UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(MARK ONE)

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004

OR

FOR THE TRANSITION PERIOD FROM                                        TO                                       

COMMISSION FILE NUMBER 0-26123

ONLINE RESOURCES CORPORATION

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

YES [X]    NO [  ]

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

YES [X]    NO [  ]

     As of October 22, 2004 there were 18,186,557 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.

ONLINE RESOURCES CORPORATION
STATEMENTS OF OPERATIONS

See accompanying notes to unaudited financial statements.

ONLINE RESOURCES CORPORATION
STATEMENTS OF CASH FLOWS

See accompanying notes to unaudited financial statements.

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 account presentation, payment and relationship management 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.

      The Company previously reported account presentation services and relationship management services as Internet banking services and consumer contact services. The decision was made to change the descriptions for those revenue items in anticipation of the Company’s pending acquisition. This change will allow the Company to more accurately present its financials following the acquisition.

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 financial 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 September 30, 2004 and 2003 were $4.55 and $4.32, respectively, and during the nine months ended September 30, 2004 and 2003 were $4.69 and $3.01, 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 and nine months ended September 30, 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, account presentation services, payment services and relationship management services. Revenues from service fees include new user registration fees, account access fees, transaction fees, customer service fees and relationship marketing support fees. Revenues from service fees are recognized over the term of the contract as the services are provided.

     Professional services revenues consist of implementation fees associated with the linking of the Company’s financial institution clients to the Company’s QuotienSM 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 three months ended September 30 , 2004 and 2003, the Company recognized revenue of $1,341 and $8,486, respectively, and during the nine months ended September 30, 2004 and 2003, the Company recognized revenue of $5,549 and $33,165, 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. Revenues 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 12% of the Company’s total revenues, for the nine months ended September 30, 2003, but no revenue was generated from Cal Fed for the quarter ended September 30, 2003 or the nine months ended September 30, 2004. 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:

6. NOTES PAYABLE

     On May 30, 2003 and June 9, 2003, the Company repurchased $1.9 million and $2.0 million, respectively, of the Convertible Notes at par, and note holders 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 for the three and nine months ended September 30, 2003 were $202,503 and $774,236, respectively.

7. COMMITMENTS

     On May 21, 2004, the Company executed a ten-year lease covering 74,000 square feet of office and data center space, replacing the majority of its current facility. The rent commencement date of the new lease is October 1, 2004, and the total obligation related to the lease is $17.9 million. The Company also executed an amendment to the lease related to its current facility that allows it to occupy a portion of the facility from October 1, 2004 through July 31, 2007. The total obligation related to the amendment is $1.3 million.

8. COMPONENTS OF COMPREHENSIVE INCOME

     Comprehensive income includes the Company’s net income adjusted for changes, net of tax, of unrealized losses on investments in marketable securities. Comprehensive income for the three and nine months ended September 30, 2004 and 2003 is as follows:

9. SUBSEQUENT EVENT

     On October 18, 2004, we announced that we had signed a definitive agreement to acquire Incurrent Solutions, Inc. (“Incurrent”), an application service provider to the credit card issuer industry, based in Parsippany, New Jersey. Under the definitive agreement, the transaction will provide the shareholders of Incurrent with $8.0 million, less transaction expenses, in cash and 1,000,000 shares of our common stock. The transaction is subject to approval by Incurrent’s shareholders, and we expect to close by early December 2004.

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:

•		our history of prior losses and lack of certainty as to our continuing profitability;
•		possible fluctuations of our quarterly financial results;
•		our potential need for additional capital to accelerate revenue and profit growth;
•		our customer base may not continue to increase;
•		our dependence on the marketing efforts of third parties;
•		our dependence on our financial institution clients to market our services;
•		the possibility that we may not be able to expand to meet increased demand for our services and related products;
•		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;
•		our potential inability to compete with larger, more established businesses offering similar products or services;
•		our inability to attract and retain qualified management and technical personnel and our dependence on our executive officers and key employees;
•		possible security breaches or system failures disrupting our business and the liability associated with these disruptions;
•		the possibility of the development of defective new products;
•		reduction or elimination of the fees we charge for some services due to the consumer demand for low-cost or free online financial services;
•		the potential impact of the consolidation of the banking and financial services industry;
•		interference with our business from the adoption of government regulations;
•		our need to maintain satisfactory ratings from federal depository institution regulators;
•		the potential of litigation;
•		the potential control of the management and affairs of the Company by our executives and directors;
•		our volatile stock price;
•		the trading of a substantial number of shares adversely impacting the price of our shares;
•		the possibility of discouraging a takeover as a result of the adoption of a Stockholder Rights Plan; and
•		the possibility of terrorism and further acts of violence.

OVERVIEW

     We are a leading outsourcer of account presentation, payment and relationship management 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 account presentation, bill payment or both, are the major driver of our revenue. Since the third quarter of 2003, the number of customers using our account presentation services increased by 11%, and the number of customers using our payment services increased 49%, for an overall 34% increase in customers. This increase along with approximately $0.5 million in termination fees resulted in a 19% increase in revenue. While we have seen some reduction in average monthly recurring revenue per user, due largely to our decisions to fix price the account presentation service to our clients and offer volume-based bill payment price reductions, this has been more than offset by a decline in the average monthly recurring cost per user. Although the average monthly recurring revenue per user decreased by 14% compared to the third quarter of 2003, the average monthly recurring costs of revenues per user decreased by 27%. This resulted in an increase in recurring gross margin per user from 58% in the third quarter of 2003 to 64% in the same quarter of 2004.

     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. Account presentation 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 account presentation 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, approximately 70% 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 continue into 2006. 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 five 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 September 30, 2004 we had an accumulated deficit of $79.2 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 available for sale securities were $16.2 million and $13.6 million as of September 30, 2004 and December 31, 2003, respectively. The $2.6 million increase in cash and investments resulted from cash provided by operating activities and financing activities of $6.7 and $0.8 million, respectively, partially offset by capital expenditures of $4.9 million. Total liabilities increased from $3.9 million as of December 31, 2003 to $5.3 million as of September 30, 2004, primarily due to an increase of $1.4 million in accounts payable resulting from several large outstanding invoices related to our impending move. The majority of these invoices will be either paid by us and reimbursed by the landlord or paid directly by the landlord.

Results of Operations

     The following table presents certain items derived from our Statements of Operations expressed as a percentage of revenue.