UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
X Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
- --- Act of 1934 for the fiscal year ended Sept. 30, 2004
Transition Report Pursuant to Section 13 or 15(d) of the Securities
- --- Exchange Act of 1934
Commission File Number 0-15245
ELECTRONIC CLEARING HOUSE, INC.
(Exact name of registrant as specified in its charter)
NEVADA 93-0946274
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
730 PASEO CAMARILLO, CAMARILLO, CALIFORNIA 93010
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (805) 419-8700, fax number:
(805) 419-8689
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
TITLE OF EACH CLASS ON WHICH REGISTERED
------------------- ---------------------
None None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.01 par value
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. X
---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes No X
--- ---
The aggregate market value of the voting stock held by non-affiliates of
the Registrant, based upon the closing sale price of the Common Stock on March
31, 2004 as reported on the NASDAQ SmallCap Market, was approximately
$60,535,000. Shares of Common Stock held by each officer and director have been
excluded in that such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily a conclusive determination
for other purposes.
As of December 13, 2004, Registrant had outstanding 6,472,331 shares of
Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE - NONE
ELECTRONIC CLEARING HOUSE, INC.
2004 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
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PART 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
ITEM 1. Business. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
ITEM 2. Properties. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
ITEM 3. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
ITEM 4. Submission of Matters to a Vote of Security Holders . . . . . . . . . . . . . . . . . 15
PART II . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
ITEM 5. Market for Registrant's Common Equity and Related Stockholder Security Matters. . . . 16
ITEM 6. Selected Consolidated Financial Data. . . . . . . . . . . . . . . . . . . . . . . . . 16
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 18
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk. . . . . . . . . . . . . . 31
ITEM 8. Financial Statements and Supplemental Data. . . . . . . . . . . . . . . . . . . . . . 31
ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures 31
ITEM 9A. Controls and Procedures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
ITEM 9B. Other Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
PART III . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33
ITEM 10. Directors and Executive Officers of the Registrant. . . . . . . . . . . . . . . . . . 33
ITEM 11. Executive Compensation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37
ITEM 12. Security Ownership of Certain Beneficial Owners and Management. . . . . . . . . . . . 40
ITEM 13. Certain Relationships and Related Transactions. . . . . . . . . . . . . . . . . . . . 42
ITEM 14. Principal Accounting Fees and Services. . . . . . . . . . . . . . . . . . . . . . . . 42
PART IV . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44
ITEM 15. Exhibits, Financial Statement Schedules and Reports on Form 8K. . . . . . . . . . . . 44
2
PART 1
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
---------------------------------------------------------
This 2004 Annual Report on Form 10-K contains statements which constitute
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. Those statements include statements regarding our intent, belief or
current expectations. Examples of forward-looking statements include statements
regarding our strategy, financial performance and revenue sources. Prospective
investors are cautioned that any such forward-looking statements are not
guarantees of future performance and involve risks and uncertainties, and that
actual results may differ materially from those projected in the forward-looking
statements as a result of various factors, including, but not limited to, those
set forth elsewhere in this Annual Report. See "Item 7. Management's Discussion
and Analysis of Financial Condition and Results of Operations - Risk Factors."
ITEM 1. BUSINESS
OVERVIEW
Electronic Clearing House, Inc. is an electronic payment processor that provides
for the payment processing needs of merchants, banks and collection agencies.
We derive the majority of our revenues from two main business segments, bankcard
and transaction processing services ("bankcard services"), whereby we provide
solutions to merchants and banks to allow them to accept credit and debit card
payments from consumers, and check-related products ("check services"), whereby
we provide various services to merchants and banks to allow them to accept and
process check payments from consumers. The principal services we offer within
these two segments include, with respect to our bankcard services, debit and
credit card processing, and with respect to our check services, check guarantee
(where, if we approve a check transaction and a check is subsequently dishonored
by the check writer's bank, the merchant is reimbursed by us), check
verification (where, prior to approving a check, we search our negative and
positive check writer database to determine whether the check writer has a
positive record or delinquent check-related debts), electronic check conversion
(the conversion of a paper check at the point of sale to a direct bank debit
which is processed for settlement through the Federal Reserve System's Automated
Clearing House ("ACH") network; the ACH is the electronic banking network
through which a majority of electronic funds transfers are made in the United
States), check re-presentment (where we attempt to clear a check on multiple
occasions via the ACH network prior to returning the check to the merchant so as
to increase the number of cleared check transactions), and check collection
(where we provide national scale collection services for a merchant or bank).
We operate our services under the following brands:
- MerchantAmerica, our retail provider of all payment processing
services to both the merchant and bank markets;
- National Check Network ("NCN"), our proprietary database of negative
and positive check writer accounts (i.e., accounts that show
delinquent history in the form of non-sufficient funds and other
negative transactions), for back-end check verification, check
authorization and check capture services, and for membership to
collection agencies; and
- XPRESSCHEX, Inc. for retail check verification, check conversion,
Automated Clearing House services (which we describe in greater detail
below), check collection and check guarantee services.
- ECHO, for wholesale check processing services offered to Visa banks
under the Visa POS Check Service program.
We discuss our services in greater detail below. Overall, our ability to
program and oversee the management of a merchant's point-of-sale system, provide
credit card and debit card processing, provide multiple check services for the
processing of checks, provide both electronic and traditional collection
services, and fully integrate all of these services into a single Internet-based
reporting capability allows us to provide for the majority of the payment
processing needs of our customers.
3
We were incorporated in Nevada in December 1981. Our executive offices are
located at 730 Paseo Camarillo, Camarillo, California 93010, and our telephone
number is (805) 419-8700. Our common stock is traded on the NASDAQ SmallCap
Market under the ticker symbol "ECHO." Information on our website,
www.echo-inc.com, does not constitute part of this annual report.
HISTORY OF THE COMPANY
ECHO has been offering bankcard and check services for over 18 years. We were
incorporated in Nevada in 1981 under the name Bio Recovery Technology, Inc. and
changed our name to Electronic Clearing House, Inc. with the acquisition of a
credit card processing company, Electronic Financial Systems, Inc. in January
1986. In 1986, ECHO developed the capability, utilizing the Federal Reserve
System's Automated Clearing House ("ACH"), a network which serves as a
nationwide, wholesale electronic payment and collection system by way of
transferring funds between banks via the Federal Reserve System, to deposit
funds into any U.S. bank of the merchant's choice. This development made it
possible for remote banks and processors to provide the same processing services
previously available only through the merchant's local bank.
In 1999, ECHO acquired Magic Software Development, Inc., a check processing
company located in Albuquerque, New Mexico, that serviced National Check Network
("NCN"), an association of approximately 60 affiliated collection agencies
across the nation. At the time, we provided a check guarantee service that only
served California merchants, but with the addition of Magic's check processing
capabilities, our check guarantee services have been offered on a national basis
since 1999. In fiscal 2000, Magic's corporate name was changed to XPRESSCHEX
and all XPRESSCHEX activity was moved to our XPRESSCHEX subsidiary. XPRESSCHEX
provides and promotes its check and ACH services to other processors and sales
organizations in addition to ECHO.
In November 1999, we acquired Peak Collection Services, a collection agency in
Albuquerque, New Mexico, and incorporated Peak into our XPRESSCHEX operations as
our Collection Division in December of 1999. Through filings and individual
testing, the XPRESSCHEX Collection Division has completed registration as a
collection agency in 48 of 50 states to date. Having a fully integrated,
nationally approved collection service allows XPRESSCHEX to operate as a central
check clearing facility for NCN's 260 collection agencies without each agency
having to authorize such activity.
In January 2000, we acquired Rocky Mountain Retail Systems ("RMRS") located in
Boulder, Colorado, which provided a national check verification service to over
200 collection agencies across the nation. RMRS maintained a national check
database of negative and positive check writer records.
In December 2000, we signed an agreement with Visa U.S.A. to participate in a
point-of-sale check processing pilot program as both an "Acquirer Processor" (a
role that accepts transactions from a merchant's point-of-sale terminal and
reformats them for submission to the Visa network) and as a "Third-Party
Processor" (a role that approves or declines checks written on accounts of banks
not yet participating in the Visa POS Check Service program and deposits
approved funds utilizing the Federal Reserve System's Automated Clearing House).
Under the program, any one of over 14,000 Visa member banks can offer various
check processing services to their merchants and utilize Visa's dedicated
communications network and banking relationships to clear check activity using
direct debits from the check writer's account. In July 2001, several major
financial institutions began participating in the pilot program. The program was
released from pilot in December of 2002 and, as of September 2004, nine
financial institutions were using ECHO as their Acquirer Processor and sixteen
financial institutions were using ECHO as their Third-Party Processor.
In May 2001, we acquired the assets of National Check Network ("NCN") and
combined the NCN positive and negative check writer records with the RMRS
database, resulting in a combined database of over 120 million check writer
records which identify the positive and negative check writing activities
occurring with individual check writers (including information related to
accepted checks, bounced checks, and the frequency of delinquent transactions).
This database is ever-growing with additional contributions daily.
4
Also in May 2001, ECHO launched MerchantAmerica.com, a web-based source of
financial information whereby an ECHO merchant can access its transactional
history, bank information, significant business and office-related services and
even build an online store and accept payment in the form of credit cards or
checks. The site also contains a national Merchant Directory that is free to any
merchant in the United States. It also provides any merchant in the United
States with the ability to edit and enhance their directory listing. While we
believe that MerchantAmerica.com is a valuable and cost-effective resource for
merchants, it also provides us with a low-cost method of keeping our merchants
informed and involved with us.
OUR SERVICES
BANKCARD AND TRANSACTION PROCESSING SERVICES
Services
- --------
With our bankcard and transaction processing services, we provide payment
solutions to merchants and banks to allow them to accept credit and debit card
payments from consumers. Our bankcard and transaction processing services
include the following:
Debit and Credit Card Payment Processing
MerchantAmerica, our retail provider of payment processing services to both the
merchant and bank markets, currently provides 24-hour daily payment processing,
"800" number access to customer service personnel and, as needed, various field
support services. Utilizing one of several methods of access to us, the
merchants' systems dial our host computers and receive credit card and debit
card authorizations, which have been electronically verified. Electronic files
are then transmitted daily by MerchantAmerica to the major credit card
organizations or to the ACH, which subsequently transfer funds from the banks to
MerchantAmerica's processing bank, which then deposits the funds into the bank
of the merchant's choice. On average, ECHO deposits funds to over 600 banks
across the nation on behalf of its merchant base each day.
Our software programs capture the transactions, retain data and enable merchants
to review, reconcile and edit transactions. MerchantAmerica's customer service
efforts include a terminal loaner program to minimize downtime, frequent sales
and activity reports, and sophisticated security services utilizing the
merchant's terminal, our host computers and assistance in the field.
Additionally, MerchantAmerica utilizes several advanced telecommunications
capabilities to provide consistent and reliable services to its merchants.
Other Payment Processing Services
We also provide various services related to our debit and credit card payment
processing, including:
- Internet Processing - ECHO allows merchants to process payment
transactions online with immediate processing, online reporting and
security services that protect the cardholder, merchant and Internet
Service Provider ("ISP") from fraud.
- Batch File Processing - ECHO allows mail order, telephone order or
direct marketing merchants to process and transmit hundreds of
thousands of payments at a time by using Microsoft Excel(R), Access(R)
or any other program that can create a "flat file" of data. In this
process, the merchant can visit the ECHO Merchant Center, log on with
its PIN and merchant number, and then upload the file to ECHO's
processing center. The transactions are processed immediately, with
reporting available almost immediately to provide response data on
each transaction.
Deriving Revenues
- ------------------
Bankcard and transaction processing services provide for the majority of our
revenues. For the year ended September 30, 2004, bankcard and transaction
processing accounted for approximately 76% of our revenues. Bankcard and
transaction processing volume rose 9.5% in fiscal 2004, from $961,248,000 in
fiscal 2003 to $1,052,588,000 in fiscal 2004, and revenue increased
approximately 11.5%, from $32,444,000 in fiscal 2003 to $36,161,000 in fiscal
2004.
In a typical transaction, ECHO receives a percentage-based fee on the dollar
amount processed and a transaction fee on the number of transactions processed.
ECHO's revenue for debit/credit card processing is derived primarily
5
from three sources: the merchant's discount rate, the merchant's transaction fee
and set monthly fees. The discount rate is expressed as a percentage of the
amount being processed and is deducted from the amount of each transaction
submitted by the merchant, while the net amount is deposited into the merchant's
bank account.
Discount rates range between 1.5% and 4.5%, and our average discount rate is
2.4%, which is consistent with our rates for the year ended September 30, 2003.
Depending upon the discount rate and the cost of clearing interchange, about 75%
to 90%, and about 85% on average, of the discount rate revenue is paid to
card-issuing banks and organizations and the sponsoring bank.
A transaction fee is charged for each transaction processed and ECHO's average
transaction fee in fiscal 2004 was $0.20 per transaction, compared to $0.19 in
fiscal 2003. We charge our bankcard merchants a range from $0.15 up to $0.32 per
transaction, depending on the type of transaction and merchant. Larger customers
tend to pay lower transaction fees given the volume of business they provide.
Both Visa and MasterCard have instituted $0.05 to $0.10 transaction fees on each
transaction processed that ECHO is required to pay. On average, ECHO pays
approximately $0.012 per transaction for communication costs, depending upon the
duration and method of transmission.
The market size for credit card processing is approximately 19 billion
transactions per year, and this number is growing annually. ECHO has a very
small percentage of this market, but we are one of the top 50 credit card
processors according to The Nilson Report, a monthly financial
subscription-based newsletter. Our competitors include First Data Corporation,
the biggest credit card processor in the United States, Certegy, NPC, Global
Payments, and many other smaller payment processors. The credit card processing
market has undergone rapid consolidation, which has raised unique challenges,
including supporting and integrating numerous processing methodologies,
initiating quality customer support and field support services and maintaining
merchant relationships. While merchant portfolios can be purchased by a
processor or a credit card agent bank, merchants are generally under no
contractual obligation to utilize the services of the new owner so many of the
most active consolidators have been experiencing difficulty in maintaining their
number of active merchants.
In an effort to enhance the bankcard transaction processing business segment's
processing infrastructure and control processing costs, we licensed several
payment processing systems from Oasis Technologies in 2002 and a full
integration of this system is currently projected for 2005. While we believe
that our data center is reliable and the costs to operate the MerchantAmerica
program are currently reasonable, no assurance can be made that such favorable
conditions will continue.
In order to engage in Visa and MasterCard processing, a cooperative relationship
is required with a bank that sponsors the Visa and MasterCard transactions.
ECHO's primary processing bank relationship is with First Regional Bank of Los
Angeles, California. As a result of its relationship, ECHO is a registered
Independent Sales Organization and Merchant Service Provider with Visa and
MasterCard, respectively, which allows us to solicit and support merchants
utilizing our services. We have an agreement with First Regional Bank, which
continues our relationship through 2005. Pursuant to the terms of the agreement,
among other matters, we market and sell merchant services and the bank provides
various support services in connection with individual transactions, in exchange
for our payment to the bank, on a monthly basis, of either a payment of $0.02
per transaction, or 10 basis points of the bankcard processing volume, depending
on the merchant and/or processing volume requirements. The agreement does not
allow either party to terminate other than for cause (as defined in the
agreement) without incurring liability for breach of the agreement.
CHECK-RELATED PRODUCTS (OR "CHECK SERVICES")
Overview
- --------
ECHO has invested significant resources and management focus in its check
services business. Check services revenue increased approximately 39.4% in
fiscal 2004, from $8,192,000 for fiscal 2003 to $11,423,000 for fiscal 2004.
Revenues from ACH and check conversion are all increasing significantly. Visa
officially released its POS Check Service as of December 2002 and several
national banks have since approved the program to be offered to their merchants.
Therefore, ECHO anticipates continued growth in check services as the marketing
efforts of participating banks in the Visa Program become more widely
implemented. (See also the discussion of the Visa POS Check Service program
below.)
6
Services
- --------
With our check services, we provide various services to merchants and banks to
allow them to accept and process check payments from consumers. Our check
services include the following:
Check Verification
For a fee, we will search NCN, our proprietary database of negative and positive
check writer accounts, attempting to match a specific piece of information, such
as a driver's license number or Magnetic Ink Character Recognition ("MICR")
number (the numeric data along the bottom of a check), provided by a merchant. A
match may identify whether the check writer has a positive record or delinquent
check-related debts. Upon notification of this match (via a coded response from
the provider), the merchant decides whether to accept or decline the check.
Verification reduces the risk of accepting a bad check for the merchant,
however, in providing this program alone, we typically offer no guarantee that
the check will be honored by the check writer's bank and make no promise of
reimbursement if the check is dishonored by the bank. Revenue from check
verification is derived from fees collected from the merchants when a check is
verified against our positive and negative check database. This revenue is
recognized when the transaction is processed, since we have no further
performance obligations.
Check Guarantee
With this service, if we approve a check transaction and a check is subsequently
dishonored by the check writer's bank, the merchant is reimbursed by us and we
acquire rights to collect the delinquent amount from the check writer.
The principal risk of providing this service is the risk of ever collecting the
amount we guarantee from a delinquent check writer whose check transaction was
dishonored by his or her own bank. If we are unable to collect the amount, we
lose that amount. On average, we usually collect on 50-60% of the amounts we
guarantee that have become delinquent. Given the risks associated with check
guarantee, especially for large volume merchants, we exercise strict risk
parameters with the merchants to which this service is offered. We typically
apply several risk management approaches with this service, which include
searching NCN's database against the data provided by the merchant, and
"scoring" each transaction according to several factors such as velocity (the
number of times a check writer has been searched in a certain period of time),
prior activity (historic negative or positive transactions with the check
writer), check writer's presence in other databases (these national databases
are selectively searched based upon the size of the check and the prior activity
with the check writer), size of the check, and historic bad check activity by
geographic and/or merchant specific locations, to name a few. If our scoring
system concludes that the risk is too high, we issue a coded response
instructing the merchant that we will not guarantee the check. If our scoring
system results in a positive result, a coded response advises the merchant that
we have guaranteed payment on that item.
Electronic Check Conversion ("ECC")
Check conversion is the ability to convert a paper check to an electronic item
at the point of sale. ECC is a relatively new system of check settlement that
is quickly gaining merchant acceptance. Under the program, the merchant slips a
customer's check either through a check reader that reads the MICR line on the
check or a check imager that records the total image of the face of the check
and the merchant enters the amount of the check into the system. The merchant
has the customer sign a receipt, much the same as in a credit card transaction,
and gives a copy of the signed receipt along with the check to the customer. The
electronic image, captured by the reader, is sent to our processing center and
we settle the check transaction electronically. Merchants' customers like this
new system because they get their check back immediately and still have a hard
copy receipt of the transaction. Banks like ECC because no paper has to be
handled by the bank to settle the transaction. While large national merchants
already have check-reading equipment, small merchants will adopt the system only
if their check volume justifies the capital investment in equipment, ranging
from $150 to $600 per reader.
Check Re-Presentment
The Federal Reserve System's Automated Clearing House ("ACH") provides the tools
to electronically present, re-present and settle funds between banks. Our check
re-presentment program allows a merchant to advise its bank that a returned
check should be sent to the XPRESSCHEX data processing center in Albuquerque,
New Mexico, rather than returned to the merchant. Upon receipt, XPRESSCHEX
converts the check to an electronic ACH
7
transaction for resubmission through the ACH network and marks the check for
possible collection activity, should it become necessary. One feature a
merchant may choose is to time the re-presentment so as to coincide with a check
writer's typical payday to better the odds of collection. Generally, the full
face value of the check is returned to the merchant upon collection and a
collection fee charged to the check writer, usually in the range of $15 to $25,
is retained by XPRESSCHEX as payment for its services.
Internet Check, Batch Check and Virtual Terminal
A check can be presented as a form of payment over the Internet and we support
the multiple types of ACH entry classes. XPRESSCHEX allows an e-commerce site
to accept a check as payment, allows a batch of check data to be sent
electronically for processing (this is commonly used by mail order or phone
order businesses) and allows both verification-only and ACH transactions to be
submitted by merchants via a secure logon and passcode connection over the
Internet.
Visa POS Check Service Program ("Visa Program")
- -----------------------------------------------------
The Visa Program represents a major new initiative by Visa to enable merchants
to receive direct online authorization for checks written against consumer
checking accounts, similar to the authorizations provided for credit and debit
card transactions. The Visa Program was offered as a pilot program by Visa to
its member banks from December of 2000 to December of 2002 over which time
several banks electronically connected their check writer data to the Visa
network, making verification of the check writer's bank account balance possible
when checks drawn on these select banks were processed. In December of 2002, the
program was officially released out of pilot. As of November 2004, approximately
12% of checking accounts in the United States are electronically connected to
the Visa network through the banks that are now participating in the Visa
Program. This number is expected to increase to 30% or higher over the coming
year as more banks connect their check writer data with Visa. ECHO has invested
significant resources and management focus in its check services business,
particularly with respect to the Visa Program, and anticipates continued growth
in check services as the marketing efforts of participating banks in the Visa
Program become more widely implemented.
As described above, "check conversion" is the ability to convert a paper check
to an electronic item at the point of sale. The Visa Program provides Visa
member banks with a check conversion service that they can sell to their bank
merchants. The Visa check conversion service allows the merchant to get an
immediate authorization or decline on a check while the check writer is at the
checkout counter. If the check is approved, the service allows the merchant to
immediately return the paper check to the check writer since the funds will be
electronically withdrawn from the check writer's account and deposited into the
merchant's account.
Being able to approve or decline a check in real time at the point of sale
requires some method to verify the check writer has either an adequate balance
in the bank to cover the check or, if that is not possible, to verify if the
check written has a match in a negative check account database. In order to
provide this check service on 100% of the checks received by a merchant, Visa
needed a solution to approve or decline (and for those approved, electronically
deposit) the checks that processed through the program on a bank that had not
yet connected its check writer data to the Visa network. We are currently one
of two companies that provide this service to Visa as a Third-Party Processor.
When a Visa member bank signs up to offer the Visa Program to its merchants, it
chooses a Third-Party Processor from the certified providers and, to date, ECHO
serves as a Third-Party Processor for sixteen financial institutions actively
participating in the program.
When Visa receives electronic check data from a merchant and the bank upon which
the check is drawn has not connected its check writer data to the Visa network,
Visa routes that check to the Third-Party Processor that was chosen by the
merchant's bank when they set up the program. The Third-Party Processor
authorizes or declines a check based upon the negative and positive data
contained in several national check account databases that are commercially
available and, for those transactions that are approved, the Third-Party
Processor will electronically move the funds from the check writer's account to
either the merchant bank's master clearing account or directly to the merchant's
banking account (depending on the bank's desired settlement method) utilizing
the Automated Clearing House ("ACH"), a funds settlement service offered through
the Federal Reserve Bank.
In addition to being a Third-Party Processor, we are one of only five companies
that are currently certified as an Acquirer Processor with Visa, a role that
accepts transactions from the merchant's point-of-sale terminal/systems and
reformats them for submission to the Visa network. We are chosen by nine banks
currently in the program to serve as their Acquirer Processor. Most banks
presently in the Visa Program are large national or regional banks
8
and already had terminal management service providers that could act as Acquirer
Processor for the Visa Program. In the future, as smaller banks make the
decision to enter the Visa Program, it is expected that many will have no prior
relationship with a terminal management provider and therefore, may potentially
choose us as their Acquirer Processor.
We derive transaction revenue in our role as a Third-Party Processor and/or
Acquirer Processor by negotiating a transaction fee with Visa and/or the bank
that chose us as its Third-Party Processor and/or Acquirer Processor. This
transaction fee averages $0.09 per transaction. The party that sells the
service to the merchant (usually the bank) enjoys the largest mark-up on the
product, offering the service in the range of $0.30 to $0.60 per check, with
external cost in the $0.12 to $0.20 range, depending on what the bank negotiates
with Visa and any third-party provider.
We entered into a sponsorship agreement with our primary credit card processing
bank, First Regional Bank, to enable us to sell the Visa Program directly to
merchants with an obligation to pay a small transaction fee per check to the
bank. This allows the bank to realize added revenue, allows us to realize
higher revenues in a marked-up pricing model, and a portion of the mark-up to be
used to compensate and motivate resellers of our products and services to offer
the Visa Program to merchants in the marketplace. The balance of the mark-up
after paying the bank and the sales organization would be additional revenue to
us. This will also enable us to use our direct sales channels to provide the
Visa Program to ECHO's current and potential merchant base.
The Visa infrastructure requires ECHO to coordinate and integrate its services
with several parties and systems. As part of the Visa Program, we have written,
tested and installed special merchant terminal software that meets specified
Visa Program requirements and certified our terminal and host response code with
Vital Processing Services, a major provider of terminal services to many major
banks. ECHO has also developed special add-on services and reporting for
specific banks or select merchants that desired to participate in the Visa
Program. Additionally, ECHO has designed and is implementing several risk
management tools that contribute to the significant reduction in net bad debt
seen by a retailer, making the Visa Program a true competitive alternative to
guarantee services.
Deriving Revenues
- ------------------
For the past several years, we have invested significant resources and
management focus in our check services business which provides various services
to merchants and banks to allow them to accept and process check payments from
consumers. This business segment comprised approximately 24% of our total
revenues for the fiscal year ended September 30, 2004. As an individual
segment, check-related revenue increased by 39.4% to $11,423,000 in fiscal 2004
from $8,192,000 for fiscal 2003.
ECHO's revenue in check services can come from several sources. Typically, the
merchant pays either a fixed fee for each transaction (verification, conversion,
etc.) or a fee based on the face amount of the check (check guarantee) or both
(check guarantee). In the Visa model, ECHO can receive transaction fees for
providing "third-party" services to Visa banks, whereby ECHO assists them in
processing checks from banks not participating in the Visa Program. In
addition, ECHO may serve a Visa bank by being a collector of the transaction
data for the merchant and submitting it to VisaNet, a process referred to as an
"Acquiring Processor". Finally, ECHO can also participate in the mark-up that
is charged on the sales price to a merchant, although this is only earned by
ECHO if its primary sales channels secured the relationship. Additional revenue
is earned if the merchant utilizes ECHO's collection services and it is
primarily derived from the collection fee associated with successful collection
of an item. If ECHO refers a collection item to an NCN member, a small
participation in the collection fee is returned to ECHO through agreement with
the NCN member. Finally, when ECHO provides a guarantee service to a merchant or
a bank, it earns a percentage of every check processed from the merchant or bank
and ECHO's earnings related thereto are directly tied to its success in
collection and its risk management capability.
The NCN database includes over 20 million negative check account records and 100
million positive records. Over 260 affiliated collection agencies continually
contribute to the database to enrich its depth and value. Through its network of
NCN members, ECHO can offer regional collection services and distribute
collection items to one or more of a select group of NCN's member agencies to
maximize a merchant's or bank's ability to collect amounts on a local level.
NCN provides an ongoing revenue stream for ECHO as collection agencies, major
national merchants, banks, other transaction processors, and thousands of small
merchants access the NCN database daily to verify the status of a check writer
in real time. Check verification has been recognized as one of the lowest
9
cost and most effective ways for retailers to lower the risks and losses
experienced in accepting checks as a form of payment. Our NCN database is one of
only four major databases in the nation that can serve this market need on a
national scale, and we are currently the fifth largest check verification
processor in the United States according to the July 2004 issue of The Nilson
Report, a monthly financial subscription-based newsletter. In addition to
operating NCN, we provide a common platform where a business can also access
other major negative check writer databases that are currently available in the
nation.
XPRESSCHEX revenues are growing due to the increased use of our check conversion
services, which include the capture (through digital imaging, or the retention
of specified personal information) of the necessary check data at the point of
sale and submission of the transaction electronically to the Federal Reserve
System's Automated Clearing House for settlement of funds. XPRESSCHEX also
maintains an active collection agency, registered in 48 states, that serves
primarily as a referral agent to select NCN members that are collection agencies
and are located in various regions of the country.
OTHER SERVICES
ECHO had historically generated a small percentage of its revenue from its
terminal business whereby we deployed proprietary software and terminal hardware
in a comprehensive system for real-time credit card authorization, capture and
compilation of compensation data, and in some cases, active management of rental
equipment information. However, we are currently not pursuing the sale of our
proprietary terminal system but rather focusing on our core bankcard and check
services business segments. In fact, in fiscal 2003, we gradually shut down our
terminal deployment operations.
STRATEGY
Overview
- --------
ECHO's strategy is to provide merchants, banks and industry-specific resellers
with electronic connectivity to various payment services in the credit card,
debit card and check-related markets. Our platform of services is very
flexible, enabling merchant customization and scalability to meet the
requirements of high transaction volumes, as well as access to the Visa Program.
ECHO's services enable merchants to maximize revenues by offering a wide variety
of payment options, reducing the costs associated with processing and handling
checks, improving collections and managing risk more effectively. Additionally,
ECHO is committed to customer service and a recent internal survey of customer
satisfaction rates showed an improvement to 4.43 out of a possible 5.0, from
approximately 4.15 in a similar survey taken three years prior.
We have targeted several areas as significant opportunities for growth,
including focusing on retail accounts for check services and developing a
scalable infrastructure to support widespread implementation of the Visa
Program. We also seek to increase profitability of our principal merchant
services by enhancing our back-end technology and identifying and targeting new
low-cost, incremental revenue opportunities, such as active promotion of our
payment services to non-profit organizations.
Promote Check Services for Middle Market Retail Accounts
- --------------------------------------------------------
While ECHO focuses its credit card services to the middle market of retail and
non-face-to-face merchants, our check services business, through various sales
channels like direct sales and sales through authorized resellers, has the
ability to target the full scope of merchants in the marketplace, from the small
merchant that may only require check verification to the national retailers that
require check conversion and national collection services.
With approximately four million merchants in the U.S. and over 95% currently
accepting credit cards as payment, ECHO estimates that approximately 60% of
merchants, or about 2.3 million merchants, that accept credit cards also accept
checks as a form of payment. Furthermore, of the group that accepts checks as a
form of payment, we estimate that only 17% of them have an electronic method to
accept checks and the other 83% accept a paper check and process it in the
traditional manner by taking the check to the bank.
ECHO's estimated market potential for check services is:
10
- Approximately 1.7 million merchants currently accept credit cards, but
do not currently accept checks as a form of payment;
- Approximately 1.9 million merchants currently accept paper checks and
may consider an electronic form of payment;
- Approximately 400,000 merchants currently converting paper checks to
electronic format at the point of sale may consider changing to a
better service and/or lower-cost provider.
While we have the ability to approach all sizes of merchants, efforts will be
focused on working with our sales channels, like direct sales and sales through
authorized resellers, to approach mid-size retail chains that can benefit most
from automating check processing and verification or participation in the Visa
Program. These mid-size accounts typically offer higher margins than larger
accounts and provide a less competitive marketplace. ECHO has recently signed
agreements with several middle market retailers and believes that the pipeline
for prospective customers is growing.
Promote Visa POS Check Service Program
- --------------------------------------
The Visa Program represents a major initiative by Visa to enable merchants to
receive direct online authorization for checks written against consumer checking
accounts, similar to the authorizations provided for credit and debit card
transactions. Given ECHO's role in the early stages of the program and our
investment of significant resources and management focus in our check services
business as a whole, and specifically with respect to the Visa Program, we
anticipate continued growth in check services as the marketing efforts of
participating banks in the Visa Program become more widely implemented.
Overall, as the market gains acceptance of the Visa Program, our opportunities
to market our check collection services, our stand-alone verification services
(not currently part of the Visa Program) and any other check services that we
are able to provide will further solidify our relationships with the various
financial institutions that have chosen us as their Acquirer Processor and/or
Third-Party Processor under the Visa Program. We intend to utilize these
opportunities to expand our check services business.
As of September 2004, sixteen financial institutions actively participating in
the program were using ECHO's services as a Third-Party Processor and are
beginning to actively sell check services to their merchants. One of the current
participating banks sold the Visa Program to a national specialty-clothing
retailer that became active in the Visa Program in June 2003 and now constitutes
the largest single user of the Visa Program to date. This national merchant
participates in the Visa Program by submitting the MICR data in real time and
then returning the paper check to the check writer at the point of sale. All
deposit and collection activity on approved checks is derived from the use of
the numeric check data and, to date, we have been successful in lowering the
retailer's return check percentage to, or below, a competitive level with rates
normally charged by national check guarantee services. Significant savings to
the retailer are therefore derived (1) from the elimination of having to handle
and process paper checks and (2) from the net financial benefit seen from the
bad check write-off percentage falling below the rates charged by the national
guarantee services.
Altogether, ECHO has grown in its knowledge and capability of facilitating the
integration and implementation of the Visa Program for new banks and developing
a standardized, but customizable platform of options based upon its experience
with the banks participating in the Visa Program. The number of project
implementation staff dedicated to the Visa Program has been increased to assist
current and future banks in making the fastest and easiest conversion to the
Visa Program. However, implementation of new banks, at least in the near term,
will rely on the bank's ability to coordinate the integration of its internal
deposit account management system to the Visa Program and this process is
outside of ECHO's realm of responsibilities.
While ECHO believes that the Visa Program has the potential to generate
significant revenues for us in the future, the market potential of this service
is still unproven and its success is dependent on the continuing marketing
support of Visa and its member banks.
11
Promote Merchant Payment Processing for Regional and Community Banks
- --------------------------------------------------------------------
ECHO has identified an under-served, niche market of smaller regional and
community banks for credit card and check payment programs. These banks are
characterized by having an asset base in the $500 million range or less, and/or
equity capital in the $10 to $50 million range. ECHO has developed a service
that allows smaller banks to offer credit card and check processing services on
a private-label basis using our back-end infrastructure with little or no
technical involvement by the bank. Much of the reporting to the merchant
utilizes the Internet as a delivery channel, an environment in which we have
significant experience and knowledge. We estimate that approximately 80% of
merchants are familiar with or connected to the Internet, many from their
personal residences. Due to the high costs and the perceived high risk, most
small banks are either unable or unwilling to compete with national banks in
providing online transaction processing and Internet-based reporting tools to
their merchants. We have designed the program to be adopted by a bank at little
or no cost while it allows the bank to generate revenues and earnings in
competition to those earned by much larger banks that have had to make major
investments in the technology.
This merchant payment processing service, which is marketed under the
MerchantAmerica name, incorporates all of ECHO's web-based features and
functionalities and our full set of services and payment options for the retail
channel. We believe that our fully integrated payment and reporting system
allows smaller banks to enjoy competitive equality with much bigger banks
without making significant investments in technology. It enables banks to
compete feature by feature with the offering of the major banks with no set-up
fee or annual charge to participate. We, in turn, benefit from the increased
processing and transaction revenues. Additional benefits of the MerchantAmerica
program to regional and community banks include the:
- Ability for banks to set processing fees for each merchant;
- Assurance that the bank controls the merchant relationship and
maintains any financial asset value related to ownership; and
- Reduction of fraud risk.
In addition to the benefits that the bank receives from the MerchantAmerica
program, the bank's merchants also receive numerous benefits, including a retail
merchant account for credit cards, debit cards and checks; an online shopping
cart and check-out payment system; sales tracking and online transaction
history; automatic referral to collection agencies; and dedicated customer
service available 24 hours a day, seven days a week.
The program was launched in August 2002 and at the end of fiscal 2004 had 19
participating banks. ECHO estimates that there are 10,000 community banks in
the United States. and no one provider of services has over 10% of the market.
Based on third-party research, we estimate that approximately 6,000 of these
banks do not directly offer bankcard services and the approximately 4,000 that
are affiliated with a service may be responsive to the MerchantAmerica value
proposition.
SALES AND MARKETING
ECHO sells its merchant and check services through several marketing channels,
including independent sales organizations (i.e, authorized resellers of our
products and services), its own internal sales force and direct merchant
referrals by existing merchants. We also offer Merchant Services through a
direct online sales channel, MerchantAmerica. Approximately 20% of our new
accounts have historically been generated through the authorized resellers of
our products and services. In fiscal 2002, ECHO restructured its sales force by
hiring more sales people for its Check Services National Sales Group, which
focuses on selling to major accounts and mid-sized retail chains, and
implementing an incentive-based commission structure with the goal of targeting
specific accounts and shortening the sales cycle. Due to the growing interest
in the Visa Program and being the Third-Party Processor of a national clothing
retailer, we have redirected much of our marketing and sales resources to
aggressively promote the Visa Program.
12
ECHO offers its payment services through several sales channels, including:
- MerchantAmerica - Payment services offered directly to merchants and
to regional and community banks to offer to their local merchants.
MerchantAmerica combines the ECHO credit card services with a full set
of check and collection services.
- Primary Sales Channels - These channels, which include First Regional
Bank sponsored Visa Program, direct merchant sales, Check Services
National Sales, group sales and MerchantAmerica direct merchant sales,
provide the highest margin opportunities.
- Secondary Sales Channels - Banks in the Visa Program, authorized
resellers, NCN Collection Agency Members and MerchantAmerica Agent
Banks are part of the secondary sales channel. These channels offer
lower margins due to the added participation in the overall revenue
such channels require. Currently ECHO has 150 authorized resellers
registered to sell ECHO's check products. NCN has over 260 member
collection agencies that serve over 85,000 merchants and many agencies
are acting as sales agents for ECHO's check services.
Management believes that we are distinctive in the number of payment methods
that we allow, the combination of transaction types that we manage directly, our
ability to integrate additional services and our ability to support each
merchant through one vertically integrated source.
Our marketing strategy is to maximize cross-selling opportunities to our
existing base of retail merchants and financial institutions, including those
merchants and financial institutions in the Visa Program; sell integrated suites
of check, credit and debit card processing services through small banks and
industry-specific resellers; enhance and market MerchantAmerica.com; and develop
the private label check service program that allows appropriate identification
between the customer and the vendor. ECHO intends to:
- Market the MerchantAmerica service to regional and community banks,
through direct sales to merchants and to not-for-profit organizations;
- Promote the Visa Program by working with Visa-referred banks to assist
them in initiating the service and also, selling the Visa service
directly to merchants through the sponsorship of ECHO's primary bank,
First Regional Bank.
- Educate national merchants, processors, banks and industry-specific
resellers on the benefits associated with our NCN services, including
check conversion, verification, ACH payments, collection and our
positive and negative database capability and enlist their active
sales thereof.
COMPETITION
Bankcard processing and check processing services are highly competitive
industries and are characterized by consolidation, rapid technological change,
rapid rates of product obsolescence and introductions of competitive products
often at lower prices and/or with greater functionality than those currently on
the market. Credit card and debit card processors have similar direct costs and
therefore their products are becoming somewhat of a commodity product where a
natural advantage accrues to the highest volume processors. To offset this fact,
we have focused on marketing to niche markets where we can maintain the margins
we deem necessary to operate profitably but no assurance can be given that this
strategy will be successful in the future.
There are a number of competitors in the check services industry, the largest of
which are TeleCheck (the leading provider of conversion and guarantee services
and a subsidiary of First Data Corporation), SCAN/eFunds (the largest
verification provider in the nation), Certegy (a spin-off of Equifax), and
Global Payments. While all four have major national accounts, the last two are
now actively moving into the smaller merchant and middle market where ECHO has
historically positioned itself. ECHO believes that it can effectively compete
due to its ownership of the NCN database, its integrated set of check and
collection services and the technological advantage of having certified as both
a Third-Party Processor and Acquirer Processor in the early stages of the Visa
Program.
ECHO is not currently a major player in the credit card processing market but we
do believe we are among the top 50 in the nation. We believe we hold a
significant competitive position in the check services market due largely to
13
our investment to date in the Visa POS Check program and the integration of our
check and collection capabilities. Despite this fact, many of our competitors
have greater financial and marketing resources than us. As a result, they may
be better able to respond more quickly to new or emerging technologies and
changes in customer requirements. Competitors also may enjoy per transaction
cost advantages due to their high processing volumes that may make it difficult
for ECHO to compete. In addition, major players in the check services industry
have developed sophisticated risk assessment technology that may provide a
competitive advantage in providing check guarantee services. We believe that our
success will depend upon our ability to continuously develop new products and
services and to enhance our current products and to introduce them promptly into
the market.
EMPLOYEES
As of September 30, 2004, we employed 210 individuals, 182 of whom were full
time employees.
REPORTABLE SEGMENTS
Refer to Note 14 "Segment Information" in the accompanying Notes to Consolidated
Financial Statements for reportable segment information.
ITEM 2. PROPERTIES
In March 2004, we sold a building in Agoura Hills, California which was
previously our corporate headquarters, for $2,382,000, and paid off the two
notes collateralized by this building. As a result of this sale, we recognized a
gain of $1,319,000 on a pre-tax basis.
In October 2003, we leased 21,500 square feet of a 40,000 square foot building
in Camarillo, California with an option to purchase the building in two years.
Our principal executive offices, including customer support, data center and
other operational departments were moved to this Camarillo location. We signed
an addendum to the October 2003 lease in July 2004 and added 11,100 square feet
to the lease. We currently occupy 32,669 square feet of this Camarillo
building. The lease payment for this facility as of September 2004 was $23,700
per month. The lease payment will increase to $35,936 per month effective
January 2005 pursuant to the provisions of the lease governing the property,
which permitted a lower rent during the period commencing July 2004 and ending
December 2004.
We have additional real property leases in Agoura Hills, California;
Albuquerque, New Mexico; Boulder, Colorado; and Lawrence, Kansas for sales, data
center and other operations, under various agreements, which expire at various
times over the next year. The total of these lease payments are approximately
$40,000 per month.
ITEM 3. LEGAL PROCEEDINGS
We are involved in various lawsuits arising in the ordinary course of business.
Based upon current information, management, after consultation with legal
counsel, believes the ultimate disposition of these lawsuits will have no
material effect upon either our results of operations, financial position, or
cash flows.
In July 2004, LML Patent Corporation, a wholly-owned subsidiary of LML Payment
Systems, Inc. ("LML"), filed a patent infringement claim against us, our
subsidiary, XPRESSCHEX, Inc. and others, relating with respect to us and our
subsidiary, to the alleged infringement by our check conversion processes of
three patents held by LML. The suit was filed in the U.S. District Court for the
District of Delaware. LML seeks an undisclosed amount of damages in connection
with the alleged infringement. We do not believe that any of our check
conversion processes infringe upon any valid or enforceable patent rights of LML
and intend to vigorously defend our position against the claims made.
Ultimately, we expect that we will not be held liable for any of the alleged
infringement. Despite this belief, the costs associated with our defense will be
significant in both 2005 and 2006. We estimate these costs to be approximately
$400,000 or higher each year. The case is scheduled to go to trial in April of
2006. Should we be held liable for any alleged infringement, which is not
expected, the ultimate liability we may sustain may include a royalty payment
primarily calculated on activity commencing in the middle of calendar 2003 for
only select conversion activity, as that was the time period in which we
actively began utilizing the check conversion
14
processes alleged to infringe the LML patents. In view of the relatively short
time period involved and the relatively small overall transaction volume arising
from the alleged infringing check conversion services in comparison to ECHO's
total transaction volume, while having to make any payment relating to these
claims would be disappointing, we believe that any such alleged damages award
should have a relatively minor impact on our results of operations, financial
position, or cash flows.
In August 2003, one of our independent sales organizations ("ISO") filed a
breach of contract arbitration claim against us in Los Angeles, California. The
dispute involved a disagreement related to the manner in which commissions were
to be calculated under the agreement. The agreement with the ISO required
binding arbitration of all disputes arising under the agreement. The arbitration
proceedings occurred in December 2004. The arbitration award is expected between
the end of calendar 2004 and the beginning of 2005. The claim arose in the
ordinary course of business and we have accrued $300,000 as a litigation accrual
related to the dispute. The accrual represents our management's good faith
evaluation of the dispute after consultation with legal counsel, however, there
can be no assurance that the actual award will not exceed the amount accrued. In
the event the arbitration award exceeds the amount accrued, such excess amount
would impact our results of operations, financial position or cash flows. Our
management does not believe any such impact would be material.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of ECHO's shareholders in the quarter ended
September 30, 2004.
15
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER SECURITY
MATTERS
Since January 17, 1986, we have been trading on the over-the-counter market
under the name Electronic Clearing House, Inc. On October 2, 1989, we were
accepted for listing on the National Association of Securities Dealers Automated
Quotation System ("NASDAQ") and trade under the symbol of "ECHO" on the NASDAQ
SmallCap Market. The following table sets forth the range of high and low
prices for our common stock during the fiscal periods indicated, as reported on
the NASDAQ SmallCap Market.
FISCAL YEAR ENDED
SEPTEMBER 30 High Low
------------ ------ -----
2004
----
First Quarter $11.33 $6.15
Second Quarter $13.06 $8.23
Third Quarter $11.47 $8.75
Fourth Quarter $ 9.99 $6.45
2003
----
First Quarter $ 2.85 $1.09
Second Quarter $ 2.75 $1.72
Third Quarter $ 4.40 $2.47
Fourth Quarter $ 9.59 $3.20
The prices set forth above are not necessarily indicative of liquidity of the
trading market. Trading in our common stock is limited and sporadic, as
indicated by the average monthly trading volume of 829,849 shares for the period
from October 2003 to September 2004. On December 13, 2004, the closing
representative price per share of our common stock, as reported on the NASDAQ
SmallCap Market, was $8.00.
HOLDERS OF COMMON STOCK
As of December 13, 2004, there were 839 record holders and 3,374 beneficial
holders of our common stock, with 6,472,331 shares outstanding. The number of
holders of record is based on the actual number of holders registered on the
books of our transfer agent and does not reflect holders of shares in "street
name" or persons, partnerships, associations, corporations or other entities
identified in security position listings maintained by depository trust
companies.
DIVIDEND POLICY
We have not paid any dividends in the past and have no current plan to pay any
dividends. We intend to devote all funds to the operation of our businesses.
EQUITY COMPENSATION PLAN INFORMATION
The Equity Compensation Plan Information identified in Item 11 of this Annual
Report on Form 10-K is incorporated herein by this reference.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following table sets forth certain selected consolidated financial data,
which should be read in conjunction with the Consolidated Financial Statements
and Management's Discussion and Analysis of Financial Condition and Results of
Operations included in Items 7 and 8 below. The following data, insofar as it
relates to each of the five years ended September 30, has been derived from our
annual financial statements, including the consolidated balance sheets at
September 30, 2004 and 2003, and the related consolidated statements of
operations and of cash flows for the three years ended September 30, 2004, 2003
and 2002, and notes thereto appearing elsewhere herein.
16
YEAR ENDED SEPTEMBER 30
--------------------------------------------------------------------
2004 2003 2002 2001 2000
------------- ------------ --------- ---------- ----------------
( ---- AMOUNTS IN THOUSANDS, EXCEPT PER SHARE ---- )
STATEMENT OF OPERATIONS DATA:
- -----------------------------
Revenues $ 47,584 $ 40,636 $ 33,291 $ 29,943 $ 28,340
Costs and expenses 44,127 38,211 36,960 29,380 28,324
------------- ------------ --------- ---------- ----------------
Income (loss) from operations 3,457 2,425 (3,669) 563 16
Interest income (expense), net (104) (172) (74) 106 196
Other income (expense), net 1,319 -0- -0- 350 312
------------- ------------ --------- ---------- ----------------
Income (loss) before income tax
(provision) benefit and cumulative
effect of an accounting change 4,672 2,253 (3,743) 1,019 524
(Provision) benefit for income taxes (1,823) (925) 1,367 (585) (233)
------------- ------------ --------- ---------- ----------------
Income (loss) before cumulative
effect of an accounting change 2,849 1,328 (2,376) 434 291
Cumulative effect of an accounting
change to adopt SFAS 142[1] -0- (4,707) -0- -0- -0-
------------- ------------ --------- ---------- ----------------
Net income (loss) $ 2,849 $ (3,379) $ (2,376) $ 434 $ 291
============= ============ ========= ========== ================
Earnings (loss) per share-basic $ 0.45 $ (0.58) $ (0.41) $ 0.07 $ 0.06
Earnings (loss) per share-diluted $ 0.41 $ (0.56) $ (0.41) $ 0.07 $ 0.05
Weighted average number of common
shares and equivalents outstanding-basic 6,312 5,812 5,788 5,797 5,257
Weighted average number of common
shares and equivalents outstanding-diluted 6,900 6,024 5,788 5,964 5,825
BALANCE SHEET DATA:
- -------------------
Working capital $ 8,004 $ 3,201 $ 3,234 $ 5,821 $ 6,029
Current assets 29,923 9,646 5,728 8,259 7,595
Total assets 39,428 18,775 18,191 18,921 17,013
Current liabilities 21,919 6,445 2,494 2,438 1,566
Long-term debt, and payable to
stockholders and related parties,
less current portion 704 1,961 2,159 744 767
Total stockholders' equity $ 16,240 $ 10,369 $ 13,538 $ 15,739 $ 14,680
[1] The Company completed the transitional impairment testing required by SFAS
142 in the first quarter of fiscal 2003 and determined that its goodwill
was fully impaired and a $4.7 million goodwill write-off was recognized.
17
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
Electronic Clearing House, Inc. is an electronic payment processor that provides
for the payment processing needs of merchants, banks and collection agencies.
We derive the majority of our revenues from two main business segments, bankcard
and transaction processing services ("bankcard services"), whereby we provide
solutions to merchants and banks to allow them to accept credit and debit card
payments from consumers, and check-related products ("check services"), whereby
we provide various services to merchants and banks to allow them to accept and
process check payments from consumers. The principal services we offer within
these two segments include, with respect to our bankcard services, debit and
credit card processing, and with respect to our check services, check guarantee,
check verification, electronic check conversion, check re-presentment, and check
collection.
We organize our service offerings under the following brand names:
- MerchantAmerica: ECHO's retail provider of payment processing services
to both merchant and bank markets;
- National Check Network ("NCN"): for wholesale check verification,
check authorization and capture services, and for referral to member
collection agencies;
- XPRESSCHEX, Inc.: for retail check verification, check conversion, ACH
services, check collection and check guarantee services.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management's discussion and analysis of financial condition and results of
operations is based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires management
to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. On an on-going basis, management evaluates its estimates,
including those related to revenue recognition, deferred taxes, reserve for
doubtful accounts, capitalization of software costs, contingencies and
litigation. Management bases its estimates on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates.
Management applies the following critical accounting policies in the preparation
of our consolidated financial statements:
- - REVENUE RECOGNITION POLICY. We earn revenue from services which include the
following: debit and credit card processing, check verification, ACH services,
check conversion, check re-presentment, check collection, check guarantee, and
inventory tracking. All of these services are performed pursuant to a contract
with customers, which state the terms and fixed price for all contracted
services. The price of a service may be a fixed fee for each transaction and/or
a percentage of the transaction processed, depending on the service. We
generally collect our fee at the time we process the transaction and
accordingly, collectibility of the service fee is reasonably assured.
Revenue from debit and credit card (collectively called bankcards) and
transaction processing revenue is based on a percentage of the transaction
value, commonly referred to as a discount fee on a credit and debit card
transaction processed by us. In addition, there is a per transaction fee
associated with each bankcard transaction which is charged to the merchant. We
recognize the processing and transaction revenue when the services are
performed.
Revenue from check verification is derived from fees collected from the
merchants when a check is verified against our own positive and negative check
database and other check databases that we use. This revenue is recognized when
the transaction is processed, since we have no further performance obligations.
18
Revenue from check conversion is derived from fees collected from merchants to
convert the paper check received by merchants into an ACH transaction, which
allows us to settle the transaction electronically for the merchant. We
recognize the revenue related to check conversion fees when the services are
performed.
Revenue from check re-presentment is derived from fees charged to check writers.
Check re-presentment is a service that allows merchants to collect a paper check
through the ACH network after a check has previously been presented to the bank
for collection unsuccessfully at least once. The fees earned from the check
writer are recognized when collected, as collectibility is not reasonably
assured until that point.
Revenue from check guarantee is derived from a percentage of the gross amount of
the check and guarantees payment of the check to the merchant in the event the
check is not honored by the check writer's bank. Merchants typically present
customer checks for processing on a regular basis and, therefore, dishonored
checks are generally identified within a few days of the date the checks are
guaranteed by us. We recognize revenue when the checks are processed at the
point of sale. At the time the guarantee revenue is recognized, we provide a
reserve for estimated guarantee losses based upon our historical loss
experience. In the event the check is dishonored, we have the right to collect
the full amount of the check from the check writer but have historically
recovered approximately 50-60% of the guaranteed checks. We establish a
receivable from the delinquent check writer for the full amount of the
guaranteed check. The check guarantee service also earns revenue based on fees
collected from delinquent check writers, which collection fee is recognized when
collected, as collectibility is not reasonably assured until that point.
Revenue from check collection is derived from collection activities performed on
behalf of a merchant on uncollected checks. The merchants usually keep the face
amount of the uncollected checks if the collection effort is successful. Our
revenue is derived from the collection fee collected from the check writer. If
we refer the collection item to another collection agency, we will receive a fee
from the collection agency upon its successful efforts. Collection fee revenue
is recognized when collected, as collectibility is not reasonably assured until
that point.
Revenue from inventory tracking is derived from transaction fees for processing
and tracking U-Haul's daily inventory activities. This revenue is recognized
when the transaction is processed, since we have no further performance
obligations.
- - DEFERRED TAXES. Deferred taxes are determined based on the differences
between the financial statement and tax basis of assets and liabilities, using
enacted tax rates in effect for the year in which the differences are expected
to reverse. Valuation allowances are established when necessary to reduce
deferred tax assets to the amounts expected to be realized. In assessing the
need for a valuation allowance, management considers estimates of future taxable
income and ongoing prudent and feasible tax planning strategies.
- - CHARGEBACK LOSSES. Chargeback losses occur when a credit card holder
presents a valid claim against one of our merchants and the merchant has
insufficient funds or is no longer in business resulting in the charge being
absorbed by us. We record a receivable for those chargebacks for which the
merchant is liable but has not made payment. We record a provision for
estimated chargeback losses at the time bankcard transactions are processed. A
reserve is estimated based upon a historically-determined percentage of gross
credit card processing volume and actual losses experienced.
- - RESEARCH AND DEVELOPMENT EXPENSE. Expenditures for activities relating to
product development and improvement are charged to expense as incurred. Such
expenditures amounted to $1,465,000 in fiscal year 2004 and $1,464,000 in fiscal
year 2003.
- - CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE. Effective October 1,
2002, we adopted Statement of Financial Accounting Standards No. 142 ("SFAS
142"), "Goodwill and Other Intangible Assets". SFAS 142 requires that goodwill
no longer be amortized, but instead be tested for impairment at least annually
using a fair value-based approach. In the year of adoption, SFAS No. 142 also
requires us to perform an initial assessment of its reporting units to determine
whether there is any indication that the goodwill carrying value may be
impaired. This transitional assessment is made by comparing the fair value of
each reporting unit, as determined in accordance with the new standard, to its
book value. To the extent the fair value of any reporting unit is less than
19
its book value, which would indicate that potential impairment of goodwill
exists, a second transitional test is required to determine the amount of
impairment. In 2003, we determined that all of our goodwill was impaired under
SFAS No. 142 and accordingly took a charge to write down the amount of that
impairment.
- - CAPITALIZATION OF SOFTWARE COSTS. The costs of purchased and internally
developed software used to provide services to customers or for the process of
internal administration are capitalized and amortized on a straight-line basis
over the lesser of three years or estimated useful life. Under the provisions of
Statement of Position 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use," we capitalize software costs when both
the preliminary project stage is completed and management has authorized further
funding for the completion of the project. Capitalization of costs ceases when
the project is substantially complete and the software is ready for its intended
use. Software developed or obtained for internal use is tested for impairment
whenever events or changes in circumstance indicates that its carrying amount
may not be recoverable.
RESULTS OF OPERATIONS
FISCAL YEARS 2004 AND 2003
- ------------------------------
Financial highlights for fiscal 2004 as compared to fiscal 2003 were as follows:
- -- Total revenue increased 17.1% to $47.6 million
- -- Gross margin from processing and transaction revenue improved to 37.4% from
33.9%
- -- Operating income increased to $3.5 million from $2.4 million
- -- Diluted earnings per share before cumulative effect of accounting change
were $0.41 as compared to $0.22 per share.
- -- Bankcard and transaction processing revenue increased by 11.5% to $36.2
million
- -- Bankcard processing volume increased 9.5% to $1.1 billion
- -- Check-related revenue increased by 39.4% to $11.4 million
- -- ACH processing volume increased 128.4% to 25.8 million transactions
REVENUE. Total revenue increased 17.1% to $47,584,000 for fiscal 2004, from
$40,636,000 for fiscal 2003. The increase can be primarily attributable to 11.5%
growth in bankcard and transaction processing revenue and 39.4% growth in check
services revenue year-over-year. This growth has occurred organically from our
existing merchants and from our marketing initiatives during the year, and as a
result of increasing acceptance of our check services products and the continued
growth in the Visa Program.
The bankcard and transaction processing revenue increase was mainly attributable
to a 9.5% increase in bankcard processing volume as compared to last fiscal
year. This increase was the result of our organic growth and the growth from
our various marketing channels such as the Agent Bank Program and the
MerchantAmerica marketing program. The increase was partially offset by the
departure of several high volume merchants during the year.
The check-related processing revenue increase was attributable to a 10.6%
increase in check verification revenue and a 101.3% increase in ACH services
revenues. The high growth in the ACH revenue was due to the increasing market
acceptance of this product and the continued growth in the Visa Program.
COST OF SALES. Bankcard processing expenses are directly related to the changes
in processing revenue. A majority of our bankcard processing expenses are fixed
costs and are reflected as a percentage of the total face amount of each
bankcard transaction, and the remaining costs are based on a fixed rate applied
to the number of transactions processed. Processing-related expenses, consisting
of bankcard processing expense and transaction and check processing expense,
increased 11.2% for the year, from $26,660,000 in fiscal 2003 to $29,634,000 in
fiscal 2004. The increase reflects the 17.3% increase in processing and
transaction revenues for the year.
20
Gross margin from processing and transaction services improved from 33.9% in
fiscal 2003 to 37.4% in fiscal 2004. This improvement in gross margin was
mainly due to: 1) check-related revenue, which has a higher gross margin, made
up 24.0% of the total revenue in fiscal 2004 as compared to 20.2% of the total
revenue in fiscal 2003 and; 2) a rate adjustment was applied to a broad base of
bankcard merchants during fiscal 2004 to offset increases in direct bankcard
processing expenses.
EXPENSE. Other operating costs such as personnel costs, telephone, depreciation
expenses and outside services increased 18.5%, from $4,373,000 in fiscal 2003 to
$5,182,000 in fiscal 2004 primarily due to more staff hired in fiscal 2004 to
support our growth. Research and development expenses remained constant, from
$1,464,000 in fiscal 2003 to $1,465,000 in fiscal 2004. Almost all of our major
development projects were in the coding and testing phases in fiscal 2004.
Several major development projects should be completed during fiscal year 2005.
However, given the rapid change in technology occurring in our industry, we plan
to continue to invest in product development in both the bankcard processing
business segment and the check-related products segment in order to remain
competitive in these financial services markets.
Selling, general and administrative (SG&A) expenses increased 37.3% from
$5,714,000 in fiscal 2003 to $7,846,000 in fiscal 2004. This increase was
primarily attributable to: 1) greater personnel costs due to cost of living
adjustments and greater employee benefits costs, such as health insurance and
worker's compensation insurance; 2) growth in sales and marketing expenses to
implement our sales and marketing strategies; 3) increased legal and
professional expenses to defend several lawsuits; 4) an increase in rent expense
due to our new corporate relocation in October 2003; and 5) a $300,000
litigation accrual related to an ordinary course contract dispute with one of
its independent sales organizations. The dispute is subject to binding
arbitration, the award from which is expected between the end of calendar 2004
and the beginning of 2005. The accrual represents management's good faith
evaluation of the dispute after consultation with its legal counsel. As a
percentage of total revenue, SG&A expenses increased from 14.1% in fiscal 2003
to 16.5% in fiscal 2004.
OPERATING INCOME. Operating income increased from $2,425,000 in fiscal 2003 to
$3,457,000 in fiscal 2004, an increase of 42.6%. The improvement in operating
income was primarily attributable to the 17.1% increase in revenue and the 3.5%
improvement in gross margin described above.
INTEREST EXPENSE. Interest expense decreased to $175,000 for fiscal 2004, from
$200,000 for fiscal 2003. The decrease was due to the full repayment of two
long-term notes. Interest income increased from $28,000 in fiscal 2003 to
$71,000 in fiscal 2004 due to higher average cash balances on hand throughout
fiscal year 2004.
GAIN ON SALE OF ASSETS. Fiscal 2004 results were favorably affected by a
pre-tax gain on sale of $1,319,000 resulting from the sale of the building that
formerly held the Company's principal executive offices. After the sale, the
Company used a portion of the proceeds to pay off two loans totaling $1,524,000,
which were collateralized by the building.
EFFECTIVE TAX RATE. The income tax provision was $1,823,000 for fiscal 2004 as
compared to $925,000 for fiscal 2003. Our effective tax rate was 39.0% for
fiscal 2004, as compared to 37.7% for fiscal 2003. See Notes to Consolidated
Financial Statements included elsewhere herein for further explanation of the
income tax expense and a reconciliation of reported income taxes to the amount
utilizing the statutory rate.
NET INCOME. Net income for fiscal 2004 was $2,849,000, as compared to a net loss
of $3,379,000 for fiscal 2003. Income before cumulative effect of an accounting
change to adopt SFAS 142 was $1,328,000 in fiscal 2003 and $2,849,000 in fiscal
2004, an increase of 114.5%. This increase was primarily attributable to the
17.1% revenue growth year-over-year and the improvements in gross margin.
SEGMENT RESULTS
Bankcard and Transaction Processing. For the year ended September 30, 2004,
bankcard processing and transaction revenue accounted for approximately 76.0% of
our revenues, compared to 79.8% in fiscal 2003. Bankcard processing and
transaction revenue increased 11.5%, from $32,444,000 in fiscal 2003 to
$36,161,000 in fiscal 2004. This increase was mainly attributable to a 9.5%
increase in bankcard processing volume as compared to last fiscal year. This
increase was partially offset by the departure of several high volume merchants.
To a lesser extent, the increase was positively impacted by a rate adjustment to
our bankcard merchant base during fiscal 2004. We continue to grow our bankcard
processing business primarily through organic growth and various sales and
marketing programs.
21
In fiscal 2004, the bankcard and transaction processing segment generated
operating income of $5,977,000, or 16.5% of the related revenues, as compared to
$4,303,000, or 13.3% of the related revenues in fiscal 2003. This increase in
operating income was reflective of the increase in revenue and the higher gross
margin as a result of the broad base rate adjustment to merchants to offset
higher operating costs.
In fiscal 2001, we purchased a fully integrated, multi-modular bankcard
processing system from Oasis Technologies for approximately $1.3 million. We
have incurred an additional $700,000 of internal development costs thus far in
implementing this system. The implementation of this system will give us greater
flexibility to price our credit card processing services, allowing us to attract
and retain larger merchants as well as the small and mid-market merchants that
have been our target market. This project has experienced numerous
implementation delays, mainly as a result of vendor software delivery issues and
the vigorous testing required prior to implementation. Management now
anticipates that portions of the Oasis system will begin productive use in the
second half of 2005.
Check Related Products. Check-related revenues increased from $8,192,000 for
fiscal 2003 to $11,423,000 for fiscal 2004, an increase of 39.4%. Check
verification revenue increased 10.6% to $3,425,000 for fiscal 2004, from
$3,097,000 for fiscal 2003. Check conversion, ACH services and check
re-presentment revenue increased 101.3% to $5,820,000 for fiscal 2004, from
$2,892,000 for fiscal 2003. Additionally, check collection revenue increased
14.0%, from $1,791,000 in fiscal 2003 to $1,816,000 in fiscal 2004. The high
growth in the check conversion and ACH revenue was due to the increasing market
acceptance of this product and to the transaction revenue generated by the Visa
Program. Total ACH transactions processed during fiscal 2004 were 25.8 million
transactions, as compared to 11.3 million transactions processed in fiscal 2003,
an increase of 128.4%. ACH transactions, like ACH revenues, increased primarily
from the increasing market acceptance of the ACH services and the Visa Program.
Check services revenue made up 24.0% of the total processing and transaction
revenues for fiscal 2004 as compared to 20.2% in fiscal 2003. Check-related
operating income was $1,644,000 in fiscal 2004, as compared to operating income
of $591,000 in fiscal 2003, an increase of 178.2%. The increase in operating
income was mainly due to the 39.4% increase in check-related revenues.
The Visa Program is continuing to gain traction during 2004. We are currently
working with 16 Visa member banks that have signed up to participate in this
Visa Program. One of the Visa acquiring banks, using us as the Third-Party
Processor, rolled out this Program to a national retailer in June 2003. This
one merchant accounted for a significant percentage of revenue generated from
the Visa Program in fiscal 2004 and an increased volume of transactions
processed. Management continues to believe that the Visa Program will provide us
with numerous opportunities to develop strategic relationships with the banks
who have chosen us to be their Third-Party Processor and Acquirer Processor
under the Visa Program. These relationships could play a major role in
increasing our check services revenue in the coming years.
RESULTS OF OPERATIONS
FISCAL YEARS 2003 AND 2002
- ------------------------------
Financial highlights for fiscal 2003 as compared to fiscal 2002 were as follows:
- -- Total revenue increased 22.1% to $40.6 million
- -- Gross margin from processing and transaction revenue improved to 33.9% from
30.1%
- -- Operating income increased to $2.4 million from a loss of $3.7 million
(which included $2.9 million of litigation related expenses).
- -- Diluted earnings per share before cumulative effect of accounting change
were $0.22 as compared to diluted loss per share before cumulative effect
of accounting change of $0.41.
- -- Bankcard and transaction processing revenue increased by 18.2% to $32.4
million
22
- -- Bankcard processing volume increased 26.4% to $961 million
- -- Check-related revenue increased by 40.4% to $8.2 million
- -- ACH processing volume increased 403.8% to 11.3 million transactions
REVENUE. In fiscal 2003, total revenue increased 22.1% to $40,636,000, from
$33,291,000 for fiscal 2002. The increase was primarily attributable to the
growth in the processing and transaction business. Total processing and
transaction revenue for fiscal 2003 increased 22.6%, from $32,889,000 in fiscal
2002 to $40,313,000 in fiscal 2003. The increase was attributable to an 18.2%
increase in bankcard and transaction processing revenue and a 40.4% increase in
check-related revenue.
The bankcard and transaction processing revenue increase was mainly attributable
to an approximate 26.4% increase in bankcard processing volume as compared to
fiscal 2002. This increase was also affected by a rate adjustment to the
bankcard merchant base during fiscal 2003 and the fact that we continued to grow
our bankcard processing business organically through various sales and marketing
programs.
The check-related processing revenue increase was attributable to a 9.8%
increase in check verification revenue and a 246.0% increase in electronic check
conversion and electronic check presentment revenue. The high growth in check
conversion revenue was due to the increasing market acceptance of this product.
Additionally, it was attributable to the transactions generated by the Visa
Program.
Terminal sales decreased by 50.8%, from $252,000 in fiscal 2002 to $124,000 in
fiscal 2003. During fiscal 2003, U-Haul stopped sending its terminals to us for
repair. We gradually shut down our terminal deployment operations during fiscal
2003.
COST OF SALES. Bankcard processing expenses are directly related to the changes
in processing revenue. A majority of our bankcard processing expenses are fixed
costs and reflected as a percentage of the total face amount of each bankcard
transaction, and the remaining costs are based on a fixed rate applied to the
number of transactions processed. Processing-related expenses, consisting of
bankcard processing expense and transaction and check processing expense,
increased 16.0% in fiscal 2003, from $22,973,000 in fiscal 2002 to $26,660,000
in fiscal 2003. The increase reflected a 22.7% increase in processing and
transaction revenues for the year. Gross margin from processing and transaction
services improved from 30.1% in fiscal 2002 to 33.9% in fiscal 2003. This
improvement in gross margin was mainly due to: 1) check-related revenue which
has a higher gross margin made up 20.2% of the total revenue in fiscal 2003 as
compared to 17.5% of the total revenue in fiscal 2002; 2) a rate adjustment was
applied to a broad base of bankcard merchants during fiscal 2003 to offset
increases in direct bankcard processing expenses; and 3) loss on chargeback
decreased substantially, from $261,000 in fiscal 2002 to $44,000 in fiscal 2003.
EXPENSE. Other operating costs such as personnel costs, telephone and
depreciation expenses increased 8.5%, from $4,032,000 in fiscal 2002 to
$4,373,000 in fiscal 2003 primarily due to the 22.1% increase in revenue.
Research and development expenses decreased 162% from $1,747,000 in fiscal 2002
to $1,464,000 in fiscal 2003, as most of our development projects entered into
coding and testing phases.
Selling, general and administrative expenses increased 9.5% from $5,219,000 in
fiscal 2002 to $5,714,000 in fiscal 2003. This increase was mainly due to the
addition of management personnel to support our growth, the increase in employee
benefits costs such as medical insurance, workers compensation insurance and the
increase in cost of living adjustments. As a percentage of total revenue,
selling, general and administrative expenses decreased from 15.7% in the fiscal
2002 to 14.1% in fiscal 2003.
Amortization of goodwill expense, which amounted to $489,000 in 2002, was
eliminated in fiscal 2003 due to the implementation of SFAS No. 142.
INTEREST EXPENSE. Interest expense increased to $200,000 for fiscal 2003, from
$129,000 in fiscal 2002. The increase was due to a $1.3 million long-term note
from a legal settlement in fiscal 2002 and an increase in capitalized leases
from equipment purchases. Interest income decreased from $55,000 in fiscal 2002
to $28,000 in fiscal 2003 due to a decline in interest rates and lower average
cash balances.
23
EFFECTIVE TAX RATE. The income tax provision was $925,000 for fiscal 2003 as
compared to an income tax benefit of $1,367,000 for fiscal 2002. Our effective
tax benefit rate was 36.5% for fiscal 2002 and a tax provision rate was 37.7%
for fiscal 2003.
NET LOSS. Net loss for fiscal 2003 was $3,379,000, as compared to a net loss of
$2,376,000 for fiscal 2002. The higher net loss in fiscal 2003 was primarily due
to a $4.7 million goodwill write-off on our adoption of SFAS 142 in October
2002. Income from operations improved substantially in fiscal 2003, from a
$3,669,000 operating loss in fiscal 2002 to $2,425,000 in operating income for
fiscal 2003. The improvement in income from operations between fiscal 2002 and
fiscal 2003 comprised the following: 1) a 22.1% increase in revenue; 2) a 3.8%
improvement in gross margin; 3) the elimination of $489,000 in goodwill
amortization expense; and 4) a one-time $2.5 million legal settlement cost was
incurred in fiscal 2002.
SEGMENT RESULTS
Bankcard and Transaction Processing. For the year ended September 30, 2003,
MerchantAmerica, our primary generator of bankcard process and transaction
revenue, accounted for approximately 80% of our revenues, compared to 82% in
fiscal 2002. Bankcard processing and transaction revenue increased 18.2%, from
$27,456,000 in fiscal 2002 to $32,444,000 in fiscal 2003. This increase was
mainly attributable to an approximate 26.4% increase in bankcard processing
volume as compared to fiscal 2002. This increase was also affected by a rate
adjustment to our bankcard merchant base during fiscal 2003 and the fact that we
continued to grow our bankcard processing business organically through various
sales and marketing programs.
In fiscal 2003, the bankcard and transaction processing segment generated
operating income of $4,303,000, or 13.3% of the related revenues, as compared to
$1,996,000, or 7.3% of the related revenues in fiscal 2002. This increase in
operating income was reflective of the increase in revenue and the higher gross
margin as a result of the rate adjustment to merchants and the lower chargeback
losses.
Check Related Products. Check-related revenues increased from $5,835,000 for
fiscal 2002 to $8,192,000 for fiscal 2003, an increase of 40.4%. Check
verification revenue increased 9.8% to $3,097,000 for fiscal 2003, from
$2,821,000 for fiscal 2002. Check conversion and check re-presentment revenue
increased 246.0% to $2,892,000 for fiscal 2003, from $836,000 for fiscal 2002.
Additionally, check collection revenue increased 5.1%, from $1,453,000 in fiscal
2002 to $1,526,000 in fiscal 2003. The high growth in the check conversion
revenue was due to the increasing market acceptance of this product and
attributable to the transaction revenue generated by the Visa Program.
Check services revenue made up 20.2% of the total processing and transaction
revenues for fiscal 2003 as compared to 17.5% in the prior year. Check-related
operating income was $591,000 for fiscal 2003, as compared to operating loss of
$872,000 in fiscal 2002. The increase in operating income was mainly due to the
40.4% increase in check-related revenues.
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 2004, we had available cash and cash equivalents of
$7,576,000, restricted cash of $1,024,000 in reserve with our primary processing
banks and working capital of $8,004,000.
Accounts receivable, net of allowance for doubtful accounts, increased slightly
to $1,943,000 at September 30, 2004 from $1,939,000 at the end of fiscal 2003.
Allowance for doubtful accounts, which reflects chargeback losses increased to
$111,000 at the end of fiscal 2004 from $71,000 at September 30, 2003. This
increase was due to the higher processing revenue generated in fiscal 2004.
Net cash provided by operating activities for the year ended September 30, 2004
was $5,325,000 as compared to net cash provided by operating activities of
$4,549,000 for fiscal 2003. The increase in cash from operations was primarily
attributable to the $1,032,000 increase in operating income between fiscal 2004
and 2003. Settlement receivable/payable results from timing differences in our
settlement process with merchants. These timing differences account for the
difference between the time that funds are received in our bank accounts and the
time that settlement payments are made to merchants. Therefore, at any given
time, settlement receivable/payable may vary and ultimately depends on the
volume of transactions processed. The increase in settlement receivable/payable
in fiscal 2004 is primarily attributable to the high volume of transactions
experienced from our check services. As our business grows, settlement
receivable/payable balances will likely increase.
24
Net cash used in investing activities was $1,904,000 for the fiscal 2004 as
compared to $3,271,000 for fiscal year 2003. During fiscal 2004, we used
$4,278,000 for purchases of equipment and capitalized software costs as compared
to $3,291,000 for fiscal 2003. We should be completing several major projects
in fiscal 2005 related to infrastructure improvements and thereby decreasing the
amount of investment required in fiscal 2005 as compared to fiscal 2004. In
fiscal 2004, we also received $2,233,000 in proceeds from the sale of our former
corporate headquarters building.
Net cash provided by financing activities was $1,247,000 for the current fiscal
year as compared to net cash used by financing activities of $179,000 for fiscal
year 2003. During fiscal 2004, we received net proceeds of $2,693,000 from a
private placement. We paid off $1,916,000 in notes payable, and used $562,000
for the repayment of capitalized leases and received $221,000 from the exercise
of employee stock options.
In November 2003, we negotiated a $1,000,000 equipment lease line and a
$3,000,000 credit line with Bank of the West for working capital needs. As of
September 30, 2004, we have drawn down $600,000 of the equipment lease line but
have not used the $3,000,000 credit line.
At September, 2004, we had the following cash commitments:
Payment Due By Period
---------------------
Contractual Less than After
Obligations Total 1 year 2-3 years 4-5 years 5 years
- ----------- ---------- ---------- ---------- ---------- --------
Long-term debt
including interest $ 970,000 $ 434,000 $ 356,000 $ 180,000 $ -0-
Capital lease
obligations 757,000 528,000 196,000 33,000 -0-
Operating leases 1,929,000 565,000 909,000 455,000 -0-
---------- ---------- ---------- ---------- --------
Total contractual
cash obligations $3,656,000 $1,527,000 $1,461,000 $ 668,000 $ -0-
========== ========== ========== ========== ========
Our primary source of liquidity is expected to be cash flow generated from
operations and cash and cash equivalents currently on hand. Management believes
that our cash flow from operations together with cash on hand, our lease line,
our established line of credit with Bank of the West, and cash previously
received from our private placement financing will be sufficient to meet our
working capital and other commitments.
NEW ACCOUNTING PRONOUNCEMENT
In December 2004, the FASB issued SFAS 123R, "Share-Based Payment, an amendment
of FASB Statements Nos. 123 and 95," that addresses the accounting for
share-based payment transactions in which a Company receives employee services
in exchange for either equity instruments of the Company or liabilities that are
based on the fair value of the Company's equity instruments or that may be
settled by the issuance of such equity instruments. SFAS 123R eliminates the
ability to account for share-based compensation transactions using the intrinsic
method that the Company currently uses and generally would require that such
transactions be accounted for using a fair-value-based method and recognized as
expense in the consolidated statement of operations. SFAS 123R is effective for
interim and annual periods beginning after June 15, 2005. Management is
currently evaluating the impact of SFAS 123R and it is expected that it will
have a significant impact on the consolidated statement of operations as the
Company will be required to expense the fair value of stock option awards.
25
RISK FACTORS
Our business, and accordingly, your investment in our common stock, is subject
to a number of risks. These risks could affect our operating results and
liquidity. You should consider the following risk factors, among others, before
investing in our common stock:
RISKS RELATED TO OUR BUSINESS
- ---------------------------------
WE RELY ON COOPERATIVE RELATIONSHIPS WITH, AND SPONSORSHIP BY, BANKS, THE
ABSENCE OF WHICH MAY AFFECT OUR OPERATIONS.
We currently rely on cooperative relationships with, and sponsorship by, banks
in order to process our Visa, MasterCard and other bankcard transactions. We
also rely on several banks for access to the Automated Clearing House ("ACH")
for submission of both credit card and check settlements. Our banking
relationships are currently with smaller banks (with assets of less than
$500,000,000). Even though smaller banks tend to be more susceptible to mergers
or acquisitions and are therefore less stable, these banks find the programs we
offer more attractive and we believe we cannot obtain similar relationships with
larger banks at this time. A bank could at any time curtail or place
restrictions on our processing volume because of its internal business policies
or due to other adverse circumstances. If a volume restriction is placed on us,
it could materially adversely affect our business operations by restricting our
ability to process credit card transactions and receive the related revenue.
Our relationships with our customers and merchants would also be adversely
affected by our inability to process these transactions.
We currently maintain one primary bankcard processing and sponsorship
relationship with First Regional Bank in Agoura Hills, California. Our
agreement with First Regional Bank continues through 2005. We also maintain
several banking relationships for ACH processing. While we believe our current
bank relationships are sound, we cannot assure that these banks will not
restrict our increasing processing volume or that we will always be able to
maintain these relationships or establish new banking relationships. Even if
new banking relationships are available, they may not be on terms acceptable to
us. With respect to First Regional Bank, while we believe their ability to
terminate our respective relationships is cost-prohibitive, they may determine
that the cost of terminating their agreement is less than the cost of continuing
to perform in accordance with their terms, and may therefore determine to
terminate those agreements prior to their expiration. Ultimately, our failure
to maintain these banking relationships and sponsorships may have a material
adverse effect on our business and results of operations.
MERCHANT FRAUD WITH RESPECT TO BANKCARD AND ACH TRANSACTIONS COULD CAUSE US TO
INCUR SIGNIFICANT LOSSES.
We significantly rely on the processing revenue derived from bankcard and ACH
transactions. If any merchants were to submit or process unauthorized or
fraudulent bankcard or ACH transactions, depending on the dollar amount, ECHO
could incur significant losses which could have a material adverse effect on our
business and results of operations. ECHO assumes and compensates the sponsoring
bank for bearing the risk of these types of transactions.
We have implemented systems and software for the electronic surveillance and
monitoring of fraudulent bankcard and ACH use. As of September 30, 2004, we
maintained a dedicated chargeback reserve of $708,000 at our primary bank
specifically earmarked for such activity. Additionally, through our sponsoring
bank, we had access to approximately $9.9 million in merchant deposits to cover
any potential chargeback losses. Despite a long history of managing such risk,
we cannot guarantee that these systems will prevent fraudulent transactions from
being submitted and processed or that the funds set aside to address such
activity will be adequate to cover all potential situations that might occur.
We do not have insurance to protect us from these losses. There is no assurance
that our chargeback reserve will be adequate to offset against any unauthorized
or fraudulent processing losses that we may incur. Depending on the size of
such losses, our results of operations could be immediately and materially
adversely affected.
26
EXCESSIVE CHARGEBACK LOSSES COULD SIGNIFICANTLY AFFECT OUR RESULTS OF OPERATIONS
AND LIQUIDITY.
Our agreements with our sponsoring bank require us to assume and compensate the
bank for bearing the risk of "chargeback" losses. Under the rules of Visa and
MasterCard, when a merchant processor acquires card transactions, it has certain
contingent liabilities for the transactions processed. This contingent
liability arises in the event of a billing dispute between the merchant and a
cardholder that is ultimately resolved in the cardholder's favor. In such a
case, the disputed transaction is charged back to the merchant and the disputed
amount is credited or otherwise refunded to the cardholder. If we are unable to
collect this amount from the merchant's account, or if the merchant refuses or
is unable to reimburse us for the chargeback due to merchant fraud, insolvency
or other reasons, we will bear the loss for the amount of the refund paid to the
cardholders.
A cardholder, through its issuing bank, generally has until the later of up to
four months after the date a transaction is processed or the delivery of the
product or service to present a chargeback to our sponsoring bank as the
merchant processor. Therefore, management believes that the maximum potential
exposure for the chargebacks would not exceed the total amount of transactions
processed through Visa and MasterCard for the last four months and other
unresolved chargebacks in the process of resolution. For the last four months
through September 30, 2004, this potential exposure totaled approximately $352
million. At September 30, 2004, we, through our sponsoring banks, had
approximately $168,000 of unresolved chargebacks that were in the process of
resolution. At September 30, 2004, we, through our sponsoring banks, had access
to $9.9 million belonging to our merchants. This money has been deposited at the
sponsoring bank by the merchants to cover any potential chargeback losses.
For the fiscal years 2004 and 2003, we processed approximately $1,053 million
(2004) and $961 million (2003) of Visa and MasterCard transactions, which
resulted in $7.6 million in gross chargeback activities for the fiscal year
ended 2004 and $9.3 million for the fiscal year ended 2003. Substantially all of
these chargebacks were recovered from the merchants.
Nevertheless, if we are unable to recover these chargeback amounts from
merchants, having to pay the aggregate of any such amounts would significantly
affect our results of operations and liquidity.
FAILURE TO PARTICIPATE IN THE VISA POS CHECK SERVICE PROGRAM WOULD CAUSE US TO
SIGNIFICANTLY SHIFT OUR OPERATING AND MARKETING STRATEGY.
We have significantly increased our infrastructure, personnel and marketing
strategy to focus on the potential growth of our check services through the Visa
POS Check Service program. We currently provide critical back-end
infrastructure for the service, including our NCN database for verification and
our access to the Federal Reserve System's Automated Clearing House for funds
settlement and for checks written on bank accounts with banks not participating
in the program.
Because we believe the market will continue to gain acceptance of the Visa POS
Check Service program, we have expended significant resources to market our
check conversion services and verification services to our merchant base, to
solidify our strategic relationships with the various financial institutions
that have chosen us as their Acquirer Processor and Third-Party processor under
the program, and to sell our other check products such as electronic check
re-presentments and check guarantee to the Visa member banks. We have also
increased our personnel to handle the increased volume of transactions arising
directly from our participation in the program.
If we fail to adequately market our services through this relationship, this
could materially affect our marketing strategy going forward. Additionally, if
we fail to adequately grow our infrastructure to address increases in the volume
of transactions, cease providing services as a Third-Party processor or Acquirer
Processor or are otherwise removed or terminated from the Visa Program, this
would require us to dramatically shift our current operating strategy.
THE BUSINESS IN WHICH WE COMPETE IS HIGHLY COMPETITIVE AND THERE IS NO ASSURANCE
THAT OUR CURRENT PRODUCTS AND SERVICES WILL STAY COMPETITIVE OR THAT WE WILL BE
ABLE TO INTRODUCE NEW PRODUCTS AND SERVICES TO COMPETE SUCCESSFULLY.
We are in the business of processing payment transactions and designing and
implementing integrated systems for our customers so that they can better use
our services. This business is highly competitive and is characterized by rapid
technological change, rapid rates of product obsolescence, and rapid rates of
new products
27
introduction. Our market share is relatively small as compared to most of our
competitors and most of these competitors have substantially more financial and
marketing resources to run their businesses. While we believe our small size
provides us the ability to move quickly in some areas, our competitors' greater
resources enable them to investigate and embrace new and emerging technologies,
quickly to respond to changes in customers needs, and to devote more resources
to product and services development and marketing. We may face increased
competition in the future and there is no assurance that current or new
competition will allow us to keep our customers. If we lose customers, our
business operations may be materially adversely affected, which could cause us
to cease our business or curtail our business to a point where we are no longer
able to generate sufficient revenues to fund operations. There is no assurance
that our current products and services will stay competitive with those of our
competitors or that we will be able to introduce new products and services to
compete successfully in the future.
IF WE ARE UNABLE TO PROCESS SIGNIFICANTLY INCREASED VOLUME ACTIVITY, THIS COULD
AFFECT OUR OPERATIONS AND WE COULD LOSE OUR COMPETITIVE POSITION.
We have built transaction processing systems for check verification, check
conversion, ACH processing, and bankcard processing activities. While current
estimates regarding increased volume are within the capabilities of each system,
it is possible that a significant increase in volume in one of the markets would
exceed a specific system's capabilities. To minimize this risk, ECHO has
redesigned and upgraded its check related processing systems and has purchased a
high end system to process bankcard activity. This system is not yet
operational, and even when it becomes operational, no assurance can be given
that it would be able to handle a significant increase in volume or that the
operational enhancements and improvements will be completed in such time to
avoid such a situation. In the event we are unable to process increases in
volume, this could significantly adversely affect our banking relationships, our
merchant customers and our overall competitive position, and could potentially
result in violations of service level agreements which would require us to pay
penalty fees to the other parties to those agreements. Losses of such
relationships, or the requirement to pay penalties, may severely impact our
results of operations and financial condition.
WE INCUR FINANCIAL RISK FROM OUR CHECK GUARANTEE SERVICE.
The check guarantee business is essentially a risk management business. Any
limitation of a risk management system could result in financial obligations
being incurred by ECHO relative to our check guarantee activity. While ECHO has
provided check guarantee services for several years, there can be no assurance
that our current risk management systems are adequate to assure against any
financial loss relating to check guarantee. ECHO is enhancing its current risk
management systems and it is being conservative with reference to the type of
merchants to which it offers guarantee services in order to minimize this risk
but no assurance can be given that such measures will be adequate. During the
year ended September 30, 2004, we incurred $128,000 in losses from uncollected
guaranteed checks.
SECURITY BREACHES COULD IMPACT OUR CONTINUED OPERATIONS.
We process confidential financial information and maintain several levels of
security to protect this data. Security includes hand and card-based
identification systems at our data center locations that restrict access to the
specific facilities, various employee monitoring and access restriction
policies, and various firewall and network management methodologies that
restrict unauthorized access through the Internet. While these systems have
worked effectively in the past, there can be no assurance that they will
continue to operate without a security breach in the future. Depending upon the
nature of the breach, the consequences of security breaches could be significant
and dramatic to ECHO's continued operations.
THE INDUSTRY IN WHICH WE OPERATE INVOLVES RAPIDLY CHANGING TECHNOLOGY AND OUR
FAILURE TO IMPROVE OUR PRODUCTS AND SERVICES OR TO OFFER NEW PRODUCTS AND
SERVICES COULD CAUSE US TO LOSE CUSTOMERS.
Our business industry involves rapidly changing technology. Recently, we have
observed rapid changes in technology as evidenced by the Internet and
Internet-related services and applications, new and better software, and faster
computers and modems. As technology changes, ECHO's customers desire and expect
better products and services. Our success depends on our ability to improve our
existing products and services and to develop and market new products and
services. The costs and expenses associated with such an effort could be
significant to us. There is no assurance that we will be able to find the funds
necessary to keep up with new
28
technology or that if such funds are available that we can successfully improve
our existing products and services or successfully develop new products and
services. Our failure to provide improved products and services to our
customers or any delay in providing such products and services could cause us to
lose customers to our competitors. Loss of customers could have a material
adverse effect on ECHO.
OUR INABILITY TO PROTECT OR DEFEND OUR TRADE SECRETS AND OTHER INTELLECTUAL
PROPERTY COULD HURT OUR BUSINESS.
We have expended a considerable amount of time and money to develop information
systems for our merchants. We regard these information systems as trade secrets
that are extremely important to our payment processing operations. We rely on
trade secret protection and confidentiality and/or license agreements with
employees, customers, partners and others to protect this intellectual property
and have not otherwise taken steps to obtain additional intellectual property
protection or other protection on these information systems. We cannot be
certain that we have taken adequate steps to protect our intellectual property.
In addition, our third-party confidentiality agreements can be breached and, if
they are, there may not be an adequate remedy available to us. If our trade
secrets become known, we may lose our competitive position, including the loss
of our merchant and bank customers. Such a loss could severely impact our
results of operations and financial condition.
Additionally, while we believe that the technology underlying our information
systems does not infringe upon the rights of any third parties, there is no
assurance that third parties will not bring infringement claims against us. We
also have the right to use the technology of others through various license
agreements. If a third party claimed our activities and/or these licenses were
infringing their technology, while we may have some protection from our
third-party licensors, we could face additional infringement claims or otherwise
be obligated to stop utilizing intellectual property critical to our technology
infrastructure. If we are not able to implement other technology to substitute
the intellectual property underlying a claim, our business operations could be
severely effected. Additionally, infringement claims would require us to incur
significant defense costs and expenses and, to the extent we are unsuccessful in
defending these claims, could cause us to pay monetary damages to the person or
entity making the claim. Continuously having to defend such claims or otherwise
making monetary damages payments could materially adversely affect our results
of operations.
IF WE DO NOT CONTINUE TO INVEST IN RESEARCH AND DEVELOPMENT, WE COULD LOSE OUR
COMPETITIVE POSITION.
Because technology in the payment processing industry evolves rapidly, we need
to continue to invest in research and development in both the bankcard
processing business segment and the check-related products segment in order to
remain competitive. Research and development expenses remained constant from
$1,464,000 in fiscal 2003 to $1,465,000 in fiscal 2004. Most of our development
project costs were capitalized once we entered into coding and testing phases,
we continue to evaluate projects, which we believe will assist us in our efforts
to stay competitive. Although we believe that our investment in these projects
will ultimately increase earnings, there is no assurance as to when or if these
new products will show profitability or if we will ever be able to recover the
costs invested in these projects. Additionally, if we fail to commit adequate
resources to grow our technology on pace with market growth, we could quickly
lose our competitive position, including the loss of our merchant and bank
customers.
FAILURE TO OBTAIN ADDITIONAL FUNDS CAN IMPACT OUR OPERATIONS AND FUTURE GROWTH.
We use funds generated from operations, as well as funds obtained through credit
facilities and equity financing, to finance our operations. In light of our
recent financing efforts, and as a result of the cash flow generated from
operations, we believe we have sufficient cash to support our business
activities, including research, development and marketing costs. However,
future growth may depend on our ability to continue to raise additional funds,
either through operations, bank borrowings, or equity or debt financings. There
is no assurance that we will be able to continue to raise the funds necessary to
finance growth or continue to generate the funds necessary to finance
operations, and even if such funds are available, that the terms will be
acceptable to us. The inability to generate the necessary funds from operations
or from third parties in the future may require us to scale back our research,
development and growth opportunities, which could harm our overall operations.
29
WHILE WE MAINTAIN INSURANCE PROTECTION AGAINST CLAIMS RELATED TO OUR SERVICES,
THERE IS NO ASSURANCE THAT SUCH PROTECTION WILL BE ADEQUATE TO COVER POTENTIAL
CLAIMS AND OUR INABILITY TO OTHERWISE PAY SUCH CLAIMS COULD HARM OUR BUSINESS.
We maintain errors and omissions insurance for the services we provide. While
we believe the limit on our errors and omissions insurance policy is adequate
and consistent with industry practice, if claims are brought by our customers or
other third parties, we could be required to pay the required claim or make
significant expenditures to defend against such claims in amounts that exceed
our current insurance coverage. There is no assurance that we will have the
money to pay potential plaintiffs for such claims if they arise beyond the
amounts insured by us. Making these payments could have a material adverse
effect on our business.
INVOLVEMENT IN LITIGATION COULD HARM OUR BUSINESS.
We are involved in various lawsuits arising in the ordinary course of business.
Although we believe that the claims asserted in such lawsuits are without merit,
the cost to us for the fees and expenses to defend such lawsuits could have a
material adverse effect on our financial condition, results of operations or
cash flow. In addition, there can be no assurance that we will not at some time
in the future experience significant liability in connection with such claims.
As of September 30, 2004, we have spent approximately $279,000 in legal fees and
expenses defending these claims.
OUR INABILITY TO RECOVER FROM NATURAL DISASTERS COULD HARM OUR BUSINESS.
We currently maintain three data centers: one in Camarillo, California, one in
Albuquerque, New Mexico and one in Boulder, Colorado. Should a natural disaster
occur in any of the locations, it is possible that ECHO would not be able to
fully recover full functionality at one of its data centers. To minimize this
risk, ECHO centralized its data processing functionality in Camarillo during
fiscal 2004 and will make Albuquerque a fully redundant site. Prior to that
time, it is possible a natural disaster could limit or completely disable a
specific service offered by ECHO until such time that the specific location
could resume its functionality. Our inability to provide such service could have
a material adverse effect on our business and results of operations.
INCREASES IN THE COSTS OF TECHNICAL COMPLIANCE COULD HARM OUR BUSINESS.
The services which ECHO offers require significant technical compliance. This
includes compliance to both Visa and MasterCard regulations and association
rules, NACHA guidelines and regulations with regard to the Federal Reserve
System's Automated Clearing House and check related issues, and various banking
requirements and regulations. ECHO has personnel dedicated to monitoring our
compliance to the specific industries we serve and, when possible, ECHO is
moving the technical compliance responsibility to other parties, as is the case
with the recent purchase of the Oasis Technologies bankcard processing system
wherein the vendor, Oasis Technologies, assumes much of the compliance
obligations regularly updated by Visa and MasterCard. As the compliance issues
become more defined in each industry, the costs associated with that compliance
may present a risk to ECHO. These costs could be in the form of additional
hardware, software or technical expertise that ECHO must acquire and/or
maintain. While ECHO currently has these costs under control, we have no
control over those entities that set the compliance requirements so no assurance
can be given that ECHO will always be able to underwrite the costs of compliance
in each industry wherein we compete.
RISKS ASSOCIATED WITH OUR COMMON STOCK
- -------------------------------------------
IF WE NEED TO SELL OR ISSUE ADDITIONAL SHARES OF COMMON STOCK OR ASSUME
ADDITIONAL DEBT TO FINANCE FUTURE GROWTH, OUR STOCKHOLDERS' OWNERSHIP COULD BE
DILUTED OR OUR EARNINGS COULD BE ADVERSELY IMPACTED.
Our business strategy may include expansion through internal growth, by
acquiring complementary businesses or by establishing strategic relationships
with targeted customers and suppliers. In order to do so, or to fund our other
activities, we may issue additional equity securities that could dilute our
stockholders' stock ownership. We
30
may also assume additional debt and incur impairment losses related to goodwill
and other tangible assets if we acquire another company and this could
negatively impact our results of operations. As of the date of this report,
management has no plan to raise additional capital through the sale of
securities and believes that our cash flow from operations together with cash on
hand and our established line of credit with Bank of the West will be sufficient
to meet our working capital and other commitments.
WE HAVE ADOPTED A NUMBER OF ANTI-TAKEOVER MEASURES THAT MAY DEPRESS THE PRICE OF
OUR COMMON STOCK.
Our rights agreement, our ability to issue additional shares of preferred stock
and some provisions of our articles of incorporation and bylaws could make it
more difficult for a third party to make an unsolicited takeover attempt of us.
These anti-takeover measures may depress the price of our common stock by making
it more difficult for third parties to acquire us by offering to purchase shares
of our stock at a premium to its market price.
OUR STOCK PRICE HAS BEEN VOLATILE.
Our common stock is quoted on the NASDAQ SmallCap Market, and there can be
substantial volatility in the market price of our common stock. Over the course
of the quarter ended September 30, 2004, the market price of our common stock
has been as high as $9.99, and as low as $6.45. Additionally, over the course
of the year ended September 30, 2004, the market price of our common stock has
been as high as $13.06 and as low as $6.15. The market price of our common
stock has been, and is likely to continue to be, subject to significant
fluctuations due to a variety of factors, including quarterly variations in
operating results, operating results which vary from the expectations of
securities analysts and investors, changes in financial estimates, changes in
market valuations of competitors, announcements by us or our competitors of a
material nature, loss of one or more customers, additions or departures of key
personnel, future sales of common stock and stock market price and volume
fluctuations. In addition, general political and economic conditions such as a
recession, or interest rate or currency rate fluctuations may adversely affect
the market price of our common stock.
WE HAVE NOT PAID AND DO NOT CURRENTLY PLAN TO PAY DIVIDENDS, AND YOU MUST LOOK
TO PRICE APPRECIATION ALONE FOR ANY RETURN ON YOUR INVESTMENT.
Some investors favor companies that pay dividends, particularly in general
downturns in the stock market. We have not declared or paid any cash dividends
on our common stock. We currently intend to retain any future earnings for
funding growth, and we do not currently anticipate paying cash dividends on our
common stock in the foreseeable future. Because we may not pay dividends, your
return on this investment likely depends on your selling our stock at a profit.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are currently not exposed to any significant financial market risks from
changes in foreign currency exchange rates or changes in interest rates and do
not use derivative financial instruments. All of our revenue and capital
spending is transacted in U.S. dollars. However, in the future, we may enter
into transactions in other currencies. An adverse change in exchange rates
would result in a decline in income before taxes, assuming that each exchange
rate would change in the same direction relative to the U.S. dollar. In
addition to the direct effects of changes in exchange rates, such changes
typically affect the volume of sales or foreign currency sales price as
competitors' products become more or less attractive.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
The Financial Statements and Supplementary Data are listed under "Item 15.
Exhibits, Financial Statement Schedules and Reports on Form 8K".
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
None.
31
ITEM 9A. CONTROLS AND PROCEDURES
As of September 30, 2004, the end of the period covered by this report, under
the supervision and with the participation of management, including our Chief
Executive Officer and our Chief Financial Officer, we have evaluated the
effectiveness of the design and operation of our disclosure controls and
procedures pursuant to Exchange Act Rules 13a-15 and 15d-15. Based upon that
evaluation, our Chief Executive Officer and our Chief Financial Officer have
concluded that our disclosure controls and procedures are effective in causing
material information to be recorded, processed, summarized and reported by our
management on a timely basis and to ensure that the quality and timeliness of
our public disclosures complies with its Securities and Exchange Commission
disclosure obligations. During the quarter ended September 30, 2004, there was
no change in our internal control over financial reporting that materially
affects, or that is reasonably likely to materially affect, our internal control
over financial reporting.
ITEM 9B. OTHER INFORMATION
None.
32
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The officers and directors of ECHO are:
Date first became
Name Position Officer or Director
- ----------------------- ------------------------- -------------------
Joel M. Barry Chairman of the Board, 1986
Chief Executive Officer,
Alice L. Cheung Chief Financial Officer, 1996
Treasurer
Alex Seltzer[1] Chief Operating Officer/ 2002
Chief Information Officer
Steven Smith[1] Chief Information Officer 2004
Sharat Shankar Senior Vice President 2003
Patricia M. Williams Senior Vice President 1997
Jack Wilson Senior Vice President 1994
Kris Winckler Senior Vice President 1999
Arnold Feinberg Vice President 2000
Jesse Fong Vice President 1994
David Griffin Vice President 1990
Robert Hare Vice President 1999
Steve Hoofring Vice President 2003
David Piatt Vice President 2003
Rick Slater Vice President 1998
Donna L. Rehman Corporate Secretary 1990
Herbert L. Lucas Director 1991
Aristides W. Georgantas Director 1999
Carl R. Terzian Director 2002
Richard Field Director 2004
[1] Steven Smith succeeds Alex Seltzer, with respect to information technology
duties previously performed by Mr. Seltzer, and joins us as a result of Mr.
Seltzer's decision to pursue other business interests. Mr. Seltzer will
continue providing services to us through December 31, 2004, the effective date
of his resignation.
JOEL M. BARRY, age 54, has been a Director of ECHO since July 1986, and Chairman
of the Board since December 1986. Mr. Barry served as Chief Financial Officer
from May 1987 to June 1990, and Executive Vice President from October 1987 to
June 1990, when he was designated Chief Executive Officer of ECHO. Mr. Barry is
33
also a Director and Chief Executive Officer of the MerchantAmerica and
XPRESSCHEX, Inc. wholly-owned subsidiaries. From August 1981 to June 1991, Mr.
Barry was a lecturer and investment counselor for Dynamic Seminars, a firm he
founded in 1981, and Basics Financial Planning and Investments, a firm he
founded in 1983. From 1972 to 1974, Mr. Barry owned and operated a recording
business and from 1975 to 1981 was employed as the Director of Marketing and
Sales with Financial Dynamics, a financial planning firm located in Covina,
California. Mr. Barry attended Oklahoma State University from 1969 to 1970,
majoring in Accounting and Ozark Bible College from 1970 to 1972, majoring in
music.
ALICE L. CHEUNG, age 47, has served as Treasurer and Chief Financial Officer
since July 1996. Ms. Cheung received her BS degree in business
administration/accounting from California State University in Long Beach,
California and became a Certified Public Accountant in May 1982. Prior to
joining ECHO, Ms. Cheung was the Treasurer and Chief Financial Officer of
American Mobile Systems from February 1988 to January 1996, prior to its merger
with Nextel Communications, Inc. Ms. Cheung is an active member of the American
Institute of Certified Public Accountants and Financial Executive Institute.
ALEX SELTZER, age 52, joined ECHO in August 2002 as Chief Operating Officer and
Chief Information Officer. Prior to joining ECHO, Mr. Seltzer was the CIO and
co-founder of Online Resources Corporation, an e-financial services outsourcer
providing home banking, bill payment, and integrated third-party financial
services to small and medium-sized U.S. banks. Mr. Seltzer holds a BS degree in
Applied Math and Computer Science from MIT in Cambridge, Massachusetts and an
MBA from Stanford Graduate School of Business in Stanford, California.
STEVEN SMITH, age 44, joined ECHO in November 2004 as Chief Information Officer.
Prior to joining ECHO, Mr. Smith was Vice President of Engineering for Digital
Insight (a financial services ASP providing Internet banking, bill payment, cash
management and loan origination capabilities to over 1,500 financial
institutions across North America), where he was accountable for all product
development. Mr. Smith has also served as a CIO and Vice President of Research
and Development for Lombardi Software in Austin, Texas and as a Partner with
Ernst & Young/CAP Gemini. Mr. Smith holds a B.A. degree in Computer Science
from The University of Texas in Austin.
SHARAT SHANKAR, age 34, joined ECHO in June 2003 as Vice President of Risk
Management and Business Intelligence. Prior to joining ECHO, Mr. Shankar worked
at TeleCheck for approximately eight years where he held a variety of positions
leading up to Vice President of Risk Management. Prior to TeleCheck, Mr. Shankar
held positions at MetLife as well as Hong Kong and Shanghai Bank, Madras, India.
Mr. Shankar holds a Bachelor of Commerce degree from Loyola College, India, and
a Master of Business Administration degree from James Madison University,
Virginia.
PATRICIA M. WILLIAMS, age 39, joined ECHO in September 1996, serving as Director
of Program Management, Ms. Williams was appointed Vice President of Corporate
Program Management in October 1997 and Vice President of Check Services in
October 2001. In June of 2003, Ms. Williams was appointed to the position of
Vice President of Sales and Marketing. Prior to joining ECHO, Ms. Williams was
an Operations Manager for Bank of America Systems Engineering in San Francisco.
Ms. Williams has also served as a Senior Program manager for the Los Angeles
office of LANSystems, Inc., a nationwide systems integrator as well as a Senior
Project Manager and Systems Engineer for Bank of America Systems Engineering in
Los Angeles. Ms. Williams holds a B.A. degree in communications from the
University of California, Los Angeles.
JACK WILSON, age 60, has served as Vice President of Merchant Services since
June 1994 and was Director of Bankcard Relations for ECHO from October 1992
until May 1994. Mr. Wilson served as Vice President for Truckee River Bank from
August 1989 until September 1992. Previously, he was Senior Vice
President/Cashier of Sunrise Bancorp and a Vice President of First Interstate
Bank. Mr. Wilson holds a teaching credential from the California Community
College System in business and finance.
KRIS WINCKLER, age 39, joined ECHO in April, 1999, as Vice President of ECHO's
XPRESSCHEX subsidiary. Mr. Winckler is currently the Senior Vice President of
Product and Strategic Planning at ECHO. Prior to joining ECHO, Mr. Winckler was
a consultant at Andersen Consulting and the President of Magic Software, a
company specializing in check verification, conversion, and ACH software. Mr.
Winckler has been active in the check and collection industry for over ten years
and has been a member of the Electronic Check Council of NACHA since 1998. Mr.
Winckler holds a B.S. degree in Electrical Engineering from the University of
New Mexico, an MBA from the University of Illinois, and is an Accredited ACH
Professional (AAP) and Certified Treasury Professional (CTP).
34
ARNOLD FEINBERG, age 55, joined ECHO in January 2000 as Vice President of sales.
Prior to joining ECHO, Mr. Feinberg was an independent sales consultant for
Rocky Mountain Retail Systems, a company that provided check authorization
software and transaction processing services and was acquired by ECHO in 2000.
From 1986 to 1993, Mr. Feinberg was employed by Lawrence Data Service, Inc.
where he developed the franchise division for regional check verification and
collection under National Check Association. Mr. Feinberg graduated from the
University of Kansas with a B.S. in Accounting and Finance.
JESSE FONG, age 53, has served as Vice President of Information Systems since
September 1994. Mr. Fong joined ECHO in 1984 and has served as programmer, Data
Processing manager and MIS director. He received a degree major in M.E. and
minor in Computer Science in 1972, received an International Marketing
certificate in 1975 and a Business Administration certificate in 1976. Mr. Fong
worked as Marketing manager, Sales manager and Trainer with the Xerox
Corporation in Taiwan from 1974 to 1978. After that, he joined Abbott
Laboratory as Country manager for two years. After immigrating to the United
States in 1980, he worked as International Marketing manager in a trading firm
for four years.
DAVID GRIFFIN, age 56, has served as Vice President of Major Accounts since June
2003. Previous to this capacity, he was Vice President of Check Guarantee from
October 2001 to June 2003, Vice President of Check Services for ECHO from June
1990 to October 2001 and Vice President of Operations from January 1986 until
September 1989, at which time he became a consultant to ECHO. Mr. Griffin has
served as Senior Vice President and General Manager for TeleCheck, Los Angeles
and TeleCheck, San Diego, from May 1983 to August 1985. Prior to these
appointments, he was Regional Manager of TeleCheck Services, a franchiser of
check guarantee services, a division of Tymshare Corporation, which was
subsequently acquired by McDonnell Douglas Corporation. Mr. Griffin holds a
business administration degree with a major in accounting from the University of
Houston.
ROBERT HARE, age 39, joined ECHO in April,1999 through the acquisition of Magic
Software Development, a company he co-founded in 1991 to provide check
verification, conversion and ACH software. Prior to founding Magic Software
Development, Mr. Hare was a software developer with Titan Business Systems and a
systems analyst with the University of New Mexico. Mr. Hare holds an A.S.
degree in Computer Programming from the University of New Mexico.
STEVE HOOFRING, age 44, joined ECHO in October 2001 as Implementation Manager
for the Check Services group and was appointed Vice President of Visa POS Check
and Client Services in October 2003. Mr. Hoofring was President of Running Dog
Software, Inc., which developed 'Enterprise' software for small to medium size
businesses. Prior to this, Mr. Hoofring held several management positions with
Emerson Power Transmission, a subsidiary of Emerson Electric, Inc. Mr. Hoofring
holds a B.S. degree in Business Administration from Northern Kentucky
University.
DAVID PIATT, age 45, joined ECHO in October 2003 as a Vice President of systems
management. Mr. Piatt has over 20 years of reengineering, information
technology and business experience in financial transaction processing, grant
management, online banking, engineering and manufacturing systems. His business
experience includes operations, program/project management, marketing, business
development, business process reengineering, Continuous Process Improvement,
Total Quality Management, Activity Based Costing, Work Breakdown Structure, cost
benefit analysis and ROI analyses. Mr. Piatt was awarded a Master's degree in
physics from Texas A&M and a bachelor's degree from Colorado State University.
RICK SLATER, age 44, joined ECHO in May 1995 as Vice President of Computer Based
Controls, Inc. ("CBC"). Mr. Slater was appointed President of CBC in December
1995, Vice President of ECHO in November 1998 and Chief Technology Officer in
October 1999. Prior to joining ECHO, Mr. Slater was President of Slater
Research, which provided contract engineering services to various institutions.
During this time, Mr. Slater directly participated in the U.S. Coast Guard
COMSTA upgrade project including site surveys, systems design and system upgrade
integration in a number of sites within the U.S. Prior to this position, Mr.
Slater served as a group leader at Aiken Advanced Systems. Mr. Slater holds a
BS degree in electrical engineering technology from Old Dominion University,
Norfolk, Virginia.
35
DONNA L. REHMAN, age 55, joined ECHO in 1988 and has served as Corporate
Secretary since 1990. For three years prior thereto, she was self-employed in
Woodland Hills, California in educational books and toys. She attended Southern
Illinois University in Carbondale and was employed as an administrative
assistant in Chicago for 4 years and Los Angeles for 5 years.
HERBERT L. LUCAS, age 78, has been a Director since 1991. Mr. Lucas received a
BA degree in History in 1950 from Princeton University and an MBA degree in 1952
from Harvard University Graduate School of Business Administration. He served
as President from 1972 to 1981 of Carnation International in Los Angeles and as
a member of the Board of Directors of the Carnation Company. Since 1982, Mr.
Lucas has managed his family investment business. He has served on the Board of
Directors of various financial and business institutions including Wellington
Trust Company, Arctic Alaska Fisheries, Inc., Scolr Pharma, Inc. and Sunworld
International Airways, Inc. Mr. Lucas has served as a Trustee of The J. Paul
Getty Trust, the Los Angeles County Museum of Art, The Morgan Library, National
Association of Independent Schools and Winrock International. He was formerly a
member of the Board of Trustees of Princeton University.
ARISTIDES W. GEORGANTAS, age 60, has served as a Director since February 1999.
Mr. Georgantas, prior to his retirement, was Executive Vice President and Chief
Operating Officer at Chase Manhattan Bank's Global Asset Management/Private
Banking Division. He serves as a director of Horizon Blue Cross Blue Shield of
New Jersey, the Glenmede Corporation, the Glenmede Trust Company, the Foundation
for Public Broadcasting in New Jersey, Mathematica Policy Research, Inc. and
the Rita Allen Foundation. Mr. Georgantas is a graduate of the University of
Massachusetts and the Columbia University Graduate School of Business.
CARL R. TERZIAN, age 69, has served as a Director since December, 2002. Mr.
Terzian graduated magna cum laude from the University of Southern California in
1957. Following his USC education, Mr. Terzian served as an international good
will ambassador for President Eisenhower and Secretary of State John Foster
Dulles; director of public and church relations for the Lutheran Hospital
Society of Southern California; civic affairs consultant to the California
savings and loan industry; and dean and professor of government and speech at
Woodbury University. In 1965, Mr. Terzian joined Charles Luckman Associates, an
architectural firm, to handle its public relations throughout the United States
and worldwide and began his own public relations firm, Carl Terzian Associates,
in 1969. Mr. Terzian currently serves as a director on the board of Transamerica
Investors, Inc. and Mercantile National Bank along with various non-profit
boards, commissions, advisory groups, and task forces.
RICHARD FIELD, age 64, became a director of ECHO in July 2004. Mr. Field has
worked in the financial services industry for over 35 years as an executive of
the Bank of New York, Chase, and Citigroup, and a director of Mastercard
International and Chairman of its U.S. Board. Since retiring from full time
employment in 1997, he has continued his career in the specialty financial areas
as a co-founder and director of LendingTree, Inc. as well as serving on the
boards of Providian Financial Corporation and HPSC, Inc. Mr. Field graduated
from Salisbury School, Connecticut, in 1959 and Trinity College, Connecticut, in
1963 with a B.A. in English and Economics.
All directors are to be elected to three year terms by the stockholders and
serve until their respective terms have expired. The Annual Meeting of
Stockholders was held on February 9, 2004, and the election of directors was
held at that time.
CODE OF ETHICAL CONDUCT
Our Board of Directors has adopted a Code of Ethical Conduct (the "Code of
Conduct"). We require all employees, directors and officers, including our Chief
Executive Officer and Chief Financial Officer, to adhere to the Code of Conduct
in addressing legal and ethical issues encountered in conducting their work. The
Code of Conduct requires that these individuals avoid conflicts of interest,
comply with all laws and other legal requirements, conduct business in an honest
and ethical manner and otherwise act with integrity and in our best interest.
The Code of Conduct contains additional provisions that apply specifically to
our Chief Financial Officer and other financial officers with respect to full
and accurate reporting. The Code of Conduct is available on our website at
www.echo-inc.com.
36
AUDIT COMMITTEE FINANCIAL EXPERT
Our Board of Directors has determined that Aristides W. Georgantas, the Chairman
of the Audit Committee of the Board of Directors, is an "audit committee
financial expert" as defined in Item 401(h) of Regulation S-K. Mr. Georgantas
is "independent" for purposes of Rule 4200(a)(15) of the NASDAQ Marketplace
Rules.
IDENTIFICATION OF AUDIT COMMITTEE
Our Board of Directors has a separately standing Audit Committee. The Audit
Committee currently consists of Messrs. Richard D. Field, Herbert L. Lucas, Jr.,
Aristides W. Georgantas, and Carl R. Terzian. Messrs. Field, Lucas, Georgantas
and Terzian are "independent directors" within the meaning of Rule 10A-3
promulgated under the Securities Exchange Act of 1934, as amended, and the
NASDAQ Marketplace Rules. The Audit Committee's primary duties and
responsibilities include appointment of the independent auditors, evaluation of
the performance and independence of such auditors and review of the annual
audited financial statements and the quarterly financial statements, as well as
the adequacy of our internal controls.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires our
directors and executive officers and the holders of 10% or more of our Common
Stock to file with the Securities and Exchange Commission initial reports of
ownership and reports of changes in ownership of our equity securities. Based
solely on our review of the copies of the forms received by us and written
representations from certain reporting persons that they have complied with the
relevant filing requirements, we believe that, during the year ended September
30, 2004, all of our executive officers, directors and the holders of 10% or
more of our Common Stock complied with all Section 16(a) filing requirements.
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth the total compensation paid and stock options
offered by us during the fiscal years ended September 30, 2004, September 30,
2003 and September 30, 2002, to our Chief Executive Officer and to each of our
five most highly compensated executive officers, other than the Chief Executive
Officer (collectively with the Chief Executive Officer, the "Named Executive
Officers"), whose compensation exceeded $100,000 during the fiscal year ended
September 30, 2004.
SUMMARY COMPENSATION TABLE
Annual Long Term
Compensation Compensation
------------------ ------------
Securities
Capacities in Underlying
Name Which Served Year Salary Bonus Options[2] Other[3]
- -------------------- ------------------ ---- -------- -------- ------------ ---------
Joel M. Barry[1] Chairman/Chief 2004 $241,500 $ 50,000 60,000 $ -0-
Executive Officer 2003 223,125 -0- 40,000 -0-
2002 209,000 -0- 50,000 -0-
Alex Seltzer[4] Chief Information 2004 $190,565 $ 48,000 30,000 $ 5,110
Officer/Chief 2003 148,295 -0- 5,000 2,250
Operating Officer 2002 14,230 -0- 50,000 -0-
Alice Cheung Chief Financial 2004 $138,000 $ 40,000 35,000 $ 4,940
Officer/Treasurer 2003 125,500 15,000 15,000 4,175
2002 110,500 11,500 5,000 3,450
37
Sharat Shankar Sr. Vice President 2004 $131,430 47,500 35,000 $ 2,343
2003 46,333 5,000 50,000 -0-
2002 -0- -0- -0- -0-
Patricia M. Williams Sr. Vice President 2004 $123,000 $ 35,000 35,000 -0-
2003 111,190 15,000 15,000 -0-
2002 103,750 16,500 10,000 3,000
Jack Wilson[1] Sr. Vice President 2004 $123,000 $ 35,000 35,000 $ 4,412
2003 111,190 15,000 15,000 2,998
2002 103,750 16,500 5,000 2,250
_______________________
[1] We provide Mr. Barry and Mr. Wilson with an automobile. There has been no
compensation paid other than that indicated in the above table.
[2] Mr. Seltzer exercised 1,000 of his options at $1.30 per option, granted in
fiscal 2003 and 10,000 of his options at $1.29 per option, granted in
fiscal 2002; Ms. Williams exercised 2,000 of her options at $2.15 per
option, granted in fiscal 2002.
[3] Represents our match of contributions to our 401(k) Plan. We contribute 50%
of the last 6% of each employee's contribution to the 401(k) Plan.
[4] Mr. Seltzer has decided to pursue other business interests. As a result,
he will only continue providing services to us through December 31, 2004,
the effective date of his resignation.
FISCAL 2004 OPTION GRANTS TABLE
The following table sets forth the stock options granted to our Chief Executive
Officer and each of the other Named Executive Officers during the fiscal year
ended September 30, 2004. Under applicable Securities and Exchange Commission
regulations, companies are required to project an estimate of appreciation of
the underlying shares of stock during the option term. We have chosen to
project this estimate using the potential realizable value at assumed annual
rates of stock price appreciation for the option term at assumed rates of
appreciation of 5% and 10%. However, the ultimate value will depend upon the
market value of our stock at a future date, which may or may not correspond to
the following projections.
Potential Realization
Value at Assumed
Annual Rates of
Stock Price
Percent of Appreciation for
Total Granted Exercise Option Term
Options to Employees in Price Expiration ---------------------------
Name Granted[1] Fiscal Year per share Date 5% 10%
- ----------------- ---------- ---------------- ---------- ---------- ------------- ------------
Joel M. Barry 60,000 14.12% $ 6.85 12/15/13 $ 167,000 $ 390,000
Alex Seltzer 30,000 7.06% $ 6.85 12/15/13 $ 84,000 $ 195,000
Alice Cheung 35,000 8.24% $ 6.85 12/15/13 $ 98,000 $ 228,000
Sharat Shankar 35,000 8.24% $ 6.85 12/15/13 $ 98,000 $ 228,000
Patricia Williams 35,000 8.24% $ 6.85 12/15/13 $ 98,000 $ 228,000
Jack Wilson 35,000 8.24% $ 6.85 12/15/13 $ 98,000 $ 228,000
[1] All options vest in five equal annual installments beginning 12 months
following the date of the grant.
38
AGGREGATED OPTION/SAR EXERCISES AND FISCAL-YEAR OPTION/SAR VALUE TABLE
The following table sets forth information concerning the exercise of stock
options during the fiscal year ended September 30, 2004 by each of our Named
Executive Officers and the number and value of unexercised options held by each
of our Named Executive Officers as of the fiscal year ended September 30, 2004.
Value of
Number of unexercised
Shares unexercised in-the-money
acquired on Value options/SARS Options/SARS
Name exercise realized at FY-end at FY-end[1]
- -------------------- ----------- --------- ------------ -------------
Joel M. Barry 32,500 $ -0- 250,000 $ 1,126,000
Alex Seltzer 11,000 $ -0- 74,000 $ 389,000
Alice Cheung 7,500 $ -0- 85,000 $ 361,000
Sharat Shankar -0- $ -0- 85,000 $ 748,000
Patricia M. Williams 1,000 $ -0- 89,000 $ 367,000
Jack Wilson 8,500 $ 65,400 71,500 $ 287,000
_____________________
[1] Based on the closing sales price of the Common Stock on September 30, 2004
of $8.80 per share, less the option exercise price.
EQUITY COMPENSATION PLAN INFORMATION
The following table sets forth information concerning our equity compensation
plans as of September 30, 2004.
(c) Number of securities
(a) Number of remaining available for
securities to be future issuance under
issued upon (b) Weighted-average equity compensation
exercise of exercise price of (excluding securities
Plan Category outstanding options outstanding options reflected in column (a))
- ------------------- ------------------- --------------------- ------------------------
Equity compensation
plans approved by
security holders[1] 1,133,925 $ 4.86 193,000
_____________________
[1] Plan represents the Officers and Key Employees Incentive Stock Option Plan,
which expired in May 2002, and our 2003 Incentive Stock Option Plan.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
No interlocking relationship exists between our Board of Directors or Executive
Officers Compensation Committee and the board of directors or compensation
committee of any other company.
DIRECTOR COMPENSATION
Each outside director received $48,250 in fiscal 2004; $28,000 and 3,031 shares
of Common Stock in fiscal 2003; and $15,000 and 6,912 shares of Common Stock in
fiscal 2002. Mr. Field, appointed on July 12, 2004, to fill a vacancy on the
Board of Directors, received $13,750 in fiscal 2004. Directors are compensated
for all reasonable expenses and are not compensated for special meetings other
than regular meetings.
39
EMPLOYMENT AGREEMENTS
None.
BONUS, PROFIT-SHARING AND OTHER REMUNERATION PLANS AND PENSION AND RETIREMENT
PLANS
In addition to salary, the Compensation Committee of the Board of Directors,
from time to time, grants options to executive officers and key personnel
pursuant to the 2003 Incentive Stock Option Plan. The Compensation Committee
thus views option grants as an important component of its long-term,
performance-based compensation philosophy. Since the value of an option bears a
direct relationship to our stock price, the Compensation Committee believes that
options motivate executive officers and key personnel to manage us in a manner
which will also benefit shareholders. As such, options are granted at the
current market price. One of the principal factors considered in granting
options to executive officers or key personnel is their ability to influence our
long-term growth and profitability.
The Compensation Committee has also established a bonus program to reward
extraordinary performance that exceeds pre-set goals established for executive
officers and key personnel. We believe that such a bonus program provides the
incentive to exceed such goals, thereby building shareholder value.
We have a contributory 401(K) Retirement Pension Plan, which covers all
employees who are qualified under the plan provisions.
STOCK OPTION PLANS
On May 13, 1992, our Board of Directors authorized adoption of an Officers and
Key Employees Incentive Stock Option Plan (the "1992 Plan"), ratified by the
shareholders at the Annual Meeting held July 10, 1992. The 1992 Plan provided
for the issuance of up to 81,250 shares of our Common Stock to be subject to
stock options, each to purchase one share of the Common Stock for $3.40 per
share, subject to adjustment in the event of stock splits, combinations of
shares, stock dividends or the like.
On November 18, 1996, our Board of Directors authorized an increase in the 1992
Plan to 843,750 shares to be subject to stock options, which action was ratified
by the shareholders at the Annual Meeting held in February 1997.
On February 4, 1999, our Board of Directors authorized an increase in the 1992
Plan to 1,343,750 shares to be subject to stock options, which action was
ratified by the shareholders at the Annual Meeting held in February 1999.
On May 13, 2002, the 1992 Plan expired. The 2003 Incentive Stock Option Plan,
which provided for the issuance of up to 900,000 shares of Common Stock
underlying stock options, was approved by our Board of Directors and by our
shareholders at the Annual Meeting of Shareholders held on February 3, 2003.
On April 19, 2004, our Compensation Committee approved certain non-material
changes to our 2003 Incentive Stock Option Plan.
On December 21, 2004, our Compensation Committee authorized an amendment and
restatement of the 2003 Incentive Stock Option Plan to, among other matters, (i)
increase the number of shares to be issued under the 2003 Incentive Stock Option
Plan from 900,000 to 1,150,000 shares, and (ii) permit the grant of restricted
stock under the plan, subject to shareholder approval.
With the exception of the foregoing, we have no stock option plans or other
similar or related plans in which any of our officers or directors participate.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
As of December 13, 2004, there were 6,472,331 shares of our Common Stock
outstanding. Based on our review of a Schedule 13D/A filed with the Securities
and Exchange Commission on September 7, 2004, the following individual has
beneficial ownership or control over 5% or more of our outstanding Common Stock:
40
Amount and Percentage of
Nature of Beneficial Outstanding Stock
Name and Address Ownership At 12/13/04
- ----------------------------- -------------------- ------------------
Melvin Laufer 519,839 8.03%
136 Beach 140th Street
Far Rockaway, NY 11694
Based on our review of a Schedule 13G/A filed with the Securities and Exchange
Commission on July 8, 2004, the following entity has beneficial ownership or
control of 5% or more of our outstanding Common Stock:
William Blair and Company LLC 708,952 10.95%
222 W. Adams Street
Chicago, IL 60606
The following table sets forth the number of shares of Common Stock owned
beneficially by our (i) directors, (ii) the Named Executive Officers (as defined
below), and (iii) the executive officers and directors as a group, as of
December 13, 2004. Such figures are based upon information furnished by the
persons named.
Amount and Percentage of
Nature of Beneficial Outstanding Stock[1]
Name and Address Ownership At 12/13/04
- --------------------------- -------------------- ---------------------
Joel M. Barry 236,119[2] 3.58%
730 Paseo Camarillo
Camarillo, CA 93010
Alice L. Cheung 45,500[2] 0.70%
730 Paseo Camarillo
Camarillo, CA 93010
Richard Field 100,000 1.55%
49 Locust Avenue
New Canaan, CT 06840
Aristides W. Georgantas 16,521 0.26%
180 Springdale Road
Princeton, NJ 08540
Herbert L. Lucas, Jr. 57,880[3] 0.89%
12011 San Vicente Blvd.
Los Angeles, CA 90049
Alex Seltzer 36,500[2][6] 0.56%
730 Paseo Camarillo
Camarillo, CA 93010
Sharat Shankar 10,000[2] 0.15%
730 Paseo Camarillo
Camarillo, CA 93010
Carl R. Terzian 3,031 0.05%
12400 Wilshire Blvd.
Los Angeles, CA 90025
Patricia M. Williams 39,675[2] 0.61%
730 Paseo Camarillo
Camarillo, CA 93010
Jack Wilson 15,075[2][4] 0.23%
730 Paseo Camarillo
Camarillo, CA 93010
All officers and directors
as a group (19 persons) [5] 778,479 11.47%
41
- ------------------------------
[1] Under Rule 13d-3, certain shares may be deemed to be beneficially owned by
more than one person (if, for example, persons share the power to vote or
the power to dispose of the shares). In addition, shares are deemed to be
beneficially owned by a person if the person has the right to acquire the
shares (for example, upon exercise of an option) within 60 days of the date
as of which the information is provided. In computing the percentage
ownership of any person, the amount of shares outstanding is deemed to
include the amount of shares beneficially owned by such person (and only
such person) by reason of these acquisition rights. As a result, the
percentage of outstanding shares of any person as shown in this table does
not necessarily reflect the person's actual ownership or voting power with
respect to the number of shares of Common Stock actually outstanding at
December 13, 2004.
[2] Includes stock options according to the terms of the Officers and Key
Employees Incentive Stock Option Plan and the 2003 Incentive Stock Option
Plan, which for the following number of shares and for the following
individuals could be acquired within 60 days through the exercise of stock
options: Joel M. Barry, 120,500 shares; Alice Cheung, 34,500 shares; Alex
Seltzer, 10,000 shares; Sharat Shankar, 10,000 shares; Patricia Williams,
35,000 shares; and Jack Wilson 10,500 shares.
[3] Includes 17,972 shares indirectly owned by Mr. Lucas through a trust for
his wife.
[4] Includes 530 shares indirectly owned by Mr. Wilson through his wife.
[5] Includes shares and stock options according to the terms of the Officers
and Key Employees Incentive Stock Option Plan and the 2003 Incentive Stock
Option Plan, which for the following number of shares and for the following
individuals could be acquired within 60 days through the exercise of stock
options: Arnold Feinberg, 20,000 shares; Jesse Fong, 13,778 shares; David
Griffin, 12,686 shares; Robert Hare, 61,032 shares; Steve Hoofring, 8,500
shares; David Piatt, 4,000 shares; Donna Rehman, 3,850 shares; Rick Slater,
34,000 shares; and Kris Winckler, 60,332 shares.
[6] Mr. Seltzer has decided to pursue other business interests. As a result,
he will only continue providing services to us through December 31, 2004,
the effective date of his resignation.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
There were no related-party transactions.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.
AUDIT FEES
PricewaterhouseCoopers, LLP, our independent accountants
("PricewaterhouseCoopers") billed us an aggregate of approximately $135,000 and
$113,000 in fees for professional services rendered for the audit of our annual
financial statements for the fiscal years ended September 30, 2004 and September
30, 2003, respectively, and the reviews of the financial statements included in
our Form 10-Q's for fiscal 2004 and 2003.
AUDIT-RELATED FEES
PricewaterhouseCoopers billed us an aggregate of approximately $50,000 and
$7,000 in fees for assurance and related services related to the audit of our
annual financial statements for the fiscal years ended September 30, 2004 and
September 30, 2003, respectively.
42
Our Audit Committee is directly responsible for interviewing and retaining our
independent accountant, considering the accounting firm's independence and
effectiveness, and pre-approving the engagement fees and other compensation to
be paid to, and the services to be conducted by, the independent accountant.
The Audit Committee does not delegate these responsibilities. During each of the
fiscal years ended September 30, 2004 and 2003, respectively, our Audit
Committee pre-approved 100% of the services described above.
43
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8K
(a) The following documents are filed as part of this report:
(1) Consolidated Financial Statements
Page
----
Report of Independent Registered Public Accounting Firm . . . . . . F-1
Consolidated Balance Sheets at September 30, 2004 and 2003 . . . . . F-2
Consolidated Statements of Operations for each of the three years
in the period ended September 30, 2004 . . . . . . . . . . . . . . F-3
Consolidated Statements of Changes in Stockholders' Equity
for each of the three years in the period ended September 30, 2004 F-4
Consolidated Statements of Cash Flows for each of the three years
in the period ended September 30, 2004 . . . . . . . . . . . . . . F-5
Notes to Consolidated Financial Statements . . . . . . . . . . . . . F-6
(2) Financial Statement Schedule:
Schedule II - Valuation and Qualifying Accounts and Reserves . . . . S-1
All other schedules are omitted because they are not applicable or the required
information is shown in the Consolidated Financial Statements or Notes thereto.
(b) Reports on Form 8K for fourth quarter ended September 30, 2004:
Current Report on Form 8-K dated July 12, 2004, filed with the Securities and
Exchange Commission on July 14, 2004.
Current Report on Form 8-K dated August 11, 2004, filed with the Securities and
Exchange Commission on August 11, 2004.
Current Report on Form 8-K dated September 27, 2004, filed with the Securities
and Exchange Commission on September 30, 2004.
(c) Exhibits:
Exhibit
Number Description of Document
- ------- -----------------------
2.1 Copy of Merger Agreement and Plan of Reorganization between Electronic Clearing House, Inc., ECHO
Acquisition Corporation, and Magic Software Development, Inc., dated April 20, 1999.[5]
2.2 Copy of Merger Agreement and Plan of Reorganization between Electronic Clearing House, Inc., ECHO
Acquisition Corporation, and Rocky Mountain Retail Systems, Inc., dated January 4, 2000.[6]
3.1 Articles of Incorporation of Bio Recovery Technology, Inc., filed with the Nevada Secretary of State on
December 11, 1981. [1]
3.4 By-Laws of Bio Recovery Technology, Inc. [1]
4.2 Specimen Common Stock Certificate. [3]
10.35 Copy of Merchant Marketing and Processing Services Agreement between Electronic Clearing House, Inc.
and First Regional Bank, dated June 24, 1997. [4]
44
10.36 Copy of Merchant Marketing and Processing Services Agreement between Electronic Clearing House, Inc.
and The Berkshire Bank, dated July 31, 1997. [4]
10.41 Copy of Processing and Software Development and License Agreement between Electronic Clearing
House, Inc. and National Bank Drafting Systems, Inc., dated October 22, 1999.[6]
10.42 Copy of Addendum to Agreement between Electronic Clearing House, Inc. and U-Haul International, dated
January 1, 2000.[6]
10.44 Copy of Electronic Check Services Agreement between Electronic Clearing House, Inc. and National Bank
Drafting Systems, Inc., dated May 17, 2000.[6]
10.46 Copy of Amended and Restated Merchant Marketing and Processing Services Agreement between
Electronic Clearing House, Inc. and First Regional Bank, dated August 1, 2000.[6]
10.47 Copy of Addendum to Amended and Restated Merchant Marketing and Processing Services Agreement
between Electronic Clearing House, Inc. and First Regional Bank, dated August 1, 2000.[6]
10.48 Copy of POS Check Third-Party Services Agreement between Visa U.S.A., Inc. and Electronic Clearing
House, Inc., dated December 12, 2000.[7]
10.49 Copy of Asset Purchase Agreement between National Check Network, Inc. and Electronic Clearing
House, Inc., dated April 19, 2001. [7]
10.50 Copy of Addendum to Agreement between U-Haul International and Electronic Clearing House, Inc., dated
October 1, 2001. [7]
10.51 Copy of First Amendment to the POS Check Third-Party Servicer Agreement between Visa U.S.A., Inc.
and Electronic Clearing House, Inc. dated December 12, 2000. [8]
10.52 Copy of Second Amendment to the POS Check Third-Party Servicer Agreement between Visa U.S.A., and
Electronic Clearing House, Inc. dated December 12, 2000. [8]
10.53 Copy of Third Amendment to the POS Check Third-Party Servicer Agreement between Visa U.S.A., and
Electronic Clearing House, Inc. dated December 12, 2000. [8]
10.54 Form of Securities Purchase Agreement by and among the Registrant and the Purchasers identified
therein. [9]
10.55 Form of Registration Rights Agreement by and among the Registrant and the Purchasers identified
therein. [9]
10.56 Office Lease dated May 21, 2003, by and between the Registrant and the 1989 Sheehan Family Trust
dated October 24, 1989, with respect to principal executive offices located at 730 Paseo Camarillo,
Camarillo, California 93010.[10]
10.57 Addendum to Office Lease dated July 7, 2004, by and between the Registrant and the 1989 Sheehan
Family Trust dated October 24, 1989, with respect to principal executive offices located at 730 Paseo
Camarillo, Camarillo, California 93010.
21.0 Subsidiaries of Registrant. [2]
23.1 Consent of PricewaterhouseCoopers LLP
24.1 Power of Attorney [11]
31.1 Certificate of Joel M. Barry, Chief Executive Officer of Electronic Clearing House, Inc. pursuant to Rule
13a-14(b) under the Securities and Exchange Act of 1934, as amended.
31.2 Certificate of Alice L. Cheung, Chief Financial Officer of Electronic Clearing House, Inc. pursuant to Rule
13a-14(b) under the Securities and Exchange Act of 1934, as amended.
32.1 Certificate of Joel M. Barry, Chief Executive Officer of Electronic Clearing House, Inc. pursuant to Rule
13a-14(b) under the Securities and Exchange Act of 1934, as amended.
32.2 Certificate of Alice L. Cheung, Chief Financial Officer of Electronic Clearing House, Inc. pursuant to Rule
13a-14(b) under the Securities and Exchange Act of 1934, as amended.
- ------------------------------
[1] Filed as an Exhibit to Registrant's Annual Report on Form 10-K for the
fiscal year ended September 30, 1988 and incorporated herein by reference.
[2] Filed as an Exhibit to Registrant's Annual Report on Form 10-K for the
fiscal year ended September 30, 1989 and incorporated herein by reference.
[3] Filed as an Exhibit to Registrant's Form S-1, Amendment No. 3, effective
November 13, 1990 and incorporated herein by reference.
[4] Filed as an Exhibit to Registrant's Annual Report on Form 10-K for fiscal
year ended September 30, 1997 and incorporated herein by reference.
[5] Filed as an Exhibit to Registrant's Annual Report on Form 10-K for fiscal
year ended September 30, 1999 and incorporated herein by reference.
45
[6] Filed as an Exhibit to Registrant's Annual Report on Form 10-K for fiscal
year ended September 30, 2000 and incorporated herein by reference.
[7] Filed as an Exhibit to Registrant's Annual Report on Form 10-K for fiscal
year ended September 30, 2001 and incorporated herein by reference.
[8] Filed as an Exhibit to Registrant's Annual Report on Form 10-K for fiscal
year ended September 30, 2002 and incorporated herein by reference.
[9] Filed as an Exhibit to Registrant's Current Report on Form 8-K dated
October 30, 2003 and incorporated herein by reference.
[10] Filed as an Exhibit to Registrant's Annual Report on Form 10-K for fiscal
year ended September 30, 2003 and incorporated herein by reference.
[11] Included on signature page.
46
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this Report to be signed on its
behalf by the undersigned, thereunto duly authorized.
ELECTRONIC CLEARING HOUSE, INC.
By: /s/ Joel M. Barry
----------------------------------
Joel M. Barry, Chief Executive
Officer and Chairman
POWER OF ATTORNEY
Each person whose signature appears below constitutes and appoints Joel M. Barry
and Alice L. Cheung, and each of them, as their true and lawful
attorneys-in-fact and agents with full power of substitution and resubstitution,
for them and in their name, place and stead, in any and all capacities, to sign
any or all amendments to this Annual Report on Form 10-K and to file the same,
with all exhibits thereto, and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorneys-in-fact and
agents, and each of them, full power and authority to do and perform each and
every act and thing requisite and necessary to be done in and about the
foregoing, as fully to all intents and purposes as he might or could do in
person, hereby ratifying and confirming all that said attorneys-in-fact and
agents, or either of them, or their substitutes, may lawfully do or cause to be
done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report
has been signed by the following persons in the capacities and on the dates
indicated.
SIGNATURE TITLE DATE
- ---------------------------- --------------------------- ----------------
/s/ Joel M. Barry Chairman of the Board ) December 29, 2004
- ---------------------------- and Chief Executive Officer )
Joel M. Barry )
)
/s/ Aristides W. Georgantas Director )
- ---------------------------- )
Aristides W. Georgantas )
)
/s/ Herbert L. Lucas, Jr. Director )
- ---------------------------- )
Herbert L. Lucas, Jr. )
)
/s/ Carl R. Terzian Director )
- ---------------------------- )
Carl R. Terzian )
)
/s/ Richard Field Director )
- ---------------------------- )
Richard Field )
)
/s/ Alice L. Cheung Chief Financial Officer )
- ---------------------------- and Treasurer )
Alice L. Cheung )
)
/s/ Marjan Hewson Controller )
- ---------------------------- )
Marjan Hewson )
47
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors:
In our opinion, the consolidated financial statements listed in the index
appearing under Item 15(a)(1) on page 44 present fairly, in all material
respects, the financial position of Electronic Clearing House, Inc. and its
subsidiaries at September 30, 2004 and 2003, and the results of their operations
and their cash flows for each of the three years in the period ended September
30, 2004 in conformity with accounting principles generally accepted in the
United States of America. In addition, in our opinion, the financial statement
schedule listed in the index appearing under Item 15(a)(2) on page 44 presents
fairly, in all material respects, the information set forth therein when read in
conjunction with the related consolidated financial statements. These financial
statements and financial statement schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and financial statement schedule based on our audits. We
conducted our audits of these statements in accordance with standards of the
Public Company Accounting Oversight Board (United States) Those standards
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
As discussed in Note 3 to the financial statements, effective October 1, 2002,
the Company adopted Financial Accounting Standards Board Statement No. 142,
"Goodwill and Other Intangible Assets" and changed its method of accounting for
good will.
PRICEWATERHOUSECOOPERS LLP
Los Angeles, California
DECEMBER 17, 2004
ELECTRONIC CLEARING HOUSE, INC.
CONSOLIDATED BALANCE SHEETS
---------------------------
September 30,
---------------------------
2004 2003
------------ -------------
ASSETS
------
Current assets:
Cash and cash equivalents $ 7,576,000 $ 2,908,000
Restricted cash 1,024,000 977,000
Settlement deposits 18,282,000 2,733,000
Settlement receivables less allowance of $22,000 and $21,000 451,000 696,000
Accounts receivable less allowance of $111,000 and $71,000 1,943,000 1,939,000
Prepaid expenses and other assets 368,000 307,000
Deferred tax asset 279,000 86,000
------------ -------------
Total current assets 29,923,000 9,646,000
Noncurrent assets:
Property and equipment, net 2,293,000 2,928,000
Software, net 6,844,000 4,445,000
Deferred tax asset -0- 1,256,000
Other assets, net 368,000 500,000
------------ -------------
Total assets $39,428,000 $ 18,775,000
============ =============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current liabilities:
Short-term borrowings and current portion of
long-term debt and capital leases $ 878,000 $ 901,000
Accounts payable 305,000 779,000
Settlement payable 18,733,000 3,429,000
Accrued expenses 2,003,000 1,336,000
------------ -------------
Total current liabilities 21,919,000 6,445,000
Noncurrent liabilities:
Long-term debt and capital leases 704,000 1,961,000
Deferred tax liability 565,000 -0-
------------ -------------
Total liabilities 23,188,000 8,406,000
------------ -------------
Commitments and contingencies - see Note 12
Stockholders' equity:
Common stock, $.01 par value, 36,000,000 shares authorized;
6,451,331 and 5,920,174 shares issued; 6,413,062 and 5,881,905
shares outstanding 64,000 59,000
Additional paid-in capital 24,658,000 21,641,000
Accumulated deficit (8,016,000) (10,865,000)
Less treasury stock at cost, 38,269 and 38,269 common shares (466,000) (466,000)
------------ -------------
Total stockholders' equity 16,240,000 10,369,000
------------ -------------
Total liabilities and stockholders' equity $39,428,000 $ 18,775,000
============ =============
See accompanying notes to consolidated financial statements.
ELECTRONIC CLEARING HOUSE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
-------------------------------------
Year ended September 30,
----------------------------------------
2004 2003 2002
------------ ------------ ------------
REVENUES $47,584,000 $40,636,000 $33,291,000
------------ ------------ ------------
COSTS AND EXPENSES:
Processing and transaction expense 29,634,000 26,660,000 22,973,000
Other operating costs 5,182,000 4,373,000 4,032,000
Research and development expense 1,465,000 1,464,000 1,747,000
Selling, general and administrative expenses 7,846,000 5,714,000 5,219,000
Amortization expense - goodwill -0- -0- 489,000
Legal settlement -0- -0- 2,500,000
------------ ------------ ------------
44,127,000 38,211,000 36,960,000
------------ ------------ ------------
Income (loss) from operations 3,457,000 2,425,000 (3,669,000)
Interest income 71,000 28,000 55,000
Interest expense (175,000) (200,000) (129,000)
Gain on sale of assets 1,319,000 -0- -0-
------------ ------------ ------------
Income (loss) before (provision) benefit for income taxes
and cumulative effect of an accounting change 4,672,000 2,253,000 (3,743,000)
(Provision) benefit for income taxes (1,823,000) (925,000) 1,367,000
------------ ------------ ------------
Income (loss) before cumulative effect of an accounting change 2,849,000 1,328,000 (2,376,000)
Cumulative effect of an accounting change to adopt SFAS 142 -0- (4,707,000) -0-
------------ ------------ ------------
Net income (loss) $ 2,849,000 $(3,379,000) $(2,376,000)
============ ============ ============
Basic net earnings (loss) per share
Before cumulative effect of accounting change $ 0.45 $ 0.23 $ (0.41)
Cumulative effect of accounting change -0- (0.81) -0-
------------ ------------ ------------
Basic net earnings (loss) per share $ 0.45 $ (0.58) $ (0.41)
============ ============ ============
Diluted net earnings (loss) per share
Before cumulative effect of accounting change $ 0.41 $ 0.22 $ (0.41)
Cumulative effect of accounting change -0- (0.78) -0-
------------ ------------ ------------
Diluted net earnings (loss) per share $ 0.41 $ (0.56) $ (0.41)
============ ============ ============
See accompanying notes to consolidated financial statements.
ELECTRONIC CLEARING HOUSE, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
----------------------------------------------------------
Shares
--------------------------------- Additional
Common Paid-in Treasury Accumulated
Treasury Common Preferred Stock Capital Stock Deficit Total
--------- ---------- ---------- --------- ------------ ---------- ------------- ------------
Balance at September 30, 2001 39,269 5,809,095 25,000 $ 58,000 $21,260,000 $(469,000) $ (5,110,000) $15,739,000
Exercise of stock options 5,500 11,000 11,000
Issuance of common stock to
outside directors 20,736 45,000 45,000
Conversion of preferred to 25,000 (25,000)
common
Exchange of stock for note (25,000) (54,000) (54,000)
receivable
Tax benefit from exercise of 173,000 173,000
stock options
Net loss (2,376,000) (2,376,000)
--------- ---------- ---------- --------- ------------ ---------- ------------- ------------
Balance at September 30, 2002 39,269 5,835,331 -0- 58,000 21,435,000 (469,000) (7,486,000) 13,538,000
Exercise of stock options 75,750 1,000 157,000 158,000
Issuance of common stock to
outside directors 9,093 21,000 21,000
Issuance of stock for (1,000) 3,000 3,000
equipment purchase
Expense related to stock
option issuance 28,000 28,000
Net loss (3,379,000) (3,379,000)
--------- ---------- ---------- --------- ------------ ---------- ------------- ------------
Balance at September 30, 2003 38,269 5,920,174 -0- 59,000 21,641,000 (466,000) (10,865,000) 10,369,000
Private Placement 437,957 4,000 2,689,000 2,693,000
Exercise of stock options 93,200 1,000 220,000 221,000
Expense related to stock
option issuance 33,000 33,000
Tax benefit from exercise of 75,000 75,000
stock option
Net income 2,849,000 2,849,000
--------- ---------- ---------- --------- ------------ ---------- ------------- ------------
Balance at September 30, 2004 38,269 6,451,331 -0- $ 64,000 $24,658,000 $(466,000) $ (8,016,000) $16,240,000
========= ========== ========== ========= ============ ========== ============= ============
See accompanying notes to consolidated financial statements.
ELECTRONIC CLEARING HOUSE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
Year ended September 30,
-----------------------------------------
2004 2003 2002
------------- ------------ ------------
Cash flows from operating activities:
Net income (loss) $ 2,849,000 $(3,379,000) $(2,376,000)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
(Gain) loss on sale of assets (1,319,000) 16,000 -0-
Cumulative effect of an accounting change -0- 4,707,000 -0-
Depreciation 634,000 512,000 480,000
Amortization of software 1,350,000 1,081,000 697,000
Amortization of goodwill -0- -0- 489,000
Provisions for losses on accounts and notes receivable 92,000 67,000 302,000
Provision for obsolete inventory 46,000 110,000 300,000
Write-down of real estate -0- 55,000 100,000
Fair value of stock issued in connection
with director's compensation -0- 21,000 45,000
Deferred income taxes 1,628,000 942,000 (1,375,000)
Stock option compensation 33,000 28,000 -0-
Tax benefit from exercise of stock option 75,000 -0- -0-
Legal settlement -0- -0- 1,300,000
Changes in assets and liabilities:
Restricted cash (47,000) (71,000) 504,000
Settlement deposits (15,549,000) (2,133,000) (21,000)
Accounts receivable (95,000) (389,000) (162,000)
Settlement receivable 244,000 (569,000) (106,000)
Accounts payable (474,000) 578,000 66,000
Settlement payable 15,304,000 2,700,000 111,000
Accrued expenses 661,000 349,000 (376,000)
Prepaid expenses (107,000) (76,000) 63,000
------------- ------------ ------------
Net cash provided by operating activities 5,325,000 4,549,000 41,000
------------- ------------ ------------
Cash flows from investing activities:
Other assets 141,000 (51,000) (81,000)
Purchase of equipment (744,000) (664,000) (253,000)
Purchased and capitalized software (3,534,000) (2,627,000) (1,501,000)
Proceeds from sale of building 2,233,000 -0- -0-
Proceeds from sale of asset -0- 71,000 -0-
------------- ------------ ------------
Net cash used in investing activities (1,904,000) (3,271,000) (1,835,000)
------------- ------------ ------------
Cash flows from financing activities:
Proceeds from issuance of notes payable 811,000 292,000 -0-
Repayment of notes payable (1,916,000) (177,000) (151,000)
Repayment of capitalized leases (562,000) (452,000) (215,000)
Proceeds from sales and leaseback of equipment -0- -0- 390,000
Proceeds from private placement of common stock 2,693,000 -0- -0-
Proceeds from exercise of stock options 221,000 158,000 11,000
------------- ------------ ------------
Net cash provided by (used in) financing activities 1,247,000 (179,000) 35,000
------------- ------------ ------------
Net increase (decrease) in cash 4,668,000 1,099,000 (1,759,000)
Cash and cash equivalents at beginning of period 2,908,000 1,809,000 3,568,000
------------- ------------ ------------
Cash and cash equivalents at end of period $ 7,576,000 $ 2,908,000 $ 1,809,000
============= ============ ============
See accompanying notes to consolidated financial statements.
ELECTRONIC CLEARING HOUSE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
NOTE 1 - NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
- -------------------------------------------------------------------------------
Electronic Clearing House, Inc. (ECHO or the Company) is a Nevada corporation.
The Company provides bankcard authorizations, electronic deposit services, check
guarantee, check verification, check conversion, and check collection services.
The following comments describe the more significant accounting policies.
Principles of Consolidation
- -----------------------------
The accompanying consolidated financial statements include the accounts of the
Company and its wholly owned subsidiaries. All significant intercompany
transactions and accounts have been eliminated.
Cash and Cash Equivalents
- ----------------------------
Cash and cash equivalents consist of unrestricted balances only. The Company
considers all highly liquid investments with original maturities of three months
or less to be cash equivalents.
Restricted Cash
- ----------------
Under the terms of the processing agreements with the Company's primary
processing banks, the Company maintains several cash accounts as a reserve
against chargeback losses. As processing fees are received by the processing
banks, they are allocated per the processing agreement to the reserve accounts.
Chargeback Losses
- ------------------
Chargeback losses occur when a credit card holder presents a valid claim against
one of the Company's merchants and the merchant has insufficient funds or is no
longer in business resulting in the charge being absorbed by the Company. The
Company records a receivable for those chargebacks for which the merchant is
liable but has not made payment. The Company records a provision for estimated
chargeback losses at the time bankcard transactions are processed. A reserve is
estimated based upon a historically-determined percentage of gross credit card
processing volume and actual losses experienced.
Settlement Deposits, Receivables and Payables
- -------------------------------------------------
Settlement receivable/payable results from timing differences in the Company's
settlement process with merchants. These timing differences are primarily due to
the timing between the funds received in the Company's bank accounts and
settlement payments made to the merchants. Cash held by the Company associated
with this settlement process is classified as settlement deposits in the
consolidated balance sheets.
Property and Equipment
- ------------------------
Property and equipment are stated at cost, less accumulated depreciation and
amortization. Expenditures for additions and major improvements are
capitalized. Repair and maintenance costs are expensed as incurred. When
property and equipment are retired or otherwise disposed of, the related cost
and accumulated depreciation are removed from the accounts. Gains or losses
from retirements and disposals are credited or charged to income. Depreciation
and amortization are computed using the straight-line method over the shorter of
the estimated useful lives of the respective assets or terms of the related
leases. The useful lives and lease terms for depreciable assets are as follows:
Note 1: (Continued)
- -------
Building 39 years
Computer equipment and software 3-5 years
Furniture, fixtures and equipment 5 years
Building improvements 5-10 years
Other Assets
- -------------
Other assets consist primarily of deposits and intangible assets such as patents
and trademarks. Costs related to obtaining a patent and trademark are
capitalized and amortized over the estimated life of the patent and trademark.
Disclosures regarding intangible assets as required under SFAS No. 142 are
included in Note 6.
Software Development Costs
- ----------------------------
Under the provisions of Statement of Position 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use," the Company
capitalizes costs associated with software developed for internal use when both
the preliminary project stage is completed and management has authorized further
funding for the completion of the project. Capitalized costs include only (1)
external direct costs of materials and services consumed in developing or
obtaining internal-use software, (2) payroll and payroll-related costs for
employees who are directly associated with the software project, and (3)
interest costs incurred, when material, while developing internal-use software.
Capitalization of such costs ceases no later than the point at which the project
is substantially complete and ready for its intended purpose. Software developed
or obtained for internal use is tested for impairment whenever events or changes
in circumstance indicates that its carrying amount may not be recoverable.
Capitalized software development costs are amortized using the straight-line
method over the lesser of three years or estimated useful life.
Costs incurred to establish the technological feasibility of software and other
computer software maintenance costs are recorded as research and development
costs and are charged to expense when incurred.
Goodwill
- --------
Goodwill represents the excess of purchase price over net assets acquired in the
acquisition of XPRESSCHEX and Rocky Mountain Retail Systems. In July 2001, the
Financial Accounting Standards Board ("FASB") issued SFAS No. 142, "Goodwill and
Other Intangible Assets", which is effective for fiscal years beginning after
December 15, 2001. SFAS 142 requires, among other things, the discontinuance of
goodwill amortization. The Company adopted SFAS 142 in the first quarter of
fiscal 2003. Based upon the evaluation findings, the Company determined that
its goodwill was fully impaired and a non-cash charge equal to the goodwill
carrying amount of $4.7 million was recognized during the first quarter of
fiscal 2003. See Note 3.
Long-Lived Assets
- ------------------
When circumstances warrant, the Company reviews its long-lived assets for
impairment using estimated undiscounted future cash flows associated with such
assets. An impairment loss would be determined as the difference between the
fair values and the carrying amounts of the assets. Management believes no such
impairment has occurred as of September 30, 2004.
Note 1: (Continued)
- -------
Revenue Recognition
- --------------------
The Company earns revenue from services which include the following: debit and
credit card processing, check guarantee, check verification, check conversion,
check re-presentment, check collection and inventory tracking. All of these
services are performed pursuant to a contract with customers which states the
terms and fixed price for all contracted services. The price of a service may
be a fixed fee for each transaction and/or a percentage of the transaction
processed, depending on the service. At the time the guarantee revenue is
recognized, the Company provides a reserve for estimated guarantee losses based
upon its historical loss experience. The Company generally collects its fee at
the time it processes the transaction and accordingly, collectibility is
assured. Based on the Company's underwriting criteria and ongoing credit
monitoring of customers, collectibility on service transactions is reasonably
assured.
Revenue from debit and credit card (collectively called "bankcards") and
transaction processing revenue is based on a percentage of the transaction
value, commonly referred to as a discount fee on a credit and debit card
transaction processed by the Company. In addition, there is a per transaction
fee associated with each bankcard transaction which is charged to the merchant.
The Company recognizes the processing and transaction revenue when the services
are performed.
Revenue from check guarantee is derived from a percentage of the gross amount of
the check and guarantees payment of the check to the merchant in the event the
check is not honored by the check writer's bank. Merchants typically present
customer checks for processing on a regular basis and, therefore, dishonored
checks are generally identified within a few days of the date the checks are
guaranteed by the Company. The Company recognizes revenue when the checks are
processed at the point of sale. In the event a check is dishonored, the Company
has the right to collect the full amount of the check from the check writer but
has historically recovered approximately 50-60% of the guaranteed checks. The
Company establishes a receivable from the delinquent check writer for the full
amount of the guaranteed check. The Company establishes a reserve against these
receivables based on historical loss experience. The check guarantee service
also earns revenue based on fees collected from delinquent check writers, which
collection fee is recognized when collected, as collectibility is not reasonably
assured until that point.
Revenue from check verification is derived from fees collected from the
merchants when a check is verified against the Company's positive and negative
check database. This revenue is recognized when the transaction is processed,
since the Company has no further performance obligations.
Revenue from check conversion is derived from fees collected from merchants to
convert the paper check received by merchants into an ACH transaction, which
allows the Company to settle the transaction electronically for the merchant.
The Company recognizes the revenue related to check conversion fees when the
services are performed.
Revenue from check re-presentment is derived from fees charged to check writers.
Check re-presentment is a service that allows merchants to collect a paper check
through the Automated Clearing House ("ACH") network after a check has
previously been presented to the bank for collection unsuccessfully at least
once. The fees earned from check writer are recognized when collected, as
collectibility is not reasonably assured until that point.
Revenue from check collection is derived from collection activities performed on
behalf of a merchant on uncollected checks. The merchant usually keeps the face
amount of the uncollected checks if the collection effort is successful. The
Company's revenue is derived from the collection fee collected from the check
writer. If the Company refers the collection item to another collection agency,
the Company will receive a fee from the collection agency upon its successful
efforts. Collection fee revenue is recognized when collected, as collectibility
is not reasonably assured until that point.
Revenue from inventory tracking is derived from transaction fees for processing
and tracking U-Haul's daily inventory activities. This revenue is recognized
when the transaction is processed, since the Company has no further performance
obligations.
Note 1: (Continued)
- ------
Income Taxes
- -------------
The Company accounts for income taxes in accordance with Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes" (FAS 109). FAS 109
requires the recognition of deferred tax liabilities and assets for the expected
future tax consequences of temporary differences between the carrying amounts
and the tax bases of assets and liabilities. A valuation allowance is
established, when necessary, to reduce deferred tax assets to the amount
expected to be realized.
Earnings (Loss) Per Share
- ----------------------------
Earnings (loss) per share is based on the weighted average number of common
shares and dilutive common equivalent shares outstanding during the period. The
shares issuable upon conversion of preferred stock and exercise of options and
warrants are included in the weighted average for the calculation of diluted net
income per share except where it would be anti-dilutive.
Stock-Based Compensation
- -------------------------
The Company has elected to account for its stock-based compensation plans in
accordance with APB Opinion No. 25 and to adopt only the disclosure requirements
of FAS 123, as amended by SFAS No. 148.
The Company measures compensation expense for its employee stock-based
compensation under APB 25. The Company provides pro-forma disclosures of net
income and earnings per share as if a fair value method had been applied using
the Black Scholes option pricing model. Compensation expense is recognized in
association with the issuance of stock options for the difference, if any,
between the trading price of the stock at the time of issuance and the price to
be paid by the optionee. Compensation expense is recorded over the vesting
period. Pro forma compensation costs for employee stock and stock option awards
is amortized over the related service periods using the straight-line method.
The weighted average fair value of the options granted during the fiscal years
ended September 30, 2004, 2003 and 2002 were $4.93, $1.66 and $1.52,
respectively. For options granted in fiscal 2004, the risk free interest rate
was approximately 3%, the expected life was 7 years, the expected volatility was
approximately 84.0%, and the expected dividend yield was 0%, all calculated on a
weighted average basis. For options granted in fiscal 2003, the risk free
interest rate was approximately 3%, the expected life was 5 years, the expected
volatility was approximately 90.8%, and the expected dividend yield was 0%, all
calculated on a weighted average basis. For options granted in fiscal 2002, the
risk free interest rate was approximately 4%, the expected life was 5 years, the
expected volatility was approximately 90.6%, and the expected dividend yield was
0%, all calculated on a weighted average basis.
The following table compares net income and earnings per share as reported to
the pro forma amounts that would be reported had compensation expense been
recognized for the stock-compensation plans in accordance with the fair value
recognition provisions of SFAS No. 123, as amended by SFAS No. 148, Accounting
for Stock-Based Compensation:
Note 1: (Continued)
- -------
For the Fiscal Years Ended
September 30,
2004 2003 2002
----------- ------------ ------------
Net income (loss)
As reported $2,849,000 $(3,379,000) $(2,376,000)
Add: stock-based employee
compensation expense included
in reported net income, net of
tax effect 20,000 -0- -0-
Deduct: total stock-based employee
compensation expense determined
under fair value-based method for
all awards, net of related tax effects $ (395,000) $ (212,000) $ (269,000)
----------- ------------ ------------
Pro forma net income (loss) $2,474,000 $(3,591,000) $(2,645,000)
=========== ============ ============
Basic earnings (loss) per share:
As reported $ 0.45 $ (0.58) $ (0.41)
Pro forma $ 0.39 $ (0.62) $ (0.46)
Diluted earnings (loss) per share:
As reported $ 0.41 $ (0.56) $ (0.41)
Pro forma $ 0.36 $ (0.60) $ (0.46)
Accounting Estimates
- ---------------------
The preparation of financial statements in conformity with generally accepted
accounting principles in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities, the
disclosure of contingent liabilities, and the reported amounts of revenues and
expenses during the reporting period. Significant estimates include allowance
for chargeback losses and deferred tax assets. Actual results could differ from
those estimates.
Fair Value of Financial Instruments
- ---------------------------------------
The amount recorded for financial instruments in the Company's consolidated
financial statements approximates fair value as defined in SFAS No. 107,
"Disclosures about Fair Value of Financial Instruments".
Reclassifications
- -----------------
Certain amounts in the September 30, 2003 and 2002 consolidated financial
statements have been reclassified to conform to the current year presentation.
New Accounting Pronouncement
- ------------------------------
In December 2004, the FASB issued SFAS 123R, "Share-Based Payment, an amendment
of FASB Statements Nos. 123 and 95," that addresses the accounting for
share-based payment transactions in which a Company receives employee services
in exchange for either equity instruments of the Company or liabilities that are
based on the fair value of the Company's equity instruments or that may be
settled by the issuance of such equity instruments. SFAS 123R eliminates the
ability to account for share-based compensation transactions using the intrinsic
method that the Company currently uses and generally would require that such
transactions be accounted for using a fair-value-based method and recognized as
expense in the consolidated statement of operations. SFAS 123R is effective for
interim and annual periods beginning after June 15, 2005. Management is
currently evaluating the impact of SFAS 123R and it is expected that it will
have a significant impact on the consolidated statement of operations as the
Company will be required to expense the fair value of stock option awards.
NOTE 2 - STATEMENT OF CASH FLOWS:
- --------------------------------
September 30
------------
2004 2003 2002
-------- -------- --------
Cash paid for:
Interest $175,000 $200,000 $129,000
Income taxes 8,000 1,000 137,000
Significant non-cash transactions for fiscal 2004 are as follows:
- Software purchases of $285,000 and capital equipment of $152,000 were
acquired under capital leases.
Significant non-cash transactions for fiscal 2003 are as follows:
- Capital equipment of $525,000 was acquired under capital leases.
Significant non-cash transactions for fiscal 2002 are as follows:
- A refund and tax credit totaling $173,000 was recognized due to the
filing of amended tax returns for options exercised in fiscal years
1999 and 2000.
- A $1.3 million 15-year long-term promissory note was issued as part of
the Premiere Lifestyles International Corporation vs. ECHO legal
settlement.
- Capital equipment of $663,000 was acquired under capital leases.
- A software license scheduled payment of $93,000 was paid directly by a
leasing company.
- The Company acquired 25,000 shares of ECHO's common stock, valued at
$54,000 for satisfaction of a chargeback receivable owed to the
Company.
NOTE 3 - CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE:
- ------------------------------------------------------------
Effective October 1, 2002, the Company adopted Statement of Financial Accounting
Standards No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets". SFAS
142 requires that goodwill no longer be amortized, but instead be tested for
impairment at least annually using a fair value-based approach. In the year of
adoption, SFAS No. 142 also required the Company to perform an initial
assessment of its reporting units to determine whether there is any indication
that the goodwill carrying value may be impaired. This transitional assessment
is made by comparing the fair value of each reporting unit, as determined in
accordance with the new standard, to its book value. To the extent the fair
value of any reporting unit is less than its book value, which would indicate
that potential impairment of goodwill exists, a second transitional test was
required to determine the amount of impairment.
The Company has determined that it has two reporting units, which correspond to
its two reportable business segments; the "Bankcard and Transaction Processing"
unit and the "Check Related Products" unit. All of the Company's goodwill
relates to business acquisition transactions, which apply exclusively to the
Check Related Products unit. The Company completed the transitional impairment
testing required by SFAS 142 in the first quarter of fiscal 2003. The Company
determined the estimated fair value of its reporting units using a discounted
cash flow technique and a market approach based upon the Company's total market
capitalization as of October 1, 2002. Based upon the valuation findings, the
Company determined that its goodwill was fully impaired and a non-cash charge
equal to the goodwill carrying amount of $4.7 million was recognized in the
Company's consolidated financial statements. As prescribed by SFAS 142, the
Company treated this non-cash goodwill impairment as a cumulative effect of
change in accounting principle. No income tax benefit has been recognized for
this charge as the goodwill is not deductible for income tax purposes.
Note 3: (Continued)
- -------
Had the provisions of SFAS No. 142 been applied for the year ended September 30,
2002, the Company's net loss before the cumulative effect of a change in
accounting principle, and net (loss) per share would have been as follows:
For the Fiscal Year Ended
2002
---------------------------
Net (loss), as reported $ (2,376,000)
Add:
Goodwill amortization 489,000
---------------------------
Adjusted net (loss) $ (1,887,000)
===========================
Basic (loss) per share, as reported $ (0.41)
Effect of SFAS No. 142 0.08
---------------------------
Adjusted basic (loss) per share $ (0.33)
===========================
Diluted (loss) per share, as reported $ (0.41)
Effect of SFAS No. 142 0.08
---------------------------
Adjusted diluted (loss) per share $ (0.33)
===========================
NOTE 4 - PROPERTY AND EQUIPMENT:
- --------------------------------
Property and equipment are comprised of the following:
September 30
--------------------------
2004 2003
------------ ------------
Land and building $ -0- $ 880,000
Computer equipment 3,630,000 3,973,000
Furniture, fixtures and equipment 897,000 1,240,000
Building improvements 76,000 291,000
Tooling equipment -0- 285,000
Auto 34,000 16,000
------------ ------------
Cost 4,637,000 6,685,000
Less: accumulated depreciation and amortization (2,344,000) (3,757,000)
------------ ------------
Net book value $ 2,293,000 $ 2,928,000
============ ============
Included in property and equipment are assets under capital lease of $1,062,000
and $1,098,000 at September 30, 2004 and 2003, with related accumulated
depreciation of $372,000 and $236,000, respectively. Amortization of assets
recorded under capital leases is included with depreciation expense.
In March 2004, the Company sold a building, which formerly held the Company's
corporate offices. The total sales price was $2,382,000, which resulted in a
pre-tax gain of $1,319,000. Proceeds from the sale were used in part to pay off
the two notes collateralized by the building.
NOTE 5 - SOFTWARE
- --------------------
The following table sets forth information regarding the costs associated with
software purchased and developed for internal use:
September 30
--------------------------
2004 2003
------------ ------------
Software $11,005,000 $ 7,495,000
Less: accumulated amortization (4,161,000) (3,050,000)
------------ ------------
Net book value $ 6,844,000 $ 4,445,000
============ ============
Included in software cost are assets under capital lease of $508,000 and
$399,000 at September 30, 2004 and 2003, and related accumulated amortization of
$132,000 and $109,000, respectively.
NOTE 6 - OTHER ASSETS
- -------------------------
Other assets consist of the following at September 30, 2004:
Accumulated Net
Cost Amortization Book Value
-------- ------------- -----------
Patents $173,000 $ 78,000 $ 95,000
Trademarks 280,000 87,000 193,000
Other 199,000 119,000 80,000
-------- ------------- -----------
$652,000 $ 284,000 $ 368,000
======== ============= ===========
Other assets consist of the following at September 30, 2003:
Accumulated Net
Cost Amortization Book Value
-------- ------------- -----------
Patents $173,000 $ 68,000 $ 105,000
Trademarks 276,000 59,000 217,000
Other 356,000 178,000 178,000
-------- ------------- -----------
$805,000 $ 305,000 $ 500,000
======== ============= ===========
Amortization expense for the years ended September 30, 2004 and 2003 was
$115,000 and $46,000, respectively. Based on the current amount of intangible
assets subject to amortization, the estimated amortization expense for each of
the five succeeding years is $38,000.
NOTE 7 - INCOME TAXES
- -------------------------
The (provision) benefit for income taxes consists of the following components:
Note 7: (Continued)
- -------
September 30
-------------------------------------
2004 2003 2002
------------ ---------- -----------
Current federal taxes $ (19,000) $ -0- $ -0-
Current state taxes (87,000) (5,000) (5,000)
Deferred taxes (1,717,000) (920,000) 1,372,000
------------ ---------- -----------
Total (provision) benefit for income taxes $(1,823,000) $(925,000) $1,367,000
============ ========== ===========
The effective tax rate varies from the U.S. Federal statutory tax rate
principally due to the following:
September 30
-------------------------------------
2004 2003 2002
------------ ---------- -----------
U.S. Federal statutory tax rate 34.00% (34.00%) (34.00%)
Add (deduct):
Non-deductible goodwill -0- 65.00% 4.30%
State and local taxes 5.10% 4.50% (6.90%)
All other (0.10%) 2.20% 0.10%
------------ ---------- -----------
Effective tax rate 39.00% 37.70% (36.50%)
============ ========== ===========
Components of the deferred tax asset (liabilities) include:
September 30
-------------------------
2004 2003
------------ -----------
Deferred tax assets (liabilities):
Capitalized software $(1,727,000) $ (715,000)
Reserve for bad debts 60,000 35,000
Inventory reserve -0- -0-
Reserve on real estate -0- -0-
Reserve on legal settlement 125,000 -0-
Inventory cost capitalized -0- 52,000
State tax expense 103,000 -0-
Installment note expense -0- 513,000
Stock option exercise 94,000 -0-
Net operating loss carryforward 861,000 1,299,000
Business tax credit 113,000 113,000
AMT credit 85,000 45,000
------------ -----------
Total deferred tax assets (liabilities) $ (286,000) $1,342,000
============ ===========
The Company has a federal net operating loss carryforward of $2,296,000, which
expires in 2010 through 2022. The Company has not recorded a valuation allowance
against deferred tax assets because it expects to have future taxable income to
recognize these assets.
NOTE 8 - SHORT-TERM BORROWINGS AND LONG-TERM DEBT:
- -------------------------------------------------
Short-term borrowings and long-term debt consist of the following:
September 30
------------------------
2004 2003
----------- -----------
Long-term promissory note collateralized by corporate headquarters
building, bearing interest at 8% per annum, repaid during 2004 $ -0- $1,229,000
Term loan collateralized by corporate headquarters building,
bearing interest at 7.87% per annum, repaid during 2004 -0- 343,000
Term loan, collateralized by equipment, due 2005, bearing
interest at prime rate, 4.75% at September 30, 2004 26,000 107,000
Term loan, collateralized by various assets of the Company,
due June 19, 2006, bearing interest at prime rate plus 1%, 5.75%
at September 30, 2004 269,000 292,000
Equipment lease line, collaterrized by various assets of the
Company, converted into term loan on October 31, 2004, interest
at prime rate plus .50%, 5.00% at September 30, 2004 600,000 -0-
Capital leases 687,000 891,000
----------- -----------
1,582,000 2,862,000
Less: current portion (878,000) (901,000)
----------- -----------
$ 704,000 $1,961,000
=========== ===========
The weighted average interest rate on the prime rate term loans for the period
they were outstanding during the year ended September 30, 2004 was 4.08%.
One of the term loans contains restrictive debt covenants consisting of debt
service coverage ratio and tangible net worth requirements. As of September 30,
2004, the Company is in compliance with all such covenants. The Company has a
$3,000,000 credit line with a bank, which was unused during fiscal year 2004.
In January 2003, an $800,000 line of credit and a $700,000 lease line for Oasis
software installment payments were secured from First Regional Bank, at a
borrowing rate of prime + 1%. The Company has drawn down $503,000 of the Oasis
lease line as of September 30, 2004. In October 2003, the Company secured a $3
million credit line for working capital needs and a $1 million equipment lease
line with Bank of the West. The Company has drawn down $600,000 of the
equipment lease line as of September 30, 2004.
Future maturities of debt are as follows:
Fiscal year ended September 30
- ------------------------------
2005 $ 878,000
2006 312,000
2007 185,000
2008 193,000
2009 14,000
thereafter -0-
----------
$1,582,000
==========
NOTE 9 - ACCRUED EXPENSES:
- -----------------------------
September 30
----------------------
Accrued expenses are comprised of the following: 2004 2003
---------- ----------
Accrued bankcard fees $ 235,000 $ 178,000
Accrued compensation and payroll taxes 700,000 535,000
Accrued communication costs 138,000 215,000
Accrued professional fees 212,000 168,000
Accrued commission 220,000 88,000
Accrued litigation expense 300,000 -0-
Other 198,000 152,000
---------- ----------
$2,003,000 $1,336,000
========== ==========
NOTE 10 - STOCKHOLDERS' EQUITY:
- ----------------------------------
Stockholders' Rights Plan
- ---------------------------
The Company has a Stockholders' Rights Plan, which was amended in September
2004. As amended, the rights plan provides that all stockholders have two
preferred share purchase rights (each a "Right") for each outstanding share of
common stock of the Company. Each Right entitles the registered holder to
purchase from the Company four one-hundredths of a share of series A Junior
Participating Preferred Stock, no par value ("Preferred Stock") of the Company
at a price of $2.00 per one one-hundredth of a share of Preferred Stock
("Purchase Price"). The description and terms of the Rights are set forth in a
Rights Agreement dated as of September 30, 1996 ("Rights Agreement"), as amended
in January 2003 and September 2004.
The Rights will separate from the Common Stock and a Distribution Date will
occur upon the earlier of (i) 10 days following a public announcement that,
without consent of the Board of Directors, a person or group of affiliated or
associated persons ("Acquired Person") have acquired beneficial ownership of
twenty-percent (20%) or more of the outstanding Common Stock, or (ii) 10
business days (or such later date as may be determined by action of the Board of
Directors prior to such time as any person becomes an Acquired Person) following
the commencement of, or announcement of an intention to make a tender offer or
exchange offer the consummation of which would result in the beneficial
ownership by a person or group of twenty-percent (20%) or more of such
outstanding Common Stock.
In the event that any person becomes the beneficial owner of twenty-percent
(20%) or more of the Common Stock of the Company, ten (10) days thereafter
("Flip-In Event") each Right would permit the holder of such Right to thereafter
have the right to receive, upon exercise thereof at the then current Purchase
Price of the Right, Common Stock which has a value of eight times the Purchase
Price of the Right (such right being called the "Flip-In Right"). In the event
the Company is acquired in a merger or other business combination transaction
where the Company is not the surviving corporation or in the event that 50% or
more of its assets or earning power is sold, proper provision shall be made so
that each Right would permit the holder of such Right to thereafter have the
right to receive, upon the exercise thereof at the then current Purchase Price
of the Right, common stock of the acquiring entity which has a value of eight
times the Purchase Price of the Right. Upon the occurrence of the Flip-In
Event, any Rights that are or were at any time owned by an Acquiring Person
shall become null and void insofar as they relate to the Flip-In Right.
The Rights are not exercisable until the Distribution Date. One of the Rights
will expire on September 30, 2006 and the other Right will expire on January 29,
2013, unless the Rights are earlier redeemed or exchanged by the Company, in
each case, as described in the Rights Agreement.
Note 10: (Continued)
- --------
Earnings (Loss) Per Share
- ----------------------------
The following table sets forth the computation of basic and diluted earnings
(loss) per share:
September 30
--------------------------------------
2004 2003 2002
---------- ------------ ------------
Numerator:
Income (loss) before cumulative effect of
an accounting change $2,849,000 $ 1,328,000 $(2,376,000)
Cumulative effect of an accounting change
to adopt SFAS 142 -0- (4,707,000) -0-
---------- ------------ ------------
Net income (loss): $2,849,000 $(3,379,000) $(2,376,000)
========== ============ ============
Denominator:
Weighted average shares outstanding for basic
earnings (loss) per share 6,311,643 5,812,005 5,788,071
Effect of dilutive stock options 588,608 212,035 -0-
---------- ------------ ------------
Adjusted weighted average shares outstanding
for diluted earnings (loss) per share 6,900,251 6,024,040 5,788,071
========== ============ ============
Basic net earnings (loss) per share:
Before cumulative effect of accounting change $ 0.45 $ 0.23 $ (0.41)
Cumulative effect of accounting change -0- (0.81) -0-
---------- ------------ ------------
Basic net earnings (loss) per share $ 0.45 $ (0.58) $ (0.41)
========== ============ ============
Diluted net earnings (loss) per share:
Before cumulative effect of accounting change $ 0.41 $ 0.22 $ (0.41)
Cumulative effect of accounting change -0- (0.78) -0-
---------- ------------ ------------
Diluted net earnings (loss) per share $ 0.41 $ (0.56) $ (0.41)
========== ============ ============
For the years ended September 30, 2004, 2003 and 2002, approximately 77,500,
270,000 and 597,584 shares, respectively, attributable to the exercise of
outstanding options were excluded from the calculation of diluted EPS because
the effect was antidilutive.
NOTE 11 - COMMON STOCK OPTIONS:
- -----------------------------------
The Company had a 1992 Incentive Stock Option Plan (the "1992 Plan"), which
provided for the issuance of up to 1,343,750 stock options, each to purchase one
share of the common stock at a price not less than 100% of the market price at
the date of grant. In May 2002, the 1992 Plan expired. The 2003 Incentive Stock
Option Plan was approved at the Annual Shareholders' Meeting in February 2003.
The 2003 Incentive Stock Option Plan has similar provisions as the 1992 Plan. On
December 21, 2004, our Compensation Committee authorized an amendment and
restatement of the 2003 Incentive Stock Option Plan to, among other matters, (i)
increase the number of shares to be issued under the 2003 Incentive Stock Option
Plan from 900,000 shares to 1,150,000 shares, and (ii) permit the grant of
restricted stock under the plan, subject to shareholder approval.
Note 11: (Continued)
- --------
Stock option activity during 2004, 2003, and 2002 was as follows:
Exercise
Options Price
---------- ----------------
Outstanding September 30, 2001 694,667 $1.60 - $16.48
==========
Granted 197,000 1.29 - 2.17
Forfeited (173,583) 1.60 - 10.24
Exercised (5,500) 2.00
----------
Outstanding September 30, 2002 712,584 $1.29 - $16.48
==========
Granted 238,000 1.30 - 8.50
Forfeited (65,959) 2.00 - 5.88
Exercised (75,750) 2.00 - 4.84
----------
Outstanding September 30, 2003 808,875 $1.29 - $16.48
==========
Granted 425,000 6.85 - 9.56
Forfeited (6,750) 1.30 - 8.48
Exercised (93,200) 1.29 - 7.00
----------
Outstanding September 30, 2004 1,133,925 $1.29 - $16.48
==========
Exercisable at September 30, 2002 318,000 $1.29 - $16.48
==========
Exercisable at September 30, 2003 321,000 $1.29 - $16.48
==========
Exercisable at September 30, 2004 355,035 $1.29 - $16.48
==========
Options available for grant
at September 30, 2003 614,500
==========
Options available for grant
at September 30, 2004 193,000
==========
All officer and key employee options are granted under the 1992 Plan and the
2003 Plan. The exercise price of the incentive stock options shall be 100% of
the fair market value on the date the option is granted. Options granted to
officers and employees are normally vested over a five-year period. Options are
exercisable for a period of five years from date of vest.
The following table summarizes information about stock options outstanding at
September 30, 2004:
Options Outstanding Options Exercisable
-------------------------------------- --------------------------
Weighted
Average Weighted Weighted
Number Remaining Average Number Average
Range of Outstanding at Contractual Exercise Exercisable at Exercise
Exercise Prices Sept. 30, 2004 Life Price Sept. 30, 2004 Price
- ---------------- -------------- ----------- --------- -------------- ----------
1.29 - $2.00 172,000 7.2 $ 1.39 54,000 $ 1.58
2.15 - $3.50 305,000 7.3 $ 2.64 107,000 $ 2.66
4.00 - $5.88 143,000 3.9 $ 4.24 144,000 $ 4.24
7.00 - $16.48 514,000 8.6 $ 7.51 50,000 $ 9.34
-------------- --------------
1,134,000 7.5 $ 4.86 355,000 $ 4.07
============== ==============
NOTE 12 - COMMITMENTS, CONTINGENT LIABILITIES, AND GUARANTEES:
- ---------------------------------------------------------------------
The Company currently relies on cooperative relationships with, and sponsorship
by, one bank in order to process its Visa, MasterCard and other bankcard
transactions. The agreement between the bank and the Company requires the
Company to assume and compensate the bank for bearing the risk of "chargeback"
losses. Under the rules of Visa and MasterCard, when a merchant processor
acquires card transactions, it has certain contingent liabilities for the
transactions processed. This contingent liability arises in the event of a
billing dispute between the merchant and a cardholder that is ultimately
resolved in the cardholder's favor. In such a case, the disputed transaction is
charged back to the merchant and the disputed amount is credited or otherwise
refunded to the cardholder. If the Company is unable to collect this amount
from the merchant's account, and if the merchant refuses or is unable to
reimburse the Company for the chargeback due to merchant fraud, insolvency or
other reasons, the Company will bear the loss for the amount of the refund paid
to the cardholders. The Company is also exposed to financial risk in providing
Automated Clearing House ("ACH") services to the merchants. As the Third-Party
processor for multiple originating banks, the Company is liable for any
fraudulent activities committed by the merchants initiating the ACH activities.
The Company utilizes stringent underwriting guidelines combined with a number of
systems and procedures to manage merchant risk. In addition, the Company
requires cash deposits by certain merchants, which are held by the Company's
sponsoring banks to minimize the risk related to merchant frauds and
chargebacks.
A cardholder, through its issuing bank, generally has until the later of up to
four months after the date a transaction is processed or the delivery of the
product or service to present a chargeback to the Company's sponsoring bank as
the merchant processor. Therefore, management believes that the maximum
potential exposure for the chargebacks would not exceed the total amount of
transactions processed through Visa and MasterCard for the last four months and
other unresolved chargebacks in the process of resolution. For the last four
months through September 30, 2004, this potential exposure totaled approximately
$352 million. At September 30, 2004, the Company, through its sponsoring banks,
had approximately $168,000 of unresolved chargebacks that were in the process of
resolution. At September 30, 2004, the Company, through its sponsoring banks,
had access to $9.9 million belonging to our merchants. This money has been
deposited at the sponsoring bank by the merchants to cover any potential
chargeback losses.
For the fiscal years 2004 and 2003, the Company processed approximately $1,053
million (2004) and $961 million (2003) of Visa and MasterCard transactions,
which resulted in $7.6 million in gross chargeback activities for the fiscal
year ended 2004 and $9.3 million for the fiscal year ended 2003. Substantially
all of these chargebacks were recovered from the merchants.
The Company's contingent obligation with respect to chargebacks constitutes a
guarantee as defined in Financial Accounting Interpretation No. 45, "Guarantor's
Accounting and Disclosure requirements for Guarantees, Including Indirect
Guarantees of Others" ("FIN 45"). FIN 45 requires that guarantees issued or
modified subsequent to December 231, 2002 be initially recorded as liabilities
in the Statement of Financial Position at fair value. Since the Company's
agreement with its sponsoring bank which establishes the guarantee obligation
was entered into prior to December 31, 2002 and has not been modified since that
date, the measurement provisions of FIN 45 are not applicable to this guarantee
arrangement.
In accordance with SFAS No. 5, "Accounting for Contingencies", the Company
records a reserve for chargeback losses based on its processing volume and
historical trends and data. As of September 30, 2004 and 2003, the allowance
for chargeback losses, which is classified as a component of the allowance for
uncollectible accounts receivable, was $46,000 and $32,000, respectively. The
expense associated with the chargeback allowance is included in processing and
transaction expense in the accompanying consolidated statements of income. The
Company expensed $50,000, $44,000, and $261,000 for the years ended September
30, 2004, 2003 and 2002, respectively for bankcard processing chargeback losses.
The Company has a small check guarantee business. The Company charges the
merchant a percentage of the face amount of the check and guarantees payment of
the check to the merchant in the event the check is not honored by the check
writer's bank. Merchants typically present customer checks for processing on a
regular basis and, therefore, dishonored checks are generally identified within
a few days of the date the checks are
Note 12: (Continued)
- --------
guaranteed by the Company. Accordingly, management believes that its best
estimate of the Company's maximum potential exposure for dishonored checks at
any given balance sheet date would not exceed the total mount of checks
guaranteed in the last 10 days prior to the balance sheet date. As of September
30, 2004, the Company estimates that its maximum potential dishonored check
exposure was approximately $631,000.
For the fiscal years ended 2004 and 2003, the Company guaranteed approximately
$19,382,000 (2004) and $15,338,000 (2003) of merchant checks, which resulted in
$139,000 (2004) and $468,000 (2003) of dishonored checks presented to the
Company for payments. The Company has the right to collect the full amount of
the check from the check writer. Based on its actual collection experience, the
Company collects approximately 50-60% of the total dishonored checks with image
and 10 - 20% without image. The Company establishes a reserve for this activity
based on historical and projected loss experience. As of September 30, 2004 and
2003, the reserve for check guarantee loss was $56,000 (2004) and $24,000
(2003). The expense associated with the guarantee costs is included in
processing and transaction expense in the accompanying consolidated statements
of income.
Lease Commitments
- ------------------
The Company leases real property under agreements, which expire at various times
over the next five years. The Company's future minimum rental payments for
capital and operating leases at September 30, 2004 are as follows:
Fiscal Year Capital Leases Operating Leases
- ------------------------------ ---------------- -----------------
2005 $ 528,000 $ 565,000
2006 160,000 466,000
2007 36,000 443,000
2008 33,000 455,000
2009 -0- -0-
---------------- -----------------
Total minimum lease payments $ 757,000 $ 1,929,000
=================
Less: imputed interest of 8.5% (70,000)
----------------
Present value of net
minimum lease payment $ 687,000
================
Rent expense for the years ended September 30, 2004, 2003, and 2002 totaled
$572,000, $299,000 and $212,000, respectively. Certain operating leases have
renewal options at the end of the lease term solely at the Company's discretion.
In May 2003, the Company leased new corporate office space in Camarillo,
California. The lease is for a period of five years at a monthly rate of
$24,000. The lease grants us a right of first refusal with respect to
additional space in the building that is not currently rented, and includes an
option for us to purchase the property, at fair value, during the first two
years of the lease.
NOTE 13 - LITIGATION
- -----------------------
The Company is involved in various legal cases arising in the ordinary course of
business. Based upon current information, management, after consultation with
legal counsel, believes the ultimate disposition thereof will have no material
effect upon either the Company's results of operations or its financial
position.
In July 2004, LML Patent Corporation, a wholly-owned subsidiary of LML Payment
Systems, Inc. ("LML"), filed a patent infringement claim against the Company,
our subsidiary, XPRESSCHEX, Inc. and others, relating with respect to the
Company and its subsidiary, to the alleged infringement by our check conversion
processes of three patents held by LML. The suit was filed in the U.S. District
Court for the District of Delaware. LML seeks an undisclosed amount of damages
in connection with the alleged infringement. We do not believe that any of our
check conversion processes infringe upon any valid or enforceable patent rights
of LML and intend to vigorously
Note 13: (Continued)
- --------
defend our position against the claims made. Ultimately, we expect that we will
not be held liable for any of the alleged infringement. The case is scheduled to
go to trial in April of 2006. Should we be held liable for any alleged
infringement, which is not expected, the ultimate liability we may sustain may
include a royalty payment primarily calculated on activity commencing in the
middle of calendar 2003 for only select conversion activity, as that was the
time period in which we actively began utilizing the check conversion processes
alleged to infringe the LML patents. In view of the relatively short time
period involved and the relatively small overall transaction volume arising from
the alleged infringing check conversion services in comparison to ECHO's total
transaction volume, we believe that any such alleged damages award should have
a relatively minor impact on our results of operations, financial position, or
cash flows.
In August 2003, one of our independent sales organizations filed a breach of
contract arbitration claim against us in Los Angeles, California. The dispute
involved a disagreement related to the manner in which commissions were to be
calculated under the agreement. The agreement with the ISO required binding
arbitration of all disputes arising under the agreement. The arbitration
proceedings occurred in December 2004. The arbitration award is expected between
the end of calendar 2004 and the beginning of 2005. The claim arose in the
ordinary course of business and we have accrued $300,000 as a litigation accrual
related to the dispute. The accrual represents our management's good faith
evaluation of the dispute after consultation with legal counsel, however, there
can be no assurance that the actual award will not exceed the amount accrued. In
the event the arbitration award exceeds the amount accrued, such excess amount
would impact our results of operations, financial position or cash flows. Our
management does not believe any such impact would be material.
NOTE 14 - SEGMENT INFORMATION
- ---------------------------------
The Company has adopted FAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information" (FAS 131). FAS 131 established revised
standards for public companies related to the reporting of financial and
descriptive information about their operating segments in financial statements.
Certain information is disclosed, per FAS 131, based on the way management
organizes financial information for making operating decisions and assessing
performance.
The Company currently operates in two business segments: Bankcard and
Transaction Processing and Check Related Products, all of which are located in
the United States. The Company also has certain corporate expenses such as
salaries and benefits, legal and professional fees, rent, and litigation accrual
expenses which are not allocated to the two business segments.
The Company's reportable operating segments have been determined in accordance
with the Company's internal management structure, which is organized based on
operating activities. The accounting policies of the operating segments are the
same as those described in the summary of significant accounting policies. The
Company evaluates performance based upon two primary factors, one is the
segment's operating income and the other is based on the segment's contribution
to the Company's future strategic growth.
September 30
----------------------------------------
Business Segments 2004 2003 2002
- -------------------------------------- ------------ ------------ ------------
Revenues:
Bankcard and Transaction Processing $36,161,000 $32,444,000 $27,456,000
Check Related Products 11,423,000 8,192,000 5,835,000
------------ ------------ ------------
$47,584,000 $40,636,000 $33,291,000
============ ============ ============
Operating Income (loss):
Bankcard and Transaction Processing $ 5,977,000 $ 4,303,000 $ 1,996,000
Check Related Products 1,644,000 591,000 (872,000)
Other - Corporate Expenses (4,164,000) (2,469,000) (2,293,000)
Legal Settlement -0- -0- (2,500,000)
------------ ------------ ------------
$ 3,457,000 $ 2,425,000 $(3,669,000)
============ ============ ============
Depreciation and Amortization:
Bankcard and Transaction Processing $ 966,000 $ 867,000 $ 727,000
Check Related Products 1,255,000 727,000 938,000
------------ ------------ ------------
$ 2,221,000 $ 1,594,000 $ 1,665,000
============ ============ ============
Note 14: (Continued)
- --------
Capital Expenditures:
Bankcard and Transaction Processing $ 2,258,000 $ 2,479,000 $ 1,474,000
Check Related Products 2,513,000 1,365,000 712,000
------------ ------------ ------------
$ 4,771,000 $ 3,844,000 $ 2,186,000
============ ============ ============
Total Assets:
Bankcard and Transaction Processing $ 8,014,000 $ 7,051,000 $ 5,399,000
Check Related Products 23,933,000 6,794,000 7,710,000
Other 7,481,000 4,930,000 5,082,000
------------ ------------ ------------
$39,428,000 $18,775,000 $18,191,000
============ ============ ============
NOTE 15 - QUARTERLY FINANCIAL DATA (Unaudited)
- ----------------------------------------------------
The following summarizes the quarterly financial results of the Company for the
fiscal years ended September 30, 2004 and September 30, 2003 (in thousands,
except share data):
Year Ended September 30, 2004
-----------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
--------- --------- -------- ---------
Net revenues $ 11,355 $ 11,766 $ 12,152 $ 12,311
Gross profit 4,394 4,243 4,484 4,582
Profit from operations 1,013 706 1,082 656
Net income 589 1,206 651 403
Earnings per share - basic $ 0.10 $ 0.19 $ 0.10 $ 0.06
Earnings per share - diluted $ 0.09 $ 0.17 $ 0.09 $ 0.06
Year Ended September 30, 2003
-----------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
--------- --------- -------- ---------
Net revenues $ 9,301 $ 9,767 $ 10,578 $ 10,990
Gross profit 2,973 3,360 3,467 4,153
Profit from operations 527 465 564 869
Net (loss) income (4,473) 268 308 518
(Loss) earnings per share - basic $ (0.77) $ 0.05 $ 0.05 $ 0.09
(Loss) earnings per share - diluted $ (0.77) $ 0.05 $ 0.05 $ 0.08
ELECTRONIC CLEARING HOUSE, INC. AND CONSOLIDATED SUBSIDIARIES
SCHEDULE II TO FORM 10K
RULE 12-09 VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
REDUCTION IN REDUCTION IN
RESERVE AND RESERVE AND
BALANCE AT CHARGED TO ACCOUNTS BALANCE AT CHARGED TO ACCOUNTS BALANCE AT CHARGED TO
DESCRIPTION 09/30/2001 EXPENSE RECEIVABLE 09/30/2002 EXPENSE RECEIVABLE 09/30/2003 EXPENSE
- ------------------ ----------- ----------- ------------- ----------- ----------- ------------- ----------- -----------
Allowance for
trade receivables/
chargeback
receivables $ 313,000 $ 302,000 $ 184,000 $ 431,000 $ 67,000 $ 407,000 $ 91,000 $ 218,000
Allowance for
obsolete
inventories $ 18,000 $ 300,000 $ 18,000 $ 300,000 $ 110,000 $ 410,000 $ -0- $ 46,000
REDUCTION IN
RESERVE AND
ACCOUNTS BALANCE AT
DESCRIPTION RECEIVABLE 09/30/2004
- ------------------ ------------- -----------
Allowance for
trade receivables/
chargeback
receivables $ 176,000 $ 133,000
Allowance for
obsolete
inventories $ -0- $ 46,000
Exhibit
Number Description of Document
- ------- -----------------------------------------------------------------------------------------------------------
2.1 Copy of Merger Agreement and Plan of Reorganization between Electronic Clearing House, Inc., ECHO
Acquisition Corporation, and Magic Software Development, Inc., dated April 20, 1999.[5]
2.2 Copy of Merger Agreement and Plan of Reorganization between Electronic Clearing House, Inc., ECHO
Acquisition Corporation, and Rocky Mountain Retail Systems, Inc., dated January 4, 2000.[6]
3.1 Articles of Incorporation of Bio Recovery Technology, Inc., filed with the Nevada Secretary of State on
December 11, 1981. [1]
3.4 By-Laws of Bio Recovery Technology, Inc. [1]
4.2 Specimen Common Stock Certificate. [3]
10.35 Copy of Merchant Marketing and Processing Services Agreement between Electronic Clearing House, Inc.
and First Regional Bank, dated June 24, 1997. [4]
10.36 Copy of Merchant Marketing and Processing Services Agreement between Electronic Clearing House, Inc.
and The Berkshire Bank, dated July 31, 1997. [4]
10.41 Copy of Processing and Software Development and License Agreement between Electronic Clearing
House, Inc. and National Bank Drafting Systems, Inc., dated October 22, 1999.[6]
10.42 Copy of Addendum to Agreement between Electronic Clearing House, Inc. and U-Haul International, dated
January 1, 2000.[6]
10.44 Copy of Electronic Check Services Agreement between Electronic Clearing House, Inc. and National Bank
Drafting Systems, Inc., dated May 17, 2000.[6]
10.46 Copy of Amended and Restated Merchant Marketing and Processing Services Agreement between
Electronic Clearing House, Inc. and First Regional Bank, dated August 1, 2000.[6]
10.47 Copy of Addendum to Amended and Restated Merchant Marketing and Processing Services Agreement
between Electronic Clearing House, Inc. and First Regional Bank, dated August 1, 2000.[6]
10.48 Copy of POS Check Third-Party Servicer Agreement between Visa U.S.A., Inc. and Electronic Clearing
House, Inc., dated December 12, 2000.[7]
10.49 Copy of Asset Purchase Agreement between National Check Network, Inc. and Electronic Clearing
House, Inc., dated April 19, 2001.[7]
10.50 Copy of Addendum to Agreement between U-Haul International and Electronic Clearing House, Inc., dated
October 1, 2001.[7]
10.51 Copy of First Amendment to the POS Check Third-Party Servicer Agreement between Visa U.S.A., Inc.
and Electronic Clearing House, Inc. dated December 12, 2000. [8]
10.52 Copy of Second Amendment to the POS Check Third-Party Servicer Agreement between Visa U.S.A.,
and Electronic Clearing House, Inc. dated December 12, 2000. [8]
10.53 Copy of Third Amendment to the POS Check Third-Party Servicer Agreement between Visa U.S.A., and
Electronic Clearing House, Inc. dated December 12, 2000. [8]
10.54 Form of Securities Purchase Agreement by and among the Registrant and the Purchasers identified
therein. [9]
10.55 Form of Registration Rights Agreement by and among the Registrant and the Purchasers identified
therein. [9]
10.56 Office Lease dated May 21, 2003, by and between the Registrant and the 1989 Sheehan Family Trust
dated October 24, 1989, with respect to principal executive offices located at 730 Paseo Camarillo,
Camarillo, California 93010.[10]
10.57 Addendum to Office Lease dated July 7, 2004, by and between the Registrant and the 1989 Sheehan
Family Trust dated October 24, 1989, with respect to principal executive offices located at 730 Paseo
Camarillo, Camarillo, California 93010.
21.0 Subsidiaries of Registrant. [2]
23.1 Consent of PricewaterhouseCoopers LLP
24.1 Power of Attorney [11]
31.1 Certificate of Joel M. Barry, Chief Executive Officer of Electronic Clearing House, Inc. pursuant to Rule
13a-14(a) under the Securities and Exchange Act of 1934, as amended.
31.2 Certificate of Alice L. Cheung, Chief Financial Officer of Electronic Clearing House, Inc. pursuant to Rule
13a-14(a) under the Securities and Exchange Act of 1934, as amended.
32.1 Certificate of Joel M. Barry, Chief Executive Officer of Electronic Clearing House, Inc. pursuant to Rule
13a-14(b) under the Securities and Exchange Act of 1934, as amended.
32.2 Certificate of Alice L. Cheung, Chief Financial Officer of Electronic Clearing House, Inc. pursuant to Rule
13a-14(b) under the Securities and Exchange Act of 1934, as amended.
- ------------------------------
[1] Filed as an Exhibit to Registrant's Annual Report on Form 10-K for the
fiscal year ended September 30, 1988 and incorporated herein by
reference.
[2] Filed as an Exhibit to Registrant's Annual Report on Form 10-K for the
fiscal year ended September 30, 1989 and incorporated herein by
reference.
[3] Filed as an Exhibit to Registrant's Form S-1, Amendment No. 3,
effective November 13, 1990 and incorporated herein by reference.
[4] Filed as an Exhibit to Registrant's Annual Report on Form 10-K for
fiscal year ended September 30, 1997 and incorporated herein by
reference.
[5] Filed as an Exhibit to Registrant's Annual Report on Form 10-K for
fiscal year ended September 30, 1999 and incorporated herein by
reference.
[6] Filed as an Exhibit to Registrant's Annual Report on Form 10-K for
fiscal year ended September 30, 2000 and incorporated herein by
reference.
[7] Filed as an Exhibit to Registrant's Annual Report on Form 10-K for
fiscal year ended September 30, 2001 and incorporated herein by
reference.
[8] Filed as an Exhibit to Registrant's Annual Report on Form 10-K for
fiscal year ended September 30, 2002 and incorporated herein by
reference.
[9] Filed as an Exhibit to Registrant's Current Report on Form 8-K dated
October 30, 2003 and incorporated herein by reference.
[10] Filed as an Exhibit to Registrant's Annual Report on Form 10-K for
fiscal year ended September 30, 2003 and incorporated herein by
reference.
[11] Included on signature page.