94,121
Shareholders’ 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; 53,113,009 and 52,093,945 shares issued and outstanding in 2003 and 2002, respectively		1			1
	Contributed capital		214,944			198,728
	Stock-based compensation plans		112			(311	)
	Retained earnings		306,726			257,965

Total shareholders’ equity			521,783			456,383

Total liabilities and shareholders’ equity		$	621,974		$	550,504


							Stock-Based
	Common		Common		Contributed		Compensation			Retained
	Shares		Stock		Capital		Plans			Earnings			Total


	(Dollars in Thousands)
Balance at January 1, 2001		50,935,460	$	1	$	178,729	$	—		$	182,828		$	361,558
Net income		—		—		—		—			52,660			52,660
Common control business unit purchase, net of tax				—		—		—			(28,600	)		(28,600	)
Issuance of common shares under stock-based compensation plans, including related tax effects		883,048		—		14,855		(477	)		—			14,378

Balance at December 31, 2001		51,818,508		1		193,584		(477	)		206,888			399,996
Net Income		—		—		—		—			51,077			51,077
Issuance of common shares under stock-based compensation plans, including related tax effects		275,437		—		5,144		166			—			5,310

Balance at December 31, 2002		52,093,945		1		198,728		(311	)		257,965			456,383
Net income		—		—		—		—			48,761			48,761
Issuance of common shares under stock-based compensation plans, including related tax effects		1,019,064		—		16,216		423			—			16,639

Balance at December 31, 2003		53,113,009	$	1	$	214,944	$	112		$	306,726		$	521,783


Furniture and equipment			3 to 10 years
Building and leasehold improvements			5 to 30 years
Software			3 to 10 years
Property leased under capital leases			3 to 35 years
Land improvements			5 to 15 years


	Year Ended
	December 31, 2003
(in thousands)
Beginning balance	$	—
Severance and related charges		1,273
Payments and other		(713	)

Ending balance		560


		2003			2002

Deferred tax assets:
	Accrued expenses	$	4,783		$	4,622
	Accrued compensation and benefits		241			602
	State net operating losses		—			530
	Intangible assets		11,546			13,197
	Other		5,618			1,423

			22,188			20,374
Deferred tax liabilities:
	Fixed assets		(6,296	)		(6,030	)

Net deferred tax assets		$	15,892		$	14,344



					Options Outstanding

		Option Shares						Weighted-Average
		Available for Grant			Option Shares			Price Per Share

January 1, 2001			6,032,575			2,806,965			11.54
	Granted		(1,464,725	)		1,511,583			25.91
	Forfeited		145,570			(145,570	)		14.42
	Exercised		—			(898,906	)		11.36

December 31, 2001			4,713,420			3,274,072			18.09
	Granted		(1,290,550	)		1,368,324			27.42
	Forfeited		230,796			(230,796	)		25.14
	Exercised		—			(356,270	)		12.97

December 31, 2002			3,653,666			4,055,330			21.29
	Granted		(102,500	)		141,776			20.01
	Forfeited		198,158			(198,158	)		26.97
	Exercised		—			(1,059,840	)		12.30

December 31, 2003			3,749,324			2,939,108			24.08


						Weighted-Average
				Weighted-		Remaining				Weighted-
Range of				Average		Contractual Life				Average Exercise
Exercise Prices		Outstanding		Exercise Price		(in years)		Exercisable		Price

	$5.50 - $10.99		184,569	$	10.19		3.6		184,569	$	10.19
	11.00 - 15.99		235,923		11.63		5.9		228,423		11.49
	16.00 - 20.99		217,161		18.72		5.9		115,000		17.85
	21.00 - 25.99		1,033,178		25.40		7.3		667,157		25.50
	26.00 - 32.95		1,268,277		28.27		8.1		488,198		28.67

	Total		2,939,108	$	24.08		7.2		1,683,347	$	22.32


	First		Second		Third		Fourth
	Quarter		Quarter		Quarter		Quarter		Year

2003
Revenue	$	105,954	$	113,614	$	124,997	$	135,533	$	480,098
Operating profit		13,929		18,377		24,232		24,271		80,809
Net income		8,547		11,066		14,309		14,839		48,761
Basic net income per common share	$	0.16	$	0.21	$	0.27	$	0.28	$	0.93
Diluted net income per common share	$	0.16	$	0.21	$	0.27	$	0.28	$	0.93