UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
X Quarterly report pursuant to Section 13 or 15(d) of the Securities
- --- Exchange Act of 1934
FOR THE PERIOD ENDED JUNE 30, 2002
OR
Transition report pursuant to Section 13 or 15(d) of the Securities
- --- Exchange Act of 1934
COMMISSION FILE NUMBER: 0-15245
ELECTRONIC CLEARING HOUSE, INC.
(Exact name of registrant as specified in its charter)
NEVADA 93-0946274
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
28001 DOROTHY DRIVE,
AGOURA HILLS, CALIFORNIA 91301
(Address of principal executive offices)
TELEPHONE NUMBER (818) 706-8999
WWW.ECHO-INC.COM
(Registrant's telephone number, including area code; web site address)
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
--- ---
As of July 31, 2002, there were 5,796,109 shares of the Registrant's Common
Stock outstanding.
ELECTRONIC CLEARING HOUSE, INC.
INDEX
-----
PART I. FINANCIAL INFORMATION
Page No.
---------
Item 1. CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED):
Consolidated Balance Sheets 3
June 30, 2002 and September 30, 2001
Consolidated Statements of Operations 4
Three months and nine months ended
June 30, 2002 and 2001
Consolidated Statements of Cash Flows 5
Nine months ended June 30, 2002 and 2001
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of 10
Financial Condition and Results of
Operations
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 18
Signatures 19
2
PART I. FINANCIAL INFORMATION
- --------------------------------
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
ELECTRONIC CLEARING HOUSE, INC.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
ASSETS
JUNE 30, SEPTEMBER 30,
2002 2001
------------ ---------------
Current assets:
Cash and cash equivalents $ 2,491,000 $ 4,147,000
Restricted cash 890,000 1,410,000
Accounts receivable less allowance of $395,000 and $313,000 1,698,000 1,864,000
Inventory, net 328,000 573,000
Prepaid expenses and other assets 139,000 137,000
------------ ---------------
Total current assets 5,546,000 8,131,000
Noncurrent assets:
Long term receivables 21,000 21,000
Property and equipment, net 5,010,000 3,754,000
Real estate held for investment, net 152,000 252,000
Deferred tax asset 2,014,000 778,000
Other assets, net 458,000 800,000
Goodwill, net 4,808,000 5,185,000
------------ ---------------
Total assets $18,009,000 $ 18,921,000
============ ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term borrowings and current portion of long-term debt $ 471,000 $ 240,000
Accounts payable 132,000 135,000
Settlement payable to merchants 558,000 618,000
Accrued expenses 1,048,000 1,395,000
Deferred income -0- 50,000
------------ ---------------
Total current liabilities 2,209,000 2,438,000
Long-term debt 2,228,000 744,000
------------ ---------------
Total liabilities 4,437,000 3,182,000
------------ ---------------
Commitments and contingencies
Stockholders' equity:
Convertible preferred stock, $.01 par value, 5,000,000 shares authorized:
Series "K", -0- and 25,000 shares issued and outstanding -0- -0-
Common stock, $.01 par value, 36,000,000 authorized:
5,835,357 and 5,809,121 shares issued; 5,796,109 and
5,769,873 shares outstanding 58,000 58,000
Additional paid-in capital 21,262,000 21,260,000
Accumulated deficit (7,279,000) (5,110,000)
Less treasury stock at cost, 39,248 common shares (469,000) (469,000)
------------ ---------------
Total stockholders' equity 13,572,000 15,739,000
------------ ---------------
Total liabilities and stockholders' equity $18,009,000 $ 18,921,000
============ ===============
See accompanying notes to consolidated financial statements.
3
ELECTRONIC CLEARING HOUSE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS NINE MONTHS
ENDED JUNE 30, ENDED JUNE 30,
---------------- ----------------
2002 2001 2002 2001
----------- ----------- ------------ ------------
Revenues:
Processing revenue $4,180,000 $3,783,000 $12,048,000 $10,921,000
Transaction revenue 4,157,000 3,753,000 12,413,000 10,414,000
Terminal sales 62,000 183,000 191,000 389,000
Other revenue 16,000 39,000 70,000 393,000
----------- ----------- ------------ ------------
8,415,000 7,758,000 24,722,000 22,117,000
----------- ----------- ------------ ------------
Costs and expenses:
Processing and transaction expense 5,795,000 4,961,000 16,675,000 14,074,000
Cost of terminals sold 85,000 153,000 437,000 345,000
Other operating costs 1,069,000 901,000 3,065,000 2,690,000
Selling, general and administrative expenses 1,480,000 1,434,000 5,008,000 4,082,000
Amortization expense - goodwill 129,000 106,000 385,000 310,000
Legal settlement -0- -0- 2,500,000 -0-
----------- ----------- ------------ ------------
8,558,000 7,555,000 28,070,000 21,501,000
----------- ----------- ------------ ------------
(Loss) income from operations (143,000) 203,000 (3,348,000) 616,000
Interest income 10,000 36,000 46,000 153,000
Interest expense (46,000) (18,000) (84,000) (60,000)
Gain on sales of asset -0- 350,000 -0- 350,000
----------- ----------- ------------ ------------
(Loss) income before provision for income taxes (179,000) 571,000 (3,386,000) 1,059,000
Benefit (provision) for income taxes 11,000 (289,000) 1,217,000 (588,000)
----------- ----------- ------------ ------------
Net (loss) income $ (168,000) $ 282,000 $(2,169,000) $ 471,000
=========== =========== ============ ============
(Loss) earnings per share - Basic $ (0.03) $ 0.05 $ (0.38) $ 0.08
=========== =========== ============ ============
(Loss) earnings per share - Diluted $ (0.03) $ 0.05 $ (0.38) $ 0.08
=========== =========== ============ ============
Shares used in computing basic
(loss) earnings per share 5,796,109 5,406,343 5,785,362 5,427,051
=========== =========== ============ ============
Shares used in computing diluted
(loss) earnings per share 5,796,109 5,593,348 5,785,362 5,621,089
=========== =========== ============ ============
See accompanying notes to consolidated financial statements.
4
ELECTRONIC CLEARING HOUSE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS
ENDED JUNE 30,
----------------
2002 2001
------------ ------------
Cash flows from operating activities:
Net (loss) income $(2,169,000) $ 471,000
Adjustments to reconcile net (loss) income to net
cash (used in) provided by operating activities:
Depreciation 476,000 305,000
Amortization of software 377,000 293,000
Amortization of goodwill 385,000 310,000
Provision for losses on accounts and notes receivable 258,000 255,000
Provision for obsolete inventory 201,000 12,000
Write-down of real estate 100,000 -0-
Fair value of stock issued in connection with
directors' compensation 45,000 45,000
Deferred income taxes (1,236,000) 446,000
Legal settlement 1,300,000 -0-
Changes in assets and liabilities:
Restricted cash 520,000 (301,000)
Accounts receivable (178,000) (711,000)
Inventory 44,000 (13,000)
Prepaid expenses and other current assets (2,000) (30,000)
Accounts payable (3,000) 59,000
Settlement payable to merchants (60,000) 209,000
Accrued expenses (315,000) (44,000)
Deferred income (50,000) -0-
Other receivable -0- (6,000)
------------ ------------
Net cash (used in) provided by operating activities ( 307,000) 1,300,000
------------ ------------
Cash flows from investing activities:
Other assets (62,000) (413,000)
Purchase of equipment and software (1,439,000) (839,000)
Cash used for acquisition -0- (169,000)
------------ ------------
Net cash used in investing activities (1,501,000) (1,421,000)
------------ ------------
Cash flows from financing activities:
Repayment of notes payable (105,000) (97,000)
Repayment of capitalized leases (144,000) (33,000)
Proceeds from sale and leaseback of equipment 390,000 -0-
Proceeds from exercise of stock options 11,000 -0-
Repurchase of common stock -0- (300,000)
------------ ------------
Net cash provided by (used in) financing activities 152,000 (430,000)
------------ ------------
Net decrease in cash (1,656,000) (551,000)
Cash and cash equivalents at beginning of period 4,147,000 3,941,000
------------ ------------
Cash and cash equivalents at end of period $ 2,491,000 $ 3,390,000
============ ============
See accompanying notes to consolidated financial statements.
5
ELECTRONIC CLEARING HOUSE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 - BASIS OF PRESENTATION:
- ------------------------------------
The accompanying consolidated financial statements as of June 30, 2002, and for
the three and nine-month periods then ended, are unaudited and reflect all
adjustments (consisting only of normal recurring adjustments) which are, in the
opinion of management, necessary for a fair statement of the financial position
and the results of operations for the interim periods. The consolidated
financial statements herein should be read in conjunction with the consolidated
financial statements and notes thereto, together with management's discussion
and analysis of financial condition and results of operations, contained in the
Company's Annual Report to Stockholders incorporated by reference in the
Company's Annual Report on Form 10-K for the fiscal year ended September 30,
2001. The results of operations for the three and nine months ended June 30,
2002 are not necessarily indicative of the likely results of operations for the
entire fiscal year ending September 30, 2002.
NOTE 2 - EARNINGS (LOSS) PER SHARE:
- -----------------------------------------
The Company calculates earnings (loss) per share as required by SFAS No. 128,
"Earnings per Share".
Three months ended June 30, Nine months ended June 30,
-------------------------- ----------------------------
2002 2001 2002 2001
------------- ----------- --------------- -----------
Net (loss) income $ (168,000) $ 282,000 $ (2,169,000) $ 471,000
============= =========== =============== ===========
Shares:
Denominator for basic earnings per
share - weighted-average shares
outstanding 5,796,109 5,406,343 5,785,362 5,427,051
Effect of dilutive securities:
Employee stock options -0- 124,836 -0- 156,648
Series K Convertible Preferred Stock -0- 25,000 -0- 25,000
Performance Shares -0- 37,169 -0- 12,390
------------- ----------- --------------- -----------
Dilutive potential common shares -0- 187,005 -0- 194,038
------------- ----------- --------------- -----------
Denominator for diluted earnings per
share - adjusted weighted-average
shares and assumed conversions 5,796,109 5,593,348 5,785,362 5,621,089
============= =========== =============== ===========
Basic (loss) earnings per share $ (0.03) $ 0.05 $ (0.38) $ 0.08
Diluted (loss) earnings per share $ (0.03) $ 0.05 $ (0.38) $ 0.08
Dilutive common stock equivalents have been excluded from the calculation of
diluted loss per share for the three and nine months ended June 30, 2002, as
their inclusion would be anti-dilutive to the loss per share calculation.
Approximately 368,750 and 343,750 stock options for the three and nine months
ended June 30, 2001, were excluded from the calculation of diluted earnings per
share as their effect would be anti-dilutive. However, these common stock
equivalents could be dilutive in the future.
6
NOTE 3 - NON-CASH TRANSACTIONS:
- -----------------------------------
Significant non-cash transactions for the nine months ended June 30, 2002 were
as follows:
- A $1.3 million 15-year long-term promissory note was issued as
part of the Premiere Lifestyles International Corporation vs.
ECHO legal settlement.
- Capital equipment of $274,000 was acquired under capital leases.
- The Company received 25,000 shares of ECHO's common stock
(converted from 25,000 shares of preferred stock), as a repayment
of a $54,000 chargeback receivable owed to the Company by a
former merchant.
Significant non-cash transactions for the nine months ended June 30, 2001 were
as follows:
- An employee exercised stock options and executed a promissory
note to the Company in the amount of $43,000. The note is
interest-bearing and fully secured by the underlying stock.
- 21,116 shares of common stock valued at $85,000 were issued for
the purchase of certain National Check Network, Inc. assets.
NOTE 4 - INVENTORY:
- ----------------------
The components of inventory are as follows:
June 30 September 30
2002 2001
------------- -------------
Raw materials $ 62,000 $ 62,000
Finished goods 485,000 529,000
------------- -------------
547,000 591,000
Less:
Allowance for obsolescence 219,000 18,000
------------- -------------
$ 328,000 $ 573,000
============= =============
NOTE 5 - SHORT-TERM BORROWINGS AND LONG-TERM DEBT:
- --------------------------------------------------------
Short-term borrowings and long-term debt consist of the following:
June 30 September 30
2002 2001
----------- --------------
Term loan collateralized by corporate headquarters building,
due February 15, 2009, bearing interest at 7.87% per annum $ 404,000 $ 438,000
7
Term loan collateralized by equipment, due 2005, bearing
interest at prime rate, 4.75% at June 30, 2002 207,000 266,000
Long-term promissory note collateralized by corporate
headquarters building, due March 25, 2017, bearing
interest at 8.00% per annum 1,289,000 -0-
Capital leases 799,000 277,000
Notes payable, bearing interest at 9.5% -0- 3,000
----------- --------------
2,699,000 984,000
Less: current portion (471,000) (240,000)
----------- --------------
Total long-term debt $2,228,000 $ 744,000
=========== ==============
NOTE 6 - SEGMENT INFORMATION:
- --------------------------------
The Company currently operates in two business segments: bankcard and
transaction processing, and check-related products, all of which are located in
the United States.
The Company's reportable operating segments have been determined in accordance
with the Company's internal management structure, which is organized based on
the Company's product lines. The Company evaluates performance based upon two
primary factors, one is the segment's operating income and the other is based on
the segment's contribution to the Company's future strategic growth.
The Company has consolidated the segment information for terminal sales into the
bankcard and transaction processing segment due to the decreased significance of
terminal sales.
Three Months Ended Nine Months Ended
June 30 June 30
-------- --------
2002 2001 2002 2001
----------- ----------- ------------ ------------
Revenues:
Bankcard and transaction
processing $6,924,000 $6,516,000 $20,343,000 $18,640,000
Check-related products 1,475,000 1,203,000 4,309,000 3,084,000
Other 16,000 39,000 70,000 393,000
----------- ----------- ------------ ------------
$8,415,000 $7,758,000 $24,722,000 $22,117,000
=========== =========== ============ ============
Operating (loss) income:
Bankcard and transaction
processing $ 543,000 $ 877,000 $ 1,666,000 $ 2,379,000
Check-related products (257,000) (158,000) (676,000) (281,000)
Other - corporate expenses (429,000) (516,000) (4,338,000) (1,482,000)
----------- ----------- ------------ ------------
$ (143,000) $ 203,000 $(3,348,000) $ 616,000
=========== =========== ============ ============
8
NOTE 7 - NEW ACCOUNTING PRONOUNCEMENTS:
- ---------------------------------------
In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 141 ("SFAS 141"), "Business Combinations".
SFAS 141 requires the purchase method of accounting for business combinations
initiated after June 30, 2001 and eliminates the pooling-of-interests method.
The Company does not believe that the adoption of SFAS 141 will have a
significant impact on its financial statements and the results of its
operations.
In July 2001, the FASB issued Statement of Financial Accounting Standards No.
142 ("SFAS"), "Goodwill and Other Intangible Assets", which is effective for
fiscal years beginning after December 15, 2001. SFAS 142 requires, among other
things, the discontinuance of goodwill amortization. In addition, the standard
includes provisions for the reclassification of certain existing recognized
intangibles as goodwill, reassessment of the useful lives of existing recognized
intangibles, reclassification of certain intangibles out of previously reported
goodwill and the identification of reporting units for purposes of assessing
potential future impairments of goodwill. SFAS 142 also requires companies to
complete a transitional goodwill impairment test six months from the date of
adoption. The Company plans to adopt SFAS 142 by the first quarter of fiscal
2003. Based upon our initial assessment, we believe that it is probable that
upon adoption, we will record a material goodwill impairment charge, which would
also be reflected in a one-time, non-cash charge to net income attributed to a
change in accounting principal.
In August 2001, FASB issued Statement of Financial Accounting Standards No. 144
("SFAS 144"), "Accounting for the Impairment or Disposal of Long-Lived Assets."
This Statement supersedes FASB Statement No. 121, ("SFAS 121") Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets To Be Disposed Of,
and the accounting and reporting provisions of APB Opinion No. 30, Reporting the
Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions, for the disposal of a segment of a business (as previously defined
in that Opinion). This statement establishes a single accounting model for
long-lived asset impairment, based on the framework established in SFAS 121, for
long-lived assets to be disposed of by sale, and resolves significant
implementation issues related to SFAS 121. The Company is currently evaluating
the impact that SFAS 144 will have on its financial statements and the results
of its operations.
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS
-----------------------------------
OVERVIEW
Electronic Clearing House, Inc. ("ECHO" or "the Company") provides a complete
solution to the payment processing needs of merchants, banks and collection
agencies. The Company's services include debit and credit card processing, check
guarantee, check verification, check conversion, check re-presentment, check
collection and inventory tracking.
The Company derives revenues from two main business segments, bankcard and
transaction processing, and check-related products and operates under the
following brands;
- MERCHANTAMERICA, ECHO's retail provider of processing services to both
the merchant and bank markets;
- National Check Network(R) (NCN(R)) for check verification;
- XPRESSCHEX, Inc. for processing check guarantee, check conversion,
check collection and check verification; and
- U-Haul(R) Services, which provides credit card authorization, collects
rental and compensation activity and tracks available inventory.
The Company's main revenue generator is its merchant services, which includes
bankcard and transaction processing and whereby ECHO receives a percentage-based
fee on the dollar amount processed and a transaction fee on the number of
transactions processed. This has historically been a profitable business,
although price competition is intense. The Company is working to enhance
back-end technology in order to reduce processing costs and enhance management
reporting capabilities.
ECHO has invested significant resources and management focus in its check
services business, whereby revenues are based on a fixed fee per transaction or
a fee based on the amount of the check for each transaction. ECHO is the sixth
largest check verification processor in the United States according to the June
2002 issue of The Nilson Report, a monthly financial subscription-based
newsletter. The Company is one of several check processors in the nation with
both an Automated Clearing House (ACH) engine, which gives the Company the
ability to transfer and verify funds, and a negative-check writer database
(NCN), which provides check risk management. The NCN database includes over 17
million bad-check writer records, 80 million positive records, and 260
affiliated collection agencies who continually contribute to the database to
enhance its depth and value.
In December 2000, ECHO signed an agreement with Visa U.S.A. as a third-party
acquiring processor in Visa's Point-of-Sale (POS) Check Services program. The
POS Check Services will allow merchants to receive immediate online
authorization for paper checks, by converting them into electronic transactions,
which will then be verified against member bank accounts. The Company provides
critical back-end infrastructure for the service, including its ACH backbone and
NCN database for checks written on non-participating banks. ECHO is the
preferred third-party acquiring processor for a majority of the financial
institutions currently testing the Visa service. Visa estimates that the program
has the potential to achieve an annual volume of 265 million transactions within
five years.
ECHO generates a recurring revenue stream for processing U-Haul rental
activities. The C.A.R.D. terminal system was developed by ECHO to provide
complex services and features for U-Haul's rental activities, which include
tracking advance reservations and dealer compensation. The last batch of
C.A.R.D. terminals was shipped in fiscal 2000, bringing the total systems in the
field to 15,000. With a useful life of 5 to 6 years, U-Haul dealers are
expected to use these systems for the next few years and ECHO will continue to
support the service and maintenance of these terminals. On-going terminal sales
are expected to be a diminishing portion of business as ECHO focuses on its core
merchant and check services business.
10
STRATEGY
ECHO's strategy is to provide merchants and financial institutions with
electronic connectivity to various payment services in the credit card, debit
card and check-related markets. ECHO's services enable merchants to maximize
revenues by offering a wide variety of payment options, reduce the costs
associated with processing and handling checks, improve collections and manage
risk more effectively. The Company has targeted several areas as significant
opportunities for growth, including focusing on middle-market retail accounts
for check services and developing a scalable infrastructure to support
widespread implementation of the Visa POS Check Services. The Company also seeks
to increase profitability of core merchant services by enhancing the back-end
technology and reducing processing costs.
- --The Company plans to grow ECHO's check services business by focusing on
mid-size retail chains that can benefit most from automating check processing
and verification. These mid-size accounts typically offer much higher margins
than larger accounts and provide a less competitive marketplace. ECHO has
recently signed agreements with several new retailers and the prospective
pipeline of customers is growing.
- --The Company plans to complete development and beta testing of Visa's POS Check
Services so as to leverage ECHO's check services products through Visa member
banks. The process of developing and bringing to market Visa POS Check Services
has been more time and resource intensive than originally anticipated due to the
unique requirements of each financial institution and extensive testing periods.
ECHO is finalizing the enhancements that Visa and these banks require and is
incorporating them into a standardized, but customizable platform of options.
This platform is under development and scheduled for completion by the end of
calendar 2002.
- --ECHO has identified an underserved, niche market of smaller regional and
community banks for its agent bank program. The Company plans to provide a
turn-key solution to allow smaller banks to offer bankcard and check processing
services using ECHO's back-end infrastructure. The program can be developed and
sold at a low incremental cost to ECHO and still provides a better priced and a
more integrated product offering to small banks than they can currently receive
from other providers.
SALES AND MARKETING
ECHO sells its merchant and check services through several marketing channels,
including independent sales organizations (ISO), its own internal sales force
and direct merchant referrals by existing merchants. Approximately 20% of the
Company's new accounts have historically been generated through the ISOs. ECHO
recently restructured its sales force and implemented an incentive-based
commission structure with the goal of targeting specific accounts and shortening
the sales cycle. The Company also offers merchant services through a direct
online sales channel, MERCHANTAMERICA.com.
Management believes that the Company is unique in the number of payment methods
that the Company offers to its merchants, the combination of transaction types
that it manages directly, its ability to integrate additional services and its
ability to support each merchant through one vertically integrated source.
The Company's marketing strategy is to maximize cross selling opportunities to
its existing base of merchants; sell integrated suites, bankcard and check
processing services to small banks; enhance and market MERCHANTAMERICA; and
develop the private label check service program.
SIGNIFICANT DEVELOPMENTS
During the fiscal third quarter, ECHO made significant progress on several key
initiatives to expand its check services platform and improve profitability of
its merchant services.
- --During the fiscal third quarter, the Company entered into an agreement to
provide a complete check management solution to a leading multimedia
entertainment retailer. The check solution will enable the retailer to
streamline and automate the process of receiving checks from its customers,
increasing the number of collections and reducing the amount of fees on returned
checks by over $1 million.
- --ECHO entered into beta tests of the Visa POS Check Services program with two
additional banks in the third fiscal quarter of 2002. The Company completed ACH
and NCN system enhancements to support these pilot programs.
- --The Company was recently selected as a third-party processor for a beta test
of the Visa POS Check Services for a global specialty clothing retailer with
over 3,000 outlets, and Visa agreed to fund the development costs related to
this program. If these tests are successful, a full launch is anticipated after
the 2002-2003 holiday season.
11
- --Merchants on MERCHANTAMERICA increased to 10% of total existing accounts
during the quarter. The Company achieved this goal six months ahead of schedule.
COMPETITION
Merchant and check services are highly competitive industries and are
characterized by rapid technological change, rapid rates of product obsolescence
and introductions of competitive products often at lower prices and/or with
greater functionality than those currently on the market.
ECHO is not currently a major player in the industries in which it competes and
many of the Company's competitors have greater financial and marketing resources
than the Company. As a result, they may be better able to respond more quickly
to new or emerging technologies and changes in customer requirements.
Competitors also enjoy per transaction cost advantages due to their high
processing volumes that may make it difficult for ECHO to compete. In addition,
major players in the check services industry have developed sophisticated risk
assessment technology that may provide a competitive advantage in providing
check guarantee services. The Company believes that its success will depend upon
its ability to continuously develop new products and services and to enhance its
current products and to introduce them promptly into the market.
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 2002 AND 2001
- -----------------------------------------
Financial highlights for the third quarter of 2002 as compared to the same
period last year were as follows:
- --Total revenue increased 8.5% to $8.4 million
- --Gross margins from processing and transaction revenue declined to 30.5% from
34.2%
- --Operating income moved into negative territory to $(143,000) from $203,000
- --Diluted loss per share of $(0.03) as compared to diluted EPS of $0.05
- --Bankcard and transaction processing revenue increased 6.3% to $6.9 million
- --Check-related revenue increased 22.6% to $1.5 million
REVENUE. Total revenue increased 8.5% to $8,415,000 for the three months ended
June 30, 2002, from $7,758,000 for the same period last year. The increase can
be primarily attributed to growth in the processing and transaction business
segments, offset by a negotiated rate reduction on its contract with U-Haul.
Total processing and transaction revenue for this third fiscal quarter increased
10.6%, from $7,536,000 in fiscal 2001 to $8,337,000 in fiscal 2002.
COST OF SALES. Bankcard processing expenses are largely a direct reflection of
any changes in processing revenue. A majority of the Company's bankcard
processing expenses are fixed as a percentage of each transaction amount, with
the remaining costs being based on a fixed rate applied to the transactions
processed. Processing-related expenses, consisting of bankcard processing
expense and transaction and check processing expense, increased from $4,961,000
in the third fiscal quarter of 2001 to $5,795,000 in the current fiscal quarter,
a 16.8% increase. The increase reflects a 10.6% increase in processing and
transaction revenues for the current fiscal quarter, as well as the higher costs
of processing.
12
Gross margin from processing and transaction services decreased from 34.2% in
the third fiscal quarter last year to 30.5% in this fiscal quarter. This
decrease in gross margin was due to an 8.8% per transaction rate reduction in
U-Haul processing revenue and the departure of several large high-margin
bankcard merchants.
EXPENSE. Other operating costs increased from $901,000 in the third fiscal
quarter of 2001 to $1,069,000 in this fiscal quarter, an increase of 18.6%. This
increase was primarily attributable to an increase in research and development
expenses, higher customer support expenses due to increased sales activities and
personnel costs and software development related to the Visa POS Check Services
pilot program. Research and development expense increased 51.8% to $466,000 in
the third fiscal quarter, from $307,000 in the same period last year.
Selling, general and administrative expenses increased slightly from $1,434,000
in the third fiscal quarter 2001 to $1,480,000 in quarter ended June 30, 2002.
As a percentage of total revenue, selling, general and administrative expenses
decreased from 18.5% in the third fiscal quarter 2001 to 17.6% in the current
fiscal quarter.
OPERATING INCOME (LOSS). Operating loss for the quarter ended June 30, 2002 was
($143,000), as compared to operating income of $203,000 in the same period last
year. The decline was due to a combination of factors including a decrease in
gross margin, as well as the Company's investment to develop infrastructure and
staff to support the Visa POS Check Services processing platform.
INTEREST EXPENSE. Interest expense increased to $46,000 for the quarter ended
June 30, 2002, from $18,000 in the same period last year. The increase is due to
the $1.3 million long-term note portion of the legal settlement expense for
Premiere Lifestyles International Corporation, which carries an 8% interest
rate.
EFFECTIVE TAX RATE. Benefit for income taxes of $11,000 in the quarter ended
June 30, 2002 was due to the net loss incurred of $179,000.
SEGMENT RESULTS
Bankcard and Transaction Processing. Bankcard processing and transaction revenue
increased 6.3%, from $6,516,000 in the third fiscal quarter 2001 to $6,924,000
for this fiscal quarter. This increase was mainly attributable to an
approximately 12.5% increase in bankcard processing volume as compared to the
same quarter last year. This was the result of the Company's successful
marketing programs such as the MERCHANTAMERICA web offerings and other sales
programs. Additionally, the bankcard processing revenue increase was partially
offset by a decrease in revenue as a result of a rate reduction offered to
U-Haul International, a major transaction processing customer.
The bankcard and transaction processing segment generated a gross margin of
26.6% in the quarter ended June 30, 2002 as compared to 31.0% in the same period
last year. Operating income for this business segment was $543,000 for the
third fiscal quarter, down 38.1% from $877,000 in the same period last year. The
decrease in margin and operating income are attributable to the departure of
several large high-margin merchants combined with a rate reduction offered to
U-Haul International.
Check Related Products. Check-related revenues increased from $1,203,000 for the
three months ended June 30, 2001 to $1,475,000 for the three months ended June
30, 2002, an increase of 22.6%. This was attributable to a 5.5% increase in
check verification revenue and a 51.8% increase in other electronic check
processing and collection revenue.
Check services revenue made up 17.5% of total processing and transaction
revenues in this quarter as compared to 15.5% in the prior year. Check-related
operating loss was $257,000 in the quarter ended June 30, 2002 as compared to a
loss of $158,000 in the same period last year. The higher loss was primarily due
to an increase in staffing to continue product development and enhancement.
13
The Visa POS Check Services pilot program is continuing as planned. The Company
is currently working with seven Visa member banks that have chosen to
participate in this Visa POS Check Services pilot program. However, during the
pilot phase, small numbers of merchants are being piloted by the banks, so the
Company will not be generating significant revenue from this Visa program until
the member banks have completed the pilot phase and begin to offer this program
to their merchant base at large. Management believes that the Visa POS Check
Services program will provide the Company with significant opportunities to
develop strategic relationships with some major banks, which could result in a
corresponding increase in our check services revenue in the coming years.
Terminal Sales. Terminal sales and lease revenue for the three months ended June
30, 2002 was $62,000, which represented a 66.1% decrease from $183,000 for the
same fiscal quarter last year. This reflects the Company's growth strategy being
focused in the transaction business and not in terminal sales.
Other. Other revenue decreased from $39,000 in the third fiscal quarter 2002 to
$16,000 in this fiscal quarter due to a decrease in the amount of customer
software development work completed during the current quarter.
NINE MONTHS ENDED JUNE 30, 2002 AND 2001
- ----------------------------------------
Financial highlights for the nine months ended June 30, 2002 as compared to the
same period last year were as follows:
- --Total revenue increased 11.8% to $24.7 million
- --ECHO reached a legal settlement agreeing to pay $2.5 million, of which $1.2
million was paid in cash during the second fiscal quarter
- --Gross margins from processing and transaction revenue declined to 31.8% from
34.0%
- --Operating loss was $(3,348,000) due to the legal settlement and higher costs
of operations
- --Diluted loss per share of $(0.38) as compared to diluted EPS of $0.08
- --Bankcard and transaction processing revenue increased 9.1% to $20.3 million
REVENUE. Revenue for the nine months of fiscal 2002 was $24,722,000, compared to
$22,117,000 for the same period last year, an increase of 11.8%, as the Company
secured additional merchant and check services clients. Total processing and
transaction revenue was $24,461,000 for the nine months ended June 30, 2002 as
compared to $21,335,000 for the nine months ended June 30, 2001, an increase of
14.7%.
COST OF SALES. Processing and transaction expenses increased from $14,074,000
for the nine months ended June 30, 2001 to $16,675,000 for the current
nine-month period, an increase of 18.5%. This is primarily related to the 14.7%
increase in processing and transaction revenue for the same nine-month period.
Gross margin on processing and transaction activities decreased from 34.0% for
the nine-month period ended June 30, 2001 to 31.8% for the same nine-month
period this year. This was mainly due to a combination of an increase in
processing expenses, departure of several large high-margin bankcard merchants
and the reduced rate offered to U-Haul International.
Cost of terminals sold increased from $345,000 for the nine months ended June
30, 2001 to $437,000 for the current nine-month period, an increase of 26.7%.
The increase was due to the $200,000 inventory obsolescence allowance recorded
in the second fiscal quarter of 2002.
EXPENSE. Other operating costs increased from $2,690,000 for the nine months
ended June 30, 2001 to $3,065,000 for the nine months ended June 30, 2002, an
increase of 13.9%, which was attributable to the increase in total processing
and transaction revenue. The Company is continuing to invest in research and
development costs related to the various check service products. Additionally,
the Company is incurring operational expenses related to the management of the
Visa POS Check Services pilot program without any offsetting revenue at the
present time. Management believes that a significant portion of our growth
strategy is contingent upon our ability to develop the major bank relationships
that the Visa program has provided to the Company.
14
Selling, general and administrative expenses increased from $4,082,000 for the
nine months ended June 30, 2001 to $5,008,000 for the nine months ended June 30,
2002, an increase of 22.7%. This increase was mainly due to the legal and
consulting fees related to the lawsuit disclosed above and higher personnel
costs. As a percentage of total revenue, selling, general and administrative
expenses were 20.3% for this nine-month period as compared to 18.5% for the same
nine-month period last year.
OPERATING INCOME (LOSS). Operating loss for the nine months ended June 30, 2002
was $(3,348,000), as compared to operating income of $616,000 in the same period
last year. The decline was primarily attributable to the settlement associated
with the lawsuit and the Company's investment to develop infrastructure and
staff to support the Visa POS check processing platform.
INTEREST EXPENSE. Interest expense increased to $84,000 for the nine months
ended June 30, 2002, from $60,000 in the same period last year. The increase is
due to the $1.3 million long-term note portion of the legal settlement expense
for Premiere Lifestyles International Corporation, which carries an 8% interest
rate.
EFFECTIVE TAX RATE. Benefit for income taxes of $1,217,000 for the nine months
ended June 30, 2002 was primarily due to the settlement of the lawsuit.
SEGMENT RESULTS.
Bankcard and Transaction Processing. Bankcard and transaction processing revenue
was $20,343,000 for the nine months ended June 30, 2002 as compared to
$18,640,000 for the same period last year, an increase of 9.1%. This increase
was mainly attributable to an approximately 12.4% increase in bankcard
processing volume as compared to the same nine-month period last year. The
bankcard processing revenue increase was partially offset by a decrease in
revenue as a result of a rate reduction offered to U-Haul, a major transaction
processing customer, in negotiating a contract renewal during the second fiscal
quarter.
The bankcard and transaction processing segment generated a gross margin of
28.7% in the nine-month period ended June 30, 2002 as compared to 30.4% in the
same period last year. Operating income for this business segment was $1,666,000
for the nine-month period, down 30% from $2,379,000 in the same period last year
due to an increase in transaction and processing expenses and reduced margin
from revenue generated from U-Haul and the departure of several large
high-margin bankcard merchants.
Check Related Products. Check-related revenue increased from $3,084,000 for the
nine months ended June 30, 2001 to $4,309,000 for the nine months ended June 30,
2002, an increase of 39.7%. Check services revenue made up 17.4% of total
processing and transaction revenues in this nine-month period as compared to
13.9% in the prior year. Check-related operating loss was $676,000 in the nine
months ended June 30, 2002 as compared to a loss of $281,000 in the same period
last year.
Terminal Sales. Terminal sales for the nine months ended June 30, 2002 were
$191,000 as compared to $389,000 for the same nine-month period ended June 30,
2001, a decrease of 50.9%.
Other. Other revenue for the nine months ended June 30, 2002 was $70,000 as
compared to $393,000 for the same nine-month period ended June 30, 2001, a
decrease of 82.2% due to lesser software development completed.
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 2002, the Company had available cash of $2,491,000, restricted
cash of $890,000 in reserve with its primary processing banks and working
capital of $3,337,000.
Accounts receivable net of allowance for doubtful accounts decreased to
$1,698,000 at June 30, 2002 from $1,864,000 at September 30, 2001. Allowance for
doubtful accounts, which reflects chargeback losses, increased to $395,000 at
the end of the fiscal third quarter from $313,000 at September 30, 2001.
Inventory costs decreased to $328,000 at June 30, 2002 from $573,000 at
September 30, 2001 as a result of a $200,000 inventory allowance.
15
Net cash used in operating activities for the nine months ended June 30, 2002
was $307,000 as compared to net cash provided by operating activities of
$1,300,000 for the nine months ended June 30, 2002. This was primarily
attributable to the $1,200,000 cash portion of legal settlement expenses
incurred during the quarter ended March 31, 2002.
In the nine months ended June 30, 2002, the Company used $1,439,000 for the
purchase of equipment and capitalized software costs. During the third fiscal
quarter, the Company received $390,000 from a leasing company for entering into
a sale and leaseback agreement for certain computer software and hardware
purchased by the Company in the recent months. Additionally, the Company has
negotiated an $850,000 lease line from the same leasing company for the purpose
of funding computer software and hardware needs in the coming months. This
funding source should be sufficient to finance the equipment needs in order to
improve the infrastructures of our data center to accommodate the growth
anticipated by the Company.
Depreciation increased to $476,000 for the nine months ended June 30, 2002 as
compared to $305,000 for the same period prior year due to the additional
equipment purchases. Amortization of software increased to $377,000 for the
nine months ended June 30, 2002, as compared to $293,000 for the same period
prior year. Amortization of goodwill increased to $385,000 for the nine months
ended June 30, 2002, as compared to $305,000 for the same period prior year. The
Company plans to adopt SFAS 142 "Goodwill and Other Intangible Assets" ("SFAS
142") and will discontinue goodwill amortization by the first quarter of fiscal
2003.
At June 30, 2002, the Company had the following cash commitments:
Payment Due By Period
---------------------
Contractual Less than
Obligations Total 1 year 2-3 years 4-5 years after 5 years
- ----------- ---------- -------- ---------- ---------- --------------
Long-term debt
including interest $2,939,918 $316,903 $ 587,755 $ 455,363 $ 1,579,897
Capital lease
Obligations 891,883 347,436 544,447 -0- -0-
Operating leases 251,081 139,793 111,288 -0- -0-
---------- -------- ---------- ---------- --------------
Total contractual
cash obligations $4,082,882 $804,132 $1,243,490 $ 455,363 $ 1,579,897
========== ======== ========== ========== ==============
The Company's primary source of liquidity is expected to be cash flow generated
from operations and cash and cash equivalents currently on hand. Management
believes that its future cash flow from operations together with cash on hand
will be sufficient to meet its working capital and other commitments as long as
the current cash flow trend remains relatively consistent.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management's discussion and analysis of financial condition and results of
operations is based upon the Company's consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States of America. The preparation of these financial statements
requires management to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses, and related disclosure of
contingent assets and liabilities. On an on-going basis, management evaluates
its estimates, including those related to revenue recognition, deferred taxes,
goodwill amortization, capitalization of software costs, contingencies and
litigation. Management bases its estimates on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates.
16
Management applies the following critical accounting policies in the preparation
of our consolidated financial statements:
- - Revenue Recognition Policy. All processing and transaction revenues are
recognized at the time the transactions are processed by the customer.
Processing and transaction revenues are principally based on the number of
transactions processed and a percentage of dollar volume processed. Terminal
sales are recorded when product is shipped and title transferred to the
customer.
- - Deferred Taxes. Deferred taxes are determined based on the differences between
the financial statement and tax bases of assets and liabilities, using enacted
tax rates in effect for the year in which the differences are expected to
reverse. Valuation allowances are established when necessary to reduce deferred
tax assets to the amounts expected to be realized. In assessing the need for a
valuation allowance, management considers estimates of future taxable income and
ongoing prudent and feasible tax planning strategies.
- - Goodwill Amortization. Goodwill represents the excess of purchase price over
tangible and other intangible assets acquired less liabilities assumed arising
from business combinations and is being amortized on a straight-line basis over
estimated useful lives ranging from 10 to 15 years. SFAS No. 142, "Goodwill and
Other Intangible Assets" ("SFAS 142"), issued in June 2001, requires, among
other things, the discontinuance of goodwill amortization. In addition, the
standard includes provisions for the reclassification of certain existing
recognized intangibles as goodwill, reassessment of the useful lives of existing
recognized intangibles, reclassification of certain intangibles out of
previously reported goodwill and the identification of reporting units for
purposes of assessing potential future impairments of goodwill. SFAS 142 also
requires companies to complete a transitional goodwill impairment test six
months from the date of adoption. The Company is currently evaluating the impact
SFAS 142 will have on its financial statements and the results of its
operations. The Company plans to adopt SFAS 142 by the first quarter of fiscal
2003. Based upon our initial assessment, we believe that it is probable that
upon adoption we will record a material goodwill impairment charge to this
recorded asset, which would also be reflected in a one-time, non-cash charge to
net income attributed to a change in accounting principal.
- - Capitalization of Software Costs. The costs of purchased and internally
developed software used to provide services to customers are capitalized and
amortized on a straight-line basis over the lesser of three years or estimated
useful life. Under the provisions of Statement of Position 98-1, "Accounting for
the Costs of Computer Software Developed or Obtained for Internal Use," the
Company capitalizes software costs when both the preliminary project stage is
completed and management has authorized further funding for the completion of
the project.
FORWARD-LOOKING STATEMENTS
The discussion of the financial condition and results of operations of the
Company should be read in conjunction with the consolidated financial statements
and notes thereto included elsewhere herein. This discussion contains
forward-looking statements, including statements regarding the Company's
strategy, financial performance and revenue sources, which involve risks and
uncertainties. The Company's actual results may differ materially from those
anticipated in these forward-looking statements as a result of certain factors,
including, but not limited to, those set forth elsewhere herein.
17
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
-------------------------------------
99.1 Certification by Joel M. Barry, Chief Executive Officer of Electronic
Clearing House, Inc. pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.2 Certification by Alice L. Cheung, Chief Financial Officer of
Electronic Clearing House, Inc. pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
The following report on Form 8-K was filed during the quarter ended June 30,
2002:
Date of Filing Item Reported
- ---------------- --------------
April 15, 2002 Press release issued announcing the resignation of Mr.
Carl W. Schafer, a director of the Registrant,
to serve on the Board of Directors.
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.
ELECTRONIC CLEARING HOUSE, INC.
----------------------------------
(Registrant)
Date: August 13, 2002 By: \s\ Alice Cheung
--------------------------------
Alice Cheung, Treasurer and
Chief Financial Officer
19