UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(MARK ONE)

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004

OR

FOR THE TRANSITION PERIOD FROM                     TO                    

COMMISSION FILE NUMBER 0-26123

ONLINE RESOURCES CORPORATION

(703) 394-5100

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

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

     As of April 30, 2004 there were 17,945,467 shares of the issuer’s common stock outstanding.

ONLINE RESOURCES CORPORATION

FORM 10-Q

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS.

ONLINE RESOURCES CORPORATION

BALANCE SHEETS

See accompanying notes to unaudited financial statements.

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ONLINE RESOURCES CORPORATION

STATEMENTS OF OPERATIONS

See accompanying notes to unaudited financial statements.

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ONLINE RESOURCES CORPORATION

STATEMENTS OF CASH FLOWS

See accompanying notes to unaudited financial statements.

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ONLINE RESOURCES CORPORATION
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)

1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION

     Online Resources Corporation, a Delaware corporation, (the “Company”) is a leading outsourcer of Internet banking, payment and customer contact services to financial institution clients nationwide. The Company offers services, branded in the clients’ name, that integrate seamlessly into a single-vendor, end-to-end solution, supported by 24x7 customer care, targeted consumer marketing, training and other network and technical professional products and services. The Company operates in one business segment.

INTERIM FINANCIAL INFORMATION

     The accompanying unaudited financial statements have been prepared in conformity with generally accepted accounting principles for interim financial information and with the instructions for Form 10-Q and Article 10 of Regulation S-X. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted, pursuant to the rules and regulations of the Securities and Exchange Commission. In the opinion of management, the statements include all adjustments necessary (which are of a normal and recurring nature) for the fair presentation of the results of the interim periods presented. These financial statements should be read in conjunction with our audited financial statements for the year ended December 31, 2003 included in the Annual Report on Form 10-K filed by the Company with the Securities and Exchange Commission on March 12, 2004. The results of operations for any interim period are not necessarily indicative of the results of operations for any other interim period or for a full fiscal year.

2. STOCK BASED COMPENSATION

     The Company accounts for stock option grants using the intrinsic value method in accordance with Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to Employees for stock-based compensation and furnishes the pro forma disclosures required under SFAS No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure. In electing to continue to follow APB No. 25 for expense recognition purposes, the Company has provided below the expanded disclosures required under SFAS No. 148 for stock-based compensation granted, including, if materially different from reported results, disclosure of pro forma net earnings or losses and earnings or losses per share had compensation expense relating to grants been measured under the fair value recognition provisions of SFAS No. 123.

     The weighted-average fair values at date of grant for options granted during the three months ended March 31, 2004 and 2003 were $4.72 and $2.00, respectively, and were estimated using the Black-Scholes option valuation model with the following weighted-average assumptions:

     A reconciliation of the Company’s net income to pro forma net income (loss) and the related basic and diluted pro forma net income (loss) per share amounts for the three months ended March 31, 2004 and 2003 is provided below. For purposes of pro forma disclosure, stock-based compensation expense is recognized in accordance with the provisions of SFAS No. 123. Further, pro forma stock-based compensation expense is amortized to expense on a straight-line basis over the vesting period.

3. REVENUE RECOGNITION

     The Company generates revenues from service fees, professional services and other supporting services. Service fees are primarily composed of three business lines, Internet banking services, payment services and consumer contact services. Revenues from service fees include new user registration fees, account access fees, transaction fees, customer service fees and relationship marketing support fees. Revenue from service fees are recognized over the term of the contract as the services are provided.

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     Professional services revenues consist of implementation fees associated with the linking of the Company’s financial institution clients to the Company’s Quotien^SM e-financial suite through various networks, web development and hosting fees, training fees and communication services. In accordance with Staff Accounting Bulletin No. 101 — Revenue Recognition in Financial Statements (“SAB 101”), as superseded by SAB 104, which the Company adopted effective January 1, 2000, implementation fees and related direct implementation costs are recognized on a straight line basis over the contract term as the services are provided, which typically range from one to five years (generally three years). Prior to 2000, the Company recognized nonrefundable implementation fees as revenue under the percentage of completion method as certain milestone output measures were completed. Due to the adoption of SAB 101, revenue that was previously recognized under the Company’s prior revenue recognition policy will be recognized under the Company’s revised revenue recognition policy through periods up to 2004 because some contract periods extend through 2004. During the quarters ended March 31, 2004 and 2003, the Company recognized revenue of $2,400 and $13,500, respectively, and related direct incremental costs that were included in the cumulative effect adjustment at January 1, 2000. Revenue from web development, web hosting and training are recognized over the term of the contract as the services are provided.

     Other revenue consists of service fees associated with enhanced third-party solutions and termination fees. Service fees for enhanced third-party solutions include fully integrated bill payment and account retrieval through Intuit’s Quicken, check ordering, inter-institution funds transfer, account aggregation and check imaging. Revenue from these service fees are recognized over the term of the contract as the services are provided. Termination fees are recognized upon termination of a contract.

4. MAJOR CUSTOMER

     One of the Company’s financial institution clients, California Federal Bank or Cal Fed, accounted for approximately $3.3 million, or 30% of the Company’s total revenues, for the quarter ended March 31, 2003. During 2002, Citigroup acquired Cal Fed and converted the Cal Fed customers to the Citigroup banking and bill payment platform in the first quarter of 2003. The $3.3 million received from Cal Fed in the first quarter of 2003 was a combination of service and termination fee revenue. No other customer accounts for more than 10% of the Company’s revenue.

5. NET INCOME PER SHARE

     The following table sets forth the computation of basic and diluted net income per share:

     Due to their anti-dilutive effects, outstanding shares from the conversion of stock options and warrants to purchase shares of common stock were excluded from the computation of diluted earnings per share.

6. NOTES PAYABLE

     On September 28, 2000, the Company completed the private placement of $20 million in convertible subordinated notes (the “Convertible Notes”) to a group of accredited investors. The Company received proceeds of $18.7 million net of debt issuance costs of $1.3 million including commission of $917,200. The Convertible Notes carried an 8% coupon. Interest payment dates were April 1 and October 1, commencing April 1, 2001. The Convertible Notes were initially convertible at a price of $4.75 per share but were subject to an annual reset under certain circumstances. In no event could the price be less than $4.00 per share. Subject to certain conditions, the Company was able to redeem all or part of the Convertible Notes prior to maturity. Jefferies & Company, Inc., one of the underwriters of the placement, also obtained 200,000 warrants that expire on September 30, 2005 that are exercisable at the same price as the conversion price under the Convertible Notes.

     During 2001, the Company repurchased $3.5 million and induced the conversion of $3.5 million of the Convertible Notes. During 2002, the Company induced the conversion of $1.0 million of the Convertible Notes. In the second quarter of 2003, the Company repurchased $3.9 million of the Convertible Notes, and Noteholders converted the remaining $8.1 million of the Convertible Notes in the fourth quarter of 2003.

     Interest expense and amortization of the debt issuance costs related to the Convertible Notes were approximately $304,000 for the quarter ended March 31, 2003.

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

CAUTIONARY NOTE

     The following management’s discussion and analysis should be read in conjunction with the accompanying Financial Statements and Notes thereto. This Quarterly Report on Form 10-Q may contain “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including, but not limited to:

•		Any statements in this document that are not statements of historical fact may be considered forward-looking;
•		Statements regarding trends in our revenues, expense levels, and liquidity and capital resources;
•		Statements about the sufficiency of the proceeds from the sale of securities and cash balances to meet currently planned working capital and capital expenditure requirements for at least the next twelve months; and
•		Other statements identified or qualified by words such as “likely”, “will”, “suggest”, “may”, “would”, “could”, “should”, “expects”, “anticipates”, “estimates”, “plans”, “projects”, “believes”, “seek”, “intend” and other similar words that signify forward-looking statements.

     These forward-looking statements represent our best judgment as of the date of the Quarterly Report on Form 10-Q, and we caution readers not to place undue reliance on such statements. Actual performance and results of operations may differ materially from those projected or suggested in the forward-looking statements due to certain risks and uncertainties, including but not limited to, the risks and uncertainties described or discussed in the section “Risk Factors” in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 12, 2004. These risks include, among others, the following:

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our history of prior losses and lack of certainty as to our continuing profitability;

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possible fluctuations of our quarterly financial results;

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our potential need for additional capital to accelerate revenue and profit growth;

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our customer base may not continue to increase;

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our dependence on the marketing efforts of third parties;

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our dependence on our financial institution clients to market our services;

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the possibility that we may not be able to expand to meet increased demand for our services and related products;

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the potential adverse impact that a loss of a material client or restructure of our agreement with a material customer may have on our financial results;

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our potential inability to compete with larger, more established businesses offering similar products or services;

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our inability to attract and retain qualified management and technical personnel and our dependence on our executive officers and key employees;

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possible security breaches or system failures disrupting our business and the liability associated with these disruptions;

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the possibility of the development of defective new products;

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reduction or elimination of the fees we charge for some services due to the consumer demand for low-cost or free online financial services;

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the potential impact of the consolidation of the banking and financial services industry;

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interference with our business from the adoption of government regulations;

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our need to maintain satisfactory ratings from federal depository institution regulators;

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the potential of litigation;

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the potential control of the management and affairs of the Company by our executives and directors;

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our volatile stock price;

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the trading of a substantial number of shares adversely impacting the price of our shares;

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the possibility of discouraging a takeover as a result of the adoption of a Stockholder Rights Plan; and

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the possibility of terrorism and further acts of violence.

OVERVIEW

     We are a leading outsourcer of Internet banking, payment and customer contact services to financial institution clients nationwide. Our services, branded in the clients’ name, integrate seamlessly into a single-vendor, end-to-end solution, supported by 24x7 customer care, targeted consumer marketing, training and other network and technical professional products and services. Our Annual Report on Form 10-K discusses the critical accounting policies considered by management to be critical for an understanding of our financial statements.

     Registered customers using Internet banking, bill payment or both, are the major driver of our revenue. Since the first quarter of 2003, the number of customers using our banking services increased by 7% and the number of customers using our payment services increased 70%, for an overall 40% increase in customers. This resulted in a 11% increase in revenue exclusive of the $2.2 million termination payment we received from Cal Fed during the first quarter of 2003. While we have seen some reduction in average monthly recurring revenue per user, due largely to our decision to fix price the banking service to our clients, this has been more than offset

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by a decline in the average monthly recurring cost per user. Although the average monthly recurring revenue per user decreased by 21% compared to the first quarter of 2003, the average monthly recurring gross margin per user remained relatively flat as a result of an 18% decrease in the average monthly recurring cost of revenues per user.

     We have long-term service contracts with our financial institution clients. The majority of our revenue is recurring, though these contracts also provide for implementation, set-up and other non-recurring fees. Internet banking services revenue is based either on a monthly license fee allowing our financial institution client to register an unlimited number of customers, or on a monthly fee for each registered customer. Payment services revenue is based on either a monthly fee for each customer enrolled, a fee per executed transaction, or a combination of the two. Our financial institution clients pay all of our fees and then determine if or how they want to pass these costs on to their customers. They typically provide Internet banking services to customers free of charge, as they derive significant potential benefits including account retention, delivery and paper cost savings, account consolidation and cross-selling of other products. However, almost all of our financial institution clients charge their customers for providing payment services.

     As a network-based service provider, we have made substantial up-front investments in infrastructure, particularly for our proprietary systems. While we continue to incur ongoing development and maintenance costs, we believe the infrastructure we have built provides us with significant operating leverage. In 2003 we began an effort to upgrade and rewrite certain of our applications infrastructure that will span a period of two to three years. We expect that this effort will require incremental capital expenditures, primarily for additional development labor, of between $3.0 million and $5.0 million over that period.

     We continue to automate processes and develop applications that allow us to make only small increases in labor and other operating costs relative to increases in customers and transactions. We believe our financial and operating performance will be based primarily on our ability to leverage additional users and transactions over this relatively fixed cost base.

FINANCIAL CONDITION

     While we have achieved net income profitability for the past three quarters and expect our profitability to be sustainable, we have historically experienced operating losses and negative cash flow due to the initial costs of developing our infrastructure and the early revenues typical of an emerging market segment. As a result, at March 31, 2004 we had an accumulated deficit of $82.5 million. We have funded our operations primarily through the issuance of equity and debt securities. Our ongoing working capital requirements consist primarily of personnel costs related to providing our services and operating, enhancing and maintaining our systems.

     Cash and investments in securities available for sale were $14.0 and $13.6 million as of March 31, 2004 and December 31, 2003, respectively. The $0.4 million increase in cash and investments resulted primarily from cash provided by operating activities of $1.1 million and cash provided by financing activities of $0.3 million, partially offset by cash used for capital expenditures of $1.0 million. Total liabilities decreased slightly from $3.9 million as of December 31, 2003 to $3.6 million as of March 31, 2004, primarily as a result of a reduction in accrued compensation expense.

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THREE MONTHS ENDED MARCH 31, 2004 COMPARED TO THE THREE MONTHS ENDED MARCH 31, 2003.

Revenues

     We generate revenue from Internet banking services, payment services, consumer contact services and professional services and other revenue. Revenue decreased $1.2 million, or 11%, to $9.8 million for the three months ended March 31, 2004, from $11.0 million for the same period of 2003. This decrease was attributable to 40%, 20% and 74% decreases in Internet banking services, consumer contact services and professional and other services revenue, respectively, partially offset by a 38% increase in payment services revenue. Overall, the reduction in revenues was principally caused by the non-recurring $2.2 million termination fee we received from Cal Fed in the first quarter of 2003.