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, 2003
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
--- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes No X
--- ---
As of July 31, 2003, there were 5,862,174 shares of the Registrant's Common
Stock outstanding.
1
ELECTRONIC CLEARING HOUSE, INC.
INDEX
-----
PART I. FINANCIAL INFORMATION
Page No.
---------
Item 1. CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED):
Consolidated Balance Sheets 3
June 30, 2003 and September 30, 2002
Consolidated Statements of Operations 4
Three months and nine months ended
June 30, 2003 and 2002
Consolidated Statements of Cash Flows 5
Nine months ended June 30, 2003 and 2002
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of 12
Financial Condition and Results of
Operations
Item 3. Quantitative and Qualitative Disclosures about Market Risk 20
Item 4. Controls and Procedures 20
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders 21
Item 6. Exhibits and Reports on Form 8-K 21
Signatures 22
2
PART I. FINANCIAL INFORMATION
- --------------------------------
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
ELECTRONIC CLEARING HOUSE, INC.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
ASSETS
JUNE 30, SEPTEMBER 30,
2003 2002
------------- ---------------
Current assets:
Cash and cash equivalents $ 5,563,000 $ 2,409,000
Restricted cash 1,112,000 906,000
Settlement receivable 707,000 148,000
Accounts receivable less allowance of $438,000 and $431,000 1,891,000 1,596,000
Prepaid expenses and other assets 459,000 403,000
Deferred tax asset 79,000 266,000
------------- ---------------
Total current assets 9,811,000 5,728,000
Noncurrent assets:
Property and equipment, net 6,396,000 5,101,000
Deferred tax asset 1,634,000 2,018,000
Other assets, less accumulated amortization of $293,000 and $259,000 529,000 637,000
Goodwill, net -0- 4,707,000
------------- ---------------
Total assets $ 18,370,000 $ 18,191,000
============= ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term borrowings and current portion of long-term debt $ 625,000 $ 515,000
Accounts payable 111,000 201,000
Settlement payable 4,490,000 729,000
Accrued expenses 1,291,000 987,000
Deferred income -0- 62,000
------------- ---------------
Total current liabilities 6,517,000 2,494,000
Long-term debt 2,148,000 2,159,000
------------- ---------------
Total liabilities 8,665,000 4,653,000
------------- ---------------
Commitments and contingencies
Stockholders' equity:
Common stock, $0.01 par value, 36,000,000 authorized:
5,855,674 and 5,835,331 shares issued; 5,816,405 and
5,796,062 shares outstanding 59,000 58,000
Additional paid-in capital 21,498,000 21,435,000
Accumulated deficit (11,383,000) (7,486,000)
Less treasury stock at cost, 39,269 common shares (469,000) (469,000)
------------- ---------------
Total stockholders' equity 9,705,000 13,538,000
------------- ---------------
Total liabilities and stockholders' equity $ 18,370,000 $ 18,191,000
============= ===============
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,
------------------------- --------------------------
2003 2002 2003 2002
------------ ----------- ------------ ------------
Revenues:
Processing revenue $ 5,673,000 $4,180,000 $15,559,000 $12,048,000
Transaction revenue 4,853,000 4,157,000 13,837,000 12,413,000
Other revenue 52,000 78,000 250,000 261,000
------------ ----------- ------------ ------------
10,578,000 8,415,000 29,646,000 24,722,000
------------ ----------- ------------ ------------
Costs and expenses:
Processing and transaction expense 7,059,000 5,795,000 19,596,000 16,675,000
Other operating costs 812,000 688,000 2,329,000 2,238,000
Research and development expense 375,000 466,000 1,042,000 1,264,000
Selling, general and administrative expenses 1,768,000 1,480,000 5,123,000 5,008,000
Amortization expense - goodwill -0- 129,000 -0- 385,000
Legal settlement -0- -0- -0- 2,500,000
------------ ----------- ------------ ------------
10,014,000 8,558,000 28,090,000 28,070,000
------------ ----------- ------------ ------------
Income (loss) from operations 564,000 (143,000) 1,556,000 (3,348,000)
Interest income 6,000 10,000 21,000 46,000
Interest expense (51,000) (46,000) (150,000) (84,000)
------------ ----------- ------------ ------------
Income (loss) before (provision) benefit for income taxes
and cumulative effect of an accounting change 519,000 (179,000) 1,427,000 (3,386,000)
(Provision) benefit for income taxes (211,000) 11,000 (617,000) 1,217,000
------------ ----------- ------------ ------------
Income (loss) before cumulative effect of an accounting change 308,000 (168,000) 810,000 (2,169,000)
Cumulative effect of an accounting change to adopt SFAS 142 -0- -0- (4,707,000) -0-
------------ ----------- ------------ ------------
Net income (loss) $ 308,000 $ (168,000) $(3,897,000) $(2,169,000)
============ =========== ============ ============
Basic net earnings (loss) per share
Before cumulative effect of accounting change $ 0.05 $ (0.03) $ 0.14 $ (0.38)
Cumulative effect of accounting change -0- -0- (0.81) -0-
------------ ----------- ------------ ------------
Basic net earnings (loss) per share $ 0.05 $ (0.03) $ (0.67) $ (0.38)
============ =========== ============ ============
Diluted net earnings (loss) per share
Before cumulative effect of accounting change $ 0.05 $ (0.03) $ 0.14 $ (0.38)
Cumulative effect of accounting change -0- -0- (0.81) -0-
------------ ----------- ------------ ------------
Diluted net earnings (loss) per share $ 0.05 $ (0.03) $ (0.67) $ (0.38)
============ =========== ============ ============
Weighted average shares outstanding
Basic 5,810,787 5,796,109 5,802,802 5,785,362
============ =========== ============ ============
Diluted 6,039,990 5,796,109 5,802,802 5,785,362
============ =========== ============ ============
See accompanying notes to consolidated financial statements.
4
ELECTRONIC CLEARING HOUSE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS
ENDED JUNE 30,
--------------------------
2003 2002
------------ ------------
Cash flows from operating activities:
Net loss $(3,897,000) $(2,169,000)
Adjustments to reconcile net loss to net
cash provided by (used in) operating activities:
Depreciation 498,000 476,000
Amortization of software 649,000 377,000
Amortization of goodwill -0- 385,000
Provision for losses on accounts and notes receivable 45,000 258,000
Provision for obsolete inventory -0- 201,000
Write-down of real estate -0- 100,000
Fair value of stock issued in connection with
directors' compensation 21,000 45,000
Deferred income taxes 571,000 (1,236,000)
Stock option compensation 20,000 -0-
Legal settlement -0- 1,300,000
Cumulative effect of an accounting change 4,707,000 -0-
Changes in assets and liabilities:
Restricted cash (206,000) 520,000
Accounts receivable (340,000) (110,000)
Settlement receivable (559,000) (68,000)
Accounts payable (90,000) (3,000)
Settlement payable 3,761,000 (60,000)
Accrued expenses 304,000 (315,000)
Prepaid expenses (118,000) (8,000)
------------ ------------
Net cash provided by (used in) operating activities 5,366,000 (307,000)
------------ ------------
Cash flows from investing activities:
Other assets 74,000 (62,000)
Purchase of equipment and software (2,129,000) (1,439,000)
------------ ------------
Net cash used in investing activities (2,055,000) (1,501,000)
------------ ------------
Cash flows from financing activities:
Proceeds from issuance of notes payable 292,000 -0-
Repayment of notes payable (133,000) (105,000)
Repayment of capitalized leases (339,000) (144,000)
Proceeds from sale and leaseback of equipment -0- 390,000
Proceeds from exercise of stock options 23,000 11,000
------------ ------------
Net cash (used in) provided by financing activities (157,000) 152,000
------------ ------------
Net increase (decrease) in cash 3,154,000 (1,656,000)
Cash and cash equivalents at beginning of period 2,409,000 4,147,000
------------ ------------
Cash and cash equivalents at end of period $ 5,563,000 $ 2,491,000
============ ============
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, 2003, 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,
2002. The results of operations for the three and nine months ended June 30,
2003 are not necessarily indicative of the likely results of operations for the
entire fiscal year ending September 30, 2003.
NOTE 2 - STOCK-BASED COMPENSATION:
- -------------------------------------
The Company measures compensation expense for its employee stock-based
compensation under APB 25. The Company provides pro-forma disclosures of net
income and earnings per share as if a fair value method had been applied using
the Black Scholes Model. Therefore, pro forma compensation costs for employee
stock and stock option awards is measured as the excess, if any, of the fair
value of the common stock at the grant date over the amount an employee must pay
to acquire the stock and is amortized over the related service periods using the
straight-line method.
The following table compares net income and earnings per share as reported to
the pro forma amounts that would be reported had compensation expense been
recognized for the stock-compensation plans in accordance with the fair value
recognition provisions of SFAS No. 123, as amended by SFAS No. 148, Accounting
for Stock-Based Compensation:
Three Months Ended Nine Months Ended
June 30, June 30,
------------------------ --------------------------
2003 2002 2003 2002
----------- ----------- ------------ ------------
Net income (loss), as reported $ 308,000 $ (168,000) $(3,897,000) $(2,169,000)
Deduct: Total stock-based employee
compensation expense determined
under fair value-based method for
all awards granted since October 1,
1995 (92,000) (90,000) (262,000) (268,000)
----------- ----------- ------------ ------------
Pro forma net income (loss) $ 216,000 $ (258,000) $(4,159,000) $(2,437,000)
=========== =========== ============ ============
Net earnings (loss) per share:
Basic - as reported $ 0.05 $ (0.03) $ (0.67) $ (0.38)
Basic - pro forma $ 0.04 $ (0.04) $ (0.72) $ (0.42)
Diluted - as reported $ 0.05 $ (0.03) $ (0.67) $ (0.38)
Diluted - pro forma $ 0.04 $ (0.04) $ (0.72) $ (0.42)
6
NOTE 3 - 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,
------------------------------- -------------------------------
2003 2002 2003 2002
------------- ---------------- ------------- ----------------
Numerator:
Income (loss) before cumulative
effect of an accounting change $ 308,000 $ (168,000) $ 810,000 $ (2,169,000)
Cumulative effect of an accounting
change to adopt SFAS 142 -0- -0- (4,707,000) -0-
------------- ---------------- ------------- ----------------
Net income (loss) $ 308,000 $ (168,000) $ (3,897,000) $ (2,169,000)
============= ================ ============= ================
Denominator:
Weighted average shares outstanding
for basic earnings (loss) per share 5,810,787 5,790,267 5,802,802 5,785,362
Effect of dilutive stock options 229,203 -0- -0- -0-
------------- ---------------- ------------- ----------------
Adjusted weighted average shares
outstanding for diluted earnings
(loss) per share 6,039,990 5,790,267 5,802,802 5,785,362
============= ================ ============= ================
Basic net earnings (loss) per share:
Before cumulative effect of accounting
change $ 0.05 $ (0.03) $ 0.14 $ (0.38)
Cumulative effect of accounting change -0- -0- (0.81) -0-
------------- ---------------- ------------- ----------------
Basic net earnings (loss) per share $ 0.05 $ (0.03) $ (0.67) $ (0.38)
============= ================ ============= ================
Diluted net earnings (loss) per share:
Before cumulative effect of
accounting change $ 0.05 $ (0.03) $ 0.14 $ (0.38)
Cumulative effect of accounting change -0- -0- (0.81) -0-
------------- ---------------- ------------- ----------------
Diluted net earnings (loss) per share $ 0.05 $ (0.03) $ (0.67) $ (0.38)
============= ================ ============= ================
For the quarter ended June 30, 2003, a total of 229,203 shares of anti-dilutive
common stock equivalents were included in the dilutive net earnings per share
calculation. For the three months ended June 30, 2002 and the nine months ended
June 30, 2003 and 2002, all dilutive common stock equivalents have been excluded
from the calculation of diluted loss per share as their inclusion would be
anti-dilutive to the loss per share calculation.
NOTE 4 - NON-CASH TRANSACTIONS:
- -----------------------------------
Significant non-cash transaction for the nine months ended June 30, 2003 was as
follows:
- Capital equipment of $279,000 was acquired under capital leases.
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.
7
NOTE 4: (CONTINUED)
- -------
- 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.
NOTE 5 - NEW ACCOUNTING PRONOUNCEMENTS:
- -------------------------------------------
In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45),
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others". This interpretation expands the
disclosures to be made by a guarantor in its financial statements about its
obligations under certain guarantees and requires the guarantor to recognize a
liability for the fair value of an obligation assumed under a guarantee. FIN 45
clarifies the requirements of SFAS 5, Accounting for Contingencies, relating to
guarantees. In general, FIN 45 applies to contracts or indemnification
agreements that contingently require the guarantor to make payments to the
guaranteed party based on changes in an underlying that is related to an asset,
liability, or equity security of the guaranteed party. The disclosure
requirements of FIN 45 are effective for the Company as of December 31, 2002,
and require disclosure of the nature of the guarantee, the maximum potential
amount of future payments that the guarantor could be required to make under the
guarantee, and the current amount of the liability, if any, for the guarantor's
obligations under the guarantee. The recognition requirements of FIN 45 are to
be applied prospectively to guarantees issued or modified after December 31,
2002. Significant guarantees that have been entered into by the Company are
disclosed in Note 8.
In May 2003, the FASB issued Statement of Financial Accounting Standards, or
SFAS, No. 150, "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity," which established standards for
how a company classifies and measures certain financial instruments with
characteristics of both liabilities and equity. SFAS 150 requires certain
financial instruments to be classified as liabilities, which were previously
classified as equity. SFAS 150 is effective for financial instruments entered
into or modified after May 31, 2003, and otherwise is effective at the beginning
of the Company's fourth quarter. The Company is currently evaluating the impact
of FAS 150, but does not think the adoption of this statement will have an
impact on the Company's results of operations, financial position or cash flows.
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 of which is the segment's operating income and the other of
which 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.
8
NOTE 6: (CONTINUED)
- -------
Three Months Ended Nine Months Ended
June 30 June 30
-------------------------- --------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
Revenues:
Bankcard and transaction
processing $ 8,612,000 $ 6,940,000 $23,927,000 $20,411,000
Check-related products 1,966,000 1,475,000 5,719,000 4,311,000
------------ ------------ ------------ ------------
$10,578,000 $ 8,415,000 $29,646,000 $24,722,000
============ ============ ============ ============
Operating income (loss):
Bankcard and transaction
processing $ 1,081,000 $ 543,000 $ 2,966,000 $ 1,666,000
Check-related products 96,000 (257,000) 304,000 (676,000)
Other - corporate expenses (613,000) (429,000) (1,714,000) (4,338,000)
------------ ------------ ------------ ------------
$ 564,000 $ (143,000) $ 1,556,000 $(3,348,000)
============ ============ ============ ============
NOTE 7 - CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE:
- ----------------------------------------------------------------------
Effective October 1, 2002, the Company adopted Statement of Financial Accounting
Standards No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets". SFAS
142 requires that goodwill no longer be amortized, but instead be tested for
impairment at least annually using a fair value-based approach. In the year of
adoption, SFAS No. 142 also requires the Company to perform an initial
assessment of its reporting units to determine whether there is any indication
that the goodwill carrying value may be impaired. This transitional assessment
is made by comparing the fair value of each reporting unit, as determined in
accordance with the new standard, to its book value. To the extent the fair
value of any reporting unit is less than its book value, which would indicate
that potential impairment of goodwill exists, a second transitional test is
required to determine the amount of impairment.
The Company has determined that it has two reporting units, which correspond to
its two reportable business segments; the "Bankcard and Transaction Processing"
unit and the "Check Related Products" unit. All of the Company's goodwill
relates to business acquisition transactions, which apply exclusively to the
Check Related Products unit. The Company completed the transitional impairment
testing required by SFAS 142 in the first quarter of fiscal 2003. The Company
determined the estimated fair value of its reporting units using a discounted
cash flow technique and a market approach based upon the Company's total market
capitalization as of October 1, 2002. Based upon the valuation findings, the
Company determined that its goodwill was fully impaired and a non-cash charge
equal to the goodwill carrying amount of $4.7 million was recognized in the
Company's condensed consolidated financial statements. As prescribed by SFAS
142, the Company treated this non-cash goodwill impairment as a cumulative
effect of change in accounting principle. No income tax benefit has been
recognized for this charge as the goodwill is not deductible for income tax
purposes.
Had the provisions of SFAS No. 142 been applied for the three and nine months
ended June 30, 2002, the Company's net income before the cumulative effect of a
change in accounting principle, and net income (loss) per share would have been
as follows:
9
NOTE 7: (CONTINUED)
- -------
For the Three Months Ended For the Nine Months Ended
June 30, June 30,
------------------------------ -------------------------------
2003 2002 2003 2002
-------------- -------------- ---------------- -------------
Net income (loss), as reported $ 308,000 $ (168,000) $ (3,897,000) $ (2,169,000)
Add:
Goodwill amortization -0- 129,000 -0- 385,000
-------------- -------------- ---------------- -------------
Adjusted net income (loss) $ 308,000 $ (39,000) $ (3,897,000) $ (1,784,000)
============== ============== ================ =============
Basic earnings (loss) per share, as reported $ 0.05 $ (0.03) $ (0.67) $ (0.38)
Effect of SFAS No. 142 -0- 0.02 -0- 0 07
-------------- -------------- ---------------- -------------
Adjusted basic earnings (loss) per share $ 0.05 $ (0.01) $ (0.67) $ (0.31)
============== ============== ================ =============
Diluted earnings (loss) per share, as reported $ 0.05 $ (0.03) $ (0.67) $ (0.38)
Effect of SFAS No. 142 -0- 0.02 -0- 0 07
-------------- -------------- ---------------- -------------
Adjusted diluted earnings (loss) per share $ 0.05 $ (0.01) $ (0.67) $ (0.31)
============== ============== ================ =============
NOTE 8 - COMMITMENTS, CONTINGENT LIABILITIES, AND GUARANTEES:
- --------------------------------------------------------------------
The Company currently relies on cooperative relationships with, and sponsorship
by, two banks in order to process its Visa, MasterCard and other bankcard
transactions. The agreement between the banks and the Company requires the
Company to assume and compensate the banks for bearing the risk of "chargeback"
losses. Under the rules of Visa and MasterCard, when a merchant processor
acquires card transactions, it has certain contingent liabilities for the
transactions processed. This contingent liability arises in the event of a
billing dispute between the merchant and a cardholder that is ultimately
resolved in the cardholder's favor. In such a case, the disputed transaction is
charged back to the merchant and the disputed amount is credited or otherwise
refunded to the cardholder. If the Company is unable to collect this amount
from the merchant's account, and if the merchant refuses or is unable to
reimburse the Company for the chargeback due to merchant fraud, insolvency or
other reasons, the Company will bear the loss for the amount of the refund paid
to the cardholders. The Company is also exposed to financial risk in providing
ACH services to the merchants. As the third-party processor for multiple
originating banks, the Company is liable for any fraudulent activities committed
by the merchants initiating the ACH activities. The Company utilizes stringent
underwriting guidelines combined with a number of systems and procedures to
manage merchant risk. In addition, the Company requires cash deposits by certain
merchants, which are held by the Company's sponsoring banks to minimize the risk
related to merchant frauds and chargebacks.
A cardholder, through its issuing bank, generally has until the later of up to
four months after the date a transaction is processed or the delivery of the
product or service to present a chargeback to the Company's sponsoring bank as
the merchant processor. Therefore, management believes that the maximum
potential exposure for the chargebacks would not exceed the total amount of
transactions processed through Visa and MasterCard for the last four months and
other unresolved chargebacks in the process of resolution. For the last four
months through June 30, 2003, this potential exposure totaled approximately $343
million. At June 30, 2003, the Company, through its sponsoring banks, had
approximately $134,000 of unresolved chargebacks that were in the process of
resolution. At June 30, 2003, the Company, through its sponsoring banks, had
access to $9.0 million in merchant deposits to cover any potential chargeback
losses.
NOTE 8: (CONTINUED)
- -------
For the three months ended June 30, 2003 and 2002, the Company processed
approximately $259 million (2003) and $196 million (2002) of Visa and MasterCard
10
transactions, which resulted in $2.2 million in gross chargeback activities for
the three months ended June 30, 2003 and $2.0 million for the three months ended
June 30, 2002. Substantially all of these chargebacks were recovered from the
merchants.
The Company records a reserve for chargeback loss allowance based on its
processing volume and historical trends and data. As of June 30, 2003 and 2002,
the allowance for chargeback losses, which is classified as a component of the
allowance for uncollectible accounts receivable, was $373,000 and $217,000,
respectively. The expense associated with the valuation allowance is included
in processing and transaction expense in the accompanying consolidated
statements of income.
The Company has a small check guarantee business. The Company charges the
merchant a percentage of the face amount of the check and guarantees payment of
the check to the merchant in the event the check is not honored by the
checkwriter's bank. Merchants typically present customer checks for processing
on a regular basis and, therefore, dishonored checks are generally identified
within a few days of the date the checks are guaranteed by the Company.
Accordingly, management believes that its best estimate of the Company's maximum
potential exposure for dishonored checks at any given balance sheet date would
not exceed the total amount of checks guaranteed in the last 10 days prior to
the balance sheet date. As of June 30, 2003, the Company estimates that its
maximum potential dishonored check exposure was approximately $333,000.
For the quarters ended June 30, 2003 and 2002, the Company guaranteed
approximately $4,112,000 (2003) and $2,931,000 (2002) of merchant checks, which
resulted in $106,000 (2003) and $191,000 (2002) of dishonored checks presented
to the Company for payments. The Company has the right to collect the full
amount of the check from the checkwriter. Based on its actual collection
experience, the Company collects approximately 50-60% of the total dishonored
checks. The Company establishes a reserve for this activity based on historical
and projected loss experience. As of June 30, 2003 and 2002, the reserve for
check guarantee loss was $118,000 (2003) and $114,000 (2002). The expense
associated with the valuation allowance is included in processing and
transaction expense in the accompanying consolidated statements of income.
During November 2002, the Company negotiated a $500,000 lease line with a
leasing company to fund certain computer equipment needs. The Company has
financed $233,000 of computer equipment through this lease line through June 30,
2003. In January 2003, an $800,000 line of credit for working capital needs and
a $700,000 lease line for funding the remaining Oasis software installment
payments were secured from First Regional Bank, the Company's primary bankcard
sponsoring bank, at a borrowing rate of prime + 1%. The Company has drawn down
$292,000 of the Oasis lease line as of June 30, 2003 and plans to continue the
draw down further when the installment payments are done.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
------------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS
---------------------------------------
OVERVIEW
Electronic Clearing House, Inc. ("ECHO" or "the Company") is an electronic
payment processor and one of the few processors in the nation who can provide a
"complete solution" to the payment processing needs of merchants, banks and
collection agencies. The Company's services include point-of-sale ("POS")
terminal management, debit and credit card processing, check guarantee, check
verification, check conversion, check re-presentment, check collection and
inventory tracking. The Company's ability to program and oversee the management
of a merchant's POS system, provide credit card and debit card processing,
provide multiple check services, provide both electronic and traditional
collection services and fully integrate all these services into a single
internet-based reporting capability constitutes a definition of what the Company
refers to as a "complete solution" to the payment processing needs of merchants,
banks and collection agencies.
The Company derives revenues from two main business segments, bankcard and
transaction processing (bank services), and check-related products (check
services), 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.
MerchantAmerica, as a retail sales channel, generates revenues through the sale
of both of the Company's business segments, while all of NCN and XPRESSCHEX
revenues are reflected in the Company's check services business segment.
The Company's main revenue generator is its bankcard and transaction processing
business segment. ECHO typically receives a percentage-based fee on the dollar
amount processed and a transaction fee on the number of transactions processed.
For the quarter ended June 30, 2003, the bankcard and transaction processing
business segment accounted for approximately 81.4% of the Company's total
revenue. This business segment has been profitable consistently, although price
competition continues to be intense.
In an effort to enhance the bankcard transaction processing business segment's
processing infrastructure and control processing costs, the Company licensed
several payment processing systems from Oasis Technologies in 2002 and a full
integration of this system is currently projected for completion by the last
quarter of 2003.
The Company's check services business segment has been experiencing rapid growth
over the past four years, building upon the Company's XPRESSCHEX subsidiary that
operated for many years as a check guarantee service primarily to
California-based merchants. The acquisition of Magic Software Development, Inc.
in 1999 and the acquisition of Rocky Mountain Retail Systems in 2000
significantly increased the Company's capabilities and provided a national
market for the Company's check services. Over the past four years, ECHO has
invested significant resources and management focus in its check services
business. Check services revenues are based on a fixed fee per transaction or a
fee based on the amount of the check for each transaction. The Company is one of
a few check processors in the nation with both an Automated Clearing House
("ACH") engine, which gives the Company the ability to transfer and settle
funds, and a robust check writer database (NCN), which provides a valuable
service for check risk management to merchants. The NCN database includes over
20 million bad-check writer records, 80 million positive records, and is
generated and refreshed daily by 280 affiliated collection agencies that
continually contribute to the database to enrich its depth and value.
12
NCN provides an ongoing revenue stream as collection agencies, major national
merchants, other transaction processors, and thousands of small merchants access
the NCN database daily to verify the status of a check writer in real time.
Check verification has been recognized as one of the lowest cost and most
effective ways for retailers to lower the risks and loss experience in accepting
checks as a form of payment and the Company's NCN database is one of only four
major databases in the nation that can serve this market need on a national
scale.
XPRESSCHEX revenues are growing due to the increased use of the Company's check
conversion services, which include capture of the necessary check data at the
point of sale and submission of the transaction electronically to the Automated
Clearing House (ACH) for settlement. Since the Company provides ACH and
settlement services to the merchants, all settlement funds received by the
Company on behalf of the merchants are recorded as settlement payable and all
settlement funds paid by the Company in advance are recorded as settlement
receivable. XPRESSCHEX also maintains an active collection agency, registered in
48 states, that serves primarily as a referral agent to select NCN members that
are collection agencies and are located in various regions of the country. This
ability to provide local collection capability through one national entity is a
distinctive advantage the Company has over other check service companies who
operate centralized collection agencies and only go to local agencies as a
secondary or last option.
In 2000, Visa U.S.A. announced its intention to utilize its processing network
(VisaNet) that connects to over 14,000 banks and about 5 million merchants to
electronically process checks. This program is referred to as Visa POS Check
Service. Visa's research shows that personal checks continue to be the most
popular form of payment among consumers, but the cost of check processing and
check fraud is high for financial institutions and merchants, averaging more
than one dollar for every check written at the point of sale. Consumers continue
to use checks for approximately 85% of all non-cash personal spending.
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 Service program. The
Visa POS Check Service allows merchants to receive immediate online
authorization for paper checks, by converting them into electronic transactions
at the point of sale and verifying them against Visa's member bank accounts.
The Company provides critical back-end infrastructure for the service, including
its NCN database for verification and its ACH backbone for funds settlement, for
checks written on non-participating banks. At the present time, ECHO is the
third-party acquiring processor for eight out of ten acquiring banks that are
currently signed up for the Visa program.
The Company is also one of only two companies that are currently certified as
acquirer processors with Visa, a role that accepts transactions from the
merchant's POS terminal and reformats them for submission to the Visa network.
To date, ECHO is the only company to register as both a third-party processor
and an acquirer processor with Visa under the Visa POS Check Service program.
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 higher margins than
larger accounts and offer a less competitive marketplace. ECHO has signed
agreements with several retailers and the pipeline for prospective customers is
growing.
13
- --The Company is continuing to enhance the Visa POS Check Service so as to
leverage ECHO's check services products through Visa member banks. As the market
gains acceptance of the Visa POS Check Services, it will significantly increase
the Company's opportunities to market its check conversion services and
verification services to its core merchant base and solidify its strategic
relationships with the various financial institutions that have chosen the
Company as their acquirer processor and/or third-party processor under the Visa
POS Check Service program. It also will create a new marketing channel for the
Company to cross sell its other check products such as electronic check
re-presentments and check guarantee to the Visa member banks participating in
the Visa POS Check Service program.
- --ECHO has also identified an underserved, niche market of smaller regional and
community banks for its agent bank program. The Company is providing a turn-key
solution to allow smaller banks to offer a full spectrum of bankcard and check
processing services to their customer base using ECHO's Merchant America product
offering. The program is being 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. Most significantly, ECHO's
program allows the banks to retain ownership of their merchants, which provides
both stability and economic benefits to the bank that other programs generally
do not provide.
SALES AND MARKETING
ECHO sells its merchant and check services through several marketing channels,
including independent sales organizations ("ISOs"), its own internal sales
force, its Agent Bank program, and direct merchant referrals by existing
merchants. Approximately 20% of the Company's new accounts have historically
been generated through the ISOs. 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 services
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 and financial institutions in the Visa POS Check
Program; sell integrated suites of payment services, bankcard and check
processing services to small banks; enhance and market MerchantAmerica; and
develop the private label check service program.
COMPETITION
Bankcard processing and check processing 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 much 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. Many competitors also have economies of scale cost advantages
over ECHO due to their high processing volumes that may make it difficult for
ECHO to compete. 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.
14
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 2003 AND 2002
- -----------------------------------------
Financial highlights for the third quarter of 2003 as compared to the same
period last year were as follows:
- --Total revenue increased 25.7% to $10.6 million
- --Gross margins from processing and transaction revenue increased to 32.9% from
30.5%
- --Diluted EPS of $0.05 as compared to diluted loss per share of $0.03
- --Bankcard and transaction processing revenue increased 24.1% to $8.6 million
- --Bankcard processing volume increased 32.1% to $259.1 million
- --Check-related revenue increased 33.3% to $2.0 million
- --ACH transactions processed increased 378.2% to 3.0 million
REVENUE. Total revenue increased 25.7% to $10,578,000 for the three months
ended June 30, 2003, from $8,415,000 for the same period last year. The
increase was primarily attributed to a 24.1% growth in the bankcard processing
business and 33.3% growth in the check services business segment. Total
processing and transaction revenue for this fiscal quarter increased 26.3%, from
$8,337,000 for the comparable quarter in fiscal 2002 to $10,526,000 in fiscal
2003.
COST OF SALES. A majority of the Company's bankcard processing expenses are
fixed as a percentage of the total processing volume, with the remaining costs
based on the number of transactions processed. Processing-related expenses,
consisting primarily of data center processing costs, interchange fees, third
party processing fees, communication fees, etc., increased from $5,795,000 in
the third fiscal quarter of 2002 to $7,059,000 in the current fiscal quarter, a
21.8% increase. The increase reflects a 26.3% increase in processing and
transaction revenues for the current fiscal quarter.
Gross margin from processing and transaction services increased from 30.5% in
the third fiscal quarter last year to 32.9% in this fiscal quarter. This
improvement in gross margin was due to the combination of a higher percentage of
check services revenue as a percentage of total revenue, and incremental margin
improvement as a result of economies of scale.
EXPENSE. Other operating costs such as personnel costs, telephone and
depreciation expenses increased from $688,000 in the third fiscal quarter of
2002 to $812,000 in this fiscal quarter, an increase of 18.0%. This increase was
primarily attributable to a 25.7% increase in total revenue. Research and
development expense decreased from $466,000 in the prior year quarter to
$375,000 in the current fiscal quarter. This was primarily due to the Visa POS
Check Service program transitioning from the pilot phase to implementation phase
and the gradual decrease in the expense due to the capitalization of related
costs associated with this program. However, the Company anticipates that it
will continue to invest in research and development to remain competitive.
Selling, general and administrative expenses increased from $1,480,000 in the
third fiscal quarter 2002 to $1,768,000 in the current quarter. This increase
was primarily attributable to the higher costs to support the Company's sales
and marketing programs, hiring of additional management staff to support the
growth of the Company, overall higher personnel costs due to cost of living
adjustments and increases in employee benefits such as medical insurance cost
and worker compensation insurance. As a percentage of total revenue, selling,
general and administrative expenses decreased from 17.6% in the third fiscal
quarter 2002 to 16.7% in the current fiscal quarter.
OPERATING INCOME. Operating income for the quarter ended June 30, 2003 was
$564,000, as compared to an operating loss of $143,000 in the same period last
year. The increase in operating income was mainly due to the 25.7% increase in
revenue and the elimination of $129,000 of goodwill amortization expense upon
the adoption of SFAS 142 by the Company in the first fiscal quarter of this
year.
15
INTEREST EXPENSE. Interest expense increased slightly to $51,000 for the
quarter ended June 30, 2003, from $46,000 in the same period last year. This was
due to an increase in capitalized lease obligations.
EFFECTIVE TAX RATE. The effective tax rate for this fiscal quarter was 37.4% as
compared to the statutory rate of 41.8%. This decrease in the rate is a result
of the revisions of estimates regarding state tax apportionments, which had the
effect of lowering the overall state rate applied.
SEGMENT RESULTS
Bankcard and Transaction Processing. Bankcard processing and transaction
processing revenue increased 24.1%, from $6,940,000 in the third fiscal quarter
2002 to $8,612,000 for this fiscal quarter. This revenue increase was mainly
attributable to an approximate 32.1% increase in bankcard processing volume as
compared to the same quarter last year. The processing volume increase was a
result of organic growth from the Company's existing merchants and new merchants
generated from other marketing initiatives, such as the Company's
MerchantAmerica program and other sales programs. The bankcard and transaction
processing revenue increase was partially offset by a 31.0% decrease in U-Haul
revenue as compared to the prior year quarter. Additionally, the Company has
one bankcard processing merchant which has grown significantly over the past
year and accounted for approximately 10% of the total bankcard and transaction
processing revenue for the quarter ended June 30, 2003. While the Company
anticipates that this merchant relationship will continue to be significant,
there can be no assurance that this merchant will continue utilizing the
Company's services or will represent a significant portion of bankcard and
transaction processing revenue in the future.
Gross margin from the bankcard and transaction processing segment remained
relatively constant, from 25.4% in the quarter ended June 30, 2002 to 25.6% in
the current fiscal quarter. Operating income for this business segment was
$1,081,000 for the third fiscal quarter, up 99.1% from $543,000 in the same
period last year. The increase in operating income is attributable to the 24.1%
increase in bankcard processing revenue this quarter over the prior year
quarter.
Check Related Products. Check-related revenues increased from $1,475,000 for the
third fiscal quarter ended June 30, 2002 to $1,966,000 for the current fiscal
quarter, an increase of 33.3%. This was attributable to a 13.4% increase in
check verification revenue and a 222.1% increase in other electronic check
processing such as check conversion, and a decrease in check collection revenue.
Check conversion revenue has grown significantly in this fiscal year as a result
of broader market acceptance of the Company's various check-related products and
as a result of the growth in the Visa POS Check Service program.
During the month of June 2003, a major national retail merchant with
approximately 3,000 storefronts initiated the Visa POS Check Service program in
all of its stores nationwide. The Company is the third-party processor in this
Visa POS relationship. As a result, the number of ACH transactions processed
during June 2003 increased by more than 300% as compared to the previous month.
Management believes that revenues generated from the Visa POS Check Service
program as a whole will continue to grow as this program starts to build
momentum.
Check services revenue made up 18.6% of total processing and transaction
revenues in this fiscal quarter as compared to 17.5% in the prior year.
Check-related operating income was $96,000 for the current fiscal quarter as
compared to an operating loss of $257,000 in the same period last year. The
improvement in this business segment was primarily attributable to the 33.3%
increase in revenue.
16
NINE MONTHS ENDED JUNE 30, 2003 AND 2002
Financial highlights for the nine months ended June 30, 2003, as compared to the
same period last year, were as follows:
- --Total revenue increased 19.9% to $29.6 million
- --Gross margins from processing and transaction revenue increased to 33.3% from
31.8%
- --Diluted EPS before cumulative effect of accounting change of $0.14 as compared
to diluted loss per share of $0.38
- --Bankcard and transaction processing revenue increased 17.2% to $23.9 million
- --Bankcard processing volume increased 27.5% to $712.1 million
- --Check-related revenue increased 32.7% to $5.7 million
- --ACH transactions processed increased 261.9% to 5.3 million
REVENUE. Total revenue increased to $29,646,000 for the nine months ended June
30, 2003, from $24,722,000 for the same period last year. Total processing and
transaction revenue for this nine-month period increased 20.2%, from $24,461,000
for the nine months ended June 30, 2002 to $29,396,000 for the current
nine-month period.
COST OF SALES. Processing-related expenses increased from $16,675,000 for the
nine-month period in 2002 to $19,596,000 for the nine months ended June 30,
2003, a 17.5% increase. The increase reflects a 20.2% increase in processing and
transaction revenues for the nine months ended June 30, 2003 as compared to the
same period in the prior year.
Gross margin from processing and transaction services increased from 31.8% in
the nine-month period last year to 33.3% for the current nine-month period. This
increase in gross margin was due to the incremental margin improvement as the
processing volume continues to grow.
EXPENSE. Other operating costs increased from $2,238,000 for the nine months
ended June 30, 2002 to $2,329,000 for the nine months ended June 30, 2003, an
increase of 4.1%. This increase was primarily attributable to a 19.9% increase
in total revenue. Research and development expense decreased from $1,264,000 in
the nine months ended June 30, 2002 to $1,042,000 in the current nine-month
period. This was mainly attributable to the Visa POS Check Service program
transitioning from the pilot phase to implementation phase and the diminishing
research and development expenses associated with this program.
Selling, general and administrative expenses increased from $5,008,000 for the
nine months ended June 30, 2002 to $5,123,000 in the current nine-month period.
This increase was attributable to the overall growth of the Company and was
partially offset by the lower legal fees experienced in the current year due to
the Premiere Lifestyles International Corporation ("PLIC") settlement in March
2002. As a percentage of total revenue, selling, general and administrative
expenses decreased from 20.3% for the nine months ended June 30, 2002 to 17.3%
in the current nine-month period.
OPERATING INCOME. Operating income for the nine months ended June 30, 2003 was
$1,556,000, as compared to an operating loss of $3,348,000 for the same period
last year. The improvement in operating income was primarily attributable to the
exclusion of the $3,095,000 legal and settlement expense related to the PLIC
lawsuit settlement in March 2002, the 19.9% increase in revenue and the
elimination of $385,000 of goodwill amortization expense.
INTEREST EXPENSE. Interest expense increased to $150,000 for the nine months
ended June 30, 2003, from $84,000 in the same period last year.
EFFECTIVE TAX RATE. The effective tax rate for the nine months ended June 30,
2003 was 43.2%, as compared to a tax benefit of $1,217,000 for the nine months
ended June 30, 2002, primarily due to the tax benefit related to the lawsuit
settlement.
17
SEGMENT RESULTS
Bankcard and Transaction Processing. Bankcard processing and transaction
processing revenue increased 17.2%, from $20,411,000 for the nine months ended
June 30, 2002 to $23,927,000 for the current nine-month period. This revenue
increase was mainly attributable to an approximate 27.5% increase in bankcard
processing volume as compared to the same nine-month period last year. The
processing volume increase was a result of organic growth from the Company's
existing merchants and other marketing initiatives.
The bankcard and transaction processing segment generated a gross margin of
26.5% for the nine months ended June 30, 2003 as compared to 27.4% in the same
period last year. This decrease in gross margin was attributable to the pricing
concession offered to several high volume merchants and a decrease in U-Haul
revenue, which yields a higher margin than the bankcard processing activities.
Check Related Products. Check-related revenues increased from $4,311,000 for the
nine months ended June 30, 2002 to $5,719,000 for the current nine-month period,
an increase of 32.7%. This was attributable to the growth in the check
conversion and check verification revenue.
Check services revenue accounted for 19.3% of total revenue for the current
nine-month period as compared to 17.4% in the same prior year period.
Check-related operating income was $304,000 for the current nine-month period as
compared to an operating loss of $676,000 in the same period last year. The
improvement in operating income was primarily attributable to the 32.7% increase
in check services revenue.
As the result of the increase in ACH processing and settlement activities
generated by the Company during the current nine-month period, settlement
receivables to merchants increased from $148,000 at September 30, 2002 to
$707,000 at June 30, 2003 and settlement payables to merchants increased from
$729,000 at September 30, 2002 to $4,490,000 at June 30, 2003. The net impact
was a net increase to cash on hand of $3,202,000 for the same nine-month period.
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 2003, the Company had available cash of $5,563,000, restricted
cash of $1,112,000 in reserve with its primary processing banks and working
capital of $3,294,000.
Accounts receivable net of allowance for doubtful accounts increased to
$1,891,000 at June 30, 2003 from $1,596,000 at September 30, 2002. Allowance for
doubtful accounts, which reflect chargeback losses, remain relatively constant
with a balance of $438,000 at June 30, 2003 from $431,000 at September 30, 2002.
Net cash provided by operating activities for the nine months ended June 30,
2003 was $5,366,000, as compared to net cash used in operating activities of
$307,000 for the nine months ended June 30, 2002. The cash generated was
attributable to income of $810,000 before a non-cash charge of $4,707,000 due to
a cumulative change in accounting principle, $3,202,000 from the net change in
settlements payables and receivables, and other operating activities.
In the nine months ended June 30, 2003, the Company used $139,000 for the
purchase of equipment and $1,990,000 for the acquisition and capitalization of
software costs. During the nine months ended June 30, 2003, the Company used
$157,000 for financing activities such as notes payable proceeds and repayment
of notes and capitalized leases obligations.
During November 2002, the Company negotiated a $500,000 lease line with a
leasing company to fund certain computer equipment needs of which approximately
$233,000 had been drawn down through June 30, 2003. In January 2003, the Company
negotiated an $800,000 line of credit for working capital needs and a $700,000
secured promissory note to fund the remaining Oasis software installment
payments from First Regional Bank, the Company's primary bankcard sponsoring
bank, at a borrowing rate of prime + 1%. In March 2003, the Company completed a
draw down of $292,000 to fund the Oasis software installment payments from First
Regional Bank. The Company anticipates a full draw down of this lease line by
the last quarter of 2003.
At June 30, 2003 the Company had the following cash commitments:
18
Payment Due By Period
---------------------
Contractual Less than After
Obligations Total 1 year 2-3 years 4-5 years 5 years
- ------------------- ---------- ---------- ---------- ---------- ----------
Long-term debt
including interest $2,943,059 $ 394,789 $ 713,582 $ 481,715 $1,352,973
Capital lease
obligations 843,464 414,558 428,906 -0- -0-
Operating leases 1,798,968 415,846 749,172 561,842 72,108
---------- ---------- ---------- ---------- ----------
Total contractual
cash obligations $5,585,491 $1,225,193 $1,891,660 $1,043,557 $1,425,081
========== ========== ========== ========== ==========
The Company's primary source of liquidity is expected to be cash flow generated
from operations and cash and cash equivalents currently on hand. However, with
the anticipated growth in the check services segment resulting from broader
market acceptance of the Company's various check-related products and growth in
the Visa POS Check Service program, a significant capital investment may be
required to fund both the infrastructure improvements and working capital needs
necessary to sustain such growth. The Company may therefore be required to seek
outside equity or other funding to support this anticipated growth. There is no
assurance that the Company will be able to secure such funding on terms
acceptable to the Company or at all.
NEW ACCOUNTING PRONOUNCEMENTS
In November 2002, the FASB issued FASB Interpretation No. 45 ("FIN 45"),
Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others. This interpretation expands the
disclosures to be made by a guarantor in its financial statements about its
obligations under certain guarantees and requires the guarantor to recognize a
liability for the fair value of an obligation assumed under a guarantee. FIN 45
clarifies the requirements of SFAS 5, Accounting for Contingencies, relating to
guarantees. In general, FIN 45 applies to contracts or indemnification
agreements that contingently require the guarantor to make payments to the
guaranteed party based on changes in an underlying that is related to an asset,
liability, or equity security of the guaranteed party. The disclosure
requirements of FIN 45 are effective for the Company as of December 31, 2002,
and require disclosure of the nature of the guarantee, the maximum potential
amount of future payments that the guarantor could be required to make under the
guarantee, and the current amount of the liability, if any, for the guarantor's
obligations under the guarantee. The recognition requirements of FIN 45 are to
be applied prospectively to guarantees issued or modified after December 31,
2002.
In May 2003, the FASB issued Statement of Financial Accounting Standards, or
SFAS, No. 150, "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity," which established standards for
how a company classifies and measures certain financial instruments with
characteristics of both liabilities and equity. SFAS 150 requires certain
financial instruments to be classified as liabilities, which were previously
classified as equity. SFAS 150 is effective for financial instruments entered
into or modified after May 31, 2003, and otherwise is effective at the beginning
of the Company's fourth quarter. The Company is currently evaluating the impact
of FAS 150, but does not think the adoption of this statement will have an
impact on the Company's results of operations, financial position or cash flows.
19
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, and in the
Company's Annual Report on Form 10-K for the fiscal year ended September 30,
2002.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
----------------------------------------------------------------
The Company could be exposed to market risk from changes in interest rates on
its lease lines. The Company's exposure to interest rate risk relates to its
$800,000 line of credit and $700,000 software lease line. There was an
outstanding balance of $292,000 against the $700,000 lease line as of June 30,
2003. However, a hypothetical 1% interest rate change would have no material
impact on the Company's results of operations.
ITEM 4. CONTROLS AND PROCEDURES
-------------------------
As of June 30, 2003, the end of the period covered by this report, the Company
carried out an evaluation, under the supervision and with the participation of
our management, including our Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of our disclosure
controls and procedures pursuant to Rules 13a-15 and 15d-15 of the Securities
Exchange Act of 1934. Based upon that evaluation, our Chief Executive Officer
and our Chief Financial Officer concluded that our disclosure controls and
procedures are effective in causing material information to be recorded,
processed, summarized and reported by our management on a timely basis and to
ensure that the quality and timeliness of the Company's public disclosures
complies with its Securities and Exchange Commission disclosure obligations.
There have been no significant changes in the Company's internal controls or in
other factors, which could significantly affect internal controls subsequent to
the date that the Company carried out its evaluation.
20
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
-----------------------------------------------------------
The Company held its Annual Meeting of Stockholders on February 3, 2003. At the
Annual Meeting, there were 5,796,062 shares of Common Stock entitled to vote,
and 4,751,235 shares (81.97%) were represented at the meeting in person or by
proxy. Immediately prior to and following the Annual Meeting, the Board of
Directors was comprised of Herbert L. Lucas, Jr., Carl R. Terzian, Aristides W.
Georgantas, and Joel M. Barry.
The following summarizes vote results for those matters submitted to our
stockholders for action at the Annual Meeting:
1. Proposal to elect Herbert L. Lucas, Jr. to serve as the Company's Class I
director for three years and until his successor has been elected and qualified.
Director For Withheld
-------- --- --------
Herbert L. Lucas, Jr. 4,678,748 72,487
2. Proposal to adopt the Company's 2003 Incentive Stock Option Plan.
For Against Abstain Broker Non-Votes
--- ------- ------- ----------------
876,940 134,320 5,009 3,734,967
3. Proposal to ratify or reject the selection of PricewaterhouseCoopers LLP
as independent public accountants of the Company for the fiscal year ending
September 30, 2003.
For Against Abstain Broker Non-Votes
--- ------- ------- ----------------
4,719,291 25,858 6,086 -0-
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
-------------------------------------
(a) Exhibits:
31.1 Certificate of Joel M. Barry, Chief Executive Officer of Electronic
Clearing House, Inc. pursuant to Rule 13a-14(a) under the Securities and
Exchange Act of 1934, as amended.
31.2 Certificate of Alice L. Cheung, Chief Financial Officer of Electronic
Clearing House, Inc. pursuant to Rule 13a-14(a) under the Securities and
Exchange Act of 1934, as amended.
32.1 Certificate of Joel M. Barry, Chief Executive Officer of Electronic
Clearing House, Inc. pursuant to Rule 13a-14(b) under the Securities and
Exchange Act of 1934, as amended.
32.2 Certificate of Alice L. Cheung, Chief Financial Officer of Electronic
Clearing House, Inc. pursuant to Rule 13a-14(b) under the Securities and
Exchange Act of 1934, as amended.
(b) Reports on Form 8-K:
Date of Filing Item Reported
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May 15, 2003 Press release issued announcing Registrant's second
quarter fiscal year 2003 earnings results.
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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.
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(Registrant)
Date: August 14, 2003 By: \s\ Alice Cheung
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Alice Cheung, Treasurer and
Chief Financial Officer
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