UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
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X Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
- --- Act of 1934 for the fiscal year ended Sept. 30, 2002
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 Identification No.)
incorporation or organization)
28001 DOROTHY DR., AGOURA HILLS, CALIFORNIA 91301-2697
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (818) 706-8999,
fax number: (818) 707-9354
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
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None None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.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. ___
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 December
10, 2002 as reported on the NASDAQ National Market, was approximately
$9,273,699. Shares of Common Stock held by each officer and director and by
each person who owns 5% or more of the outstanding Common Stock 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 10, 2002, Registrant had outstanding 5,796,062 shares of Common
Stock.
DOCUMENTS INCORPORATED BY REFERENCE
None
ELECTRONIC CLEARING HOUSE, INC.
2002 FORM 10-K ANNUAL REPORT
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TABLE OF CONTENTS
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PART I. Page
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Item 1. Business . . . . . . . . . . . . . . . . . . . . . . . . . 3
Item 2. Properties . . . . . . . . . . . . . . . . . . . . . . . . 11
Item 3. Legal Proceedings. . . . . . . . . . . . . . . . . . . . . 12
Item 4. Submission of Matters to a Vote of Security Holders. . . . 12
PART II
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Item 5. Market for Registrant's Common Equity and Related
Stockholder Security Matters . . . . . . . . . . . . . . . 13
Item 6. Selected Consolidated Financial Data . . . . . . . . . . . 14
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations. . . . . . . . . . . . 15
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 24
Item 8. Financial Statements and Supplemental Data . . . . . . . . 24
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosures . . . . . . . . . . . 24
PART III
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Item 10. Directors and Executive Officers of the Registrant . . . . 25
Item 11. Executive Compensation . . . . . . . . . . . . . . . . . . 28
Item 12. Security Ownership of Certain Beneficial Owners
and Management . . . . . . . . . . . . . . . . . . . . . . 31
Item 13. Certain Relationships and Related Transactions . . . . . . 32
Item 14. Controls and Procedures. . . . . . . . . . . . . . . . . . 32
PART IV
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Item 15. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K. . . . . . . . . . . . . . . . . . . . 33
2
PART 1
ITEM 1. BUSINESS
GENERAL DESCRIPTION OF BUSINESS
Electronic Clearing House, Inc. ("ECHO" or the "Company") provides a complete
solution to the payment processing needs of merchants, banks and collection
agencies. The Company's services include debit and credit card processing, check
guarantee, check verification, check conversion, check re-presentment, check
collection and inventory tracking. ECHO is one of the few full service,
comprehensive providers that offers credit card, check, and collection services
all centrally reported and managed.
The Company derives revenues from two main business segments, bankcard and
transaction processing services and check services, and operates under the
following brands:
- MerchantAmerica, ECHO's retail provider of processing services to both
the merchant and bank markets;
- National Check Network ("NCN") for wholesale of check verification,
check authorization and capture, and for membership to collection
agencies;
- XPRESSCHEX, Inc. for retail check verification, check conversion,
Automated Clearing House ("ACH") services, check collection and check
guarantee services; and
- U-Haul Services, which provides credit card authorization, check
verification and check guarantee to U-Haul dealers, manages all dealer
rental and contract activity, and tracks both compensation and
available dealer inventory.
ECHO's merchant and check services offer the following benefits:
CREDIT AND DEBIT CARD CHECKS INTERNET PAYMENT INTERNET AND WEB SITE
SERVICES SERVICES
- ---------------------- --------------------- ------------------------- -------------------------
Connectivity options: --Check verification Credit cards via: MerchantAmerica suite of:
- --POS Terminals services powered
by NCN --Card swipe or --Web site hosting and
- --Touch tone phone manual entry development
--Electronic Check using browser based
- --Personal computer Conversion (ECC) "Virtual Terminal" --On-line payment
software reporting/transaction
--ECC powered by Check Services of: history
- --Fax machine VISA
--Verification and --E-mail services
Cards include: --Check Guarantee funds settlement
VISA, MC, AMEX, via browser based --On-line advertising
DISC, Diner's, JCB, --Check Collections "Virtual Terminal"
STAR, NYCE, PULSE, --National Merchant
Interlink, Maestro --Electronic Check --FREE Secure Directory
Re-presentment Gateway
--On-line banking access
--Consolidated --FREE Online Store
Returns --Merchant business
--FREE Shopping services resource
Cart portal
The Company's primary revenue generator is its bankcard and transaction
processing services whereby ECHO receives a fee based on the number of
transactions processed and the number of accounts serviced. This has
historically been a profitable business segment for the Company, although price
competition is intense. The Company is enhancing its back-end technology and has
identified new revenue opportunities to improve profitability.
For the past two years, ECHO has invested significant resources and management
focus in its check services business. Revenues are based on a fixed fee per
transaction and/or a fee based on the face amount of the check. ECHO is the
3
sixth largest check verification processor in the United States according to the
June 2002 issue of The Nilson Report, a monthly financial subscription-based
newsletter. The Company is one of the few check processors with a full suite of
merchant front-end connectivity capabilities; a negative check writer database
(NCN), an Automated Clearing House ("ACH") engine (which provides the tools to
electronically authorize, represent and settle funds between banks), and a
national collection service. Having this unique set and breadth of services
allows the Company to offer a total check management system that the Company
believes few competitors can offer.
The NCN database contains over 81 million check account records and the Company
has developed business relationships with over 260 collection agencies that
constantly keep the database updated. Through its network of NCN members, ECHO
can offer regional collection services and distribute collection items to one or
more of NCN's 260 member agencies to maximize local collection capability.
In addition to operating NCN, one of ECHO's goals is to provide a common
platform wherein a business can also access each of the other major check
databases that are currently available in the nation and thereby increase its
inherent value to it customers.
ECHO is working with Visa U.S.A. as both an Acquiring Party and a Third-Party
Processor in Visa's Point-of-Sale (POS) Check Program ("Visa Program"), which
began pilot testing in July 2001. The Visa Program allows banks to offer their
merchants a service that will 1) program their POS systems to receive immediate
online authorization for paper checks, 2) allow the merchant to set thresholds
for specific services, such as check guarantee and check verification, 3) allow
the merchants to convert a check into an electronic transaction and return the
check to the check writer at the point of sale, and 4) process the settlement of
funds into the merchant's bank. The Company provides critical back-end
infrastructure for the overall service, including its NCN front-end capture
capabilities, access to and review of the NCN database for all non-participating
bank activity, and use of the Company's ACH settlement and re-presentment
system. ECHO is currently working with six of the eight major financial
institutions that have chosen to participate in the pilot program and ECHO
believes that it is currently the preferred third-party provider for 14,000
banks who are members of Visa if they wish to participate in the program. The
Visa Program has grown more rapidly in the most recent months; however, it has
not yet generated significant revenue to the Company.
ECHO has historically generated a small percentage of its revenue from the
terminal business. The biggest buyer of systems in the past five years has been
U-Haul International who has acquired in excess of 15,000 systems and deployed
them to their dealers across the country. ECHO acts as the central clearing
agent for these systems and intends to continue to support the U-Haul deployed
base of terminals. However, the Company is currently not pursuing the sale of
its proprietary terminal system but rather focusing on its core bankcard and
check services business segments.
HISTORY OF THE COMPANY
ECHO has been offering merchant and check services for over 20 years. The
Company was incorporated in Nevada in 1981 under the name Bio Recovery
Technology, Inc. and changed its 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"), 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 1985, the Company purchased CBC, a company that had expertise in computer
control systems. CBC subsequently developed a series of high performance
terminals and secure printers that have been used primarily in the money order
dispensing market by American Express, Comdata, U-Haul, the United States Postal
Service and innoVentry. As a corporate subsidiary, CBC was dissolved at the end
of fiscal year 2002.
In 1995, a system utilizing CBC's terminal, ECHO's data center, and customer
support services was developed and deployed to 2,000 U-Haul dealers for the
real-time credit card authorization and management of rental equipment for
U-Haul International. The number of active dealers under the system has been
more than 15,000 (see "U-Haul International"). With regard to proprietary
issues, three patent applications related to the Company's printer methodology
have been granted (see "Patents").
In early 1996, the Company purchased Xynet, a business with specialties in the
Internet, Windows NT programming and worldwide communications networks. Through
this acquisition, the Company was able to expand its scope of acceptable
transaction input devices beyond the traditional POS systems to include
transactions submitted over the Internet and over a common telephone. Through
the expertise of the programming and management personnel resulting from this
acquisition, the Company also expanded the tools it makes available to specific
industries to utilize its services.
4
In 1999, ECHO acquired Magic Software Development, Inc., a check processing
company located in Albuquerque, New Mexico, that serviced National Check
Network, an association of around 60 collection agencies across the nation.
Since 1986, the Company provided a check guarantee service that only served
California merchants, but, with the addition of Magic's check processing
capabilities, the check guarantee services are now being offered on a national
basis. In fiscal 2000, Magic's corporate name was changed to XPRESSCHEX ("XCX")
and all XPRESSCHEX activity was moved to the new XCX entity. XCX provides and
promotes its check and electronic funds transfer ("EFT") services to other
processors and sales organizations in addition to ECHO.
In November 1999, the Company acquired Peak Collection Services, a collection
agency in Albuquerque, New Mexico, and incorporated Peak as the Collection
Division into the XCX operation in December of 1999. Through filings and
individual testing, the XCX Collection Division has completed registration as a
collection agency in 48 of 50 states to date. Having a fully integrated,
nationally approved collection service adds considerable value to the XCX suite
of check services and allows XCX 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, the Company 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, the Company signed an agreement with Visa, U.S.A. to
participate in a POS check processing pilot program as a "Third-Party, Acquiring
Processor". Under the pilot, any one of over 14,000 Visa member banks who choose
to participate ("Participating Member") can offer check conversion (converting a
paper check to an electronic transaction at the point of sale), check conversion
with check verification and/or check conversion with check guarantee 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 for Visa's POS Check Service. As of September
2002, six of the eight financial institutions participating in the pilot program
are using ECHO's services as a third-party processor.
In May 2001, the Company acquired the assets of National Check Network ("NCN")
and combined the NCN negative check writer records with RMRS database, resulting
in a combined database of over 81 million check writer records.
Also in May 2001, ECHO launched MerchantAmerica.com, a web-based source of
aggregated 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 of over
1.4 million merchants that is free to any merchant in the U.S.A. It also
provides any merchant in the U.S.A. with the ability to edit and enhance their
directory listing. While the Company believes that MerchantAmerica.com is a
valuable and cost-effective resource for merchants, it also provides the Company
with a low-cost method of keeping its merchants informed and involved with the
Company.
STRATEGY
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. The Company's performance and technical
capabilities have enabled it to develop a solid foundation as a one-stop
provider of leading-edge check and merchant services. With more than twenty
years of experience, the Company has a history of providing reliable,
customer-focused service to national merchants. The Company's platform of
services is uniquely 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 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.
The Company has targeted several areas as significant opportunities for growth,
including focusing on middle market retail accounts for check services and
developing a scalable infrastructure to support widespread implementation of the
Visa Program. The Company also seeks to increase profitability of core merchant
services by enhancing the back-end technology and identifying and targeting new
low-cost, incremental revenue opportunities.
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, the Company's Check Services business, through
effective sales channels, is targeting the full scope of merchants in the
marketplace, from the small merchant who may only need check verification to the
national retailers who have need of check conversion and national collection
services.
With approximately four million merchants in the U.S. and over 95% currently
accepting credit cards as payment, the potential market for check services is
significant. ECHO estimates that approximately 60% of merchants, or
5
about 2.3 million merchants, who accept credit cards also accept checks as a
form of payment. Furthermore, of the group that accepts checks as a form of
payment, the Company estimates that only 10% of them have an electronic method
to accept checks and the other 90% 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:
- - Approximately 1.5 million merchants currently accepting credit cards, but
who do not currently accept checks as a form of payment;
- - Approximately 1.9 million merchants currently accepting paper checks and
who may consider an electronic form of payment;
- - Approximately 400,000 merchants currently converting paper checks to
electronic at the POS and may consider changing to a better service and/or
lower-cost provider.
Efforts will be focused on working with the Company's sales channels to approach
mid-size retail chains that can benefit most from automating check processing
and verification. These mid-size accounts typically offer higher margins than
larger accounts and provide a less competitive marketplace. ECHO has recently
signed agreements with several new retailers, including Hastings Entertainment,
a video and entertainment business with 130 locations.
VISA POS CHECK PROGRAM
The Company has essentially completed the development and beta-testing of the
Visa Program and is preparing to leverage ECHO's check services assets through
Visa member banks. Six of the eight financial institutions currently testing the
program have chosen ECHO as their company's third-party processor and are
beginning to actively sell check services to their merchants. Visa has requested
ECHO's assistance in integrating several national merchants, including a major
global specialty-clothing retailer, into the Visa Program and the Company is
actively working to assist these merchants with development that is partially
being reimbursed by Visa.
Recently, ECHO's primary credit card processing bank, First Regional Bank,
decided to participate in the Visa Program enabling ECHO to provide independent
sales organizations with a sponsoring bank to offer the Visa Program to
merchants in the marketplace. This will enable the Company to use its 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. Therefore, the process of developing and
bringing to market the Visa Program has been more time and resource intensive
than originally anticipated due to the unique requirements of each financial
institution and extensive testing periods. As part of the Visa Program, the
Company has completed the following:
- - ECHO wrote, tested and installed special merchant terminal software that
specifically meets the Visa Program requirements.
- - ECHO certified its terminal and host response code with Vital Processing
Services, a major provider of terminal services to major banks.
- - ECHO developed special add-on services and reporting for specific banks or
select merchants who desired to use the Visa Program.
ECHO has used its relationships with the banks participating in the Visa pilot
program to gain knowledge in order to facilitate the integration and
implementation of the Visa Program for new banks and to develop a standardized,
but customizable platform of options. The Company's staff 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 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 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.
TURNKEY SOLUTION FOR REGIONAL AND COMMUNITY BANKS
ECHO has identified an underserved, niche market of smaller regional and
community banks for credit card and check payment programs. ECHO has developed a
turnkey solution that allows smaller banks to offer credit card and check
processing services on a private-label basis using the Company's back-end
infrastructure. Much of the reporting to the merchant utilizes the Internet as a
delivery channel, an environment in which the Company has significant experience
and knowledge. The Company estimates 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.
The Company has designed the program to be adopted by a bank at little or no
cost and yet it allows the bank to generate revenues and earnings in competition
to those earned by much larger banks who have had to make major investment in
the technology.
6
The new turnkey initiative, which is packaged under the MerchantAmerica name,
incorporates all of ECHO's Internet features and the Company's full retail set
of services and payment options. ECHO believes that its fully integrated payment
and reporting system allows smaller banks to enjoy not just competitive equality
but, in many cases, competitive advantage. 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. The Company, in turn, benefits 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.
The program was launched in August 2002 and, approximately two months later, at
the end of fiscal 2002, ECHO had six participating banks in the program. ECHO
estimates that there are 10,000 community banks in the U.S. and no one provider
of services has over 10% of the market. Based on third-party research, the
Company estimates 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. ECHO has experienced
positive initial reaction to recent outreach and marketing efforts.
BANKCARD AND TRANSACTION PROCESSING REVIEW
Bankcard and transaction processing volume rose 13% in fiscal 2002 and revenue
increased approximately 8%. While this has historically been a profitable
business, price competition is intense and has been impacting margins. ECHO
receives a fee based on the number of transactions processed and the number of
accounts serviced. The Company is enhancing its back-end technology and has
identified new revenue opportunities to improve profitability and margins.
ECHO is a registered Independent Service Organization and Merchant Service
Provider with Visa and MasterCard. 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.
The Company currently has two processing bank relationships: First Regional
Bank, Los Angeles, California, and The Berkshire Bank, New York, New York.
For the year ended September 30, 2002, MerchantAmerica accounted for
approximately 82% of the Company's revenues, compared to 83% in fiscal 2001.
MerchantAmerica presently provides 24-hour daily processing capability, "800"
number access to customer service personnel and, as needed, various field
support services. Utilizing one of the numerous methods of access to the
Company, the merchants' systems dial the Company's host computers and receive
credit card and/or check authorizations for accounts, 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
and which are then deposited 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.
The Company's software programs capture the transactions, retain data and enable
merchants to review, reconcile and edit transactions. MerchantAmerica has been
successful in its customer service efforts, which include a terminal loaner
program to minimize downtime, frequent sales and activity reports and
sophisticated security services utilizing the merchant's terminal, the Company's
host computers and field activity. MerchantAmerica utilizes several advanced
telecommunications capabilities involving manageable network design, robust
communications protocols, circuit troubleshooting, and packet switching, in
order to provide consistent and reliable services to its merchants.
ECHO's revenue for MerchantAmerica's credit card processing is derived primarily
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.
7
Discount rates range between 1.5% and 4.5%, and the Company's average discount
rate is 2.1%, which is consistent with the prior year. Depending upon the
discount rate and the cost of clearing interchange, about 75% to 90% 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 revenue in fiscal 2002 is $.18 per transaction, compared to $0.17 in
fiscal 2001. The Company maintains a range from $0.15 up to $0.32 per
transaction, depending on the level of merchant and customer interface. Larger
customers tend to pay lower transaction fees given the volume of business. Both
Visa and MasterCard have instituted $0.05 to $0.10 transaction fees on each
transaction processed. However, due to lower costs of communications and
negotiated contracts, ECHO's direct costs have been lowered to a range of
between $0.03 and $0.05 per transaction, depending upon duration and method of
transmission. However, the overall increases of processing such as personnel
costs, infrastructure costs, and other expenses have all contributed to a higher
cost of sales as a percentage of revenue in fiscal 2002. While bankcard and
transaction processing revenue increased by 8.4% in fiscal 2002, as compared to
fiscal 2001, cost of sales such as personnel costs increased from $840,000 in
fiscal 2001 to $1,251,000 in fiscal 2002, a 49% increase. Additionally,
depreciation and amortization expense related to computer software and hardware
increased from $598,000 in fiscal 2001 to $844,000 in fiscal 2002, a 41%
increase.
The market size for credit card processing is approximately 1.2 trillion
transactions per year, and this number is growing annually. ECHO has a very
small percentage of this market share, but the Company is one of the top 50
credit card processors according to The Nilson Report, a monthly financial
subscription-based newsletter. The Company's new agent bank program has
competitors that include First Data Corporation ("FDC"), the biggest credit card
processor in the U.S.; NPC; Global Payments; and Prism.
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 under no
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.
The Company's data center is reliable and the costs to operate the
MerchantAmerica program are currently reasonable, but no assurance can be made
that such favorable conditions will continue. Both Visa and MasterCard have
historically increased their interchange fees and transaction fees to the point
that building a profitable transaction business solely based upon credit card
activity has become increasingly difficult. The Company has a bankcard merchant
portfolio that is profitable and the Company has added other forms of
transaction processing, such as checks that are not affected by such changes.
CHECK-RELATED PRODUCTS REVIEW
In 1987, the Company initiated its check guarantee services to merchants located
in California so a merchant could accept a customer's check with confidence of
receiving payment. To support merchants in other states, the Company has
historically supported alternative check verification and guarantee services to
operate concurrently with the Company's credit card software in the merchant's
terminal. In 1999, the Company acquired Magic Software Development, Inc.
(renamed "XPRESSCHEX") that provided ACH settlement services and supported a
membership-based national verification service for collection agencies. In
November 1999, the Company acquired Peak Collection Services, a collection
agency, and integrated its operation into the XPRESSCHEX group location in
Albuquerque, New Mexico. In January 2000, the Company acquired Rocky Mountain
Retail Systems, Inc. ("RMRS"), another provider of national check verification
services. RMRS also originated and maintained National Check Information Service
("NCIS"), a database of negative-check writers that was available to merchants
and collection agencies across the nation on a fee per transaction basis.
In May 2001, the Company acquired the assets of National Check Network ("NCN").
In September 2001, the Company combined its check services all into one
corporate entity under the name of XPRESSCHEX, Inc., combined the negative and
positive databases of NCN and NCIS, and decided to promote its check
verification services using only the NCN name in the future. The combination of
the Company's check services, XPRESSCHEX's ACH services, XPRESSCHEX's collection
capabilities and the verification services through the NCN database formed the
foundation for ECHO's fully integrated national check services.
ECHO has invested significant resources and management focus in its check
services business and the Company's efforts are beginning to show results. Check
services revenue increased approximately 34% in fiscal 2002 from fiscal 2001.
Revenues from all sectors of check services, including check verification, check
conversion, check re-presentment, are all increasing significantly. Also, Visa
remains committed to its POS Check pilot program and Visa is encouraging
participating banks to move to a full implementation wherein they offer the
service to all of their merchants.
8
ECHO's revenue in check services can come from several sources. Typically, the
merchant pays either a fixed fee for each transaction (verification, conversion,
re-presentment, return check processing ("RCK"), etc.) or a fee based on the
face amount of the check (check guarantee). Transaction revenue is received for
check verification, check conversion, check re-presentment and RCK services. In
the Visa model, ECHO can receive transaction fees for providing "third-party"
services to Visa banks, which assists them in processing checks from
non-participating banks. 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 certain 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 following check services are being offered by the Company:
Check Verification
For a fee, the Company will search NCN, its proprietary database of
negative-check writers, attempting to match a specific piece of information,
such as a driver's license number or Magnetic Ink Character Recognition ("MICR")
number, provided by the merchant. A match identifies the check writer as having
current, 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;
however, ECHO offers no guarantee that the check will be honored by the check
writer's bank and makes no promise of reimbursement if the check is dishonored
by the bank.
Check Guarantee
Under check guarantee, ECHO will apply several risk management approaches, one
of which is to search NCN's database against the data provided by the merchant
and essentially "score" each transaction. If ECHO's scoring system concludes
there is too much risk, the Company issues a coded response instructing the
merchant to refuse to accept the check. If ECHO's scoring system results in a
positive result, a coded response advises the merchant that the Company has
guaranteed payment on that item. If that check is subsequently dishonored by
the check writer's bank, the merchant is reimbursed by the Company. Given the
risks associated with check guarantee, especially for large volume merchants,
ECHO exercises strict risk parameters on the merchants to which this service is
offered.
Electronic Check Conversion ("ECC")
ECC is a relatively new system of check settlement that is slowly 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 then returns the
check to the customer and the electronic image, captured by the reader, allows
the Company to settle the check transaction electronically. Customers like this
new system because they get their check back immediately and still have their
hard copy of the transaction. Banks like ECC because no paper has to be handled
by the bank to settle the transaction. However, merchants will adopt the system
only if their check volume justifies the capital investment in equipment,
ranging from $150 to $600.
Check Re-Presentment ("RCK")
XPRESSCHEX 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 return it to the merchant. Upon receipt, XPRESSCHEX converts the check to
an electronic ACH transaction for resubmission through the ACH network and
images the check for possible collection activity, should it become necessary.
Timing of re-presentment is made so as to coincide with payday and better the
odds of collection. 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 RCK services.
XPRESSCHEXONLINE(sm) and XPRESSCHEXPLUS(sm)
A check can be presented as a form of payment over the Internet and
ECHO supports the multiple types of ACH entry classes. XPRESSCHEXONLINE allows
any e-commerce site to accept a check as payment. XPRESSCHEXPLUS allows a batch
of check data to be sent to XPRESSCHEX for processing and is commonly used by
mail order or phone order businesses.
Visa POS Check Service ("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
demand deposit accounts, similar to the authorizations provided for credit and
debit card transactions. A merchant will be able to have the option of 1)
converting the check to an electronic image only and the funds being deposited
electronically, or 2) converting the check to an electronic image, the funds
9
being deposited and verifying either the availability of funds or the presence
of the check writer in a negative database at the POS, or 3) converting the
check to an electronic image, having the funds deposited and having it
guaranteed by a third party.
Once authorization is obtained, the customer is required to sign a separate
sales receipt authorizing the conversion of the check transaction to an
electronic transaction. The merchant then voids the paper check and returns it
to the customer along with a signed sales receipt.
Visa's processing system, VisaNet, currently processes transactions for about 5
million U.S. merchants and has access to 90% of the demand deposit accounts in
the country. In the case of checks written on an account at a financial
institution participating in the Visa Program, the check will be authorized
directly by that bank. However, for financial institutions that have chosen the
Company as their third-party processor and where the check is written on an
account at a non-participating bank, the check will be verified against 81
million known checking accounts stored in ECHO's NCN database.
ECHO is strategically positioned to capitalize on the potential growth of the
Visa Program, which has the potential to provide merchants with a more
cost-effective means of check verification, conversion and guarantee, while
leveraging the strong marketing channel and brand recognition of Visa and its
member banks. The Company is currently working with six of the eight major
financial institutions that have chosen to participate in the pilot program. For
check verification, conversion and guarantee, ECHO has provided solutions to
Visa member banks as part of the Visa Program. The Company believes that its
relationship with the Visa Program gives ECHO the potential to become a leading
check services processor over the coming years.
U-HAUL RELATIONSHIP
ECHO's relationship with U-Haul International represents a mature business with
a solid revenue stream. The Company has been working with U-Haul International
since 1995, when ECHO developed and deployed a comprehensive system for
real-time credit card authorization, capture and compilation of compensation
data, and active management of rental equipment information. The software, which
operates on ECHO's proprietary EB920 terminal, prepares the rental contract
between the dealer and the customer and reports the activity electronically to
the corporate office, thereby eliminating the need for a U-Haul dealer to
manually prepare weekly summary reports of rental activity. The system tracks
all financial data and forwards both rental and financial data daily to ECHO's
data center, where it distributes the rental data on an hourly basis around the
nation to the points of destination. This allows a receiving dealer to accept
reservations for rental of the specific equipment prior to the equipment's
actual arrival.
ECHO's revenues are derived from equipment sales to U-Haul, custom development
work, and income resulting from daily transaction processing services provided
to dealers and U-Haul Corporate. While the Company has experienced a declining
trend in transaction volume, due in part to U-Haul's development of a web-based
processing service, it has been able to cross-sell its check services into the
terminal base of more than 15,000 dealers. In fiscal 2001, the Company entered
into a revised three-year contract with U-Haul International, which covers
processing services, software development, data distribution, equipment
purchases/warranty, customer support and consulting, and which resulted in a
reduction in transaction fees.
SALES AND MARKETING
ECHO sells its Merchant and Check Services through several marketing channels,
including independent sales organizations ("ISO"), its own internal sales force
and direct merchant referrals by existing merchants. The Company also offers
Merchant Services through a direct online sales channel, MerchantAmerica.
Approximately 20% of the Company's new accounts have historically been generated
through the ISOs. ECHO recently restructured its sales force by hiring more
sales people for its Check Services National Sales Group focused 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.
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 POS Check 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 POS Check pilot program, ISOs,
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 138 ISOs 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.
10
Management believes that the Company is unique in the number of payment methods
that it allows, the combination of transaction types that it manages directly,
its ability to integrate additional services and its ability to support each
merchant through one vertically integrated source.
The Company's marketing strategy is to maximize cross-selling opportunities to
its existing base of retail merchants; 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 POS Check 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 the Company's NCN services,
including check conversion, verification, ACH payments, collection and its
positive and negative database capability and enlist their active sales
thereof.
COMPETITION
Merchant and check 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 wherein a natural
advantage accrues to the highest volume processors. To offset this fact, the
Company has focused on marketing to niche markets wherein it can maintain the
margins it deems 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 has competitive
advantages, including its front-end connectivity capabilities, 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 and Acquiring
Party Processor with the Visa Program. The Company believes its flexibility in
offering a variety of check and collection services that enable its merchants
and resellers to select the most cost-effective means of check acceptance and
collection effort for them is a distinctive advantage.
ECHO is not currently a major player in the industries in which it competes and
many of the Company's competitors have greater financial and marketing resources
than the Company. As a result, they may be better able to respond more quickly
to new or emerging technologies and changes in customer requirements.
Competitors also enjoy per transaction cost advantages due to their high
processing volumes that may make it difficult for ECHO to compete. In addition,
major players in the check services industry have developed sophisticated risk
assessment technology that may provide a competitive advantage in providing
check guarantee services. The Company believes that its success will depend upon
its ability continuously to develop new products and services and to enhance its
current products and to introduce them promptly into the market.
REPORTABLE SEGMENTS
Refer to Note 12 "Reportable Segments" in the accompanying Notes to Consolidated
Financial Statements for reportable segment information and financial
information about geographic areas.
ITEM 2. PROPERTIES
In October 1994, the Company purchased the three-story, 13,500 square foot
building in Agoura Hills, California it currently occupies for $880,000. The
Company currently has two notes collateralized by this building. The current
monthly debt service for these two notes is approximately $19,000. This
building houses the Company's headquarters and computer facilities.
The Company leases real property in Agoura Hills and Westlake Village,
California; Albuquerque, New Mexico; Boulder, Colorado; and Kansas City, Kansas
for sales, data center and other operations, under various agreements, which
expire at various times over the next two years. The total lease payments are
approximately $18,000 per month.
11
The Company owns several pieces of raw land for investment consisting of four
noncontiguous parcels in Missouri totaling approximately five acres, two
noncontiguous parcels in Texas totaling approximately forty-four acres, one acre
in Castilla County, Colorado, one-third acre in Eureka County, Nevada, a single
lot in Arrowhead County, Washington, a single lot in Ventura County, California,
three acres in Independence County, Arkansas, and 498 acres in San Bernardino
County, California. The Company sold the 498 acres in San Bernardino County,
California in October 2002.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in various lawsuits arising in the ordinary course of
business.
On December 27, 2001, the Company settled its collections lawsuit against First
Preferred Bank (successor-in-interest to First Charter Bank) by filing a Mutual
Release and Settlement Agreement with the Los Angeles Superior Court that i)
settles the counter lawsuit filed by First Charter against ECHO, and ii)
releases ECHO and First Preferred Bank from any other liability in connection
with the Merchant Marketing and Processing Agreement (the "Agreement") with
First Charter Bank entered into on June 25, 1994 and subsequently terminated on
October 11, 2000 by ECHO before filing suit.
On March 6, 2002, by resolution of the Board of Directors upon advise of counsel
subsequent to closing arguments at trial and a March 1, 2002 Mediation, the
Company settled all claims without admission of liability arising from
litigation known as Premiere Lifestyles International Corporation, Inc.
("Premiere") v. Electronic Clearing House, Inc. in the Los Angeles County
Superior Court. The Company made a one-time cash payment of $1,200,000 to
Premiere and executed a long-term promissory note collateralized by the
Company's office building in Agoura Hills, California in favor of Premiere for
an additional $1,300,000, payable over 15 years with an interest rate of 8%.
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, 2002.
EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of the Company are as follows:
Name Position
------------------------- -----------------------------------
Joel M. Barry Chairman of the Board,
Chief Executive Officer
Alice L. Cheung Chief Financial Officer,
Treasurer
Alex Seltzer Chief Operating Officer/Chief
Information Officer
Patricia M. Williams Vice President, Check Services
Jack Wilson Vice President, Merchant Services
Jesse Fong Vice President,
Information Systems
David Griffin Vice President, Check Guarantee
Rick Slater Vice President, Chief
Technology Officer
Donna L. Rehman Corporate Secretary
R. Marshall Frost Counsel
12
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
SECURITY MATTERS
Since January 17, 1986, the Company has been trading on the over-the-counter
market under the name Electronic Clearing House, Inc. On October 2, 1989, the
Company was accepted for listing on the National Association of Securities
Dealers Automated Quotation System ("NASDAQ") and trades under the symbol of
"ECHO" on the Nasdaq SmallCap Market. The following table sets forth the range
of high and low prices for the Company's common stock during the fiscal periods
indicated. The prices set forth below represent quotations between dealers and
do not include retail markups, markdowns or commissions and may not represent
actual transactions. Moreover, due to the lack of an established trading
market for the Company's common stock, such quotations may bear no relationship
to the fair market value of the Company's common stock and may not indicate
prices at which the Company's common stock would trade in an established public
trading market.
FISCAL YEAR ENDED
SEPTEMBER 30 High Low
----------------- ----- -----
2002
-----------------
First Quarter $2.92 $1.88
Second Quarter $2.44 $2.00
Third Quarter $2.10 $1.16
Fourth Quarter $1.58 $1.08
2001
-----------------
First Quarter $6.25 $2.00
Second Quarter $5.25 $2.19
Third Quarter $4.12 $2.28
Fourth Quarter $3.64 $1.24
The prices set forth above are not necessarily indicative of liquidity of the
trading market. Trading in the Company's common stock is limited and sporadic,
as indicated by the average monthly trading volume of 149,341 shares for the
period from October 2001 to September 2002. On December 10, 2002, the closing
representative price per share of the Company's common stock, as reported
through Nasdaq SmallCap Market, was $1.60.
HOLDERS OF COMMON STOCK
As of November 12, 2002, there were approximately 857 record holders and 4,233
beneficial holders of the Company's common stock, with 5,796,062 shares
outstanding. The number of holders of record is based on the actual number of
holders registered on the books of the Company's 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
The Company has not paid any dividends in the past and has no current plan to
pay any dividends. The Company intends to devote all funds to the operation of
its businesses.
13
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 at items 7 and 8 below. The following data, insofar as they
relate to each of the five years ended September 30, have been derived from
annual financial statements, including the consolidated balance sheet at
September 30, 2002 and 2001 and the related consolidated statement of operations
and of cash flows for the three years ended September 30, 2002, and notes
thereto appearing elsewhere herein.
Year Ended September 30
-----------------------------------------------
2002 2001 2000 1999 1998
-------- -------- -------- ------- --------
( ---- AMOUNTS IN THOUSANDS, EXCEPT PER SHARE ---- )
STATEMENT OF OPERATIONS DATA:
- -----------------------------
Revenues . . . . . . . . . . . . . . . . . . $33,291 $29,943 $28,340 $23,828 $21,063
Costs and expenses . . . . . . . . . . . . . 36,960 29,380 28,324 22,636 19,852
-------- -------- -------- ------- --------
(Loss) income from operations. . . . . . . . (3,669) 563 16 1,192 1,211
Interest income (expense), net . . . . . . . (74) 106 196 95 14
Other income (expense), net. . . . . . . . . -0- 350 312 -0- (35)
-------- -------- -------- ------- --------
(Loss) income before income tax
benefit (provision) . . . . . . . . . . . . (3,743) 1,019 524 1,287 1,190
Benefit (provision) for income taxes . . . . 1,367 (585) (233) 1,331 (36)
-------- -------- -------- ------- --------
Net (loss) income. . . . . . . . . . . . . . $(2,376) $ 434 $ 291 $ 2,618 $ 1,154
======== ======== ======== ======= ========
(Loss) earnings per share-basic. . . . . . . $ (0.41) $ 0.07 $ 0.06 $ 0.58 $ 0.31
(Loss) earnings per share-diluted. . . . . . $ (0.41) $ 0.07 $ 0.05 $ 0.45 $ 0.21
Weighted average number of common
shares and equivalents outstanding-basic. . 5,788 5,797 5,257 4,536 3,744
Weighted average number of common
shares and equivalents outstanding-diluted. 5,788 5,964 5,825 5,825 5,459
BALANCE SHEET DATA:
- -------------------
Working capital. . . . . . . . . . . . . . . $ 3,234 $ 5,821 $ 6,029 $ 5,010 $ 3,611
Current assets . . . . . . . . . . . . . . . 5,728 8,259 7,595 6,159 5,154
Total assets . . . . . . . . . . . . . . . . 18,191 18,921 17,013 12,932 8,025
Current liabilities. . . . . . . . . . . . . 2,494 2,438 1,566 1,149 1,543
Long-term debt, and payable to
stockholders and related parties,
less current portion. . . . . . . . . . . . 2,159 744 767 599 639
Total stockholders' equity . . . . . . . . . $13,538 $15,739 $14,680 $11,184 $ 5,843
14
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
The following discussion of the financial condition and results of operations of
Electronic Clearing House, Inc. ("ECHO" or the "Company") should be read in
conjunction with the consolidated financial statements and notes thereto
included elsewhere herein. This discussion contains forward-looking statements,
including statements regarding the Company's strategy, financial performance and
revenue sources, which involve risks and uncertainties. The Company's actual
results may differ materially from those anticipated in these forward-looking
statements as a result of certain factors, including, but not limited to, those
set forth elsewhere herein.
OVERVIEW
ECHO provides a complete solution to the payment processing needs of merchants,
banks and collection agencies. The Company's services include debit and credit
card processing, check guarantee, check verification, check conversion, check
re-presentment, check collection and inventory tracking.
The Company derives revenues from two main business segments, bankcard and
transaction processing services and check services, and operates under the
following brands: MerchantAmerica, ECHO's retail provider of processing services
to both the merchant and bank markets; National Check Network ("NCN") for
transaction verification; XPRESSCHEX, Inc. for processing check guarantee, check
conversion, check collection and check verification; and U-Haul Services, which
provides credit card authorization, rental activity and tracks available
inventory.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management's discussion and analysis of financial condition and results of
operations is based upon the Company's consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States. 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, goodwill amortization, capitalization of software
costs, contingencies and litigation. Management bases its estimates on
historical experience and on various other assumptions that are believed to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ from these
estimates.
Management applies the following critical accounting policies in the preparation
of our consolidated financial statements:
- - Revenue Recognition Policy. All processing and transaction revenues are
recognized at the time the transactions are processed by the customer.
Processing and transaction revenues are principally based on the number of
transactions processed and a percentage of dollar volume processed. Terminal
sales are recorded when product is shipped and title transferred to the
customer.
- - Reserve for Doubtful Accounts. The Company established a reserve for doubtful
accounts equal to the estimated uncollectible amounts. The Company's estimate
is based on historical collection experience and a review of the current status
of account receivable. It is reasonably possible that the Company's estimate of
the reserve for doubtful accounts will change from time to time.
- - 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.
- - Research and Development Expense. Expenditures for research activities
relating to product development and improvement are charged to expense as
incurred. Such expenditures amounted to $1,719,000 in fiscal year 2002 and
$1,070,000 in fiscal year 2001.
- - Goodwill Amortization. Goodwill represents the excess of purchase price over
tangible and other intangible assets acquired less liabilities assumed arising
from business combinations and is being amortized on a straight-line basis over
estimated useful lives ranging from 10 to 15 years. SFAS No. 142, "Goodwill and
Other Intangible Assets" ("SFAS 142"), issued in June 2001, requires, among
other things, the discontinuance of goodwill amortization. In addition, the
standard includes provisions for the reclassification of certain existing
recognized intangibles as goodwill, reassessment of the useful lives of existing
recognized intangibles, reclassification of certain intangibles out of
15
previously reported goodwill and the identification of reporting unit for
purposes of assessing potential future impairments of goodwill. SFAS 142 also
requires companies to complete a transitional goodwill impairment test six
months from the date of adoption. The Company is required to adopt these
statements effective the first quarter of fiscal 2003. The Company has completed
the Step 1 - goodwill impairment test, as prescribed by SFAS 142, utilizing
discounted cash flow analysis for the check services reporting unit that has
goodwill. The results of this analysis indicate potential goodwill impairment
for this reporting unit. The Company has begun, but not completed, Step 2 -
measurement of the impairment loss, by evaluating the fair value of the check
services business segment through discounted cash flow models and other
analytical means. The Company expects to record any impairment loss as a
cumulative effect of a change in accounting principle in the first quarter of
2003.
- - Capitalization of Software Costs. The costs of purchased and internally
developed software used to provide services to customers or internal
administrative expenses are capitalized and amortized on a straight-line basis
over the lesser of three years or estimated useful life. Under the provisions of
Statement of Position 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use," the Company capitalizes software costs
when both the preliminary project stage is completed and management has
authorized further funding for the completion of the project.
In June 2002, the FASB issued SFAS 146, "Accounting for Costs Associated with
Exit or Disposal Activities", which is effective for exit or disposal activities
initiated after December 31, 2002. SFAS 146 requires that a liability for a
cost associated with an exit or disposal activity be recognized and measured
initially at fair value only when the liability is incurred. The Company does
not expect the adoption of SFAS 146 will have a material impact on its financial
statements and the results of its operations.
RESULTS OF OPERATIONS
FISCAL YEARS 2002 AND 2001
- ------------------------------
Financial highlights for fiscal 2002 as compared to fiscal 2001 were as follows:
- --Total revenue increased 11.2% to $33.3 million
- --Gross margin from processing and transaction revenue declined to 30.8% from
33.9%
- --Operating income moved into negative territory to $(3.7) million from $563,000
- --Diluted loss per share of $(0.41) as compared to diluted earnings per share of
$0.07
- --Fiscal 2002 results reflect one-time legal settlement of $2.5 million
- --Bankcard and transaction processing revenue rose 8.4% to $27.3 million
- --Check-related revenue increased by 34.2% to $5.8 million
REVENUE. Total revenue increased 11.2% to $33,291,000 for the fiscal 2002, from
$29,943,000 for fiscal 2001. The increase can be primarily attributed to growth
in the processing and transaction business. Total processing and transaction
revenue for fiscal 2002 increased 13.0%, from $29,096,000 in fiscal 2001 to
$32,889,000 in fiscal 2002.
COST OF SALES. Bankcard processing expenses are largely a reflection of changes
in processing revenue. A majority of the Company's bankcard processing expenses
are fixed as a percentage of each transaction amount, with the remaining costs
being based on a fixed rate applied to the transactions processed.
Processing-related expenses, consisting of bankcard processing expense and
transaction and check processing expense, increased 18.2% for the year, from
$19,239,000 in fiscal 2001 to $22,747,000 in fiscal 2002. The increase reflects
a 13.0% increase in processing and transaction revenues for the year, as well as
the higher costs of processing. Gross margin from processing and transaction
services decreased from 33.9% in fiscal 2001 to 30.8% in fiscal 2002. This
decrease in gross margin was due to a combination of factors such as higher
personnel and infrastructure costs, increased costs paid to a third-party
service provider, the departure of several higher volume/high margin credit card
merchants, and a lower rate charged to U-Haul as a result of a contract
negotiation.
While bankcard and transaction processing revenue increased by 8.4% in fiscal
2002, as compared to fiscal 2001, cost of sales such as personnel costs
increased from $840,000 in fiscal 2001 to $1,251,000 in fiscal 2002, a 49%
increase. Additionally, depreciation and amortization expense related to
computer software and hardware increased from $598,000 in fiscal 2001 to
$844,000 in fiscal 2002, a 41% increase.
16
Cost of terminals sold was $588,000 for the year, as compared to $419,000 in the
fiscal 2001. The cost of terminals continued to exceed the terminal sales as a
result of a $300,000 inventory allowance provision for fiscal 2002. This
allowance was related to the write-down of certain obsolete customized printers
and other slow-moving inventory.
EXPENSE. Other operating costs such as personnel costs, telephones and
depreciation expenses decreased 1.8%, from $2,468,000 in fiscal 2001 to
$2,424,000 in fiscal 2002 due to stringent cost controls. Research and
development expenses increased 60.7% from $1,070,000 in fiscal 2001 to
$1,719,000 in fiscal 2002. The Company is continuing to invest in research and
development related to the various check service products at the current level.
Even though most of the check services program development is near completion,
the Company anticipates that it will continue to invest in research and
development expenses in order to remain competitive in the market place.
Additionally, the Company incurred operational expenses related to the
management of the Visa POS Check Services pilot program ("Visa Program") without
any offsetting revenue during this period.
Selling, general and administrative expenses increased 12.7% from $5,760,000 in
fiscal 2001 to $6,493,000 in fiscal 2002. This increase was mainly due to the
hiring of additional sales personnel in support of both merchant and check
services and additional administrative staff to support the growth of the
Company. In fiscal 2002, the Company hired a new COO/CIO. As a percentage of
total revenue, selling, general and administrative expenses increased slightly
from 19.2% in the fiscal 2001 to 19.5% in fiscal 2002.
Amortization of goodwill expense remained relatively constant, from $424,000 in
fiscal 2001 to $489,000 in fiscal 2002. However, periodic goodwill amortization
expense will be eliminated upon the adoption of SFAS 142 in the first quarter of
fiscal 2003.
INTEREST EXPENSE. Interest expense increased to $129,000 for fiscal 2002, from
$81,000 last year. The increase is due to the $1.3 million long-term note
portion of the legal settlement expense for Premiere Lifestyles International
Corporation, which carries an 8% interest rate. Interest income declined from
$187,000 in fiscal 2001 to $55,000 in fiscal 2002 due to a decline in interest
rates and lower average cash balances.
EFFECTIVE TAX RATE. Benefit for income taxes of $1,367,000 in fiscal 2002 was
due to the operating loss incurred of $3,743,000. The Company's effective tax
benefit rate was 36.5% for fiscal 2002 and a tax provision rate of 57.4% for
fiscal 2001. 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 (LOSS). Net loss for fiscal 2002 was $2,376,000, as compared to net
income of $434,000 last year. The decline was primarily due to the $2.5 million
legal settlement on a pre-tax basis with Premiere. The Company made a one-time
cash payment of $1,200,000 to Premiere and executed a long-term promissory note
collateralized by the Company's Agoura Hills, California office building in
favor of Premiere for an additional $1,300,000, payable over 15 years, with an
interest rate of 8%. In addition, operating income fell in fiscal 2002
primarily due to a $649,000 increase in research and development expense, a
$300,000 increase in provision for inventory allowance and a $250,000 decrease
in other revenue.
SEGMENT RESULTS
Bankcard and Transaction Processing. Bankcard processing and transaction revenue
increased 8.4%, from $25,220,000 in fiscal 2001 to $27,339,000 for fiscal 2002.
This increase was mainly attributable to an approximately 13.2% increase in
bankcard processing volume as compared to last year and was the result of the
Company's successful marketing programs, including the MerchantAmerica web
offerings and other sales programs. The increase in bankcard processing revenue
was partially offset by a decrease in revenue as a result of a rate reduction
offered to U-Haul, a major transaction processing customer, and the loss of
several high volume, high margin merchants.
In fiscal 2002, the bankcard and transaction processing segment generated
operating income of $1,996,000, or 7.3% of associated revenues, as compared to
$3,183,000, or 12.6% of revenues, in fiscal 2001. The 59.5% decrease in
operating income is attributable to a $303,000 increase in research and
development expense, a $300,000 increase in inventory allowance and a $168,000
decrease in other revenue. Additionally, gross margin decreased due to the
departure of several high margin merchants combined with higher overall
operating costs.
The Company implemented a rate increase in October 2002 to its credit card
processing merchants, which is expected to offset the higher operating costs and
to improve the gross margin from credit card processing activities in fiscal
2003.
17
The Company anticipates significant service enhancements and cost savings as it
integrates with the Oasis Payment Processing System being acquired from Oasis
Technologies for approximately $1.3 million of which $553,000 progress payments
were made through September 30, 2002. This project is expected to be completed
by the last quarter of 2003. This system will process card payments more
efficiently and with more features and flexibility, thus free up the Company's
technical staff to speed up the development of new services and further
integrate the multiple merchant-related services. With its direct settlement
framework, Oasis will offer pricing advantages by eliminating a key component of
the Company's cost structure by eliminating a third-party processor, a savings
of approximately ten basis points for every credit card dollar processed. The
implementation of this system will give the Company a greater flexibility to
price its credit card processing services, allowing the Company to attract and
retain larger merchants as well as the small and mid-market merchants that have
been its target market.
Check Related Products. Check-related revenues increased from $4,323,000 for
fiscal 2001 to $5,802,000, an increase of 34.2%. This was attributable to a
11.1% increase in check verification revenue and a 72.7% increase in electronic
check presentment revenue.
Check services revenue made up 17.6% of the total processing and transaction
revenues for fiscal 2002 as compared to 14.9% in the prior year. Check-related
operating loss was $872,000 for the year, as compared to operating loss of
$234,000 in fiscal 2001. The increase was due to the costs associated with the
development of the Visa Program and the Company's other new products, as well as
an increase in staffing to support current and anticipated processing volume.
The Visa Program is continuing as planned. The Company is currently working with
six Visa member banks that have chosen to participate in this Visa pilot
program. During the pilot phase, small numbers of merchants have been testing
the Visa Program in conjunction with the banks. The Company will not be
generating significant revenue from this Visa Program until the member banks
have completed the pilot phase and begin to offer this program to their merchant
base. Development and testing of the Visa POS Check Services platform was
largely completed by the end of fiscal 2002, and some member banks have now
begun to actively market the service to their merchant base. Management believes
that the Visa POS Check Services Program will provide the Company with
significant opportunities to develop strategic relationships with some major
banks, which could result in an increase in our check services revenue in the
coming years.
Other. Other revenue decreased from $400,000 in fiscal 2001 to $150,000 in
fiscal 2002 due to a decrease in the amount of customer software development
work completed during the year.
FISCAL YEARS 2001 AND 2000
- ------------------------------
Financial highlights for fiscal 2001 as compared to fiscal 2000 were as follows:
- --Total revenue increased 5.7% to $29.9 million
- --Gross margin from processing and transaction revenue improved from 29.4% to
33.9%
- --Income from operations rose to $563,000 from $16,000
- --Check-related revenues increased 124.5% to $4,323,000
- --Check services revenue grew to 14.9% of total processing and transaction
revenues
- --After-tax net income increased 49.1% to $434,000
- --Basic and diluted earnings per share of $0.07 in fiscal 2001 as compared to
$0.06 per basic share and $0.05 per diluted share
REVENUE. Total revenues for fiscal year 2001 were $29,943,000, an increase of
5.7% over revenues of $28,340,000 for fiscal year 2000. Overall, total
processing and transaction revenue increased from $25,677,000 for fiscal 2000 to
$29,096,000 for fiscal 2001, an increase of 13.3%.
COST OF SALES. Bankcard processing expenses should largely reflect the changes
in processing revenue. A majority of the Company's bankcard processing expenses
are fixed as a percentage of each transaction amount, with the remaining costs
based on a fixed rate applied to the transactions processed. Processing-related
expenses, consisting of bankcard processing expense and transaction expense,
increased from $18,128,000 for fiscal year 2000 to $19,239,000 in Fiscal 2001,
an increase of 6.1%. This reflected the 13.3% increase in processing and
transaction revenues for Fiscal 2001. Gross margin from processing and
transaction revenue improved from 29.4% to 33.9%. The increase in gross margin
was attributable to the increase in check services revenue, which normally
yields a higher gross margin. Additionally, the Company was able to lower its
communications costs and chargeback losses during fiscal year 2001.
18
Cost of terminals sold and leased decreased from $1,790,000 in fiscal year 2000
to $419,000 in fiscal year 2001, a decrease of 76.6%. This is attributable to
the 81.8% decrease in terminal sales revenue for the year. However, the gross
margin decreased from 27.2% in fiscal 2000 to 6.3% in fiscal 2001. This was due
to the Company's decision to lower small quantity equipment pricing in fiscal
2001.
EXPENSE. Other operating costs increased from $2,161,000 in fiscal year 2000
to $2,468,000 in fiscal year 2001, an increase of 14.2%. This increase
was reflective of the 13.3% increase in processing and transaction revenue and
the significant operating expenses attributable to the development of the
various check services programs as discussed herein.
Selling and general and administrative expenses increased from $4,816,000 in
fiscal year 2000 to $5,760,000 in fiscal year 2001, an increase of 19.6%.
Approximately $600,000 of this increase was attributable to the legal and
consulting fees related to the ongoing litigation, which is continuing into the
first fiscal quarter of 2002. Additionally, the Company continues to invest in
higher personnel costs required to support the growth and management of the
various check services and the rollout of MerchantAmerica.com, an Internet
website designed to promote the products and services of the Company and to
enhance merchant reporting functions. As a percentage of total revenue, selling,
general and administrative expenses increased from 17.0% of total revenue in
fiscal year 2000 to 19.2% of total revenue in fiscal year 2001.
OPERATING INCOME. Income from operations for fiscal 2001 was $563,000, as
compared to $16,000 in fiscal 2000. The increase was primarily attributable to
higher transaction revenue and improved gross margin for processing and
transaction revenue.
INTEREST EXPENSE. Interest expense decreased to $81,000 for fiscal 2001 from
$88,000 in fiscal 2002. This was offset by interest income, which declined to
$187,000 in fiscal 2001 from $284,000 in fiscal 2000. Also, the Company posted a
gain on the sale of an asset. In June 2001, the Company sold a merchant list to
a financial institution for cash proceeds of $350,000.
EFFECTIVE TAX RATE. Income tax expense was $585,000 for fiscal year 2001 and
$233,000 for fiscal year 2000. The Company's effective tax rate was 57.4% for
fiscal 2001 and 44.5% for fiscal 2000. 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.
SEGMENT RESULTS
Bankcard and Transaction Processing. Revenues derived from the electronic
processing of transactions are recognized at the time the transactions are
processed by the merchant. Bankcard and transaction processing revenue decreased
3.8%, from $26,210,000 in fiscal year 2000 to $25,220,000 for fiscal year 2001.
Increases in bankcard processing volume year-over-year and U-Haul transaction
processing revenue were offset by the reduction in processing revenue from the
innoVentry bankcard processing joint venture, which was terminated in September
2000.
The bankcard and transaction processing segment generated operating income of
$3,183,000, or 12.6% of revenues, for fiscal 2001, as compared to $2,668,000, or
10.2% of revenue, in fiscal 2000. The 19.3% increase in operating income was due
to an increase in transaction and processing volume.
The Company entered into an amended contract with U-Haul in September 2001 and
thereby extended the contract for another three-year term. The Company currently
serves approximately 15,000 U-Haul dealers nationwide.
Check-Related Products. Check-related revenues increased from $1,926,000 for
fiscal year 2000 to $4,323,000 in fiscal 2001, a 124.5% increase. This was
attributable to the additional check services being offered to the merchants in
the current fiscal year and the continued higher growth experienced in the
check-related business segment. Check services revenue made up 14.4% of total
processing and transaction revenues in fiscal 2001 as compared to 6.8% in the
prior year. Check-related operating loss was $234,000 in fiscal 2001, as
compared to a loss of $883,000 in fiscal 2000. Management believes that the
growth in check-related activities will continue to outpace the growth in the
bankcard processing activities.
During fiscal 2001, the Company fully integrated its check services, such as
check verification, check conversion, check guarantee, check re-presentment,
along with debit and credit card transactions through a VeriFone terminal
platform. This is one of the first terminal applications available in the market
today that includes check conversion and captures check images with a scanner.
Other. Other revenue increased from $204,000 in fiscal year 2000 to $400,000 in
fiscal 2001, an increase of 96.1% due to more billable software development
work.
19
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 2002, the Company had available cash of $2,409,000,
restricted cash of $906,000 in reserve with its primary processing banks and
working capital of $3,234,000.
Accounts receivable, net of allowance for doubtful accounts, decreased to
$1,744,000 at September 30, 2002 from $1,864,000 at the end of fiscal 2001.
Allowance for doubtful accounts, which reflects chargeback losses and dues to
Visa and MasterCard increased to $431,000 at the end of the fiscal 2002 from
$313,000 at September 30, 2001. This increase was attributable to the higher
processing volume in fiscal 2002.
Net cash provided by operating activities for the year ended September 30, 2002
was $62,000 as compared to net cash provided by operating activities of
$2,349,000 for fiscal 2001. The reduction in cash from operations was primarily
attributable to the net loss, including the $1,200,000 cash portion of legal
settlement expenses incurred during the quarter ended March 31, 2002.
During fiscal 2002, the Company used $1,754,000 for the purchase of equipment
and capitalized software costs. As of November 2002, the Company negotiated a
$500,000 lease line with a leasing company for the purpose of future computer
equipment purchases. The Company is also finalizing a $700,000 loan with its
primary sponsoring bank to fund the remaining scheduled payments of the Oasis
software in fiscal year 2003. Total net cash used in investing activities was
$1,835,000 for the current fiscal year as compared to $1,681,000 for fiscal year
2001.
In April 2002, the Company received $390,000 in proceeds from the sale and
leaseback of certain computer software and hardware purchased. The Company used
$215,000 for the repayment of capitalized leases in fiscal year 2002 as compared
to $47,000 in fiscal year 2001. This increase was due to the additional new
capitalized leases completed in the current fiscal year. Total net cash
provided by financing activities was $35,000 for the current fiscal year as
compared to net cash used by financing activities of $462,000 for fiscal year
2001.
At September, 2002, the Company 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 $2,859,000 $ 315,000 $ 565,000 $ 455,000 $1,524,000
Capital lease
obligations 914,000 377,000 537,000 -0- -0-
Operating leases 261,000 123,000 138,000 -0- -0-
---------- --------- ---------- --------- ----------
Total contractual
cash obligations $4,034,000 $ 815,000 $1,240,000 $ 455,000 $1,524,000
========== ========= ========== ========= ==========
The Company's primary source of liquidity is expected to be cash flow generated
from operations and cash and cash equivalents currently on hand. Management
believes that its cash flow from operations together with cash on hand will be
sufficient to meet its working capital and other commitments.
RISK FACTORS
The Company is subject to a number of risks, which could affect operating
results and liquidity, including, among others, the following:
DEPENDENCY ON BANK RELATIONSHIPS.
The Company currently relies on cooperative relationships with, and sponsorship
by, banks in order to process its Visa, MasterCard and other bankcard
transactions. The Company's 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 more attractive and the Company believes that it
cannot obtain similar relationships with larger banks at this time. A bank
could at any time curtail or place restrictions on the processing volume. A
bank might do this because of its internal business policies or due to other
adverse circumstances. If a volume restriction is placed on the Company, it
could materially adversely affect the business operations by restricting the
Company's ability to process credit card transactions and receive the related
20
revenue. The Company's relationships with its customers and merchants would
also be adversely affected by its inability to process these transactions. To
limit this problem, the Company currently maintains relationships with two
banks. However, the Company cannot assure that these banks will not restrict
its processing volume or that the Company will always be able to maintain its
present banking relationships or establish new banking relationships. Even if
new banking relationships are available, they may not be on terms acceptable to
the Company. The Company's failure to maintain these banking relationships and
sponsorships would have a material adverse effect on the business and results of
operations.
BUSINESS RELATIONSHIP WITH U-HAUL INTERNATIONAL.
The business relationship with U-Haul is important to the Company but due to the
growing merchant and check business and the full deployment to all U-Haul
dealers, U-Haul has gradually become a less significant customer over the years.
U-Haul accounted for approximately 6% of ECHO's revenue in 2002 and 8% of the
revenue in 2001. The Company believes it has a good relationship with U-Haul
and that its services are highly valued by U-Haul and its dealers, however,
there can be no assurance that the Company will be able to maintain the business
relationship with U-Haul, or that sales to U-Haul will continue at the same
levels as previous years. Losing U-Haul as a customer still could have a
significant impact to the Company.
BANKCARD FRAUD.
The Company significantly relies on the processing of bankcard transactions. If
any merchants were to submit or process unauthorized or fraudulent bankcard
transactions, depending on the dollar amount, ECHO could incur significant
losses which could have a material adverse effect on the business and results of
operations. These types of losses are handled by the sponsoring banks as
follows:
- First Regional Bank - ECHO assumes and compensates the bank for
bearing the risk of these types of losses.
- The Berkshire Bank - ECHO assumes and compensates the bank for bearing
the risk of these types of losses.
The Company has implemented systems and software for the electronic surveillance
and monitoring of fraudulent bankcard use. The Company also maintains a
dedicated reserve of $533,000 at its primary bank specifically earmarked for
such activity. Despite a long history of managing such risk, the Company 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. The
Company does not have insurance to protect it from these losses, but the Company
does allocate ten basis points (.001) of daily processing activity as a reserve
against these types of losses. There is no assurance that this reserve will be
adequate to offset against any unauthorized or fraudulent processing losses that
the Company may incur. Depending on the size of such losses the Company's
results of operations could be immediately and materially adversely affected.
DEPENDENCE ON KEY EMPLOYEES.
The Company's success has been and will continue to be dependent on the services
of key technical and managerial personnel such as Joel M. Barry, our chairman of
the board and chief executive officer. The loss of Mr. Barry could have a
materially adverse impact on the Company's business. The Company believes that
its success also depends on its ability to continue to be able to attract,
retain and motivate highly skilled technical and management employees and
consultants who are in great demand. There can be no assurance that the Company
will be able to attract and retain such employees and its failure to do so could
adversely affect its business.
RISK OF NOT REMAINING LISTED ON NASDAQ.
The Company is currently listed on the Nasdaq SmallCap market. There is no
assurance that the listing of the Company's common stock will, in the future,
always continue to satisfy the Nasdaq listing requirements. If the Company was
delisted from Nasdaq, this would have a material adverse effect on the price and
the liquidity of the Company's common stock.
COMPETITION.
The Company is in the business of processing transactions and designing and
implementing integrated systems for its customers so that they can better use
ECHO's services. This business is highly competitive and is characterized by
rapid technological change, rapid rates of product obsolescence, and rapid rates
21
of new products introduction. The Company's market share is relatively small as
compared to most of its competitors and most of these competitors have
substantially more financial and marketing resources to run their businesses.
This enables the Company's competitors to quickly respond to new and emerging
technologies, changes in customers needs, and to devote more resources to
product and services development and marketing. The Company may face increased
competition in the future and there is no assurance that current or new
competition will allow the Company to keep its customers. If the Company loses
customers, its business operations may be materially adversely affected, which
could cause it to cease its business or curtail its business to a point where
the Company is no longer able to generate sufficient revenues to fund
operations. There is no assurance that the Company's current products and
services will stay competitive with those of the Company's competitors or that
the Company will be able to introduce new products and services to compete
successfully in the future.
RAPID TECHNOLOGY CHANGES.
The Company's business industry involves rapidly changing technology. Recently,
the Company has observed rapid changes in technology as evident 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. The Company's success depends on its
ability to improve its 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 the Company. There is no assurance that the
Company will be able to find the funds necessary to keep up with new technology
or that if such funds are available that the Company can successfully improve
its existing products and services or successfully develop new products and
services. The Company's failure to provide improved products and services to
its customers or any delay in providing such products and services could cause
it to lose customers to its competitors. Loss of customers could have a
material adverse effect on ECHO.
DEPENDENCE ON TECHNOLOGY AND RELATED PATENTS.
The Company currently owns three patents that relate to unique aspects of its
products or services. Even though the Company has these patents, there can be
no assurance the Company's competitors will not be able to develop a better
product or a better way of providing the Company's services to its current or
potential new customers. The Company's patents have not been tested in the
courts so the Company is unable to determine if they will be sustained in the
Company's favor. If ECHO's patents are not sustained in its favor, the
Company's competitors could determine its business methods and then develop and
market competing products and services. Such an outcome could cause the Company
to lose customers, which could materially adversely affect its results of
operations. The Company has expended considerable time and money in the
development of ideas and seeking patent protection for them. If the Company
seeks additional patents in the future, or if the Company is required to
prosecute or defend its patents, the expenses associated with such
patent-related activities could be substantial and could have a material adverse
effect on the results of operations.
CERTAIN OF THE COMPANY'S INTELLECTUAL PROPERTY IS NOT PROTECTED.
The Company has expended a considerable amount of time and money to develop
information systems for its merchants. The Company has not obtained any
intellectual property protection or other protection on these information
systems. The Company also believes that these information systems do not
infringe upon the rights of any third parties, however, there is no assurance
that third parties will not bring infringement claims against the Company. The
Company also has the right to use certain technology of others through various
license agreements. If a third party claimed these licenses were infringing
their technology, the Company could face additional infringement claims and
potential negative results. If an infringement claim is brought against the
Company and the Company loses, it could be required to stop using that type of
product, system or service as well as pay monetary damages to the person or
entity making the claim. This result could materially adversely affect results
of operations and manner in which the Company could do business. If the Company
was not able to implement another method its business could fail. If the
Company is required to continuously defend infringement claims, the costs and
expenses associated with such a defense could be very expensive to the Company
and could materially adversely affect the results of operations.
INVESTMENT IN RESEARCH AND DEVELOPMENT.
The Company continues to enter into projects, which it believes will assist the
Company in its efforts to stay competitive. Although the Company believes that
its investment in these projects will ultimately increase earnings, there is no
assurance as to when or if these new products will show profitability.
22
NEED FOR ADDITIONAL FUNDS.
The Company uses funds generated from operations to finance its operations. The
Company currently believes that the cash flow from operations is sufficient to
support its business activities, including research, development and marketing
costs. Future growth will depend on the Company's ability to raise additional
funds, either through operations, bank borrowings, or equity or debt financings.
There is no assurance that the Company will be able 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. The inability to generate the necessary funds from operations or
from third parties could force the Company to cut back its operations by
limiting research, development and growth opportunities, which could have a
material adverse effect on ECHO.
UNDERWRITER/MARKET MAKER.
Trading markets for ECHO's common stock is maintained on Nasdaq by various
broker/dealers who are members of the National Association of Securities
Dealers. None of the market makers are under any legal obligation to maintain a
market in the Company's common stock and may discontinue such activities at any
time. If these market makers choose not to maintain a market in the Company's
common stock, such a discontinuance could have a material adverse effect on the
price and liquidity of the Company's common stock.
LACK OF INSURANCE PROTECTION FOR THE COMPANY'S PRODUCTS AND SERVICES.
The Company does not have insurance protection against claims for product
liability or errors and omissions for the products and services sold by the
Company. If claims are brought by the Company's customers or other third
parties, the Company could be required to pay the required claim or make
significant expenditures to defend against such claims. There is no assurance
that the Company will have the money to pay such claims if they arise. If the
Company does have the money to pay the claims, such a payment could have a
material adverse effect upon on the Company.
COST OF DEFENDING LAWSUITS.
The Company is involved in various lawsuits arising in the ordinary course of
business. Although the Company believes that the claims asserted in such
lawsuits are without merit, the cost to the Company for the fees and expenses to
defend such lawsuits could have a material adverse effect on the Company's
financial condition, results of operations or cash flow. In addition, there can
be no assurance that the Company will not at some time in the future experience
significant liability in connection with such claims.
U-HAUL RELATIONSHIP.
The Company provides processing services to U-Haul International by acting as
the central processor of U-Haul dealer rental activity and reservations. During
2002, U-Haul's ability to reach financing arrangements with its lenders was
delayed and presents a potential risk to ECHO should U-Haul be unable to secure
adequate financing agreements in the future. The primary risk to the Company in
the event of a U-Haul bankruptcy announcement is believed to be timely payment
of its outstanding invoices at the time of declaration. The Company believes
any on-going payment under a bankruptcy action would be reasonable to expect due
to the critical nature of the Company's service to U-Haul and its dealers. The
Company is working closely with U-Haul to keep its current invoices paid and
does not expect any significant issue to arise but no assurance can be given
that a U-Haul declaration of bankruptcy would not have a material effect on the
Company.
HANDLING SIGNIFICANTLY INCREASED VOLUME.
The Company has built transaction processing systems for check verification,
check conversion, ACH processing, and bankcard processing activity. While
current estimates regarding increased volume are within the throughput
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 is in the process of redesigning and upgrading its
check related processing systems and ECHO has purchased a state-of-the-art
system to process bank card activity that should be operational by the end of
2003. No assurance can be given that the current systems would be able to handle
a significant increase in volume or that the operational enhancements and
improvements will be completed in such time to avoid such a situation.
23
RECOVERING FROM NATURAL DISASTER.
The Company maintains three data center operations, one in Agoura Hills,
California, one in Albuquerque, New Mexico and one in Boulder, Colorado. Should
a natural disaster occur in one of the locations, it is possible that ECHO would
not be able to fully recover full functionality at one of its data center
locations. To minimize this risk, ECHO is moving its data processing
functionality from Boulder to Albuquerque in 2003 and will be making its Agoura
Hills and Albuquerque operations fully redundant to each other by the end of
2003. Prior to that time, it is possible a natural disaster could limit or
completely terminate a specific service offered by ECHO until such time that the
specific location could resume its functionality.
FINANCIAL RISK FROM CHECK GUARANTEE.
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 its check guarantee activity. While ECHO has
provided check guarantee services for several years, there can be no assurance
that its 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 it offers guarantee services to in order to minimize this risk but no
assurance can be given that such measures will be adequate.
SECURITY BREACH.
The Company processes confidential financial information and maintains several
levels of security to protect this data. Security includes hand and card-based
identification systems at its 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 certain breaches could be significant
and dramatic to ECHO's continued operations. ECHO has undertaken a SAS70 audit
to continue to identify security issues and enhance their detection and defenses
therefrom, however, no assurance can be given that ECHO's efforts in this regard
will always prove to be adequate or successful.
COST OF TECHNICAL COMPLIANCE.
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 ACH and check related
issues, and various banking requirements and regulations. ECHO has personnel
dedicated to monitoring the Company's 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 Oasis assumes much of the
compliance obligation relative to Visa and MasterCard issues. As the compliance
issues become more defined in each industry, the cost associated thereto 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, it has 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 it competes.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is currently not exposed to any significant financial market risks
from changes in foreign currency exchange rates or changes in interest rates and
does not use derivative financial instruments. All of our revenue and capital
spending is transacted in U.S. dollars. However, in the future, the Company 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
24
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The officers and directors of the Company are:
Date first became
Name Position Officer or Director
- -------------------------------- ------------------------- -------------------
Joel M. Barry [2] Chairman of the Board, 1986
Chief Executive Officer,
Alice L. Cheung Chief Financial Officer, 1996
Treasurer
Jesse Fong Vice President, 1994
Information Systems
David Griffin Vice President, 1990
Check Guarantee
Alex Seltzer Chief Operating Officer/ 2002
Chief Information Officer
Rick Slater Vice President, Chief 1998
Technology Officer
Patricia M. Williams Vice President, 1997
Check Services
Jack Wilson Vice President, 1994
Merchant Services
Donna L. Rehman Corporate Secretary 1990
R. Marshall Frost Counsel 1994
Aristides W. Georgantas[1][2][3] Director 1999
Carl R. Terzian[1][2][3] Director 2002
Herbert L. Lucas [1][2][3] Director 1991
- ---------------------------------------------------------
[1] Member, Audit Committee
[2] Member, Nominating Committee
[3] Member, Executive Compensation Committee
25
JOEL M. BARRY, age 52, has been a Director of the Company 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 the
Company. Mr. Barry is 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 45, 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 the Company, 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.
JESSE FONG, age 51, has served as Vice President of Information Systems since
September 1994. Mr. Fong joined the Company 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 54, has served as Vice President of Check Guarantee since
October 2001. Previous to this capacity, he was Vice President of Check Services
for the Company 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
the Company. 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.
ALEX SELTZER, age 50, joined the Company in August 2002 as Chief Operating
Officer and Chief Information Officer. Prior to joining the Company, 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.
In addition to his extensive experience in designing and implementing online
financial and payment services, Mr. Seltzer excels at motivating and directing
teams, clients and organizations. 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.
RICK SLATER, age 42, joined the Company 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 the Company, 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. While a group
leader at Aiken Advanced Systems, Mr. Slater held a TS/SCI security clearance
and developed numerous military signal collection systems installed throughout
the world. Mr. Slater holds a BS degree in electrical engineering technology
from Old Dominion University, Norfolk, Virginia.
PATRICIA M. WILLIAMS, age 37, joined the Company 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. 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.
26
JACK WILSON, age 58, has served as Vice President of Merchant Services since
June 1994 and was Director of Bankcard Relations for the Company 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.
DONNA L. REHMAN, age 53, joined the Company 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.
R. MARSHALL FROST, age 55, has served the Company in varying capacities since
1987 and is currently In-House Counsel. Mr. Frost received his BA degree in
business administration with emphasis in accounting from California State
University at Fullerton, his AA degree in pre-med from Fullerton College, his JD
degree from Ventura College of Law, and his MBA degree from the University of
Redlands. Mr. Frost is an active member of the California Bar and a certified
broker with the California Department of Real Estate.
ARISTIDES W. GEORGANTAS, age 58, 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 Trust Company, the Foundation for Public Broadcasting
in New Jersey, and Mathematica Policy Research, Inc. Mr. Georgantas is a
graduate of the University of Massachusetts and the Columbia University Graduate
School of Business.
HERBERT L. LUCAS, age 76, 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., Nutraceutix, 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, and Winrock International
Institute for Agricultural Research and Development. He was formerly a member
of the Board of Trustees of Princeton University.
CARL R. TERZIAN, age 67, 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.
All directors are to be elected to specific terms, from one year to three years,
by the stockholders and serve until the next annual meeting or until their terms
have expired. The Annual Meeting of Stockholders was held on February 2, 2001,
and the election of directors was held at that time.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires the
Company's directors and executive officers and the holders of 10% or more of the
Company's Common Stock to file with the Securities and Exchange Commission
initial reports of ownership and reports of changes in ownership of equity
securities of the Company. To the Company's knowledge, based upon the fact that
there have been no 13D's or 13G's filed, no individual has beneficial ownership
or control over 5% or more of the Company's outstanding Common Stock. Based
upon a review of Forms 3 and 4, the Company believes that all reports required
pursuant to Section 16(a) with respect to the 2002 fiscal year were timely
filed.
27
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth the total compensation paid and stock options
offered by the Company to its Chief Executive Officer and to each of its most
highly compensated executive officers, other than the Chief Executive Officer,
whose compensation exceeded $100,000 during the fiscal years ended September 30,
2002, 2001 and 2000.
SUMMARY COMPENSATION TABLE
Annual Long Term
Compensation Compensation
------------------- ------------
Securities
Capacities in Underlying
Name Which Served Year Salary[1] Bonus Options[2] Other[3]
- -------------------- ----------------- ---- ---------- ------- ----------- --------
Joel M. Barry Chairman/Chief 2002 $ 209,000 $ -0- 50,000 -0-
Executive Officer 2001 203,000 25,000 12,500 -0-
2000 190,000 50,000 12,500 -0-
Alice L. Cheung Chief Financial 2002 $ 110,500 $11,500 5,000 3,450
Officer/Treasurer 2001 104,750 10,000 5,000 2,600
2000 99,500 14,250 2,500 2,450
Rick Slater Vice President, 2002 $ 119,000 $ 5,000 5,000 1,450
Chief Technology 2001 117,850 7,000 2,500 600
Officer 2000 113,300 13,200 5,000 550
Jack Wilson Vice President, 2002 $ 103,750 $16,500 5,000 2,250
Merchant Services 2001 91,250 10,000 7,500 2,600
2000 83,750 9,600 5,000 2,650
Patricia M. Williams Vice President, 2002 $ 103,750 $16,500 10,000 3,000
Check Services 2001 96,500 10,000 10,000 2,400
2000 84,500 12,000 5,000 2,100
- ------------------------------
[1] The Company provides Mr. Barry and Mr. Wilson with an automobile. There has
been no compensation paid other than that indicated in the above table.
[2] None of these options have been exercised (see "Stock Option Plan").
[3] Represents the Company's match of contributions to the Company's 401(k)
plan. The Company contributes 25% of each employee's contribution to the
401(k) plan.
28
FISCAL 2002 OPTION GRANTS TABLE
The following table sets forth the stock options granted to the Company's Chief
Executive Officer and each of its executive officers, other than the Chief
Executive Officer, whose compensation exceeded $100,000 during fiscal 2002.
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. The Company has 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 the Company's
stock at a future date, which may or may not correspond to projections below.
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 50,000 37.88% $ 2.15 12/27/11 $ 29,500 $ 65,500
Alice L. Cheung 5,000 3.79% $ 2.15 12/27/11 $ 2,950 $ 6,550
Rick Slater 5,000 3.79% $ 2.15 12/27/11 $ 2,950 $ 6,550
Jack Wilson 5,000 3.79% $ 2.15 12/27/11 $ 2,950 $ 6,550
Patricia M. Williams 10,000 7.58% $ 2.15 12/27/11 $ 5,900 $ 13,100
- ------------------------------
[1] All options vest in five equal annual installments beginning 12 months following the
date of the grant.
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, 2002 by each of the Company's
Named Executive Officers and the number and value of unexercised options held by
each of the Company's Named Executive Officers as of the fiscal year ended
September 30, 2002.
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 -0- $ -0- 215,000 $ -0-
Alice L. Cheung -0- $ -0- 50,000 $ -0-
Rick Slater 5,500 $ 660 57,500 $ -0-
Jack Wilson -0- $ -0- 37,500 $ -0-
Patricia M. Williams -0- $ -0- 45,000 $ -0-
- ---------------------
[1] Based on the closing sales price of the Common Stock on September 30, 2002
of $1.20 per share, less the option exercise price.
29
EQUITY COMPENSATION PLAN INFORMATION
The following table sets forth information concerning the equity compensation
plans of the Company as of September 30, 2002.
(a) Number of (c) Number of securities
securities to be remaining available for
issued upon (b) Weighted-average future issuance under
exercise of exercise price of equity compensation
outstanding options outstanding options (excluding securities
Plan Category warrants and rights warrants and rights reflected in column (a))
- --------------------- ------------------- -------------------- ------------------------
Equity compensation
plans approved by
security holders[1] 636,750 $ 3.80 -0-
Equity compensation
plans not approved by
security holders[2] 25,834 $ 2.00 -0-
Total 662,584 $ 3.73 -0-
- ----------------------------------
[1] Plan represents the 1992 Incentive Stock Option Plan, which expired in May
2002, and no further awards will be made under the plan.
[2] Shares issuable upon exercise of an option issued to a former executive
officer pursuant to an employment agreement approved by the Board of
Directors on September 13, 1994. The option has a term of five years from
the date of the grant.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
No interlocking relationship exists between the Company's 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 $15,000 and 6,912 shares of Common Stock in
fiscal 2002; $15,000 and 3,750 shares of Common Stock in fiscal 2001; and
$15,000 and 1,465 shares of Common Stock in fiscal 2000. Directors are
compensated for all reasonable expenses and are not compensated for special
meetings other than regular meetings.
EMPLOYMENT AGREEMENTS
None.
BONUS, PROFIT-SHARING AND OTHER REMUNERATION PLANS AND PENSION AND RETIREMENT
PLANS
The Company has established a bonus program to reward extraordinary performance
that exceeds pre-set goals established for executive officers and key personnel.
The Company believes that such a bonus program provides the incentive to exceed
such goals, thereby building shareholder value.
The Company has a contributory 401(K) Retirement Pension Plan, which covers all
employees who are qualified under the plan provisions.
30
STOCK OPTION PLAN
On May 13, 1992, the Company's Board of Directors authorized adoption of an
Officers and Key Employees Incentive Stock Option Plan ("Plan"), ratified by the
shareholders at the Annual Meeting held July 10, 1992. The Plan provided for
the issuance of up to 81,250 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, the Company's Board of Directors authorized an increase in
the Plan to 843,750 options and was ratified by the shareholders at the Annual
Meeting held in February 1997.
On February 4, 1999, the Company's Board of Directors authorized an increase in
the Plan to 1,343,750 options and was ratified by the shareholders at the Annual
Meeting held in February 1999.
On May 13, 2002, the 1992 Incentive Stock Option Plan expired. The 2003
Incentive Stock Option Plan has been approved by the Board of Directors of the
Company and has been offered to the shareholders of the Company for approval at
the Annual Meeting of Shareholders on February 3, 2003.
With the exception of the foregoing, the Company has no stock option plans or
other similar or related plans in which any of its officers or directors
participate.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
As of November 15, 2002, there were 5,796,062 shares of the Company's Common
Stock outstanding. To the Company's knowledge, based upon the fact that there
have been no 13D's or 13G's filed, no individual has beneficial ownership or
control over 5% or more of the Company's outstanding Common Stock.
The following table sets forth the number of shares of Common Stock owned
beneficially by the Company's executive officers and directors as of November
15, 2002. 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 11/15/02
--------------------------- -------------------- ---------------------
Joel M. Barry 259,612[2] 4.30%
28001 Dorothy Drive
Agoura Hills, CA 91301
Alice L. Cheung 54,500[2] 0.93%
28001 Dorothy Drive
Agoura Hills, CA 91301
Rick Slater 58,000[2] 0.98%
28001 Dorothy Drive
Agoura Hills, CA 91301
Patricia M. Williams 45,675[2] 0.78%
28001 Dorothy Drive
Agoura Hills, CA 91301
Jack Wilson 42,075[2][4] 0.72%
28001 Dorothy Drive
Agoura Hills, CA 91301
31
Aristides W. Georgantas 13,490 0.23%
180 Springdale Road
Princeton, NJ 08540
Herbert L. Lucas, Jr. 54,849 [3] 0.94%
12011 San Vicente Blvd.
Los Angeles, CA 90049
Carl R. Terzian -0- 0.00%
12400 Wilshire Blvd.
Los Angeles, CA 90025
All officers and directors
as a group (13 persons) 595,915 9.45%
- ------------------------------
[1] Outstanding Common Shares with effect given to individual shareholder's
exercise of stock options described in footnotes 2 through 4.
[2] Includes stock options according to the terms of the 1992 Incentive Stock
Option Plan, which for the following number of shares for the following
individuals could be acquired within 60 days through the exercise of stock
options: Joel M. Barry, 135,000 shares; Alice Cheung, 40,000 shares; Rick
Slater, 48,000 shares; Patricia Williams, 21,000 shares; and Jack Wilson,
25,000 shares. See "Item 11. Executive Compensation".
[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.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
There were no related-party transactions.
ITEM 14. CONTROLS AND PROCEDURES.
Within the 90 days prior to the date of 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
Rule 13a-14. Based upon that evaluation, our Chief Executive Officer and our
Chief Financial Officer have concluded that our disclosure controls and
procedures are effective in timely alerting them to material information
relating to us (including our consolidated subsidiaries) required to be included
in our periodic SEC filings. There have been no significant changes in our
internal controls or in other factors that could significantly affect internal
controls subsequent to the date of their evaluation.
32
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 Accountants. . . . . . . . . . . . . . . . . F-1
Consolidated Balance Sheet at September 30, 2002 and 2001. . . . . F-2
Consolidated Statement of Operations for each of the three years
in the period ended September 30, 2002 . . . . . . . . . . . . . . F-3
Consolidated Statement of Changes in Stockholders' Equity
for each of the three years in the period ended September 30, 2002 F-4
Consolidated Statement of Cash Flows for each of the three years
in the period ended September 30, 2002 . . . . . . . . . . . . . . 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 ending September 30, 2002:
None
(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]
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]
33
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.
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.
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.
21.0 Subsidiaries of Registrant. [2]
99.1 Certification of Joel M. Barry pursuant to 18 U.S.C. Section
1350, as adopted pursuant to section 906 of the Sarbanes-Oxley
Act of 2002.
99.2 Certification of Alice Cheung pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to section 906 of the Sarbanes-Oxley Act of
2002.
_________________________________
[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.
34
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
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 23, 2002
- --------------------------- 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\ Alice L. Cheung Chief Financial Officer )
- --------------------------- and Treasurer )
Alice L. Cheung )
)
)
)
\s\ Marjan Hewson Controller )
- --------------------------- )
Marjan Hewson )
35
Form of Certification for Form 10-K
I, Joel M. Barry, certify that:
1. I have reviewed this annual report on Form 10-K of Electronic Clearing
House, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: December 23, 2002
\s\ Joel M. Barry
------------------------------------
Chairman, Chief Executive Officer
Form of Certification for Form 10-K
I, Alice L. Cheung, certify that:
1. I have reviewed this annual report on Form 10-K of Electronic Clearing
House, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: December 23, 2002
\s\ Alice L. Cheung
----------------------------
Chief Financial Officer
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
and Stockholders of
Electronic Clearing House, Inc.:
In our opinion, the consolidated financial statements listed in the index
appearing under Item 15(a)(1) on page 33 present fairly, in all material
respects, the financial position of Electronic Clearing House, Inc. and its
subsidiaries at September 30, 2002 and 2001, and the results of their operations
and their cash flows for each of the three years in the period ended September
30, 2002 in conformity with accounting principles generally accepted in the
United States of America. In addition, in our opinion, the financial statement
schedules listed in the index appearing under Item 15(a)(2) on page 33 present
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 auditing standards
generally accepted in the United States of America, which 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.
\S\ PRICEWATERHOUSECOOPERS LLP
Los Angeles
December 2, 2002
F1
ELECTRONIC CLEARING HOUSE, INC.
CONSOLIDATED BALANCE SHEETS
---------------------------
September 30,
--------------------------
2002 2001
------------ ------------
ASSETS
------
Current assets:
Cash and cash equivalents $ 2,409,000 $ 4,147,000
Restricted cash 906,000 1,410,000
Accounts receivable less allowance of $431,000 and $313,000 1,744,000 1,864,000
Inventory 234,000 573,000
Prepaid expenses and other assets 169,000 137,000
Deferred tax asset 266,000 128,000
------------ ------------
Total current assets 5,728,000 8,259,000
Noncurrent assets:
Property and equipment, net 5,101,000 3,754,000
Deferred tax asset 2,018,000 650,000
Other assets less accumulated amortization of $259,000 and $212,000 637,000 1,073,000
Goodwill, net 4,707,000 5,185,000
------------ ------------
Total assets $18,191,000 $18,921,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current liabilities:
Short-term borrowings and current portion of
long-term debt $ 515,000 $ 240,000
Accounts payable 201,000 135,000
Settlement payable to merchants 729,000 618,000
Accrued expenses 987,000 1,395,000
Deferred income 62,000 50,000
------------ ------------
Total current liabilities 2,494,000 2,438,000
Long-term debt 2,159,000 744,000
------------ ------------
Total liabilities 4,653,000 3,182,000
------------ ------------
Commitments and contingencies
Stockholders' equity:
Convertible preferred stock, $.01 par value, 5,000,000 shares authorized
Series "K", -0- and 25,000 shares issued and outstanding, -0- -0-
Common stock, $.01 par value, 36,000,000 shares authorized;
5,835,331 and 5,809,121 shares issued; 5,796,062 and 5,769,873
shares outstanding 58,000 58,000
Additional paid-in capital 21,435,000 21,260,000
Accumulated deficit (7,486,000) (5,110,000)
Less treasury stock at cost, 39,269 and 39,269 common shares (469,000) (469,000)
------------ ------------
Total stockholders' equity 13,538,000 15,739,000
------------ ------------
Total liabilities and stockholders' equity $18,191,000 $18,921,000
============ ============
See accompanying notes to consolidated financial statements.
F2
ELECTRONIC CLEARING HOUSE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
-------------------------------------
Year ended September 30,
----------------------------------------
2002 2001 2000
------------ ------------ ------------
REVENUES:
Processing revenue $16,363,000 $14,719,000 $14,917,000
Transaction revenue 16,526,000 14,377,000 10,760,000
Terminal sales 252,000 447,000 2,459,000
Other revenue 150,000 400,000 204,000
------------ ------------ ------------
33,291,000 29,943,000 28,340,000
------------ ------------ ------------
COSTS AND EXPENSES:
Processing and transaction expense 22,747,000 19,239,000 18,128,000
Cost of terminals sold 588,000 419,000 1,790,000
Other operating costs 2,424,000 2,468,000 2,161,000
Research and development expense 1,719,000 1,070,000 1,070,000
Selling, general and administrative expenses 6,493,000 5,760,000 4,816,000
Amortization expense - goodwill 489,000 424,000 359,000
Legal settlement 2,500,000 -0- -0-
------------ ------------ ------------
36,960,000 29,380,000 28,324,000
------------ ------------ ------------
(Loss) income from operations (3,669,000) 563,000 16,000
Interest income 55,000 187,000 284,000
Interest expense (129,000) (81,000) (88,000)
Gain on sale of asset -0- 350,000 312,000
------------ ------------ ------------
(Loss) income before benefit (provision) for income taxes (3,743,000) 1,019,000 524,000
Benefit (provision) for income taxes 1,367,000 (585,000) (233,000)
------------ ------------ ------------
Net (loss) income $(2,376,000) $ 434,000 $ 291,000
============ ============ ============
(Loss) earnings per share - Basic $ (0.41) $ 0.07 $ 0.06
============ ============ ============
(Loss) earnings per share - Diluted $ (0.41) $ 0.07 $ 0.05
============ ============ ============
Shares used in computing basic
(loss) earnings per share 5,788,071 5,797,120 5,257,393
============ ============ ============
Shares used in computing diluted
(loss) earnings per share 5,788,071 5,963,808 5,825,097
============ ============ ============
See accompanying notes to consolidated financial statements.
F3
ELECTRONIC CLEARING HOUSE, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
----------------------------------------------------------
Stock Additional
--------------------------------- Paid-in Treasury Accumulated
Treasury Common Preferred Amount Capital Stock Deficit
--------- ---------- ---------- ---------- ------------ ---------- ------------
Balance at September 30, 1999 21,478 4,968,532 65,000 $ 50,000 $17,107,000 $(138,000) $(5,835,000)
Exercise of warrants 87,500 1,000 139,000
Exercise of stock options 116,583 1,000 248,000
Conversion of preferred to common 40,000 (40,000)
Issuance of common stock to
outside directors 4,394 45,000
Issuance of common stock - acquisition 255,000 3,000 3,099,000
Purchase of treasury stock 17,797 (331,000)
Net income 291,000
--------- ---------- ---------- ---------- ------------ ---------- ------------
Balance at September 30, 2000 39,275 5,472,009 25,000 55,000 20,638,000 (469,000) (5,544,000)
Exercise of stock options 15,000 47,000
Issuance of common stock to
outside directors 11,250 45,000
Issuance of common stock - acquisition 21,166 85,000
Issuance of performance stock 375,000 4,000 776,000
Issuance of treasury stock (6)
Exchange of stock for note receivable (85,304) (1,000) (331,000)
Net income 434,000
--------- ---------- ---------- ---------- ------------ ---------- ------------
Balance at September 30, 2001 39,269 5,809,121 25,000 58,000 21,260,000 (469,000) (5,110,000)
Exercise of stock options 5,500 11,000
Issuance of common stock to
outside directors 20,736 45,000
Conversion of preferred to common 25,000 (25,000)
Exchange of stock for note receivable (25,000) (54,000)
Tax benefit from exercise of stock options 173,000
Net loss (2,376,000)
--------- ---------- ---------- ---------- ------------ ---------- ------------
Balance at September 30, 2002 39,269 5,835,357 -0- $ 58,000 $21,435,000 $(469,000) $(7,486,000)
========= ========== ========== ========== ============ ========== ============
Total
------------
Balance at September 30, 1999 $11,184,000
Exercise of warrants 140,000
Exercise of stock options 249,000
Conversion of preferred to common -0-
Issuance of common stock to
outside directors 45,000
Issuance of common stock - acquisition 3,102,000
Purchase of treasury stock (331,000)
Net income 291,000
------------
Balance at September 30, 2000 14,680,000
Exercise of stock options 47,000
Issuance of common stock to
outside directors 45,000
Issuance of common stock - acquisition 85,000
Issuance of performance stock 780,000
Issuance of treasury stock 0
Exchange of stock for note receivable (332,000)
Net income 434,000
------------
Balance at September 30, 2001 15,739,000
Exercise of stock options 11,000
Issuance of common stock to
outside directors 45,000
Conversion of preferred to common
Exchange of stock for note receivable (54,000)
Tax benefit from exercise of stock options 173,000
Net loss (2,376,000)
------------
Balance at September 30, 2002 $13,538,000
============
See accompanying notes to consolidated financial statements.
F4
ELECTRONIC CLEARING HOUSE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
Year ended September 30,
----------------------------------------
2002 2001 2000
------------ ------------ ------------
Cash flows from operating activities:
Net (loss) income $(2,376,000) 434,000 291,000
Adjustments to reconcile net (loss) income to net cash
provided by operating activities:
Depreciation 640,000 488,000 325,000
Amortization of software 537,000 433,000 233,000
Amortization of goodwill 489,000 414,000 352,000
Provisions for losses on accounts and notes receivable 302,000 326,000 586,000
Provision for obsolete inventory 300,000 -0- -0-
Write-down of real estate 100,000 -0- -0-
Fair value of stock issued in connection
with director's compensation 45,000 45,000 45,000
Deferred income taxes (1,375,000) 436,000 178,000
Legal settlement 1,300,000 -0- -0-
Gain on sale of asset -0- (350,000) (312,000)
Changes in assets and liabilities, net of effects of acquisitions:
Restricted cash 504,000 (393,000) (281,000)
Accounts receivable (268,000) (307,000) (824,000)
Inventory 39,000 21,000 (14,000)
Accounts payable 66,000 15,000 (53,000)
Settlement payable to merchants 111,000 448,000 170,000
Accrued expenses (376,000) 349,000 128,000
Other receivable 24,000 (10,000) (36,000)
------------ ------------ ------------
Net cash provided by operating activities 62,000 2,349,000 788,000
------------ ------------ ------------
Cash flows from investing activities:
Other assets (81,000) (458,000) (139,000)
Purchase of equipment and software (1,754,000) (1,404,000) (1,246,000)
Increase in notes receivable -0- -0- (1,027,000)
Repayment of notes receivable -0- -0- 1,000,000
Proceeds from sale of asset -0- 350,000 1,000,000
Cash (used) acquired in acquisition -0- (169,000) 80,000
------------ ------------ ------------
Net cash used in investing activities (1,835,000) (1,681,000) (332,000)
------------ ------------ ------------
Cash flows from financing activities:
Proceeds from issuance of notes payable -0- -0- 400,000
Repayment of notes payable (151,000) (130,000) (156,000)
Repayment of capitalized leases (215,000) (47,000) (48,000)
Proceeds from sales and leaseback of equipment 390,000 -0- -0-
Proceeds from common stock warrants exercised -0- -0- 140,000
Proceeds from exercise of stock options 11,000 47,000 249,000
Repurchase of stock -0- (332,000) -0-
------------ ------------ ------------
Net cash provided by (used in) financing activities 35,000 (462,000) 585,000
------------ ------------ ------------
Net (decrease) increase in cash (1,738,000) 206,000 1,041,000
Cash and cash equivalents at beginning of period 4,147,000 3,941,000 2,900,000
------------ ------------ ------------
Cash and cash equivalents at end of period $ 2,409,000 $ 4,147,000 $ 3,941,000
============ ============ ============
See accompanying notes to consolidated financial statements.
F5
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 bank card authorizations, electronic deposit services,
check guarantee, check verification, check conversion, check collection,
inventory tracking services and various Internet services to retail and
wholesale merchants, and U-Haul dealers across the nation. In addition, the
Company sells electronic terminals for use by its customers and other processing
companies.
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.
Accounts Receivable Chargeback
- --------------------------------
Accounts receivable 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. A reserve is
estimated based upon a historically-determined percentage of gross credit card
processing volume and actual losses experienced.
Inventory
- ---------
Inventory is stated at the lower of cost or market, cost being determined on the
first-in, first-out method. Inventory consists of terminals and printers held
for sale or lease and related component parts.
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:
F6
Note 1: (Continued)
- -------
Building 39 years
Computer equipment and software 3-5 years
Furniture, fixtures and equipment 5 years
Building improvements 10 years
Other Assets
- -------------
Other Assets consist primarily of patents, trademarks and deposits. Costs
related to obtaining a patent and trademark are capitalized and amortized over
the estimated life of the patent and trademark.
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. 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 and is being
amortized on a straight-line basis over estimated useful lives of 10 years and
15 years, respectively. 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. In
addition, the standard includes provisions for the reclassification of certain
existing recognized intangibles as goodwill, reassessment of the useful lives of
existing recognized intangibles, reclassification of certain intangibles out of
previously reported goodwill and the identification of reporting units for
purposes of assessing potential future impairments of goodwill. SFAS 142 also
requires companies to complete a transitional goodwill impairment test six
months from the date of adoption. The Company plans to adopt SFAS 142 by the
first quarter of fiscal 2003. The Company is required to adopt these statements
effective the first quarter of fiscal 2003. The Company has completed the Step
1 - goodwill impairment test, as prescribed by SFAS 142, utilizing discounted
cash flow analysis for the check services reporting unit that has goodwill. The
results of this analysis indicate potential goodwill impairment for this
reporting unit. The Company has begun, but not completed, Step 2 - measurement
of the impairment loss, by evaluating the fair value of the check services
business segment through discounted cash flow models and other analytical means.
The Company expects to record any impairment loss as a cumulative effect of a
change in accounting principle in the first quarter of 2003.
Long-Lived Assets
- ------------------
When circumstance indicates, 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, 2002 and 2001.
Revenues and Expenses
- -----------------------
All processing and transaction revenues are recognized at the time the
transactions are processed by the merchant. Processing costs paid to banks are
included in costs and expenses when incurred. Terminal sales are recorded when
product is shipped and title transferred to the customer. Other revenues are
recognized when services are considered complete and no further obligations are
required.
F7
Note 1: (Continued)
- -------
The Company expensed $261,000, $272,000, and $528,000 for the years ended
September 30, 2002, 2001 and 2000, respectively for bankcard processing
chargeback losses. The Company provided for other uncollectible leases and
notes receivable balances of $13,000, $7,700 and $35,000 for the years ended
September 30, 2002, 2001 and 2000, respectively.
The Company has one customer that accounted for approximately $1,942,000,
$2,493,000, and $4,082,000 of revenues for the years ended 2002, 2001 and 2000,
respectively. The revenues for this customer are recorded as part of the
transaction processing segment.
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. For the basic net
income per common share, the convertible preferred stock is not considered to be
equivalent to common stock.
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. The pro forma disclosure required by FAS 123 is included in Note 9.
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 an officer or director.
Compensation expense is recorded over the period the officer or director
performs the related service.
Accounting Estimates
- ---------------------
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and 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".
NOTE 2 - STATEMENT OF CASH FLOWS:
- -----------------------------------
September 30
--------------------------
2002 2001 2000
-------- ------- -------
Cash paid for:
Interest $129,000 $81,000 $88,000
Income taxes 137,000 72,000 40,000
F8
Note 2: (Continued)
- -------
Significant non-cash transactions for fiscal 2002 are as follows:
- A refund and tax credit totaling $173,000 will be recognized due to
the filing of amended tax returns for cashless 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.
Significant non-cash transactions for fiscal 2001 are as follows:
- 21,116 shares of common stock valued at $85,000 were issued for the
purchase of certain National Check Network, Inc. assets.
- In September 2001, the Company's Board of Directors approved a
one-for-four (1:4) reverse stock split. As stipulated in the Merger
Agreement, this event triggered the issuance of the remaining 375,000
performance shares to the RMRS selling shareholders. The performance
shares were valued at $780,000, based on the market price on the date
of stock issuance, and recorded on the books as goodwill to be
amortized over fifteen years.
- Capital equipment of $216,000 was acquired under capital leases.
Significant non-cash transactions for fiscal 2000 are as follows:
- In connection with two business acquisition transactions, the Company
issued 255,000 shares of common stock with a market value of
$3,102,000.
- The Company acquired 17,797 shares of its common stock valued at
$331,000 for repayment of a note receivable.
NOTE 3 - INVENTORY
- --------------------
The components of inventory are as follows:
September 30
------------------
2002 2001
-------- --------
Raw materials $ 61,000 $ 62,000
Finished goods 473,000 529,000
-------- --------
534,000 591,000
Less: Allowance for obsolescence 300,000 18,000
-------- --------
$234,000 $573,000
======== ========
F9
NOTE 4 - PROPERTY AND EQUIPMENT:
- ------------------------------------
Property and equipment are comprised of the following:
September 30
----------------------------
2002 2001
-------------- ------------
Land and building $ 880,000 $ 880,000
Computer equipment and software 7,904,000 5,541,000
Furniture, fixtures and equipment 995,000 977,000
Building improvements 281,000 281,000
Tooling equipment 285,000 285,000
Auto 16,000 16,000
-------------- ------------
Cost 10,361,000 7,980,000
Less: accumulated depreciation and amortization ( 5,260,000) (4,226,000)
-------------- ------------
Net book value $ 5,101,000 $ 3,754,000
============== ============
Included in property and equipment are assets under capital lease of $1,072,000
and $425,000 at September 30, 2002 and 2001, with related accumulated
depreciation of $224,000 and $165,000, respectively, and capitalized software
development costs of $3,129,000 and $2,037,000, with related accumulated
amortization of $1,373,000 and $873,000, respectively.
NOTE 5 - INCOME TAXES
- ---------------------
The benefit (provision) for income taxes consists of the following components:
September 30
-----------------------------------
2002 2001 2000
----------- ---------- ----------
Current federal taxes $ -0- $ (29,000) $ (4,000)
Current state taxes (5,000) (120,000) (51,000)
Deferred taxes 1,372,000 (436,000) (178,000)
----------- ---------- ----------
Total benefit (provision) for income taxes $1,367,000 $(585,000) $(233,000)
=========== ========== ==========
September 30
-------------------------
2002 2001 2000
-------- ------ -------
U.S. Federal statutory tax rate (34.00)% 34.00% 34.00%
Add (deduct):
Non-deductible goodwill 4.3% 14.3% 22.8 %
State and local taxes (6.9)% 8.3% 7.1 %
Valuation allowance 0 % 0% (19.3)%
All other .1 % 0.8% (0.1)%
-------- ------ -------
Effective tax rate (36.50)% 57.40% 44.50 %
======== ====== =======
F10
Note 5: (Continued)
- -------
During the year ended September 30, 2000, the Company recognized the income tax
benefit of a reserve established against the value of certain real estate owned
by it.
Components of the deferred tax asset include:
September 30
----------------------
2002 2001
---------- ----------
Deferred tax assets:
Reserve for bad debts $ 34,000 $ 25,000
Inventory reserve 120,000 8,000
Reserve on real estate 160,000 109,000
Inventory cost capitalized 52,000 54,000
State tax expense 40,000 41,000
Installment note expense 543,000 -0-
Net operating loss carryforward 1,179,000 390,000
Business tax credit 113,000 113,000
AMT credit 45,000 38,000
---------- ----------
Total deferred tax assets $2,284,000 $ 778,000
========== ==========
The Company has a federal net operating loss carryforward of $3,248,000, which
expires in 2007 through 2016.
NOTE 6 - SHORT-TERM BORROWINGS AND LONG-TERM DEBT:
- ----------------------------------------------------
Short-term borrowings and long-term debt consist of the following:
September 30
----------------------
2002 2001
---------- ----------
Long-term promissory note collateralized by corporate headquarters
building, due March 25, 2017, bearing interest at 8% per annum $1,277,000 $ -0-
Term loan collateralized by corporate headquarters building,
due February 15, 2009, bearing interest at 7.87% per annum 392,000 438,000
Term loan, collateralized by equipment, due 2005, bearing
interest at prime rate, 4.75% at September 30, 2002 187,000 266,000
Capital leases 818,000 277,000
Notes payable, bearing interest at 9.5% -0- 3,000
---------- ----------
2,674,000 984,000
Less: current portion (515,000) (240,000)
---------- ----------
$2,159,000 $ 744,000
========== ==========
The weighted average interest rate on the prime rate term loan for the period it
was outstanding during the year ended September 30, 2002 was 4.94%
One of the term loans contains restrictive debt covenants consisting of debt
service coverage ratio and tangible net worth requirements.
F11
Note 6: (Continued)
- -------
Future maturities of debt are as follows:
Fiscal year ended September 30
------------------------------
2003 $ 515,000
2004 502,000
2005 307,000
2006 124,000
2007 135,000
thereafter 1,091,000
-----------
$ 2,674,000
===========
NOTE 7 - ACCRUED EXPENSES:
- ----------------------------
September 30
--------------------------
Accrued expenses are comprised of the following: 2002 2001
-------------- ----------
Accrued bankcard fees $ 200,000 $ 136,000
Accrued compensation and payroll taxes 281,000 240,000
Accrued communication costs 234,000 289,000
Accrued professional fees 115,000 362,000
Accrued commission 111,000 147,000
Other 46,000 221,000
-------------- ----------
$ 987,000 $1,395,000
============== ==========
NOTE 8 - STOCKHOLDERS' EQUITY:
- --------------------------------
Preferred Stock
- ---------------
During fiscal 1996, the Company issued 425,000 shares of Series K Preferred
Stock (Class K Stock) for an aggregated price of $850,000. Each share of Class
K Stock has a stated value of $2.00 per share and is convertible into one share
of common stock after adjustment for the one-for-four (1:4) reverse stock split
in September 2001. Class K Stock has priority in liquidation over the Company's
common stock but is junior in liquidation to all previous classes of preferred
stock. Between fiscal 1997 through 1999, a total of 400,000 shares of Class K
Stock were converted into 400,000 shares of the Company's common stock. As of
September 30, 2002, all 25,000 shares of Class K Stock outstanding have been
converted into common stock.
Stockholders' Rights Plan
- -------------------------
The Company has a Stockholders' Rights Plan. All stockholders have one preferred
share purchase right ("Right") for each outstanding share of common stock of the
Company. Each Right entitles the registered holder to purchase from the Company
one-hundredth 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"), after adjustment
for the one-for-four (1:4) reverse stock split in September 2001. The
description and terms of the Rights are set forth in a Rights Agreement dated as
of September 30, 1996 ("Rights Agreement").
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%) of more such outstanding
Common Stock.
F12
Note 8: (Continued)
- -------
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 holder of a Right will 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 two 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 holder of
a Right will 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 two 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. The Rights will
expire on September 30, 2006 ("Final Expiration Date"), unless the Rights are
earlier redeemed or exchanged by the Company, in each case, as description in
the Rights Agreement.
(Loss) Earnings Per Share
- ----------------------------
The following table sets forth the computation of basic and diluted (loss)
earnings per share:
September 30
------------------------------------
2002 2001 2000
------------ ---------- ----------
Net (loss) income: $(2,376,000) $ 434,000 $ 291,000
Shares:
Denominator for basic (loss) earnings per
share - weighted-average shares
outstanding 5,788,071 5,797,120 5,257,393
Effect of dilutive securities:
Employee stock options -0- 141,688 514,304
Warrants -0- -0- 14,848
Series K Convertible Preferred Stock -0- 25,000 25,000
Series L Convertible Preferred Stock -0- -0- 13,552
------------ ---------- ----------
Dilutive potential common shares -0- 166,688 567,704
------------ ---------- ----------
Denominator for diluted (loss) earnings per
share - adjusted weighted-average
shares and assumed conversions 5,788,071 5,963,808 5,825,097
============ ========== ==========
Basic (loss) earnings per share ($0.41) $ 0.07 $ 0.06
============ ========== ==========
Diluted (loss) earnings per share ($0.41) $ 0.07 $ 0.05
============ ========== ==========
NOTE 9 - 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 has been approved by the Board of Directors of the Company and will
be offered to the shareholders of the Company for approval at the Annual
Shareholders' Meeting in February 2003. The 2003 Incentive Stock Option Plan has
similar provisions as the 1992 Plan.
F13
Note 9: (Continued)
- -------
Stock option activity during 2002, 2001, and 2000 was as follows:
Stock option activity during 2002, 2001, and 2000 was as follows:
Exercise
Options Price
--------- -----------------
Outstanding September 30, 1999 829,583 $ 1.60 - $ 8.00
Granted 106,250 7.00 - 16.48
Forfeited (32,917) 5.76 - 10.24
Exercised (116,583) 1.60 - 4.48
---------
Outstanding September 30, 2000 786,333 $ 1.60 - $16.48
=========
Granted 88,750 2.84 - 3.24
Forfeited (165,416) 1.60 - 8.48
Exercised (15,000) 2.00 - 3.40
---------
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
=========
Exercisable at September 30, 2000 527,500 $ 1.84 - $10.04
=========
Exercisable at September 30, 2001 437,000 $ 1.60 - $16.48
=========
Exercisable at September 30, 2002 318,000 $ 1.29 - $16.48
=========
Options available for grant
at September 30, 2001 461,500
=========
Options available for grant
at September 30, 2002 374,750
=========
All officer and key employee options are granted under the 1992 Plan, with the
exception of 25,834 shares of options granted to a former executive officer,
vesting over a period of 3 years and 50,000 shares of stock options, vesting
over a period of 5 years which was issued to an executive officer under the 2003
Incentive Stock Option Plan, pending shareholders' approval. The exercise price
of both the incentive stock options and directors' options shall be 100% of the
fair market value on the date the option is granted. Options granted to outside
directors are normally vested immediately. 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, 2002:
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, 2002 Life Price Sept. 30, 2002 Price
- ---------------- -------------- -------------- ------------ --------------- ---------------
1.29 - $2.00 226,000 4.7 $ 1.79 171,000 $ 1.85
2.18 - $3.36 223,000 8.4 $ 2.49 34,000 $ 3.16
4.00 - $5.88 174,000 5.7 $ 4.39 90,000 $ 4.56
7.00 - $16.48 90,000 7.3 $ 9.10 23,000 $ 9.00
-------------- ---------------
713,000 6.4 $ 3.56 318,000
============== ===============
F14
Note 9: (Continued)
- -------
The weighted average fair value of the options granted under the plan in effect
at September 30, 2002, during the fiscal years ended September 30, 2002, 2001
and 2000 were $1.52, $1.89, and $3.20, respectively. Fair value was determined
using the Black Scholes options pricing formula. For options granted in fiscal
2002, the risk free interest rate was appropriately 4%, the expected life was
3-5 years, the expected volatility was appropriately 90.6%, and the expected
dividend yield was 0%, all calculated on a weighted average basis. For options
granted in fiscal 2001, the risk free interest rate was approximately 5%, the
expected life was 3-5 years, the expected volatility was approximately 80.0% and
the expected dividend yield was 0%, all calculated on a weighted average basis.
For options granted in fiscal 2000, the risk-free interest rate was
approximately 6%, the expected life was 3-5 years, the expected volatility was
approximately 90.1% and the expected dividend yield was 0%, all calculated on a
weighted average basis.
On a pro forma basis under the provision of FAS 123, net loss and net loss per
share would have increased by $358,000 and $0.06 for the year ended September
30, 2002, respectively; net income and net income per share would have decreased
by $321,000 and $0.06 for the year ended September 30, 2001, respectively; and
net income and net income per share would have decreased by $245,000 and $0.05
for the year ended September 30, 2000, respectively.
NOTE 10 - COMMITMENTS AND CONTINGENCIES:
- ------------------------------------------
Lease Commitments
- -----------------
The Company leases real property under agreements, which expire at various times
over the next three years. The Company's future minimum rental payments for
capital and operating leases at September 30, 2002 are as follows:
Fiscal Year Capital Leases Operating Leases
- ------------------------------ --------------- -----------------
2003 $ 377,000 $ 123,000
2004 352,000 138,000
2005 185,000 -0-
--------------- -----------------
Total minimum lease payments $ 914,000 $ 261,000
=================
Less: imputed interest of 8.7% 96,000
---------------
Present value of net
minimum lease payment $ 818,000
===============
Rent expense for the years ended September 30, 2002, 2001, and 2000 totaled
$212,000, $193,000, and $155,000, respectively. Certain operating leases have
renewal options at the end of the lease term solely at the Company's discretion.
NOTE 11 - 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.
On March 6, 2002, by resolution by the Board of Directors upon advise of counsel
subsequent to closing arguments at trial and a March 1, 2002 Mediation, the
Company settled all claims without admission of liability arising from
litigation known as Premiere Lifestyles International Corporation, Inc.
("Premiere") v. Electronic Clearing House, Inc. in the Los Angeles County
Superior Court. The Company made a one-time cash payment of $1,200,000 to
Premiere and executed a long-term promissory note collateralized by the
Company's office building in Agoura Hills, California in favor of Premiere for
an additional $1,300,000, payable over 15 years with an interest rate of 8%.
F15
NOTE 12 - 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 three business segments: Bankcard and
Transaction Processing, Check Related Products, and other, all of which are
located in the United States.
The Company's reportable operating segments have been determined in accordance
with the Company's internal management structure, which is organized based on
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. Certain segment information for fiscal
year 2001 and 2000 were reclassified as a result of the elimination of the
terminal sale business segment in fiscal 2002.
September 30
----------------------------------------
Business Segments 2002 2001 2000
- ------------------------------------- ------------ ------------ ------------
Revenues:
Bankcard and Transaction Processing $27,339,000 $25,220,000 $26,210,000
Check Related Products 5,802,000 4,323,000 1,926,000
Other 150,000 400,000 204,000
------------ ------------ ------------
$33,291,000 $29,943,000 $28,340,000
============ ============ ============
Operating Income (loss):
Bankcard and Transaction Processing $ 1,996,000 $ 3,183000 $ 2,668,000
Check Related Products (872,000) (234,000) (883,000)
Other - Corporate Expenses (2,293,000) (2,386,000) (1,769,000)
Legal Settlement (2,500,000) -0- -0-
------------ ------------ ------------
$(3,669,000) $ 563,000 $ 16,000
============ ============ ============
Depreciation and Amortization:
Bankcard and Transaction Processing $ 727,000 $ 571,000 $ 472,000
Check Related Products 938,000 764,000 495,000
------------ ------------ ------------
$ 1,665,000 $ 1,335,000 $ 967,000
============ ============ ============
Capital Expenditures:
Bankcard and Transaction Processing $ 1,474,000 $ 823,000 $ 954,000
Check Related Products 712,000 859,000 187,000
------------ ------------ ------------
$ 2,186,000 $ 1,682,000 $ 1,141,000
============ ============ ============
Total Assets:
Bankcard and Transaction Processing $ 5,399,000 $ 5,268,000 $ 4,459,000
Check Related Products 7,710,000 7,934,000 5,949,000
Other 5,082,000 5,719,000 6,605,000
------------ ------------ ------------
$18,191,000 $18,921,000 $17,013,000
============ ============ ============
F16
NOTE 13 - NEW ACCOUNTING PRONOUNCEMENTS
- -----------------------------------------
In July 2001, the FASB issued Statement of Financial Accounting Standards No.
142 ("SFAS"), "Goodwill and Other Intangible Assets", which is effective for
fiscal years beginning after December 15, 2001. SFAS 142 requires, among other
things, the discontinuance of goodwill amortization. In addition, the standard
includes provisions for the reclassification of certain existing recognized
intangibles as goodwill, reassessment of the useful lives of existing recognized
intangibles, reclassification of certain intangibles out of previously reported
goodwill and the identification of reporting units for purposes of assessing
potential future impairments of goodwill. SFAS 142 also requires companies to
complete a transitional goodwill impairment test six months from the date of
adoption. The Company is required to adopt these statements effective the first
quarter of fiscal 2003. The Company has completed the Step 1 - goodwill
impairment test, as prescribed by SFAS 142, utilizing discounted cash flow
analysis for the check services reporting unit that has goodwill. The results
of this analysis indicate potential goodwill impairment for this reporting unit.
The Company has begun, but not completed, Step 2 - measurement of the impairment
loss, by evaluating the fair value of the check services business segment
through discounted cash flow models and other analytical means. The Company
expects to record any impairment loss as a cumulative effect of a change in
accounting principle in the first quarter of 2003.
In August 2001, FASB issued Statement of Financial Accounting Standards No. 144
("SFAS 144"), "Accounting for the Impairment or Disposal of Long-Lived Assets."
This Statement supersedes FASB Statement No. 121, ("SFAS 121") Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets To Be Disposed Of,
and the accounting and reporting provisions of APB Opinion No. 30, Reporting the
Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions, for the disposal of a segment of a business (as previously defined
in that Opinion). This statement establishes a single accounting model for
long-lived asset impairment, based on the framework established in SFAS 121, for
long-lived assets to be disposed of by sale, and resolves significant
implementation issues related to SFAS 121. SFAS 144 is effective for fiscal
years beginning after December 15, 2001. The Company does not believe that the
adoption of SFAS 144 will have a significant impact on its financial statements
and the results of operations upon adoption.
In June 2002, the FASB issued SFAS 146, "Accounting for Costs Associated with
Exit or Disposal Activities", which is effective for exit or disposal activities
initiated after December 31, 2002. This statement addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and other Costs to Exit an
Activity (including certain costs incurred in a restructuring)." The Company
does not believe that the adoption of SFAS 146 will have a significant impact on
its financial statements and the results of operation upon adoption.
NOTE 14 - QUARTERLY FINANCIAL DATA (UNAUDITED)
- ----------------------------------------------------
The following summarizes the unaudited quarterly financial results of the
Company for the fiscal years ended September 30, 2002 and September 30, 2001 (in
thousands, except share data):
Year Ended September 30, 2002
------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
--------- --------- --------- ---------
Net revenues $ 7,921 $ 8,386 $ 8,415 $8,569
Gross profit 2,796 2,360 2,535 2,265
(Loss) from operations (76) (3,129) (143) (321)
Net (loss) (93) (1,908) (168) (207)
(Loss) per share - basic $ (0.02) $ (0.33) $ (0.03) $(0.03)
(Loss) per share - diluted $ (0.02) $ (0.33) $ (0.03) $(0.03)
F17
Note 14: (Continued)
- --------
Year Ended September 30, 2001
---------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
-------- -------- -------- ---------
Net revenues $ 6,979 $ 7,380 $ 7,758 $ 7,826
Gross profit 2,266 2,788 2,644 2,587
Income (loss) from operations 63 350 203 (53)
Net income (loss) 22 167 282 (37)
Basic net income (loss) per
common share $ 0.00 $ 0.03 $ 0.05 $ (0.01)
Diluted net income (loss) per
common share $ 0.00 $ 0.03 $ 0.05 $ (0.01)
F18
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
DESCRIPTION 09/30/1999 EXPENSE RECEIVABLE 09/30/2000 EXPENSE RECEIVABLE 09/30/2001
- ----------------------- ----------- ----------- ------------- ----------- ----------- ------------- -----------
Allowance for
trade receivables/
chargeback receivables $ 1,001,000 $ 586,000 $ 1,207,000 $ 380,000 $ 326,000 $ 393,000 $ 313,000
Allowance for
notes receivable $ 148,000 $ 29,000 $ -0- $ 177,000 $ -0- $ 177,000 $ -0-
Allowance for
obsolete inventories $ 202,000 $ -0- $ 199,000 $ 3,000 $ 15,000 $ -0- $ 18,000
REDUCTION IN
RESERVE AND
CHARGED TO ACCOUNTS BALANCE AT
DESCRIPTION EXPENSE RECEIVABLE 09/30/2002
- ----------------------- ----------- ------------- -----------
Allowance for
trade receivables/
chargeback receivables $ 302,000 $ 184,000 $ 431,000
Allowance for
notes receivable $ -0- $ -0- $ -0-
Allowance for
obsolete inventories $ 300,000 $ 18,000 $ 300,000