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 JUNE 30, 2002 OR Transition report pursuant to Section 13 or 15(d) of the Securities --- Exchange Act of 1934 COMMISSION FILE NUMBER: 0-15245 ELECTRONIC CLEARING HOUSE, INC. (Exact name of registrant as specified in its charter) NEVADA 93-0946274 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 28001 DOROTHY DRIVE, AGOURA HILLS, CALIFORNIA 91301 (Address of principal executive offices) TELEPHONE NUMBER (818) 706-8999 WWW.ECHO-INC.COM (Registrant's telephone number, including area code; web site address) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes X No --- --- As of July 31, 2002, there were 5,796,109 shares of the Registrant's Common Stock outstanding. ELECTRONIC CLEARING HOUSE, INC. INDEX ----- PART I. FINANCIAL INFORMATION Page No. --------- Item 1. CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED): Consolidated Balance Sheets 3 June 30, 2002 and September 30, 2001 Consolidated Statements of Operations 4 Three months and nine months ended June 30, 2002 and 2001 Consolidated Statements of Cash Flows 5 Nine months ended June 30, 2002 and 2001 Notes to Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of 10 Financial Condition and Results of Operations PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K 18 Signatures 19 2

PART I. FINANCIAL INFORMATION -------------------------------- ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS ELECTRONIC CLEARING HOUSE, INC. CONSOLIDATED BALANCE SHEETS (UNAUDITED) ASSETS JUNE 30, SEPTEMBER 30, 2002 2001 ------------ --------------- Current assets: Cash and cash equivalents $ 2,491,000 $ 4,147,000 Restricted cash 890,000 1,410,000 Accounts receivable less allowance of $395,000 and $313,000 1,698,000 1,864,000 Inventory, net 328,000 573,000 Prepaid expenses and other assets 139,000 137,000 ------------ --------------- Total current assets 5,546,000 8,131,000 Noncurrent assets: Long term receivables 21,000 21,000 Property and equipment, net 5,010,000 3,754,000 Real estate held for investment, net 152,000 252,000 Deferred tax asset 2,014,000 778,000 Other assets, net 458,000 800,000 Goodwill, net 4,808,000 5,185,000 ------------ --------------- Total assets $18,009,000 $ 18,921,000 ============ =============== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Short-term borrowings and current portion of long-term debt $ 471,000 $ 240,000 Accounts payable 132,000 135,000 Settlement payable to merchants 558,000 618,000 Accrued expenses 1,048,000 1,395,000 Deferred income -0- 50,000 ------------ --------------- Total current liabilities 2,209,000 2,438,000 Long-term debt 2,228,000 744,000 ------------ --------------- Total liabilities 4,437,000 3,182,000 ------------ --------------- Commitments and contingencies Stockholders' equity: Convertible preferred stock, $.01 par value, 5,000,000 shares authorized: Series "K", -0- and 25,000 shares issued and outstanding -0- -0- Common stock, $.01 par value, 36,000,000 authorized: 5,835,357 and 5,809,121 shares issued; 5,796,109 and 5,769,873 shares outstanding 58,000 58,000 Additional paid-in capital 21,262,000 21,260,000 Accumulated deficit (7,279,000) (5,110,000) Less treasury stock at cost, 39,248 common shares (469,000) (469,000) ------------ --------------- Total stockholders' equity 13,572,000 15,739,000 ------------ --------------- Total liabilities and stockholders' equity $18,009,000 $ 18,921,000 ============ =============== See accompanying notes to consolidated financial statements.

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ELECTRONIC CLEARING HOUSE, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) THREE MONTHS NINE MONTHS ENDED JUNE 30, ENDED JUNE 30, ---------------- ---------------- 2002 2001 2002 2001 ----------- ----------- ------------ ------------ Revenues: Processing revenue $4,180,000 $3,783,000 $12,048,000 $10,921,000 Transaction revenue 4,157,000 3,753,000 12,413,000 10,414,000 Terminal sales 62,000 183,000 191,000 389,000 Other revenue 16,000 39,000 70,000 393,000 ----------- ----------- ------------ ------------ 8,415,000 7,758,000 24,722,000 22,117,000 ----------- ----------- ------------ ------------ Costs and expenses: Processing and transaction expense 5,795,000 4,961,000 16,675,000 14,074,000 Cost of terminals sold 85,000 153,000 437,000 345,000 Other operating costs 1,069,000 901,000 3,065,000 2,690,000 Selling, general and administrative expenses 1,480,000 1,434,000 5,008,000 4,082,000 Amortization expense - goodwill 129,000 106,000 385,000 310,000 Legal settlement -0- -0- 2,500,000 -0- ----------- ----------- ------------ ------------ 8,558,000 7,555,000 28,070,000 21,501,000 ----------- ----------- ------------ ------------ (Loss) income from operations (143,000) 203,000 (3,348,000) 616,000 Interest income 10,000 36,000 46,000 153,000 Interest expense (46,000) (18,000) (84,000) (60,000) Gain on sales of asset -0- 350,000 -0- 350,000 ----------- ----------- ------------ ------------ (Loss) income before provision for income taxes (179,000) 571,000 (3,386,000) 1,059,000 Benefit (provision) for income taxes 11,000 (289,000) 1,217,000 (588,000) ----------- ----------- ------------ ------------ Net (loss) income $ (168,000) $ 282,000 $(2,169,000) $ 471,000 =========== =========== ============ ============ (Loss) earnings per share - Basic $ (0.03) $ 0.05 $ (0.38) $ 0.08 =========== =========== ============ ============ (Loss) earnings per share - Diluted $ (0.03) $ 0.05 $ (0.38) $ 0.08 =========== =========== ============ ============ Shares used in computing basic (loss) earnings per share 5,796,109 5,406,343 5,785,362 5,427,051 =========== =========== ============ ============ Shares used in computing diluted (loss) earnings per share 5,796,109 5,593,348 5,785,362 5,621,089 =========== =========== ============ ============ See accompanying notes to consolidated financial statements.

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ELECTRONIC CLEARING HOUSE, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) NINE MONTHS ENDED JUNE 30, ---------------- 2002 2001 ------------ ------------ Cash flows from operating activities: Net (loss) income $(2,169,000) $ 471,000 Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities: Depreciation 476,000 305,000 Amortization of software 377,000 293,000 Amortization of goodwill 385,000 310,000 Provision for losses on accounts and notes receivable 258,000 255,000 Provision for obsolete inventory 201,000 12,000 Write-down of real estate 100,000 -0- Fair value of stock issued in connection with directors' compensation 45,000 45,000 Deferred income taxes (1,236,000) 446,000 Legal settlement 1,300,000 -0- Changes in assets and liabilities: Restricted cash 520,000 (301,000) Accounts receivable (178,000) (711,000) Inventory 44,000 (13,000) Prepaid expenses and other current assets (2,000) (30,000) Accounts payable (3,000) 59,000 Settlement payable to merchants (60,000) 209,000 Accrued expenses (315,000) (44,000) Deferred income (50,000) -0- Other receivable -0- (6,000) ------------ ------------ Net cash (used in) provided by operating activities ( 307,000) 1,300,000 ------------ ------------ Cash flows from investing activities: Other assets (62,000) (413,000) Purchase of equipment and software (1,439,000) (839,000) Cash used for acquisition -0- (169,000) ------------ ------------ Net cash used in investing activities (1,501,000) (1,421,000) ------------ ------------ Cash flows from financing activities: Repayment of notes payable (105,000) (97,000) Repayment of capitalized leases (144,000) (33,000) Proceeds from sale and leaseback of equipment 390,000 -0- Proceeds from exercise of stock options 11,000 -0- Repurchase of common stock -0- (300,000) ------------ ------------ Net cash provided by (used in) financing activities 152,000 (430,000) ------------ ------------ Net decrease in cash (1,656,000) (551,000) Cash and cash equivalents at beginning of period 4,147,000 3,941,000 ------------ ------------ Cash and cash equivalents at end of period $ 2,491,000 $ 3,390,000 ============ ============ See accompanying notes to consolidated financial statements.

5 ELECTRONIC CLEARING HOUSE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) NOTE 1 - BASIS OF PRESENTATION: ------------------------------------ The accompanying consolidated financial statements as of June 30, 2002, and for the three and nine-month periods then ended, are unaudited and reflect all adjustments (consisting only of normal recurring adjustments) which are, in the opinion of management, necessary for a fair statement of the financial position and the results of operations for the interim periods. The consolidated financial statements herein should be read in conjunction with the consolidated financial statements and notes thereto, together with management's discussion and analysis of financial condition and results of operations, contained in the Company's Annual Report to Stockholders incorporated by reference in the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 2001. The results of operations for the three and nine months ended June 30, 2002 are not necessarily indicative of the likely results of operations for the entire fiscal year ending September 30, 2002. NOTE 2 - EARNINGS (LOSS) PER SHARE: ----------------------------------------- The Company calculates earnings (loss) per share as required by SFAS No. 128, "Earnings per Share".

Three months ended June 30, Nine months ended June 30, -------------------------- ---------------------------- 2002 2001 2002 2001 ------------- ----------- --------------- ----------- Net (loss) income $ (168,000) $ 282,000 $ (2,169,000) $ 471,000 ============= =========== =============== =========== Shares: Denominator for basic earnings per share - weighted-average shares outstanding 5,796,109 5,406,343 5,785,362 5,427,051 Effect of dilutive securities: Employee stock options -0- 124,836 -0- 156,648 Series K Convertible Preferred Stock -0- 25,000 -0- 25,000 Performance Shares -0- 37,169 -0- 12,390 ------------- ----------- --------------- ----------- Dilutive potential common shares -0- 187,005 -0- 194,038 ------------- ----------- --------------- ----------- Denominator for diluted earnings per share - adjusted weighted-average shares and assumed conversions 5,796,109 5,593,348 5,785,362 5,621,089 ============= =========== =============== =========== Basic (loss) earnings per share $ (0.03) $ 0.05 $ (0.38) $ 0.08 Diluted (loss) earnings per share $ (0.03) $ 0.05 $ (0.38) $ 0.08

Dilutive common stock equivalents have been excluded from the calculation of diluted loss per share for the three and nine months ended June 30, 2002, as their inclusion would be anti-dilutive to the loss per share calculation. Approximately 368,750 and 343,750 stock options for the three and nine months ended June 30, 2001, were excluded from the calculation of diluted earnings per share as their effect would be anti-dilutive. However, these common stock equivalents could be dilutive in the future. 6 NOTE 3 - NON-CASH TRANSACTIONS: ----------------------------------- Significant non-cash transactions for the nine months ended June 30, 2002 were as follows: - A $1.3 million 15-year long-term promissory note was issued as part of the Premiere Lifestyles International Corporation vs. ECHO legal settlement. - Capital equipment of $274,000 was acquired under capital leases. - The Company received 25,000 shares of ECHO's common stock (converted from 25,000 shares of preferred stock), as a repayment of a $54,000 chargeback receivable owed to the Company by a former merchant. Significant non-cash transactions for the nine months ended June 30, 2001 were as follows: - An employee exercised stock options and executed a promissory note to the Company in the amount of $43,000. The note is interest-bearing and fully secured by the underlying stock. - 21,116 shares of common stock valued at $85,000 were issued for the purchase of certain National Check Network, Inc. assets. NOTE 4 - INVENTORY: ---------------------- The components of inventory are as follows: June 30 September 30 2002 2001 ------------- ------------- Raw materials $ 62,000 $ 62,000 Finished goods 485,000 529,000 ------------- ------------- 547,000 591,000 Less: Allowance for obsolescence 219,000 18,000 ------------- ------------- $ 328,000 $ 573,000 ============= ============= NOTE 5 - SHORT-TERM BORROWINGS AND LONG-TERM DEBT: -------------------------------------------------------- Short-term borrowings and long-term debt consist of the following:

June 30 September 30 2002 2001 ----------- -------------- Term loan collateralized by corporate headquarters building, due February 15, 2009, bearing interest at 7.87% per annum $ 404,000 $ 438,000 7 Term loan collateralized by equipment, due 2005, bearing interest at prime rate, 4.75% at June 30, 2002 207,000 266,000 Long-term promissory note collateralized by corporate headquarters building, due March 25, 2017, bearing interest at 8.00% per annum 1,289,000 -0- Capital leases 799,000 277,000 Notes payable, bearing interest at 9.5% -0- 3,000 ----------- -------------- 2,699,000 984,000 Less: current portion (471,000) (240,000) ----------- -------------- Total long-term debt $2,228,000 $ 744,000 =========== ==============

NOTE 6 - SEGMENT INFORMATION: -------------------------------- The Company currently operates in two business segments: bankcard and transaction processing, and check-related products, all of which are located in the United States. The Company's reportable operating segments have been determined in accordance with the Company's internal management structure, which is organized based on the Company's product lines. The Company evaluates performance based upon two primary factors, one is the segment's operating income and the other is based on the segment's contribution to the Company's future strategic growth. The Company has consolidated the segment information for terminal sales into the bankcard and transaction processing segment due to the decreased significance of terminal sales.

Three Months Ended Nine Months Ended June 30 June 30 -------- -------- 2002 2001 2002 2001 ----------- ----------- ------------ ------------ Revenues: Bankcard and transaction processing $6,924,000 $6,516,000 $20,343,000 $18,640,000 Check-related products 1,475,000 1,203,000 4,309,000 3,084,000 Other 16,000 39,000 70,000 393,000 ----------- ----------- ------------ ------------ $8,415,000 $7,758,000 $24,722,000 $22,117,000 =========== =========== ============ ============ Operating (loss) income: Bankcard and transaction processing $ 543,000 $ 877,000 $ 1,666,000 $ 2,379,000 Check-related products (257,000) (158,000) (676,000) (281,000) Other - corporate expenses (429,000) (516,000) (4,338,000) (1,482,000) ----------- ----------- ------------ ------------ $ (143,000) $ 203,000 $(3,348,000) $ 616,000 =========== =========== ============ ============

8 NOTE 7 - NEW ACCOUNTING PRONOUNCEMENTS: --------------------------------------- In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 141 ("SFAS 141"), "Business Combinations". SFAS 141 requires the purchase method of accounting for business combinations initiated after June 30, 2001 and eliminates the pooling-of-interests method. The Company does not believe that the adoption of SFAS 141 will have a significant impact on its financial statements and the results of its operations. In July 2001, the FASB issued Statement of Financial Accounting Standards No. 142 ("SFAS"), "Goodwill and Other Intangible Assets", which is effective for fiscal years beginning after December 15, 2001. SFAS 142 requires, among other things, the discontinuance of goodwill amortization. In addition, the standard includes provisions for the reclassification of certain existing recognized intangibles as goodwill, reassessment of the useful lives of existing recognized intangibles, reclassification of certain intangibles out of previously reported goodwill and the identification of reporting units for purposes of assessing potential future impairments of goodwill. SFAS 142 also requires companies to complete a transitional goodwill impairment test six months from the date of adoption. The Company plans to adopt SFAS 142 by the first quarter of fiscal 2003. Based upon our initial assessment, we believe that it is probable that upon adoption, we will record a material goodwill impairment charge, which would also be reflected in a one-time, non-cash charge to net income attributed to a change in accounting principal. In August 2001, FASB issued Statement of Financial Accounting Standards No. 144 ("SFAS 144"), "Accounting for the Impairment or Disposal of Long-Lived Assets." This Statement supersedes FASB Statement No. 121, ("SFAS 121") Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets To Be Disposed Of, and the accounting and reporting provisions of APB Opinion No. 30, Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for the disposal of a segment of a business (as previously defined in that Opinion). This statement establishes a single accounting model for long-lived asset impairment, based on the framework established in SFAS 121, for long-lived assets to be disposed of by sale, and resolves significant implementation issues related to SFAS 121. The Company is currently evaluating the impact that SFAS 144 will have on its financial statements and the results of its operations. 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS ----------------------------------- OVERVIEW Electronic Clearing House, Inc. ("ECHO" or "the Company") provides a complete solution to the payment processing needs of merchants, banks and collection agencies. The Company's services include debit and credit card processing, check guarantee, check verification, check conversion, check re-presentment, check collection and inventory tracking. The Company derives revenues from two main business segments, bankcard and transaction processing, and check-related products and operates under the following brands; - MERCHANTAMERICA, ECHO's retail provider of processing services to both the merchant and bank markets; - National Check Network(R) (NCN(R)) for check verification; - XPRESSCHEX, Inc. for processing check guarantee, check conversion, check collection and check verification; and - U-Haul(R) Services, which provides credit card authorization, collects rental and compensation activity and tracks available inventory. The Company's main revenue generator is its merchant services, which includes bankcard and transaction processing and whereby ECHO receives a percentage-based fee on the dollar amount processed and a transaction fee on the number of transactions processed. This has historically been a profitable business, although price competition is intense. The Company is working to enhance back-end technology in order to reduce processing costs and enhance management reporting capabilities. ECHO has invested significant resources and management focus in its check services business, whereby revenues are based on a fixed fee per transaction or a fee based on the amount of the check for each transaction. ECHO is the sixth largest check verification processor in the United States according to the June 2002 issue of The Nilson Report, a monthly financial subscription-based newsletter. The Company is one of several check processors in the nation with both an Automated Clearing House (ACH) engine, which gives the Company the ability to transfer and verify funds, and a negative-check writer database (NCN), which provides check risk management. The NCN database includes over 17 million bad-check writer records, 80 million positive records, and 260 affiliated collection agencies who continually contribute to the database to enhance its depth and value. In December 2000, ECHO signed an agreement with Visa U.S.A. as a third-party acquiring processor in Visa's Point-of-Sale (POS) Check Services program. The POS Check Services will allow merchants to receive immediate online authorization for paper checks, by converting them into electronic transactions, which will then be verified against member bank accounts. The Company provides critical back-end infrastructure for the service, including its ACH backbone and NCN database for checks written on non-participating banks. ECHO is the preferred third-party acquiring processor for a majority of the financial institutions currently testing the Visa service. Visa estimates that the program has the potential to achieve an annual volume of 265 million transactions within five years. ECHO generates a recurring revenue stream for processing U-Haul rental activities. The C.A.R.D. terminal system was developed by ECHO to provide complex services and features for U-Haul's rental activities, which include tracking advance reservations and dealer compensation. The last batch of C.A.R.D. terminals was shipped in fiscal 2000, bringing the total systems in the field to 15,000. With a useful life of 5 to 6 years, U-Haul dealers are expected to use these systems for the next few years and ECHO will continue to support the service and maintenance of these terminals. On-going terminal sales are expected to be a diminishing portion of business as ECHO focuses on its core merchant and check services business. 10 STRATEGY ECHO's strategy is to provide merchants and financial institutions with electronic connectivity to various payment services in the credit card, debit card and check-related markets. ECHO's services enable merchants to maximize revenues by offering a wide variety of payment options, reduce the costs associated with processing and handling checks, improve collections and manage risk more effectively. The Company has targeted several areas as significant opportunities for growth, including focusing on middle-market retail accounts for check services and developing a scalable infrastructure to support widespread implementation of the Visa POS Check Services. The Company also seeks to increase profitability of core merchant services by enhancing the back-end technology and reducing processing costs. --The Company plans to grow ECHO's check services business by focusing on mid-size retail chains that can benefit most from automating check processing and verification. These mid-size accounts typically offer much higher margins than larger accounts and provide a less competitive marketplace. ECHO has recently signed agreements with several new retailers and the prospective pipeline of customers is growing. --The Company plans to complete development and beta testing of Visa's POS Check Services so as to leverage ECHO's check services products through Visa member banks. The process of developing and bringing to market Visa POS Check Services has been more time and resource intensive than originally anticipated due to the unique requirements of each financial institution and extensive testing periods. ECHO is finalizing the enhancements that Visa and these banks require and is incorporating them into a standardized, but customizable platform of options. This platform is under development and scheduled for completion by the end of calendar 2002. --ECHO has identified an underserved, niche market of smaller regional and community banks for its agent bank program. The Company plans to provide a turn-key solution to allow smaller banks to offer bankcard and check processing services using ECHO's back-end infrastructure. The program can be developed and sold at a low incremental cost to ECHO and still provides a better priced and a more integrated product offering to small banks than they can currently receive from other providers. SALES AND MARKETING ECHO sells its merchant and check services through several marketing channels, including independent sales organizations (ISO), its own internal sales force and direct merchant referrals by existing merchants. Approximately 20% of the Company's new accounts have historically been generated through the ISOs. ECHO recently restructured its sales force and implemented an incentive-based commission structure with the goal of targeting specific accounts and shortening the sales cycle. The Company also offers merchant services through a direct online sales channel, MERCHANTAMERICA.com. Management believes that the Company is unique in the number of payment methods that the Company offers to its merchants, the combination of transaction types that it manages directly, its ability to integrate additional services and its ability to support each merchant through one vertically integrated source. The Company's marketing strategy is to maximize cross selling opportunities to its existing base of merchants; sell integrated suites, bankcard and check processing services to small banks; enhance and market MERCHANTAMERICA; and develop the private label check service program. SIGNIFICANT DEVELOPMENTS During the fiscal third quarter, ECHO made significant progress on several key initiatives to expand its check services platform and improve profitability of its merchant services. --During the fiscal third quarter, the Company entered into an agreement to provide a complete check management solution to a leading multimedia entertainment retailer. The check solution will enable the retailer to streamline and automate the process of receiving checks from its customers, increasing the number of collections and reducing the amount of fees on returned checks by over $1 million. --ECHO entered into beta tests of the Visa POS Check Services program with two additional banks in the third fiscal quarter of 2002. The Company completed ACH and NCN system enhancements to support these pilot programs. --The Company was recently selected as a third-party processor for a beta test of the Visa POS Check Services for a global specialty clothing retailer with over 3,000 outlets, and Visa agreed to fund the development costs related to this program. If these tests are successful, a full launch is anticipated after the 2002-2003 holiday season. 11 --Merchants on MERCHANTAMERICA increased to 10% of total existing accounts during the quarter. The Company achieved this goal six months ahead of schedule. COMPETITION Merchant and check services are highly competitive industries and are characterized by rapid technological change, rapid rates of product obsolescence and introductions of competitive products often at lower prices and/or with greater functionality than those currently on the market. ECHO is not currently a major player in the industries in which it competes and many of the Company's competitors have greater financial and marketing resources than the Company. As a result, they may be better able to respond more quickly to new or emerging technologies and changes in customer requirements. Competitors also enjoy per transaction cost advantages due to their high processing volumes that may make it difficult for ECHO to compete. In addition, major players in the check services industry have developed sophisticated risk assessment technology that may provide a competitive advantage in providing check guarantee services. The Company believes that its success will depend upon its ability to continuously develop new products and services and to enhance its current products and to introduce them promptly into the market. RESULTS OF OPERATIONS THREE MONTHS ENDED JUNE 30, 2002 AND 2001 ----------------------------------------- Financial highlights for the third quarter of 2002 as compared to the same period last year were as follows: --Total revenue increased 8.5% to $8.4 million --Gross margins from processing and transaction revenue declined to 30.5% from 34.2% --Operating income moved into negative territory to $(143,000) from $203,000 --Diluted loss per share of $(0.03) as compared to diluted EPS of $0.05 --Bankcard and transaction processing revenue increased 6.3% to $6.9 million --Check-related revenue increased 22.6% to $1.5 million REVENUE. Total revenue increased 8.5% to $8,415,000 for the three months ended June 30, 2002, from $7,758,000 for the same period last year. The increase can be primarily attributed to growth in the processing and transaction business segments, offset by a negotiated rate reduction on its contract with U-Haul. Total processing and transaction revenue for this third fiscal quarter increased 10.6%, from $7,536,000 in fiscal 2001 to $8,337,000 in fiscal 2002. COST OF SALES. Bankcard processing expenses are largely a direct reflection of any changes in processing revenue. A majority of the Company's bankcard processing expenses are fixed as a percentage of each transaction amount, with the remaining costs being based on a fixed rate applied to the transactions processed. Processing-related expenses, consisting of bankcard processing expense and transaction and check processing expense, increased from $4,961,000 in the third fiscal quarter of 2001 to $5,795,000 in the current fiscal quarter, a 16.8% increase. The increase reflects a 10.6% increase in processing and transaction revenues for the current fiscal quarter, as well as the higher costs of processing. 12 Gross margin from processing and transaction services decreased from 34.2% in the third fiscal quarter last year to 30.5% in this fiscal quarter. This decrease in gross margin was due to an 8.8% per transaction rate reduction in U-Haul processing revenue and the departure of several large high-margin bankcard merchants. EXPENSE. Other operating costs increased from $901,000 in the third fiscal quarter of 2001 to $1,069,000 in this fiscal quarter, an increase of 18.6%. This increase was primarily attributable to an increase in research and development expenses, higher customer support expenses due to increased sales activities and personnel costs and software development related to the Visa POS Check Services pilot program. Research and development expense increased 51.8% to $466,000 in the third fiscal quarter, from $307,000 in the same period last year. Selling, general and administrative expenses increased slightly from $1,434,000 in the third fiscal quarter 2001 to $1,480,000 in quarter ended June 30, 2002. As a percentage of total revenue, selling, general and administrative expenses decreased from 18.5% in the third fiscal quarter 2001 to 17.6% in the current fiscal quarter. OPERATING INCOME (LOSS). Operating loss for the quarter ended June 30, 2002 was ($143,000), as compared to operating income of $203,000 in the same period last year. The decline was due to a combination of factors including a decrease in gross margin, as well as the Company's investment to develop infrastructure and staff to support the Visa POS Check Services processing platform. INTEREST EXPENSE. Interest expense increased to $46,000 for the quarter ended June 30, 2002, from $18,000 in the same period last year. The increase is due to the $1.3 million long-term note portion of the legal settlement expense for Premiere Lifestyles International Corporation, which carries an 8% interest rate. EFFECTIVE TAX RATE. Benefit for income taxes of $11,000 in the quarter ended June 30, 2002 was due to the net loss incurred of $179,000. SEGMENT RESULTS Bankcard and Transaction Processing. Bankcard processing and transaction revenue increased 6.3%, from $6,516,000 in the third fiscal quarter 2001 to $6,924,000 for this fiscal quarter. This increase was mainly attributable to an approximately 12.5% increase in bankcard processing volume as compared to the same quarter last year. This was the result of the Company's successful marketing programs such as the MERCHANTAMERICA web offerings and other sales programs. Additionally, the bankcard processing revenue increase was partially offset by a decrease in revenue as a result of a rate reduction offered to U-Haul International, a major transaction processing customer. The bankcard and transaction processing segment generated a gross margin of 26.6% in the quarter ended June 30, 2002 as compared to 31.0% in the same period last year. Operating income for this business segment was $543,000 for the third fiscal quarter, down 38.1% from $877,000 in the same period last year. The decrease in margin and operating income are attributable to the departure of several large high-margin merchants combined with a rate reduction offered to U-Haul International. Check Related Products. Check-related revenues increased from $1,203,000 for the three months ended June 30, 2001 to $1,475,000 for the three months ended June 30, 2002, an increase of 22.6%. This was attributable to a 5.5% increase in check verification revenue and a 51.8% increase in other electronic check processing and collection revenue. Check services revenue made up 17.5% of total processing and transaction revenues in this quarter as compared to 15.5% in the prior year. Check-related operating loss was $257,000 in the quarter ended June 30, 2002 as compared to a loss of $158,000 in the same period last year. The higher loss was primarily due to an increase in staffing to continue product development and enhancement. 13 The Visa POS Check Services pilot program is continuing as planned. The Company is currently working with seven Visa member banks that have chosen to participate in this Visa POS Check Services pilot program. However, during the pilot phase, small numbers of merchants are being piloted by the banks, so the Company will not be generating significant revenue from this Visa program until the member banks have completed the pilot phase and begin to offer this program to their merchant base at large. Management believes that the Visa POS Check Services program will provide the Company with significant opportunities to develop strategic relationships with some major banks, which could result in a corresponding increase in our check services revenue in the coming years. Terminal Sales. Terminal sales and lease revenue for the three months ended June 30, 2002 was $62,000, which represented a 66.1% decrease from $183,000 for the same fiscal quarter last year. This reflects the Company's growth strategy being focused in the transaction business and not in terminal sales. Other. Other revenue decreased from $39,000 in the third fiscal quarter 2002 to $16,000 in this fiscal quarter due to a decrease in the amount of customer software development work completed during the current quarter. NINE MONTHS ENDED JUNE 30, 2002 AND 2001 ---------------------------------------- Financial highlights for the nine months ended June 30, 2002 as compared to the same period last year were as follows: --Total revenue increased 11.8% to $24.7 million --ECHO reached a legal settlement agreeing to pay $2.5 million, of which $1.2 million was paid in cash during the second fiscal quarter --Gross margins from processing and transaction revenue declined to 31.8% from 34.0% --Operating loss was $(3,348,000) due to the legal settlement and higher costs of operations --Diluted loss per share of $(0.38) as compared to diluted EPS of $0.08 --Bankcard and transaction processing revenue increased 9.1% to $20.3 million REVENUE. Revenue for the nine months of fiscal 2002 was $24,722,000, compared to $22,117,000 for the same period last year, an increase of 11.8%, as the Company secured additional merchant and check services clients. Total processing and transaction revenue was $24,461,000 for the nine months ended June 30, 2002 as compared to $21,335,000 for the nine months ended June 30, 2001, an increase of 14.7%. COST OF SALES. Processing and transaction expenses increased from $14,074,000 for the nine months ended June 30, 2001 to $16,675,000 for the current nine-month period, an increase of 18.5%. This is primarily related to the 14.7% increase in processing and transaction revenue for the same nine-month period. Gross margin on processing and transaction activities decreased from 34.0% for the nine-month period ended June 30, 2001 to 31.8% for the same nine-month period this year. This was mainly due to a combination of an increase in processing expenses, departure of several large high-margin bankcard merchants and the reduced rate offered to U-Haul International. Cost of terminals sold increased from $345,000 for the nine months ended June 30, 2001 to $437,000 for the current nine-month period, an increase of 26.7%. The increase was due to the $200,000 inventory obsolescence allowance recorded in the second fiscal quarter of 2002. EXPENSE. Other operating costs increased from $2,690,000 for the nine months ended June 30, 2001 to $3,065,000 for the nine months ended June 30, 2002, an increase of 13.9%, which was attributable to the increase in total processing and transaction revenue. The Company is continuing to invest in research and development costs related to the various check service products. Additionally, the Company is incurring operational expenses related to the management of the Visa POS Check Services pilot program without any offsetting revenue at the present time. Management believes that a significant portion of our growth strategy is contingent upon our ability to develop the major bank relationships that the Visa program has provided to the Company. 14 Selling, general and administrative expenses increased from $4,082,000 for the nine months ended June 30, 2001 to $5,008,000 for the nine months ended June 30, 2002, an increase of 22.7%. This increase was mainly due to the legal and consulting fees related to the lawsuit disclosed above and higher personnel costs. As a percentage of total revenue, selling, general and administrative expenses were 20.3% for this nine-month period as compared to 18.5% for the same nine-month period last year. OPERATING INCOME (LOSS). Operating loss for the nine months ended June 30, 2002 was $(3,348,000), as compared to operating income of $616,000 in the same period last year. The decline was primarily attributable to the settlement associated with the lawsuit and the Company's investment to develop infrastructure and staff to support the Visa POS check processing platform. INTEREST EXPENSE. Interest expense increased to $84,000 for the nine months ended June 30, 2002, from $60,000 in the same period last year. The increase is due to the $1.3 million long-term note portion of the legal settlement expense for Premiere Lifestyles International Corporation, which carries an 8% interest rate. EFFECTIVE TAX RATE. Benefit for income taxes of $1,217,000 for the nine months ended June 30, 2002 was primarily due to the settlement of the lawsuit. SEGMENT RESULTS. Bankcard and Transaction Processing. Bankcard and transaction processing revenue was $20,343,000 for the nine months ended June 30, 2002 as compared to $18,640,000 for the same period last year, an increase of 9.1%. This increase was mainly attributable to an approximately 12.4% increase in bankcard processing volume as compared to the same nine-month period last year. The bankcard processing revenue increase was partially offset by a decrease in revenue as a result of a rate reduction offered to U-Haul, a major transaction processing customer, in negotiating a contract renewal during the second fiscal quarter. The bankcard and transaction processing segment generated a gross margin of 28.7% in the nine-month period ended June 30, 2002 as compared to 30.4% in the same period last year. Operating income for this business segment was $1,666,000 for the nine-month period, down 30% from $2,379,000 in the same period last year due to an increase in transaction and processing expenses and reduced margin from revenue generated from U-Haul and the departure of several large high-margin bankcard merchants. Check Related Products. Check-related revenue increased from $3,084,000 for the nine months ended June 30, 2001 to $4,309,000 for the nine months ended June 30, 2002, an increase of 39.7%. Check services revenue made up 17.4% of total processing and transaction revenues in this nine-month period as compared to 13.9% in the prior year. Check-related operating loss was $676,000 in the nine months ended June 30, 2002 as compared to a loss of $281,000 in the same period last year. Terminal Sales. Terminal sales for the nine months ended June 30, 2002 were $191,000 as compared to $389,000 for the same nine-month period ended June 30, 2001, a decrease of 50.9%. Other. Other revenue for the nine months ended June 30, 2002 was $70,000 as compared to $393,000 for the same nine-month period ended June 30, 2001, a decrease of 82.2% due to lesser software development completed. LIQUIDITY AND CAPITAL RESOURCES As of June 30, 2002, the Company had available cash of $2,491,000, restricted cash of $890,000 in reserve with its primary processing banks and working capital of $3,337,000. Accounts receivable net of allowance for doubtful accounts decreased to $1,698,000 at June 30, 2002 from $1,864,000 at September 30, 2001. Allowance for doubtful accounts, which reflects chargeback losses, increased to $395,000 at the end of the fiscal third quarter from $313,000 at September 30, 2001. Inventory costs decreased to $328,000 at June 30, 2002 from $573,000 at September 30, 2001 as a result of a $200,000 inventory allowance. 15 Net cash used in operating activities for the nine months ended June 30, 2002 was $307,000 as compared to net cash provided by operating activities of $1,300,000 for the nine months ended June 30, 2002. This was primarily attributable to the $1,200,000 cash portion of legal settlement expenses incurred during the quarter ended March 31, 2002. In the nine months ended June 30, 2002, the Company used $1,439,000 for the purchase of equipment and capitalized software costs. During the third fiscal quarter, the Company received $390,000 from a leasing company for entering into a sale and leaseback agreement for certain computer software and hardware purchased by the Company in the recent months. Additionally, the Company has negotiated an $850,000 lease line from the same leasing company for the purpose of funding computer software and hardware needs in the coming months. This funding source should be sufficient to finance the equipment needs in order to improve the infrastructures of our data center to accommodate the growth anticipated by the Company. Depreciation increased to $476,000 for the nine months ended June 30, 2002 as compared to $305,000 for the same period prior year due to the additional equipment purchases. Amortization of software increased to $377,000 for the nine months ended June 30, 2002, as compared to $293,000 for the same period prior year. Amortization of goodwill increased to $385,000 for the nine months ended June 30, 2002, as compared to $305,000 for the same period prior year. The Company plans to adopt SFAS 142 "Goodwill and Other Intangible Assets" ("SFAS 142") and will discontinue goodwill amortization by the first quarter of fiscal 2003. At June 30, 2002, the Company had the following cash commitments:

Payment Due By Period --------------------- Contractual Less than Obligations Total 1 year 2-3 years 4-5 years after 5 years ----------- ---------- -------- ---------- ---------- -------------- Long-term debt including interest $2,939,918 $316,903 $ 587,755 $ 455,363 $ 1,579,897 Capital lease Obligations 891,883 347,436 544,447 -0- -0- Operating leases 251,081 139,793 111,288 -0- -0- ---------- -------- ---------- ---------- -------------- Total contractual cash obligations $4,082,882 $804,132 $1,243,490 $ 455,363 $ 1,579,897 ========== ======== ========== ========== ==============

The Company's primary source of liquidity is expected to be cash flow generated from operations and cash and cash equivalents currently on hand. Management believes that its future cash flow from operations together with cash on hand will be sufficient to meet its working capital and other commitments as long as the current cash flow trend remains relatively consistent. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Management's discussion and analysis of financial condition and results of operations is based upon the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, management evaluates its estimates, including those related to revenue recognition, deferred taxes, goodwill amortization, capitalization of software costs, contingencies and litigation. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates. 16 Management applies the following critical accounting policies in the preparation of our consolidated financial statements: - Revenue Recognition Policy. All processing and transaction revenues are recognized at the time the transactions are processed by the customer. Processing and transaction revenues are principally based on the number of transactions processed and a percentage of dollar volume processed. Terminal sales are recorded when product is shipped and title transferred to the customer. - Deferred Taxes. Deferred taxes are determined based on the differences between the financial statement and tax bases of assets and liabilities, using enacted tax rates in effect for the year in which the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized. In assessing the need for a valuation allowance, management considers estimates of future taxable income and ongoing prudent and feasible tax planning strategies. - Goodwill Amortization. Goodwill represents the excess of purchase price over tangible and other intangible assets acquired less liabilities assumed arising from business combinations and is being amortized on a straight-line basis over estimated useful lives ranging from 10 to 15 years. SFAS No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"), issued in June 2001, requires, among other things, the discontinuance of goodwill amortization. In addition, the standard includes provisions for the reclassification of certain existing recognized intangibles as goodwill, reassessment of the useful lives of existing recognized intangibles, reclassification of certain intangibles out of previously reported goodwill and the identification of reporting units for purposes of assessing potential future impairments of goodwill. SFAS 142 also requires companies to complete a transitional goodwill impairment test six months from the date of adoption. The Company is currently evaluating the impact SFAS 142 will have on its financial statements and the results of its operations. The Company plans to adopt SFAS 142 by the first quarter of fiscal 2003. Based upon our initial assessment, we believe that it is probable that upon adoption we will record a material goodwill impairment charge to this recorded asset, which would also be reflected in a one-time, non-cash charge to net income attributed to a change in accounting principal. - Capitalization of Software Costs. The costs of purchased and internally developed software used to provide services to customers are capitalized and amortized on a straight-line basis over the lesser of three years or estimated useful life. Under the provisions of Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use," the Company capitalizes software costs when both the preliminary project stage is completed and management has authorized further funding for the completion of the project. FORWARD-LOOKING STATEMENTS The discussion of the financial condition and results of operations of the Company should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere herein. This discussion contains forward-looking statements, including statements regarding the Company's strategy, financial performance and revenue sources, which involve risks and uncertainties. The Company's actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including, but not limited to, those set forth elsewhere herein. 17 PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K ------------------------------------- 99.1 Certification by Joel M. Barry, Chief Executive Officer of Electronic Clearing House, Inc. pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99.2 Certification by Alice L. Cheung, Chief Financial Officer of Electronic Clearing House, Inc. pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. The following report on Form 8-K was filed during the quarter ended June 30, 2002: Date of Filing Item Reported ---------------- -------------- April 15, 2002 Press release issued announcing the resignation of Mr. Carl W. Schafer, a director of the Registrant, to serve on the Board of Directors. 18 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. ELECTRONIC CLEARING HOUSE, INC. ---------------------------------- (Registrant) Date: August 13, 2002 By: \s\ Alice Cheung -------------------------------- Alice Cheung, Treasurer and Chief Financial Officer 19