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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2003
OR
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____________ to _____________
Commission file number: 0-26802
CHECKFREE CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 58-2360335
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
4411 EAST JONES BRIDGE ROAD, NORCROSS, GEORGIA
30092 (Address of principal executive offices,
including zip code)
(678) 375-3000
(Registrant's telephone number, including area code)
NOT APPLICABLE
(Former name, former address and former fiscal year,
if changed since last report)
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 the
filing requirements for at least 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 X NO
----- -----
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date: 89,232,197 shares of
Common Stock, $.01 par value, were outstanding at May 12, 2003.
FORM 10-Q
CHECKFREE CORPORATION
TABLE OF CONTENTS
-----------------
Page No.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
Unaudited Condensed Consolidated Balance Sheets 3
June 30, 2002 and March 31, 2003
Unaudited Condensed Consolidated Statements of Operations 4
For the Three and Nine Months Ended
March 31, 2002 and 2003
Unaudited Condensed Consolidated Statements of Cash Flows 5
For the Nine Months Ended
March 31, 2002 and 2003
Notes to Unaudited Condensed Consolidated 6
Financial Statements For the Three and Nine Months Ended
March 31, 2002 and 2003
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations. 15
Item 3. Quantitative and Qualitative Disclosures About Market Risk. 31
Item 4. Controls and Procedures. 32
PART II. OTHER INFORMATION
Item 1. Legal Proceedings. N/A
Item 2. Changes in Securities and Use of Proceeds. N/A
Item 3. Defaults Upon Senior Securities. N/A
Item 4. Submission of Matters to a Vote of Security Holders. N/A
Item 5. Other Information. N/A
Item 6. Exhibits and Reports on Form 8-K. 33
Signatures. 34
Certifications of CEO and CFO under Section 302 of the Sarbanes-Oxley Act of 2002. 35
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CHECKFREE CORPORATION AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
JUNE 30, MARCH 31,
2002 2003
----------------- -----------------
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
Current assets:
Cash and cash equivalents................................................ $ 115,009 $ 177,949
Investments.............................................................. 90,958 50,399
Restricted investments................................................... -- 3,000
Accounts receivable, net................................................. 88,030 81,506
Prepaid expenses and other assets........................................ 8,355 12,378
Deferred income taxes.................................................... 11,816 8,640
----------------- -----------------
Total current assets................................................. 314,168 333,872
Property and equipment, net................................................... 95,625 100,570
Other assets:
Capitalized software, net................................................ 71,845 35,261
Goodwill, net............................................................ 530,758 529,214
Strategic agreements, net................................................ 519,275 426,318
Other intangible assets, net............................................. 24,609 11,854
Investments.............................................................. 69,788 135,690
Restricted investments................................................... 3,000 --
Other noncurrent assets.................................................. 8,409 7,536
----------------- -----------------
Total other assets................................................... 1,227,684 1,145,873
----------------- -----------------
Total........................................................... $ 1,637,477 $ 1,580,315
================= =================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable......................................................... $ 10,049 $ 9,679
Accrued liabilities...................................................... 54,914 54,500
Current portion of long-term obligations................................. 5,054 5,291
Deferred revenue......................................................... 42,410 39,439
----------------- -----------------
Total current liabilities............................................ 112,427 108,909
Accrued rent and other........................................................ 3,019 3,486
Deferred income taxes......................................................... 39,993 6,216
Long-term obligations - less current portion.................................. 3,877 7,199
Convertible subordinated notes................................................ 172,500 172,500
Stockholders' equity:
Preferred stock- 50,000,000 authorized shares, $.01 par value;
no amounts issued or outstanding..................................... -- --
Common stock- 500,000,000 authorized shares, $.01 par value;
issued 93,629,718 and 94,654,360 shares, respectively;
outstanding 88,085,894 and 89,098,536 shares, respectively........... 881 891
Additional paid-in capital............................................... 2,435,310 2,446,426
Accumulated deficit...................................................... (1,130,405) (1,165,618)
Unearned compensation.................................................... (125) --
Accumulated other comprehensive income................................... -- 306
----------------- -----------------
Total stockholders' equity........................................... 1,305,661 1,282,005
----------------- -----------------
Total........................................................... $ 1,637,477 $ 1,580,315
================= =================
See Notes to Unaudited Condensed Consolidated Financial Statements.
3
CHECKFREE CORPORATION AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
-------------------------------- -------------------------------
2002 2003 2002 2003
-------------- -------------- -------------- -------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Revenues:
Processing and servicing....................... $ 108,603 $ 121,899 $ 313,056 $ 352,398
License fees................................... 7,085 5,703 18,890 16,647
Maintenance fees............................... 5,595 6,563 17,804 19,066
Other.......................................... 3,303 7,136 12,849 18,930
-------------- -------------- -------------- -------------
Total revenues............................. 124,586 141,301 362,599 407,041
-------------- -------------- -------------- -------------
Expenses:
Cost of processing, servicing and support...... 66,961 59,103 202,816 177,994
Research and development....................... 13,464 13,595 43,554 39,104
Sales and marketing............................ 13,142 13,631 43,418 40,582
General and administrative..................... 9,654 9,656 32,638 28,657
Depreciation and amortization.................. 100,831 57,011 334,863 170,987
Impairment of intangible assets................ -- -- 155,072 --
Reorganization charge.......................... 15,871 -- 15,871 --
-------------- -------------- -------------- -------------
Total expenses............................. 219,923 152,996 828,232 457,324
-------------- -------------- -------------- -------------
Loss from operations................................ (95,337) (11,695) (465,633) (50,283)
Interest, net....................................... (1,272) (1,589) (2,987) (4,055)
Loss on investments................................. -- (1,297) -- (3,228)
-------------- -------------- -------------- -------------
Loss before income taxes and cumulative effect of
accounting change.............................. (96,609) (14,581) (468,620) (57,566)
Income tax benefit.................................. (19,150) (6,751) (87,081) (25,247)
-------------- -------------- -------------- -------------
Loss before cumulative effect of accounting
change......................................... (77,459) (7,830) (381,539) (32,319)
Cumulative effect of accounting change.............. -- -- -- (2,894)
-------------- -------------- -------------- -------------
Net loss............................................ $ (77,459) $ (7,830) $ (381,539) $ (35,213)
============== ============== ============== =============
Basic and diluted loss per share:
Basic and diluted net loss per common share
before cumulative effect of accounting
change...................................... $ (0.89) $ (0.09) $ (4.37) $ (0.36)
Cumulative effect of accounting change......... -- -- -- (0.03)
-------------- -------------- -------------- -------------
Net loss per common share...................... $ (0.89) $ (0.09) $ (4.37) $ (0.40)
============== ============== ============== =============
Equivalent number of shares.................... 87,446 88,949 87,250 88,672
============== ============== ============== =============
See Notes to Unaudited Condensed Consolidated Financial Statements.
4
CHECKFREE CORPORATION AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED
MARCH 31,
---------------------------------
2002 2003
--------------- --------------
(IN THOUSANDS)
Operating activities:
Net loss........................................................ $ (381,539) $ (35,213)
Adjustments to reconcile net loss to net cash provided by
operating activities:
Depreciation and amortization................................... 334,863 170,987
Deferred income tax provision................................... (87,081) (24,274)
Impairment of intangible assets................................. 155,072 --
Non-cash portion of reorganization charge....................... 1,640 --
Cumulative effect of accounting change.......................... -- 2,894
Impact of warrants issued to customer........................... -- (644)
Loss on investments............................................. -- 3,228
Net loss on disposition of property and equipment............... -- 426
Change in certain assets and liabilities:
Accounts receivable......................................... 14,713 6,524
Prepaid expenses and other.................................. 1,755 (3,301)
Accounts payable............................................ (2,542) (370)
Accrued liabilities and other .............................. 7,968 (1,370)
Deferred revenue............................................ (4,802) (2,971)
--------------- --------------
Net cash provided by operating activities.............. 40,047 115,916
Investing activities:
Purchase of property and software............................... (17,307) (20,800)
Proceeds from sale of property and software..................... -- 580
Capitalization of software development costs.................... (3,632) (3,133)
Purchase of investments - held to maturity...................... (77,615) (38,031)
Proceeds from maturities of investments - held to maturity...... 59,169 102,047
Increase in restricted investments.............................. (3,000) --
Purchase of other investments................................... -- (85)
Purchase of investments - available for sale.................... -- (102,990)
Proceeds from maturities of investments - available for sale.... -- 10,966
--------------- --------------
Net cash used in investing activities.................. (42,385) (51,446)
Financing activities:
Principal payments under capital lease and other long-term
obligations.................................................... (3,268) (9,208)
Proceeds from sale of stock and exercise of warrants............ 688 --
Proceeds from stock options exercised........................... 1,576 5,407
Proceeds from employee stock purchase plan...................... 3,146 2,271
--------------- --------------
Net cash provided by (used in) financing activities.... 2,142 (1,530)
--------------- --------------
Net increase (decrease) in cash and cash equivalents................. (196) 62,940
Cash and cash equivalents:
Beginning of period............................................. 124,122 115,009
--------------- --------------
End of period................................................... $ 123,926 $ 177,949
=============== ==============
See Notes to Unaudited Condensed Consolidated Financial Statements.
5
CHECKFREE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2002 AND 2003
1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
UNAUDITED INTERIM FINANCIAL INFORMATION
The accompanying unaudited condensed consolidated financial
statements and notes thereto have been prepared in accordance with the rules and
regulations of the Securities and Exchange Commission for Form 10-Q and include
all of the information and disclosures required by generally accepted accounting
principles for interim financial reporting. The results of operations for the
nine months ended March 31, 2002 and 2003 are not necessarily indicative of the
results for the full year.
These financial statements should be read in conjunction with
the financial statements, accounting policies and notes to financial statements
thereto included in the Company's Annual Report filed with the Securities and
Exchange Commission on Form 10-K. In the opinion of management, the accompanying
unaudited condensed consolidated financial statements reflect all adjustments
(consisting only of normal recurring adjustments) which are necessary for a fair
representation of financial results for the interim periods presented.
RECLASSIFICATIONS
Certain reclassifications have been made to the prior year's
financial information to conform to the March 31, 2003 presentation.
INVESTMENTS
During the quarter ended September 30, 2002, the Company began
classifying new purchases of investment securities as available-for-sale to
allow for more flexibility in cash management. Available-for-sale securities are
carried at fair value and changes in fair value are recorded as unrealized gains
or losses in accumulated other comprehensive income, a component of
stockholders' equity. As of March 31, 2003, investments available-for-sale were
$92,024,000 and $92,502,000 at amortized cost and fair value, respectively.
Investments available-for-sale represent approximately 49% of the Company's
total investment portfolio.
RECENT ACCOUNTING PRONOUNCEMENTS
In August 2001, the Financial Accounting Standards Board
("FASB") issued Statement of Financial Accounting Standards ("SFAS") 143,
"Accounting for Asset Retirement Obligations." SFAS 143 addresses financial
accounting and reporting for obligations associated with the retirement of
tangible long-lived assets and the associated retirement costs. The Company
adopted SFAS 143 as of July 1, 2002. The adoption of this statement had no
impact on the Company's results of operations or financial position for the nine
months ended March 31, 2003.
On July 1, 2002, the Company adopted SFAS 144, "Accounting for
the Impairment or Disposal of Long-Lived Assets." SFAS 144 superseded SFAS 121,
"Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets to Be
Disposed Of" and the accounting and reporting provisions of Accounting
Principles Board ("APB") Opinion 30, "Reporting 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. SFAS 144 addresses financial accounting and reporting
for the impairment or disposal of long-lived assets. The adoption of this
statement had no impact on the Company's results of operations or financial
position for the nine months ended March 31, 2003.
In April 2002, the FASB issued SFAS 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." This statement eliminates the current requirement that gains and
losses on extinguishment of debt must be classified as extraordinary items in
the income statement. Instead, the statement requires that gains and losses on
extinguishment of debt be evaluated against the
6
criteria in APB Opinion 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" to determine whether or not it
should be classified as an extraordinary item. In addition, the statement
contains other corrections to authoritative accounting literature in SFAS 4, 44
and 64. The changes in SFAS 145 related to debt extinguishment are effective for
the Company's 2003 fiscal year and the other changes were effective beginning
with transactions after May 15, 2002. In August 2002, the Company announced that
its board of directors had authorized a repurchase program under which the
Company may purchase up to $40 million of shares of its common stock and
convertible notes. Should the Company purchase any of its convertible notes and
realize a gain or loss on the transaction, SFAS 145 will require the Company to
evaluate the transaction against the criteria in APB Opinion 30 to determine if
the gain or loss should be classified as an extraordinary item. If
classification as an extraordinary item is not appropriate, the gain or loss
would be included as part of income before income taxes.
In June 2002, the FASB issued SFAS 146, "Accounting for Costs
Associated with Exit or Disposal Activities," which addresses accounting for
reorganization and similar costs. SFAS 146 supersedes previous accounting
guidance, principally Emerging Issues Task Force ("EITF") 94-03, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (Including Certain Costs Incurred in a Restructuring)." SFAS 146
requires that the liability for costs associated with an exit or disposal
activity be recognized when the liability is incurred. Under EITF 94-03, a
liability for an exit cost was recognized at the date of a company's commitment
to an exit plan. SFAS 146 also establishes that the liability should initially
be measured and recorded at fair value. Accordingly, SFAS 146 may affect the
timing of recognizing any future reorganization costs as well as the amount
recognized. The provisions of SFAS 146 are effective for reorganization
activities initiated after December 31, 2002.
In November 2002, the EITF reached a consensus on Issue 00-21,
"Multiple Deliverable Revenue Arrangements." EITF 00-21 addresses certain
aspects of the accounting by a vendor for arrangements under which it will
perform multiple revenue-generating activities. It also addresses when and how
an arrangement involving multiple deliverables should be divided into separate
units of accounting. The guidance in EITF 00-21 is effective for revenue
arrangements entered into in fiscal periods beginning after June 15, 2003, with
early application permitted. Companies may elect to report the change in
accounting as a cumulative effect of a change in accounting principle in
accordance with APB Opinion 20, "Accounting Changes" and SFAS 3, "Reporting
Accounting Changes in Interim Financial Statements (an amendment of APB Opinion
No. 28)." The Company is in the process of evaluating the effects of EITF 00-21.
In November 2002, FASB Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others," ("FIN 45") was issued. This
interpretation elaborates on the disclosures to be made by a guarantor in its
interim and annual financial statements about its obligations under certain
guarantees that it has issued. It also clarifies that a guarantor is required to
recognize, at the inception of a guarantee, a liability for the fair value of
the obligation undertaken in issuing the guarantee. The disclosure requirements
of FIN 45 were effective for financial statements of interim or annual periods
ending after December 15, 2002. The Company had no significant guarantees it was
required to disclose under FIN 45. The initial recognition and initial
measurement provisions of FIN 45 are applicable on a prospective basis to
guarantees issued or modified after December 31, 2002.
In December 2002, the FASB issued SFAS 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure - an Amendment of FASB
Statement No. 123," which provides alternative methods of transition for an
entity that voluntarily changes to the fair value based method of accounting for
stock-based employee compensation. SFAS 148 requires prominent disclosure about
the effects on reported net income of an entity's accounting policy decisions
with respect to stock-based employee compensation and amends APB Opinion 28,
"Interim Financial Reporting," to require disclosure about those effects in
interim financial information. The Company has provided the interim disclosure
provisions for this Form 10-Q below. The Company has continued to account for
stock-based compensation under the provisions of APB Opinion 25, "Accounting for
Stock Issued to Employees," using the intrinsic value method. Accordingly, the
adoption of SFAS 148 had no impact on the Company's results of operations or
financial position for the nine months ended March 31, 2003.
7
The Company applies APB Opinion 25, "Accounting for Stock
Issued to Employees" and related Interpretations in accounting for its stock
option plans and employee stock purchase plan. Had compensation cost for the
Company's stock-based compensation plans been determined based on the fair value
at the grant dates for awards under those plans in accordance with the
provisions of SFAS 123, "Accounting for Stock-Based Compensation," the Company's
net loss and net loss per share would have been as follows (in thousands, except
per share data):
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
------------------------------ ------------------------------
2002 2003 2002 2003
------------- ------------ ------------- ------------
Net loss, as reported.......................... $ (77,459) $ (7,830) $ (381,539) $ (35,213)
Stock-based compensation included in net loss.. 15 (205) 45 (175)
Stock-based compensation under SFAS 123........ (9,299) (6,044) (26,727) (21,398)
------------- ------------ ------------- ------------
Pro-forma net loss................... $ (86,743) $(14,079) $ (408,221) $ (56,786)
============= ============ ============= ============
Pro-forma net loss per share:
------------- ------------ ------------- ------------
Basic and diluted................... $ (0.99) $ (0.16) $ (4.67) $ (0.64)
============= ============ ============= ============
In April 2003, the FASB issued SFAS 149, "Amendment of
Statement 133 on Derivative Instruments and Hedging Activities," which amends
and clarifies accounting for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging activities
under Statement 133, "Accounting for Derivative Instruments and Hedging
Activities." SFAS 149 is effective for contracts entered into or modified after
June 30, 2003. The Company is in the process of evaluating any effects of this
new statement.
2. STRATEGIC AGREEMENT
As a result of the strategic agreement signed with Bank of
America in October 2000, Bank of America owned approximately 11.4% and 9.5% of
the Company as of June 30, 2002 and March 31, 2003, respectively, and is
considered a related party. The following amounts related to Bank of America are
included in the Company's consolidated financial statements for the periods
indicated (in thousands):
JUNE 30, MARCH 31,
2002 2003
---------- -----------
Current assets:
Accounts receivable, net .................................................. $22,632 $18,619
------- -------
Total current assets ............................................... $22,632 $18,619
======= =======
Current liabilities:
Accrued liabilities ....................................................... $ 808 $ 3,594
Deferred revenues ......................................................... 824 870
------- -------
Total current liabilities .......................................... $ 1,632 $ 4,464
======= =======
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
----------------- -----------------
2002 2003 2002 2003
------- ------- ------- -------
Revenues from Bank of America:
Processing and servicing ................................................. $14,960 $23,535 $41,530 $62,556
License .................................................................. 168 361 168 553
Maintenance fees ......................................................... 224 269 461 441
Other .................................................................... 105 2,326 135 3,975
------- ------- ------- -------
Total revenues ................................................. $15,457 $26,491 $42,294 $67,525
======= ======= ======= =======
8
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
----------------- -----------------
2002 2003 2002 2003
------- ------- ------- -------
Expenses incurred to Bank of America:
Cost of processing, servicing and support ............................... $ 7,473 $ -- $19,392 $ 4
------- ------- ------- -------
Total expenses ................................................. $ 7,473 $ -- $19,392 $ 4
======= ======= ======= =======
Revenues and accounts receivable relate to all segments of the
Company, but primarily to electronic billing and payment services provided to
Bank of America. Cost of processing expenses relate to reimbursements to Bank of
America in connection with a transition services agreement in place while the
Company completed the conversion of Bank of America customers to its processing
platform. Please refer to Management's Discussion and Analysis of Financial
Condition and Results of Operations included in this Form 10-Q for additional
information regarding the Company's transactions with Bank of America.
3. GOODWILL AND OTHER INTANGIBLE ASSETS
On July 1, 2002, the Company adopted SFAS 142, "Goodwill and
Other Intangible Assets." SFAS 142 changes the accounting for goodwill and other
intangible assets. Goodwill is no longer subject to amortization over its
estimated useful life. Rather, goodwill is subject to at least an annual
assessment for impairment by applying a fair-value-based test.
Upon adoption of SFAS 142, the Company transferred $1,350,000
of unamortized workforce in place intangible assets, net of the associated
deferred income taxes, into goodwill, discontinued the amortization of goodwill
and was required to perform a transitional impairment test. This impairment test
required the Company to (1) identify its reporting units, (2) determine the
carrying value of each reporting unit by assigning assets and liabilities,
including existing goodwill and intangible assets, to those reporting units, and
(3) determine the fair value of each reporting unit. If the carrying value of
any reporting unit exceeded its fair value, then additional testing was required
to determine if the goodwill carried on the balance sheet was impaired. After
completing step one of the transitional impairment test, the Company determined
that goodwill associated with its i-Solutions reporting unit, a unit within the
Company's Software segment, was potentially impaired.
The amount of goodwill impairment was then determined through
an analysis similar to that of a purchase price allocation, where the fair value
of the individual tangible and intangible assets (excluding goodwill) and
liabilities of the i-Solutions reporting unit was compared to the fair value of
the reporting unit, with the residual amount being the fair value assigned to
goodwill. The fair value of the i-Solutions reporting unit was estimated using a
combination of the cost, market and income approaches. Specifically, the
discounted cash flow and market multiples methodologies were utilized to
determine the fair value of the reporting unit by estimating the present value
of the future cash flows of the reporting unit along with reviewing revenue and
earnings multiples for comparable publicly traded companies and applying these
to the reporting unit's projected cash flows. Fair value of each of the assigned
assets and liabilities was determined using either a cost, market or income
approach, as appropriate, for each individual asset or liability. The resulting
impairment charge of $2,894,000 was recorded in the three months ended September
30, 2002, and is reflected as a cumulative effect of a change in accounting
principle in the Condensed Consolidated Statement of Operations for the nine
months ended March 31, 2003.
9
The following table adjusts net loss and net loss per share
for the impact of the implementation of SFAS 142 as follows (in thousands,
except per share data):
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
-------------------------- ------------------------
2002 2003 2002 2003
------------ ---------- ----------- ---------
Loss before cumulative effect of accounting change ......... $ (77,459) $ (7,830) $ (381,539) $ (32,319)
Cumulative effect of accounting change ..................... -- -- -- (2,894)
------------ ---------- ----------- ---------
Net loss ................................................... (77,459) (7,830) (381,539) (35,213)
Add back: goodwill amortization, net of tax ............... 41,742 -- 141,360 --
------------ ---------- ----------- ---------
Adjusted net loss .......................................... $ (35,717) $ (7,830) $ (240,179) $ (35,213)
============ ========== =========== =========
Basic and diluted net loss per share:
Basic and diluted net loss per common share before
cumulative effect of accounting
change ............................................ $ (0.89) $ (0.09) $ (4.37) $ (0.36)
Cumulative effect of accounting change ................ -- -- -- (0.03)
------------ ---------- ----------- ---------
Net loss per common share ............................. (0.89) (0.09) (4.37) (0.40)
Goodwill amortization, net of tax ..................... 0.48 -- 1.62 --
------------ ---------- ----------- ---------
Adjusted basic and diluted net loss per share ......... $ (0.41) $ (0.09) $ (2.75) $ (0.40)
============ ========== =========== =========
The components of the Company's various amortizing intangible assets
are as follows (in thousands):
JUNE 30, MARCH 31,
2002 2003
-------- --------
Capitalized software:
Product technology from acquisitions and strategic agreement ................... $166,578 $166,578
Internal development costs ..................................................... 24,946 28,014
-------- --------
Total ................................................................. 191,524 194,592
Less: accumulated amortization ....................................... 119,679 159,331
-------- --------
Capitalized software, net ............................................. $ 71,845 $ 35,261
======== ========
Strategic agreements:
Strategic agreements ........................................................... $744,424 $744,424
Less: accumulated amortization ................................................ 225,149 318,106
-------- --------
Strategic agreements, net ............................................. $519,275 $426,318
======== ========
Other intangible assets:
Workforce(1) ................................................................... $ 11,944 $ --
Tradenames ..................................................................... 47,968 47,968
Customer base .................................................................. 45,358 45,358
Covenants not to compete ....................................................... 1,200 1,200
-------- --------
Total ................................................................. 106,470 94,526
Less: accumulated amortization ................................................ 81,861 82,672
-------- --------
Other intangible assets, net .......................................... $ 24,609 $ 11,854
======== ========
(1) As of July 1, 2002, in accordance with SFAS 142, the Company
reclassified its workforce intangibles, net of accumulated
amortization, into goodwill.
10
Amortization of intangible assets totaled $47,664,000 and $143,408,000 for the
three months and nine months ended March 31, 2003, respectively. Amortization
expense for the year ended June 30, 2003, and the next four fiscal years is
estimated to be as follows (in thousands):
Fiscal Year Ending June 30,
2003..................................... $190,488
2004..................................... 143,438
2005..................................... 130,831
2006..................................... 43,346
2007..................................... 25,716
As of March 31, 2003, the Company's only non-amortizing
intangible asset is goodwill. The changes in the carrying value of goodwill by
segment for the nine months ended March 31, 2003, were as follows (in
thousands):
ELECTRONIC INVESTMENT
COMMERCE SOFTWARE SERVICES TOTAL
-------------- ------------- ------------- --------------
Balance as of June 30, 2002...................... $ 503,255 $ 16,116 $ 11,387 $ 530,758
Reclassification of workforce, net of tax........ 483 867 -- 1,350
Impairment loss from adoption of SFAS 142........ -- (2,894) -- (2,894)
-------------- ------------- ------------- --------------
Balance as of March 31, 2003..................... $ 503,738 $ 14,089 $ 11,387 $ 529,214
============== ============= ============= ==============
4. INVESTMENTS
The Company has certain investments which are accounted for
under the cost method. These investments are periodically evaluated to determine
if any decline in value is other than temporary. In performing this evaluation,
the Company considers various factors including any decline in market price,
where available, the investee's financial condition, results of operations,
operating trends and other financial ratios. During the nine months ended March
31, 2003, the Company determined that the decline in value of certain of these
investments was other than temporary. In making that determination, the Company
considered the fact that the market value of certain investments had been below
the Company's basis for a period of time exceeding six months, as well as other
financial and operating trends of the respective companies. The resulting loss
of $3,228,000 is reflected in loss on investments in the accompanying Unaudited
Condensed Consolidated Statement of Operations.
5. COMMON STOCK
In the nine months ended March 31, 2003, the Company issued
stock for various employee benefit programs. The Company issued 402,102 shares
to fund its 401(k) match, the cost of which was accrued in the year ended June
30, 2002, and 256,423 shares of common stock in conjunction with its associate
stock purchase plan, which was funded through employee payroll deductions in the
immediately preceding six-month period.
In November 2002, the Company's stockholders approved the 2002
Stock Incentive Plan (the "2002 Plan"). Under the provisions of the 2002 Plan,
the Company may grant incentive or non-qualified stock options, stock
appreciation rights ("SARs"), restricted stock, performance units or performance
shares for not more than 6,000,000 shares of common stock to certain key
employees, officers and non-employee directors. The terms of the options, SARs,
restricted stock, performance units or performance shares granted under the 2002
Plan are determined by a committee of the Company's Board of Directors, however,
in the event of a change in control as defined in the 2002 Plan, they shall
become immediately exercisable. The 2002 Plan will replace the Company's 1995
Stock Option Plan (the "1995 Plan") going forward, except that the 1995 Plan
will continue to exist to the extent that options granted prior to the effective
date of the 2002 Plan continue to remain outstanding. Additionally, the
Company's stockholders approved an increase in the number of shares reserved and
available for sale under the 1997 Associate Stock Purchase Plan from 1,000,000
shares to 2,000,000 shares.
11
6. STOCK-RELATED TRANSACTIONS WITH THIRD PARTIES
In October 1999, the Company entered into an agreement with
one of its customers whereby the customer purchased 250,000 shares of the
Company's stock, has been issued warrants on 1,000,000 shares, and has the
ability to earn warrants on up to 2,000,000 additional shares. All warrants
contain a strike price of $39.25 and were exercisable on September 15, 2002,
contingent upon achievement of various annual revenue targets and maintaining
the continued existence of the agreement through that date. During the quarter
ended June 30, 2002, vesting of the warrants for one million shares became
probable. As such, the Company recorded a non-cash charge of $2,748,000 for the
fair value of the portion of the warrants earned through June 30, 2002. During
the quarter ended September 30, 2002, the Company recorded a non-cash increase
in revenue of $644,000, reflecting the portion of the warrants earned during the
quarter and the final fair value of the one million warrants that vested on
September 15, 2002. Fair value was determined based on a Black-Scholes option
pricing model valuation. Under the provisions of EITF 01-9, "Accounting for
Consideration by a Vendor to a Customer (Including a Reseller of the Vendor's
Products)," the non-cash charge of $2,748,000 was recorded as a reduction of
revenue, and the non-cash adjustment of $644,000 was recorded as an increase to
revenue.
7. EARNINGS PER SHARE
The following table reconciles the differences in income and
shares outstanding between basic and dilutive for the periods indicated (in
thousands except per share data):
FOR THE THREE MONTHS ENDED
-------------------------------------------------------------------------------------------------
MARCH 31, 2002 MARCH 31, 2003
----------------------------------------------- ---------------------------------------------
PER- PER-
LOSS SHARES SHARE LOSS SHARES SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT (NUMERATOR) (DENOMINATOR) AMOUNT
--------------- -------------- -------- ------------- --------------- ---------
Basic EPS.......... $ (77,459) 87,446 $(0.89) $ (7,830) 88,949 $ (0.09)
======== =========
Effect of dilutive
securities:
Options and -- --
warrants....... -- --
-------------- -------------- ------------- ---------------
Diluted EPS........ $ (77,459) 87,446 $(0.89) $ (7,830) 88,949 $ (0.09)
============== ============== ======== ============= =============== =========
FOR THE NINE MONTHS ENDED
-------------------------------------------------------------------------------------------------
MARCH 31, 2002 MARCH 31, 2003
----------------------------------------------- ---------------------------------------------
PER- PER-
LOSS SHARES SHARE LOSS SHARES SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT (NUMERATOR) (DENOMINATOR) AMOUNT
--------------- -------------- -------- ------------- --------------- ---------
Basic EPS.......... $ (381,539) 87,250 $(4.37) $ (35,213) 88,672 $ (0.40)
======== =========
Effect of dilutive
securities:
Options and -- --
warrants....... -- --
-------------- -------------- ------------- ---------------
Diluted EPS........ $ (381,539) 87,250 $(4.37) $ (35,213) 88,672 $ (0.40)
============== ============== ======== ============= =============== =========
Anti-dilution provisions of SFAS 128, "Earnings Per Share,"
require consistency between diluted per-common-share amounts and basic
per-common-share amounts in loss periods. Had the Company recognized net income
for the periods presented, an additional 2,262,000, 3,280,000, 3,973,000 and
1,923,000 of in-the-money options and warrants would have been included in the
diluted earnings per share calculation for the three and nine months ended March
31, 2002 and 2003, respectively. Using the treasury stock purchase method
prescribed by SFAS 128, this would have increased diluted shares outstanding by
464,000, 926,000, 1,082,000 and 342,000 for the three and nine months ended
March 31, 2002 and 2003, respectively.
The weighted average diluted common shares outstanding for the
three and nine months ended March 31, 2002 and 2003, also exclude the effect of
approximately 8,508,000, 6,695,000, 6,481,000 and 8,030,000 of out-of-the-money
options and warrants, respectively, and the 2,357,000 share effect for the
assumed conversion of the convertible subordinated notes, as their effect would
be anti-dilutive. In addition, the after-tax effect of
12
interest expense on the convertible subordinated notes of approximately
$1,592,000 for the three months ended March 31, 2002 and 2003, and $5,066,000
for the nine months ended March 31, 2002 and 2003, has not been added back to
the numerator, as its effect would be anti-dilutive.
8. REORGANIZATION CHARGES
During the year ended June 30, 2002, the Company announced it
would streamline operations in its Electronic Commerce division, refine its
strategy for the i-Solutions business unit of its Software division, and
discontinue certain product lines associated with its Investment Services
division. As a result of these actions, the Company closed or consolidated
operations in several locations and eliminated certain other positions in the
Company. The streamlining of its Electronic Commerce division operations
resulted from efficiencies gained from the consolidation of three legacy
transaction processing platforms to its Genesis platform and resulted in the
closing of its San Francisco, California location on April 30, 2002; its
Houston, Texas location on June 30, 2002; and its Austin, Texas location on
September 30, 2002. The refinement in strategy for the i-Solutions business
resulted in the closing of its Ann Arbor, Michigan and Singapore locations on
March 19, 2002. These actions resulted in the termination of 707 employees.
As a result of these actions, during the year ended June 30,
2002, the Company recorded reorganization charges and established a
reorganization reserve for certain charges related to the reorganization plan. A
summary related to the reorganization reserve for the nine months ended March
31, 2003, is as follows (in thousands):
REORGANIZATION REORGANIZATION
RESERVE AT CASH RESERVE AT
JUNE 30, 2002 PAYMENTS MARCH 31, 2003
------------- -------- --------------
Severance and other employee costs ............................. $ 4,701 $(4,665) $ 36
Office closure and business exit costs ......................... 3,028 (2,143) 885
Other exit costs ............................................... 71 (61) 10
------- ------- -------
Total ..................................................... $ 7,800 $(6,869) $ 931
======= ======= =======
In conjunction with the reorganization activities described
above, the Company revised the estimated useful lives of Existing Product
Technology and Customer Base intangible assets related to the product lines that
are to be discontinued from its Mobius Group acquisition. This resulted in
additional amortization expense of $242,000 and $1,035,000 for the three and
nine months ended March 31, 2003, respectively, which represents an after-tax
impact of $145,000 and $621,000 for the same periods. There was no impact to
earnings per share for the three months ended March 31, 2003, and the impact to
earnings per share was $(0.01) for the nine months ended March 31, 2003.
9. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (IN THOUSANDS)
NINE MONTHS ENDED
MARCH 31,
--------------------
2002 2003
--------- --------
Interest paid .................................................................. $ 6,300 $ 6,192
========= ========
Income taxes paid .............................................................. $ 49 $ 1,951
========= ========
Supplemental disclosure of non-cash investing and financing activities:
Capital lease additions and purchase of other long-term assets............ $ -- $ 13,017
========= ========
Stock funding of 401(k) match ............................................ $ 3,621 $ 3,229
========= ========
Stock funding of Associate Stock Purchase Plan ............................ $ 4,434 $ 3,272
========= ========
13
10. COMPREHENSIVE LOSS
The Company began investing in available-for-sale securities
during the quarter ended September 30, 2002. Available-for-sale securities are
recorded at fair value and changes in fair value are recorded as unrealized
gains or losses and accumulated in other comprehensive income. As a result, the
Company is required to report the components of comprehensive loss which are as
follows (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
----------------------------- -----------------------------
2002 2003 2002 2003
------------- ------------ ------------- ------------
Net loss........................................... $ (77,459) $ (7,830) $ (381,539) $ (35,213)
Net unrealized gains (losses) on investment
securities available-for-sale, net of tax...... -- (7) -- 306
------------- ------------ ------------- ------------
Comprehensive loss................................. $ (77,459) $ (7,837) $ (381,539) $ (34,907)
============= ============ ============= ============
11. BUSINESS SEGMENTS
The Company operates in three business segments - Electronic
Commerce, Software and Investment Services. These reportable segments are
strategic business units that offer different products and services. The Company
evaluates performance based on revenues and operating income (loss) of the
respective segments. Segment operating income (loss) excludes
acquisition-related intangible asset amortization and certain one-time charges.
There are no inter-segment sales.
The following sets forth certain financial information
attributable to the Company's business segments for the three months and nine
months ended March 31, 2002 and 2003 (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
---------------------- ----------------------
2002 2003 2002 2003
--------- --------- --------- ---------
Revenues:
Electronic Commerce ............................................ $ 89,773 $ 104,521 $ 260,240 $ 299,337
Investment Services ............................................ 20,014 20,439 59,111 60,907
Software ....................................................... 14,799 16,341 43,248 46,797
--------- --------- --------- ---------
Total ................................................. $ 124,586 $ 141,301 $ 362,599 $ 407,041
========= ========= ========= =========
Segment operating income (loss):
Electronic Commerce ........................................... $ 9,390 $ 31,881 $ 16,444 $ 83,419
Investment Services ........................................... 6,882 5,642 17,717 16,269
Software ...................................................... 2,539 5,116 3,229 12,139
Corporate ..................................................... (7,984) (8,344) (27,359) (24,450)
--------- --------- --------- ---------
Total ................................................. 10,827 34,295 10,031 87,377
Purchase accounting amortization .................................... (90,293) (45,990) (304,721) (138,304)
Impairment of intangible assets ..................................... -- -- (155,072) --
Reorganization charge ............................................... (15,871) -- (15,871) --
Impact of warrants .................................................. -- -- -- 644
Loss on investments ................................................. -- (1,297) -- (3,228)
Interest, net ....................................................... (1,272) (1,589) (2,987) (4,055)
--------- --------- --------- ---------
Total loss before income taxes and cumulative
effect of accounting change ........................... $ (96,609) $ (14,581) $(468,620) $ (57,566)
========= ========= ========= =========
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
CheckFree was founded in 1981 as an electronic payment processing
company and has become a leading provider of financial electronic commerce
products and services. Our current business was developed through the expansion
of our core electronic payments business and the acquisition of companies
operating in similar or complementary businesses.
We operate our business through three independent but inter-related
divisions:
- Electronic Commerce;
- Investment Services; and
- Software.
Through our Electronic Commerce division, we enable consumers to
receive and pay bills electronically. For the year ended June 30, 2002, we
processed approximately 316 million electronic payments and delivered
approximately 9.8 million electronic bills. For the quarter ended March 31,
2003, we processed nearly 112 million electronic payments and delivered over 8.8
million electronic bills. As of March 31, 2003, there were over nine million
consumers initiating payments via CheckFree-supported technology. The number of
transactions we process each year continues to grow. Growth in the number of
transactions processed exceeded 36% for the year ended June 30, 2002, and 36%
for the quarter ended March 31, 2003, against the same periods in the prior
year. The Electronic Commerce division accounted for approximately 72% of our
fiscal 2002 revenue and approximately 74% of total revenue for the nine months
ended March 31, 2003.
Our Electronic Commerce division's products allow consumers to:
- receive electronic bills through the Internet;
- pay any bill -- whether it arrives over the Internet or
through traditional mail -- to anyone;
- make payments not related to bills -- to anyone; and
- perform customary banking transactions, including balance
inquiries, transfers between accounts and on-line statement
reconciliations.
The majority of consumers using our services access our system through
Consumer Service Providers (CSPs). CSPs are companies, such as banks, brokerage
firms, Internet portals and content sites, Internet-based banks, Internet
financial sites and personal financial management software providers, that use
our products to enable consumers to receive and/or pay bills electronically. We
have relationships with hundreds of CSPs. Some of our largest CSPs, as
determined by type of CSP and number of consumers using our products, are Bank
of America, Bank One, Charles Schwab & Co., Merrill Lynch & Co., SunTrust, U.S.
Postal Service, Wachovia, Wells Fargo and Yahoo!. This list of our CSPs is not
exhaustive and may not fully represent our customer base.
We have developed our own open infrastructure, known as Genesis, to
process electronic bills and payments. The Genesis system is accessed by CSPs
using various Web-based applications. In March 2001, we introduced our latest
application for electronic billing and payments -- "WebPay for Consumers" (or
WebPay 3.2), which added to our core product the ability for consumers to
receive and pay e-bills over e-mail and to exchange money with each other using
e-mail "invitations" to receive money. WebPay 3.2 helps consumers automate the
complete process of viewing and paying bills -- they can receive bills online
and pay those bills online, too. WebPay 3.2 also allows the consumer to "Pay
Anyone" electronically -- from a child in college, to a lawn care or other
service provider, to a friend, using the Genesis system. We now have 842 CSPs
offering full electronic billing and payment as the number of sites where
consumers can both view and pay bills continues to increase.
Through our Investment Services division, we provide a range of
outsourced portfolio management services to help more than 250 institutions
deliver portfolio management, performance measurement and reporting services to
their clients. As of March 31, 2003, our clients used the CheckFree APL
Portfolio Accounting System to manage about 1.2 million portfolios totaling more
than $500 billion in assets. The Investment Services division accounted for
approximately 16% of our fiscal 2002 revenue and approximately 15% of total
revenue for the nine-
15
month period ended March 31, 2003.
Our institutional client base includes investment advisors, brokerage
firms, banks and insurance companies. Our fee-based money manager clients are
typically sponsors or managers of "wrap" or separately managed accounts, money
management products, or traditional money managers, managing investments of
institutions and high net worth individuals.
Our portfolio management systems are marketed under the product name
APL, and provide the following functions:
- account open and trading capabilities;
- graphical client reporting;
- performance measurement;
- decision support tools;
- account analytics;
- tax lot accounting;
- manager due diligence;
- multiple strategy portfolios;
- straight through processing;
- Depository Trust Corporation interfacing;
- billing functions; and
- system and data security.
In addition to our APL and APL Wrap portfolio management products, our
Investment Services division also offers investment performance and reporting
products and services. Marketed under the names M-Search and M-Watch, these
products are a result of the acquisition of Mobius Group, Inc. in March 1999.
Through our Software division, we deliver software, maintenance,
support and professional services to large financial service providers and other
companies across a range of industries. The Software division is comprised of
three units, each with its own distinct set of software products. The ACH
Solutions unit provides software and services that are used to process more than
two-thirds of the nation's eight billion Automated Clearing House (ACH)
payments. The CheckFree Financial and Compliance Solutions (CFACS) unit enables
organizations to handle their reconciliation and compliance requirements. The
i-Solutions unit provides software and services that enable end-to-end e-billing
and e-statement creation, delivery and payment. The Software division accounted
for approximately 12% of our fiscal 2002 revenue and 11% of total revenue for
the nine months ended March 31, 2003.
16
RESULTS OF OPERATIONS
The following table sets forth as percentages of total operating
revenues, certain consolidated statements of operations data:
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
---------------- ----------------
2002 2003 2002 2003
------- ------ ------ ------
Total Revenues: ........................................................ 100.0% 100.0% 100.0% 100.0%
Expenses:
Cost of processing, servicing and support ........................... 53.8% 41.8% 55.9% 43.7%
Research and development ............................................ 10.8% 9.6% 12.0% 9.6%
Sales and marketing ................................................. 10.6% 9.7% 12.0% 10.0%
General and administrative .......................................... 7.7% 6.8% 9.0% 7.0%
Depreciation and amortization ....................................... 80.9% 40.3% 92.4% 42.0%
Impairment of intangible assets ..................................... -- -- 42.8% --
Reorganization Charge ............................................... 12.7% -- 4.4% --
-------- ------ ------ ------
Total expenses ............................................... 176.5% 108.3% 228.4% 112.4%
-------- ------ ------ ------
Loss from operations ................................................... -76.5% -8.3% -128.4% -12.4%
Interest, net .......................................................... -1.0% -1.1% -0.8% -1.0%
Loss on investments .................................................... -- -0.9% -- -0.8%
-------- ------ ------ ------
Loss before income taxes and cumulative
effect of accounting change ......................................... -77.5% -10.3% -129.2% -14.1%
Income tax benefit ..................................................... -15.4% -4.8% -24.0% -6.2%
-------- ------ ------ ------
Loss before cumulative effect of accounting
change ............................................................. -62.2% -5.5% -105.2% -7.9%
Cumulative effect of accounting change ................................. -- -- -- -0.7%
-------- ------ ------ ------
Net loss ............................................................... -62.2% -5.5% -105.2% -8.6%
======== ====== ====== ======
Revenues. Total revenue increased by $16.7 million, or 13%, from $124.6
million for the three months ended March 31, 2002, to $141.3 million for the
three months ended March 31, 2003, and by $44.4 million, or 12%, from $362.6
million for the nine months ended March 31, 2002, to $407.0 million for the nine
months ended March 31, 2003. Quarter over quarter revenue growth is driven by
16% growth in our Electronic Commerce business, 10% growth in our Software
business and 2% growth in our Investment Services business. Year over year
revenue growth is driven by 15% growth in our Electronic Commerce business, 8%
growth in our Software business and 3% growth in our Investment Services
business.
Growth in our Electronic Commerce business was driven primarily by an
increase in transactions processed from 82.0 million for the three months ended
March 31, 2002, to 111.9 million for the three months ended March 31, 2003, and
from 227.8 million for the nine months ended March 31, 2002, to 313.6 million
for the nine months ended March 31, 2003. Please refer to the SEGMENT
INFORMATION section of this report, Electronic Commerce division, for analysis
of changes in the mix of business inherent in our transaction growth.
Additionally, revenue related to minimum guarantees from Microsoft and First
Data Corporation have increased by $2.3 million on a quarter over quarter basis,
and by $6.8 million on a year over year basis. Growth in Electronic Commerce
revenue has been dampened somewhat by a decrease in interest rates, which has
negatively impacted our interest sensitive offerings, such as our account
balance transfer product, and further by certain of our larger customers
transferring payment volume to an in-house solution over the past two quarters.
Growth in our Investment Services and Software businesses has been
dampened by poor economic conditions. Portfolios managed within Investment
Services have remained relatively flat over the past several quarters, as
investors reducing stock holdings have offset new portfolio growth. Our pricing
in Investment Services
17
is primarily based on portfolios managed, and as a result, we have experienced
less than historical revenue growth in this business. We expect this trend to
continue until stock market performance improves. We have also experienced
modest growth in our Software businesses, as the recession continues and
customers take longer than normal to evaluate discretionary investment-spending
alternatives such as third party software product offerings. In the quarter
ended December 31, 2002, we sold more software licenses than we expected and we
began work on a large software services contract that extended through the March
31, 2003 quarter. The combination of these events provided a near term boost to
Software revenue; however, until the economy begins to rebound, we expect to
experience modest growth in our Software business as well.
Our processing and servicing revenue increased by $13.3 million, or
12%, from $108.6 million for the three months ended March 31, 2002, to $121.9
million for the three months ended March 31, 2003, and by $39.3 million, or 13%,
from $313.1 million for the nine months ended March 31, 2002, to $352.4 million
for the nine months ended March 31, 2003. We earn processing and servicing
revenue in both our Electronic Commerce and our Investment Services businesses.
As previously mentioned, portfolios managed have remained basically flat over
the past several quarters and as a result, we have seen only modest growth in
processing and servicing revenue from our Investment Services business. Growth
in processing and servicing revenue has therefore come primarily from the
aforementioned growth in transactions processed within our Electronic Commerce
business. Additionally, we delivered over 8.8 million electronic bills in the
quarter ended March 31, 2003, as compared to 3.1 million in the same period last
year. As part of our acquisition of TransPoint in September 2000, we entered
into agreements with Microsoft and First Data Corporation, both of which include
monthly minimum revenue guarantees that increase annually over the five-year
term of the agreements. We are operating below the minimum levels in both
agreements and, as a result of the increased minimum levels, revenue from
Microsoft and First Data Corporation grew by $2.3 million from the three months
ended March 31, 2002, to the three months ended March 31, 2003, and by $6.8
million from the nine months ended March 31, 2002, to the nine months ended
March 31, 2003. Reductions in interest yields from this time last year have had
a dampening effect on our interest sensitive products such as our account
balance transfer offering, which has offset further growth in Electronic
Commerce processing and servicing revenue. Furthermore, our largest customer
reached a pricing milestone late in the quarter ended December 31, 2002, which
reduced our revenue per subscriber for that customer by approximately 15%, and
we expect a similar reduction when the same customer reaches another pricing
milestone in the quarter ended June 30, 2003. We reflected the full impact of
the first pricing change in the quarter ended March 31, 2003, and will see the
impact from the second change in the quarter ended June 30, 2003.
At the end of our 2002 fiscal year, we introduced a series of
transaction-based metrics that are designed to help investors better understand
trends in our revenue base. We offer two basic levels of electronic billing and
payment services to our customers. Customers that use our Full Service offering
outsource all, or a portion of, their electronic billing and payment process to
us. For instance, a Full Service customer might not use a CheckFree hosted user
interface, but still use our full array of services, including payment
processing, payment warehouse, claims processing, e-Bill, on-line proof of
payment, customer care, and other aspects of our service. Also, while a Full
Service customer may build its own payment warehouse, we maintain a customer
record and payment history within our payment warehouse to support the Full
Service customer's servicing needs. Customers in the Full Service category may
contract to pay us either on a per-subscriber basis, a per-transaction basis, or
a blend of both. Customers that utilize our Payment Services offering receive a
limited subset of our electronic billing and payment services. Additionally,
within the Payment Services offering, we offer services to billers for
electronic bill delivery and hosting services, as well as other payments
services such as account balance transfer.
A third category of revenue we simply refer to as Other Electronic
Commerce. Other Electronic Commerce includes our Health and Fitness business and
other ancillary revenue sources, such as CSP and biller implementation and
consulting services.
As we have previously reported, three of our larger customers, all of
whom were original principals of a consortium known as Spectrum, have announced
intentions of creating or using an in-house payment warehouse for routing bill
payment transactions, and each are in various stages of this transition process.
For payment processing services, each of the three principal banks participating
in the Spectrum consortium signed a multi-year transaction processing agreement
in August 2000 with Metavante, a payment processing division of Marshall and
Ilsley Corporation (M&I), which included guaranteed minimum transaction levels
during the contract period. As a result, each of these banks is working on
diverting payment transactions from CheckFree in order to meet these minimum
18
requirements. J.P. Morgan Chase ("Chase"), which has historically maintained an
in-house payment warehouse as a Payment Services customer of CheckFree, moved
all of its internet-based bill payment transactions, except for those processed
through personal financial management (PFM) programs such as Intuit's Quicken or
Microsoft Money, to Metavante during the quarter ended December 31, 2002. Wells
Fargo has begun directing new electronic bill payment customers onto its
in-house system and began routing some payments from existing customers to
Metavante during the quarter ended March 31, 2003. Wachovia recently initiated
its in-house payment warehouse and has begun migrating legacy Wachovia bill pay
customers, on a state-by-state basis, onto its in-house system. We plan to work
with both Wells Fargo and Wachovia to integrate their in-house payment systems
with CheckFree. Wells Fargo announced in April 2003 that, together, we have
enabled their in-house system with e-Bill capability. For reference purposes,
Wells Fargo currently operates as a Payment Services customer while Wachovia
operates as a Full Service customer.
We understand that a fourth bank customer, Bank One, intends to move
its electronic payment processing to an in-house payment warehouse as well. Bank
One has started processing its own "on us" payments at this time and we expect
to see transaction volumes trail off over time as they fully enable their system
and take payment processing in-house. An "on us" payment involves a bank
customer that pays a same-bank credit card, mortgage loan, auto loan, or other
similar payment without using a third party payment processor.
We believe that the complexity and costs of building, supporting, and
hosting an in-house payment warehouse and user interface are substantial, and
execution is likely limited to a few large banks. Regardless, we expect to
compete for payment transaction volume from banks that ultimately choose an
in-house payment routing alternative.
Our license fee revenue decreased by $1.4 million, or 20%, from $7.1
million for the three months ended March 31, 2002, to $5.7 million for the three
months ended March 31, 2003, and by $2.3 million, or 12%, from $18.9 million for
the nine months ended March 31, 2002, to $16.6 million for the nine months ended
March 31, 2003. License revenue is derived by our Software business. The
recessionary economy continues to cause potential customers to extend their
evaluation time on discretionary spending for items such as software products
which has resulted in slower than normal software license sales. We expect this
trend to continue until the economy begins to rebound.
Our maintenance fee revenue increased by $1.0 million, or 17%, from
$5.6 million for the three months ended March 31, 2002, to $6.6 million for the
three months ended March 31, 2003, and by $1.3 million, or 7%, from $17.8
million for the nine months ended March 31, 2002, to $19.1 million for the nine
months ended March 31, 2003. Maintenance revenue, which represents annually
renewable product support for our software customers, is isolated to our
Software business, and tends to grow with incremental license sales. When
combining decreases in new license sales, customer retention rates of at least
80% across all of our Software business units and moderate price increases on a
year over year basis, the result is a modestly growing maintenance base.
Although we defer revenue recognition on maintenance billings until cash is
collected, which can cause quarter-to-quarter fluctuations in maintenance
revenue, until license sales regain historical growth rates, we expect to
continue to see moderate growth in maintenance in the near term.
Our other revenue increased by $3.8 million, or 116%, from $3.3 million
for the three months ended March 31, 2002, to $7.1 million for the three months
ended March 31, 2003, and by $6.1 million, or 47%, from $12.8 million for the
nine months ended March 31, 2002, to $18.9 million for the nine months ended
March 31, 2003. Other revenue consists primarily of consulting and
implementation fees across all three of our business segments. The primary
driver of growth in this area is a consulting services project we are engaged in
with a large bank customer within our ACH software business unit. This project
is expected to continue throughout the remainder of fiscal 2003.
Cost of Processing, Servicing and Support. Our cost of processing,
servicing and support was $67.0 million, or 53.8% of total revenue, for the
three months ended March 31, 2002, and was $59.1 million, or 41.8% of total
revenue, for the three months ended March 31, 2003. Cost of processing,
servicing and support was $202.8 million, or 55.9% of total revenue, for the
nine months ended March 31, 2002, and was $178.0 million, or 43.7% of total
revenue, for the nine months ended March 31, 2003. Cost of processing, servicing
and support as a percentage of processing and servicing only revenue (total
revenue less license fees) was 57.0% for the three months ended
19
March 31, 2002 versus 43.6% for the three months ended March 31, 2003, and was
59.0% for the nine months ended March 31, 2002 versus 45.6% for the nine months
ended March 31, 2003. The largest single factor resulting in the decline in
processing and servicing costs, in light of growth in processing and servicing
revenue, was platform consolidation in our Electronic Commerce business. For
most of fiscal 2002, we were maintaining three redundant payment-processing
platforms. Through December 2001, we were converting Bank of America subscribers
from the legacy Bank of America processing platform we purchased in October 2000
and, through March 2002, we maintained the redundant system to close out
remaining customer care inquiries and claims, at which time we retired the
redundant processing platform. Throughout this period, we paid Bank of America
to run and maintain the platform for us. Once we retired the Bank of America
system, we were able to close our customer care facility in San Francisco on
April 30, 2002, and our Houston customer care facility in the month ended June
30, 2002. Additionally, as we migrated all but a few CSPs off of our legacy
Austin processing platform onto Genesis by the end of June 2002, we closed our
Austin office as well. The combination of platform consolidation and office
closings eliminated approximately $6.0 million of redundant quarterly processing
and servicing costs in the Electronic Commerce business. Additionally, our
electronic payment rate has improved from approximately 70% for the three months
ended March 31, 2002, to over 74% for the three months ended March 31, 2003.
Electronic payments carry a significantly lower variable cost per unit than do
paper-based payments and are far less likely to result in a costly customer care
claim. We continue to invest in additional efficiency and quality improvements
within our customer care processes and our information technology infrastructure
to drive improvements in our total cost per transaction. During the quarter
ended December 31, 2002, we hired additional customer care resources in
expectation of seasonally high call volumes that have historically taken place
after the holiday season. This year, however, we did not experience such higher
call volumes. As a result, we had a modest spike in processing costs in the
December 31, 2002 quarter that we managed to a lower cost during this quarter,
in spite of transaction growth. We expect our efforts toward greater efficiency
and quality to continue to result in further improvement in cost per transaction
in future periods.
Research and Development. Our research and development costs were $13.5
million, or 10.8% of total revenue, for the three months ended March 31, 2002,
and $13.6 million, or 9.6% of total revenue, for the three months ended March
31, 2003. Research and development costs were $43.6 million, or 12.0% of total
revenue, for the nine months ended March 31, 2002, and $39.1 million, or 9.6% of
total revenue, for the nine months ended March 31, 2003. On March 19, 2002, we
announced a company reorganization that resulted in a reduction in workforce
that impacted all areas of the company, including research and development.
Although the absolute dollar value of research and development may vary somewhat
from quarter to quarter, the reduction in workforce resulted in savings on a
year over year basis. We continue to invest significantly in product enhancement
and quality improvement programs in all three of our businesses.
Sales and Marketing. Our sales and marketing costs were $13.1 million,
or 10.6% of total revenue, for the three months ended March 31, 2002, and were
$13.6 million, or 9.7% of total revenue, for the three months ended March 31,
2003. Our sales and marketing costs were $43.4 million, or 12.0% of total
revenue, for the nine months ended March 31, 2002, and were $40.6 million, or
10.0% of total revenue, for the nine months ended March 31, 2003. During the
current fiscal year we introduced new relationship management and account
management positions in our Investment Services business, which is the primary
factor in the increase in sales and marketing costs on quarter over quarter
basis. The previously mentioned reorganization announced on March 19, 2002,
however, impacted sales and marketing resources as well, and resulted in a year
over year reduction in costs in this area. We closed our i-Solutions office in
Ann Arbor as part of the restructuring. While other business units were impacted
by the reorganization, this was the primary factor in lower year over year sales
and marketing costs.
General and Administrative. Our general and administrative costs were
$9.7 million, or 7.7% of total revenue, for the three months ended March 31,
2002, and were $9.7 million, or 6.8% of total revenue, for the three months
ended March 31, 2003. Our general and administrative costs were $32.6 million,
or 9.0% of total revenue, for the nine months ended March 31, 2002, and were
$28.7 million, or 7.0% of total revenue, for the nine months ended March 31,
2003. We continue to carefully manage our corporate expenses, resulting in
expected leverage in overhead costs.
Depreciation and Amortization. Depreciation and amortization costs
decreased from $100.8 million for the three months ended March 31, 2002, to
$57.0 million for the three months ended March 31, 2003. Depreciation and
amortization costs decreased from $334.9 million for the nine months ended March
31, 2002 to $171.0 million for
20
the nine months ended March 31, 2003. In July 2002, we adopted Statement of
Financial Accounting Standards ("SFAS") 142, "Goodwill and Other Intangible
Assets." Upon adoption, goodwill is no longer subject to amortization over its
estimated useful life. Instead, goodwill is subject to at least an annual
assessment for possible impairment. We will continue to amortize all other
intangible assets, such as acquired technology, strategic agreements, trade
names, and the like, over their respective useful lives. As a result of the
change, amortization from acquisition related intangible assets has decreased
from $90.3 million for the three months ended March 31, 2002, to $46.0 million
for the three months ended March 31, 2003, and from $304.7 million for the nine
months ended March 31, 2002, to $138.3 million for the nine months ended March
31, 2003. Underlying depreciation and amortization from operating fixed assets
and internally developed product costs has increased from $10.5 million for the
three months ended March 31, 2002, to $11.0 million for the three months ended
March 31, 2003, and from $30.1 million for the nine months ended March 31, 2002,
to $32.7 million for the nine months ended March 31, 2003. The increase in
non-acquisition related depreciation and amortization is the result of continued
investment in new product innovations and fixed assets necessary to support the
continued growth of the company.
Impairment of Intangible Assets. In the quarter ended December 31,
2001, we recorded charges totaling $155.1 million for the impairment of
intangible assets. This was the combined result of a charge of $107.4 million
for the impairment of goodwill associated with our acquisition of BlueGill
Technologies in April 2000 (currently referred to as CheckFree i-Solutions), and
of $47.7 million for the retirement of certain technology assets we acquired
from TransPoint in September 2000.
Upon successful integration of BlueGill Technologies into the
operations of our Software business, during fiscal 2001, we established a
revenue budget for fiscal 2002 that anticipated continued rapid growth in
software license sales. We experienced a drop in demand for electronic billing
software during the quarter ended September 30, 2001; however, we did not
believe this would impact our longer-term expectations for this product line
and, therefore, in our estimation, there was no impairment at that time. When
software sales declined again in the quarter ended December 31, 2001, we
reevaluated our long-term expectations and viewed this as a triggering event
that required evaluation of possible impairment per the guidelines of SFAS 121,
"Accounting for the Impairment of Long-Lived Assets to be Disposed of." Our
tests relative to the total tangible and intangible assets related to the
i-Solutions product line revealed that the assets were in fact impaired. This
resulted in a charge of $107.4 million to write down the value of goodwill
related to the acquisition of BlueGill.
As part of the acquisition of TransPoint in September 2000, we were
contractually required to maintain the TransPoint operating technology for up to
three years for any customer that wished to remain on the system. When valuing
the TransPoint assets, we established an intangible asset for current technology
and assigned it a three-year life. By December 31, 2001, we had migrated all of
the subscribers, billers and CSPs to our Genesis platform and the last of our
international partners gave notice of their intention to cancel their
maintenance agreement with us during the December 2001 quarter. Additionally, we
had recently concluded that components of the TransPoint technology were not
compatible with current or future planned initiatives. We viewed these as
triggering events that required the evaluation of possible impairment per SFAS
121. Our overall testing indicated that there was no impairment of the
TransPoint assets in general; however, we then evaluated SFAS 121 requirements
related to the retirement of assets and identified two technologies for which we
had no future use. We retired these two technologies, resulting in a charge of
$47.7 million in the quarter ended December 31, 2001.
Reorganization Charge. In January 2002, we announced our plans to close
our customer care facility in San Francisco, effective April 30, 2002, which
resulted in the termination of employees at that facility. At that time we also
announced our intent to eliminate certain of our financial planning products
within our Investment Services division, which also resulted in a small
reduction of employees in our Raleigh, North Carolina office. On March 19, 2002,
we further announced the closing of our Houston and Austin, Texas offices, our
Ann Arbor, Michigan office and our Singapore office, combined with a net
reduction in force totaling 450 employees. As a result of those actions, we
incurred a charge of $15.9 million consisting primarily of severance and related
employee benefits and lease termination fees. We accounted for these actions in
accordance with Emerging Task Force (EITF) 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity."
Through March 31, 2003, we have not incurred a material change in actual costs
from our initial estimates.
Interest. Net interest decreased from net interest expense of $1.3
million for the three months ended March 31, 2002, to net interest expense of
$1.6 million for the three months ended March 31, 2003. Net interest decreased
21
from net interest expense of $3.0 million for the nine months ended March 31,
2002, to net interest expense of $4.1 million for the nine months ended March
31, 2003. Net interest is composed of interest income, offset by interest
expense.
Interest income decreased from $1.9 million for the three months ended
March 31, 2002, to $1.6 for the three months ended March 31, 2003, and decreased
from $6.6 million for the nine months ended March 31, 2002, to $5.7 million for
the nine months ended March 31, 2003. A significant increase in average invested
balances has been more than offset by a 90 basis point decrease in average
yields on a quarter over quarter and year over year bases.
Interest expense increased slightly from $3.1 million for the three
months ended March 31, 2002, to $3.2 million for the three months ended March
31, 2003, and from $9.6 million for the nine months ended March 31, 2002, to
$9.8 million for the nine months ended March 31, 2003. The increase in interest
expense is due primarily to an increase in long-term lease obligations since
last year. Anchored by the fixed rate of 6.5% on our $172 million of outstanding
convertible debt, average interest rates have remained stable for us over these
periods.
Loss on Investments. Due primarily to a decline in the market value of
one of our investments in a private imaging company, which has been below our
book value for over six months, we judged this to be an "other than temporary"
decline in the market value and, accordingly, in the quarter ended March 31,
2003, we recorded a charge of $1.3 million to reflect the loss. Due to a decline
in the market value of our investment in Billserv Inc., which had been below our
book basis for over six months at the time, we also judged this to be an "other
than temporary" decline in the investment and in the quarter ended December 31,
2002, we recorded a charge of $1.9 million to reflect the loss.
Income Taxes. We recorded an income tax benefit of $19.2 million, with
an effective rate of 19.8%, for the three months ended March 31, 2002, and an
income tax benefit of $6.8 million, with an effective rate of 46.3% for the
three months ended March 31, 2003. We recorded an income tax benefit of $87.1
million, with an effective rate of 18.6%, for the nine months ended March 31,
2002, and an income tax benefit of $25.2 million, with an effective rate of
43.9%, for the nine months ended March 31, 2003. Our prior year results included
the impact of non-deductible goodwill amortization expense. With our adoption of
SFAS 142 in July 2002, we stopped amortizing goodwill. Our resulting tax rate in
fiscal 2003 is now more in line with a blended statutory rate of about 40%, with
the exception of estimated research and experimental tax credits that we have
recorded in the current year.
Cumulative Effect of Accounting Change. On July 1, 2002, we adopted
SFAS 142, "Goodwill and Other Intangible Assets." SFAS 142 changes the
accounting for goodwill and other intangible assets. Goodwill is no longer
subject to amortization over its estimated useful life. Rather, goodwill is
subject to at least an annual assessment for impairment by applying a
fair-value-based test.
In accordance with SFAS 142, we were required to perform a transitional
impairment test. The test was performed as of July 1, 2002. This impairment test
required us to (1) identify our reporting units, (2) determine the carrying
value of each reporting unit by assigning assets and liabilities, including
existing goodwill and intangible assets, to those reporting units, and (3)
determine the fair value of each reporting unit. If the carrying value of any
reporting unit exceeded its fair value, then the amount of any goodwill
impairment was determined through fair value analysis of each of the assigned
assets (excluding goodwill) and liabilities.
As a result of the transitional impairment test, we determined that
goodwill associated with our i-Solutions reporting unit was impaired. We
recorded an impairment charge of $2.9 million and reflected it as a cumulative
effect of a change in accounting principle in the Unaudited Condensed
Consolidated Statement of Operations during the three- month period ended
September 30, 2002. Refer to Note 3. "Goodwill and Other Intangible Assets" in
the Notes to Unaudited Condensed Consolidated Unaudited Financial Statements For
the Three and Nine Months Ended March 31, 2002 and 2003, for further discussion
regarding the current year and expected future impact of this change on our
depreciation and amortization expense.
22
SEGMENT INFORMATION
The following table sets forth revenue and operating income (loss) by
industry segment for the periods noted (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
---------------------------- ----------------------------
2002 2003 2002 2003
------------ ------------ ------------ ------------
(IN THOUSANDS)
REVENUE:
Electronic Commerce...................... $ 89,773 $ 104,521 $ 260,240 $ 299,337
Investment Services...................... 20,014 20,439 59,111 60,907
Software................................. 14,799 16,341 43,248 46,797
------------ ------------ ------------ ------------
Total revenue..................... $ 124,586 $ 141,301 $ 362,599 $ 407,041
============ ============ ============ ============
OPERATING INCOME (LOSS):
Electronic Commerce...................... $ 9,390 $ 31,881 $ 16,444 $ 83,419
Investment Services...................... 6,882 5,642 17,717 16,269
Software................................. 2,539 5,116 3,229 12,139
Corporate................................ (7,984) (8,344) (27,359) (24,450)
Purchase accounting amortization......... (90,293) (45,990) (304,721) (138,304)
Impairment of intangible assets ......... -- -- (155,072) --
Reorganization charge.................... (15,871) -- (15,871) --
Impact of warrants....................... -- -- -- 644
------------ ------------ ------------ ------------
Total operating loss.............. $ (95,337) $ (11,695) $ (465,633) $ (50,283)
============ ============ ============ ============
ELECTRONIC COMMERCE. Revenue in our Electronic Commerce business increased
by $14.7 million, or 16%, from $89.8 million for the three months ended March
31, 2002, to $104.5 million for the three months ended March 31, 2003. Revenue
increased by $39.1 million, or 15%, from $260.2 million for the nine months
ended March 31, 2002, to $299.3 million for the nine months ended March 31,
2003. The increase in revenue over both periods of time is driven primarily by
an increase in transaction volume.
At the end of our 2002 fiscal year, we introduced a series of
transaction-based metrics designed to help investors better understand trends in
our revenue base. We offer two levels of electronic billing and payment services
to our customers. Customers that utilize our Full Service offering outsource
all, or a portion of, their electronic billing and payment process to us. For
instance, a Full Service customer might not use a CheckFree hosted user
interface, but still use our full array of services, including payment
processing, payment warehouse, claims processing, e-bill, on-line proof of
payment, customer care, and other aspects of our service. Also, while a Full
Service customer might build its own payment warehouse, we maintain a customer
record and payment history within our payment warehouse to support the Full
Service customer's servicing needs. Customers in the Full Service category may
contract to pay us either on a per-subscriber basis, a per-transaction basis, or
a combination of both. Customers that utilize our Payment Services offering
receive a limited subset of our electronic billing and payment services.
Additionally, within the Payment Services offering, we provide services to
billers for electronic bill delivery and hosting services, as well as other
payment services such as account balance transfer.
A third category of revenue we simply refer to as Other Electronic
Commerce. Other Electronic Commerce includes our Health and Fitness business and
other ancillary revenue sources, such as CSP and biller implementation and
consulting services. The following table provides a historical trend of revenue,
underlying transaction metrics, and subscriber metrics where appropriate, for
the Electronic Commerce business:
23
THREE MONTHS ENDED
------------------------------------------------------
12/31/01 3/31/02 6/30/02 9/30/02 12/31/02 3/31/03
-------- ------- ------- ------- -------- -------
(In millions)
FULL SERVICE RELATIONSHIPS
Revenue ......................................................... $ 67.2 $ 71.1 $ 74.1 $ 71.6 $ 75.1 $ 81.5
Active subscribers............................................... 2.7 2.9 3.1 3.2 3.5 3.9
Transactions processed........................................... 60.9 65.5 69.0 67.2 74.9 80.3
PAYMENT SERVICE RELATIONSHIPS
Revenue ......................................................... $ 10.2 $ 10.3 $ 10.7 $ 14.7 $ 13.9 $ 12.8
Transactions processed........................................... 15.5 16.9 18.9 29.5 30.1 31.6
OTHER ELECTRONIC COMMERCE
Revenue ......................................................... $ 8.2 $ 8.3 $ 9.8 $ 9.7 $ 9.2 $ 10.3
Non-cash warrant impact on revenue .............................. -- -- $ (2.7) $ 0.6 -- --
TOTALS
Electronic Commerce revenue...................................... $ 85.6 $ 89.7 $ 91.9 $ 96.6 $ 98.2 $104.6
Transactions processed .......................................... 76.4 82.4 87.9 96.7 105.0 111.9
We experienced generally steady growth in Full Service revenue, active
subscribers, and transactions processed until the September 30, 2002 quarter.
During the quarter ended September 30, 2002, one of our larger customers, Wells
Fargo, converted from a Full Service relationship to a Payment Service
relationship. Approximately 300,000 active subscribers and their related
transactions switched categories. Although Payment Service transactions generate
less revenue per transaction, because we provide less service, the cost per
transaction is less as well. While the shift of a customer to Payment Service
from Full Service will reduce revenue, we do not expect such a shift to have a
significant impact on our operating margin over time. Although Bank of America
accounts for over one third of our active Full Service subscribers, growth in
active subscribers and transactions processed are the result of broad growth
throughout the channel. CSP customer pricing in this category can be based on
transactions processed, the number of subscribers, or a combination of both.
Additionally, in order to share the benefits associated with scale efficiencies,
pricing is tiered in nature, whereby a customer exceeding predetermined volumes
is eligible for a lower price on a going forward basis. In addition, the mix of
customers utilizing transaction versus subscriber based pricing will have an
impact on revenue per transaction. In the latter half of the quarter ended
December 31, 2002, Bank of America reached a pricing tier discount level, and we
expect them to reach a second pricing tier discount early in the quarter ended
June 30, 2003. Our pricing with Bank of America is based on active subscribers.
In addition, as previously described, we anticipate reductions in subscribers
and/or transactions from Full Service customers Wachovia and Bank One over the
remainder of this fiscal year and fiscal 2004, which will result in lower
revenue from these customers.
We experienced moderate growth in revenue and transactions processed in the
Payment Service category until the quarter ended September 30, 2002. As
previously mentioned, Wells Fargo converted from a Full Service relationship to
a Payment Service relationship, which caused the significant increase in revenue
and transactions in this category. We