SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended June 30, 2004

or

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

For the transition period from          to

Commission File Number: 1-11905

National Processing, Inc.

(216) 222-3368
(Registrant’s telephone number, including area code)

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

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

The number of shares outstanding of the Registrant’s Common Stock as of July 31, 2004 was 53,213,224.

NATIONAL PROCESSING, INC.

INDEX

2

National Processing, Inc.

See notes to Consolidated Financial Statements

3

National Processing, Inc.

See notes to Consolidated Financial Statements

4

National Processing, Inc.

See notes to Consolidated Financial Statements

5

National Processing, Inc.

See notes to Consolidated Financial Statements

6

National Processing, Inc.

1.		ORGANIZATION AND BUSINESS
		Organization

          National Processing, Inc. and subsidiaries (the “Company”) are providers of electronic payment processing services. The Company is 83% 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.

Business

          The Company derives approximately 97% of its revenue from merchant processing services. The majority of this revenue is derived from the authorization, processing, financial settlement and reporting of card transactions, including credit and debit card transactions. The Company provides these services to merchants located primarily in the United States.

          Approximately 3% of the Company’s revenue is derived from processing non-card based payments. Through an exclusive contract, the Company settles 100% of domestic airline tickets issued by travel agencies and settled through the Airlines Reporting Corporation. The Company also settles commission payments for car rental companies, cruise line operators, and hotels. In the healthcare industry, the Company provides financial settlement and reporting to healthcare organizations such as insurance companies, managed care organizations, and self-insured organizations.

Sponsorship Agreement

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

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2.		SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
		Principles of Consolidation and Basis of Presentation

          The Consolidated Financial Statements include the accounts of National Processing, Inc. and its subsidiaries, including a 70% ownership interest in ABN AMRO Merchant Services, LLC (“AAMS”). The results of operations of AAMS are included in the Consolidated Financial Statements, and the 30% minority ownership interest has been accounted for as a minority interest. All significant intercompany transactions and balances have been eliminated in consolidation. The accounting and reporting policies of the Company conform with accounting principles generally accepted in the United States. Certain 2003 amounts have been reclassified to conform with the 2004 presentation. Reclassifications had no effect on previously reported net income or equity.

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

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

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

          Although the Consolidated Balance Sheet at December 31, 2003 has been derived from the audited Consolidated Financial Statements at that date, the accompanying interim Consolidated Financial Statements do not include all of the information and footnotes required by accounting principles generally accepted in the United States. These interim financial statements should be read in conjunction with the Company’s 2003 Annual Report on Form 10-K.

Revenue Recognition

          The Company recognizes revenue as services are performed, recording revenue net of certain costs not controlled by the Company, primarily interchange and debit network fees. Interchange and debit network fees for the three months ended June 30, 2004 and 2003 were $674 million and $611 million, respectively. For the six months ended June 30, 2004 and 2003, interchange and debit network fees were $1.275 billion and $1.182 billion, respectively.

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Stock-Based Compensation

          The Company has various stock-based compensation plans that allow for the granting of stock to eligible employees and directors. Prior to January 1, 2003, the Company accounted for these plans under the recognition and measurement principles of Accounting Principles Board Opinion (“APB”) 25, Accounting for Stock Issued to Employees, and related interpretations. Under APB 25, compensation expense for employee stock options was not recognized if the exercise price of the option equaled or exceeded the market price of the stock on the date of grant. Effective January 1, 2003, the Company adopted the fair value method of recording stock options under the transitional guidance of Statement of Financial Accounting Standards (“SFAS”) 148, Accounting for Stock-Based Compensation – Transition and Disclosure. Compensation expense for employee stock options granted after January 1, 2003 is 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.

(in thousands, except share amounts)

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

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3.		RECENT ACCOUNTING PRONOUNCEMENTS
		Accounting for Stock-Based Compensation

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

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

          As the cost of anticipated future option awards is phased in over a four-year period (generally, the vesting 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 increases or decreases from the current estimate, or if the current accounting guidance changes.

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

          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 the Company’s financial condition, 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.

Consolidation of Variable Interest Entities

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

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          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 have not had a material impact on the Company’s financial position, results of operations, or liquidity.

4.

ACQUISITIONS

          On June 9, 2003, the Company acquired Bridgeview Payment Solutions, Inc. (“BPS”) from Bridgeview Bank and Trust Company for $32.4 million in cash. The 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. The Company renamed BPS to Best Payment Solutions after the acquisition.

5.

IMPAIRMENT, RESTRUCTURING AND RELATED EXPENSES

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

6.

COMMITMENTS AND CONTINGENCIES

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

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          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, as defined below, transactions and unresolved chargebacks in the process of resolution. For the four-month period from March through June 2004, this amount totaled approximately $54 billion. At June 30, 2004, the Company had $5.2 million of unresolved chargebacks that were in process of resolution.

          For the three months ended June 30, 2004 and 2003, the Company processed $33.2 million and $36.0 million, respectively, in chargebacks presented by issuing banks. For the six months ended June 30, 2004 and 2003, the Company processed $73.5 million and $76.2 million, respectively, in chargebacks presented by issuing banks. Actual losses recorded for the three months ended June 30, 2004 and 2003 were $0.9 million and $0.8 million, respectively. Actual losses recorded for the six months ended June 30, 2004 and 2003, were $2.0 million and $1.8 million, respectively. The Company accrues for probable losses based on historical experience and at June 2004 and 2003 had $1.2 million and $1.1 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. For the six months ended June 30, 2004, the Company processed approximately $4.6 billion of merchant transactions related to delayed-delivery purchases.

          The Company currently processes card transactions for United Airlines, Inc., which is currently operating under Chapter 11 protection. 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 United Airlines but does not intend to renew the contract when its current term expires. In the event of liquidation of United Airlines, the Company could become financially responsible for refunding tickets purchased through Visa^® and MasterCard_® under the chargeback rules of those associations. At June 30, 2004, the estimated dollar value of tickets purchased, but as yet unflown, under the United Airlines merchant processing contract, was approximately $853 million. Based upon available information, this amount represents management’s best estimate of its maximum potential chargeback exposure related to United Airlines, Inc. As of June 30, 2004, the Company held no significant collateral under this contract.

          During 2003 and 2004, the Company’s obligation to process card transactions for three other airline merchants ceased with these merchants transitioning to new processors. At June 30, 2004, the estimated dollar value of tickets purchased, but as yet unflown, under these concluding contracts was approximately $36 million. This amount represents management’s best estimate of its maximum potential chargeback exposure under these contracts. As of June 30, 2004, the Company held cash collateral of $1.3 million and third-party indemnifications of $110 million against this remaining chargeback exposure.

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          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.

MasterCard® Guarantee

          The Company has 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.

Visa® Guarantee

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

Litigation

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

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7.

NET INCOME PER COMMON SHARE

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

8.

TRANSACTIONS WITH AFFILIATES

          The Company leases certain facilities from NCBK under long-term agreements classified as “Obligations Under Capital Leases” in the accompanying Consolidated Balance Sheets. The Company paid $0.1 million, including interest, under this lease for each of the six months ended June 30, 2004 and 2003.

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

          The Company and National City are parties to agreements pursuant to which the Company outsources a portion of certain functions to National City and its affiliates including information technology services, tax services, human resource services, internal audit and legal services. The Company also utilizes NCBK and other National City subsidiaries for the majority of its banking services. Charges for these services totaled $1.3 million and $2.5 million for the quarter and six months ended June 30, 2004, respectively. For the quarter and six months ended June 30, 2003, charges for these services totaled $0.8 million and $1.6 million, respectively.

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9.

SUBSEQUENT EVENT

Merger Agreement with Bank of America

      On July 12, 2004, the Company and Bank of America entered into an Agreement and Plan of Merger by and among Bank of America Corporation, Monarch Acquisition, Inc. and National Processing, Inc. At the effective time of the merger, Monarch Acquisition, an indirect wholly owned subsidiary of Bank of America, will be merged with and into National Processing. National Processing will continue as the surviving corporation and will become an indirect wholly owned subsidiary of Bank of America. At the closing of the merger, each share of National Processing common stock will be converted into the right to receive $26.60 in cash, without interest. The completion of this transaction is subject to the approval of the Company’s shareholders, regulatory approval and other customary conditions and is expected to occur in the fourth quarter of 2004.

      The Company expects to incur expenses of approximately $10 million related to the merger with Bank of America. These merger-related expenses include investment banking fees, and legal and professional fees. The Company will also pay up to $23 million in cash resulting from accelerated vesting of equity awards and payments under previously existing compensation plans and employment agreements.

      A contingent termination fee of $50 million is payable by the Company to Bank of America in the event that the merger agreement is terminated due to the Company’s failure to meet certain conditions precedent to close as detailed in the merger agreement.

Certain Other Agreements

      Pursuant to, and simultaneously with the execution of, the merger agreement, National City and certain of its affiliates entered into, or agreed to enter into, various agreements with the Company and Bank of America. These agreements are discussed below.

Service and Sponsorship Agreement

      The Company and NCBK are parties to a Sponsorship Agreement entered into on June 30, 1996. Pursuant to the sponsorship agreement, the Company serves as NCBK’s sole agent for the purpose of providing electronic data authorization and capture, reporting, settlement and clearing services for merchants who participate in Visa^® and MasterCard_® programs. In connection with NCBK’s role as sponsor, NCBK, the Company and United Airlines, Inc. entered into the Charge Card Processing Agreement dated November 15, 2000 (the “UAL Contract”). The sponsorship agreement provides, among other things, that the Company will indemnify NCBK against certain losses and claims, including chargebacks for airline tickets that have been purchased pursuant to the UAL Contract.

      In connection with the merger, the Company and NCBK entered into a Service and Sponsorship Agreement dated July 12, 2004, effective upon closing of the merger, with respect to the UAL Contract. Pursuant to this Service and Sponsorship Agreement, Bank of America through the Company has agreed to make a one-time payment of $36 million to NCBK in exchange for NCBK’s agreement to release the Company from its obligation under the sponsorship agreement to

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indemnify NCBK against any losses or claims to the extent related to and arising from the UAL Contract. National City has also agreed, pursuant to the Shareholders Agreement, to assume the Company’s obligations and potential liabilities under, and to indemnify Bank of America for losses related to, the UAL Contract. As a result of the arrangement, NCBK will remain liable for any such losses or claims under the UAL Contract.

      In addition, pursuant to the terms of service and sponsorship agreement, the Company will pay NCBK processing fees for NCBK’s settlement of United Airlines transactions services set forth in the service and sponsorship agreement. The Company will pass through to NCBK the fees it receives from United Airlines, less the cost of processing such transactions. National City will have the opportunity to earn a profit of approximately $1 million under the Service and Sponsorship Agreement over the term of that agreement.

Master Referral Agreement

      National City and Bank of America entered into a Master Referral Agreement dated July 12, 2004, effective upon closing of the merger, pursuant to which National City is eligible to receive fees from Bank of America based on National City’s and its affiliates’ use of Bank of America’s merchant services. National City and its affiliates are also eligible to receive fees in the event that their respective business customers utilize Bank of America’s merchant services. National City and its affiliates have agreed to refer their processing business through the Company. The agreement has a ten-year term, which includes a repricing option after the fifth year. National City is subject to termination fees in the event of a termination of the agreement other than in certain limited circumstances.

Transition Services Agreement

      In connection with the merger, National City and the Company will enter into a Transition Services Agreement, pursuant to which National City or its affiliates will provide, at cost, certain services to the Company following the completion of the merger with respect to information technology and human resources. Human resources services will be provided for up to six months following the merger and information technology services will be provided for up to twelve months after the merger. Any provision of services beyond the applicable term for such service will be on a cost plus 15% basis.

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

     The following should be read in conjunction with the Company’s 2003 Annual Report on Form 10-K and subsequent filings with the Securities and Exchange Commission.

     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 2004, U.S. consumers have continued to substitute card-based payments for checks and cash. As a result, transactions and dollar volume processed for the quarter ended June 30, 2004, increased 16% and 15%, respectively, over 2003. For the six months ended June 30, 2004, transactions and dollar volume processed increased 16% and 14%, respectively, over the comparable 2003 period.

     In 2004, the Company continued to experience 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. 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 would lead to higher processing volumes. Additionally, in 2004 the Company is focused 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.

     On July 12, 2004, the Company and Bank of America entered into an Agreement and Plan of Merger by and among Bank of America Corporation, Monarch Acquisition, Inc. and National Processing, Inc. At the effective time of the merger, Monarch Acquisition, an indirect wholly owned subsidiary of Bank of America, will be merged with and into National Processing. National Processing will continue as the surviving corporation and become an indirect wholly owned subsidiary of Bank of America. At the closing of the merger, each share of National Processing common stock will be converted into the right to receive $26.60 in cash, without interest. The completion of this transaction is subject to the approval of the Company’s shareholders, regulatory approval and other customary conditions and is expected to occur in the fourth quarter of 2004. See Note 9 to the accompanying Consolidated Financial Statements for additional information.

Components of Revenue and Expenses

Revenue

     The majority of the Company’s revenue is derived from processing contracts with merchants for the authorization, processing, and settlement of credit and debit card transactions. Processing fee revenue is earned either on a “per transaction” basis or “discount” basis, which is a percent of dollar volume processed. Merchant contracts generally have terms ranging from three to five years. Processing fee revenue is recorded in the period the related transaction is processed and is recorded net of interchange fees charged by the credit card associations and fees charged by debit networks. Interchange and debit network fees for the three months ended June 30, 2004 and 2003 were $674 million and $611 million, respectively. For the six months ended June 30, 2004 and 2003, interchange and debit network fees were $1.275 billion and $1.182 billion, respectively. The increase in interchange and debit network fees is attributed to higher dollar processing volumes. The Company also derives revenue from sources other than processing fees, including equipment and supply sales, equipment repair fees, application and installation fees, and third-party commissions.

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     Approximately 3% of the Company’s revenue is derived from processing non-card based payments. 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 three months ended June 30, 2004 and 2003, earnings on customer balances were $0.7 million and $0.6 million, respectively. For the six months ended June 30, 2004 and 2003, earnings on customer balances were $1.3 million and $1.1 million, respectively.

Expenses

     Operating expenses include costs of providing services to customers including authorization fees and data processing costs. Assessments are liabilities to Visa^® and MasterCard_® that originate from the Company’s agreements with these associations.

     General and administrative expenses include management and administrative expenses as well as fees for certain administrative services provided by National City and its affiliates.

Three Months Ended June 30, 2004 Compared to Three Months Ended June 30, 2003

     Revenue for the three months ended June 30, 2004 increased 17% to $132.6 million from $113.6 million in 2003.

     Merchant processing revenue was $129.2 million for the quarter, up 18% from second quarter 2003 revenue of $109.6 million. Merchant processing transaction volume processed for the three months ended June 30, 2004 increased 16% to 1.19 billion transactions from 1.03 billion transactions in 2003. Merchant processing dollar volume processed for the three months ended June 30, 2004 increased 15% to $48.4 billion from $42.2 billion in 2003. The increase in transaction volume is primarily due to growth in existing national customers and the addition of new regional merchants. Merchant processing revenue for the second quarter of 2004 versus the comparable 2003 period was higher due primarily to the increased transaction and dollar volumes, strong customer retention, additional revenue resulting from the acquisition of Bridgeview Payment Solutions, and the benefit of rate and pricing changes.

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     Revenue from non-card based payments was $3.5 million for the quarter, down 14% from second quarter of 2003 revenue of $4.0 million. This decrease was due primarily to lower revenue from the Company’s Airlines Reporting Corporation contract.

     Operating expenses for the three months ended June 30, 2004 increased 14% to $57.4 million from $50.2 million in 2003 due primarily to increased merchant transaction volume.

     Assessments expense increased 16% to $38.2 million for the three months ended June 30, 2004 from $33.0 million in 2003 due to increased merchant transaction volume.

     General and administrative expenses increased by 28% to $7.4 million for the three months ended June 30, 2004 from $5.7 million in 2003. This increase was due primarily to increases in incentive compensation and expenses related to equity-based compensation.

     Depreciation and amortization increased 14% to $5.7 million for the three months ended June 30, 2004 from $5.0 million in 2003. This increase was due primarily to increased intangible asset amortization from the acquisition of Best Payment Solutions.

     In May 2003, the Company implemented various initiatives focused on improving the long-term profitability of the Company. In connection with these initiatives, the Company eliminated 48 information technology positions, which resulted in severance for 30 employees. The Company also incurred a loss on the sale of 14 regional sales offices. The Company recorded a charge of $1.3 million in the second quarter of 2003 related to these initiatives. As of June 30, 2004, the Company had $0.3 million remaining in accrued liabilities related to severance and lease commitments.

     Operating profit margin as a percentage of revenue increased to 18% for the three months ended June 30, 2004 from 16% in 2003 due to the items discussed above.

     Net interest income earned on the Company’s cash and cash equivalents for the three months ended June 30, 2004 was $0.7 million, down 17% from $0.8 million in the 2003 second quarter due to lower average interest rates in 2004, offset partially by higher balances.

     The overall effective tax rate for the second quarter of 2004 was 37.8%, compared to 38.8% for the same quarter a year ago. This decrease is due to changes in estimated rates for state and local taxes.

     For the three months ended June 30, 2004, minority interest was $1.0 million, up 38% from $0.7 million in the second quarter of 2003. This increase is due to higher earnings from AAMS, which is 70% owned by National Processing.

     Net income increased 30% to $14.4 million for the three months ended June 30, 2004 from $11.1 million in 2003 due to the items discussed above.

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Six Months Ended June 30, 2004 Compared to Six Months Ended June 30, 2003

     Revenue for the six months ended June 30, 2004 increased 16% to $254.8 million from $219.6 million in 2003.

     Merchant processing revenue was $248.1 million for the six months ended June 30, 2004, up 17% from $211.5 million in 2003. Merchant processing transaction volume processed for the six months ended June 30, 2004 increased 16% to 2.307 billion transactions from 1.982 billion transactions in 2003. Merchant processing dollar volume processed for the six months ended June 30, 2003 increased 14% to $92.8 billion compared to $81.6 billion in 2003. The increase in transaction volume is primarily due to growth in existing national customers and the addition of new regional merchants. Merchant processing revenue for the six months ended June 30, 2004 versus the comparable 2003 period was higher due primarily to the increased transaction and dollar volumes, strong customer retention, additional revenue resulting from the acquisition of Bridgeview Payment Solutions, and the benefit of rate and pricing changes.

     Revenue from non-card based payments was $6.7 million for the six months ended June 30, 2004, down 17% from 2003 revenue of $8.1 million. This decrease was due primarily to lower revenue from the Company’s Airlines Reporting Corporation contract.

     Operating expenses for the six months ended June 30, 2004 increased 11% to $113.3 million from $101.8 million in 2003 due primarily to increased transaction volume in Merchant Card Services.

     Assessments expense increased 14% to $73.1 million for the six months ended June 30, 2004 from $64.2 million in 2003 due to increased merchant transaction volume.

     General and administrative expenses increased by 34% to $13.4 million for the six months ended June 30, 2004 from $10.1 million in 2003 due to increases in incentive compensation and expenses related to equity-based compensation.

     Depreciation and amortization increased 14% to $11.4 million for the six months ended June 30, 2004 from $10.0 million in 2003 due primarily to increased intangible asset amortization from the acquisition of Best Payment Solutions.

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     In May 2003, the Company implemented various initiatives focused on improving the long-term profitability of the Company. In connection with these initiatives, the Company eliminated 48 information technology positions, which resulted in severance for 30 employees. The Company also incurred a loss on the sale of 14 regional sales offices. The Company recorded a charge of $1.3 million in the second quarter of 2003 related to these initiatives. As of June 30, 2004, the Company had $0.3 million remaining in accrued liabilities related to severance and lease commitments.

     Operating profit margin as a percentage of revenue increased to 17% for the six months ended June 30, 2004 from 15% in 2003 due to the items discussed above.

     Net interest income earned on the Company’s cash and cash equivalents for the six months ended June 30, 2004 was $1.3 million, down 19% from $1.7 million for the six months ended June 30, 2003 due to lower average interest rates in 2003, offset partially by higher balances.

     The overall effective tax rate for the six months ended June 30, 2004 was 37.6%, compared to 38.7% for the same period a year ago. This decrease is due to changes in estimated rates for state and local taxes.

     For the six months ended June 30, 2004, minority interest was $1.7 million, up 39% from $1.2 million in 2003. This increase is due to higher earnings from AAMS, which is 70% owned by National Processing.

     Net income increased 34% to $26.4 million for the six months ended June 30, 2004 from $19.6 million in 2003 due to the items discussed above.

Chargeback and Market Uncertainties

Chargebacks

     See Note 6 to the Consolidated Financial Statements.

Additional Factors

     The Company is dependent on overall consumer spending trends. The Company is also subject to competitive pricing in the markets in which it competes. These factors may impact the Company’s future revenue and operating profits.

Application of Critical Accounting Policies

General

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

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Income Taxes

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

     Management judgments and estimates are required in determining the income tax provision as well as the balances of deferred tax assets and liabilities. As of June 30, 2004, the Company had net deferred tax assets of $11.3 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

     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 $53.5 million as of June 30, 2004, 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 the value of the assets. Alternatively, assets may ultimately be used by the Company for longer than their assigned depreciable lives.

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

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     Goodwill and other intangible assets, net of accumulated amortization, totaled $153.6 million as of June 30, 2004, which represented 24% of total assets. The Company determines amortization periods for intangible assets based on estimated future cash flows. The Company analyzes goodwill and other intangible assets for impairment on an annual basis or more frequently if events or circumstances warrant. In assessing the recoverability of goodwill and intangible assets, the Company makes estimates regarding future cash flows and assumptions about other factors to determine the fair value. Changes in estimates or the related assumptions may cause the Company to record impairment charges for the related assets.

Chargebacks and Other Contingencies

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

Recent Accounting Pronouncements

     See Note 3 to the Consolidated Financial Statements.

Seasonality

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

Liquidity and Capital Resources

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

     The Company’s capital expenditures include amounts for computer hardware, external and internally developed software, and improvements to operating facilities. During the six months ended June 30, 2004 and 2003, the Company’s capital expenditures totaled $8.6 million and $3.4 million, respectively. Such expenditures were financed from operating cash flow, which totaled $50.9 million and $63.6 million for the six months ended June 30, 2004 and 2003, respectively. Operating cash flow decreased due to the timing of working capital items, primarily accounts receivable balances.

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

     In February 2004 and March 2003, the Company paid $2.8 million and $2.4 million, respectively, to the minority shareholder of AAMS. These payments represent the pro rata share of earnings due to the minority shareholder for the preceding year.

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     On July 12, 2004, the Company and Bank of America entered into an Agreement and Plan of Merger by and among Bank of America Corporation, Monarch Acquisition, Inc. and National Processing, Inc. At the effective time of the merger, Monarch Acquisition, an indirect wholly owned subsidiary of Bank of America, will be merged with and into National Processing. National Processing will continue as the surviving corporation and become an indirect wholly owned subsidiary of Bank of America. At the closing of the merger, each share of National Processing common stock will be converted into the right to receive $26.60 in cash, without interest. The completion of this transaction is subject to the approval of the Company’s shareholders, regulatory approval and other customary conditions and is expected to occur in the fourth quarter of 2004. The Company expects to incur expenses of approximately $10 million related to the merger with Bank of America. These merger-related expenses include investment banking fees, and legal and professional fees. The Company will also pay up to $23 million in cash resulting from accelerated vesting of equity awards and payments under previously existing compensation plans and employment agreements. Under the terms of the merger agreement, the Company must pay a termination fee of $50 million in the event the Company terminates the merger agreement or fails to meet its obligations set forth in the merger agreement. Additionally, upon closing of the merger, pursuant to the Service and Sponsorship Agreement, Bank of America, through the Company has agreed to make a one-time payment of $36 million to NCBK in exchange for NCBK’s agreement to release the Company from its obligation under the Sponsorship Agreement. See Note 9 to the accompanying Consolidated Financial Statements for additional information.

     As the Company does not carry significant amounts of inventory and historically has experienced short collection periods for its accounts receivable, it does not require substantial working capital to support revenue growth. Working capital requirements will vary depending upon future acquisition activity. Increases in working capital needs and future capital expenditures are expected to be financed through operating cash flow and current cash balances. Due to increased transaction volumes in the holiday months, accounts receivable balances are typically higher at year end which typically results in a negative operating cash flow in the fourth quarter.

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Forward-Looking Statements

     The section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contains forward-looking statements. Forward-looking statements give current expectations or forecasts of future events and are not guarantees of future performance. Forward-looking statements may be identified by the use of words such as “may,” “will,” “intend,” “expect,” “believe,” “anticipate,” “plan,” “estimate,” “project,” “target,” “forecast,” “seek” and other similar words used in connection with any discussion of future operating or financial performance. The forward-looking statements are based on management’s expectations that involve a number of risks and uncertainties, and, although management believes the expectations reflected in such forward-looking statements are reasonable, actual results may differ materially from those expressed or implied in such statements. Risks and uncertainties that could cause actual results to differ materially include, without limitation, the Company’s ability to execute its business plans; changes in general economic conditions in the United States and other relevant economies; changes in consumer spending habits; changes in the growth rate of the card processing industry from recent years; ability to execute the Company’s acquisition strategy; successful integration of acquisitions; consolidation in the banking, card processing or electronic payment settlement industries; consolidation of major customers or industries serviced; industry competition; renewal of major customer relationships; changes in interest rates; governmental and economic stability in foreign countries in which the Company operates; litigation or changes in existing litigation, chargebacks, customer bankruptcy, claims and assessments; reliance on third party processing relationships; changes in banking regulations; changes in credit card association rules, regulations or operations; changes in other laws or regulations that impact the Company’s business; changes in accounting policies and procedures as may be required due to new accounting pronouncements of the Financial Accounting Standards Board or other regulatory agencies; technological changes; timely and successful implementation of future processing systems projects; financial or other business impacts due to systems infiltrations; and successful business continuity plans. Additional information concerning factors that could cause actual results to differ materially from those expressed or implied in the forward-looking statements is available in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 and subsequent filings with the Securities and Exchange Commission. You are advised to consult any further disclosures the Company makes on related subjects in the Company’s Forms 10-Q, 8-K and 10-K reports filed with the Commission. Copies of the Company’s filings with the Commission are available at no cost on the Commission’s web site at www.sec.gov or on the Company’s web site at www.npc.net.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

Derivative Instruments

     The Company does not use derivative instruments.

Market Risk of Financial Instruments

     The Company’s primary market risk exposure with regard to financial instruments is to changes in interest rates. As of June 30, 2004, the Company had $291 million in cash and cash equivalents. For the first six months of 2004, NCBK also held an average of approximately $226 million of customer cash balances. The Company retains the incremental interest earned on certain of these funds above what is contractually due to the customers. Interest earned on customer cash balances is included as a component of revenue.

     Because of the short-term nature of these instruments, a sudden change in market interest rates would not impact the fair value of these instruments. The Company’s earnings, however, are impacted by changes in interest rates, with respect to interest on the Company’s cash and cash equivalents and on customer funds maintained by NCBK. At June 30, 2004, a hypothetical 100 basis point increase in short-term interest rates would result in an increase of approximately $5 million in annual pre-tax income. A hypothetical 100 basis point decrease in short-term interest rates would result in a decrease of approximately $5 million in annual pre-tax income.

Item 4. Controls and Procedures

     As of June 30, 2004, an evaluation was performed under the supervision and with the participation of the Company’s management, including the Chairman and Chief Executive Officer (“CEO”) and the Chief Financial Officer (“CFO”), of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based on that evaluation, the Company’s management, including the CEO and CFO, concluded the Company’s disclosure controls and procedures as of June 30, 2004 were effective in ensuring information required to be disclosed in this Quarterly Report on Form 10-Q was recorded, processed, summarized and reported on a timely basis. There have been no changes in the Company’s internal control over financial reporting that occurred during the quarter ended June 30, 2004 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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Part II — Other Information

Item 1. Legal Proceedings (None)

Item 2. Unregistered Sales of Equity Securities (None)

Item 3. Defaults Upon Senior Securities (None)

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

On May 5, 2004, at the Annual Shareholders Meeting of the Company, the shareholders took the following actions:

1.

Elected as directors all nominees designated in the proxy statement dated March 19, 2004 as follows:

Directors whose terms continued after the Annual Shareholders Meeting include: J. Armando Ramirez, Paul G. Clark, Jeffrey P. Gotschall, and Jeffrey D. Kelly.

2.

Approved the Audit Committee’s selection of Ernst & Young LLP as independent auditor for the Company for 2004: 52,781,793 votes cast for, 9,657 votes cast against, and 560 votes abstained.

Item 5. Other Information (None)

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

          The exhibits filed as part of the Form 10-Q for the quarter ended June 30, 2004 are accessible at no cost on the Company’s website at www.npc.net or through the Securities and Exchange Commission’s website at www.sec.gov. Copies of the exhibits may be requested at a cost of $0.30 per page from National Processing’s investor relations department.

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b.

Reports on Form 8-K

          April 15, 2004: On April 15, 2004, the Company issued a news release reporting earnings and including a financial summary for the quarter ended March 31, 2004.

          May 28, 2004: On May 28, 2004, the Company issued a news release announcing that its Board of Directors is reviewing the Company’s various strategic alternatives.

          July 13, 2004: On July 13, 2004, the Company and Bank of America announced a definitive agreement had been reached for Bank of America to purchase all outstanding shares of the Company.

          July 16, 2004: On July 16, 2004, the Company issued a news release reporting earnings and including a financial summary for the quarter and six months ended June 30, 2004.

SIGNATURES

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

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