UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

For the quarterly period ended September 30, 2004

OR

For the transition period from ____ to ____

Commission File Number 1-31951

eFunds Corporation

Registrant’s telephone number, including area code: (480) 629-7700

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.

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

The number of shares outstanding of the registrant’s common stock, par value $.01 per share, at October 29, 2004 was 48,831,054

Table of Contents

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

eFUNDS CORPORATION AND SUBSIDIARIES

See Notes to Condensed Consolidated Financial Statements

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eFUNDS CORPORATION AND SUBSIDIARIES

See Notes to Condensed Consolidated Financial Statements

2

eFUNDS CORPORATION AND SUBSIDIARIES

See Notes to Condensed Consolidated Financial Statements

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eFUNDS CORPORATION AND SUBSIDIARIES

NOTE 1 — DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION:

The goal of eFunds Corporation and its wholly-owned subsidiaries (the Company) is to enable trusted commerce by delivering integrated information, payment and technology solutions that strengthen their customers’ overall profitability through increased revenue, reduced costs and improved operating efficiency and technology performance. The Company’s principal focus is on issuers of transaction accounts, such as financial institutions, financial services companies, electronic funds transfer networks, retailers, government agencies, telecommunications companies and other businesses. The Company delivers information, payment and technology solutions through four basic business units and through combinations of the products and services offered by these units.

For the periods presented, the Company had four operating segments: Electronic Payments; Risk Management; Global Outsourcing; and Automated Teller Machine (ATM) Management. The Electronic Payments segment provides electronic funds transfer (EFT) processing services, including automated clearinghouse (ACH) processing and electronic benefit transfer (EBT) services for government agencies, EFT software, software applications development, maintenance and installation. The Risk Management segment provides data based risk management services and other related products to financial institutions, retailers and other businesses that assist in detecting fraud and assessing the risk of opening a new account or accepting a check. The Global Outsourcing segment provides business process outsourcing services and information technology services. The ATM Management segment provides ATM deployment, management and branding services. On September 20, 2004, the Company entered into a definitive agreement to sell a component of the ATM Management segment (Note 4).

The Company was incorporated in Delaware in December 1984. Prior to its initial public offering (the IPO) in June 2000, the Company was a wholly-owned subsidiary of Deluxe Corporation (Deluxe). In December 2000, Deluxe distributed all of its remaining shares of the Company’s common stock to its shareholders through a spin-off transaction (Spin-Off).

The unaudited condensed consolidated financial statements of the Company for the three and nine month periods ended September 30, 2004 and 2003 have been prepared in accordance with accounting principles generally accepted in the United States of America and the instructions to Form 10-Q and Article 10 of Regulation S-X. All material intercompany accounts and transactions have been eliminated. In the opinion of management, all adjustments considered necessary for a fair presentation, which are of a normal recurring nature, have been included. Interim results are not necessarily indicative of results for a full year. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2003 included in the Company’s 2003 Annual Report on Form 10-K filed with the Securities and Exchange Commission (SEC).

NOTE 2 — EMPLOYEE STOCK-BASED COMPENSATION:

The Company accounts for the issuance of stock options to employees using the intrinsic value method prescribed by Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. No stock option based employee compensation cost is reflected in net income as all options granted under the Company’s plans had an exercise price at least equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share that would result if the Company had applied the fair value recognition provision of Statement of Financial Accounting Standards

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(SFAS) No. 123, “Accounting for Stock-Based Compensation,” to its stock-based employee compensation during the periods indicated:

For purposes of applying SFAS No. 123, the weighted average estimated fair value of stock options granted during the three and nine month periods ended September 30, 2004 was $7.74 and $7.82, respectively, and for the same periods in 2003 was $5.11 and $3.82, respectively. This value was estimated at the option grant date using a Black-Scholes option-pricing model.

From time to time the Company issues restricted stock unit awards to employees and directors that generally vest over periods ranging from one to three years. No consideration is paid for these awards. During the three and nine month periods ended September 30, 2004, the Company issued approximately 3,000 and 134,000 units of restricted stock, respectively, and for the same periods in 2003 issued approximately 1,000 and 19,000 units, respectively. The Company recorded compensation expense for restricted stock unit awards during the three and nine months ended September 30, 2004 of approximately $214,000 and $557,000, respectively, and for the same periods in 2003 the Company recorded compensation expense for restricted stock unit awards of approximately $67,000 and $193,000, respectively.

NOTE 3 — ACQUISITIONS:

In April of 2004, the Company acquired Penley, Inc. (Penley), which provides identity verification services, and Loss Control Solutions (LCS), which offers fraud investigation case management software for the financial services industry. The primary reason for these acquisitions was to expand the product suite and customer set within the Risk Management segment. The results of operations for the acquired entities have been included in the Company’s condensed consolidated statements of operations since the acquisition dates.

The aggregate initial purchase price paid for the entities was approximately $6 million, of which approximately $5 million was funded from existing cash on hand. Approximately $0.6 million of the purchase price was placed in escrow subject to the satisfaction of certain post-closing conditions. Additional amounts could become payable to the former stockholders of Penley if the acquired business achieves certain revenue and income targets during the two year period following the acquisition. The maximum additional amount payable to such stockholders is $21 million.

The results of operations of Penley and LCS are not material to the Company, and accordingly, pro forma results of operations for the acquisitions are not disclosed. The estimated fair value of the net assets acquired was approximately $6 million, which included approximately $5 million of goodwill and approximately $1 million of intangible assets related to acquired contracts which have an estimated life of approximately 6 years. All of the goodwill and intangible assets associated with this transaction were assigned to the Risk Management segment.

NOTE 4 — ASSETS AND LIABILITIES RELATED TO ASSETS HELD FOR SALE:

At such time as management determines that a material long-lived asset or a long-lived asset that is part of a group that includes other assets and liabilities (asset group) is to be disposed of within a twelve-month period and all other criteria required under SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” have been met, that material asset or asset group is reclassified on the condensed consolidated balance sheet as held for sale and recorded at the lower of its carrying amount or fair value less cost to sell.

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On September 20, 2004, the Company entered into a definitive agreement (the Agreement) to sell the ATM machines and merchant contracts (the ATM Portfolio) associated with the ATM Management segment. The consummation of this transaction is subject to customary closing conditions and is currently expected to occur during the fourth quarter of 2004. The ATM Portfolio represents a significant component of the ATM Management segment and the Company does not expect to present the ATM Management segment as a separate operating segment in periods subsequent to the closing of the transaction. Amounts received by the Company that exceed the recorded book value of the ATM Portfolio will be deferred and recognized as revenues over the five year term of the Master Services Agreement discussed below.

Concurrently with the execution of the Agreement, the Company entered into a five year Master Services Agreement with the buyer of the ATM Portfolio that is to become effective upon the closing of the transactions contemplated by the Agreement. Pursuant to the Master Services Agreement, the Company will provide processing, help desk, monitoring and other ATM management services to the buyer. The processing service revenues and related costs will be reported within the Electronic Payments segment and the ATM management service revenues and related costs will be reported within the Global Outsourcing segment.

In accordance with SFAS No. 144, the assets and liabilities related to the ATM Portfolio asset group have been classified as assets held for sale and liabilities related to assets held for sale. The results of the ATM Portfolio are not recorded as discontinued operations because the Company will have significant continuing involvement in the operation of the asset group following the sale through the Master Services Agreement. The carrying amounts of the major classes of assets classified as held for sale are net accounts receivable of approximately $4.9 million, net property and equipment of approximately $6.3 million, goodwill of approximately $76.0 million, net other intangible assets of approximately $17.2 million and other current assets of approximately $1.7 million. The liabilities related to assets held for sale consist of accounts payable and other current liabilities of approximately $9.7 million.

NOTE 5 — INTANGIBLES:

Intangible assets consist primarily of goodwill, capitalized software costs and acquired contracts. Intangible assets, both acquired and developed, subject to amortization are presented below. Certain intangible assets presented in the table for 2003 have been reclassified to conform with current period presentation.

For the three and nine month periods ended September 30, 2004, amortization expense for intangible assets was $5.4 million and $16.8 million, respectively, and for the three and nine month periods ended September 30, 2003 the amortization expense for intangible assets was $4.9 million and $15.1 million, respectively. The estimated amortization expense for intangible assets held at September 30, 2004 is $5 million for the three months ended December 31, 2004. For the years ended December 31, 2005, 2006, 2007, 2008 and 2009, the estimated amortization expense for intangible assets held at September 30, 2004 is $14 million, $9 million, $6 million, $3 million, and $1 million, respectively.

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The change in the carrying amount of goodwill for the nine months ended September 30, 2004 is as follows:

NOTE 6 — RESTRUCTURING, ASSET IMPAIRMENT AND OTHER CHARGES:

During the third quarter of 2003, the Company recorded restructuring charges of $3.6 million for severance benefits related to business process improvement initiatives and reversed $0.9 million of lease related reserves to reflect the subleasing of certain properties for which a restructuring charge was initially recorded in 2002. During the three months ended June 30, 2004, the Company recorded approximately $0.8 million of restructuring charges related to severance benefits for approximately 35 employees. These charges are expected to be paid through 2005. The following table summarizes the change in the Company’s restructuring accruals for the nine months ended September 30, 2004, including the long-term portion of lease related accruals of approximately $1.3 million at September 30, 2004 that are payable through January 2010:

NOTE 7 — ACCRUED CONTRACT LOSSES:

Through March 31, 2004, the Company’s accrued contract losses pertained to long-term service contracts for electronic benefits processing in the Electronic Payments segment. In the third quarter of 2003, the Company recorded a $2.3 million benefit related to a reduction in the estimate of future losses on certain government EBT contracts.

During the second quarter of 2004, a $0.5 million provision for expected losses was recorded for certain long-term software contracts held by the Electronic Payments segment. These contracts require significant modification to the underlying software and the revenue associated with the contracts was recognized using the percentage-of-completion method, which relies on estimates of total expected contract costs. Unexpected increases in the scope of these projects resulted in unanticipated increases in the expense required to perform the contracts with the result that the Company now expects to incur losses in the performance of these contracts. The losses recorded are based on the Company’s best current estimates of the contracts’ ultimate revenues and expenses. Actual results may differ from the Company’s estimates. In the event such differences arise, a revision to the loss reserve would be required. The following table summarizes the activity of the accrued contract loss reserve:

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NOTE 8 — LONG-TERM DEBT:

Long-term debt was as follows:

Long-term debt consists of capital lease obligations related to purchased software and equipment. The range of interest rates on capital lease obligations is approximately 2% to 6%. Carrying value approximates fair value for these obligations, which are due through the year 2009.

NOTE 9 — INCOME PER SHARE:

The following table reflects the calculation of basic and diluted income per share:

Options to purchase approximately 0.9 million shares and 0.2 million shares of common stock were excluded from the above calculations as they were antidilutive during the three and nine month periods ended September 30, 2004, respectively. Options to purchase approximately 3.1 million shares and 4.3 million shares of common stock were excluded from the above calculations as they were antidilutive during the three and nine month periods ended September 30, 2003, respectively.

NOTE 10 — COMPREHENSIVE INCOME:

The Company’s total comprehensive income for the three month periods ended September 30, 2004 and 2003 was $10.9 million and $9.6 million, respectively. The Company’s total comprehensive income for the nine month periods ended September 30, 2004 and 2003 was $29.6 million and $20.5 million, respectively. The Company’s total comprehensive income consists of net income and foreign currency translation adjustments.

NOTE 11 — BUSINESS SEGMENT INFORMATION:

The Company’s segment reporting was revised during the quarter ended March 31, 2004 to reflect additional organizational and cost group changes. Certain revenues and expenses from collection activities have been reclassified between the Electronic Payments, Risk Management and Global Outsourcing segments. Certain amortization cost groups were realigned with the respective business segments that benefited from the use of the related assets. During the periods presented, the Company’s business segments were: Electronic Payments; Risk Management; Global Outsourcing; and ATM Management. The Company reports segment information consistent with the way management internally disaggregates its operations to assess performance and to allocate resources. The Electronic Payments segment provides EFT processing services, including ACH processing, EBT services for government agencies, EFT software, software applications development, maintenance and installation. The Risk Management segment provides data based risk management services and other related products to financial institutions, retailers and other businesses that assist in detecting fraud and assessing the risk of opening a new account or accepting a check. The Global Outsourcing segment provides business process outsourcing and information technology services. The ATM Management segment provides ATM deployment, management and branding services.

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The accounting policies of the segments are the same as those applied by the Company on a consolidated basis. For internal reporting purposes, the Company aggregates costs based upon managerial control. The majority of these managed cost groups are directly assigned to a reportable segment. For cost groups supporting more than one reportable segment, the costs are assigned based upon the product line or project benefited. The assignment of costs is based upon estimates of factors considered most appropriate for the cost group such as transactions, calls, customers, square footage, revenues and headcount. The Company does not allocate expenses that benefit all segments and are corporate or administrative in nature. These costs are designated as Corporate expenses and include, among other things, executive leadership costs, investor relations and general legal, consulting, accounting and finance costs.

Information concerning operations in the Company’s reportable segments is as follows:

¹ See Note 4.

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The Company has not disclosed assets, interest income, interest expense or income taxes by segment because this information is not reviewed by the chief operating decision maker, produced internally nor practicable to prepare. Depreciation and amortization for each of the Company’s reporting segments is as follows:

Revenue is attributed to geographic areas based on the location of the assets producing the revenue. Certain amounts presented for 2003 have been reclassified to conform with current period presentation. The Company’s operations by geographic area are as follows:

NOTE 12 — COMMITMENTS AND CONTINGENCIES:

Future commercial commitments

In connection with the Company’s government services, collection and ATM placement activities, the Company posts surety bonds with state agencies guaranteeing its performance of certain obligations related to the relevant contracts or state requirements. The aggregate amount of such bonds outstanding at September 30, 2004 was $14.9 million.

At September 30, 2004, the Company provided guarantees of $0.5 million on certain equipment lease payments for Canadian customers of its ATM management business. These guarantees were established prior to the acquisition of Access Cash International, L.L.C. in 2001 and expire through 2008. The Company would be required to make payments under these guarantees in the event that these customers could not meet their own payment obligations. Through September 30, 2004, the Company has been required to make payments of approximately $0.3 million pursuant to these guarantees. The customers’ ATM equipment assets are utilized as collateral on these guarantees. There are no amounts being carried as liabilities for the Company’s obligations under these guarantees.

The Company uses cash collateral to secure letters of credit it issues in the ordinary course of business. The Company had $1.2 million in letters of credit outstanding in the United States at September 30, 2004, mostly related to leases. These letters of credit were secured by $1.3 million in cash collateral. In addition, the Company obtained bank guarantees of $0.5 million related to the performance on a customer contract and certain obligations related to local government requirements in India. These bank guarantees in India are collateralized by $0.5 million of time deposits.

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Contractual cash obligations

As of September 30, 2004, the Company had contractual cash obligations for capital leases, operating leases, outsourcing and maintenance obligations in the aggregate amount of approximately $107.6 million. The following table sets forth the Company’s obligations as of September 30, 2004 for the time periods specified. The Company’s long-term debt consists of capital lease obligations related to purchased software and equipment.

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Future minimum lease payments for non-cancelable operating leases are presented net of minimum sublease rentals of $3.2 million due in the future under non-cancelable subleases.

Other commitments

The Company has vault cash agreements with various financial institutions who provide cash to certain of the ATMs owned or managed by the Company. Although some portion of this cash may be physically located in the ATMs managed by the Company, this cash is not included in cash and cash equivalents on the Company’s condensed consolidated balance sheet because the Company does not take title to the cash under the bailee/bailor relationship established by the agreements. Based upon the daily outstanding balance of funds provided to the ATMs, the Company generally pays a monthly fee ranging from prime, as defined, plus one half percent up to prime plus 3%. The average monthly rate paid during the first nine months of 2004 approximated 7%. The Company indemnifies the financial institutions against any loss of the cash in the ATMs. Two of the agreements require the Company to maintain a security deposit equal to 1% of the daily outstanding balance. The agreements may be terminated upon notice by either party and have various expiration dates ranging from November 2004 to June 2005. Total cash provided pursuant to these vault cash agreements was approximately $37 million at September 30, 2004 and approximately $41 million at December 31, 2003.

As part of its transaction processing business, the Company provides cash settlement services to financial institutions and state and local governments. These services involve the movement of funds between the various parties associated with ATM, point-of-sale or EBT transactions and this activity results in a balance due to the Company at the end of each business day that it recoups over the next few business days. The balances due to the Company are included in cash and cash equivalents. As of September 30, 2004, approximately $25 million was due to the Company and it received these funds in early October 2004.

The Company seeks to maintain cash balances that are adequate to ensure that it can advance funds to its processing customers if unusual circumstances prevent the Company from being able to process their settlement files in a timely fashion. Although highly infrequent, the Company has funded approximately $30 million under such a circumstance in the past. The Company currently seeks to maintain a cash balance of approximately $75 million to ensure that it can fund this obligation.

The Company is evaluating means to reduce the need for it to maintain these minimum cash balance levels, including the possibility of obtaining an overnight credit facility to fund these obligations.

Under a third party indemnification agreement, the Company agreed to indemnify Deluxe in connection with any liabilities incurred by Deluxe after the Spin-Off as a result of Deluxe’s purchase or lease of property or services for the Company’s benefit under any master agreement. The Company also agreed to indemnify Deluxe in connection with any guarantees under which Deluxe guaranteed the Company’s performance of agreements with third parties. The Company is obligated to indemnify Deluxe for any liability to the extent such liability primarily relates to the past, present or future operation of the Company’s business or operations. No amounts have been paid to Deluxe under this agreement.

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The Company and Deluxe also entered into a Cross-Indemnification Agreement pursuant to which both the Company and Deluxe agreed to indemnify each other against any liabilities arising out of the underwriting agreement related to the Company’s IPO, except insofar as any such liability arises out of a breach of such agreement by the party seeking indemnification. No payments have been made pursuant to this agreement.

The Company’s agreements with users of its products and services generally contain indemnity clauses under which the Company agrees to indemnify its customers and hold them harmless from and against liabilities arising from claims of patent, copyright or other intellectual property infringement brought by a third party related to those products or services. The Company’s agreements may also provide indemnification for claims relating to property damage or personal injury resulting from the performance of services by the Company or its subcontractors. Historically, the Company’s costs to defend lawsuits or settle claims relating to these indemnity agreements have not been significant.

The Company’s amended and restated certificate of incorporation and by-laws require it to indemnify its directors and officers to the fullest extent permitted by Delaware law. Indemnification of the Company’s employees and other agents is permitted to the same extent. The Company’s amended and restated certificate of incorporation also permits the Company to secure insurance on behalf of any officer, director, employee or other agent for any liability arising out of his or her actions in such capacity, regardless of whether the amended and restated certificate of incorporation would permit such indemnification. These indemnification obligations are implicated with respect to the directors and officers of the Company named as defendants in the Federal Securities Action and Shareholder Derivative Actions described below, and could be implicated if any of the Company’s former officers are named as individual respondents in connection with the SEC investigation described below. Although the Company maintains insurance policies providing coverage for these types of matters, the Company’s insurance carriers may decline coverage, or the coverage may be insufficient to cover the Company’s expenses and liability.

Other contingencies

The Company is currently the subject of an investigation by the SEC with respect to restatements of its prior period financial statements that occurred in 2002. The Company has been cooperating fully with the SEC staff and intends to continue to do so. The Company may, however, become subject to a fine or other remedies in connection with the investigation and may be required to indemnify certain of its former officers for expenses incurred in connection with the SEC inquiry. The Company has incurred, and may continue to incur, significant additional legal expenses in connection with this investigation and the outcome of the SEC investigation may affect the course of the Federal Securities Action and the Shareholder Derivative Actions described below.

The Company, its former chief executive and chief financial officers and its current chief financial officer were defendants in a federal securities action (the Federal Securities Action) that was pending in the U.S. District Court for the District of Arizona. The Consolidated Amended Complaint (Complaint) filed in this Action alleged, among other things, that during the period from July 21, 2000 through October 24, 2002 the defendants made false and misleading statements and omissions of material facts and that the plaintiff and other members of a putative class of shareholders suffered damages as a result. This Complaint was dismissed by order of the Court on July 12, 2004. The plaintiffs appealed this order of dismissal to the Ninth Circuit Court of Appeals on August 11, 2004. At the request of the parties, the Court vacated the original briefing schedule of this appeal. The Court has not established a new briefing schedule.

The Company is a nominal defendant in two substantially identical shareholder derivative actions filed in the Superior Court of Arizona, Maricopa County in January 2003 (the Shareholder Derivative Actions). The complaints in these actions allege, among other things, that certain of the Company’s current and former directors named in the complaints as defendants breached their fiduciary duties to the Company in connection with certain alleged issues involving the Company’s accounting practices and internal controls. The complaints also name as a defendant the Company’s former external auditor. These actions were stayed pending the resolution of the motion to dismiss the Federal Securities Action that is discussed above and the parties are now considering the possible settlement of this litigation. The Company cannot, however, predict the ultimate outcome of these actions with certainty.

The Company, along with numerous other defendants, is a defendant in an action pending in the U.S. District Court for the Southern District of Florida. The complaint in this action alleges that the Company purchased motor vehicle records from the State of Florida and used that data for marketing and other purposes that are not permitted under

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the Federal Driver’s Privacy Protection Act. The plaintiffs are seeking liquidated damages of not less than $2,500 for each affected member of a purported class, plus costs and attorney’s fees. The plaintiffs are also asking for injunctive relief to prevent further alleged violations of the Federal Act. On March 11, 2004, the Company joined in a motion to dismiss this case filed by a co-defendant and the Company filed its own further motion to dismiss a portion of this case on June 23, 2004. On June 25, 2004 the Company filed a motion for summary judgment. All of these motions are pending before the court. The Company cannot predict whether the plaintiffs in this case will be successful in certifying their complaint as a class action. The Company believes that it has meritorious defenses with regard to the allegations made in this lawsuit and intends to vigorously defend this action.

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

Our Management’s Discussion and Analysis of our Financial Condition and Results of Operations (MD&A) begins with an executive overview of our business. This overview includes a description of our business goals, the business models for our segments, key events during the quarter ended September 30, 2004 and certain trends, risks and challenges. We then discuss our results of operations for the three and nine month periods ended September 30, 2004 compared to the three and nine month periods ended September 30, 2003. This is followed by a discussion of our liquidity and capital resources, including cash resources, sources and uses of cash and commercial commitments. You should read the description of our Critical Accounting Policies and Estimates in our Annual Report on Form 10-K for the year ending December 31, 2003 because understanding these policies and estimates is important in order to fully understand our reported financial results and our business outlook for future periods.

You should read the following discussion together with our condensed consolidated financial statements and the notes to those financial statements included in this Quarterly Report on Form 10-Q and our 2003 Annual Report on Form 10-K. In addition to historical information, this discussion contains “forward-looking statements” as defined in the U.S. Private Securities Litigation Reform Act of 1995. All forward-looking statements are subject to various risks and uncertainties that could cause our actual future results to differ materially from those presently anticipated due to a variety of factors, including those discussed in the risk factors and cautionary statements in Part II, Item 5 of this Quarterly Report on Form 10-Q.

EXECUTIVE OVERVIEW

Our Business

Our goal is to enable trusted commerce by delivering integrated information, payment and technology solutions that strengthen our customers’ overall profitability through increased revenue, reduced costs and improved operating efficiency and technology performance. Our principal focus is on issuers of transaction accounts, such as financial institutions, financial services companies, electronic funds transfer networks, retailers, government agencies, telecommunications companies and other businesses. In evaluating our financial condition and operating results, our management focuses on revenues, operating income, return on invested capital and cash flows.

We currently deliver our information, payment and technology solutions through four basic business units and through combinations of the products and services offered by these units. Our most profitable business segments are Electronic Payments and Risk Management, although our Global Outsourcing and Automated Teller Machine (ATM) Management segments also contribute to our overall value proposition.

On September 20, 2004, we entered into a definitive agreement (the Agreement) to sell the ATM machines and merchant contracts (the ATM Portfolio) associated with our ATM Management segment. The consummation of this transaction is subject to customary closing conditions and is currently expected to occur during the fourth quarter of 2004. The ATM Portfolio represents a significant component of our ATM Management segment, and we do not expect to present the ATM Management segment as a separate operating segment in periods subsequent to the closing of this transaction. Amounts received by us that exceed the recorded book value of the ATM Portfolio will be deferred and recognized as revenues over the five year term of the Master Services Agreement discussed below.

Concurrently with the execution of the Agreement, we entered into a five year Master Services Agreement with the buyer of the ATM Portfolio that is to become effective upon the closing of the transactions contemplated by the Agreement. Pursuant to the Master Services Agreement, we will provide processing, help desk, monitoring and other ATM management services to the buyer. The processing service revenues and related costs will be reported within our Electronic Payments segment and the ATM management service revenues and related costs will be reported within our Global Outsourcing segment. We expect a significant reduction in revenues and the related controllable costs upon consummation of the sale of the ATM Portfolio because the revenues we expect to receive from the Master Services Agreement, including amounts recognized from the amortization of the gain on the ATM Portfolio sale, are not expected to initially exceed 15% of the revenues previously generated by the ATM Portfolio.

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One of our goals is to enhance our ability to market and sell comprehensive solutions incorporating multiple elements of the products and services offered by our business lines to our customers. The business model of each of our segments is summarized below.

Electronic Payments

This segment derives its revenue based upon our customers’ needs to process electronic transactions. The majority of this segment’s revenue is derived from processing debit transactions that originate at an ATM or point-of-sale device. We also derive revenue from providing electronic benefit transfer (EBT) services for government agencies. The remaining revenue from this segment is derived from the licensing and maintenance of the electronic funds transfer (EFT) software that our customers use to process electronic debit transactions. The provision of EFT processing services requires substantial capital investment for computers and related peripherals, maintenance, system modifications and upgrades, security and redundancy. Although these requirements add barriers to competitive entrance, they also create a relatively high ratio of fixed operating costs to total costs. Processors are also required to maintain significant cash reserves to cover temporary imbalances in the flow of funds associated with electronic funds transfers. Additionally, the software applications used for processing at our data centers and which we license to our software customers are primarily developed in-house and require frequent compliance updates and competitive upgrades, creating a dependence upon experienced and qualified information technology (IT) personnel. Other operating expenses include telecommunications costs to support the transmission of electronic debit transactions and settlement. When evaluating the performance of this business, we focus primarily on increasing its recurring revenue base through, among other things, the retention of our current EFT and EBT processing customers and the acquisition of new processing relationships. Expanding our software sales and establishing a processing presence in foreign markets are also areas of management emphasis.

Risk Management

This segment derives its revenue from database inquiries primarily from financial institutions and retailers seeking to comply with regulations or mitigate the risk associated with accepting checks, providing credit or opening debit accounts for new consumers. Revenue from financial institutions represented the majority of this segment’s revenue during the three and nine month periods ended September 30, 2004, and the balance of the segment’s revenue was derived from retail customers using our check verification service. Operating costs generally include data acquisition costs, the cost of technology, regulatory compliance infrastructure and customer support centers. Our primary efforts in managing this business are directed towards increasing its revenues by improving customer usage rates and expanding our product suite and customer set.

Global Outsourcing

Our global outsourcing business derives its revenues from the need of companies to remain competitive by reducing costs while maintaining or improving service levels. Revenues in this segment can be from a variety of business process outsourcing (BPO) services (such as transaction account acquisition, credit card operations, brokerage support, customer support, credit decisioning, loan operations and collections) and IT outsourcing. Operating costs in this segment are primarily related to employee expense, telecommunications costs and facilities costs. Our principal goal for this business is to expand its customer base in our core target markets of financial services, retail and telecommunications companies.

ATM Management

Our ATM Management segment derived its revenues from the use, sale, branding and management of ATMs. Surcharge and interchange revenue represented the majority of our revenue from this segment during the three and nine month periods ended September 30, 2004. Equipment sales were non-recurring and, along with branding fees, represented a minority of the revenue in this segment. Operating costs in this segment primarily included processing and telecommunication costs, the cost of the equipment we sold and the residual payments we made to the merchants where the ATMs we managed were deployed. As noted above, we entered into a definitive agreement to sell certain assets and ownership interests of the ATM Management segment during the third quarter.

Key Events During the Three Months Ended September 30, 2004

•

We entered into a definitive agreement to sell the ATM Portfolio and a five year Master Services Agreement under which our Electronic Payments and Global Outsourcing segments will provide ATM processing and management services to the buyer.

•

We reached record levels of inquiry volumes in our Risk Management segment.

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•

The District Court in Arizona dismissed a federal securities class action lawsuit filed against us and the plaintiffs in this case appealed this decision to the Ninth Circuit Court of Appeals.

•

Richard J. Lehmann and William J. Ryan joined our Board of Directors.

•

Oasis Technology Ltd. continued to incur operating losses and has not performed up to the original expectations developed during our acquisition of this Company.

Trends

Our strategic planning and forecasting processes include the consideration of economic, industry-wide and Company specific trends that may impact our customers, competitors and operations. We identify the more material positive and negative trends affecting our business below:

•

increased fraud and identity theft and regulatory requirements are driving an increasing need for risk management products;

•

consolidation in industries we serve is resulting in increasing competition and pricing pressures;

•

we are seeing an improving pipeline and volume growth in our electronic payment processing business;

•

increased outsourcing as a means to control costs is driving a demand for offshore outsourcing services as well as an increased level of interest in developing expanded offshore capabilities by industry participants;

•

the use of offshore outsourcing services continues to be a point of political debate;

•

a continued shift in the mix of payment mechanisms toward debit transactions is driving a need for electronic payment solutions and associated risk management services;

•

we have not been successful in obtaining new EBT contracts and expect our revenues from this business to begin to decline in 2005;

•

the demand from financial institutions for access to surcharge free ATMs is increasing;

•

our revenues from existing IT outsourcing customers continue to decline;

•

the rate of new ATM deployment and per ATM transaction volumes in the United States is declining;

•

there continues to be a migration from the use of traditional paper checks to electronic payments;

•

the independent ATM management industry is consolidating;

•

the market for EFT software is soft and sales in this area currently relate more to product enhancements, customization and maintenance rather than new software sales;

•

ATM markets outside the United States are growing; and

•

our India operations continue to experience pressure on compensation costs as competition increases.

Risks and Challenges

In addition to the trends affecting our industry and our Company as noted above, we consider risks and challenges that could impact the Company’s future financial results, including the following and those described in Part II, Item 5, “Risk Factors and Cautionary Statements”:

•

We are unable to predict the results of the investigation by the SEC, the stockholders litigation or the purported class action litigation filed in Florida.

•

Our business may be adversely affected if the proposed sale of our ATM Portfolio is not completed.

•

Estimates of future financial results are inherently unreliable.

•

Consolidation in the industries we serve may adversely affect our ability to sell our products and services.

•

Our ability to expand through acquisitions involves risks and may not be successful.

•

We face intense competition in all areas of our business, and if we do not compete effectively, our business will be harmed.

•

If we experience system failures, the products and services we provide to our customers could be delayed or interrupted, which could harm our business and reputation and result in the loss of customers.

•

Our sales of IT services have been declining and our largest IT services contract has been extended on less favorable terms than the original contract.

•

Legislation or regulation could harm our ability to collect and use data, increase our operating costs or otherwise harm our business.

•

If the security of our databases is compromised, our reputation could suffer and customers may not be willing to use our products and services.

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•

We may experience software defects, development delays and installation difficulties, which would harm our business and reputation and expose us to potential liability.

•

There are a number of risks associated with our international sales and operations that could harm our business.

•

Changes in Indian tax laws could adversely affect our results of operations.

•

We face termination and compliance risks with respect to our government contracts and we expect our revenues from this business to decline in upcoming periods.

•

We may be unable to protect our intellectual property rights.

•

Provisions in our charter documents and Delaware law may delay or prevent a change in control.

RESULTS OF OPERATIONS

The following table presents our condensed consolidated financial results for the three and nine month periods ended September 30, 2004 and 2003:

*

Represents an increase or decrease in excess of 100%.

Net Revenue

Net revenue by reportable segment and for the Company as a whole for the three and nine month periods ended September 30, 2004 and 2003 was as follows:

(1)

Amounts do not sum due to rounding.

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In conjunction with our enhanced segment revenue presentation, customer reimbursed fees have been included in the related product lines within the Electronic Payments and Global Outsourcing segments. Amounts in prior periods have been reclassified to conform with this presentation.

Electronic Payments

The increase in the Electronic Payments segment revenues during the three and nine months ended September 30, 2004 as compared to the same periods in 2003 is due to:

•

an increase in EFT processing revenues resulting from higher transaction volumes and customer reimbursed fees;

•

an increase in EBT processing revenues from new contracts that commenced primarily during the second and third quarter of 2003; and

•

an increase in software revenues from open systems software sales attributable to our acquisition of Oasis Technology Ltd. in November 2003.

The following table provides further detail regarding the revenue we generated from our software business during the periods indicated:

We expect the total revenues from our Electronic Payments segment to be higher in 2004 as compared to 2003 due to increased volumes from our existing financial institution processing customers, our success in securing new financial institution customers and higher software sales. Additionally, we expect revenues generated through EBT contracts that began in 2003 will contribute to the increase in revenues in 2004. Although we continue to pursue new EBT contracts, we cannot predict whether our bids will be successful and, in any event, we expect the revenues we receive from EBT activities to begin to decline due to scheduled contract expirations in future periods. We expect this trend to begin in 2005.

Risk Management

An increase in ChexSystems(SM) transaction volumes associated with new debit account openings resulted in an improvement in our financial institution product revenues of 10% and 13% during the three and nine month periods ended September 30, 2004, respectively, as compared to the same periods in 2003. The increase in revenues from our financial institution products was partially offset by declines in revenues from our retail check verification customers during the three and nine months ended September 30, 2004 due to price concessions and customer attrition. Revenues from our Risk Management segment are expected to be higher in 2004 as compared to 2003 due to increased demand for our financial institution products and services offset somewhat by lower retail products revenues due to the impact of price concessions and customer attrition. We expect that future revenues from our retail products will be relatively flat.

Global Outsourcing

Revenues from our outsourcing business increased during the three and nine months ended September 30, 2004 as compared to the same periods in 2003 due to an increase in BPO service volumes and the impact of new BPO client contracts that commenced subsequent to the third quarter of 2003. The increase in BPO revenues was partially offset by decreases in our IT services revenues. We continue to focus on obtaining revenue growth in our BPO business by establishing new client relationships and through an expansion of the services provided to our existing clients. For the full year 2004, we expect net revenue from our Global Outsourcing segment will increase as compared to 2003 because of growth in our BPO business.

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ATM Management

The decrease in the revenues we received from our ATM business during the three and nine month periods ended September 30, 2004 as compared to the same periods in 2003 is due to a general decline in transaction volumes. The revenues for this segment are expected to decline for the full year 2004 as compared to 2003 due to the anticipated completion of the ATM Portfolio sale in the fourth quarter and lower transaction volumes.

Business Segment Margin Contributions

The following table presents our operating income (loss) by segment and total operating income for the three and nine month periods ended September 30, 2004 and 2003:

*

Represents an increase or decrease in excess of 100%.

Electronic Payments

The decline in margins during the three and nine months ended September 30, 2004 as compared to the same periods in 2003 is primarily due to the favorable impact of a $2.3 million reduction of a loss contract provision during the third quarter of 2003. There was no similar benefit recorded in 2004. Also contributing to the decline in margins was an increase in our fixed costs associated with our acquisition of Oasis Technology in November 2003. The decrease in margins was somewhat offset by improvements in our EFT processing and EBT revenues during the quarter and nine months ended September 30, 2004 as compared to the same periods in 2003. Operating margins for the Electronic Payments segment for 2004 are expected to be lower than those seen in 2003 due to a smaller proportion of the revenues from this business being derived from software license fees and the absence of the loss contract reversals we recorded in 2003. We continue to focus on reducing expenses associated with our open systems software product line in order to improve the operating margins of this segment.

Risk Management

We achieved higher margins in our Risk Management segment during the three and nine months ended September 30, 2004 as compared to the same periods in 2003 from an increase in ChexSystems(SM) revenues and a reduction in costs through the utilization of our India operations for contact center and software development work. We expect that cost reductions and higher transaction volumes from our ChexSystems(SM) products will result in higher margins for this segment in 2004 as compared to 2003.

Global Outsourcing

The margins for our global outsourcing business improved during the three and nine months ended September 30, 2004 as compared to the same periods in 2003 due to an increase in BPO revenues and from cost reductions related to increased productivity and capacity utilization. We expect that margins in this business will increase in 2004 as compared to 2003 due to increased BPO revenues, continued cost reductions and increased shortfall fees under our primary IT services contract that will be recognized in the fourth quarter of 2004. We have recently amended our primary IT services contract to extend its scheduled expiration date of March 31, 2005 by one year. There are, however, no minimum spending targets associated with this extension period. We expect that the revenues we receive from this contract will continue to decline.

ATM Management

The decline in operating margins in this segment during the third quarter of 2004 as compared to the third quarter of 2003 is due to the decrease in processing revenues resulting from lower transaction volumes. The increase in operating margins during the nine month period ended September 30, 2004 as compared to the same period in 2003 is attributable to cost reduction efforts. We expect that the operating margins for the ATM Management segment for the full year 2004 will be consistent with the 2003 operating margins.

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Corporate

Unallocated corporate overhead includes, among other things, the cost of executive leadership, investor relations, shared legal, consulting, accounting and finance functions and certain technology expenses. Corporate expenses during the three and nine months ended September 30, 2003 were unusually low due to benefits from reductions in telecommunication costs and other certain non-recurring cost reductions specific to those periods in 2003. We did not experience a similar level of cost reductions during the three and nine months ended September 30, 2004. Corporate overhead costs incurred for the remainder of 2004 are expected to be generally consistent with the costs experienced during the first nine months of 2004.

Operating Expenses

Operating expenses for the three and nine months ended September 30, 2004 and 2003 were as follows: