National Processing 10-Q 2000 Q2 Quarterly report

TABLE OF CONTENTS

Exhibit 10.28

Exhibit 27.1

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended June 30, 2000

or

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

For the transition period from________________to___________

Commission File Number: 1-11905

National Processing, Inc.
(Exact name of Registrant as specified in its charter)

Ohio (State or other jurisdiction of incorporation or organization)	61-1303983 (I.R.S. Employer Identification No.)
1231 Durrett Lane Louisville, Kentucky (Address of principal executive offices)	40213-2008 (Zip Code)

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

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

The number of shares outstanding of the Registrant’s Common Stock as of July 31, 2000 was 50,825,653.

NATIONAL PROCESSING, INC.

INDEX

			Page No.
Part I. Financial Information
	Item 1. Consolidated Financial Statements (unaudited)
		Consolidated Balance Sheets – June 30, 2000 and December 31, 1999		3
		Consolidated Statements of Operations –
		Three and Six Months Ended June 30, 2000 and 1999		4
		Consolidated Statement of Changes in Shareholders’ Equity –
		Six Months Ended June 30, 2000		5
		Consolidated Statements of Cash Flows –
		Six Months Ended June 30, 2000 and 1999		6
		Notes to Consolidated Financial Statements		7
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			10
	Item 3. Quantitative and Qualitative Disclosure About Market Risk			17
Part II. Other Information
	Item 1. Legal Proceedings (None)
	Item 2. Changes in Securities and Use of Proceeds (None)
	Item 3. Defaults Upon Senior Securities (None)
	Item 4. Submission of Matters to a Vote of Security Holders			18
	Item 5. Other Information (None)
	Item 6. Exhibits and Reports on Form 8-K			18
Signatures				19

2

National Processing, Inc.
Consolidated Balance Sheets
Unaudited
(Dollars in thousands)

		June 30		December 31
		2000		1999
Assets
Current assets:
	Cash and cash equivalents	$	31,094	$	32,042
	Securities available for sale		96,000		60,000
	Accounts receivable — trade		77,688		104,486
	Restricted deposits — customer funds		29,445		22,177
	Deferred tax assets		546		812
	Other current assets		10,930		11,743
Total current assets			245,703		231,260
Property and equipment:
	Furniture and equipment		81,192		81,439
	Building and leasehold improvements		18,852		21,006
	Software		20,913		18,027
	Property leased from affiliate		4,173		4,173
	Land and improvements		2,436		2,851
			127,566		127,496
Accumulated depreciation and amortization			66,252		62,408
			61,314		65,088
Other assets:
	Goodwill, net of accumulated amortization of $6,209 in 2000 and $5,040 in 1999		87,262		88,431
	Other intangible assets		32,102		34,628
	Deferred tax assets		3,289		3,698
	Other assets		6,315		6,109
Total other assets			128,968		132,866
Total assets		$	435,985	$	429,214
Liabilities and shareholders’ equity
Current liabilities:
	Restricted deposits — client funds	$	29,445	$	22,177
	Accounts payable — trade		9,024		12,262
	Accrued bankcard assessments		18,802		20,122
	Income tax payable		4,665		16,318
	Other accrued liabilities		31,724		35,963
Total current liabilities			93,660		106,842
Obligation under property leased from affiliate			2,058		2,123
Other long-term liabilities			332		796
Deferred tax liabilities			3,164		3,047
Total liabilities			99,214		112,808
Shareholders’ equity:
	Preferred stock, without par value; 5,000,000 shares authorized; no shares issued or outstanding		—		—
	Common stock, without par value; 95,000,000 shares authorized; 50,820,653 and 50,644,651 shares issued and outstanding in 2000 and 1999, respectively		1		1
	Contributed capital		177,305		176,964
	Retained earnings		159,465		139,441
Total shareholders’ equity			336,771		316,406
Total liabilities and shareholders’ equity		$	435,985	$	429,214

See notes to consolidated financial statements

3

National Processing, Inc.
Consolidated Statements of Operations
Unaudited
(In thousands, except per share amounts)

	Three Months Ended					Six Months Ended
	June 30					June 30
	2000		1999			2000		1999
Revenue	$	104,513	$	109,813		$	202,380	$	234,276
Operating expenses		52,736		57,314			100,200		117,811
Wages and other personnel expenses		19,656		24,059			38,874		55,155
General and administrative expenses		9,940		12,672			22,121		29,479
Depreciation and amortization		5,325		4,746			10,698		11,832
Impairment, restructuring and related expenses (credits)		1,500		(6,500	)		1,500		69,666
Operating profit (loss)		15,356		17,522			28,987		(49,667	)
Net interest income		1,878		566			3,693		584
Income (loss) before provision for income taxes		17,234		18,088			32,680		(49,083	)
Provision for income taxes		6,758		6,115			12,656		7,129
Net income (loss)	$	10,476	$	11,973		$	20,024	$	(56,212	)
Basic and diluted net income (loss) per common share	$	0.21	$	0.24		$	0.39	$	(1.11	)

See notes to consolidated financial statements

4

National Processing, Inc.
Consolidated Statement of Changes in Shareholders’ Equity
Unaudited
(In thousands)

	Common		Contributed		Retained
	Stock		Capital		Earnings		Total
Balance at January 1, 2000	$	1	$	176,964	$	139,441	$	316,406
Net income		—		—		20,024		20,024
Stock options exercised		—		341		—		341
Balance at June 30, 2000	$	1	$	177,305	$	159,465	$	336,771

See notes to consolidated financial statements

5

National Processing, Inc.
Consolidated Statements of Cash Flows
Unaudited
(In thousands)

				Six Months Ended
				June 30
				2000			1999
Operating activities
	Net income (loss)			$	20,024		$	(56,212	)
	Items not requiring cash currently:
			Depreciation and amortization		10,698			11,832
			Impairment, restructuring and related expenses		1,500			69,666
			Deferred income taxes		792			(947	)
			Loss on disposition of fixed assets		16			502
	Change in current assets and liabilities:
			Accounts receivable — trade		26,798			19,881
			Accounts payable — trade		(1,238	)		1,113
			Accrued bankcard assessments		(1,320	)		(1,496	)
			Income taxes payable		(11,653	)		39,979
			Other current assets/liabilities		(2,049	)		2,624
			Other, net		(670	)		340
	Net cash provided by operating activities				42,898			87,282
Investing Activities
	Capital expenditures				(6,197	)		(5,896	)
	Proceeds from sales of fixed assets				75			420
	Purchases of securities available for sale				(76,000	)		(60,000	)
	Proceeds from maturities of securities available for sale				40,000			—
	Proceeds from sale of business lines				—			62,554
	Other investing activities				(2,000	)		—
	Net cash used by investing activities				(44,122	)		(2,922	)
Financing Activities
	Principal payments under property leased from affiliate				(65	)		(76	)
	Exercise of stock options				341			—
	Net cash provided by (used by) financing activities				276			(76	)
Net increase (decrease) in cash and cash equivalents					(948	)		84,284
Cash and cash equivalents, beginning of period					32,042			7,254
Cash and cash equivalents, end of period				$	31,094		$	91,538
Supplemental cash flow information:
		Taxes paid (refunded)		$	21,905		$	(32,626	)

See notes to consolidated financial statements

6

NATIONAL PROCESSING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Unaudited

1.	ACCOUNTING POLICIES
	The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, although the balance sheet at December 31, 1999 has been derived from the audited consolidated financial statements at that date, the accompanying consolidated financial statements do not include all the information and footnotes required by generally accepted accounting principles. These financial statements should be read in conjunction with National Processing, Inc.’s (the “Company”) audited consolidated financial statements for the year ended December 31, 1999 which include full disclosure of relevant financial policies and information.
	In the opinion of management, the accompanying consolidated financial statements have been prepared on a basis consistent with accounting principles applied in the prior periods and include all adjustments (consisting of normal recurring accruals) considered necessary for fair presentation of the financial position, results of operations and cash flows for the interim periods presented. The results of operations for the interim periods are not necessarily indicative of the results that may be expected for the full year or any other interim period.
2.	IMPAIRMENT, RESTRUCTURING AND RELATED EXPENSES
	In the second quarter of 2000, a pre-tax charge of $1.5 million was recorded for site consolidation initiatives. The charge totaled $1.0 million after-tax, or $0.02 per share, and related primarily to the write-off of leasehold improvements and the accrual of future contractual rent payments on abandoned facilities.
	During the quarter ended March 31, 1999, the Company recorded nonrecurring restructuring charges of $2.2 million, including $1.9 million for severance pay for approximately 540 employees and $0.3 million for other costs. These charges related to two of the Company’s facilities which have been closed and consolidated into the Company’s other operating facilities. These charges decreased net income and earnings per share by approximately $1.8 million and $.04, respectively. At June 30, 2000, the remaining liability was $0.4 million and related primarily to future severance payments for approximately 80 employees.
	During the first quarter of 1999, the Company committed to a formal plan to dispose of its Freight, Payables, Remittance and Check Services business lines and recorded impairment losses and related expenses of $73.9 million related to the sale and wind-down of these business lines. The charges decreased first quarter 1999 net income and earnings per share by $72.0 million and $1.42, respectively. Effective April 1, 1999, the Company sold its Freight and Payables business lines for $18.3 million. Effective June 1, 1999, the Company sold its Remittance and Check business lines for $44.3 million. As a result of the final dispositions of these business lines, the Company recorded a pre-tax

7

	credit of $6.5 million to the impairment loss in the second quarter of 1999. At June 30, 2000, the Company had $2.7 million remaining related to the final obligations of these dispositions recorded in other accrued liabilities. The remaining obligations are primarily for future severance payments, rent subsidies and processing subsidies. For the six months ended June 30, 1999, these divested business units had revenues of $57.3 million.
3.	RECLASSIFICATIONS
	Certain 1999 amounts have been reclassified to conform with the 2000 presentation.
4.	COMMITMENTS AND CONTINGENCIES
	In the normal course of business, the Company is involved in litigation from time to time. In the opinion of management, the ultimate liability, if any, arising from this litigation is not expected to have a material adverse effect on the Company’s financial condition, results of operations or liquidity.
5.	NET INCOME PER COMMON SHARE
	The calculation of net income per common share follows (in thousands, except per share amounts):

		Three Months Ended				Six Months Ended
		June 30				June 30
		2000		1999		2000		1999
BASIC
	Net income (loss)	$	10,476	$	11,973	$	20,024	$	(56,212	)
	Average common shares outstanding		50,799		50,645		50,792		50,645
	Net income (loss) per common share — basic	$	0.21	$	0.24	$	0.39	$	(1.11	)
DILUTED
	Net income (loss)	$	10,476	$	11,973	$	20,024	$	(56,212	)
	Average common shares outstanding		50,799		50,645		50,792		50,645
	Stock option adjustment		166		2		106		—
	Average common shares outstanding — diluted		50,965		50,647		50,898		50,645
	Net income (loss) per common share — diluted	$	0.21	$	0.24	$	0.39	$	(1.11	)

6.

SEGMENT REPORTING

National Processing, Inc. operates two business segments – Merchant Services and Corporate Outsourcing Solutions. Merchant Services authorizes, processes and settles credit and debit card transactions for a variety of merchants. Corporate Outsourcing Solutions provides a variety of financial and administrative processing solutions to large corporate customers. These solutions include financial settlement, image scanning, data capture, storage and retrieval, call center, and value-added customer reporting.

8

      During the first half of 1999, the Company sold its Check business line (formerly part of the Merchant Services segment) and its Remittance, Payables and Freight business lines (all formerly part of the Corporate Outsourcing Solutions segment). The Company identifies business segments by the services they offer. The accounting policies of the reportable segments are the same as those of the Company. Prior period amounts were classified to conform to the current line of business reporting structure. The segment previously defined as Travel Services is now included in the Corporate Outsourcing Solutions segment.

      General and administrative expenses, other than direct Corporate expenses, are allocated to the segments based upon various methods determined by the nature of the expenses. There are no intersegment revenues. Impairment, restructuring and related expenses are reflected in the business segments to which they relate. Depreciation expense for corporate fixed assets is allocated to the segments. Corporate net operating assets are comprised primarily of cash, securities available for sale and income tax balances.

				Corporate
	Merchant			Outsourcing					Consolidated
(Dollars in thousands)	Services			Solutions		Corporate			Total
For the quarter ended June 30, 2000
Revenue	$	76,104		$	28,409	$	—		$	104,513
Impairment, restructuring and related expenses		—			1,500		—			1,500
Operating profit (loss)		13,450			3,623		(1,717	)		15,356
Depreciation and amortization		3,564			1,761		—			5,325
Net interest income		1,364			514		—			1,878
Net operating assets		103,004			51,001		182,766			336,771
For the quarter ended June 30, 1999
Revenue	$	74,021		$	35,792	$	—		$	109,813
Impairment, restructuring and related expenses (credits)		(9,336	)		2,836		—			(6,500	)
Operating profit		17,384			1,654		(1,516	)		17,522
Depreciation and amortization		2,921			1,825		—			4,746
Net interest income		358			208		—			566
Net operating assets		90,217			15,481		190,749			296,447

				Corporate
	Merchant			Outsourcing						Consolidated
(Dollars in thousands)	Services			Solutions			Corporate			Total
For the six months ended June 30, 2000
Revenue	$	147,015		$	55,365		$	—		$	202,380
Impairment, restructuring loss and related expenses		—			1,500			—			1,500
Operating profit (loss)		25,659			7,182			(3,854	)		28,987
Depreciation and amortization		7,096			3,602			—			10,698
Net interest income		2,783			910			—			3,693
Net operating assets		103,004			51,001			182,766			336,771
For the six months ended June 30, 1999
Revenue	$	147,813		$	86,463		$	—		$	234,276
Impairment, restructuring and related expenses		21,636			48,030			—			69,666
Operating loss		(6,712	)		(39,689	)		(3,266	)		(49,667	)
Depreciation and amortization		6,226			5,606			—			11,832
Net interest income		387			197			—			584
Net operating assets		90,217			15,481			190,749			296,447

9

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

Components of Revenue and Expenses

      Revenue.The Company’s Merchant Services revenue is primarily derived from fees paid by merchants for the authorization and settlement of credit and debit card transactions. Revenue is recorded net of interchange fees charged by the credit card associations. Corporate Outsourcing Solutions provides a variety of financial and administrative processing solutions to large corporate customers. These solutions include financial settlement, image scanning, data capture, storage and retrieval, call center, and value-added customer reporting. A portion of Corporate Outsourcing Solutions revenue is also derived from an exclusive long-term contract with the Airlines Reporting Corporation (ARC) under which the Company is compensated on a “cost plus” basis. A small portion of revenue is derived from earnings on cash balances, which are maintained by customers pursuant to contract terms.

      Expenses.Operating expenses include all direct costs of providing services to customers including wages and other personnel expenses. The most significant components of operating expenses are assessment fees, authorization fees, data processing expenses, wages and benefits, and general and administrative expenses.

Results of Operations

      The Company divested certain business units during 1999 in order to focus on its core business lines. Accordingly, the segment results presented below for the comparison of 2000 to 1999 segregate the operating performance for the remaining core business lines versus those that were divested. The segment profits as presented herein differ from the operating profits presented in Note 6 in the accompanying consolidated financial statements due to the segregation of nonrecurring items and divested business lines.

10

Three Months Ended June 30, 2000 Compared to Three Months Ended June 30, 1999

				2000						1999						Change
(Dollars in thousands)							% of						% of
				Amount			Revenues			Amount			Revenues			Amount			%
Revenue:
	Merchant Services			$	76,104			73	%	$	64,549			59	%	$	11,555			18	%
	Corporate Outsourcing Solutions				28,409			27			27,678			25			731			3
			Total Core Revenue		104,513			100			92,227			84			12,286			13
	Divested Business Lines				—			—			17,586			16			(17,586	)		(100	)
			Total Revenue		104,513			100			109,813			100			(5,300	)		(5	)
Operating Expenses:
	Merchant Services				62,654			82			56,497			88			6,157			11
	Corporate Outsourcing Solutions				23,286			82			22,951			83			335			1
			Core Operating Expenses		85,940			82			79,448			86			6,492			8
	Divested Business Lines				—			—			17,827			101			(17,827	)		(100	)
			Total Operating Expenses		85,940			82			97,275			89			(11,335	)		(12	)
Segment Profit (Loss):
		Merchant Services			13,450			18			8,052			12			5,398			67
		Corporate Outsourcing Solutions			5,123	(2)		18			4,727			17			396			8
			Total Core Segment Profit		18,573			18			12,779			14			5,794			45
		Divested Business Lines			—			—			(241	)(1)		(1	)		241			(100	)
			Total Segment Profit		18,573			18			12,538			11			6,035			48
Other General and Administrative Expenses					1,717			2			1,516			1			201			13
Net Interest Income					1,878			2			566			1			1,312			232
Income Before Taxes and Nonrecurring Items					18,734			18			11,588			11			7,146			62
Nonrecurring Items:
			Impairment, Restructuring and Related (Expenses) Credits		(1,500	)		(1	)		6,500			6			(8,000	)		NM
Income Before Taxes					17,234			16			18,088			16			(854	)		(5	)
Provision for Income Taxes					6,758			6			6,115			6			643			11
Net Income				$	10,476			10		$	11,973			11		$	(1,497	)		(13	)

NM – Not meaningful

(1)	Excludes $6.5 million impairment credit for the business lines divested in the first half of 1999 (Freight, Payables, Remittance and Check Services).
(2)	Excludes $1.5 million charge for site consolidation initiatives.

				2000						1999					Change
(Dollars in thousands,
except per share amounts)				Amount			%			Amount		%			Amount			%
Excluding Nonrecurring Items:
	Pre-Tax Income			$	18,734			100	%	$	11,588		100	%	$	7,146			62	%
	Taxes				7,283			39			3,336		29			3,947			118
		Net Income		$	11,451			61		$	8,252		71		$	3,199			39
		Per Share — Diluted		$	0.22					$	0.16				$	0.06			38
Nonrecurring Items:
	Pre-Tax Income (Loss)			$	(1,500	)		100	%	$	6,500		100	%	$	(8,000	)		NM
	Taxes				(525	)		35			2,779		43			(3,304	)		NM
			Net Income (Loss)	$	(975	)		65		$	3,721		57		$	(4,696	)		NM
			Per Share — Diluted	$	(0.02	)				$	0.08				$	(0.10	)		NM
Total:
	Pre-Tax Income			$	17,234			100	%	$	18,088		100	%	$	(854	)		(5	)
	Taxes				6,758			39			6,115		34			643			11
			Net Income	$	10,476			61		$	11,973		66		$	(1,497	)		(13	)
			Per Share — Diluted	$	0.21					$	0.24				$	(0.03	)		(13	)

NM — Not meaningful

11

Three Months Ended June 30, 2000 Compared to Three Months Ended June 30, 1999

Merchant Services

      Revenue for the core business line increased 18% to $76.1 million from $64.5 million. Transaction and dollar volume processed increased 27% and 21%, respectively, primarily due to new customer accounts, including the acquisition of a merchant processing portfolio on December 31, 1999, and increased volume from existing customers. Operating expenses for the core business line increased 11% to $62.7 million from $56.5 million primarily due to the customer base expansion and increased volume. Operating margins as a percentage of revenue increased to 18% from 12%, primarily due to increased revenue from higher-margin regional merchants, improved pricing related to vendor renegotiations, and economies of scale based on increased volumes. In addition, the 1999 period contained Year 2000 testing and remedition expenses that did not recur in 2000. Due primarily to the factors outlined above, segment profit for the quarter ended June 30, 2000 increased 67% to $13.5 million in 2000 from $8.1 million in 1999.

Corporate Outsourcing Solutions

      Revenue for the core business lines increased 3% to $28.4 million from $27.7 million. Revenue increased due to volume growth and pricing adjustments in certain products within the Travel business line and volume growth in the Healthcare Claims Processing Services business line. These increases were partially offset by decreases in revenues resulting from the continuing conversion from paper to electronic ticketing and reporting. Operating expenses for the core business lines increased 1% to $23.3 million from $23.0 million due primarily to increased volumes. As a result of the items discussed above, segment profit for the quarter ended June 30, 2000 increased 8% to $5.1 million from $4.7 million in 1999.

Other General and Administrative Expenses

      Other general and administrative expenses are comprised of corporate expenses that are not included in the determination of segment profit for the business segments. For the quarter ended June 30, 2000, these expenses increased 13% to $1.7 million from $1.5 million in 1999, due primarily to a new performance incentive program instituted for certain exempt employees who were not previously included under the Company’s other performance incentive programs.

Divested Business Lines

      Divested business lines are comprised of the Remittance, Payables, Freight (all formerly part of the Corporate Outsourcing Solutions segment) and Check Services (formerly part of the Merchant Services segment) business lines that were sold by the Company in the first half of 1999. Segment loss for the divested business lines was $0.2 million in the second quarter of 1999.

12

Net Interest Income

      Net interest income for the second quarter increased to $1.9 million from $0.6 million for the same period of 1999 due to the increased level of cash and investments as well as rising interest rates. The increased levels of cash and investments were due primarily to the receipt of sale proceeds from the business lines that were divested in the second quarter of 1999, as well as internal cash flow.

Nonrecurring Items

      In the second quarter of 2000, a pre-tax charge of $1.5 million was recorded related to site consolidation initiatives. The charge totaled $1.0 million after-tax, or $0.02 per share.

      In the second quarter of 1999, a pre-tax credit of $6.5 million was recorded related to the dispositions of the Freight, Payables, Remittance and Check business lines. The credit, which totaled $3.7 million after-tax, or $0.08 per share, represents favorable adjustments to the first quarter estimated impairment loss for the disposition of these business lines, which were completed during the second quarter of 1999.

Provision for Income Taxes

      Excluding the impact of nonrecurring items, the effective tax rate was 38.9% for the second quarter of 2000 compared to 28.8% for the same period a year ago. This increase was due primarily to recording income tax on all foreign income at its U.S. statutory rate in 2000, as well as an increase in U.S. income versus offshore income, which is additionally subject to state and local taxation. The increase in the effective tax rate in the second quarter of 2000 was partially offset by $0.3 million due to a reduction in the state net operating loss carryforward valuation allowance.

13

Six Months Ended June 30, 2000 Compared to Six Months Ended June 30, 1999

				2000						1999						Change
(Dollars in thousands)							% of						% of
				Amount			Revenues			Amount			Revenues			Amount			%
Revenue:
	Merchant Services			$	147,015			73	%	$	123,519			53	%	$	23,496			19	%
	Corporate Outsourcing Solutions				55,365			27			53,422			23			1,943			4
			Total Core Revenue		202,380			100			176,941			76			25,439			14
	Divested Business Lines				—			—			57,335			24			(57,335	)		(100	)
			Total Revenue		202,380						234,276			100			(31,896	)		(14	)
Operating Expenses:
	Merchant Services				121,356			83			109,165			88			12,191			11
	Corporate Outsourcing Solutions				46,683			84			44,184			83			2,499			6
			Core Operating Expenses		168,039			83			153,349			87			14,690			10
	Divested Business Lines				—			—			57,662			101			(57,662	)		(100	)
			Total Operating Expenses		168,039			83			211,011			90			(42,972	)		(20	)
Segment Profit (Loss):
		Merchant Services			25,659			17			14,354	(1)		12			11,305			79
		Corporate Outsourcing Solutions			8,682	(4)		16			9,238	(2)		17			(556	)		(6	)
			Total Core Segment Profit		34,341			17			23,592			13			10,749			46
		Divested Business Lines			—			—			(327	)(3)		(1	)		327			(100	)
			Total Segment Profit		34,341			17			23,265			10			11,076			48
Other General and Administrative Expenses					3,854			2			3,266			1			588			18
Net Interest Income					3,693			2			584			—			3,109			532
Income Before Taxes and Nonrecurring Items					34,180			17			20,583			9			13,597			66
Nonrecurring Items:
			Impairment, Restructuring and Related Expenses		(1,500	)		(1	)		(69,666	)		(30	)		68,166			NM
Income (Loss) Before Taxes					32,680			16			(49,083	)		(21	)		81,763			NM
Provision for Income Taxes					12,656			6			7,129			3			5,527			NM
Net Income (Loss)				$	20,024			10		$	(56,212	)		(24	)	$	76,236			NM

NM – Not meaningful

(1)	Excludes $0.5 million of restructuring charges related to facility closing.
(2)	Excludes $1.7 million of restructuring charges related to facility closing.
(3)	Excludes $67.4 million of impairment and related expenses for the business lines divested in the first half of 1999 (Freight, Payables, Remittance and Check Services).
(4)	Excludes $1.5 million charge for site consolidation initiatives.

				2000						1999						Change
(Dollars in thousands,
except per share amounts)				Amount			%			Amount			%			Amount			%
Excluding Nonrecurring Items:
	Pre-Tax Income			$	34,180			100	%	$	20,583			100	%	$	13,597			66	%
	Taxes				13,181			39			6,657			32			6,524			98
		Net Income		$	20,999			61		$	13,926			68		$	7,073			51
		Per Share — Diluted		$	0.41					$	0.27					$	0.14			50
Nonrecurring Items:
	Pre-Tax Income (Loss)			$	(1,500	)		100		$	(69,666	)		100	%	$	68,166			NM
	Taxes				(525	)		35			472			(1	)		(997	)		NM
			Net Income (Loss)	$	(975	)		65		$	(70,138	)		101		$	69,163			NM
			Per Share — Diluted	$	(0.02	)				$	(1.38	)				$	1.36			NM
Total:
	Pre-Tax Income (Loss)			$	32,680			100	%	$	(49,083	)		100	%	$	81,763			NM
	Taxes				12,656			39			7,129			(15	)		5,527			NM
			Net Income (Loss)	$	20,024			61		$	(56,212	)		115		$	76,236			NM
			Per Share — Diluted	$	0.39					$	(1.11	)				$	1.50			NM

NM — Not meaningful

14

Six Months Ended June 30, 2000 Compared to Six Months Ended June 30, 1999

Merchant Services

      Revenue for the core business line increased 19% to $147.0 million from $123.5 million. Transaction and dollar volume increased 27% and 21%, respectively, primarily due to new customer accounts, including the acquisition of a merchant processing portfolio on December 31, 1999, and increased volume from existing customers. Operating expenses for the core business line increased 11% to $121.4 million from $109.2 million primarily due to the customer base expansion and increased volume. Operating margins as a percentage of revenue increased to 17% from 12%, primarily due to increased revenue from higher-margin regional merchants, improved pricing related to vendor renegotiations, and economies of scale based on increased volumes. In addition, the 1999 period contained Year 2000 testing and remedition expenses that did not recur in 2000. Due primarily to the factors outlined above, segment profit for the six months ended June 30, 2000, increased 79% to $25.7 million in 2000 from $14.4 million in 1999.

Corporate Outsourcing Solutions

      Revenue for the core business lines increased 4% to $55.4 million from $53.4 million. This increase was principally related to volume growth in the Healthcare Claims Processing Services business line and certain products within the Travel business line. These increases were partially offset by decreases in revenue resulting from the continuing conversion from paper to electronic ticketing and reporting. Operating expenses for the core business lines increased 6% to $46.7 million from $44.2 million due primarily to increased volumes, as well as severance expense of $0.5 million recorded in the first quarter of 2000. As a result of the items discussed above, segment profit for the six months ended June 30, 2000 decreased 6% to $8.7 million in 2000 from $9.2 million in 1999.

Other General and Administrative Expenses

      Other general and administrative expenses are comprised of corporate expenses that are not included in the determination of segment profit for the business segments. For the six months ended June 30, 2000, these expenses increased 18% to $3.9 million in 2000 from $3.3 million in 1999, due primarily to a new performance incentive program instituted for certain exempt employees who were not previously included under the Company’s other performance incentive program.

Divested Business Lines

      Divested business lines are comprised of the Remittance, Payables, Freight (all formerly part of the Corporate Outsourcing Solutions segment) and Check Services (formerly part of the Merchant Services segment) business lines that were sold by the Company in the first half of 1999. Segment loss for the divested business lines was $0.3 million in the six months ended June 30, 1999.

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Net Interest Income

      Net interest income for the six months ended June 30, 2000 increased to $3.7 from $0.6 million for the same period in 1999 due to the increased level of cash and investments as well as rising interest rates. The increased levels of cash and investments were due primarily to the receipt of sale proceeds from the business lines that were divested in the second quarter of 1999, as well as internal cash flow.

Nonrecurring Items

      In the second quarter of 2000, a pre-tax charge of $1.5 million was recorded related to site consolidation initiatives. The charge totaled $1.0 million after-tax, or $0.02 per share.

      During the quarter ended March 31, 1999, the Company recorded nonrecurring restructuring charges of $2.2 million, including $1.9 million for severance pay for approximately 540 employees and $0.3 million for other costs. These charges related to two of the Company’s facilities which have been closed and consolidated into the Company’s other operating facilities. These charges decreased net income and earnings per share by approximately $1.8 million and $.04, respectively. At June 30, 2000, the remaining liability was $0.4 million and related primarily to future severance payments for approximately 80 employees.

      During the first half of 1999, the Company committed to a formal plan to dispose of its Freight, Payables, Remittance and Check Services business lines and recorded impairment losses and related expenses of $67.4 million related to the sale and wind-down of these business lines. The charges decreased net income and earnings per share for the six months ended June 30, 1999 by $68.3 million and $1.35, respectively. Effective April 1, 1999, the Company sold its Freight and Payables business lines for $18.3 million. Effective June 1, 1999, the Company sold its Remittance and Check business lines for $44.3 million. At March 31, 2000, the Company had $2.7 million remaining related to the final obligations of these dispositions recorded in other accrued liabilities. The remaining obligations are primarily for future severance payments, rent subsidies and processing subsidies. For the six months ended June 30, 1999, these divested business units had revenues of $57.3 million.

Provision for Income Taxes

      Excluding the impact of nonrecurring items, the effective tax rate was 38.6% for the six months ended June 30, 2000 compared to 32.3% for the same period a year ago. This increase was due primarily to recording income tax on all foreign income at its U.S. statutory tax rate in 2000, as well as an increase in U.S. income versus offshore income, which is additionally subject to state and local taxation. The increase in the effective tax rate in the first six months of 2000 was partially offset by $0.6 million due to a reduction in the state net operating loss carryforward valuation allowance.

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

16

Seasonality

      The Company experiences seasonality in its businesses. The Company typically realizes higher revenues in the third and fourth calendar quarters and lower revenues in the first calendar quarter, reflecting increased transaction volumes and travel in the summer and holiday months and decreased transaction volume during the quarter immediately following the holiday season.

Liquidity and Capital Resources

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

      The Company’s capital expenditures include amounts for computer hardware and software, scanning and other document processing equipment as well as leasehold improvements to operating facilities. During the six month period ended June 30, 2000, the Company’s capital expenditures totaled $6.2 million. Such expenditures were principally financed from operating cash flow, which totaled approximately $42.9 million for the six month period. Operating cash flow during the six month period ended June 30, 1999 totaled $87.3 million and capital expenditures were $5.9 million. It is anticipated that future expenditures will be funded with operating cash flow.

      As the Company does not carry significant amounts of inventory and historically has experienced short collection periods for its accounts receivable, it does not require substantial working capital to support its revenue growth. Working capital requirements will vary depending upon future acquisition activity. Increases in working capital needs are expected to be financed through operating cash flow and current cash balances.

      The Company maintains restricted cash balances held on behalf of clients pending distribution to vendors which are shown on the balance sheet as assets and equivalent offsetting liabilities. These cash balances totaled approximately $29.4 million and $22.2 million as of June 30, 2000 and December 31, 1999, respectively.

Forward Looking Statements

      The section entitled “Business Segment Review” contains certain forward-looking statements (as defined in the Private Securities Litigation Reform Act of 1995). These forward-looking statements involve significant risks and uncertainties, including changes in general economic and financial market conditions and the Company’s ability to execute its business plans. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, actual results may differ materially.

Item 3. Quantitative and Qualitative Disclosure About Market Risk

      There have been no material changes in market risk as disclosed in the Company’s 1999 Form 10-K.

17

Part II — Other Information

Item 1. Legal Proceedings (None)

Item 2. Changes in Securities and Use of Proceeds (None)

Item 3. Defaults Upon Senior Securities (None)

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

      On May 5, 2000, at the Annual Stockholders Meeting of the Registrant, the shareholders took the following actions:

      1. Elected as directors all nominees designated in the proxy statement of March 28, 2000 as follows:

	Number of Votes
	For		Withheld
Jon L. Gorney		50,640,315		41,227
Jeffrey P. Gotschall		50,641,715		39,827
Jeffrey D. Kelly		50,643,797		37,745
J. Armando Ramirez		50,642,815		38,727

      2. Approved the National Processing, Inc. 2000 Stock Option Plan: 47,416,339 votes cast for 1,963,685, votes cast against, and 4,800 votes withheld.

      3. Approved the selection of Ernst & Young LLP as independent auditors for the Registrant for 2000: 50,655,142 votes cast for, 25,600 votes cast against, and 800 votes withheld.

Item 5. Other Information (None)

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

a. Exhibits

10.28 National Processing, Inc. 2000 Stock Option Plan

27.1 Financial Data Schedule

b. Reports on Form 8-K

      April 17, 2000: On April 17, 2000, the Registrant issued a press release reporting earnings for the quarter ended March 31, 2000.

18

SIGNATURES

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

	NATIONAL PROCESSING, INC.
Date: August 11, 2000	By: /s/ Thomas A. Wimsett
	Thomas A. Wimsett President and Chief Executive Officer (Duly Authorized Signer)
	By: /s/ David E. Fountain
	David E. Fountain Senior Vice President and Chief Financial Officer (Principal Financial Officer)

19