UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

 

(Mark One)

 

ý		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
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

Commission file number 000-23195

 

TIER TECHNOLOGIES, INC.

(Exact name of Registrant as specified in its charter)

 

 

 

10780 Parkridge Blvd., 4^th Floor

Reston, Virginia 20191

(Address of principal executive offices)

 

Not applicable

(Former name, former address, and former fiscal year, if changed since last report)

 

(571) 382-1090

(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.

 

(1) Yes ý No o

(2) Yes ý No o

 

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

 

(1) Yes ý No o

 

As of July 30, 2004, the number of shares outstanding of the Registrant’s Class A Common Stock was 160,000 and the number of shares outstanding of the Registrant’s Class B Common Stock was 19,182,491.

 

 

TIER TECHNOLOGIES, INC.

 

FORM 10-Q

 

TABLE OF CONTENTS

 

		Page
Part I—FINANCIAL INFORMATION
Item 1.	Condensed Consolidated Financial Statements (unaudited)
	Condensed Consolidated Balance Sheets as of June 30, 2004 and September 30, 2003.	3
	Condensed Consolidated Statements of Operations for the three and nine months ended June 30, 2004 and 2003.	4
	Condensed Consolidated Statements of Cash Flows for the nine months ended June 30, 2004 and 2003	5
	Notes to Condensed Consolidated Financial Statements.	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations.	18
Item 3.	Quantitative and Qualitative Disclosures About Market Risk.	42
Item 4.	Controls and Procedures.	42
Part II—OTHER INFORMATION
Item 1.	Legal Proceedings	43
Item 6.	Exhibits and Reports on Form 8-K.	44
Signature		45

 

Private Securities Litigation Reform Act Safe Harbor Statement

 

Certain statements contained in this report, including statements regarding the development of and demand for our services and our markets, anticipated trends in various expenses, expected costs of legal proceedings and other statements that are not historical facts, are forward-looking statements within the meaning of the federal securities laws. These forward-looking statements relate to future events or our future financial and/or operating performance and can generally be identified as such because the context of the statement will include words such as “may”, “will”, “intends”, “plans”, “believes”, “anticipates”, “expects”, “estimates”, “shows”, “predicts”, “potential”, “continue”, or “opportunity”, the negative of these words or words of similar import. These forward-looking statements are subject to risks and uncertainties, including the risks and uncertainties described and referred to under “Factors That May Affect Future Results” beginning on page 31, that could cause actual results to differ materially from those anticipated as of the date of this report.

 

2

 

PART I.   FINANCIAL INFORMATION

 

ITEM 1.   FINANCIAL STATEMENTS

 

TIER TECHNOLOGIES, INC.

 

CONDENSED CONSOLIDATED BALANCE SHEETS

(unaudited)

(in thousands)

 

		June 30, 2004			September 30, 2003
ASSETS
Current assets:
Cash and cash equivalents		$	32,929		$	26,178
Short-term investments		4,199			5,492
Accounts receivable, net		19,503			20,024
Unbilled receivables		2,753			7,872
Assets of discontinued operations		682			3,550
Prepaid expenses and other current assets		4,350			4,602
Total current assets		64,416			67,718
Equipment and software, net		6,656			5,422
Notes and accrued interest receivable from related parties, less current portion		2,339			2,152
Goodwill		43,115			29,625
Other acquired intangible assets, net		29,720			24,832
Long-term investments		22,346			24,883
Restricted investments		7,540			7,707
Non-current assets of discontinued operations		—			760
Other assets		3,084			1,875
Total assets		$	179,216		$	164,974
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	1,993		$	2,087
Accrued liabilities		10,370			8,476
Accrued subcontractor expenses		5,121			5,494
Accrued compensation and related liabilities		4,751			3,654
Income taxes payable		4,410			—
Deferred revenue		3,413			3,299
Liabilities of discontinued operations		307			2,043
Current portion of long-term debt		114			150
Total current liabilities		30,479			25,203
Long-term debt, less current portion		118			195
Non-current liabilities of discontinued operations		12			432
Other liabilities		4,023			994
Total liabilities		34,632			26,824
Commitments and contingencies
Shareholders’ equity:
Common stock, no par value		171,567			164,742
Notes receivable from shareholders		(1,773		)	(1,773		)
Accumulated other comprehensive loss		(330		)	(350		)
Accumulated deficit		(24,880		)	(24,469		)
Total shareholders’ equity		144,584			138,150
Total liabilities and shareholders’ equity		$	179,216		$	164,974

 

See Notes to Condensed Consolidated Financial Statements

 

3

 

TIER TECHNOLOGIES, INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

(in thousands, except per share data)

 

		Three Months Ended June 30,						Nine Months Ended June 30,
		2004			2003			2004			2003
Net revenues		$	40,733		$	42,719		$	96,902		$	101,970
Costs and expenses:
Direct costs		28,111			30,878			65,479			69,193
Selling and marketing		2,003			1,540			5,136			4,394
General and administrative		6,951			5,756			19,543			16,966
Restructuring charges		1,847			—			3,108			—
Depreciation and amortization		1,160			1,258			3,398			4,022
Income from continuing operations		661			3,287			238			7,395
Interest income (expense), net		305			250			875			924
Income from continuing operations before income taxes		966			3,537			1,113			8,319
Provision for income taxes		35			1,352			105			3,145
Income from continuing operations, net of income taxes		931			2,185			1,008			5,174
Income (loss) from discontinued operations, net of income taxes		(17		)	(58		)	(1,418		)	258
Net income (loss)		$	914		$	2,127		$	(410	)	$	5,432
Income from continuing operations, net of income taxes:
Per basic share		$	0.05		$	0.12		$	0.05		$	0.27
Per diluted share		$	0.05		$	0.12		$	0.05		$	0.27
Income (loss) from discontinued operations, net of income taxes:
Per basic share		$	—		$	—		$	(0.08	)	$	0.01
Per diluted share		$	—		$	—		$	(0.07	)	$	0.01
Net income (loss):
Per basic share		$	0.05		$	0.11		$	(0.02	)	$	0.29
Per diluted share		$	0.05		$	0.11		$	(0.02	)	$	0.28
Shares used in computing basic income (loss) per share		19,030			18,600			18,846			18,829
Shares used in computing diluted income (loss) per share		19,513			18,821			19,229			19,343

 

See Notes to Condensed Consolidated Financial Statements

 

4

 

TIER TECHNOLOGIES, INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

(in thousands)

 

		Nine Months Ended June 30,
		2004			2003
Operating activities
Income from continuing operations, net of income taxes		$	1,008		$	5,174
Adjustments to reconcile income from continuing operations, net of income taxes to net cash from continuing operations provided by operating activities:
Asset impairment charge		571			—
Depreciation and amortization		5,081			5,657
Provision for doubtful accounts		482			578
Tax benefit of stock options exercised		—			200
Stock options revision charge		552			—
Forgiveness of notes receivable from employees		8			40
Change in operating assets and liabilities, net of effects of business combinations:
Accounts receivable		4,891			(5,520		)
Prepaid expenses and other assets		(806		)	(431		)
Accounts payable and accrued liabilities		8,692			(899		)
Deferred revenue		(906		)	(256		)
Net cash from continuing operations provided by operating activities		19,573			4,543
Investing activities
Purchase of equipment and software		(2,605		)	(1,407		)
Notes and accrued interest receivable from related parties		(259		)	(201		)
Repayments on notes and accrued interest receivable from related parties		62			15
Business combinations, net of cash acquired		(15,613		)	286
Purchases of available-for-sale securities		(16,593		)	(24,803		)
Sales of available-for-sale securities		—			5,989
Maturities of available-for-sale securities		20,198			17,431
Other assets		27			(2		)
Net cash from continuing operations used in investing activities		(14,783		)	(2,692		)
Financing activities
Borrowings under bank line of credit		2,200			—
Repayment under bank line of credit		(2,200		)	—
Net proceeds from issuance of Class B common stock		1,826			1,400
Repurchase of Class B common stock		—			(6,665		)
Payments on capital lease obligations and other financing arrangements		(113		)	(412		)
Net cash from continuing operations provided by (used in) financing activities		1,713			(5,677		)
Net cash provided by (used in) continuing operations		6,503			(3,826		)
Net cash provided by (used in) discontinued operations		248			(1,450		)
Net increase (decrease) in cash and cash equivalents		6,751			(5,276		)
Cash and cash equivalents at beginning of period		26,178			40,609
Cash and cash equivalents at end of period		$	32,929		$	35,333
Supplemental disclosures of cash flow information
Cash paid during the period for:
Interest		$	37		$	44
Income taxes paid (refunded), net		$	(7,022	)	$	2,680
Supplemental disclosures of non-cash transactions
Equipment acquired under capital lease obligations and other financing arrangements		$	—		$	68
Conversion of Class A common stock to Class B common stock		$	761		$	—
Class B common stock issued in business combination		$	4,447		$	—

 

See Notes to Condensed Consolidated Financial Statements

 

5

 

TIER TECHNOLOGIES, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

NOTE 1—BASIS OF PRESENTATION

 

The accompanying condensed consolidated financial statements of Tier Technologies, Inc. (‘‘Tier’’ or the ‘‘Company’’) include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation. In the opinion of management, the condensed consolidated financial statements reflect all normal and recurring adjustments, which are necessary for a fair presentation of the Company’s financial position, results of operations and cash flows as of the dates and for the periods presented. The condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information. Consequently, these statements do not include all the disclosures normally required by generally accepted accounting principles for annual financial statements nor those normally made in the Company’s Annual Report on Form 10-K. Accordingly, reference should be made to the Company’s Form 10-K filed on December 19, 2003 and other reports the Company has filed with the Securities and Exchange Commission for additional disclosures, including a summary of the Company’s accounting policies, which have not materially changed. The consolidated results of operations for the nine months ended June 30, 2004 are not necessarily indicative of results that may be expected for the fiscal year ending September 30, 2004 or any future period, and the Company makes no representations related thereto.

 

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities and the results of operations during the reporting period.  Although management believes that the estimates and assumptions used in preparing the accompanying condensed consolidated financial statements and related notes are reasonable in light of known facts and circumstances, actual results could differ materially from those estimates.

 

Certain reclassifications have been made to the prior period financial statements to conform to the current period presentation.

 

 

NOTE 2—REVENUE RECOGNITION

 

The Company derives net revenues from three principal delivery offerings:  transaction and payment processing, systems design and integration, and maintenance and support services.  Net revenues include software license revenues and reimbursements from clients for out-of-pocket expenses.  Neither software license nor reimbursements revenues were greater than 10% of total net revenues for each period included in these condensed consolidated financial statements.

 

Transaction and Payment Processing – Transaction and payment processing revenues are recorded in accordance with Staff Accounting Bulletin (“SAB”) 104, Revenue Recognition. Transaction processing revenues include revenues recorded at the Company’s child support payment processing centers and the revenues of the Company’s Electronic Payment Processing (“EPP”) segment.  The EPP segment includes revenues from two wholly-owned subsidiaries of the Company:  all revenues from Official Payments Corporation (“OPC”) and the electronic processing revenues of EPOS Corporation (“EPOS”), an Alabama corporation acquired effective June 1, 2004.  These revenues are based upon a per-transaction fee or a percentage of the dollar amount processed and are recognized each month based on the number of transactions performed and dollar amount processed in that month after the Company has received a signed contract, the price per transaction or fee percentage is fixed according to the contract, and collectibility is reasonably assured. The Company assesses the probability of collection based upon the client’s financial condition and prior payment history.  For EPP, transaction fees are generally borne by the consumer utilizing our services, not the governmental or other entity. EPP receives real-time authorization for credit and debit card transactions, which ensures availability of cardholder funds for payment.  Revenues for EPOS are included only from the date of acquisition.

 

Systems Design and Integration - Systems design and integration includes software application license revenues and software development and systems integration service revenues to develop applications to enhance our clients’ operating functionality.

 

6

 

License and services revenues for contracts involving significant modification, customization or services which are essential to the functionality of the software are recognized over the period of each engagement, using the percentage-of-completion method of Statement of Position 81-1 “Accounting for the Performance of Construction Type and Certain Production Type Contracts.” The ratio of costs incurred to total estimated project costs is used as the measure of progress towards completion.  Due to the long-term nature of these contracts, estimates of total project costs are subject to changes over the contract term. A provision for a loss contract on an engagement is made in the period in which the loss becomes probable and can be reasonably estimated.  If the loss cannot be reasonably estimated, a zero profit methodology is applied to the contract whereby the amount of revenue recognized is limited to the amount of costs until such time, as the total loss can be estimated. Advance payments from clients and amounts billed to clients in excess of revenue recognized are recorded as deferred revenue. Amounts recognized as revenue in advance of contractual billing are recorded as unbilled receivables. Revenues recognized under the percentage-of-completion method were $9,743,000 and $22,022,000 for the nine months ended June 30, 2004 and 2003, respectively.

 

Where costs are incurred related to an unapproved change order, the costs are deferred until the change order is approved provided that the Company believes it is probable that the cost will be recovered through a change in the contract price. Included in prepaid and other assets at June 30, 2004 and September 30, 2003 were $0 and $34,000, respectively, of deferred costs related to change orders not yet approved.

 

Revenues from software license fees not requiring significant modification are recognized in accordance with Statement of Position 97-2, “Software Revenue Recognition.” Revenues from license fees are recognized when persuasive evidence of an agreement exists, delivery of the software has occurred, no significant Company obligations with regard to implementation or integration exist, the fee is fixed or determinable and collectibility is probable. Arrangements for which the fees are not deemed probable for collection are recognized upon cash collection.  Arrangements for which the fees are not deemed fixed or determinable are recognized on the earlier of the due date or when payment is received.  Revenues from software license fees not requiring significant modification were $370,000 and $56,000 for the nine months ended June 30, 2004 and 2003, respectively.

 

For license arrangements with multiple obligations (for example, undelivered maintenance and support), the Company allocates revenues to each component of the arrangement using the residual value method of accounting based on the fair value of the undelivered elements, which is specific to the Company.  Fair value for the maintenance and support obligations for software licenses is based upon the specific sale of renewals to customers or upon renewal rates quoted in the contracts.

 

Under the terms of its license agreements, the Company does not offer return rights or price protection.  Therefore, no provisions have been made for sales returns.  For its proprietary software, the Company offers routine, short-term warranties that its software will operate free of material defects and in conformity with written documentation.  Under these agreements, if the Company has an active maintenance agreement with the customer, the Company accounts for any obligation in conformity with Statement of Financial Accounting Standards No. 5, “Accounting for Contingencies.”  If the Company does not have a maintenance contract in place, the warranty is considered implied maintenance and the Company defers the amount of revenues consistent with the fair value of other maintenance and support obligations.

 

Maintenance and Support Services – The Company provides ongoing maintenance and support services. Maintenance revenue is deferred and recognized on a straight-line basis as services revenue over the life of the related contract, which is typically one year.  Non-essential support services, including training and consulting, are also typically provided on a time and materials basis and revenue is recognized as the services are performed. Revenue is recognized after a contract is signed which indicates a fixed or determinable price and the Company believes, based upon its assessment of the customer’s financial condition that collection is reasonably assured.

 

Multiple Elements Arrangements – The Company has several engagements that provide a combination of services from several delivery offerings as part of the overall project.  For these multiple element arrangements, the Company

 

7

 

allocates revenue to each element based on the fair value of the delivery offering.  In establishing fair value, the Company uses prices charged on similar contracts.  For multiple element arrangements entered into beginning July 1, 2003, the Company has followed the provisions of Emerging Issues Task Force Issue 00-21, “Revenue Arrangements with Multiple Deliverables” (EITF 00-21).  For these multiple element arrangements, the Company accounts for each unit of the contract as a separate unit when each unit provides value to the customer on a stand-alone basis and there is objective evidence of the fair value of the stand-alone unit.  The implementation of EITF 00-21 did not have a material effect on the Company’s recognition of revenue.

 

 

NOTE 3—CUSTOMER CONCENTRATION AND RISK

 

The Company derives a significant portion of its net revenues from a limited number of clients. For the three months ended June 30, 2004 and 2003, revenue from one client totaled approximately $9,713,000 and $12,246,000, respectively, which represented 23.8% and 28.7%, respectively, of total net revenues.  In both comparative three month periods, the revenues from this client represented the highest concentration in any quarter during the respective fiscal years.  For the nine months ended June 30, 2004 and 2003, revenues from the same client totaled approximately $13,303,000 and $15,637,000, respectively, which represented 13.7% and 15.3%, respectively, of total net revenues.

 

The Company’s contracts with government agencies typically include a termination for convenience clause.  The termination for convenience clause provides the agency with the right to terminate a contract, in whole or in part, for any reason deemed to be in the public’s best interest.  Each contract has specific remedies under a termination for convenience that generally provide a settlement claim which includes costs relating or allocable to the terminated contract, including settlement expenses and a reasonable profit. The Company’s contracts with government agencies also typically provide for termination for cause when either party endangers the performance in the contract.

 

The Company has several large accounts receivable and unbilled receivable balances, and any dispute, early contract termination or other collection issues could have a material adverse impact on its financial condition and results of operations.  Unbilled receivables were $2,753,000 and $7,872,000 at June 30, 2004 and September 30, 2003, respectively.  Amounts will become billable upon completion of project milestones or customer acceptance. The entire unbilled receivables balance as of June 30, 2004 and September 30, 2003 was expected to become billable within one year.   At June 30, 2004, two clients accounted for 52.6% and 35.6% of total unbilled receivables and 8.4% and 23.7%, of total net accounts receivable and unbilled receivables.  An additional client accounted for 11.7% of total net accounts receivable and unbilled receivables at June 30, 2004.  At September 30, 2003, three clients accounted for 44.2%, 25.0% and 20.3% of total unbilled receivables and 20.1%, 16.3% and 7.2% of total net accounts receivable and unbilled receivables.

 

On August 25, 2003, the Company received a notice of termination for default of a significant contract with the California Public Employees Retirement System (“CalPERS”). The Company recorded $12,831,000 in September 2003 as a revenue reversal on this loss contract for amounts unbilled and uncollected as of the date of termination. The Company also wrote-off $532,000 in deferred costs in September 2003 related to change orders that were being negotiated at June 30, 2003.  From inception through June 30, 2003, the Company had recorded revenue under the percentage-of-completion method of $20,340,000 under the terms of the contract and collected $7,508,000 in cash including $985,000 in July 2003. No revenues were recognized in connection with this contract for the nine months ended June 30, 2004.  The Company filed a lawsuit to overturn the termination of the contract for default and to recover all uncollected unbilled receivables, delay, disruption and interference costs, attorneys’ fees and other costs associated with the contract.  On August 4, 2004, the Company and CalPERS reached an agreement in a judicially supervised settlement conference before the Sacramento Superior Court wherein CalPERS withdrew the termination for default and the parties rescinded the contract.  The parties also mutually released each other from any and all claims arising out of the contract.  The parties are in the process of preparing a written settlement agreement  (See Note 14).

 

8

 

Included in other assets at June 30, 2004 was approximately $2,395,000, which represented balances billed but not paid by clients under retainage provisions in the contracts, of which approximately $2,358,000 was expected to be collected within two years, and $37,000 was expected to be collected within four years. Included in accounts receivable and other assets at September 30, 2003 was approximately $1,448,000 of retainage of which approximately $461,000 was expected to be collected within one year, $430,000 was expected to be collected within two years and $557,000 was expected to be collected within three years.

 

NOTE 4—LONG-TERM INVESTMENTS

 

Investments with maturities greater than 12 months as of the balance sheet date are classified as long-term investments.  These long-term investments are categorized by the Company as available-for-sale and are recorded at amounts that approximate fair value based on quoted market prices and are primarily comprised of state and local municipalities’ debt readily traded on over-the-counter markets.  Unrealized gains and losses on these investments were not material and there were no other-than-temporary impairments to these investments.

 

Restricted investments were approximately $7,540,000 and $7,707,000 at June 30, 2004 and September 30, 2003, respectively, and were pledged in connection with performance bonds and real estate operating leases and will be restricted for the terms of the project performance periods and lease periods, the latest of which is estimated to be through June 2005.

 

NOTE 5—BANK LINES OF CREDIT

 

At June 30, 2004, the Company had a $15,000,000 revolving credit facility, all of which may be used for letters of credit.  The credit facility has a maturity date of January 31, 2005.  The credit facility is collateralized by first priority liens and security interests in the Company’s assets. Interest is based on either the adjusted LIBOR rate plus 2.25% or the lender’s announced prime rate at the Company’s option, and is payable monthly.  As of June 30, 2004, there was approximately $985,000 of standby letters of credit outstanding under this facility.  Among other provisions, the credit facility requires the Company to maintain certain minimum financial ratios. As of June 30, 2004, the Company was in compliance with all of the financial ratios of the credit facility.

 

One of the standby letters of credit outstanding under the credit facility was issued in April 2004 in the amount of $935,000, and was used to guarantee the performance bond of a third party required by a project contract that is anticipated to be completed in August 2005.  In conjunction with this guarantee, the Company entered into an indemnification agreement with the third party which pledges to hold harmless, indemnify and make the Company whole from and against any and all amounts actually claimed or withdrawn as well as other business consideration.  In accordance with Financial Accounting Standards Board (“FASB”) Interpretation No. 45 (“FIN 45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others”, the Company recorded a liability for the fair value of $935,000 in accrued liabilities and an equal receivable in prepaid expenses and other current assets.  The recorded amounts will be eliminated if the Company is released from the risk upon expiration or settlement of the obligation.

 

In addition to the letters of credit issued under the credit facility, the Company had letters of credit totaling approximately $3,151,000, which were collateralized by certain securities in the Company’s long-term investment portfolio at June 30, 2004.  Also, the Company’s subsidiary, OPC, had a letter of credit outstanding in the amount of approximately $138,000 collateralized by a certificate of deposit.  The majority of these letters of credit were issued to secure performance bonds and to meet various facility lease requirements.

 

9

 

NOTE 6—GOODWILL AND OTHER ACQUIRED INTANGIBLE ASSETS

 

As of October 1, 2002, the Company adopted Statement of Financial Accounting Standard No. 142 (“SFAS 142”), “Goodwill and Other Intangible Assets” and ceased amortizing goodwill. The Company completed initial impairment tests in accordance with SFAS 142 in the first quarter of fiscal year 2003.  Results of the initial impairment tests did not indicate any impairment loss.  Impairment tests involve the use of estimates related to the fair market values of the business operations with which goodwill is associated.  Losses, if any, resulting from the annual impairment tests will be reflected in operating income in the statement of operations. During the fourth quarter of fiscal year 2003, the Company decided to shut down the U.S. Commercial Services segment and the United Kingdom Operations segment and accordingly recorded a restructuring charge of $17,646,000 to write-off substantially all of the associated goodwill.  As of September 30, 2003, the remaining fair market value of the goodwill associated with these segments totaled $457,000. The fair market value was determined by estimating the expected margin on the remaining contracts in these segments.

 

During the nine months ended June 30, 2004, the Company wrote-off the remaining $457,000 of goodwill associated with the U.S. Commercial Services segment in discontinued operations as a result of the fulfillment of the remaining contracts in the quarter ended December 31, 2003.  In the fourth quarter of fiscal year 2003, the Company performed its annual impairment test to determine if the goodwill associated with its remaining segments was impaired.  The results did not indicate any impairment loss for the remaining segments.

 

Other acquired intangible assets, net, consisted of the following at June 30, 2004 and September 30, 2003 (in thousands):

 

		Amortization Period		June 30, 2004									September 30, 2003
				Gross			Accumulated Amortization			Net			Gross			Accumulated Amortization			Net
Client relationships		10 years		$	24,400		$	(4,677	)	$	19,723		$	24,400		$	(2,847	)	$	21,553
Tradename		10 years		3,200			(613		)	2,587			3,200			(373		)	2,827
Technology		3 years		740			(473		)	267			740			(288		)	452
Acquired assets, related to EPOS acquisition		5 years		7,206			(120		)	7,086			—			—			—
Acquired contracts		12 months		575			(518		)	57			500			(500		)	—
Total				$	36,121		$	(6,401	)	$	29,720		$	28,840		$	(4,008	)	$	24,832

 

The changes in the carrying amount of goodwill for the nine months ended June 30, 2004 are as follows (in thousands):

 

		Government Business Process Outsourcing			Package Software and Systems Integration			Electronic Payment Processing			Total
Balance as of September 30, 2003		$	5,298		$	9,721		$	14,606		$	29,625
Activity		—			13,490			—			13,490
Balance as of June 30, 2004		$	5,298		$	23,211		$	14,606		$	43,115

 

The Company is in the process of obtaining a formal valuation for the EPOS acquisition and has preliminarily estimated goodwill of $13,490,000 and intangible assets of $7,206,000 with an average amortization period of five years.

 

10

 

NOTE 7 — SHAREHOLDERS’ EQUITY

 

Pro Forma Impact of Employee Stock Options

 

In December 2002, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 148 (“SFAS 148”), “Accounting for Stock-Based Compensation Costs – Transition and Disclosure,” which provides alternative methods of transition for an entity that voluntarily changes to the fair value-based method of accounting for stock-based compensation.  SFAS 148 also requires additional disclosures about the effects on reported net income of an entity’s accounting policy with respect to stock-based compensation.  The Company accounts for employee stock options in accordance with Accounting Principles Board Opinion No. 25 (“APB 25”), “Accounting for Stock Issued to Employees” and provides the disclosure required in Statement of Financial Accounting Standards No. 123 (“SFAS 123”), “Accounting for Stock-Based Compensation.” Stock options issued to non-employees are accounted for in accordance with Emerging Issues Task Force Issue No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services.”  The Company adopted the disclosure provisions of SFAS 148 in January 2003.

 

The following table illustrates the effect on net income (loss) and net income (loss) per share if the Company would have applied the fair value recognition provisions of SFAS 123 to stock-based compensation:

 

		Three Months Ended June 30,						Nine Months Ended June 30,
		2004			2003			2004			2003
		(in thousands, except per share data)
Net income (loss), as reported		$	914		$	2,127		$	(410	)	$	5,432
Deduct:  Pro forma employee compensation cost related to stock options, net of tax		962			596			2,214			2,193
Pro forma net income (loss)		$	(48	)	$	1,531		$	(2,624	)	$	3,239
Net income (loss) per basic share:
As reported		$	0.05		$	0.11		$	(0.02	)	$	0.29
Pro forma		$	—		$	0.08		$	(0.14	)	$	0.17
Net income (loss) per diluted share:
As reported		$	0.05		$	0.11		$	(0.02	)	$	0.28
Pro forma		$	—		$	0.08		$	(0.14	)	$	0.17

 

11

 

NOTE 8 — INCOME (LOSS) PER SHARE

 

The following table sets forth the computation of basic and diluted income (loss) per share:

 

		Three Months Ended June 30,						Nine Months Ended June 30,
		2004			2003			2004			2003
		(in thousands, except per share data)
Numerator:
Income from continuing operations, net of  income taxes		$	931		$	2,185		$	1,008		$	5,174
Income (loss) from discontinued operation, net of income taxes		(17		)	(58		)	(1,418		)	258
Net income (loss)		$	914		$	2,127		$	(410	)	$	5,432
Denominator for basic income (loss) per share-weighted average common shares outstanding		19,030			18,600			18,846			18,829
Effects of dilutive securities:
Common stock options		483			221			383			514
Denominator for diluted income (loss) per share- adjusted weighted average common shares and  assumed conversions		19,513			18,821			19,229			19,343
Income from continuing operations, net of income taxes:
Per basic share		$	0.05		$	0.12		$	0.05		$	0.27
Per diluted share		$	0.05		$	0.12		$	0.05		$	0.27
Income (loss) from discontinued operation, net of income taxes:
Per basic share		$	—		$	—		$	(0.08	)	$	0.01
Per diluted share		$	—		$	—		$	(0.07	)	$	0.01
Net income (loss):
Per basic share		$	0.05		$	0.11		$	(0.02	)	$	0.29
Per diluted share		$	0.05		$	0.11		$	(0.02	)	$	0.28

 

For the three and nine months ended June 30, 2004, options to purchase approximately 1,753,000 and 2,051,000 shares of Class B common stock, respectively, at prices ranging from $10.88 to $20.70 per share and $10.20 to $20.70 per share, respectively, were outstanding but were not included in the computation of diluted income (loss) per share because the options’ exercise prices were greater than the average market price of the shares for this period.  For the three and nine months ended June 30, 2003, options to purchase approximately 1,801,000 and 1,331,000 shares of Class B common stock, respectively, at prices ranging from $8.53 to $20.70 per share and $13.75 to $20.70 per share, respectively, were outstanding but were not included in the computation of diluted income per share because the options’ exercise prices were greater than the average market price of the shares for this period.

 

NOTE 9—COMPREHENSIVE INCOME (LOSS)

 

The Company’s comprehensive income (loss) was as follows:

 

		Three Months Ended June 30,						Nine Months Ended June 30,
		2004			2003			2004			2003
		(in thousands)
Net income (loss)		$	914		$	2,127		$	(410	)	$	5,432
Net change in unrealized gain on available for-sale investments		(197		)	(33		)	(224		)	(17		)
Foreign currency translation adjustment.		(10		)	102			244			(34		)
Comprehensive income (loss)		$	707		$	2,196		$	(390	)	$	5,381

 

12

 

NOTE 10—ACQUISITIONS

 

All acquisitions have been accounted for using the purchase method of accounting.  The initial purchase price for each acquisition described below includes cash paid, stock issued at the date of acquisition and estimated acquisition costs. Beginning October 1, 2002, the Company adopted SFAS 142, “Goodwill and other Intangible Assets,” and no longer amortizes goodwill and indefinite lived intangible assets. Under SFAS 142, goodwill and indefinite lived intangible assets are reviewed at least annually for impairment.  Separable intangible assets that have finite useful lives continue to be amortized over their useful lives.

 

Effective June 1, 2004, the Company purchased all of the outstanding stock of EPOS Corporation (“EPOS”), a Alabama corporation that supplies interactive voice response communication and electronic transaction processing technologies.  The total purchase price was approximately $20,060,000 and was comprised of approximately $15,613,000 in cash and 402,422 shares of Class B common stock valued at approximately $4,447,000, based on the closing price of Class B common stock on June 1, 2004.  The cash payment of $15,613,000 includes payments directly to EPOS lenders of approximately $7,544,000 and estimated acquisition costs of approximately $811,000.  The estimated identifiable intangible assets total $7,206,000 and are being amortized over five years.  Total estimated goodwill of $13,490,000 was preliminarily allocated to the Package Software and Systems Integration (“PSSI”) segment.  The preliminary value assigned to intangible assets and goodwill are based upon management’s estimates as the Company is awaiting the finalization of appraisals and other studies before the identification and valuation of assets can be complete, which is expected in the fourth quarter of fiscal year 2004.  The Company does not expect to deduct goodwill arising from this transaction for income tax purposes.

 

Many requests for proposals issued in the child support payment processing and unemployment insurance practices require interactive voice response communication capabilities, such as those provided by EPOS.  Additionally, EPOS has established electronic payment processing capabilities and clients in the secondary education and utilities vertical industries that broaden the Company’s overall capabilities and client base.  The Company has established strategic, operational business, financial, and valuation criteria that it uses to evaluate potential acquisitions and believes that these criteria, including valuation, are in line with market conditions.

 

The total purchase price paid was preliminarily allocated to the assets acquired and liabilities assumed as follows (in thousands):

 

Accounts receivable		$	1,139
Prepaid expenses and other current assets		1,014
Equipment and software		1,838
Other assets		37
Accounts payable and accrued expenses		(1,473		)
Deferred revenue		(1,020		)
Deferred income tax liability		(2,162		)
Other long-term liability		(9		)
Other acquired intangible assets		7,206
Goodwill		13,490
Total consideration		$	20,060

 

13

 

The following unaudited pro forma summary presents consolidated information as if the acquisition of EPOS had occurred as of October 1, 2002.  This pro forma summary is provided for information purposes only and is based on historical information after including the impact of certain adjustments such as increased estimated amortization expense due to the preliminary recording of intangible assets.  These pro forma results do not necessarily reflect actual results that would have occurred nor is it necessarily indicative of future results of operations of the combined entities (in thousands, except per share data):

 

		Nine months ended June 30, 2004			Nine months ended June 30, 2003
Net revenues		$	107,851		$	110,282
Net income (loss)		$	(961	)	$	4,991
Basic net income (loss) per share		$	(0.05	)	$	0.26
Diluted net income (loss) per share		$	(0.05	)	$	0.25
Shares used in computing basic net income (loss) per share		19,206			19,232
Shares used in computing diluted net income (loss) per share		19,588			19,745

 

In April 2004, the Company acquired from PublicBuy.net LLC an e-procurement software solution and related assets that streamline the purchasing process for public procurement officials for approximately $1,259,000 in cash, including $66,000 in estimated transaction costs.  The total purchase price was allocated to intangible assets for $75,000, which are being amortized over 12 months, and software for $1,184,000.  The Company intends to license this software as part of its suite of financial management software offerings.

 

NOTE 11—SEGMENT INFORMATION

 

Following the restructuring in the fourth quarter of fiscal year 2003, the Company has been managed through three reportable segments: Government Business Process Outsourcing (“GBPO”), Government Systems Integration (“Government SI”) and OPC.  Accordingly, the prior year amounts have been reclassified to conform to the current year presentation.  In connection with the acquisition of EPOS, the Company renamed two of its segments; consequently, the three reportable segments are now as follows:  GBPO, Package Software and Systems Integration (“PSSI”), formerly known as Government SI, and Electronic Payment Processing (“EPP”), formerly known as OPC.  The GBPO segment provides transaction processing services. The PSSI segment provides systems integration, licensing and maintenance services.  The EPP segment provides transaction and payment processing services.  The Company evaluates the performance of its operating segments based on net revenues and direct costs, while other operating costs are evaluated on a geographical basis.  Accordingly, the Company does not include selling and marketing expenses, general and administrative expenses, depreciation and amortization expense not attributable to state child support payment processing centers, interest income (expense), other income (expense) and income tax expense in segment profitability.  The table below presents financial information for the three reportable segments:

 

		GBPO			PSSI			EPP			Total
		(in thousands)
Three Months Ended June 30, 2004:
Net revenues		$	11,777		$	12,147		$	16,809		$	40,733
Direct costs		7,310			8,098			12,703			28,111
Three Months Ended June 30, 2003
Net revenues		12,524			11,970			18,225			42,719
Direct costs		8,245			8,561			14,072			30,878
Nine Months Ended June 30, 2004:
Net revenues		34,787			29,680			32,435			96,902
Direct costs		22,602			19,986			22,891			65,479
Nine Months Ended June 30, 2003:
Net revenues		36,377			34,666			30,927			101,970
Direct costs		22,076			24,552			22,565			69,193

 

14

 

NOTE 12—RESTRUCTURING

 

During the fourth quarter of fiscal year 2003, the Company initiated a strategic review of its business units.  This review was completed in the fourth quarter of fiscal year 2003 and the Company decided to renew its focus on its core Government Services businesses while exiting unprofitable or marginal business operations.  As a result of this review, the Company recorded a charge of approximately $19,786,000 during the three months ended September 30, 2003.  This charge was comprised of $18,197,000 of goodwill, intangible and tangible asset impairment charges, $882,000 related to the closure of several offices (net of estimated sublease income of $115,000) and $707,000 of severance related to the termination of employees in the exited businesses. The restructuring plan included the termination of approximately 50 employees, of which approximately     20 employees were terminated during the three months ended September 30, 2003 and the remaining employees were terminated during the three months ended December 31, 2003.  Goodwill and asset impairment charges of approximately $1,323,000 were incurred for the nine months ended June 30, 2004, of which approximately $571,000 was included in restructuring charges and approximately $752,000 was included in loss from discontinued operations.  Severance of approximately $2,291,000 was incurred for the nine months ended June 30, 2004, of which approximately $1,461,000 primarily resulted from the signing of a termination agreement with the Company’s former chief executive officer and was included in restructuring charges and approximately $830,000 was included in loss from discontinued operations.  Also included in restructuring charges for the nine months ended June 30, 2004 was an additional $1,076,000 comprised of $222,000 related to estimated facility closure costs for one additional office and $854,000 for the closure of our Walnut Creek, California office (net of estimated sublease income of $1,544,000).

 

As a result of the acquisition of OPC in July 2002, the Company assumed certain liabilities for restructuring costs that OPC had previously recognized in connection with the involuntary termination of employees and the consolidation of facilities (net of estimated sublease income of $295,000). The assumed severance liability included severance for 27 individuals and the closing of certain office space.

 

In June 2004, the Company completed the consolidation of its Walnut Creek, California and Reston, Virginia offices.  As part of the office consolidation, the Company relocated the accounting, financial planning, information technology, legal, human resources and facilities corporate functions to the Reston office and closed the Walnut Creek office.  The Company believes that the office consolidation will improve the efficiency of its workforce, reduce its cost structure, assist in developing a consistent corporate culture and streamline the overall back office operations.  As anticipated, some members of the staff formerly resident in Walnut Creek have relocated to the Reston office as part of the office consolidation, and the Company has hired new staff for the Reston office to perform functions formerly carried out in Walnut Creek.  The Company estimates that it will incur restructuring and other related pre-tax charges totaling approximately $2,800,000 in connection with the office consolidation.  The estimated charges are comprised of approximately $385,000 in severance payments for employees who do not relocate to the Reston office, $1,290,000 in asset impairment charges and facility closure costs, net of estimated sublease income of $1,488,000, and approximately $1,125,000 in other charges related to the office consolidation.  The Company recorded approximately $1,552,000 (net of estimated sublease income of $1,488,000) of these charges in the three months ended June 30, 2004 comprised of $436,000 in asset impairment charges, $854,000 in facility closure costs and $262,000 in other charges related to the office consolidation. The Company expects the remaining charges to be recorded in the three months ending September 30, 2004.

 

15

 

At September 30, 2003, the Company had restructuring liabilities totaling $2,330,000 of which $656,000 was recorded in accrued liabilities, $668,000 was recorded in other long-term liabilities and $1,006,000 was recorded in liabilities of discontinued operations.  The following is a summary of the restructuring liabilities from September 30, 2002 through September 30, 2003 (in thousands):

 

		Liability as of September 30, 2002			Additions/ (Reductions)			Cash Payments			Liability as of September 30, 2003
Severance – OPC		$	2,254		$	(38	)	$	(1,083	)	$	1,133
Facilities closure – OPC		513			(15		)	(361		)	137
Severance – continuing operations		—			280			(280		)	—
Facilities closure – continuing operations		—			53			—			53
Severance – discontinued operations.		—			427			(249		)	178
Facilities closure – discontinued operations		—			829			—			829
		$	2,767		$	1,536		$	(1,973	)	$	2,330

 

At June 30, 2004, the Company had restructuring liabilities totaling $2,772,000, of which $1,460,000 was recorded in accrued liabilities, $1,162,000 was recorded in non-current other liabilities, $138,000 was included in current liabilities of discontinued operations and $12,000 was recorded in non-current liabilities of discontinued operations. Approximately $266,000 of the non-current restructuring liability is expected to be paid in fiscal year 2005, approximately $507,000 in fiscal year 2006, approximately $222,000 in fiscal year 2007, and the balance is expected to be paid in fiscal year 2008. The following is a summary of the restructuring liabilities from September 30, 2003 to June 30, 2004 (in thousands):

 

		Liability as of September 30, 2003			Additions/ (Reductions)			Cash Payments			Liability as of June 30, 2004
Severance – OPC		$	1,133		$	—		$	(345	)	$	788
Facilities closure – OPC		137			—			(66		)	71
Severance – continuing operations		—			1,099			(495		)	604
Facilities closure – continuing operations		53			1,260			(154		)	1,159
Severance – discontinued operations.		178			827			(965		)	40
Facilities closure – discontinued operations		829			(420		)	(299		)	110
		$	2,330		$	2,766		$	(2,324	)	$	2,772

 

NOTE 13 — DISCONTINUED OPERATIONS

 

During the quarter ended September 30, 2003, the Company completed a strategic review of all business units and began a restructuring plan which included exiting the U.S. Commercial Services segment and the United Kingdom Operations segment. During the quarter ended December 31, 2003, the Company completed the restructuring and abandoned those businesses.  Accordingly, the financial position, results of operations and cash flows of the U.S. Commercial Services and United Kingdom Operations segments have been reported as discontinued operations for each period presented.  The discontinued operations activity for the three and nine months ended June 30, 2004 included a reduction in the estimated facility closure charges as a result of renegotiating more favorable lease-buyout terms for one of the facilities.  The revenues for the three months ended June 30, 2004 of $53,000 resulted from a project on which the Company had completed its efforts as of December 31, 2003 but had a task which was subsequently performed by a subcontractor with no margin derived by the Company.  The discontinued operations activity for the three and nine months ended June 30, 2003 represented the historical results of operations of these discontinued businesses.

 

16

 

 

At June 30, 2004, the Company had net assets of discontinued operations of approximately $363,000 comprised of cash, accounts receivable, prepaid expenses, restructuring liabilities, and accounts payable and other accrued liabilities.

 

The operating results of the discontinued operations were as follows:

 

		Three Months Ended June 30,						Nine Months Ended June 30,
		2004			2003			2004			2003
		(in thousands)
Net revenues		$	53		$	2,808		$	1,780		$	8,979
Income (loss) from discontinued operations, net of income taxes		$	(17	)	$	(58	)	$	(1,418	)	$	258

 

NOTE 14 - LEGAL PROCEEDINGS

 

In November 2003, the Company filed a lawsuit in California Superior Court, Sacramento County, against CalPERS to overturn CalPERS’ decision to terminate the contract relating to the Company’s systems integration project for CalPERS for default and to recover added costs associated with that project.  The Company sought to recover damages and project delay, disruption and interference costs on the project.  In December 2003, CalPERS filed a cross-complaint against the Company and made a claim against the performance bond for this contract.  On August 4, 2004, the Company and CalPERS reached an agreement in a judicially supervised settlement conference before the Sacramento Superior Court wherein CalPERS withdrew the termination for default and the parties rescinded the contract.  The parties released each other from any and all claims arising out of the contracts.  The parties are in the process of preparing a written settlement agreement.

 

In June 2003, the Company announced that it had received a subpoena from a grand jury in the Southern District of New York to produce certain documents pursuant to an investigation involving the child support payment processing industry by the United States Department of Justice (“DOJ”), Antitrust Division.  The Company has fully cooperated, and intends to continue to cooperate fully, with the subpoena and with the DOJ’s investigation.  On November 20, 2003, the DOJ granted conditional amnesty to the Company pursuant to the Antitrust Division’s Corporate Leniency Policy.  Consequently, the DOJ will not bring any criminal charges against the Company, its officers, directors and employees, as long as the Company continues to comply with the Corporate Leniency Policy, which requires, among other things, the Company’s full cooperation in the investigation and restitution payments if it is determined that parties were injured as a result of impermissible anti-competitive conduct. During the nine months ended June 30, 2004, the Company incurred approximately $456,000 of legal costs to comply with the subpoena which includes approximately $211,000 cost incurred under indemnification agreements partially offset by a claim payment received from the Company’s insurance carrier for approximately $227,000.  Due to the preliminary nature of the government’s inquiry, the Company is not able to assess the full impact on our financial condition and results of operations.

 

NOTE 15 – SUBSEQUENT EVENT

 

In connection with the planned integration of EPOS and OPC, the Company estimates that it will incur in the three months ended September 30, 2004 approximately $1,000,000 related to severance for OPC’s former chief operating officer and other integration charges.

 

17