UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

For the quarterly period ended September 30, 2004

OR

For the transition period from ____ to ____

Commission File Number 1-31951

eFunds Corporation

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

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

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

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

Table of Contents

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

eFUNDS CORPORATION AND SUBSIDIARIES

See Notes to Condensed Consolidated Financial Statements

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eFUNDS CORPORATION AND SUBSIDIARIES

See Notes to Condensed Consolidated Financial Statements

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eFUNDS CORPORATION AND SUBSIDIARIES

See Notes to Condensed Consolidated Financial Statements

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eFUNDS CORPORATION AND SUBSIDIARIES

NOTE 1 — DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION:

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

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

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

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

NOTE 2 — EMPLOYEE STOCK-BASED COMPENSATION:

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

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

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

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

NOTE 3 — ACQUISITIONS:

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

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

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

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

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

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

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

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

NOTE 5 — INTANGIBLES:

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

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

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

NOTE 6 — RESTRUCTURING, ASSET IMPAIRMENT AND OTHER CHARGES:

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

NOTE 7 — ACCRUED CONTRACT LOSSES:

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

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

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NOTE 8 — LONG-TERM DEBT:

Long-term debt was as follows:

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

NOTE 9 — INCOME PER SHARE:

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