-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, JUk4niHHYV3xXTnX6Z+2VhN15eXysFmhCk+ztbc3Sykbb/oJKnJdOnV+Bs2ZMQu6 hHZkpQSc73qVScQevWsNWw== 0001015402-04-000505.txt : 20040213 0001015402-04-000505.hdr.sgml : 20040213 20040213155112 ACCESSION NUMBER: 0001015402-04-000505 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20031231 FILED AS OF DATE: 20040213 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ELECTRONIC CLEARING HOUSE INC CENTRAL INDEX KEY: 0000721773 STANDARD INDUSTRIAL CLASSIFICATION: FUNCTIONS RELATED TO DEPOSITORY BANKING, NEC [6099] IRS NUMBER: 930946274 STATE OF INCORPORATION: NV FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-15245 FILM NUMBER: 04598904 BUSINESS ADDRESS: STREET 1: 28001 DOROTHY DR CITY: AGOURA HILLS STATE: CA ZIP: 91301-2697 BUSINESS PHONE: 8187068999 MAIL ADDRESS: STREET 1: 28001 DOROTHY DRIVE CITY: AGOURA HILLS STATE: CA ZIP: 91301 FORMER COMPANY: FORMER CONFORMED NAME: BIO RECOVERY TECHNOLOGY INC DATE OF NAME CHANGE: 19860122 10-Q 1 doc1.txt 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 DECEMBER 31, 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.) 730 PASEO CAMARILLO, CAMARILLO, CALIFORNIA 93010 (Address of principal executive offices) TELEPHONE NUMBER (805) 419-8700, FAX NUMBER (805) 419-8689 WWW.ECHO-INC.COM (Registrant's telephone number, including area code; fax number; 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 February 1, 2004, there were 6,339,562 shares of the Registrant's Common Stock outstanding.
ELECTRONIC CLEARING HOUSE, INC. INDEX ----- Page No. -------- PART I. FINANCIAL INFORMATION Item 1. Consolidated Financial Statements: Consolidated Balance Sheets 3 December 31, 2003 and September 30, 2003 (unaudited) Consolidated Statements of Operations 4 Three months ended December 31, 2003 and 2002 (unaudited) Consolidated Statements of Cash Flows 5 Three months ended December 31, 2003 and 2002 (unaudited) Notes to Consolidated Financial Statements (unaudited) 6 Item 2. Management's Discussion and Analysis of 10 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 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 ASSETS DECEMBER 31, SEPTEMBER 30, 2003 2003 -------------- --------------- (UNAUDITED) Current assets: Cash and cash equivalents $ 13,440,000 $ 5,641,000 Restricted cash 1,129,000 977,000 Settlement receivable 1,078,000 717,000 Accounts receivable less allowance of $115,000 and $91,000 2,021,000 1,918,000 Prepaid expenses and other assets 392,000 307,000 Deferred tax asset 105,000 86,000 -------------- --------------- Total current assets 18,165,000 9,646,000 Noncurrent assets: Property and equipment, net 3,209,000 2,928,000 Software, net 5,043,000 4,445,000 Deferred tax asset 856,000 1,256,000 Other assets, net 470,000 500,000 -------------- --------------- Total assets $ 27,743,000 $ 18,775,000 ============== =============== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Short-term borrowings and current portion of long-term debt $ 1,039,000 $ 901,000 Accounts payable 450,000 779,000 Settlement payable 8,744,000 3,429,000 Accrued expenses 1,405,000 1,336,000 Deferred income 100,000 -0- -------------- --------------- Total current liabilities 11,738,000 6,445,000 Long-term debt 2,230,000 1,961,000 -------------- --------------- Total liabilities 13,968,000 8,406,000 -------------- --------------- Commitments and contingencies Stockholders' equity: Common stock, $.01 par value, 36,000,000 authorized; 6,376,331 and 5,920,174 shares issued; 6,338,062 and 5,881,905 shares outstanding, respectively 64,000 59,000 Additional paid-in capital 24,453,000 21,641,000 Accumulated deficit (10,276,000) (10,865,000) Less treasury stock at cost, 38,269 common shares (466,000) (466,000) -------------- --------------- Total stockholders' equity 13,775,000 10,369,000 -------------- --------------- Total liabilities and stockholders' equity $ 27,743,000 $ 18,775,000 ============== ===============
See accompanying notes to consolidated financial statements 3
ELECTRONIC CLEARING HOUSE, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) THREE MONTHS ENDED DECEMBER 31, -------------------------- 2003 2002 ------------ ------------ Revenues: Processing revenue $ 5,693,000 $ 4,747,000 Transaction revenue 5,592,000 4,415,000 Other revenue 70,000 139,000 ------------ ------------ 11,355,000 9,301,000 ------------ ------------ Costs and expenses: Processing and transaction expense 6,891,000 6,244,000 Other operating costs 1,340,000 961,000 Research and development expense 383,000 384,000 Selling, general and administrative expenses 1,728,000 1,185,000 ------------ ------------ 10,342,000 8,774,000 ------------ ------------ Income from operations 1,013,000 527,000 Interest income 13,000 8,000 Interest expense (56,000) (52,000) ------------ ------------ Income before provision for income taxes and cumulative effect of an accounting change 970,000 483,000 Provision for income taxes (381,000) (249,000) ------------ ------------ Income before cumulative effect of an accounting change 589,000 234,000 Cumulative effect of an accounting change to adopt SFAS 142 -0- (4,707,000) ------------ ------------ Net earnings (loss) $ 589,000 $(4,473,000) ============ ============ Basic net earnings (loss) per share Before cumulative effect of accounting change $ 0.10 $ 0.04 Cumulative effect of accounting change -0- (0.81) ------------ ------------ Basic net earnings (loss) per share $ 0.10 $ (0.77) ============ ============ Diluted net earnings (loss) per share Before cumulative effect of accounting change $ 0.09 $ 0.04 Cumulative effect of accounting change -0- (0.81) ------------ ------------ Diluted net earnings (loss) per share $ 0.09 $ (0.77) ============ ============ Weighted average shares outstanding Basic 6,182,767 5,796,062 ============ ============ Diluted 6,678,880 5,809,309 ============ ============
See accompanying notes to consolidated financial statements. 4
ELECTRONIC CLEARING HOUSE, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) THREE MONTHS ENDED DECEMBER 31, -------------------------- 2003 2002 ------------ ------------ Cash flows from operating activities: Net income (loss) $ 589,000 $(4,473,000) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation 176,000 164,000 Amortization of software 330,000 203,000 Provisions for losses on accounts and notes receivable 28,000 94,000 Deferred income taxes 381,000 249,000 Stock option compensation 9,000 -0- Cumulative effect of an accounting change -0- 4,707,000 Changes in assets and liabilities: Restricted cash (152,000) (52,000) Accounts receivable (131,000) (174,000) Settlement receivable (361,000) (35,000) Accounts payable (329,000) (108,000) Settlement payable 5,315,000 413,000 Deferred income 100,000 (62,000) Accrued expenses 69,000 225,000 Prepaid expenses and other assets (35,000) (39,000) ------------ ------------ Net cash provided by operating activities 5,989,000 1,112,000 ------------ ------------ Cash flows from investing activities: Other assets 1,000 (46,000) Purchase of equipment (305,000) (48,000) Purchased and capitalized software (664,000) (410,000) ------------ ------------ Net cash used in investing activities (968,000) (504,000) ------------ ------------ Cash flows from financing activities: Proceeds from issuance of notes payable 211,000 -0- Repayment of notes payable (112,000) (43,000) Repayment of capitalized leases (129,000) (125,000) Proceeds from private placement 2,761,000 -0- Proceeds from exercise of stock options 47,000 -0- ------------ ------------ Net cash provided by (used in) financing activities 2,778,000 (168,000) ------------ ------------ Net increase in cash 7,799,000 440,000 Cash and cash equivalents at beginning of period 5,641,000 2,409,000 ------------ ------------ Cash and cash equivalents at end of period $13,440,000 $ 2,849,000 ============ ============
See accompanying notes to consolidated financial statements. 5 ELECTRONIC CLEARING HOUSE, INC. ------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------ NOTE 1 - BASIS OF PRESENTATION: - ------------------------------- The accompanying consolidated financial statements as of December 31, 2003, and for the three-month period ended December 31, 2003 and 2002 are unaudited and reflect all adjustments (consisting only of normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of the financial position and the results of operations for the interim period. 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, 2003. The results of operations for the three months ended December 31, 2003 are not necessarily indicative of the likely results for the entire fiscal year ending September 30, 2004. Certain reclassifications have been made to the prior year financial statements to conform with the current year presentation. 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 December 31, --------- ------------ 2003 2002 --------- ------------ Net income (loss), as reported $589,000 $(4,473,000) Add: Stock-based employee compensation expense included in reported net income, net of related tax effects 5,000 -0- Deduct: Total stock-based employee compensation expense determined under fair value-based method for all awards, net of related tax effects (53,000) (50,000) --------- ------------ Pro forma net income (loss) $541,000 $(4,523,000) ========= ============ Net earnings (loss) per share: Basic - as reported $ 0.10 $ (0.77) Basic - pro forma $ 0.09 $ (0.78) Diluted - as reported $ 0.09 $ (0.77) Diluted - pro forma $ 0.08 $ (0.78)
6 NOTE 3 - EARNINGS (LOSS) PER SHARE: - ----------------------------------- The Company calculates net earnings (loss) per share as required by Statement of Financial Accounting Standard No. 128, "Earnings per Share".
Three months ended December 31, 2003 2002 ---------- ------------ Numerator: Income before cumulative effect of an accounting change $ 589,000 $ 234,000 Cumulative effect of an accounting change to adopt SFAS 142 -0- (4,707,000) ---------- ------------ Net income (loss) $ 589,000 $(4,473,000) ========== ============ Denominator: Weighted average shares outstanding for basic earnings (loss) per share 6,182,767 5,796,062 Effect of dilutive stock options 496,113 13,247 ---------- ------------ Adjusted weighted average shares outstanding for diluted earnings (loss) per share 6,678,880 5,809,309 ========== ============ Basic net earnings (loss) per share: Before cumulative effect of accounting change $ 0.10 $ 0.04 Cumulative effect of accounting change -0- (0.81) ---------- ------------ Basic net earnings (loss) per share $ 0.10 $ (0.77) ========== ============ Diluted net earnings (loss) per share: Before cumulative effect of accounting change $ 0.09 $ 0.04 Cumulative effect of accounting change -0- (0.81) ---------- ------------ Diluted net earnings ( loss) per share $ 0.09 $ (0.77) ========== ============
For the three months ended December 31, 2003 and 2002, 85,750 and 616,750 shares attributable to the exercise of outstanding options were excluded from the calculation of diluted earnings per share because the effect was antidilutive. NOTE 4 - SUPPLEMENTAL CASH FLOW INFORMATION: - --------------------------------------------
December 31 ---------------- 2003 2002 ------- ------- Cash paid for: Interest $56,000 $52,000 Income taxes 7,000 -0-
Significant non-cash transactions for the three months ended December 31, 2003 were as follows: - Software purchases of $285,000 and capital equipment of $152,000 were acquired under capital leases. Significant non-cash transactions for the three months ended December 31, 2002 were as follows: - Capital equipment of $30,000 was acquired under capital leases. 7 NOTE 5 - SEGMENT INFORMATION: - ----------------------------- The Company primarily 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.
For the Three Months Ended December 31, 2003 2002 -------------- --------------- Revenues: Bankcard and transaction processing $ 8,624,000 $ 7,519,000 Check-related products 2,731,000 1,782,000 -------------- --------------- $ 11,355,000 $ 9,301,000 ============== =============== Operating income: Bankcard and transaction processing $ 1,551,000 $ 922,000 Check-related products 412,000 106,000 Other - corporate expenses (950,000) (501,000) -------------- --------------- $ 1,013,000 $ 527,000 ============== =============== December 31, September 30, 2003 2003 -------------- --------------- Total assets: Bankcard and transaction processing $ 7,476,000 $ 7,051,000 Check-related products 12,915,000 6,794,000 Other 7,352,000 4,930,000 -------------- --------------- $ 27,743,000 $ 18,775,000 ============== ===============
NOTE 6 - COMMITMENTS, CONTINGENT LIABILITIES, AND GUARANTEES: - -------------------------------------------------------------------- The Company currently relies on cooperative relationships with, and sponsorship by, one bank in order to process its Visa, MasterCard and other bankcard transactions. The agreement between the bank and the Company requires the Company to assume and compensate the bank 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 Automated Clearing House ("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 8 Note 6: (Continued) - ------- resolution. For the last four months through December 31, 2003, this potential exposure totaled approximately $335 million. At December 31, 2003, the Company, through its sponsoring banks, had approximately $175,000 of unresolved chargebacks that were in the process of resolution. At December 31, 2003, the Company, through its sponsoring banks, had access to $9.5 million in merchant deposits to cover any potential chargeback losses. For the three months ended December 31, 2003 and 2002, the Company processed approximately $251 million (2003) and $217 million (2002) of Visa and MasterCard transactions, which resulted in $1.8 million in gross chargeback activities for the three months ended December 31, 2003 and $2.8 million for the three months ended December 31, 2002. Substantially all of these chargebacks were recovered from the merchants. The Company's contingent obligation with respect to chargebacks constitutes a guarantee as defined in Financial Accounting Interpretation No. 45, "Guarantor's Accounting and Disclosure requirements for Guarantees, Including Indirect Guarantees of Others" ("FIN 45"). FIN 45 requires that guarantees issued or modified subsequent to December 31, 2002 be initially recorded as liabilities in the Statement of Financial Position at fair value. Since the Company's agreement with its sponsoring bank, which establishes the guarantee obligation was entered into prior to December 31, 2002 and has not been modified since that date, the measurement provisions of FIN 45 are not applicable to this guarantee arrangement. In accordance with SFAS No. 5, "Accounting for Contingencies", the Company records a reserve for chargeback loss allowance based on its processing volume and historical trends and data. As of December 31, 2003 and 2002, the allowance for chargeback losses, which is classified as a component of the allowance for uncollectible accounts receivable, was $49,000 and $446,000, respectively. The expense associated with the valuation allowance is included in processing and transaction expense in the accompanying consolidated statements of income. The Company expensed $17,000 and $100,000 for the three months ended December 31, 2003 and 2002, for bankcard processing chargeback losses. 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 check writer'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 December 31, 2003, the Company estimates that its maximum potential dishonored check exposure was approximately $490,000. For the quarters ended December 31, 2003 and 2002, the Company guaranteed approximately $3,958,000 (2003) and $3,619,000 (2002) of merchant checks, which resulted in $17,000 (2003) and $157,000 (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 check writer. 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 December 31, 2003 and 2002, the reserve for check guarantee loss was $14,000 (2003) and $119,000 (2002). The expense associated with the valuation allowance is included in processing and transaction expense in the accompanying consolidated statements of income. 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND --------------------------------------------------------------- RESULTS OF OPERATIONS --------------------- OVERVIEW Electronic Clearing House, Inc. is an electronic payment processor that provides for the payment processing needs of merchants, banks and collection agencies. We derive the majority of our revenues from two main business segments, bankcard and transaction processing services, whereby we provide solutions to merchants and banks to allow them to accept credit and debit card payments from consumers, and check-related products, whereby we provide various services to merchants and banks to allow them to accept and process check payments from consumers. The principal services we offer within these two segments include the following: With respect to our bankcard and transaction processing services: - Debit and credit card processing; and - U-Haul transaction processing. With respect to our check-related products: - Check verification - where, prior to approving a check, we search our negative and positive check writer database to determine whether the check writer has current, delinquent check-related debts; - Electronic check conversion - the conversion of a paper check at the point of sale to a direct bank debit which is processed for settlement through the Federal Reserve System's Automated Clearing House, or ACH, network. The ACH is the electronic banking network through which all electronic funds transfers are made in the United States; - Check guarantee - where, if we approve a check transaction and a check is subsequently dishonored by the check writer's bank, the merchant is reimbursed by us; - Check re-presentment - where we attempt to clear a check on multiple occasions via the ACH network prior to returning the check to the merchant so as to increase the number of cleared check transactions; and - Check collection - where we provide national scale collection services for a merchant or bank. We operate our services under the following brands: - MerchantAmerica, our retail provider of payment processing services to both the merchant and bank markets; - National Check Network, or NCN, our proprietary database of negative and positive check writer accounts, for back-end check verification, check authorization and check capture services, and for membership to collection agencies. Negative check writer accounts typically identify a check writer's delinquent history in the form of non-sufficient funds and other negative transactions; and - XPRESSCHEX, Inc. for retail check verification, check conversion, ACH services, check collection and check guarantee services. Overall, our ability to program and oversee the management of a merchant's point-of-sale system, provide credit card and debit card processing, provide multiple check services for the processing of checks, provide both electronic and traditional collection services, and fully integrate all of these services into a single Internet-based reporting capability allows us to provide for the majority of the payment processing needs of our customers. Bankcard and transaction processing services provide for the majority of our revenues. We typically receive a percentage-based fee on the dollar amount processed and a transaction fee on the number of transactions processed. For the quarter ended December 31, 2003, the bankcard and transaction processing business segment accounted for approximately 75.9% of the Company's total revenue. Over the past three years, we have invested significant resources and management focus in our 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. For the quarter ended December 31, 2003, the check services business segment accounted for approximately 24.1% of the Company's total revenue. We are one of a few check processors in the nation with both an ACH engine, which gives us 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. 10 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 our 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 our check conversion services, which include capture of the necessary check data at the point of sale and submission of the transaction electronically to the ACH for settlement. Since we provide ACH and settlement services to the merchants, all settlement funds received by us 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 we have 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 the Visa Point-Of-Sale ("POS") Check Service. The Visa POS Check Service was offered as a pilot program by Visa to its member banks from December of 2000 to December of 2002 over which time several banks electronically connected their check writer data to the Visa network, making verification of the check writer's bank account balance possible when checks drawn on these select banks were processed. In December of 2002, the program was officially released out of pilot and, as of December 2003, approximately 10% of checking accounts in the U.S.A. are electronically connected to the Visa network through the banks that are now participating in the Visa POS Check Service. This number is expected to increase to 20% or higher over the coming year as more banks connect their check writer data with Visa. ECHO has invested significant resources and management focus in its check services business, particularly with respect to the Visa POS Check Service, and anticipates continued growth in check services as the marketing efforts of participating banks in the Visa POS Check Service become more widely implemented. Being able to approve or decline a check in real time at the point of sale requires some method to verify the check writer has either an adequate balance in the bank to cover the check or, if that is not possible, to verify if the check written has a match in a negative check account database. In order to provide this check service on 100% of the checks received by a merchant, Visa needed a solution to approve or decline (and for those approved, electronically deposit) the checks that processed through the program on a bank that had not yet connected its check writer data to the Visa network. We are currently one of two companies that provide this service to Visa as a Third-Party Processor. When a Visa member bank signs up to offer the Visa POS Check Service to its merchants, it chooses a Third-Party Processor from the certified providers. To date, nine of the thirteen financial institutions actively participating in the program are using ECHO's services as a Third-Party Processor and are beginning to actively sell check services to their merchants, and two additional participating institutions currently in the program intend to actively market this program to their merchants and use ECHO's services as a Third-Party Processor in 2004. In addition to being a Third-Party Processor, we are one of only five companies that are currently certified as an Acquirer Processor with Visa, a role that accepts transactions from the merchant's point-of-sale terminal/systems and reformats them for submission to the Visa network. We were chosen by two of the seventeen banks currently in the program to serve as their Acquirer Processor. Most banks presently in the Visa POS Check Service are large national or regional banks and already had terminal management service providers that could act as Acquirer Processor for the Visa POS Check Service. In the future, as smaller banks make the decision to enter the Visa POS Check Service, it is expected that many will have no prior relationship with a terminal management provider and therefore, may potentially choose us as their Acquirer Processor. 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. We derive transaction revenue in our role as a Third-Party Processor and/or Acquirer Processor by negotiating a transaction fee with Visa and/or the bank that chose us as its Third-Party Processor and/or Acquirer Processor. This transaction fee averages $0.09 per transaction. The party that sells the service to the merchant (usually the bank) enjoys the largest mark-up on the product, offering the service in the range of $0.30 to $0.60 per check, with external cost in the $0.12 to $0.20 range, depending on what the bank negotiates with Visa and any Third-Party providers. 11 STRATEGY Our strategy is to provide merchants, banks and industry-specific resellers with electronic connectivity to various payment services in the credit card, debit card and check-related markets. Our platform of services is very flexible, enabling merchant customization and scalability to meet the requirements of high transaction volumes, as well as access to the Visa POS Check Service program. Our services enable merchants to maximize revenues by offering a wide variety of payment options, reducing the costs associated with processing and handling checks, improving collections and managing risk more effectively. We plan to grow our 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. We are continuing to enhance the Visa POS Check Service so as to leverage our check services products through Visa member banks. As the market gains acceptance of the Visa POS Check Service, it will significantly increase the opportunities to market our check conversion services and verification services to our core merchant base and solidify our strategic relationships with the various financial institutions that have chosen us 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 us to cross sell our 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. We have also identified an underserved, niche market of smaller regional and community banks for our agent bank program. We are providing a 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, our 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 We sell our bankcard and check services through several marketing channels, including independent sales organizations (i.e, authorized resellers of our products and services), our own internal sales force and direct merchant referrals by existing merchants. We also offer Merchant Services through a direct online sales channel, MerchantAmerica. Approximately 20% of our new accounts have historically been generated through the authorized resellers of our products and services. In fiscal 2002, ECHO restructured its sales force by hiring more sales people for its Check Services National Sales Group, which focuses on selling to major accounts and mid-sized retail chains, and implementing an incentive-based commission structure with the goal of targeting specific accounts and shortening the sales cycle. Due to the growing interest in the Visa POS Check Service and being the Third Party Processor of a national clothing retailer, we have redirected much of our marketing and sales resources to aggressively promote the Visa POS Check Service. Management believes that we are unique in the number of payment services that we offer to our merchants, the combination of transaction types that we manage directly, our ability to integrate additional services and our ability to support each merchant through one vertically integrated source. Our marketing strategy is to maximize cross selling opportunities to our existing base of merchants and financial institutions in the Visa POS Check Service 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. We are not currently a major player in the industries in which we compete and many of our competitors have much greater financial and marketing resources than us. 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. Our competitors also have the financial resources to offer services to large merchants at a much lower rate than us in order to gain market share. We believe that our success will depend upon our ability to continuously develop new products and services and to enhance our current products and to introduce them promptly into the market. 12 RESULTS OF OPERATIONS THREE MONTHS ENDED DECEMBER 31, 2003 - ------------------------------------ Financial highlights for the first quarter of 2004 as compared to the same period last year were as follows: - --Total revenue increased 22.1% to $11.4 million - --Gross margins from processing and transaction revenue increased to 38.9% from 31.8% - --Diluted EPS of $0.09 as compared to diluted loss per share of $0.04 before the cumulative effect of an accounting change in the prior year quarter - --Bankcard and transaction processing revenue increased 14.7% to $8.6 million - --Bankcard processing volume increased 15.7% to $250.8 million - --Check-related revenue increased 53.3% to $2.7 million - --ACH transactions processed increased 612.6% to 7.3 million transactions REVENUE. Total revenue increased 22.1% to $11,355,000 for the three months ended December 31, 2003, from $9,301,000 for the same period last year. The increase was primarily attributed to a 14.7% growth in the bankcard processing business and 53.3% growth in the check services business segment. Total processing and transaction revenue for this fiscal quarter increased 23.2%, from $9,162,000 for the comparable quarter in fiscal 2003 to $11,285,000 in fiscal 2004. COST OF SALES. A majority of our 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, and communication fees increased from $6,244,000 in the first fiscal quarter of 2003 to $6,891,000 in the current fiscal quarter, a 10.4% increase. The increase reflects a 23.2% increase in processing and transaction revenues for the current fiscal quarter. Gross margin from processing and transaction services increased from 31.8% in the first fiscal quarter 2003 to 38.9% 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 a rate adjustment implemented in August 2003, which favorably impacted our year-over-year comparisons. EXPENSE. Other operating costs such as personnel costs, telephone and depreciation expenses increased from $961,000 in the first fiscal quarter of 2003 to $1,340,000 in this fiscal quarter, an increase of 39.4%. This increase was primarily attributable to the additional costs to support the 22.1% revenue growth for the current quarter, as compared to the prior year quarter. The Visa POS Check Service required a substantial increase in personnel costs to support the implementation and training of the various financial institutions that have chosen us as their Third-Party Processor. We have also hired a team of risk management staff dedicated to monitor and enhance our risk management procedures to adequately support the Visa POS Check Service. Additionally, as a result of the increase in our customer support call volume during the first fiscal quarter of 2004, the cost of customer support increased from $320,000 for the quarter ended December 31, 2002 to $476,000 for the quarter ended December 31, 2003, an increase of 49%. Overall, because the Visa POS Check Service is still a relatively new program, we anticipate the cost to support the financial institutions that are continuing to sign up under the Visa POS Check Service program will continue to remain at a higher level. Research and development expense remained flat at $384,000 in the prior year quarter compared to $383,000 in the current fiscal quarter. We anticipate the need to continue to invest in research and development and product enhancements in order to remain competitive. Selling, general and administrative expenses increased from $1,185,000 in the first fiscal quarter 2003 to $1,728,000 in the current quarter. This increase was primarily attributable to the increase in sales and marketing expenses as we continue to follow our sales and marketing strategies, increase in administrative salaries and increase in rent as we moved into a new corporate location in October 2003. As a percentage of total revenue, selling, general and administrative expenses increased from 12.7% in the first fiscal quarter 2003 to 15.2% in the current fiscal quarter. 13 OPERATING INCOME. Operating income for the quarter ended December 31, 2003 was $1,013,000, as compared to an operating income of $527,000 in the same period last year, a 92.2% increase. The increase in operating income was mainly due to the 22.1% increase in revenue and the improvement in gross margin from 31.8% in the prior year quarter to 38.9% in the current quarter. INTEREST EXPENSE. Net interest expense remained constant as compared to prior year quarter, from $44,000 for the quarter ended December 31, 2002 to $43,000 in the current quarter. EFFECTIVE TAX RATE. The effective tax rate for this fiscal quarter was 39.3% as compared to 37.3% for the prior quarter and the statutory rate of approximately 40%. SEGMENT RESULTS Bankcard and Transaction Processing. Bankcard processing and transaction processing revenue increased 14.7%, from $7,519,000 in the first fiscal quarter 2003 to $8,624,000 for this fiscal quarter. This revenue increase was mainly attributable to an approximate 15.7% increase in bankcard processing volume as compared to the same quarter last year. The processing volume increase was a result of organic growth from our existing merchants and new merchants generated from other marketing initiatives. Gross margin from the bankcard and transaction processing segment increased, from 26.7% in the quarter ended December 31, 2002 to 31.6% in the current fiscal quarter mainly as a result of the rate increase implemented in August 2003. Operating income for this business segment was $1,551,000 for this current fiscal quarter, up 68.2% from $922,000 in the same period last year. The increase in operating income is attributable to the 14.7% increase in bankcard processing revenue this quarter over the prior year quarter combined with a rate adjustment implemented in August 2003. Check Related Products. Check-related revenues increased from $1,782,000 for the prior year quarter ended December 31, 2002 to $2,731,000 for the current fiscal quarter, an increase of 53.3%. This was attributable to the increase in check verification revenue and the increase in other electronic check processing revenue such as check conversion, and a decrease in check collection revenue. Check conversion revenue has grown significantly in this fiscal quarter as compared to the prior year quarter as a result of the growth in the Visa POS Check Service program. During the third quarter of fiscal 2003, a major national retail merchant with approximately 3,000 storefronts initiated the Visa POS Check Service program in all of its stores nationwide. We are the Third-Party Processor in this Visa POS relationship. As a result, the number of ACH transactions processed during this first fiscal quarter increased by more than 600% as compared to the same period last year, especially due to the higher check volume from the holiday season. However, the operating margin generated from this one merchant is less than the margin realized from other Visa POS merchants due to pricing concessions provided to this merchant. The bank that sponsored this merchant into the Visa POS Check Service program is currently in the process of negotiating a multi-year agreement with the merchant. At the same time, another payment processor not currently in the Visa POS program is also attempting to gain this merchant's business. While we believe this merchant will ultimately remain in the Visa POS Check Service program, there can be no assurance of this. We currently anticipate these negotiations will be concluded in March 2004. Check services revenue made up 24.1% of total revenue in this fiscal quarter as compared to 19.2% in the prior year quarter. Check-related operating income was $412,000 for the current fiscal quarter as compared to an operating income of $106,000 in the same period last year. The improvement in this business segment was primarily attributable to the 53.3% increase in revenue. LIQUIDITY AND CAPITAL RESOURCES As of December 31, 2003, we had available cash and cash equivalents of $13,440,000, restricted cash of $1,129,000 in reserve with its primary processing banks and working capital of $6,427,000. Accounts receivable net of allowance for doubtful accounts increased to $2,021,000 at December 31, 2003 from $1,918,000 at September 30, 2003. This increase was primarily due to increases in revenue and billings. Allowance for doubtful accounts mainly reserved for chargeback losses, increased slightly to $115,000 at December 31, 2003 from $91,000 at September 30, 2003. Net cash provided by operating activities for the three months ended December 31, 2003 was $5,989,000, as compared to net cash provided by operating activities of $1,112,000 for the three months ended December 31, 2002. A large portion of this increase was attributable to a $4,954,000 net increase in settlement payable to merchants. Cash amounts classified as settlement payable are amounts due to be paid to merchants and result from timing differences in our settlement process with those merchants. These timing 14 differences account for the difference between the time that funds are received in our bank accounts and the time that settlement payments are made to merchants. Therefore, at any given time, settlement payable may vary and ultimately depends on the volume of transactions processed. The increase in settlement payable in the first quarter of fiscal 2004 is primarily attributable to the high volume of transactions experienced from our check services. As our business grows, settlement payable will likely increase. The balance of our net cash provided by operating activities was generated by the net income of $589,000 and other operating activities. In the three months ended December 31, 2003, we used $305,000 for the purchase of equipment and $664,000 for the acquisition and capitalization of software costs. During the three months ended December 31, 2003, we received net proceeds of $2,761,000 from a $3 million private placement, which was completed in October 2003. In October 2003, we negotiated a $3,000,000 line of credit and a $1 million equipment lease line with Bank of the West. We have not used either one of these two lines of credit as of this date. At December 31, 2003, we had the following cash commitments:
Payment Due By Period --------------------- Contractual Less than After Obligations Total 1 year 2-3 years 4-5 years 5 years - ------------------- ---------- ---------- ---------- ---------- ---------- Long-term debt $2,920,000 $ 563,000 $ 675,000 $ 455,000 $1,227,000 including interest Capital lease Obligations 1,309,000 679,000 567,000 63,000 -0- Operating leases 1,726,000 485,000 735,000 506,000 -0- ---------- ---------- ---------- ---------- ---------- Total contractual cash obligations $5,955,000 $1,727,000 $1,977,000 $1,024,000 $1,227,000 ========== ========== ========== ========== ==========
Our primary source of liquidity is expected to be cash flow generated from operations and cash and cash equivalents currently on hand and the secured $3 million line of credit and the $1 million equipment lease line. Neither of these credit lines have been utilized as of this date. 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, 2003. RISK FACTORS We are subject to a number of risks, which could affect operating results and liquidity, including, among others, the following: RISKS RELATED TO OUR BUSINESS - --------------------------------- WE RELY ON COOPERATIVE RELATIONSHIPS WITH, AND SPONSORSHIP BY, BANKS, THE ABSENCE OF WHICH MAY AFFECT OUR OPERATIONS. We currently rely on cooperative relationships with, and sponsorship by, banks in order to process our Visa, MasterCard and other bankcard transactions. We also rely on several banks for access to the Automated Clearing House ("ACH") for submission of both credit card and check settlements. Our banking relationships are currently with smaller banks (with assets of less than $500,000,000). Even though smaller banks tend to be more susceptible to mergers or acquisitions and are therefore less stable, these banks find the programs we offer more attractive and we believe we cannot obtain similar relationships with larger banks at this time. A bank could at any time curtail or place restrictions on our processing volume because of its internal business policies or due to other adverse circumstances. If a volume restriction is placed on us, it could materially adversely affect our business operations by 15 restricting our ability to process credit card transactions and receive the related revenue. Our relationships with our customers and merchants would also be adversely affected by our inability to process these transactions. We currently maintain one primary bankcard processing and sponsorship relationship with First Regional Bank in Agoura Hills, California. Our agreement with First Regional Bank continues through 2005. Additionally, we have reached a tentative agreement with Woodforest Bank in Woodforest, Texas, to sponsor our bankcard activity. We also maintain several banking relationships for ACH processing. While we believe our current bank relationships are sound, we cannot assure that these banks will not restrict our increasing processing volume or that we will always be able to maintain these relationships or establish new banking relationships. Even if new banking relationships are available, they may not be on terms acceptable to us. With respect to First Regional Bank and Woodforest Bank, while we believe their respective ability to terminate our respective relationships is cost-prohibitive, they may independently determine that the cost of terminating their agreements is less than the cost of continuing to perform in accordance with their terms, and may therefore determine to terminate those agreements prior to their expiration. Ultimately, our failure to maintain these banking relationships and sponsorships may have a material adverse effect on our business and results of operations. MERCHANT FRAUD WITH RESPECT TO BANKCARD AND ACH TRANSACTIONS COULD CAUSE US TO INCUR SIGNIFICANT LOSSES. We significantly rely on the processing revenue derived from bankcard and ACH transactions. If any merchants were to submit or process unauthorized or fraudulent bankcard or ACH transactions, depending on the dollar amount, ECHO could incur significant losses which could have a material adverse effect on our business and results of operations. ECHO assumes and compensates the sponsoring bank for bearing the risk of these types of transactions. We have implemented systems and software for the electronic surveillance and monitoring of fraudulent bankcard and ACH use. As of December 31, 2003, we maintained a dedicated chargeback reserve of $664,000 at our primary bank specifically earmarked for such activity. Additionally, through our sponsoring bank, we had access to approximately $9.5 million in merchant deposits to cover any potential chargeback losses. Despite a long history of managing such risk, we cannot guarantee that these systems will prevent fraudulent transactions from being submitted and processed or that the funds set aside to address such activity will be adequate to cover all potential situations that might occur. We do not have insurance to protect us from these losses. There is no assurance that our chargeback reserve will be adequate to offset against any unauthorized or fraudulent processing losses that we may incur. Depending on the size of such losses, our results of operations could be immediately and materially adversely affected. FAILURE TO PARTICIPATE IN THE VISA POS CHECK SERVICE PROGRAM WOULD CAUSE US TO SIGNIFICANTLY SHIFT OUR OPERATING AND MARKETING STRATEGY. We have significantly increased our infrastructure, personnel and marketing strategy to focus on the potential growth of our check services through the Visa POS Check Service program. We currently provide critical back-end infrastructure for the service, including our NCN database for verification and our access to the Federal Reserve System's Automated Clearing House for funds settlement, for checks written on bank accounts with banks not participating in the program. Because we believe the market will continue to gain acceptance of the Visa POS Check Service program, we have expended significant resources to market our check conversion services and verification services to our merchant base, to solidify our strategic relationships with the various financial institutions that have chosen us as their Acquirer Processor and Third-Party Processor under the program, and to sell our other check products such as electronic check re-presentments and check collection services to the Visa member banks. We have also increased our personnel to handle the increased volume of transactions arising directly from our participation in the program. If we fail to adequately market our services through this relationship, this could materially affect our marketing strategy going forward. Additionally, if we fail to adequately grow our infrastructure to address increases in the volume of transactions, cease providing services as a Third-Party Processor or acquirer processor or are otherwise removed or terminated from the Visa program, this would require us to dramatically shift our current operating strategy. THE BUSINESS IN WHICH WE COMPETE IS HIGHLY COMPETITIVE AND THERE IS NO ASSURANCE THAT OUR CURRENT PRODUCTS AND SERVICES WILL STAY COMPETITIVE OR THAT WE WILL BE ABLE TO INTRODUCE NEW PRODUCTS AND SERVICES TO COMPETE SUCCESSFULLY. We are in the business of processing payment transactions and designing and implementing integrated systems for our customers so that they can better use our services. This business is highly competitive and is characterized by rapid technological change, rapid rates of product obsolescence, and rapid rates of new products introduction. Our market share is relatively small as compared to most of our competitors and most of these competitors have substantially more financial and marketing resources to run their 16 businesses. While we believe our small size provides us the ability to move quickly in some areas, our competitors' greater resources enables them to investigate and embrace new and emerging technologies quickly to respond to changes in customers needs, and to devote more resources to product and services development and marketing. We may face increased competition in the future and there is no assurance that current or new competition will allow us to keep our customers. If we lose customers, our business operations may be materially adversely affected, which could cause us to cease our business or curtail our business to a point where we are no longer able to generate sufficient revenues to fund operations. There is no assurance that our current products and services will stay competitive with those of our competitors or that we will be able to introduce new products and services to compete successfully in the future. IF WE ARE UNABLE TO PROCESS SIGNIFICANTLY INCREASED VOLUME ACTIVITY, THIS COULD AFFECT OUR OPERATIONS AND WE COULD LOSE OUR COMPETITIVE POSITION. We have built transaction processing systems for check verification, check conversion, ACH processing, and bank card processing activity. While current estimates regarding increased volume are within the capabilities of each system, it is possible that a significant increase in volume in one of the markets would exceed a specific system's capabilities. To minimize this risk, ECHO has redesigned and upgraded its check related processing systems and has purchased a high-end system to process bankcard activity. This system is not yet operational, and even when it becomes operational, no assurance can be given that the current systems would be able to handle a significant increase in volume or that the operational enhancements and improvements will be completed in such time to avoid such a situation. In the event we are unable to process increases in volume, this could significantly adversely affect our banking relationships, our merchant customers and our overall competitive position. Losses of such relationships would severely impact our results of operations and financial condition. WE INCUR FINANCIAL RISK FROM OUR CHECK GUARANTEE SERVICE. The check guarantee business is essentially a risk management business. Any limitation of a risk management system could result in financial obligations being incurred by ECHO relative to our check guarantee activity. While ECHO has provided check guarantee services for several years, there can be no assurance that our current risk management systems are adequate to assure against any financial loss relating to check guarantee. ECHO is enhancing its current risk management systems and it is being conservative with reference to the type of merchants to which it offers guarantee services in order to minimize this risk but no assurance can be given that such measures will be adequate. SECURITY BREACHES COULD IMPACT OUR CONTINUED OPERATIONS. We process confidential financial information and maintain several levels of security to protect this data. Security includes hand and card-based identification systems at our data center locations that restrict access to the specific facilities, various employee monitoring and access restriction policies, and various firewall and network management methodologies that restrict unauthorized access through the Internet. While these systems have worked effectively in the past, there can be no assurance that they will continue to operate without a security breach in the future. Depending upon the nature of the breach, the consequences of security breaches could be significant and dramatic to ECHO's continued operations. THE INDUSTRY IN WHICH WE OPERATE INVOLVES RAPIDLY CHANGING TECHNOLOGY AND OUR FAILURE TO IMPROVE OUR PRODUCTS AND SERVICES OR TO OFFER NEW PRODUCTS AND SERVICES COULD CAUSE US TO LOSE CUSTOMERS. Our business industry involves rapidly changing technology. Recently, we have observed rapid changes in technology as evidenced by the Internet and Internet-related services and applications, new and better software, and faster computers and modems. As technology changes, ECHO's customers desire and expect better products and services. Our success depends on our ability to improve our existing products and services and to develop and market new products and services. The costs and expenses associated with such an effort could be significant to us. There is no assurance that we will be able to find the funds necessary to keep up with new technology or that if such funds are available that we can successfully improve our existing products and services or successfully develop new products and services. Our failure to provide improved products and services to our customers or any delay in providing such products and services could cause us to lose customers to our competitors. Loss of customers could have a material adverse effect on ECHO. 17 OUR INABILITY TO PROTECT OR DEFEND OUR TRADE SECRETS AND OTHER INTELLECTUAL PROPERTY COULD HARM OUR BUSINESS. We have expended a considerable amount of time and money to develop information systems for our merchants. We regard these information systems as trade secrets that are extremely important to our payment processing operations. We rely on trade secret protection and confidentiality and/or license agreements with employees, customers, partners and others to protect this intellectual property and have not otherwise taken steps to obtain additional intellectual property protection or other protection on these information systems. We cannot be certain that we have taken adequate steps to protect our intellectual property. In addition, our third-party confidentiality agreements can be breached and, if they are, there may not be an adequate remedy available to us. If our trade secrets become known, we may lose our competitive position, including the loss of our merchant and bank customers. Such a loss could severely impact our results of operations and financial condition. Additionally, while we believe that the technology underlying our information systems does not infringe upon the rights of any third parties, there is no assurance that third parties will not bring infringement claims against us. We also have the right to use the technology of others through various license agreements. If a third party claimed our activities and/or these licenses were infringing their technology, while we may have some protection from our third party licensors, we could face additional infringement claims or otherwise be obligated to stop utilizing intellectual property critical to our technology infrastructure. If we are not able to implement other technology to substitute the intellectual property underlying a claim, our business operations could be severely effected. Additionally, infringement claims would require us to incur significant defense costs and expenses and, to the extent we are unsuccessful in defending these claims, could cause us to pay monetary damages to the person or entity making the claim. Continuously having to defend such claims or otherwise making monetary damages payments could materially adversely affect our results of operations. IF WE DO NOT CONTINUE TO INVEST IN RESEARCH AND DEVELOPMENT, WE COULD LOSE OUR COMPETITIVE POSITION. Because technology in the payment processing industry evolves rapidly, we need to continue to invest in research and development in both the bankcard processing business segment and the check-related products segment in order to remain competitive. Research and development expenses remained constant from $384,000 for the quarter ended December 31, 2002 to $383,000 for the quarter ended December 31, 2003. Most of our research and development project costs were capitalized once we entered into coding and testing phases, we continue to evaluate projects, which we believe will assist us in our efforts to stay competitive. Although we believe that our investment in these projects will ultimately increase earnings, there is no assurance as to when or if these new products will show profitability or if we will ever be able to recover the costs invested in these projects. Additionally, if we fail to commit adequate resources to grow our technology on pace with market growth, we could quickly lose our competitive position, including the loss of our merchant and bank customers. FAILURE TO OBTAIN ADDITIONAL FUNDS CAN IMPACT OUR OPERATIONS AND FUTURE GROWTH. We use funds generated from operations, as well as funds obtained through credit facilities and equity financing, to finance our operations. In light of our recent financing efforts, and as a result of the cash flow generated from operations, we believe we have sufficient cash to support our business activities, including research, development and marketing costs. However, future growth may depend on our ability to continue to raise additional funds, either through operations, bank borrowings, or equity or debt financings. There is no assurance that we will be able to continue to raise the funds necessary to finance growth or continue to generate the funds necessary to finance operations, and even if such funds are available, that the terms will be acceptable to us. The inability to generate the necessary funds from operations or from third parties in the future may require us to scale back our research, development and growth opportunities, which could harm our overall operations. WHILE WE MAINTAIN INSURANCE PROTECTION AGAINST CLAIMS RELATED TO OUR SERVICES, THERE IS NO ASSURANCE THAT SUCH PROTECTION WILL BE ADEQUATE TO COVER POTENTIAL CLAIMS AND OUR INABILITY TO OTHERWISE PAY SUCH CLAIMS COULD HARM OUR BUSINESS. We maintain errors and omissions insurance for the services we provide. While we believe the limit on our errors and omissions insurance policy is adequate and consistent with industry practice, if claims are brought by our customers or other third parties, we could be required to pay the required claim or make significant expenditures to defend against such claims in amounts that exceed our current insurance coverage. There is no assurance that we will have the money to pay potential plaintiffs for such claims if they arise beyond the amounts insured by us. Making these payments could have a material adverse effect on our business. 18 INVOLVEMENT IN LITIGATION COULD HARM OUR BUSINESS. We are involved in various lawsuits arising in the ordinary course of business. Although we believe that the claims asserted in such lawsuits are without merit, the cost to us for the fees and expenses to defend such lawsuits could have a material adverse effect on our financial condition, results of operations or cash flow. In addition, there can be no assurance that we will not at some time in the future experience significant liability in connection with such claims. For the quarter ended December 31, 2003, we have spent approximately $80,000 in legal fees and expenses defending these claims. OUR INABILITY TO RECOVER FROM NATURAL DISASTERS COULD HARM OUR BUSINESS. We currently maintain four data centers: one in Agoura Hills, California, one in Camarillo, California, one in Albuquerque, New Mexico and one in Boulder, Colorado. Should a natural disaster occur in any of the locations, it is possible that ECHO would not be able to fully recover full functionality at one of its data centers. To minimize this risk, ECHO will centralize its data processing functionality in Camarillo in 2004 and will make Albuquerque a fully redundant site. Prior to that time, it is possible a natural disaster could limit or completely disable a specific service offered by ECHO until such time that the specific location could resume its functionality. Our inability to provide such service could have a material adverse effect on our business and results of operations. INCREASES IN THE COSTS OF TECHNICAL COMPLIANCE COULD HARM OUR BUSINESS. The services which ECHO offers require significant technical compliance. This includes compliance to both Visa and MasterCard regulations and association rules, NACHA guidelines and regulations with regard to the Federal Reserve System's Automated Clearing House and check related issues, and various banking requirements and regulations. ECHO has personnel dedicated to monitoring our compliance to the specific industries we serve and, when possible, ECHO is moving the technical compliance responsibility to other parties, as is the case with the recent purchase of the Oasis Technologies bankcard processing system wherein the vendor, Oasis Technologies, assumes much of the compliance obligations regularly updated by Visa and MasterCard. As the compliance issues become more defined in each industry, the costs associated with that compliance may present a risk to ECHO. These costs could be in the form of additional hardware, software or technical expertise that ECHO must acquire and/or maintain. While ECHO currently has these costs under control, we have no control over those entities that set the compliance requirements so no assurance can be given that ECHO will always be able to underwrite the costs of compliance in each industry wherein we compete. RISKS ASSOCIATED WITH OUR COMMON STOCK - -------------------------------------- IF WE NEED TO SELL OR ISSUE ADDITIONAL SHARES OF COMMON STOCK OR ASSUME ADDITIONAL DEBT TO FINANCE FUTURE GROWTH, OUR STOCKHOLDERS' OWNERSHIP COULD BE DILUTED OR OUR EARNINGS COULD BE ADVERSELY IMPACTED. Our business strategy may include expansion through internal growth, by acquiring complementary businesses or by establishing strategic relationships with targeted customers and suppliers. In order to do so, or to fund our other activities, we may issue additional equity securities that could dilute our stockholders' stock ownership. We may also assume additional debt and incur impairment losses related to goodwill and other tangible assets if we acquire another company and this could negatively impact our results of operations. As of the date of this report, management has no plan to raise additional capital through the sale of securities and believes that our cash flow from operations together with cash on hand and our established line of credit with Bank of the West will be sufficient to meet our working capital and other commitments. WE HAVE ADOPTED A NUMBER OF ANTI-TAKEOVER MEASURES THAT MAY DEPRESS THE PRICE OF OUR COMMON STOCK. Our rights agreement, our ability to issue additional shares of preferred stock and some provisions of our articles of incorporation and bylaws could make it more difficult for a third party to make an unsolicited takeover attempt of us. These anti-takeover measures may depress the price of our common stock by making it more difficult for third parties to acquire us by offering to purchase shares of our stock at a premium to its market price. OUR STOCK PRICE HAS BEEN VOLATILE. Our common stock is quoted on the NASDAQ SmallCap Market, and there can be substantial volatility in the market price of our common stock. Over the course of the quarter ended December 31, 2003, the market price of our common stock has been as high as $10.99 and as low as $6.19. Additionally, over the course of the year ended September 30, 2003, the market price of our common stock has been as high as $9.59 and as low as $1.09. The market price of our common stock has been, and is likely to continue to be, 19 subject to significant fluctuations due to a variety of factors, including quarterly variations in operating results, operating results which vary from the expectations of securities analysts and investors, changes in financial estimates, changes in market valuations of competitors, announcements by us or our competitors of a material nature, loss of one or more customers, additions or departures of key personnel, future sales of common stock and stock market price and volume fluctuations. In addition, general political and economic conditions such as a recession, or interest rate or currency rate fluctuations may adversely affect the market price of our common stock. WE HAVE NOT PAID AND DO NOT CURRENTLY PLAN TO PAY DIVIDENDS, AND YOU MUST LOOK TO PRICE APPRECIATION ALONE FOR ANY RETURN ON YOUR INVESTMENT. Some investors favor companies that pay dividends, particularly in general downturns in the stock market. We have not declared or paid any cash dividends on our common stock. We currently intend to retain any future earnings for funding growth, and we do not currently anticipate paying cash dividends on our common stock in the foreseeable future. Because we may not pay dividends, your return on this investment likely depends on your selling our stock at a profit. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ---------------------------------------------------------- We could be exposed to market risk from changes in interest rates on our lease lines. Our exposure to interest rate risk relates to the $3,000,000 line of credit and $1,000,000 equipment lease line. There are no outstanding balances against either of these credit lines as of December 31, 2003. A hypothetical 1% interest rate change would have no material impact on our results of operations. ITEM 4. CONTROLS AND PROCEDURES ----------------------- As of December 31, 2003, the end of the period covered by this report, we 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 our public disclosures complies with our Securities and Exchange Commission disclosure obligations. There have been no significant changes in our internal controls or in other factors, which could significantly affect internal controls subsequent to the date that we carried out our evaluation. 20 PART II. OTHER INFORMATION 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 - -------------- ------------- October 31, 2003 On October 30, 2003, the Registrant closed the sale of an aggregate of 437,957 shares of its common stock in a private placement transaction at a price of $6.85 per share to institutional investors, resulting in gross proceeds to the Registrant of approximately $3.0 million. December 16, 2003 On December 16, 2003, the Registrant issued a press release announcing its financial results for the quarter and fiscal year ended September 30, 2003. December 29, 2003 On December 26, 2003, the registrant issued a press release announcing its recalculation of diluted earnings per share for the fiscal year ended September 30, 2003.
21 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: February 13, 2004 By: /s/ Alice Cheung ------------------ Alice Cheung, Treasurer and Chief Financial Officer 22 EX-31.1 3 doc2.txt EXHIBIT 31.1 EXHIBIT 31.1 CERTIFICATION OF CEO PURSUANT TO SECURITIES EXCHANGE ACT RULES 13A-14(A) AND 15D-14(A) AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Joel M. Barry, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Electronic Clearing House, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c. Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management of other employees who have a significant role in the registrant's internal control over financial reporting. Date: February 13, 2004 /s/ Joel M. Barry ------------------------- Joel M. Barry Chief Executive Officer EX-31.2 4 doc3.txt EXHIBIT 31.2 EXHIBIT 31.2 CERTIFICATION OF CFO PURSUANT TO SECURITIES EXCHANGE ACT RULES 13A-14(A) AND 15D-14(A) AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Alice L. Cheung, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Electronic Clearing House, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c. Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management of other employees who have a significant role in the registrant's internal control over financial reporting. Date: February 13, 2004 /s/ Alice L. Cheung ------------------------- Alice L. Cheung Chief Financial Officer EX-32.1 5 doc4.txt EXHIBIT 32.1 EXHIBIT 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Electronic Clearing House, Inc. (the "Company") on Form 10-Q for the period ended December 31, 2003, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Joel M. Barry, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of my knowledge: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Joel M. Barry Joel M. Barry Chief Executive Officer February 13, 2004 EX-32.2 6 doc5.txt EXHIBIT 32.2 EXHIBIT 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Electronic Clearing House, Inc. (the "Company") on Form 10-Q for the period ended December 31, 2003, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Alice L. Cheung, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of my knowledge: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Alice L. Cheung Alice L. Cheung Chief Financial Officer February 13 , 2004 -----END PRIVACY-ENHANCED MESSAGE-----