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
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
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
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
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
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. |
