UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
X Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
--- Act of 1934 for the fiscal year ended SEPTEMBER 30, 2005
Transition Report Pursuant to Section 13 or 15(d) of the Securities
--- Exchange Act of 1934
COMMISSION FILE NUMBER 0-15245
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ELECTRONIC CLEARING HOUSE, INC.
(Exact name of registrant as specified in its charter)
[GRAPHIC OMITTED]
NEVADA 93-0946274
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
730 PASEO CAMARILLO, CAMARILLO, CALIFORNIA 93010
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code:(805) 419-8700,
fax number: (805) 419-8682
Securities registered pursuant to Section 12(b) of the Act:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
------------------- -----------------------------------------
None None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.01 par value
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes No X
--- ---
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Act). Yes No X
--- ---
The aggregate market value of the voting stock held by non-affiliates of
the Registrant, based upon the closing sale price of the Common Stock on March
31, 2005, as reported on the NASDAQ Capital Market, was approximately
$51,246,840. Shares of Common Stock held by each officer and director have been
excluded in that such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily a conclusive determination
for other purposes.
As of December 12, 2005, the Registrant had outstanding 6,661,701 shares of
Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE - NONE
ELECTRONIC CLEARING HOUSE, INC.
2005 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
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PART 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
ITEM 1. Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
ITEM 2. Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
ITEM 3. Legal Proceedings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
ITEM 4. Submission of Matters to a Vote of Security Holders. . . . . . . . . . . . . . . . . . 14
PART II . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
ITEM 5. Market for Registrant's Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities. . . . . . . . . . . . . . . . . . . . . . . 15
ITEM 6. Selected Financial Data. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 17
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk . . . . . . . . . . . . . . 30
ITEM 8. Financial Statements and Supplementary Data. . . . . . . . . . . . . . . . . . . . . . 30
ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures 30
ITEM 9A. Controls and Procedures. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
ITEM 9B. Other Information. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
PART III . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
ITEM 10. Directors and Executive Officers of the Registrant . . . . . . . . . . . . . . . . . . 31
ITEM 11. Executive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
ITEM 12. Security of Certain Beneficial Owners and Management
and Related Stockholder Matters. . . . . . . . . . . . . . . . . . . . . . . . . . . . 38
ITEM 13. Certain Relationships and Related Transactions . . . . . . . . . . . . . . . . . . . . 40
ITEM 14. Principal Accounting Fees and Services . . . . . . . . . . . . . . . . . . . . . . . . 40
PART IV . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41
ITEM 15. Exhibits, Financial Statement Schedules. . . . . . . . . . . . . . . . . . . . . . . . 41
2
PART I
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
---------------------------------------------------------
This 2005 Annual Report on Form 10-K contains statements which constitute
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. Those statements include statements regarding our intent, belief or
current expectations. Examples of forward-looking statements include statements
regarding our strategy, financial performance and revenue sources. Prospective
investors are cautioned that any such forward-looking statements are not
guarantees of future performance and involve risks and uncertainties, and that
actual results may differ materially from those projected in the forward-looking
statements as a result of various factors, including, but not limited to, those
set forth elsewhere in this Annual Report. See "Item 7. Management's Discussion
and Analysis of Financial Condition and Results of Operations - Risk Factors."
ITEM 1. BUSINESS
OVERVIEW
Electronic Clearing House, Inc. is an electronic payment processor that provides
for the payment processing needs of merchants, banks and collection agencies.
We derive the majority of our revenue from two main business segments: 1)
bankcard and transaction processing services ("bankcard services"), whereby we
provide solutions to merchants and banks to allow them to accept credit and
debit card payments from consumers; and 2) check-related products ("check
services"), whereby we provide various services to merchants and banks to allow
them to accept and process check payments from consumers. The principal
services we offer within these two segments include, with respect to our
bankcard services, debit and credit card processing, and with respect to our
check services, check guarantee (where, if we approve a check transaction and a
check is subsequently dishonored by the check writer's bank, the merchant is
reimbursed by us), check verification (where, prior to approving a check, we
search our negative and positive check writer database to determine whether the
check writer has a positive record or delinquent check-related debts),
electronic check conversion (the conversion of a paper check at the point of
sale to a direct bank debit which is processed for settlement through the
Federal Reserve System's Automated Clearing House ("ACH") network), check
re-presentment (where we attempt to clear a check on multiple occasions via the
ACH network prior to returning the check to the merchant so as to increase the
number of cleared check transactions), and check collection (where we provide
national scale collection services for a merchant or bank). We operate our
services under the following brands:
- MerchantAmerica, our retail provider of all credit card, debit card
and check payment processing services to both the merchant and bank
markets;
- National Check Network ("NCN"), our proprietary database of negative
and positive check writer accounts (i.e., accounts that show
delinquent history in the form of non-sufficient funds and other
negative transactions), for check verification, check conversion
capture services, and for membership to collection agencies;
- XPRESSCHEX, Inc. for check collection services; and
- ECHO, for wholesale credit card and check processing services.
We discuss our services in greater detail below. Overall, our ability to
program and oversee the management of a merchant's point-of-sale system, provide
credit card and debit card processing, provide multiple services for the
processing of checks, provide both electronic and traditional collection
services, and fully integrate all of these services into a single Internet-based
reporting capability allows us to provide for the majority of the payment
processing needs of our customers.
We were incorporated in Nevada in December 1981. Our executive offices are
located at 730 Paseo Camarillo, Camarillo, California 93010, and our telephone
number is (805) 419-8700. Our common stock is traded on the NASDAQ Capital
Market under the ticker symbol "ECHO." Information on our website,
www.echo-inc.com, does not constitute part of this annual report.
3
HISTORY OF THE COMPANY
ECHO has been offering bankcard and check services for over 19 years. We were
incorporated in Nevada in 1981 under the name Bio Recovery Technology, Inc. and
changed our name to Electronic Clearing House, Inc. with the acquisition of a
credit card processing company, Electronic Financial Systems, Inc. in January
1986. In 1986, ECHO developed the capability, utilizing the Federal Reserve
System's Automated Clearing House ("ACH"), a network that serves as a
nationwide, wholesale electronic payment and collection system by way of
transferring funds between banks via the Federal Reserve System, to deposit
funds into any U.S. bank of the merchant's choice. This development made it
possible for remote banks and processors to provide the same processing services
previously available only through the merchant's local bank.
In 1999, ECHO acquired Magic Software Development, Inc., a check processing
company located in Albuquerque, New Mexico, that serviced National Check Network
("NCN"), an association of approximately 60 affiliated collection agencies
across the nation. At the time, we provided a check guarantee service that only
served California merchants, but with the addition of Magic's check processing
capabilities, our check guarantee services have been offered on a national basis
since 1999. In fiscal 2000, Magic's corporate name was changed to XPRESSCHEX.
In November 1999, we acquired Peak Collection Services, a collection agency in
Albuquerque, New Mexico, and incorporated Peak into our XPRESSCHEX operations as
our Collection Division in December of 1999. The XPRESSCHEX Collection Division
conducts collections on a national basis. Having a fully integrated, nationally
approved collection service allows XPRESSCHEX to operate as a central check
clearing facility for NCN's collection agencies without each agency having to
authorize such activity.
In January 2000, we acquired Rocky Mountain Retail Systems ("RMRS") located in
Boulder, Colorado, which provided a national check verification service to over
200 collection agencies across the nation. RMRS maintained a national check
database of negative and positive check writer records.
In December 2000, we signed an agreement with Visa U.S.A. to participate in a
point-of-sale check processing pilot program as both an "Acquirer Processor" (a
role that accepts transactions from a merchant's point-of-sale terminal and
reformats them for submission to the Visa network) and as a "Third-Party
Processor" (a role that approves or declines checks written on accounts of banks
not yet participating in the Visa POS Check Service program and deposits
approved funds utilizing the ACH). Under the program, any one of over 14,000
Visa member banks can offer various check processing services to their merchants
and utilize Visa's dedicated communications network and banking relationships to
clear check activity using direct debits from the check writer's account. In
July 2001, several major financial institutions began participating in the pilot
program. The program was released from pilot in December of 2002 and, as of
September 2005, nine financial institutions were using ECHO as their Acquirer
Processor and fifteen financial institutions were using ECHO as their
Third-Party Processor.
In May 2001, we acquired the assets of National Check Network ("NCN") and
combined the NCN positive and negative check writer records with the RMRS
database, resulting in a combined database of over 120 million check writer
records which identify the positive and negative check writing activities
occurring with individual check writers (including information related to
accepted checks, bounced checks, and the frequency of delinquent transactions).
This database is ever-growing with additional contributions daily and as of
September 30, 2005, contained over 160 million records.
In May 2001, ECHO launched MerchantAmerica.com, a web-based source of financial
information whereby an ECHO merchant can access their transactional history,
bank information, significant business and office-related services and build an
online store and accept payment in the form of credit cards or checks. The site
also contains a National Merchant Directory that is free to any merchant in the
United States. Additionally, it provides any merchant in the United States with
the ability to edit and enhance their directory listing. While we believe that
MerchantAmerica.com is a valuable and cost-effective resource for merchants, it
provides us with a low-cost method of keeping our merchants informed and
involved with us.
4
OUR SERVICES
BANKCARD AND TRANSACTION PROCESSING SERVICES
Services
--------
With our bankcard and transaction processing services, we provide payment
solutions to merchants and banks to allow them to accept credit and debit card
payments from consumers. Our bankcard and transaction processing services
include the following:
Debit and Credit Card Payment Processing
ECHO currently provides 24-hour daily payment processing, "800" number access to
customer service personnel and, as needed, various field support services.
Utilizing one of several methods of access to us, the merchants' systems dial
our host computers that are connected to all the major card authorizing centers,
and receive credit card and debit card authorizations. At the end of each day,
electronic files of authorized transactions are transmitted to the major credit
card organizations. They withdraw the funds from the card issuing banks and
deposit a lump sum for the day's processing activity into our processing bank on
the following morning. Using a distribution file that we provide to them daily,
our processing bank then distributes and deposits the individual merchant's
funds into the bank account of the merchant's choice. On average, ECHO deposits
funds to over 600 banks across the nation on behalf of its merchants each day.
Other Payment Processing Services
We also provide various services related to our debit and credit card payment
processing, including:
- Internet Processing - ECHO allows merchants to process payment
transactions online with immediate processing, online reporting and
security services that protect the cardholder, merchant and Internet
Service Provider ("ISP") from fraud.
- Batch File Processing - ECHO allows mail order, telephone order or
direct marketing merchants to process and transmit payments by using
Microsoft Excel(R), Access(R) or any other program that can create a
"flat file" of data. In this process, the merchant can visit the ECHO
Merchant Center, log on through a secure gateway, and upload the file
to ECHO's processing center. The transactions are processed
immediately, with reporting available almost immediately on each
transaction.
Deriving Revenue
-----------------
Bankcard and transaction processing services provide for the majority of our
revenue. For the year ended September 30, 2005, bankcard and transaction
processing accounted for approximately 74.0% of our revenue. Bankcard and
transaction processing volume rose 12.7% in fiscal 2005, from $1,052,657,000 in
fiscal 2004 to $1,186,397,000 in fiscal 2005, and revenue increased
approximately 11.4%, from $36,897,000 in fiscal 2004 to $41,093,000 in fiscal
2005.
ECHO's revenue for debit/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. Discount rates
range between 1.5% and 3.5%. Interchange, the fee charged by the card-issuing
bank and paid each day when transactions are processed, normally constitutes 75%
to 85% of the discount rate revenue. Other external costs, such as Visa and
MasterCard dues and bank fees, increase external fees we pay to 85% to 90% of
the total discount rate charged.
A transaction fee is charged for each transaction processed and ECHO's average
transaction fee in fiscal 2005 was $0.20 per transaction, the same as in fiscal
2004. Both Visa and MasterCard have instituted a $0.10 transaction fee on each
transaction processed that ECHO and all processors are required to pay. In
addition, on average, ECHO pays approximately $0.01 per transaction for
communication costs, depending upon the duration and method of transmission.
5
The market size for credit card processing is approximately 19 billion
transactions per year, and this number is growing annually. ECHO has a very
small percentage of this market, but we are one of the top 50 credit card
processors according to The Nilson Report, a monthly financial
subscription-based newsletter. Our competitors include First Data Corporation,
the biggest credit card processor in the United States, NPC/Bank of America,
Total Systems, Global Payments, and a few other direct payment processors. The
credit card processing market has undergone rapid consolidation, which has
raised unique challenges, including supporting and integrating numerous
processing methodologies, initiating quality customer support and field support
services and maintaining merchant relationships. While merchant portfolios can
be purchased by a processor or a credit card agent bank, merchants are generally
under no contractual obligation to utilize the services of the new owner so many
of the most active consolidators have been experiencing difficulty in
maintaining their number of active merchants.
In an effort to enhance the bankcard transaction processing business segment's
processing infrastructure and control processing costs, we have acquired three
payment processing modules from Oasis Technologies/eFunds; Clearing, Merchant
Accounting System (MAS) and Switch. Integration of the Clearing module is
currently scheduled to be complete in the second quarter of 2006 followed by
several months of testing. While we believe that the new processing modules
will operate as represented and result in significant operating efficiencies,
there is no assurance this will actually be the case.
Historically, ECHO has been effective in selling to merchants who operate in
non-face-to-face, card not present environments, such as the internet, mail
order and telephone order types of businesses. Approximately 70% of our monthly
credit card volume comes from these types of merchants. Our Agent Bank program
brings retail, face-to-face, card present types of merchants to us so we intend
to continue to promote this channel going forward. Once the Clearing module is
installed and operational, we also intend to broaden our marketing reach to
actively pursue more retail types of business. Since there is more competition
for this type of business, the price we charge to the merchant for our services
will reflect lower margins than we have historically been accustomed to getting.
While we intend to continue to pursue our historic higher margin merchant
markets, the added scope of merchant we intend to pursue and the lower margins
inherent in this market may compress our margins overall, depending upon how
successful each channel is in bringing new merchant relationships.
In order to engage in Visa and MasterCard processing, a cooperative relationship
is required with a Visa/MasterCard Primary Member Bank that sponsors the
merchants to accept Visa and MasterCard transactions. ECHO's primary processing
bank relationship is with First Regional Bank of Los Angeles, California. As a
result of its relationship, ECHO is a registered Independent Sales Organization
and Merchant Service Provider with Visa and MasterCard, respectively, which
allows us to solicit and support merchants utilizing our services. We have an
agreement with First Regional Bank, which continues our relationship through
late 2005 and extension of the agreement is expected. Pursuant to the terms of
the agreement, among other matters, we market and sell merchant services and the
bank provides various support services in connection with individual
transactions, in exchange for our payment to the bank, on a monthly basis, of a
payment of $0.02 per transaction. The agreement does not allow either party to
terminate other than for cause (as defined in the agreement) without incurring
liability for breach of the agreement.
CHECK-RELATED PRODUCTS (OR "CHECK SERVICES")
Overview
--------
ECHO has invested significant resources and management focus in its check
services business. Check services revenue increased approximately 26.6% in
fiscal 2005, from $11,423,000 in fiscal 2004 to $14,458,000 in fiscal 2005.
Revenue from ACH and check conversion continues to increase. Growth has come
primarily from four sources: Internet wallet providers, cross-selling electronic
checks into the credit card merchant base we already serve, casino check cashing
services and the Visa POS Check program.
Wallet providers allow a customer to fund an online wallet with a lump sum and
then the customer can use the wallet at various sites on the Internet.
(Probably the best known wallet service on the Internet is PayPal, a service
owned by eBay.) ECHO is assisting various providers of wallet services to fund
the initial wallet transaction. Subsequent transactions of transferring funds
from the online wallet are generally not handled by ECHO because the payment is
typically handled online by the wallet provider themselves.
6
Approximately 70% of ECHO's credit card processing merchants operate their
businesses in non-face-to-face environments such as mail order, phone order and
the Internet. These relationships historically have higher margins than those
seen with normal retail merchants because of the higher risk of fraud. We are
finding good success in selling electronic checks to these merchants because it
is a significantly lower cost form of payment.
ECHO has established an integrated processing relationship with the largest
check cashing provider to the gaming and casino market. Our services are
primarily centered on providing check verification (using our NCN data base),
check conversion (moving paper checks to electronic transactions at the check
cashing cage in the casino), and several sophisticated risk management services
that are used to assist the provider in confidently accepting checks. Through
this source, ECHO expects to provide these services to several of the largest
casinos and gaming customers in the industry.
ECHO is both a Third-Party Processor and an Acquirer Processor for the Visa POS
Check Program. Visa officially released its POS Check Service as of December
2002 and several national banks have entered the program since its inception to
both sell the service to their merchants and to connect all of their checking
accounts to the Visa network. While the transactional growth in 2005 has been
slower than expected, Visa's connectivity to checking account balances has
increased significantly over the past year, moving nationally from less than 10%
to 20%, and 30% and higher in many metropolitan areas. (See the discussion of
the Visa POS Check Service program below.)
Services
--------
With our check services, we provide various services to merchants and banks to
allow them to accept and process check payments from consumers. Our check
services include the following:
Check Verification
For a fee, we will search NCN, our proprietary database of negative and positive
check writer accounts, attempting to match a specific piece of information, such
as a driver's license number or Magnetic Ink Character Recognition ("MICR")
number (the numeric data along the bottom of a check), provided by a merchant.
A match may identify whether the check writer has a positive record or a
negative record of check cashing activity in the past. Upon notification of this
match (via a coded response from the provider), the merchant decides whether to
accept or decline the check. Verification reduces the risk of accepting a bad
check for the merchant, however, in providing this program alone, we typically
offer no guarantee that the check will be honored by the check writer's bank and
make no promise of reimbursement if the check is dishonored by the bank. Revenue
from check verification is derived from fees collected from the merchants when a
check is verified against our positive and negative check database. This revenue
is recognized when the transaction is processed, since we have no further
performance obligations.
Check Guarantee
With this service, if we approve a check transaction and the check is
subsequently dishonored by the check writer's bank, the merchant is reimbursed
by us and we must undertake any effort to collect the delinquent amount from the
check writer.
The principal risk of providing this service is the risk of collecting the
amount we guarantee from a delinquent check writer whose check transaction was
dishonored by his or her own bank. If we are unable to collect the amount, we
lose that amount. On average, we collect 50-60% of the amounts on those checks
that become delinquent. Given the risks associated with check guarantee,
especially for large volume merchants, we exercise strict risk parameters with
the merchants to which this service is offered. We typically apply several risk
management approaches with this service, which include searching NCN's database,
and "scoring" each transaction. This includes several factors such as velocity
(the number of times a check writer has been searched in a certain period of
time), prior activity (historic negative or positive transactions with the check
writer), check writer's presence in other databases (these national databases
are selectively searched based upon the size of the check and the prior activity
with the check writer), size of the check, and historic bad check activity by
geographic and/or merchant specific locations, to name a few. If our scoring
system concludes that the risk is too high, we issue a coded response
instructing the merchant that we will not guarantee the check. If our scoring
system results in a positive result, a coded response advises the merchant that
we have guaranteed payment on that item.
7
Electronic Check Conversion ("ECC")
Check conversion is the ability to convert a paper check to an electronic item
at the point of sale. ECC is a relatively new system of check settlement that
is quickly gaining merchant acceptance. Under the program, the merchant slips a
customer's completely filled-in check either through a check reader that reads
the MICR line on the check or a check imager that records the total image of the
face of the check and the merchant enters the amount of the check into the
system. The merchant has the customer sign a receipt, much the same as in a
credit card transaction, and gives a copy of the signed receipt along with the
check to the customer. The electronic image, captured by the reader, is sent to
our processing center and we settle the check transaction electronically.
Merchants' customers like this new system because they get their check back
immediately and still have a hard copy receipt of the transaction. Banks like
ECC because no paper has to be handled by the bank to settle the transaction.
While most national merchants already have MICR check-reading equipment, small
merchants will adopt the system only if their check volume justifies the capital
investment in equipment, ranging from $125 to $150 per MICR reader and $300 to
$600 for an imager.
Check Re-Presentment
The Federal Reserve System's Automated Clearing House ("ACH") provides the tools
to electronically present, re-present and settle funds between banks. Our check
re-presentment program allows a merchant to advise its bank that a returned
check should be sent to the XPRESSCHEX data processing center in Albuquerque,
New Mexico, rather than returned to the merchant. Upon receipt, XPRESSCHEX
converts the check to an electronic ACH transaction for resubmission through the
ACH network and marks the check for possible collection activity, should it
become necessary. One feature a merchant may choose is to time the
re-presentment so as to coincide with a check writer's typical payday to better
the odds of collection. Generally, the full face value of the check is returned
to the merchant upon collection and a collection fee charged to the check
writer, usually in the range of $15 to $25, is retained by XPRESSCHEX as payment
for its services.
Internet Check, Batch Check and Virtual Terminal
A check can be presented as a form of payment over the Internet and we support
the multiple types of ACH entry classes. XPRESSCHEX allows an e-commerce site
to accept a check as payment, allows a batch of check data to be sent
electronically for processing (this is commonly used by mail order or phone
order businesses) and allows both verification-only and ACH transactions to be
submitted by merchants via a secure logon and passcode connection over the
Internet.
Visa POS Check Service Program ("Visa Program")
-----------------------------------------------------
The Visa POS Check Program enables merchants to receive direct online
authorization for checks written against consumer checking accounts, similar to
the authorizations provided for credit and debit card transactions. The Visa
Program was offered as a pilot program by Visa to its member banks from December
of 2000 to December of 2002 over which time several banks electronically
connected their check writer data to the Visa network, making verification of
the check writer's bank account balance possible when checks drawn on these
select banks were processed. In December of 2002, the program was officially
released out of pilot and more banks have been added each year to the Visa
network. As of September 2005, a national merchant could expect connection to
around 20% of the nation's checking accounts from all locations and, within
select metropolitan areas, 30% or higher connectivity. This number is expected
to increase to 30% on average for a national merchant and, within select cities,
40% or higher over the coming year as more banks connect their check writer data
to the Visa network. ECHO has invested significant resources and management
focus in its check services business, particularly with respect to the Visa
Program.
As described above, "check conversion" is the ability to convert a paper check
to an electronic item at the point of sale. The Visa Program provides Visa
member banks with a check conversion service that they can sell to their bank
merchants. The Visa Program allows the merchant to get an immediate
authorization or decline on a check while the check writer is at the checkout
counter. If the check is approved, the service allows the merchant to
immediately return the paper check to the check writer since the funds will be
electronically withdrawn from the check writer's account and deposited into the
merchant's account.
Being able to approve or decline a check in real time at the point of sale
requires some method to verify the check writer has either an adequate balance
in the bank to cover the check or, if that is not possible, to verify if the
check written is in a negative check account database. In order to provide this
check service on 100% of the checks received by a merchant, Visa needed a
solution to approve or decline (and for those approved, electronically deposit)
the checks that processed through the program on a bank that had not yet
connected its check writer data
8
to the Visa network. We are currently one of two companies that provide this
service to Visa as a Third-Party Processor. When a Visa member bank signs up to
offer the Visa Program to its merchants, it chooses a Third-Party Processor from
the certified providers and, to date, ECHO serves as a Third-Party Processor for
fifteen financial institutions actively participating in the program.
When Visa receives electronic check data from a merchant and the bank upon which
the check is drawn has not connected its check writer data to the Visa network,
Visa routes that check to the Third-Party Processor that was chosen by the
merchant's bank when they set up the program. The Third-Party Processor
authorizes or declines a check based upon the negative and positive data
contained in several national check account databases that are commercially
available and, for those transactions that are approved, the Third-Party
Processor will electronically move the funds from the check writer's account to
either the merchant bank's master clearing account or directly to the merchant's
banking account (depending on the bank's desired settlement method) utilizing
the ACH.
In addition to being a Third-Party Processor, we are currently certified as an
Acquirer Processor with Visa, a role that accepts transactions from the
merchant's point-of-sale terminal/systems and reformats them for submission to
the Visa network. We were chosen by nine banks currently in the program to serve
as their Acquirer Processor. Most banks presently in the Visa Program are large
national or regional banks and already had terminal management service providers
that could act as Acquirer Processor for the Visa Program. In the future, as
smaller banks make the decision to enter the Visa Program, it is expected that
many will have no prior relationship with a terminal management provider and
therefore, may potentially choose us as their Acquirer Processor.
We derive transaction revenue in our role as a Third-Party Processor and/or
Acquirer Processor by negotiating a transaction fee with Visa and/or the bank
that chose us as its Third-Party Processor and/or Acquirer Processor. This
Third-Party Processor transaction fee averages $0.07 to $0.09 per transaction
and the Acquirer Processor transaction fee is generally $0.02 to $0.04. The
party that sells the service to the merchant (usually the bank) enjoys the
largest mark-up on the product, offering the service in the range of $0.20 to
$0.50 per check, with external cost in the $0.12 to $0.15 range, depending on
what the bank negotiates with Visa and any third-party provider.
We entered into a sponsorship agreement with our primary credit card processing
bank, First Regional Bank, to enable us to sell the Visa Program directly to
merchants with an obligation to pay a $0.01 transaction fee per check to the
bank. This allows the bank to realize added revenue, allows us to realize higher
revenue in a marked-up pricing model, and a portion of the mark-up to be used to
compensate and motivate resellers of our products and services to offer the Visa
Program to merchants in the marketplace. The balance of the mark-up after
paying the bank and the sales organization would be additional revenue to us.
This will also enable us to use our direct sales channels to provide the Visa
Program to ECHO's current and potential merchant base.
The Visa infrastructure requires ECHO to coordinate and integrate its services
with several parties and systems. As part of the Visa Program, we have written,
tested and installed special merchant terminal software that meets specified
Visa Program requirements and certified our terminal and host response code with
Vital Processing Services, a major provider of terminal services to many major
banks. ECHO has also developed special add-on services and reporting for
specific banks or select merchants that desired to participate in the Visa
Program. Additionally, ECHO has designed and implemented several risk management
tools that contribute to the significant reduction in net bad debt seen by
retailers, making the Visa Program a true competitive alternative to guarantee
services.
In fiscal 2005, the Visa POS Check Program has not grown at the pace anticipated
but several major marketing hurdles have been addressed. At its initial release
in 2002, there were five primary concerns expressed by banks and/or national
merchants who were approached to either sell and/or participate in the service.
Those concerns were:
- Visa was connected to less than 10% of the nation's checking accounts.
The added value that justified the higher cost of the Visa Program was
questionable when compared to a simple check verification service that
utilizes national negative databases.
- It was believed that a merchant would have to buy a check imager to
participate in the program at a cost of around $600 for each check-out
lane, a major investment for national merchants.
9
- There was a concern as to how customers would react, positively or
negatively, to getting their checks back at the point of sale.
- There was a concern that the service would slow down the check-out
time.
- There was concern that ECHO could perform, being such a small company.
Regarding the first four concerns, Visa has effectively addressed the issue of
check coverage by increasing its connectivity nationally to around 20% and in
certain areas to 30% or higher; the perceived need for an imager to be used has
been disproved by several national merchants who are on the program, being very
successful using their existing MICR check reading equipment; check writers have
accepted the program very positively; and, there has been no slow-down in the
check-out times at the point of sale.
On the final concern of ECHO's performance, several national merchants have come
on the Visa POS Check program and are using ECHO. These would include merchants
such as Gap, Banana Republic, Old Navy, Burlington Coat Factory, Pearle Vision,
Things Remembered and Sheetz Petroleum, to name a few. All these merchants have
seen significant costs savings in centralizing their check clearing services
into one account (compared to literally thousands of bank accounts in some
cases) and all have seen a significant reduction in their bad check losses since
moving to the Visa POS Check program.
With each of the initial concerns about the Visa POS Check Program being
adequately addressed, we believe the merchants and/or banks that were initially
made aware of the Program should be advised of the progress and encouraged to
take another look at participating in the Program. We plan to do this ourselves
and, as requested, to assist Visa and any of its member banks in sharing this
positive update on the growing effectiveness of the Visa POS Check program.
Deriving Revenue
-----------------
For the past several years, we have invested significant resources and
management focus in our check services business. This business segment
comprised approximately 26.0% of our total revenue for the fiscal year ended
September 30, 2005. As an individual segment, check-related revenue increased
by 26.6% to $14,458,000 in fiscal 2005 from $11,423,000 in fiscal 2004.
ECHO's revenue in check services can come from several sources. Typically, the
merchant pays either a fixed fee for each transaction (verification, conversion,
etc.) or a fee based on the face amount of the check (check guarantee) or both
(check guarantee). In the Visa model, ECHO can receive transaction fees for
providing Third-Party services to Visa banks, whereby ECHO assists them in
processing checks from banks not participating in the Visa Program. In
addition, ECHO may serve a Visa bank as a collector of the transaction data for
the merchant and submitting such data to VisaNet, a process referred to as an
Acquirer Processor. ECHO can also participate in the mark-up over cost that is
charged to those merchants ECHO sells directly through its own primary sales
channels. 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 directly or to a bank to offer to their
merchants, it earns a percentage of every check processed from the merchant.
ECHO's earnings in this case are directly tied to its success in collection and
its risk management capability.
The NCN database includes over 30 million negative check account records and 130
million positive records. Approximately 300 affiliated collection agencies
continually contribute to the database to enrich its depth and value. Through
its network of NCN members, ECHO can offer regional collection services and
distribute collection items to one or more of a select group of NCN's member
agencies to maximize a merchant's or bank's ability to collect amounts on a
local level. NCN provides an ongoing revenue stream for ECHO as collection
agencies, major national merchants, banks, other transaction processors, and
thousands of small merchants access the NCN database daily to verify the status
of a check writer in real time. Check verification has been recognized as one
of the lowest cost and most effective ways for retailers to lower the risks and
losses experienced in accepting checks as a form of payment. Our NCN database is
one of only four national databases that can serve this market need on a
national scale, and we are currently the fifth largest check verification
processor in the United States according to the September 2005 issue of The
Nilson Report, a monthly financial subscription-based newsletter. In addition
to operating NCN, we provide a common platform where a business can also access
other major negative check writer databases that are currently available in the
nation.
10
XPRESSCHEX collection revenue comes from two sources: service fees and
percentage of the check collection agreements. When XPRESSCHEX is engaged by a
merchant or a bank to immediately collect on returned checks that were converted
from paper to an electronic item, XPRESSCHEX normally receives the service fee
of $15 to $25 that is charged to the check writer, not the merchant. Some
merchants also engage XPRESSCHEX in the active collection of paper checks that
have bounced or in the active collection of secondary efforts after all initial
attempts at collection have been exhausted by the merchant. In these cases,
XPRESSCHEX negotiates a percentage of the check amount, ranging from 10% to 25%,
depending on several factors.
STRATEGY
Overview
--------
ECHO's service strategy is to provide merchants, banks and industry-specific
resellers with electronic payment services that combine credit card, debit card
and electronic check and collection services with quality customer support.
ECHO's services enable merchants to maximize revenue by offering a wide variety
of payment options, minimize costs by dealing with one source and improve their
bad debt collection rates through use of ECHO's integrated collection and risk
management services.
Our sales strategy is four-fold: to target providers of point-of-sale systems
who serve various industries in the merchant marketplace; to continue to pursue
community banks with the combined set of services we currently offer; to focus
our direct sales team on specific associations and merchants in industries where
both checks and credit cards are common forms of payment; and to continue to
support and promote the Visa POS Check Program. We intend to capitalize on our
advantage of being a full credit card and check processor by combining our
products and using our lower overall processing costs to allow the system
provider, community bank or association to enjoy a financial benefit from their
customer's processing activity.
Electronic Payment Services for POS System Providers
We believe there are significant opportunities in working closely with those
firms that specialize in certain industries and provide a point-of-sale (POS)
capability to merchants of some nature. By aligning our processing with these
parties, we believe we can leverage our sales activity and have longer term
relationships with merchants than are historically the case for most processors.
We also believe our full processing capability allows us to include the POS
system provider with some economic benefit from the processing volume of the
users of its system.
Promote Merchant Payment Processing for Regional and Community Banks
ECHO pursues small regional and community banks for credit card and check
payment programs that are characterized by having an asset base in the $500
million range or less, and/or equity capital in the $10 to $50 million range.
ECHO has developed a service that allows smaller banks to offer credit card and
check processing services on a private-label basis using our back-end
infrastructure with little or no technical involvement by the bank. Much of the
reporting to the merchant utilizes the Internet as a delivery channel, an
environment in which we have significant experience and knowledge. 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 credit card and check real
time processing services and Internet-based reporting tools to their merchants.
We have designed the program to be adopted by a bank at little or no cost while
it allows the bank to generate revenue and earnings in competition to those
earned by much larger banks that have had to make major investments in the
technology.
This merchant payment processing service, which is marketed under the
MerchantAmerica name, incorporates all of ECHO's web-based features and
functionalities and our full set of services and payment options. We believe
that our fully integrated payment and reporting system allows smaller banks to
enjoy competitive equality with much bigger banks without making significant
investments in technology. We, in turn, benefit from the increased processing
and transaction revenue. 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
- Reduction of fraud risk.
11
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; all returned check being automatically referred to our collection
agency; and dedicated customer service available 24 hours a day, seven days a
week.
The program was launched in August 2002 and at the end of fiscal 2005 had
twenty-four participating banks. ECHO estimates that there are 10,000 community
banks in the United States and no one provider of services has over 10% of the
market. Based on third-party research, we estimate that approximately 6,000 of
these banks do not offer any payment solution but refer their merchants to
outside providers. The approximately 4,000 banks that are affiliated with a
payment service, we believe, will be very responsive to the MerchantAmerica
value proposition when a comparison of features and costs is reviewed.
Promote to Associations and Guilds
There are over 8,000 associations and guilds in the United States and many of
the 4.1 million merchants belong to one of these organizations. We believe our
combination of services and our controlled cost structure will allow us to
attract many of these organizations to actively refer their members to us for
meeting their payment processing needs.
Promote Visa POS Check Service Program
Given ECHO's role as a "first adopter" in the early stages of the Visa Program
and our subsequent investment of significant resources and management focus with
respect to the Visa Program, we expect to see increased growth in check services
as the marketing efforts of participating banks in the Visa Program become more
widely implemented.
A large participating bank sold the Visa Program to the national retailer, Gap,
and it deployed the service to all of their stores (Gap, Banana Republic and
Old Navy) in June of 2003. Their stores submit check MICR data (the numbers
along the bottom of a check) in real time and then return the paper check to the
check writer at the point of sale. ECHO responds with an approval or decline to
the check in less than two seconds and for those it approves, it moves the funds
nightly from the customers account to the merchant's account. ECHO also
coordinates all electronic check representment and collection on returned checks
when needed. Gap remains the largest merchant in the Visa Program to date.
The primary source of savings to merchants on the Visa Program are derived from
(1) the elimination of having to handle and process paper checks and (2) the net
financial benefit seen from the bad check write-off percentage falling below the
rates charged by the national guarantee services.
While ECHO believes that the Visa Program has the potential to generate
significant revenue for us in the future, the market potential of this service
is still unproven and its success is largely dependent on the continuing
marketing support of ECHO, Visa and Visa's member banks.
SALES AND MARKETING
ECHO offers its payment services through several sales channels.
- Primary Sales Channels - Direct sales personnel are dedicated to
various industries and/or services. We employ approximately 20 people
who serve in either field or office positions that are dedicated to
sales.
- Secondary Sales Channels - All or a portion of our services are sold
through banks who sign up with our MerchantAmerica Agent Bank program,
through banks who are selling the Visa POS Check Program, through
authorized resellers, independent sales organizations (ISO's) and
through one of our 300 NCN Collection Agency Members. These channels
offer lower margins to us due to the added participation in the
overall revenue such channels require. Currently ECHO has 150
authorized resellers registered to sell ECHO's check products.
12
Management believes that we are distinctive in the number of payment methods
that we allow, the combination of transaction types that we manage directly, our
ability to integrate additional services and our ability to support each
merchant through one vertically integrated source.
Our marketing strategy is to build processing relationships with certain
providers of POS software/hardware that serve select merchant markets; maximize
cross-selling opportunities to our existing base of retail merchants and
financial institutions; sell integrated suites of check, credit and debit card
processing services through small banks and industry-specific resellers; enhance
and market MerchantAmerica.com; and pursue associations aggressively.
COMPETITION
Bankcard processing and check processing services are highly competitive
industries and are characterized by consolidation, rapid technological change,
rapid rates of product obsolescence and introductions of competitive products
often at lower prices and/or with greater functionality than those currently on
the market. Credit card and debit card processors have similar direct costs and
therefore their products are becoming somewhat of a commodity product where a
natural advantage accrues to the highest volume processors. To offset this fact,
we have focused on marketing to niche markets where we can maintain the margins
we deem necessary to operate profitably but no assurance can be given that this
strategy will be successful in the future.
There are a number of competitors in the check services industry, the largest of
which are TeleCheck (the leading provider of conversion and guarantee services
and a subsidiary of First Data Corporation), SCAN/eFunds (the largest
verification provider in the nation), Certegy (recently purchased by Fidelity)
and Global Payments. While all four have major national accounts, we have been
successful in winning the processing relationships for national accounts from
each one. ECHO believes that it can effectively compete due to its ownership of
the NCN database, its integrated set of check and collection services and the
technological advantage of having been certified as both a Third-Party Processor
and Acquirer Processor with the Visa POS Check Program.
ECHO is among the top 50 credit card processors in the nation when evaluated by
processing volume. ECHO is among a much smaller group when evaluated by
processing capability. Of the top 50 firms, approximately 40 of them are
independent sales organizations or banks that may manage the front-end
authorization service but they hire the back-end clearing and settlement
services from a full service processor. There are probably 10 or fewer firms
capable of full credit card processing and these would include First Data
Corporation, Total Systems, NPC (Bank of America), Global Payments, First
Horizon, and CSS. We believe we hold the distinction of being the smallest
public company who, with the installation of the Oasis Clearing module in 2006,
will serve as a full service processor in credit cards. All of our competitors
have greater financial and marketing resources than us. As a result, they may
be better able to respond more quickly to new or emerging technologies and
changes in customer requirements. Competitors also may enjoy per transaction
cost advantages due to their high processing volumes that may make it difficult
for ECHO to compete.
We believe that being the smallest processor also has some advantages. There
are many merchants who are sizable to us that the larger processors do not
consider to be major merchants. We are finding these merchants appreciate
getting preferential treatment from their processor. Also, our willingness to
send top management into the field to meet regularly with our major merchants at
their location is a perceived distinction and we are using it as a merchant
retention tool. While we understand that slightly lower costs can be generated
by processing high volumes, we do not think the economic advantages that high
volume affords are enough to eliminate ECHO as an acceptable and competitive
processor in most cases. Despite these potential advantages, we believe that our
success will depend largely on our ability to continuously exceed expectations
in terms of performance, service, and price, on our ability to develop new
products and services, and on how well and how quickly we enhance our current
products and introduce them into the market.
EMPLOYEES
As of September 30, 2005, we employed 222 individuals, 203 of whom were full
time employees.
13
REPORTABLE SEGMENTS
Refer to Note 14 "Segment Information" in the accompanying Notes to Consolidated
Financial Statements for reportable segment information.
ITEM 2. PROPERTIES
In March 2004, we sold a building in Agoura Hills, California which was
previously our corporate headquarters, for $2,382,000, and paid off the two
notes collateralized by this building. As a result of this sale, we recognized a
gain of $1,319,000 on a pre-tax basis.
In October 2003, we leased 21,566 square feet of a 40,000 square foot building
in Camarillo, California. Our principal executive offices, including customer
support, data center and other operational departments were moved to this
Camarillo location. We signed an addendum to the Camarillo lease in July 2004
and added 11,103 square feet to the lease. We currently occupy 32,669 square
feet of the Camarillo building. The lease payment for this facility as of
September 2005 was $35,936 per month.
We have additional real property leases in Albuquerque, New Mexico; Lakewood,
Colorado; Provo, Utah; Lawrence, Kansas; and Glendale, California for sales,
data center and other operations, under various agreements, which expire at
various times over the next year. The total of these lease payments are
approximately $18,000 per month.
ITEM 3. LEGAL PROCEEDINGS
We are involved in various lawsuits arising in the ordinary course of business.
Based upon current information, management, after consultation with legal
counsel, believes the ultimate disposition of these lawsuits will have no
material effect upon either our results of operations, financial position, or
cash flows.
In July 2004, LML Patent Corporation, a wholly-owned subsidiary of LML Payment
Systems, Inc. ("LML"), filed a patent infringement claim against us, our
subsidiary, XPRESSCHEX, Inc. and others, relating with respect to us and our
subsidiary, to the alleged infringement by our check conversion processes of
three patents held by LML. In September 2005, the patent infringement claims for
two (2) of the patents were dropped. The suit was filed in the U.S. District
Court for the District of Delaware. The discovery process and expert witness
reports have been completed and claims construction briefs and summary judgment
briefs have been filed with the court in anticipation of a December 19, 2005
hearing on these issues. LML seeks an undisclosed amount of damages in
connection with the alleged infringement.
We were aware of the LML patents prior to LML's initiation of the claims and had
previously obtained competent legal opinions from outside patent counsel that
neither we nor any of our subsidiaries infringe on any valid or enforceable
patent rights of LML being asserted in the litigation. No documents came out of
the discovery process to alter our original belief, and we will continue to
vigorously defend our position against the remaining claims made.
Ultimately, we expect that we will not be held liable for any of the alleged
infringement, including for any treble punitive damages. The case is scheduled
to go to trial in April of 2006. Should we be held liable for any alleged
infringement, which is not expected, the ultimate liability we may sustain may
include a royalty payment primarily calculated on activity commencing in the
middle of calendar 2003 for only select conversion activity, as that was the
time period in which we actively began utilizing the check conversion processes
alleged to infringe the LML patents. In view of the relatively short time
period involved and the relatively small overall transaction volume arising from
the alleged infringing check conversion services in comparison to our total
transaction volume, we believe that any such alleged damages award should have a
relatively minor impact on our results of operations, financial position, or
cash flows.
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, 2005.
14
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES
Since January 17, 1986, we have been trading on the over-the-counter market
under the name Electronic Clearing House, Inc. On October 2, 1989, we were
accepted for listing on the National Association of Securities Dealers Automated
Quotation System ("NASDAQ") and trade under the symbol of "ECHO" on the NASDAQ
Capital Market. The following table sets forth the range of high and low prices
for our common stock during the fiscal periods indicated, as reported on the
NASDAQ Capital Market.
FISCAL YEAR ENDED
SEPTEMBER 30 High Low
------------------ ------ -----
2005
------------------
First Quarter $ 9.65 $7.42
Second Quarter $ 9.22 $7.99
Third Quarter $10.35 $7.10
Fourth Quarter $ 9.36 $8.00
2004
------------------
First Quarter $11.33 $6.15
Second Quarter $13.06 $8.23
Third Quarter $11.47 $8.75
Fourth Quarter $ 9.99 $6.45
The prices set forth above are not necessarily indicative of liquidity of the
trading market. Trading in our common stock is limited and sporadic, as
indicated by the average monthly trading volume of 307,639 shares for the period
from October 2004 to September 2005. On December 12, 2005, the closing
representative price per share of our common stock, as reported on the NASDAQ
Capital Market, was $9.90.
HOLDERS OF COMMON STOCK
As of December 12, 2005, there were 822 record holders and 2,591 beneficial
holders of our common stock, with 6,661,701 shares outstanding. The number of
holders of record is based on the actual number of holders registered on the
books of our transfer agent and does not reflect holders of shares in "street
name" or persons, partnerships, associations, corporations or other entities
identified in security position listings maintained by depository trust
companies.
DIVIDEND POLICY
We have not paid any dividends in the past and have no current plan to pay any
dividends. We intend to devote all funds to the operation of our businesses.
EQUITY COMPENSATION PLAN INFORMATION
The Equity Compensation Plan Information identified in Item 11 of this Annual
Report on Form 10-K is incorporated herein by this reference.
PURCHASES OF EQUITY SECURITIES
We have not repurchased, nor has any affiliated purchaser repurchased, shares of
our common stock.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth certain selected consolidated financial data,
which should be read in conjunction with the Consolidated Financial Statements
and Management's Discussion and Analysis of Financial Condition and Results of
Operations included in Items 7 and 8 below. The following data, insofar as it
relates to each of the five
15
years ended September 30, has been derived from our annual financial statements,
including the consolidated balance sheets at September 30, 2005 and 2004, and
the related consolidated statements of operations and of cash flows for the
three years ended September 30, 2005, 2004 and 2003, and notes thereto appearing
elsewhere herein.
YEAR ENDED SEPTEMBER 30
------------------------------------------------------------------------
2005 2004 2003 2002 2001
--------------- -------------- ----------- ----------- -------------
( ---- AMOUNTS IN THOUSANDS, EXCEPT PER SHARE ---- )
STATEMENT OF OPERATIONS DATA:
-----------------------------
Revenue $ 55,551 $ 48,320 $ 41,149 $ 33,291 $ 29,943
Costs and expenses 53,872 44,863 38,724 36,960 29,380
--------------- -------------- ----------- ----------- -------------
Income (loss) from operations 1,679 3,457 2,425 (3,669) 563
Interest income (expense), net 23 (104) (172) (74) 106
Other income (expense), net -0- 1,319 -0- -0- 350
--------------- -------------- ----------- ----------- -------------
Income (loss) before income tax
(provision) benefit and cumulative
effect of an accounting change 1,702 4,672 2,253 (3,743) 1,019
(Provision) benefit for income taxes (669) (1,823) (925) 1,367 (585)
--------------- -------------- ----------- ----------- -------------
Income (loss) before cumulative
effect of an accounting change 1,033 2,849 1,328 (2,376) 434
Cumulative effect of an accounting
change to adopt SFAS 142[1] -0- -0- (4,707) -0- -0-
--------------- -------------- ----------- ----------- -------------
Net income (loss) $ 1,033 $ 2,849 $ (3,379) $ (2,376) $ 434
=============== ============== =========== =========== =============
Earnings (loss) per share-basic $ 0.16 $ 0.45 $ (0.58) $ (0.41) $ 0.07
Earnings (loss) per share-diluted $ 0.15 $ 0.41 $ (0.56) $ (0.41) $ 0.07
Weighted average number of common
shares and equivalents outstanding-basic 6,485 6,312 5,812 5,788 5,797
Weighted average number of common
shares and equivalents outstanding-diluted 6,939 6,900 6,024 5,788 5,964
BALANCE SHEET DATA:
-------------------
Working capital $ 8,037 $ 8,004 $ 3,201 $ 3,234 $ 5,821
Current assets 29,310 29,923 9,646 5,728 8,259
Total assets 40,817 39,428 18,775 18,191 18,921
Current liabilities 21,273 21,919 6,445 2,494 2,438
Long-term debt, and payables to
stockholders and related parties,
less current portion 705 704 1,961 2,159 744
Total stockholders' equity $ 17,772 $ 16,240 $ 10,369 $ 13,538 $ 15,739
[1] The Company completed the transitional impairment testing required by SFAS
142 in the first quarter of fiscal 2003 and determined that its goodwill
was fully impaired and a $4.7 million goodwill write-off was recognized.
16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
Electronic Clearing House, Inc. is an electronic payment processor that provides
for the payment processing needs of merchants, banks and collection agencies.
We derive the majority of our revenue from two main business segments, bankcard
and transaction processing services ("bankcard services"), whereby we provide
solutions to merchants and banks to allow them to accept credit and debit card
payments from consumers, and check-related products ("check services"), whereby
we provide various services to merchants and banks to allow them to accept and
process check payments from consumers. The principal services we offer within
these two segments include, with respect to our bankcard services, debit and
credit card processing, and with respect to our check services, check guarantee,
check verification, electronic check conversion, check re-presentment, and check
collection.
We organize our service offerings under the following brand names:
- MerchantAmerica: ECHO's retail provider of payment processing services
to both merchant and bank markets;
- National Check Network ("NCN"): for check verification, check
conversion capture services and for membership to collection agencies;
- XPRESSCHEX, Inc.: for check collection services; and
- ECHO: for wholesale credit card and check processing services.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management's discussion and analysis of financial condition and results of
operations is based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires management
to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenue and expenses, and related disclosure of contingent assets
and liabilities. On an on-going basis, management evaluates its estimates,
including those related to revenue recognition, deferred taxes, reserve for
doubtful accounts, capitalization of software costs, contingencies and
litigation. Management bases its estimates on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates.
Management applies the following critical accounting policies in the preparation
of our consolidated financial statements:
- REVENUE RECOGNITION POLICY. We earn revenue from services which include
the following: debit and credit card processing, check verification, ACH
services, check conversion, check re-presentment, check collection, check
guarantee, and inventory tracking. All of these services are performed pursuant
to a contract with customers which states the terms and fixed price for all
contracted services. The price of a service may be a fixed fee for each
transaction and/or a percentage of the transaction processed, depending on the
service. We generally collect our fee at the time we process the transaction
and accordingly, collectibility of the service fee is reasonably assured.
Revenue from debit and credit card (collectively called bankcards) and
transaction processing revenue is based on a percentage of the transaction
value, commonly referred to as a discount fee on a credit and debit card
transaction processed by us. In addition, there is a per transaction fee
associated with each bankcard transaction which is charged to the merchant. We
recognize the processing and transaction revenue when the services are
performed.
Revenue from check verification is derived from fees collected from the
merchants when a check is verified against our own positive and negative check
database and other check databases that we use. This revenue is recognized when
the transaction is processed, since we have no further performance obligations.
Revenue from check conversion is derived from fees collected from merchants to
convert the paper check received by merchants into an ACH transaction, which
allows us to settle the transaction electronically for the merchant. We
recognize the revenue related to check conversion fees when the services are
performed.
17
Revenue from check re-presentment is derived from fees charged to check writers.
Check re-presentment is a service that allows merchants to collect a paper check
through the ACH network after a check has previously been presented to the bank
for collection unsuccessfully at least once. The fees earned from the check
writer are recognized when collected, as collectibility is not reasonably
assured until that point.
Revenue from check guarantee is derived from a percentage of the gross amount of
the check and guarantees payment of the check to the merchant in the event the
check is not honored by the check writer's bank. Merchants typically present
customer checks for processing on a regular basis and, therefore, dishonored
checks are generally identified within a few days of the date the checks are
guaranteed by us. We recognize revenue when the checks are processed at the
point of sale. At the time the guarantee revenue is recognized, we provide a
reserve for estimated guarantee losses based upon our historical loss
experience. In the event the check is dishonored, we have the right to collect
the full amount of the check from the check writer. We establish a receivable
from the delinquent check writer for the full amount of the guaranteed check.
The check guarantee service also earns revenue based on fees collected from
delinquent check writers, which collection fee is recognized when collected, as
collectibility is not reasonably assured until that point.
Revenue from check collection is derived from collection activities performed on
behalf of a merchant on uncollected checks. The merchants usually keep the face
amount of the uncollected checks if the collection effort is successful. Our
revenue is derived from the collection fee collected from the check writer. If
we refer the collection item to another collection agency, we will receive a fee
from the collection agency upon its successful efforts. Collection fee revenue
is recognized when collected, as collectibility is not reasonably assured until
that point.
Revenue from inventory tracking is derived from transaction fees for processing
and tracking U-Haul's daily inventory activities. This revenue is recognized
when the transaction is processed, since we have no further performance
obligations.
- DEFERRED TAXES. Deferred taxes are determined based on the differences
between the financial statement and tax basis of assets and liabilities, using
enacted tax rates in effect for the year in which the differences are expected
to reverse. Valuation allowances are established when necessary to reduce
deferred tax assets to the amounts expected to be realized. In assessing the
need for a valuation allowance, management considers estimates of future taxable
income and ongoing prudent and feasible tax planning strategies.
- CHARGEBACK LOSSES. Chargeback losses occur when a credit card holder
presents a valid claim against one of our merchants and the merchant has
insufficient funds or is no longer in business resulting in the charge being
absorbed by us. We record a receivable for those chargebacks for which the
merchant is liable but has not made payment. We record a provision for
estimated chargeback losses at the time bankcard transactions are processed. A
reserve is estimated based upon a historically-determined percentage of gross
credit card processing volume and actual losses experienced.
- RESEARCH AND DEVELOPMENT EXPENSE. Expenditures for activities relating to
product development and improvement are charged to expense as incurred. Such
expenditures amounted to $1,609,000 in fiscal year 2005 and $1,465,000 in fiscal
year 2004.
- CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE. Effective October
1, 2002, we adopted Statement of Financial Accounting Standards No. 142 ("SFAS
142"), "Goodwill and Other Intangible Assets". SFAS 142 requires that goodwill
no longer be amortized, but instead be tested for impairment at least annually
using a fair value-based approach. SFAS No. 142 required us to perform an
initial assessment of our reporting units to determine whether there was any
indication that the goodwill carrying value was impaired. This transitional
assessment was made by comparing the fair value of each reporting unit, as
determined in accordance with the new standard, to its book value. In 2003, we
determined that all of our goodwill was impaired under SFAS No. 142 and
accordingly took a charge to write down the amount of that impairment.
- CAPITALIZATION OF SOFTWARE COSTS. The costs of purchased and internally
developed software used to provide services to customers or for the process of
internal administration are capitalized and amortized on a straight-line basis
over the lesser of three years or estimated useful life. Under the provisions of
Statement of Position 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use," we capitalize software
18
costs when both the preliminary project stage is completed and management has
authorized further funding for the completion of the project. Capitalization of
costs ceases when the project is substantially complete and the software is
ready for its intended use. Software developed or obtained for internal use is
tested for impairment whenever events or changes in circumstances indicate that
its carrying amount may not be recoverable.
RESULTS OF OPERATIONS
FISCAL YEARS 2005 AND 2004
------------------------------
Financial highlights for fiscal 2005 as compared to fiscal 2004 were as follows:
-- Total revenue increased 15.0% to $55.6 million
-- Gross margin from processing and transaction revenue decreased to 35.1%
from 36.8%
-- Operating income decreased from $3.5 million to $1.7 million
-- Diluted earnings per share were $0.15 as compared to $0.41 per share.
-- Bankcard and transaction processing revenue increased by 11.4% to $41.1
Million
-- Bankcard processing volume increased 12.7% to $1.2 billion
-- Check-related revenue increased by 26.6% to $14.5 million
-- ACH processing volume increased 24.6% to 32.1 million transactions
REVENUE. Total revenue increased 15.0% to $55,551,000 for fiscal 2005, from
$48,320,000 for fiscal 2004. The increase can be primarily attributable to 11.4%
growth in bankcard and transaction processing revenue and 26.6% growth in check
services revenue year-over-year. This growth has occurred organically from our
existing merchants and from our marketing initiatives during the year.
The bankcard and transaction processing revenue increase was mainly attributable
to a 12.7% increase in bankcard processing volume as compared to fiscal 2004.
This increase was the result of our organic growth and the growth from our
various marketing channels such as the Agent Bank Program and the
MerchantAmerica marketing program.
The check-related processing revenue increase was attributable to a 41.8%
increase in ACH services revenue and a 6.4% increase in check verification
revenue. The high growth in ACH revenue was mainly due to wallet funding
activities and increases in overall ACH activities.
COST OF SALES. Bankcard processing expenses are directly related to the changes
in processing revenue. A majority of our bankcard processing expenses are fixed
costs and are reflected as a percentage of the total face amount of each
bankcard transaction, and the remaining costs are based on a fixed rate applied
to the number of transactions processed. Processing-related expenses, consisting
of bankcard processing expense and transaction and check processing expense,
increased 18.1% for the year, from $30,370,000 in fiscal 2004 to $35,867,000 in
fiscal 2005. The increase reflects the 15.0% increase in total revenue for the
year, a $449,000 increase in amortization expense and a $1,020,000 increase in
commission expense.
Total gross margin from processing and transaction services decreased from 36.8%
in fiscal 2004 to 35.1% in fiscal 2005. Gross margin from bankcard and
transaction processing decreased from 29.4% in fiscal 2004 to 27.2% in fiscal
2005. The decrease in gross margin was primarily attributable to several high
volume merchants who negotiated lower than average discount rates due to the
size of their accounts. Additionally, gross margin from check processing
decreased from 61.1% in fiscal 2004 to 57.6% in fiscal 2005. The check services
gross margin decrease was mainly attributable to an increase in commission
expense and amortization expense.
EXPENSE. Other operating costs such as personnel costs, telephone, depreciation
expenses and outside services increased 9.1%, from $5,182,000 in fiscal 2004 to
$5,653,000 in fiscal 2005. This was primarily due to the 9% increase in salaries
to support the 15% growth in fiscal 2005.
19
Research and development expenses increased 9.8%, from $1,465,000 in fiscal 2004
to $1,609,000 in fiscal 2005. Research and development initiatives are critical
for us to remain competitive with our peers. Several major development projects
were completed during fiscal year 2005. However, given the rapid change in
technology in our industry, we plan to continue to invest in product development
in both the bankcard processing business segment and the check-related products
segment in order to stay ahead of our competitors.
Selling, general and administrative (SG&A) expenses increased 36.9% from
$7,846,000 in fiscal 2004 to $10,743,000 in fiscal 2005. This increase was
primarily attributable to: 1) greater personnel costs due to cost of living
adjustments; 2) growth in sales and marketing expenses to implement our sales
and marketing strategies; 3) a $1,141,000 increase in legal expenses to defend
several lawsuits; and 4) $150,000 increase in legal settlement expenses. Even
though we were expecting legal expenses related to the LMLP lawsuit to decrease
in the second half of 2005, legal expense continues to be higher than expected.
As a percentage of total revenue, SG&A expenses increased from 16.2% in fiscal
2004 to 19.3% in fiscal 2005.
OPERATING INCOME. Operating income decreased from $3,457,000 in fiscal 2004 to
$1,679,000 in fiscal 2005, a decrease of 51.4%. The decrease in operating
income was primarily attributable to the 1.7% decrease in gross margin and the
increased selling, general and administrative expenses described above.
INTEREST EXPENSE. Interest expense decreased to $113,000 for fiscal 2005, from
$175,000 for fiscal 2004. The decrease was due to the full repayment of one note
and some capital leases during fiscal 2005. Interest income increased from
$71,000 in fiscal 2004 to $136,000 in fiscal 2005 due to higher than average
cash balances on hand throughout fiscal year 2005.
GAIN ON SALE OF ASSETS. Fiscal 2004 results were favorably affected by a
pre-tax gain of $1,319,000 resulting from the sale of the building that formerly
held the Company's principal executive offices.
EFFECTIVE TAX RATE. The income tax provision was $669,000 for fiscal 2005 as
compared to $1,823,000 for fiscal 2004. Our effective tax rate was 39.3% for
fiscal 2005, as compared to 39.0% for fiscal 2004. See Notes to Consolidated
Financial Statements included elsewhere herein for a further explanation of the
income tax expense and a reconciliation of reported income taxes to the amount
utilizing the statutory rate.
NET INCOME. Net income for fiscal 2005 was $1,033,000, as compared to $2,849,000
for fiscal 2004. This decrease was primarily attributable to the gain on the
sale of assets in fiscal 2004 and the 36.9% increase in selling, general and
administrative expenses in fiscal 2005.
SEGMENT RESULTS
Bankcard and Transaction Processing. For the year ended September 30, 2005,
bankcard processing and transaction revenue accounted for approximately 74.0% of
our revenue, compared to 76.4% in fiscal 2004. Bankcard processing and
transaction revenue increased 11.4%, from $36,897,000 in fiscal 2004 to
$41,093,000 in fiscal 2005. This increase was mainly attributable to a 12.7%
increase in bankcard processing volume as compared to fiscal 2004. We continue
to increase our bankcard processing business primarily through organic growth
and various sales and marketing programs.
In fiscal 2005, the bankcard and transaction processing segment generated
operating income of $5,829,000, or 14.2% of the related revenue, as compared to
$5,977,000, or 16.2% of the related revenue in fiscal 2004. This decrease in
operating income was primarily due to the lower gross margin combined with
higher research and development expenses and selling G&A expense.
We purchased a fully integrated, multi-modular bankcard processing system from
Oasis Technologies for approximately $1.6 million. We have incurred an
additional $1.5 million of internal development costs thus far in implementing
this system. The implementation of this system will give us greater flexibility
to price our credit card processing services, allowing us to attract and retain
larger merchants as well as the small and mid-market merchants that have been
our target market. This project has experienced numerous implementation delays,
mainly as a result of vendor software delivery issues and the vigorous testing
required prior to implementation. Management now anticipates the clearing
portions of the Oasis system to begin live customer deployment in the second
half of 2006.
20
Check Related Products. Check-related revenue increased from $11,423,000 for
fiscal 2004 to $14,458,000 for fiscal 2005, an increase of 26.6%. Check
verification revenue increased 6.4% to $3,645,000 for fiscal 2005, from
$3,425,000 for fiscal 2004. Check conversion, ACH services and check
re-presentment revenue increased 41.8% to $8,251,000 for fiscal 2005, from
$5,820,000 for fiscal 2004. Additionally, check collection revenue increased
15.4%, from $1,816,000 in fiscal 2004 to $2,096,000 in fiscal 2005. The high
growth in ACH revenue was due to wallet funding activities and the overall
increase in the ACH and conversion product. Total ACH transactions processed
during fiscal 2005 were 32.1 million transactions, as compared to 25.8 million
transactions processed in fiscal 2004, an increase of 24.6%.
Check services revenue made up 26.0% of the total processing and transaction
revenue for fiscal 2005 as compared to 23.6% in fiscal 2004. Check-related
operating income was $2,204,000 in fiscal 2005, as compared to operating income
of $1,644,000 in fiscal 2004, an increase of 34.1%. The increase in operating
income was mainly due to the 26.6% increase in check-related revenue.
The Visa Program has not grown as much as we had expected in the past year. Even
though we are getting new merchants to sign up under the Visa Program, some of
the larger merchants have shown a rather significant decline in the total
transactions processed for fiscal 2005 as compared to fiscal 2004. We attribute
this to the overall decline in check usage in the market. Additionally, certain
store branded credit cards from one of our major Visa POS Check merchants
shifted some of the payment transactions away from check. We are currently
working with 16 Visa member banks that have signed up to participate in the Visa
Program.
FISCAL YEARS 2004 AND 2003
------------------------------
Financial highlights for fiscal 2004 as compared to fiscal 2003 were as follows:
-- Total revenue increased 17.4% to $48.3 million
-- Gross margin from processing and transaction revenue improved to 36.8% from
33.5%
-- Operating income increased to $3.5 million from $2.4 million
-- Diluted earnings per share before cumulative effect of accounting change
were $0.41 as compared to $0.22 per share.
-- Bankcard and transaction processing revenue increased by 12.0% to $36.9
million
-- Bankcard processing volume increased 9.5% to $1.1 billion
-- Check-related revenue increased by 39.4% to $11.4 million
-- ACH processing volume increased 128.4% to 25.8 million transactions
REVENUE. Total revenue increased 17.4% to $48,320,000 for fiscal 2004, from
$41,149,000 for fiscal 2003. The increase was primarily attributable to 12.0%
growth in bankcard and transaction processing revenue and 39.4% growth in check
services revenue year-over-year. This growth occurred organically from our
existing merchants and from our marketing initiatives during fiscal 2004, and as
a result of increasing acceptance of our check services products and the
continued growth in the Visa Program.
The bankcard and transaction processing revenue increase was mainly attributable
to a 9.5% increase in bankcard processing volume as compared to fiscal 2003.
This increase was the result of our organic growth and the growth from our
various marketing channels such as the Agent Bank Program and the
MerchantAmerica marketing program. The increase was partially offset by the
departure of several high volume merchants during fiscal 2004.
The check-related processing revenue increase was attributable to a 10.6%
increase in check verification revenue and a 101.3% increase in ACH services
revenue. The high growth in ACH revenue was due to increasing market acceptance
of this product and continued growth in the Visa Program.
COST OF SALES. Bankcard processing expenses are directly related to changes in
processing revenue. A majority of our bankcard processing expenses are fixed
costs and are reflected as a percentage of the total face
21
amount of each bankcard transaction, and the remaining costs are based on a
fixed rate applied to the number of transactions processed. Processing-related
expenses, consisting of bankcard processing expense and transaction and check
processing expense, increased 11.8% for fiscal 2004, from $27,173,000 in fiscal
2003 to $30,370,000 in fiscal 2004. The increase reflected the 17.4% increase
in processing and transaction revenue for fiscal 2004.
Gross margin from processing and transaction services improved from 33.5% in
fiscal 2003 to 36.8% in fiscal 2004. This improvement in gross margin was
mainly due to: 1) check-related revenue, which has a higher gross margin, which
made up 23.6% of the total revenue in fiscal 2004 as compared to 19.9% of the
total revenue in fiscal 2003; and 2) a rate adjustment was applied to a broad
base of bankcard merchants during fiscal 2004 to offset increases in direct
bankcard processing expenses.
EXPENSE. Other operating costs such as personnel costs, telephone, depreciation
expenses and outside services increased 18.5%, from $4,373,000 in fiscal 2003 to
$5,182,000 in fiscal 2004 primarily due to additional staff hired in fiscal 2004
to support our growth. Research and development expenses remained constant, from
$1,464,000 in fiscal 2003 to $1,465,000 in fiscal 2004. Almost all of our major
development projects were in the coding and testing phases in fiscal 2004.
Selling, general and administrative (SG&A) expenses increased 37.3% from
$5,714,000 in fiscal 2003 to $7,846,000 in fiscal 2004. This increase was
primarily attributable to: 1) greater personnel costs due to cost of living
adjustments and greater employee benefits costs, such as health insurance and
worker's compensation insurance; 2) growth in sales and marketing expenses to
implement our sales and marketing strategies; 3) increased legal and
professional expenses to defend several lawsuits; 4) an increase in rent expense
due to our corporate relocation in October 2003; and 5) a $300,000 litigation
accrual related to an ordinary course contract dispute with one of our
independent sales organizations. The accrual represented management's good
faith evaluation of the dispute after consultation with its legal counsel. As a
percentage of total revenue, SG&A expenses increased from 13.9% in fiscal 2003
to 16.2% in fiscal 2004.
OPERATING INCOME. Operating income increased from $2,425,000 in fiscal 2003 to
$3,457,000 in fiscal 2004, an increase of 42.6%. The improvement in operating
income was primarily attributable to the 17.4% increase in revenue and the 3.3%
improvement in gross margin described above.
INTEREST EXPENSE. Interest expense decreased to $175,000 for fiscal 2004, from
$200,000 for fiscal 2003. The decrease was due to the full repayment of two
long-term notes. Interest income increased from $28,000 in fiscal 2003 to
$71,000 in fiscal 2004 due to higher than average cash balances on hand
throughout fiscal 2004.
GAIN ON SALE OF ASSETS. Fiscal 2004 results were favorably affected by a
pre-tax gain of $1,319,000 resulting from the sale of the building that formerly
held the Company's principal executive offices. After the sale, the Company used
a portion of the proceeds to pay off two loans totaling $1,524,000, which were
collateralized by the building.
EFFECTIVE TAX RATE. The income tax provision was $1,823,000 for fiscal 2004 as
compared to $925,000 for fiscal 2003. Our effective tax rate was 39.0% for
fiscal 2004, as compared to 37.7% for fiscal 2003. See Notes to Consolidated
Financial Statements included elsewhere herein for a further explanation of the
income tax expense and a reconciliation of reported income taxes to the amount
utilizing the statutory rate.
NET INCOME. Net income for fiscal 2004 was $2,849,000, as compared to a net loss
of $3,379,000 for fiscal 2003. Income before cumulative effect of an accounting
change to adopt SFAS 142 was $1,328,000 in fiscal 2003 and $2,849,000 in fiscal
2004, an increase of 114.5%. This increase was primarily attributable to the
17.1% revenue growth year-over-year and the improvements in gross margin.
SEGMENT RESULTS
Bankcard and Transaction Processing. For the year ended September 30, 2004,
bankcard processing and transaction revenue accounted for approximately 76.4% of
our revenue, compared to 80.1% in fiscal 2003. Bankcard processing and
transaction revenue increased 12.0%, from $32,957,000 in fiscal 2003 to
$36,897,000 in fiscal 2004. This increase was mainly attributable to a 9.5%
increase in bankcard processing volume as compared to fiscal 2003. This increase
was partially offset by the departure of several high volume merchants. To a
lesser extent, the increase was positively impacted by a rate adjustment to our
bankcard merchant base during fiscal 2004. We continue to grow our bankcard
processing business primarily through organic growth and various sales and
marketing programs.
22
In fiscal 2004, the bankcard and transaction processing segment generated
operating income of $5,977,000, or 16.2% of the related revenue, as compared to
$4,303,000, or 13.1% of the related revenue in fiscal 2003. This increase in
operating income was reflective of the increase in revenue and higher gross
margins resulting from the broad-base rate adjustment to merchants to offset
higher operating costs.
In fiscal 2001, we purchased a fully integrated, multi-modular bankcard
processing system from Oasis Technologies for approximately $1.3 million. We
incurred an additional $700,000 of internal development costs in fiscal 2004 in
implementing this system.
Check Related Products. Check-related revenue increased from $8,192,000 for
fiscal 2003 to $11,423,000 for fiscal 2004, an increase of 39.4%. Check
verification revenue increased 10.6% to $3,425,000 for fiscal 2004, from
$3,097,000 for fiscal 2003. Check conversion, ACH services and check
re-presentment revenue increased 101.2% to $5,820,000 for fiscal 2004, from
$2,892,000 for fiscal 2003. Additionally, check collection revenue increased
1.4%, from $1,791,000 in fiscal 2003 to $1,816,000 in fiscal 2004. The high
growth in the check conversion and ACH revenue was due to the increasing market
acceptance of this product and to the transaction revenue generated by the Visa
Program. Total ACH transactions processed during fiscal 2004 were 25.8 million
transactions, as compared to 11.3 million transactions processed in fiscal 2003,
an increase of 128.4%. ACH transactions, like ACH revenue, increased primarily
from the increasing market acceptance of the ACH services and the Visa Program.
Check services revenue made up 23.6% of the total processing and transaction
revenue for fiscal 2004 as compared to 19.9% in fiscal 2003. Check-related
operating income was $1,644,000 in fiscal 2004, as compared to operating income
of $591,000 in fiscal 2003, an increase of 178.2%. The increase in operating
income was mainly due to the 39.4% increase in check-related revenue.
One of the Visa acquiring banks, using us as the Third-Party Processor, rolled
out this Program to a national retailer in June 2003. This one merchant
accounted for a significant percentage of revenue generated from the Visa
Program in fiscal 2004 and an increased volume of transactions processed.
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 2005, we had available cash and cash equivalents of
$6,732,000, restricted cash of $1,448,000 in reserve with our primary processing
banks and working capital of $8,037,000.
Accounts receivable, net of allowance for doubtful accounts, increased to
$2,421,000 at September 30, 2005 from $1,943,000 at the end of fiscal 2004.
Allowance for doubtful accounts, which reflects chargeback losses decreased to
$92,000 at the end of fiscal 2005 from $111,000 at September 30, 2004. The
increase in accounts receivable was due to the higher processing revenue
generated in fiscal 2005 and therefore higher month-end balances.
Net cash provided by operating activities for the year ended September 30, 2005
was $3,888,000 as compared to net cash provided by operating activities of
$5,325,000 for fiscal 2004. The $1,437,000 decrease in cash from operations was
primarily attributable to the $1,816,000 decrease in net income between fiscal
2005 and 2004.
Net cash used in investing activities was $4,636,000 for the fiscal 2005 as
compared to $1,904,000 for fiscal year 2004. During fiscal 2005, we used
$4,640,000 for purchases of equipment and capitalized software costs as compared
to $4,278,000 for fiscal 2004.
Net cash used by financing activities was $96,000 for the current fiscal year as
compared to net cash provided by financing activities of $1,247,000 for fiscal
year 2004. We paid off $438,000 in notes payable, used $452,000 for the
repayment of capitalized leases and received $394,000 from the exercise of
employee stock options. During fiscal 2004, we received net proceeds of
$2,693,000 from a private placement.
As of September 2005, we have a $2,000,000 equipment lease line and a $3,000,000
credit line with Bank of the West for working capital needs. As of September 30,
2005, we have drawn down $1,000,000 of the equipment lease line but have not
used the $3,000,000 credit line.
23
At September, 2005, we had the following cash commitments:
Payments Due By Period
----------------------
Contractual Less than More Than
Obligations Total 1 year 1-3 years 3-5 years 5 years
-------------------- ---------- ---------- ---------- ---------- ----------
Long-term debt
including interest $1,038,000 $ 339,000 $ 570,000 $ 129,000 $ -0-
Capital lease
obligations 229,000 160,000 69,000 -0- -0-
Operating leases 1,535,000 537,000 998,000 -0- -0-
---------- ---------- ---------- ---------- ----------
Total contractual
cash obligations $2,802,000 $1,036,000 $1,637,000 $ 129,000 $ -0-
========== ========== ========== ========== ==========
Our primary source of liquidity is expected to be cash flow generated from
operations and cash and cash equivalents currently on hand. Management believes
that our cash flow from operations together with cash on hand, our equipment
lease line, our established line of credit with Bank of the West, and cash
previously received from our private placement financing will be sufficient to
meet our working capital and other commitments.
OFF-BALANCE SHEET ARRANGEMENTS
At September 30, 2005, we did not have any off-balance sheet arrangements.
NEW ACCOUNTING PRONOUNCEMENT
In December 2004, the FASB issued SFAS 123R, "Share-Based Payment, an amendment
of FASB Statements Nos. 123 and 95," that addresses the accounting for
share-based payment transactions in which a Company receives employee services
in exchange for either equity instruments of the Company or liabilities that are
based on the fair value of the Company's equity instruments or that may be
settled by the issuance of such equity instruments. SFAS 123R eliminates the
ability to account for share-based compensation transactions using the intrinsic
method that the Company currently uses and generally would require that such
transactions be accounted for using a fair-value-based method and recognized as
expense in the consolidated statement of operations. SFAS 123R is effective for
annual periods beginning after June 15, 2005. Management is currently
evaluating the impact of SFAS 123R and it is expected that it will have a
significant impact on the consolidated statement of operations as the Company
will be required to expense the fair value of stock option awards.
RISK FACTORS
Our business, and accordingly, your investment in our common stock, is subject
to a number of risks. These risks could affect our operating results and
liquidity. You should consider the following risk factors, among others, before
investing in our common stock:
RISKS RELATED TO OUR BUSINESS
---------------------------------
WE RELY ON COOPERATIVE RELATIONSHIPS WITH, AND SPONSORSHIP BY, BANKS, THE
ABSENCE OF WHICH MAY AFFECT OUR OPERATIONS.
We currently rely on cooperative relationships with, and sponsorship by, banks
in order to process our Visa, MasterCard and other bankcard transactions. We
also rely on several banks for access to the Automated Clearing House ("ACH")
for submission of both credit card and check settlements. Our banking
relationships are currently with smaller banks (with assets of less than
$500,000,000). Even though smaller banks tend to be more susceptible to mergers
or acquisitions and are therefore less stable, these banks find the programs we
offer more attractive and we believe we cannot obtain similar relationships with
larger banks at this time. A bank could at any time curtail or place
restrictions on our processing volume because of its internal business policies
or due to
24
other adverse circumstances. If a volume restriction is placed on us, it could
materially adversely affect our business operations by restricting our ability
to process credit card transactions and receive the related revenue. Our
relationships with our customers and merchants would also be adversely affected
by our inability to process these transactions.
We currently maintain one primary bankcard processing and sponsorship
relationship with First Regional Bank in Agoura Hills, California. Our agreement
with First Regional Bank continues through 2005. We are currently negotiating
with First Regional Bank on an extension of the agreement. We also maintain
several banking relationships for ACH processing. While we believe our current
bank relationships are sound, we cannot assure that these banks will not
restrict our increasing processing volume or that we will always be able to
maintain these relationships or establish new banking relationships. Even if new
banking relationships are available, they may not be on terms acceptable to us.
With respect to First Regional Bank, while we believe their ability to terminate
our relationship is cost-prohibitive, they may determine that the cost of
terminating their agreement is less than the cost of continuing to perform in
accordance with its terms, and may therefore determine to terminate their
agreement prior to its expiration. Ultimately, our failure to maintain these
banking relationships and sponsorships may have a material adverse effect on our
business and results of operations.
MERCHANT FRAUD WITH RESPECT TO BANKCARD AND ACH TRANSACTIONS COULD CAUSE US TO
INCUR SIGNIFICANT LOSSES.
We significantly rely on the processing revenue derived from bankcard and ACH
transactions. If any merchants were to submit or process unauthorized or
fraudulent bankcard or ACH transactions, depending on the dollar amount, ECHO
could incur significant losses which could have a material adverse effect on our
business and results of operations. ECHO assumes and compensates the sponsoring
bank for bearing the risk of these types of transactions.
We have implemented systems and software for the electronic surveillance and
monitoring of fraudulent bankcard and ACH use. As of September 30, 2005, we
maintained a dedicated chargeback reserve of $776,000 at our primary bank
specifically earmarked for such activity. Additionally, through our sponsoring
bank, as of September 30, 2005, we had access to approximately $13.7 million in
merchant deposits to cover any potential chargeback losses. Despite a long
history of managing such risk, we cannot guarantee that these systems will
prevent fraudulent transactions from being submitted and processed or that the
funds set aside to address such activity will be adequate to cover all potential
situations that might occur. We do not have insurance to protect us from these
losses. There is no assurance that our chargeback reserve will be adequate to
offset against any unauthorized or fraudulent processing losses that we may
incur. Depending on the size of such losses, our results of operations could be
immediately and materially adversely affected.
EXCESSIVE CHARGEBACK LOSSES COULD SIGNIFICANTLY AFFECT OUR RESULTS OF OPERATIONS
AND LIQUIDITY.
Our agreements with our sponsoring bank require us to assume and compensate the
bank for bearing the risk of "chargeback" losses. Under the rules of Visa and
MasterCard, when a merchant processor acquires card transactions, it has certain
contingent liabilities for the transactions processed. This contingent
liability arises in the event of a billing dispute between the merchant and a
cardholder that is ultimately resolved in the cardholder's favor. In such a
case, the disputed transaction is charged back to the merchant and the disputed
amount is credited or otherwise refunded to the cardholder. If we are unable to
collect this amount from the merchant's account, or if the merchant refuses or
is unable to reimburse us for the chargeback due to merchant fraud, insolvency
or other reasons, we will bear the loss for the amount of the refund paid to the
cardholders.
A cardholder, through its issuing bank, generally has until the later of up to
four months after the date a transaction is processed or the delivery of the
product or service to present a chargeback to our sponsoring bank as the
merchant processor. Therefore, management believes that the maximum potential
exposure for the chargebacks would not exceed the total amount of transactions
processed through Visa and MasterCard for the last four months and other
unresolved chargebacks in the process of resolution. For the last four months
through September 30, 2005, this potential exposure totaled approximately $443
million. At September 30, 2005, we, through our sponsoring banks, had
approximately $106,000 of unresolved chargebacks that were in the process of
resolution. At September 30, 2005, we, through our sponsoring banks, had access
to $13.7 million belonging to our merchants. This money has been deposited at
the sponsoring bank by the merchants to cover any potential chargeback losses.
25
For the fiscal years 2005 and 2004, we processed approximately $1,186 million
and $1,053 million, respectively, of Visa and MasterCard transactions, which
resulted in $7.1 million in gross chargeback activities for the fiscal year
ended 2005 and $7.6 million for the fiscal year ended 2004. Substantially all of
these chargebacks were recovered from the merchants.
Nevertheless, if we are unable to recover these chargeback amounts from
merchants, having to pay the aggregate of any such amounts would significantly
affect our results of operations and liquidity.
FAILURE TO PARTICIPATE IN THE VISA POS CHECK SERVICE PROGRAM WOULD CAUSE US TO
SIGNIFICANTLY SHIFT OUR OPERATING AND MARKETING STRATEGY.
We have significantly increased our infrastructure, personnel and marketing
strategy to focus on the potential growth of our check services through the Visa
POS Check Service program. We currently provide critical back-end
infrastructure for the service, including our NCN database for verification and
our access to the Federal Reserve System's Automated Clearing House for funds
settlement and for checks written on bank accounts with banks not participating
in the program.
Because we believe the market will continue to gain acceptance of the Visa POS
Check Service program, we have expended significant resources to market our
check conversion services and verification services to our merchant base, to
solidify our strategic relationships with the various financial institutions
that have chosen us as their Acquirer Processor and Third-Party processor under
the program, and to sell our other check products such as electronic check
re-presentments and check guarantee to the Visa member banks. We have also
increased our personnel to handle the increased volume of transactions arising
directly from our participation in the program.
Our failure to adequately market our services through this relationship could
materially affect our marketing strategy going forward. Additionally, if we
fail to adequately grow our infrastructure to address increases in the volume of
transactions, cease providing services as a Third-Party processor or Acquirer
Processor or are otherwise removed or terminated from the Visa Program, this
would require us to dramatically shift our current operating strategy.
THE INABILITY OF THIRD-PARTY SOFTWARE VENDORS TO CONTINUE TO SUPPORT AND PROVIDE
MAINTENANCE SERVICES WITH RESPECT TO THEIR PRODUCTS COULD SIGNIFICANTLY
ADVERSELY AFFECT OUR RESULTS OF OPERATIONS AND FINANCIAL CONDITION.
We utilize various third-party software applications and depend on the providers
of such software applications to provide support and maintenance services to us.
In the event that a third-party software vendor fails to continue to support and
maintain its software application, or fails to do so in a timely manner, this
could significantly affect our results of operations and financial condition.
Our inability to ultimately implement, or a determination to cease the
implementation of various of our software technology initiatives will
significantly adversely affect our results of operations and financial
condition.
We have spent significant time and monetary resources implementing several
software technologies, which resulted in significant cost being capitalized by
us as non-current software assets. The implementation of these technologies
will provide us with substantial operational advantages that would allow us to
attract and retain larger merchants, as well as the small and mid-market
merchants that have been our target market. Management believes that the
implementation of these software technologies, and the technologies themselves,
continues to be in the best interests of, and the most viable alternative for,
the Company. However, the inability to ultimately implement, or a determination
to cease the implementation of these software technologies would cause these
assets to become impaired, and the corresponding impairment would significantly
adversely affect our results of operations and financial condition.
THE BUSINESS IN WHICH WE COMPETE IS HIGHLY COMPETITIVE AND THERE IS NO ASSURANCE
THAT OUR CURRENT PRODUCTS AND SERVICES WILL STAY COMPETITIVE OR THAT WE WILL BE
ABLE TO INTRODUCE NEW PRODUCTS AND SERVICES TO COMPETE SUCCESSFULLY.
We are in the business of processing payment transactions and designing and
implementing integrated systems for our customers so that they can better use
our services. This business is highly competitive and is
26
characterized by rapid technological change, rapid rates of product
obsolescence, and rapid rates of new product introduction. Our market share is
relatively small as compared to most of our competitors and most of these
competitors have substantially more financial and marketing resources to run
their businesses. While we believe our small size provides us the ability to
move quickly in some areas, our competitors' greater resources enable them to
investigate and embrace new and emerging technologies, to quickly respond to
changes in customers needs, and to devote more resources to product and services
development and marketing. We may face increased competition in the future and
there is no assurance that current or new competition will allow us to keep our
customers. If we lose customers, our business operations may be materially
adversely affected, which could cause us to cease our business or curtail our
business to a point where we are no longer able to generate sufficient revenue
to fund operations. There is no assurance that our current products and
services will stay competitive with those of our competitors or that we will be
able to introduce new products and services to compete successfully in the
future.
IF WE ARE UNABLE TO PROCESS SIGNIFICANTLY INCREASED VOLUME ACTIVITY, THIS COULD
AFFECT OUR OPERATIONS AND WE COULD LOSE OUR COMPETITIVE POSITION.
We have built transaction processing systems for check verification, check
conversion, ACH processing, and bankcard processing activities. While current
estimates regarding increased volume are within the capabilities of each system,
it is possible that a significant increase in volume in one of the markets would
exceed a specific system's capabilities. To minimize this risk, ECHO has
redesigned and upgraded its check related processing systems and has purchased a
high end system to process bankcard activity. This system is not yet
operational, and even when it becomes operational, no assurance can be given
that it would be able to handle a significant increase in volume or that the
operational enhancements and improvements will be completed in time to avoid
such a situation. In the event we are unable to process increases in volume,
this could significantly adversely affect our banking relationships, our
merchant customers and our overall competitive position, and could potentially
result in violations of service level agreements which would require us to pay
penalty fees to the other parties to those agreements. Losses of such
relationships, or the requirement to pay penalties, may severely impact our
results of operations and financial condition.
WE INCUR FINANCIAL RISK FROM OUR CHECK GUARANTEE SERVICE.
The check guarantee business is essentially a risk management business. Any
limitation of a risk management system could result in financial obligations
being incurred by ECHO relative to our check guarantee activity. While ECHO has
provided check guarantee services for several years, there can be no assurance
that our current risk management systems are adequate to assure against any
financial loss relating to check guarantee. ECHO is enhancing its current risk
management systems and it is being conservative with reference to the type of
merchants to which it offers guarantee services in order to minimize this risk
but no assurance can be given that such measures will be adequate. During the
year ended September 30, 2005, we incurred $258,000 in losses from uncollected
guaranteed checks.
SECURITY BREACHES COULD IMPACT OUR CONTINUED OPERATIONS.
We process confidential financial information and maintain several levels of
security to protect this data. Security includes hand and card-based
identification systems at our data center locations that restrict access to the
specific facilities, various employee monitoring and access restriction
policies, and various firewall and network management methodologies that
restrict unauthorized access through the Internet. While these systems have
worked effectively in the past, there can be no assurance that they will
continue to operate without a security breach in the future. Depending upon the
nature of the breach, the consequences of security breaches could be significant
and dramatic to ECHO's continued operations.
THE INDUSTRY IN WHICH WE OPERATE INVOLVES RAPIDLY CHANGING TECHNOLOGY AND OUR
FAILURE TO IMPROVE OUR PRODUCTS AND SERVICES OR TO OFFER NEW PRODUCTS AND
SERVICES COULD CAUSE US TO LOSE CUSTOMERS.
Our business industry involves rapidly changing technology. Recently, we have
observed rapid changes in technology as evidenced by the Internet and
Internet-related services and applications, new and better software, and faster
computers and modems. As technology changes, ECHO's customers desire and expect
better products and services. Our success depends on our ability to improve our
existing products and services and to develop and market new products and
services. The costs and expenses associated with such an effort could be
27
significant to us. There is no assurance that we will be able to find the funds
necessary to keep up with new technology or that if such funds are available
that we can successfully improve our existing products and services or
successfully develop new products and services. Our failure to provide improved
products and services to our customers or any delay in providing such products
and services could cause us to lose customers to our competitors. Loss of
customers could have a material adverse effect on ECHO.
OUR INABILITY TO PROTECT OR DEFEND OUR TRADE SECRETS AND OTHER INTELLECTUAL
PROPERTY COULD HURT OUR BUSINESS.
We have expended a considerable amount of time and money to develop information
systems for our merchants. We regard these information systems as trade secrets
that are extremely important to our payment processing operations. We rely on
trade secret protection and confidentiality and/or license agreements with
employees, customers, partners and others to protect this intellectual property
and have not otherwise taken steps to obtain additional intellectual property
protection or other protection on these information systems. We cannot be
certain that we have taken adequate steps to protect our intellectual property.
In addition, our third-party confidentiality agreements can be breached and, if
they are, there may not be an adequate remedy available to us. If our trade
secrets become known, we may lose our competitive position, including the loss
of our merchant and bank customers. Such a loss could severely impact our
results of operations and financial condition.
Additionally, while we believe that the technology underlying our information
systems does not infringe upon the rights of any third parties, there is no
assurance that third parties will not bring infringement claims against us. We
also have the right to use the technology of others through various license
agreements. If a third party claimed our activities and/or these licenses were
infringing their technology, while we may have some protection from our
third-party licensors, we could face additional infringement claims or otherwise
be obligated to stop utilizing intellectual property critical to our technology
infrastructure. If we are not able to implement other technology to substitute
the intellectual property underlying a claim, our business operations could be
severely effected. Additionally, infringement claims would require us to incur
significant defense costs and expenses and, to the extent we are unsuccessful in
defending these claims, could cause us to pay monetary damages to the person or
entity making the claim. Continuously having to defend such claims or otherwise
making monetary damages payments could materially adversely affect our results
of operations.
IF WE DO NOT CONTINUE TO INVEST IN RESEARCH AND DEVELOPMENT, WE COULD LOSE OUR
COMPETITIVE POSITION.
Because technology in the payment processing industry evolves rapidly, we need
to continue to invest in research and development in both the bankcard
processing business segment and the check-related products segment in order to
remain competitive. Research and development expenses increased from $1,465,000
in fiscal 2004 to $1,609,000 in fiscal 2005. Most of our development project
costs were capitalized once we entered into coding and testing phases. We
continue to evaluate projects, which we believe will assist us in our efforts to
stay competitive. Although we believe that our investment in these projects will
ultimately increase earnings, there is no assurance as to when or if these new
products will show profitability or if we will ever be able to recover the costs
invested in these projects. Additionally, if we fail to commit adequate
resources to grow our technology on pace with market growth, we could quickly
lose our competitive position, including the loss of our merchant and bank
customers.
FAILURE TO OBTAIN ADDITIONAL FUNDS CAN IMPACT OUR OPERATIONS AND FUTURE GROWTH.
We use funds generated from operations, as well as funds obtained through credit
facilities and equity financing, to finance our operations. In light of our
recent financing efforts, and as a result of the cash flow generated from
operations, we believe we have sufficient cash to support our business
activities, including research, development and marketing costs. However,
future growth may depend on our ability to continue to raise additional funds,
either through operations, bank borrowings, or equity or debt financings. There
is no assurance that we will be able to continue to raise the funds necessary to
finance growth or continue to generate the funds necessary to finance
operations, and even if such funds are available, that the terms will be
acceptable to us. The inability to generate the necessary funds from operations
or from third parties in the future may require us to scale back our research,
development and growth opportunities, which could harm our overall operations.
28
WHILE WE MAINTAIN INSURANCE PROTECTION AGAINST CLAIMS RELATED TO OUR SERVICES,
THERE IS NO ASSURANCE THAT SUCH PROTECTION WILL BE ADEQUATE TO COVER POTENTIAL
CLAIMS AND OUR INABILITY TO OTHERWISE PAY SUCH CLAIMS COULD HARM OUR BUSINESS.
We maintain errors and omissions insurance for the services we provide. While
we believe the limit on our errors and omissions insurance policy is adequate
and consistent with industry practice, if claims are brought by our customers or
other third parties, we could be required to pay the required claim or make
significant expenditures to defend against such claims in amounts that exceed
our current insurance coverage. There is no assurance that we will have the
money to pay potential plaintiffs for such claims if they arise beyond the
amounts insured by us. Making these payments could have a material adverse
effect on our business.
INVOLVEMENT IN LITIGATION COULD HARM OUR BUSINESS.
We are involved in various lawsuits arising in the ordinary course of business.
Although we believe that the claims asserted in such lawsuits are without merit,
the cost to us for the fees and expenses to defend such lawsuits could have a
material adverse effect on our financial condition, results of operations or
cash flow. In addition, there can be no assurance that we will not at some time
in the future experience significant liability in connection with such claims.
As of September 30, 2005, we have spent approximately $1,420,000 in legal fees
and expenses defending these claims.
OUR INABILITY TO RECOVER FROM NATURAL DISASTERS COULD HARM OUR BUSINESS.
We currently maintain two data centers: one in Camarillo, California, and one in
Albuquerque, New Mexico. Should a natural disaster occur in any of the
locations, it is possible that ECHO would not be able to fully recover full
functionality at one of its data centers. To minimize this risk, ECHO
centralized its data processing functionality in Camarillo during fiscal 2005
and will make Albuquerque a fully redundant site. Prior to that time, it is
possible a natural disaster could limit or completely disable a specific service
offered by ECHO until such time that the specific location could resume its
functionality. Our inability to provide such service could have a material
adverse effect on our business and results of operations.
INCREASES IN THE COSTS OF TECHNICAL COMPLIANCE COULD HARM OUR BUSINESS.
The services which ECHO offers require significant technical compliance. This
includes compliance to both Visa and MasterCard regulations and association
rules, NACHA guidelines and regulations with regard to the Federal Reserve
System's Automated Clearing House and check related issues, and various banking
requirements and regulations. ECHO has personnel dedicated to monitoring our
compliance to the specific industries we serve and when possible, ECHO is moving
the technical compliance responsibility to other parties, as is the case with
the recent purchase of the Oasis Technologies bankcard processing system wherein
the vendor, Oasis Technologies, assumes much of the compliance obligations
regularly updated by Visa and MasterCard. As the compliance issues become more
defined in each industry, the costs associated with that compliance may present
a risk to ECHO. These costs could be in the form of additional hardware,
software or technical expertise that ECHO must acquire and/or maintain. While
ECHO currently has these costs under control, we have no control over those
entities that set the compliance requirements so no assurance can be given that
ECHO will always be able to underwrite the costs of compliance in each industry
wherein we compete.
RISKS ASSOCIATED WITH OUR COMMON STOCK
-------------------------------------------
IF WE NEED TO SELL OR ISSUE ADDITIONAL SHARES OF COMMON STOCK OR ASSUME
ADDITIONAL DEBT TO FINANCE FUTURE GROWTH, OUR STOCKHOLDERS' OWNERSHIP COULD BE
DILUTED OR OUR EARNINGS COULD BE ADVERSELY IMPACTED.
Our business strategy may include expansion through internal growth, by
acquiring complementary businesses or by establishing strategic relationships
with targeted customers and suppliers. In order to do so, or to fund our other
activities, we may issue additional equity securities that could dilute our
stockholders' stock ownership. We may also assume additional debt and incur
impairment losses related to goodwill and other tangible assets if we acquire
another company and this could negatively impact our results of operations. As
of the date of this report, management has no plan to raise additional capital
through the sale of securities and believes that our cash flow from operations
together with cash on hand and our established line of credit with Bank of the
West will be sufficient to meet our working capital and other commitments.
29
WE HAVE ADOPTED A NUMBER OF ANTI-TAKEOVER MEASURES THAT MAY DEPRESS THE PRICE OF
OUR COMMON STOCK.
Our rights agreement, our ability to issue additional shares of preferred stock
and some provisions of our articles of incorporation and bylaws could make it
more difficult for a third party to make an unsolicited takeover attempt of us.
These anti-takeover measures may depress the price of our common stock by making
it more difficult for third parties to acquire us by offering to purchase shares
of our stock at a premium to its market price.
OUR STOCK PRICE HAS BEEN VOLATILE.
Our common stock is quoted on the NASDAQ Capital Market, and there can be
substantial volatility in the market price of our common stock. Over the course
of the quarter ended September 30, 2005, the market price of our common stock
has been as high as $9.36, and as low as $8.00. Additionally, over the course
of the year ended September 30, 2005, the market price of our common stock has
been as high as $10.35 and as low as $7.10. The market price of our common
stock has been, and is likely to continue to be, subject to significant
fluctuations due to a variety of factors, including quarterly variations in
operating results, operating results which vary from the expectations of
securities analysts and investors, changes in financial estimates, changes in
market valuations of competitors, announcements by us or our competitors of a
material nature, loss of one or more customers, additions or departures of key
personnel, future sales of common stock and stock market price and volume
fluctuations. In addition, general political and economic conditions such as a
recession, or interest rate or currency rate fluctuations may adversely affect
the market price of our common stock.
WE HAVE NOT PAID AND DO NOT CURRENTLY PLAN TO PAY DIVIDENDS, AND YOU MUST LOOK
TO PRICE APPRECIATION ALONE FOR ANY RETURN ON YOUR INVESTMENT.
Some investors favor companies that pay dividends, particularly in general
downturns in the stock market. We have not declared or paid any cash dividends
on our common stock. We currently intend to retain any future earnings for
funding growth, and we do not currently anticipate paying cash dividends on our
common stock in the foreseeable future. Because we may not pay dividends, your
return on this investment likely depends on your selling our stock at a profit.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are currently not exposed to any significant financial market risks from
changes in foreign currency exchange rates or changes in interest rates and do
not use derivative financial instruments. All of our revenue and capital
spending is transacted in U.S. dollars. However, in the future, we may enter
into transactions in other currencies. An adverse change in exchange rates
would result in a decline in income before taxes, assuming that each exchange
rate would change in the same direction relative to the U.S. dollar. In
addition to the direct effects of changes in exchange rates, such changes
typically affect the volume of sales or foreign currency sales price as
competitors' products become more or less attractive.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Financial Statements and Supplementary Data are listed under "Item 15.
Exhibits, Financial Statement Schedules".
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
None.
ITEM 9A. CONTROLS AND PROCEDURES
As of September 30, 2005, the end of the period covered by this report, under
the supervision and with the participation of management, including our Chief
Executive Officer and our Chief Financial Officer, we have evaluated the
effectiveness of the design and operation of our disclosure controls and
procedures pursuant to Exchange Act Rules 13a-15 and 15d-15. Based upon that
evaluation, our Chief Executive Officer and our Chief Financial Officer have
concluded that our disclosure controls and procedures are effective in causing
material information to be recorded, processed, summarized and reported by our
management on a timely basis and to
30
ensure that the quality and timeliness of our public disclosures complies with
our Securities and Exchange Commission disclosure obligations. During the
quarter ended September 30, 2005, there was no change in our internal control
over financial reporting that materially affects, or that is reasonably likely
to materially affect, our internal control over financial reporting.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The officers and directors of ECHO are:
Date first became
Name Position Officer or Director
----------------------- ------------------------ -------------------
Joel M. Barry Chairman of the Board, 1986
Chief Executive Officer
Charles J. Harris Director, President, COO 2005
Alice L. Cheung Chief Financial Officer, 1996
Treasurer
Sharat Shankar Senior Vice President 2003
Patricia M. Williams Senior Vice President 1997
Jack Wilson Senior Vice President 1994
Kris Winckler Senior Vice President 1999
Steve Hoofring Senior Vice President 2003
Rick Slater Vice President, CTO 1998
Arnold Feinberg Vice President 2000
Jesse Fong Vice President 1994
David Griffin Vice President 1990
Robert Hare Vice President 1999
Donna L. Rehman Corporate Secretary 1990
Herbert L. Lucas, Jr. Director 1991
Aristides W. Georgantas Director 1999
Carl R. Terzian Director 2002
Richard D. Field Director 2004
H. Eugene Lockhart Director 2005
31
JOEL M. BARRY, age 55, has been a Director of ECHO since July 1986, and Chairman
of the Board since December 1986. Mr. Barry served as Chief Financial Officer
from May 1987 to June 1990, and Executive Vice President from October 1987 to
June 1990, when he was designated Chief Executive Officer of ECHO. Mr. Barry is
also a Director and Chief Executive Officer of the MerchantAmerica and
XPRESSCHEX, Inc. wholly owned subsidiaries. From August 1983 to June 1991, Mr.
Barry was a lecturer and investment counselor for Basics Financial Planning and
Investments, a firm he founded in 1983. From 1981 to 1983, Mr. Barry owned and
operated Dynamic Seminars, a marketing company for Financial Dynamics, a
financial planning firm located in Covina, California. From 1975 to 1981, Mr.
Barry was manager of Quality Assurance and In-House Customer Service at Science
Dynamics Corporation, a medical data processing firm. From 1972 to 1974, Mr.
Barry owned and operated a gospel music recording business located in Anaheim,
California.
CHARLES J. HARRIS, age 43, joined ECHO in September 2005 as President, Chief
Operating Officer and a Director to serve on the Board of Directors of ECHO.
Prior to joining the Company, Mr. Harris served in executive, operational and
sales leadership positions at prominent organizations including Paymentech and
Electronic Data Systems. His last position was as President of Merchant Link, a
wholly-owned subsidiary of Paymentech, which supplies electronic payment
technologies and outsourced services to the point-of-sale market.
ALICE L. CHEUNG, age 48, has served as Treasurer and Chief Financial Officer
since July 1996. Ms. Cheung became a Certified Public Accountant in May 1982.
From February 1988 to January 1996, Ms. Cheung was the Treasurer and Chief
Financial Officer of American Mobile Systems (AMS). AMS merged with Nextel
Communications, Inc. in 1995. Ms. Cheung is an active member of the American
Institute of Certified Public Accountants and Financial Executive Institute.
SHARAT SHANKAR, age 35, joined ECHO in June 2003 as Vice President Risk
Management and Business Intelligence and in December 2003, he was promoted to
Senior Vice President. In April 2005, Mr. Shankar was appointed to hold the
position of General Manager Check Services. Prior to joining ECHO, Mr. Shankar
worked at TeleCheck for approximately eight years where he held a variety of
positions leading up to Vice President of Risk Management. Prior to TeleCheck,
Mr. Shankar held positions at MetLife as well as Hong Kong and Shanghai Bank,
Madras, India.
PATRICIA M. WILLIAMS, age 40, joined ECHO in September 1996, serving as Director
of Program Management. Ms. Williams was appointed Vice President Corporate
Program Management in October 1997 and Vice President Check Services in October
2001. In June of 2003, Ms. Williams was appointed to the position of Vice
President Sales and Marketing and in December 2003, was promoted to Senior Vice
President. In April 2005 Ms. Williams was appointed to hold the position of
General Manager of Credit Card Services. 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.
JACK WILSON, age 61, has served as Vice President of Merchant Services since
June 1994 and was Director of Bankcard Relations for ECHO from October 1992
until May 1994. In December 2003, he was promoted to Senior Vice President
Merchant Services and in April 2005, he was appointed to the position of Senior
Vice President Credit Card Services. 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.
KRIS WINCKLER, age 40, joined ECHO in April, 1999, as Vice President of ECHO's
XPRESSCHEX subsidiary. In December 2003, he was promoted to Senior Vice
President Product and Strategic Planning and in April 2005, he was appointed to
the position of Senior Vice President Check Services. Prior to joining ECHO, Mr.
Winckler was a consultant at Andersen Consulting and the President of Magic
Software, a company specializing in check verification, conversion, and ACH
software. Mr. Winckler has been active in the check and collection industry for
over ten years and has been a member of the Electronic Check Council of NACHA
since 1998. Mr. Winckler is an Accredited ACH Professional (AAP) and Certified
Treasury Professional (CTP).
STEVE HOOFRING, age 45, joined ECHO in October 2001 as Implementation Manager
for the Check Services group and was appointed Vice President Visa POS Check and
Client Services in October 2003 and Senior Vice President Operations in August
2005. Mr. Hoofring was President of Running Dog Software, Inc., which developed
'Enterprise' software for small to medium size businesses. Prior to this, Mr.
Hoofring held several management positions with Emerson Power Transmission, a
subsidiary of Emerson Electric, Inc.
32
RICK SLATER, age 45, joined ECHO in May 1995 as Vice President of Computer Based
Controls, Inc. ("CBC"). Mr. Slater was appointed President of CBC in December
1995, Vice President of ECHO in November 1998 and Chief Technology Officer in
October 1999. Prior to joining ECHO, Mr. Slater was President of Slater
Research, which provided contract engineering services to various institutions.
During this time, Mr. Slater directly participated in the U.S. Coast Guard
COMSTA upgrade project including site surveys, systems design and system upgrade
integration in a number of sites within the U.S. Prior to this position, Mr.
Slater served as a group leader at Aiken Advanced Systems.
ARNOLD FEINBERG, age 56, joined ECHO in January 2000 as Vice President of Sales.
Prior to joining ECHO, Mr. Feinberg was an independent sales consultant for
Rocky Mountain Retail Systems, a company that provided check authorization
software and transaction processing services and was acquired by ECHO in 2000.
From 1986 to 1993, Mr. Feinberg was employed by Lawrence Data Service, Inc.
where he developed the franchise division for regional check verification and
collection under National Check Association.
JESSE FONG, age 54, has served as Vice President of Information Systems since
September 1994. Mr. Fong joined ECHO in 1984 and has served as programmer, Data
Processing manager and MIS director. 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 57, has served as Vice President of Major Accounts since June
2003. Previous to this capacity, he was Vice President of Check Guarantee from
October 2001 to June 2003, Vice President of Check Services for ECHO from June
1990 to October 2001 and Vice President of Operations from January 1986 until
September 1989, at which time he became a consultant to ECHO. Mr. Griffin has
served as Senior Vice President and General Manager for TeleCheck, Los Angeles
and TeleCheck, San Diego, from May 1983 to August 1985. Prior to these
appointments, he was Regional Manager of TeleCheck Services, a franchiser of
check guarantee services, a division of Tymshare Corporation, which was
subsequently acquired by McDonnell Douglas Corporation.
ROBERT HARE, age 40, joined ECHO in April 1999 through the acquisition of Magic
Software Development, a company he co-founded in 1991 to provide check
verification, conversion and ACH software. Prior to founding Magic Software
Development, Mr. Hare was a software developer with Titan Business Systems and a
systems analyst with the University of New Mexico.
DONNA L. REHMAN, age 56, joined ECHO in 1988 and has served as Corporate
Secretary since 1990. For three years prior thereto, she was self-employed in
Woodland Hills, California in educational books and toys. She was employed as
an administrative assistant in Chicago for 4 years and Los Angeles for 5 years.
HERBERT L. LUCAS, JR., age 79, has been a Director since 1991. He served as
President from 1972 to 1981 of Carnation International in Los Angeles and as a
member of the Board of Directors of the Carnation Company. Since 1982, Mr. Lucas
has managed his family investment business. He has served on the Board of
Directors of various financial and business institutions including Wellington
Trust Company, Arctic Alaska Fisheries, Inc., Scolr Pharma, Inc. and Sunworld
International Airways, Inc. Mr. Lucas has served as a Trustee of The J. Paul
Getty Trust, the Los Angeles County Museum of Art, The Morgan Library, National
Association of Independent Schools and Winrock International. He was formerly a
member of the Board of Trustees of Princeton University.
ARISTIDES W. GEORGANTAS, age 61, has served as a Director since February 1999.
Mr. Georgantas, prior to his retirement, was Executive Vice President and Chief
Operating Officer at Chase Manhattan Bank's Global Asset Management/Private
Banking Division. He serves as a director of Horizon Blue Cross Blue Shield of
New Jersey, the Glenmede Corporation, the Glenmede Trust Company, the Foundation
for Public Broadcasting in New Jersey, Mathematica Policy Research, Inc. and the
Rita Allen Foundation.
CARL R. TERZIAN, age 70, has served as a Director since December, 2002.
Following his 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
33
Associates, in 1969. Mr. Terzian currently serves as a director on the board of
Transamerica Investors, Inc., National Mercantile Bancorp and Mercantile
National Bank along with various non-profit boards, commissions, advisory
groups, and task forces.
RICHARD D. FIELD, age 65, became a Director of ECHO in July 2004. Mr. Field has
worked in the financial services industry for over 35 years as an executive of
the Bank of New York, Chase, and Citigroup, and a director of Mastercard
International and Chairman of its U.S. Board. Since retiring from full time
employment in 1997, he has continued his career in the specialty financial areas
as a co-founder and director of LendingTree, Inc. as well as serving on the
boards of Providian Financial Corporation and HPSC, Inc.
H. EUGENE LOCKHART, age 56, was appointed as a member of ECHO's Board of
Directors in May 2005. Mr. Lockhart is a Venture Partner with Oak Investment
Partners responsible for the development and management of Oak's Financial
Services Technology Portfolio. Mr. Lockhart was previously President and CEO of
MasterCard International, President of the Global Retail Bank, Senior Vice
Chairman of BankAmerica Corporation, and President of Consumer Services at AT&T.
Mr. Lockhart currently sits on various public boards such as RJR/Nabisco
Holdings, RadioShack Corporation, Dun & Bradstreet, Inc., IMS Health, Inc. and
Asset Acceptance Capital Corporation.
All directors are to be elected to three year terms by the stockholders and
serve until their respective terms have expired. The Annual Meeting of
Stockholders was held on February 7, 2005, and the election of directors was
held at that time. All officers serve at the pleasure of our Board of
Directors.
CODE OF ETHICAL CONDUCT
Our Board of Directors has adopted a Code of Ethical Conduct (the "Code of
Conduct"). We require all employees, directors and officers, including our Chief
Executive Officer and Chief Financial Officer, to adhere to the Code of Conduct
in addressing legal and ethical issues encountered in conducting their work.
The Code of Conduct requires that these individuals avoid conflicts of interest,
comply with all laws and other legal requirements, conduct business in an honest
and ethical manner and otherwise act with integrity and in our best interest.
The Code of Conduct contains additional provisions that apply specifically to
our Chief Financial Officer and other financial officers with respect to full
and accurate reporting. The Code of Conduct is available on our website at
www.echo-inc.com.
AUDIT COMMITTEE FINANCIAL EXPERT
Our Board of Directors has determined that Aristides W. Georgantas, the Chairman
of the Audit Committee of the Board of Directors, is an "audit committee
financial expert" as defined in Item 401(h) of Regulation S-K. Mr. Georgantas
is "independent" for purposes of Rule 4200(a)(15) of the NASDAQ Marketplace
Rules.
IDENTIFICATION OF AUDIT COMMITTEE
Our Board of Directors has a separately standing Audit Committee. The Audit
Committee currently consists of Richard D. Field, Aristides W. Georgantas, H.
Eugene Lockhart, Herbert L. Lucas, Jr., and Carl R. Terzian. Messrs. Field,
Georgantas, Lockhart, Lucas and Terzian are "independent directors" within the
meaning of Rule 10A-3 promulgated under the Securities Exchange Act of 1934, as
amended, and the NASDAQ Marketplace Rules. The Audit Committee's primary duties
and responsibilities include appointment of the independent auditors, evaluation
of the performance and independence of such auditors and review of the annual
audited financial statements and the quarterly financial statements, as well as
the adequacy of our internal controls.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires our
directors and executive officers and the holders of 10% or more of our Common
Stock to file with the Securities and Exchange Commission initial reports of
ownership and reports of changes in ownership of our equity securities. Based
solely on our review of the copies of the forms received by us and written
representations from certain reporting persons that they have complied with the
relevant filing requirements, we believe that, during the year ended September
30, 2005, all of our executive officers, directors and the holders of 10% or
more of our Common Stock complied with all Section 16(a) filing requirements,
except for Steven Smith, our former Chief Information Officer, who did not
timely file a Form 3.
34
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth the total compensation paid and stock options
offered by us during the fiscal years ended September 30, 2005, September 30,
2004 and September 30, 2003, to our Chief Executive Officer and to each of our
five most highly compensated executive officers, other than the Chief Executive
Officer (collectively with the Chief Executive Officer, the "Named Executive
Officers"), whose compensation exceeded $100,000 during the fiscal year ended
September 30, 2005.
SUMMARY COMPENSATION TABLE
Annual Long Term
Compensation Compensation
----------------- ------------
Securities
Capacities in Underlying
Name Which Served Year Salary Bonus Options[2] Other[3]
-------------------- ------------------ ------- -------- ------- ------------ ---------
Joel M. Barry[1] Chairman/Chief 2005 $261,875 $50,000 30,000 $ -0-
Executive Officer 2004 241,500 50,000 60,000 -0-
2003 223,125 -0- 40,000 -0-
Sharat Shankar Sr. Vice President 2005 $143,750 $56,000 21,000 $ 5,855
2004 131,430 47,500 35,000 2,343
2003 46,333 5,000 50,000 -0-
Arnold Feinberg Vice President 2005 $143,870 $50,000 14,000 $ 5,465
2004 120,200 50,000 20,000 4,616
2003 99,333 50,000 10,000 3,014
Alice Cheung Chief Financial 2005 $147,500 $42,000 30,000 $ 5,390
Officer/Treasurer 2004 138,000 40,000 35,000 4,940
2003 125,500 15,000 15,000 4,175
Patricia M. Williams Sr. Vice President 2005 $136,250 $31,000 21,000 $ -0-
2004 123,000 35,000 35,000 -0-
2003 111,190 15,000 15,000 -0-
Jack Wilson[1] Sr. Vice President 2005 $136,250 $31,000 21,000 $ 5,141
2004 123,000 35,000 35,000 4,412
2003 111,190 15,000 15,000 2,998
---------------------
[1] We provide Mr. Barry and Mr. Wilson with an automobile. There has been no
compensation paid other than that indicated in the above table.
[2] Mr. Feinberg exercised 4,000 shares of his options at $1.30 per share,
granted in fiscal 2003; Ms. Williams exercised 6,000 shares of her options
at $1.30 per share, granted in fiscal 2003.
[3] Represents our match of contributions to our 401(k) Plan. We contribute 50%
of the first 6% of each employee's contribution to the 401(k) Plan.
35
FISCAL 2005 OPTION GRANTS TABLE
The following table sets forth the stock options granted to our Chief Executive
Officer and each of the other Named Executive Officers during the fiscal year
ended September 30, 2005. Under applicable Securities and Exchange Commission
regulations, companies are required to project an estimate of appreciation of
the underlying shares of stock during the option term. We have chosen to
project this estimate using the potential realizable value at assumed annual
rates of stock price appreciation for the option term at assumed rates of
appreciation of 5% and 10%. However, the ultimate value will depend upon the
market value of our stock at a future date, which may or may not correspond to
the following projections.
Potential Realization
Value at Assumed
Annual Rates of
Stock Price
Percent of Appreciation for
Total Granted Exercise Option Term
Options to Employees in Price Expiration --------------------------
Name Granted[1] Fiscal Year per share Date 5% 10%
------------------ ---------- ---------------- ---------- ---------- ----------- -------------
Joel M. Barry 30,000 11.54% $ 7.60 11/15/14 $ 93,000 $ 216,000
Sharat Shankar 21,000 8.08% $ 7.60 11/15/14 $ 65,000 $ 151,000
Arnold Feinberg 14,000 5.38% $ 7.60 11/15/14 $ 43,000 $ 101,000
Alice Cheung 30,000 11.54% $ 7.60 11/15/14 $ 93,000 $ 216,000
Patricia M. Williams 21,000 8.08% $ 7.60 11/15/14 $ 65,000 $ 151,000
Jack Wilson 21,000 8.08% $ 7.60 11/15/14 $ 65,000 $ 151,000
---------------------
[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, 2005 by each of our Named
Executive Officers and the number and value of unexercised options held by each
of our Named Executive Officers as of the fiscal year ended September 30, 2005.
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 15,000 $ -0- 265,000 $ 1,221,225
Sharat Shankar -0- $ -0- 106,000 $ 418,650
Arnold Feinberg 4,000 $ 28,340 69,000 $ 147,200
Alice Cheung 8,500 $ 36,357 106,500 $ 401,425
Patricia M. Williams 18,000 $ 79,536 92,000 $ 331,830
Jack Wilson -0- $ -0- 92,500 $ 353,725
---------------------
[1] Based on the closing sales price of the Common Stock on September 30, 2005
of $9.25 per share, less the option exercise price.
36
EQUITY COMPENSATION PLAN INFORMATION
The following table sets forth information concerning our equity compensation
plans as of September 30, 2005.
(c) Number of securities
(a) Number of remaining available for
securities to be future issuance under
issued upon (b) Weighted-average equity compensation
exercise of exercise price of (excluding securities
Plan Category outstanding options outstanding options reflected in column (a))
------------------- ------------------- --------------------- -------------------------
Equity compensation
plans approved by
security holders[1] 1,116,125 $5.51 285,600
---------------------
[1] Plan represents the Officers and Key Employees Incentive Stock Option Plan,
which expired in May 2002, and our 2003 Incentive Stock Option Plan.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Compensation Committee of our Board of Directors is currently composed of
Richard D. Field, Aristides W. Georgantas, H. Eugene Lockhart, Herbert L. Lucas,
Jr., who serves as the Chairman of the Committee, and Carl R. Terzian. No
interlocking relationship exists between our Board of Directors, Compensation
Committee or executive officers and the board of directors, compensation
committee or executive officers of any other company.
DIRECTOR COMPENSATION
In fiscal 2005, Messrs. Georgantas, Lucas and Field each received $55,000.00 and
Mr. Terzian received $52,500.00. Mr. Lockhart, appointed on May 5, 2005, to fill
a vacancy on the Board of Directors, received $8,333.34 in fiscal 2005. Each
outside director received $48,250 in fiscal 2004 and $28,000 and 3,031 shares of
Common Stock in fiscal 2003. 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
In addition to salary, the Compensation Committee, from time to time, grants
stock options and restricted stock grants to executive officers and key
personnel pursuant to the 2003 Incentive Stock Option Plan. The Compensation
Committee thus views equity-based compensation as an important component of its
long-term, performance-based compensation philosophy. Since the value of stock
options and grants of restricted stock bears a direct relationship to our stock
price, the Compensation Committee believes that stock options and grants of
restricted stock motivate executive officers and key personnel to manage us in a
manner which will also benefit shareholders. As such, stock options and grants
of restricted stock are granted at the current market price. One of the
principal factors considered in granting stock options and grants of restricted
stock to executive officers or key personnel is their ability to influence our
long-term growth and profitability.
The Compensation Committee has also established a bonus program to reward
extraordinary performance that exceeds pre-set goals established for executive
officers and key personnel. We believe that such a bonus program provides the
incentive to exceed such goals, thereby building shareholder value.
We have a contributory 401(K) Retirement Pension Plan, which covers all
employees who are qualified under the plan provisions. In fiscal 2005, we also
adopted a non-qualified deferred compensation plan that provides
37
additional retirement investment alternatives for eligible employees and
directors and is complementary to our contributory 401(K) Retirement Pension
Plan.
STOCK OPTION PLANS
On May 13, 1992, our Board of Directors authorized adoption of an Officers and
Key Employees Incentive Stock Option Plan (the "1992 Plan"), ratified by the
shareholders at the Annual Meeting held July 10, 1992. The 1992 Plan provided
for the issuance of up to 81,250 shares of our Common Stock to be subject to
stock options, each to purchase one share of the Common Stock for $3.40 per
share, subject to adjustment in the event of stock splits, combinations of
shares, stock dividends or the like.
On November 18, 1996, our Board of Directors authorized an increase in the 1992
Plan to 843,750 shares to be subject to stock options, which action was ratified
by the shareholders at the Annual Meeting held in February 1997.
On February 4, 1999, our Board of Directors authorized an increase in the 1992
Plan to 1,343,750 shares to be subject to stock options, which action was
ratified by the shareholders at the Annual Meeting held in February 1999.
On May 13, 2002, the 1992 Plan expired. The 2003 Incentive Stock Option Plan,
which provided for the issuance of up to 900,000 shares of Common Stock
underlying stock options, was approved by our Board of Directors and by our
shareholders at the Annual Meeting of Shareholders held on February 3, 2003.
On April 19, 2004, our Compensation Committee approved certain non-material
changes to our 2003 Incentive Stock Option Plan.
On December 21, 2004, our Compensation Committee authorized an amendment and
restatement of the 2003 Incentive Stock Option Plan to, among other matters, (i)
increase the number of shares to be issued under the 2003 Incentive Stock Option
Plan from 900,000 to 1,150,000 shares, and (ii) permit the grant of restricted
stock under the plan.
With the exception of the foregoing, we have no stock option plans or other
similar or related plans in which any of our officers or directors participate.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
As of December 12, 2005, there were 6,661,701 shares of our Common Stock
outstanding. Based on our review of Schedules 13D and 13G filed with the
Securities and Exchange Commission on the dates noted, the following persons
have beneficial ownership or control over 5% or more of our outstanding Common
Stock:
Amount and Percentage of
Nature of Beneficial Outstanding Stock
Name and Address Ownership At 12/12/05
--------------------------------------- -------------------- ------------------
Melvin Laufer 519,839 7.80%
136 Beach 140th Street
Far Rockaway, NY 11694
Schedule 13D/A filed September 3, 2004
William Blair and Company LLC 771,507 11.58%
222 W. Adams Street
Chicago, IL 60606
Schedule 13G/A filed June 30, 2005
38
Discovery Equity Partners LP; Discovery 736,919 11.06%
Group I LLC; Daniel J. Donoghue;
Michael R. Murphy
71 South Wacker Drive
Chicago, IL 60606
Schedule 13G filed May 13, 2005
The following table sets forth the number of shares of Common Stock owned
beneficially by our (i) directors, (ii) the Named Executive Officers (as defined
below), and (iii) the executive officers and directors as a group, as of
December 12, 2005. Such figures are based upon information furnished by the
persons named.
Amount and Percentage of
Nature of Beneficial Outstanding Stock[1]
Name and Address Ownership At 12/12/05
--------------------------- -------------------- ---------------------
Joel M. Barry 294,619[2] 4.32%
730 Paseo Camarillo
Camarillo, CA 93010
Alice L. Cheung 65,500[2] 0.98%
730 Paseo Camarillo
Camarillo, CA 93010
Arnold Feinberg 39,800[2] 0.59%
15638 54th
Oskaloosa, KS 66066
Richard Field 203,696[3] 3.06%
49 Locust Avenue
New Canaan, CT 06840
Aristides W. Georgantas 16,521 0.25%
180 Springdale Road
Princeton, NJ 08540
Herbert L. Lucas, Jr. 57,880[4] 0.87%
12011 San Vicente Blvd.
Los Angeles, CA 90049
Sharat Shankar 38,200[2] 0.57%
730 Paseo Camarillo
Camarillo, CA 93010
Carl R. Terzian 3,031 0.05%
12400 Wilshire Blvd.
Los Angeles, CA 90025
Patricia M. Williams 51,875[2] 0.77%
730 Paseo Camarillo
Camarillo, CA 93010
Jack Wilson 52,275[2][5] 0.78%
730 Paseo Camarillo
Camarillo, CA 93010
All officers and directors
as a group (19 persons) 1,116,011[6] 15.62%
39
------------------------------
[1] Under Rule 13d-3, certain shares may be deemed to be beneficially owned by
more than one person (if, for example, persons share the power to vote or
the power to dispose of the shares). In addition, shares are deemed to be
beneficially owned by a person if the person has the right to acquire the
shares (for example, upon exercise of an option) within 60 days of the date
as of which the information is provided. In computing the percentage
ownership of any person, the amount of shares outstanding is deemed to
include the amount of shares beneficially owned by such person (and only
such person) by reason of these acquisition rights. As a result, the
percentage of outstanding shares of any person as shown in this table does
not necessarily reflect the person's actual ownership or voting power with
respect to the number of shares of Common Stock actually outstanding at
December 12, 2005.
[2] Includes stock options according to the terms of the Officers and Key
Employees Incentive Stock Option Plan and the 2003 Incentive Stock Option
Plan, which for the following number of shares and for the following
individuals could be acquired within 60 days through the exercise of stock
options: Joel M. Barry, 164,000 shares; Alice Cheung, 53,500 shares; Arnold
Feinberg, 39,800 shares; Sharat Shankar, 38,200 shares; Patricia Williams,
46,200 shares; and Jack Wilson 46,700 shares.
[3] Includes 103,400 shares which are in an IRA account in Mr. Field's name.
[4] Includes 17,972 shares indirectly owned by Mr. Lucas through a trust for
his wife.
[5] Includes 530 shares indirectly owned by Mr. Wilson through his wife.
[6] Includes shares and stock options according to the terms of the Officers
and Key Employees Incentive Stock Option Plan and the 2003 Incentive Stock
Option Plan, which for the following number of shares and for the following
individuals could be acquired within 60 days through the exercise of stock
options: Jesse Fong, 15,154 shares; David Griffin, 20,786 shares; Robert
Hare, 54,991 shares; Charles Harris; 50,000 shares; Steven Hoofring, 25,500
shares; Donna Rehman, 4,900 shares; Rick Slater, 36,400 shares; and Kris
Winckler, 83,532 shares.
CHANGES IN CONTROL
We do not have any arrangements which may at a subsequent date result in a
change in control.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
There were no related-party transactions since the beginning of fiscal 2005.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
AUDIT FEES
PricewaterhouseCoopers, LLP, our independent accountants
("PricewaterhouseCoopers") billed us an aggregate of approximately $190,000 and
$135,000 in fees for professional services rendered for the audit of our annual
financial statements for the fiscal years ended September 30, 2005 and September
30, 2004, respectively, and the reviews of the financial statements included in
our Form 10-Q's for fiscal 2005 and 2004.
AUDIT-RELATED FEES
PricewaterhouseCoopers billed us an aggregate of approximately $5,000 and
$50,000 in fees for assurance and related services related to the audit of our
annual financial statements for the fiscal years ended September 30, 2005 and
September 30, 2004, respectively.
Our Audit Committee is directly responsible for interviewing and retaining our
independent accountant, considering the accounting firm's independence and
effectiveness, and pre-approving the engagement fees and other compensation to
be paid to, and the services to be conducted by, the independent accountant.
The Audit Committee does not delegate these responsibilities. During each of the
fiscal years ended September 30, 2005 and 2004, respectively, our Audit
Committee pre-approved 100% of the services described above.
40
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) The following documents are filed as part of this report:
(1) Consolidated Financial Statements
Page
----
Report of Independent Registered Public Accounting Firm . . . . . . . . . F-1
Consolidated Balance Sheets at September 30, 2005 and 2004 . . . . . . . . F-2
Consolidated Statements of Operations for each of the three years
in the period ended September 30, 2005 . . . . . . . . . . . . . . . . . . F-3
Consolidated Statements of Changes in Stockholders' Equity
for each of the three years in the period ended September 30, 2005 . . . . F-4
Consolidated Statements of Cash Flows for each of the three years
in the period ended September 30, 2005 . . . . . . . . . . . . . . . . . . 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.
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.[4]
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.[5]
3.1 Articles of Incorporation of Bio Recovery Technology, Inc., filed with the Nevada Secretary of State on
December 11, 1981.[1]
3.1.1 Amendment to the Articles of Incorporation of Electronic Clearing House, Inc. filed with the Nevada
Secretary of State on June 21, 1990.
3.1.2 Amendment to the Articles of Incorporation of Electronic Clearing House, Inc. filed with the Nevada
Secretary of State on September 27, 1991.
3.1.3 Amendment to the Articles of Incorporation of Electronic Clearing House, Inc. filed with the Nevada
Secretary of State on August 5, 1993.
3.1.4 Amendment to the Articles of Incorporation of Electronic Clearing House, Inc. filed with the Nevada
Secretary of State on April 7, 1995.
3.1.5 Amendment to the Articles of Incorporation of Electronic Clearing House, Inc. filed with the Nevada
Secretary of State on April 7, 1997.
3.1.6 Amendment to the Articles of Incorporation of Electronic Clearing House, Inc. filed with the Nevada
Secretary of State on March 13, 1998.
3.1.7 Amendment to the Articles of Incorporation of Electronic Clearing House, Inc. filed with the Nevada
Secretary of State on June 21, 1999.
41
3.1.8 Amendment to the Articles of Incorporation of Electronic Clearing House, Inc. filed with the Nevada
Secretary of State on September 6, 2001.
3.2 By-Laws of Bio Recovery Technology, Inc.[1]
3.2.1 Amendment to the By-Laws of Electronic Clearing House, Inc., dated April 25, 2005.
3.2.2 Amendment to the By-Laws of Electronic Clearing House, Inc., dated September 9, 2005.
4.1 Amended and Restated Rights Agreement between Electronic Clearing House, Inc. and OTR, Inc.,
dated January 29, 2003.[11]
4.1.1 Amendment Number One to Amended and Restated Rights Agreement dated September 27, 2004.[12]
4.2 Specimen Common Stock Certificate. [2]
4.3 Amended and Restated 2003 Incentive Stock Option Plan.[13]
4.4 Amended and Restated Officers and Key Employees Incentive Stock Option Plan.[14]
10.35 Copy of Merchant Marketing and Processing Services Agreement between Electronic Clearing House,
Inc. and First Regional Bank, dated June 24, 1997. [3]
10.42 Copy of Addendum to Agreement between Electronic Clearing House, Inc. and U-Haul International,
dated January 1, 2000.[5]
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.[5]
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.[5]
10.48 Copy of POS Check Third-Party Services Agreement between Visa U.S.A., Inc. and Electronic Clearing
House, Inc., dated December 12, 2000.[6]
10.49 Copy of Asset Purchase Agreement between National Check Network, Inc. and Electronic Clearing
House, Inc., dated April 19, 2001. [6]
10.50 Copy of Addendum to Agreement between U-Haul International and Electronic Clearing House, Inc.,
dated October 1, 2001. [6]
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. [7]
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. [7]
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. [7]
10.54 Form of Securities Purchase Agreement by and among the Registrant and the Purchasers identified
therein. [8]
10.55 Form of Registration Rights Agreement by and among the Registrant and the Purchasers identified
therein. [8]
10.56 Office Lease dated May 21, 2003, by and between the Registrant and the 1989 Sheehan Family Trust
dated October 24, 1989, with respect to principal executive offices located at 730 Paseo Camarillo,
Camarillo, California 93010.[9]
10.57 First Amendment to Lease dated July 10, 2003, by and between the Registrant and the 1989 Sheehan
Family Trust dated October 24, 1989, with respect to principal executive offices located at 730 Paseo
Camarillo, Camarillo, California 93010.
10.58 Addendum to Office Lease dated July 7, 2004, by and between the Registrant and the 1989 Sheehan
Family Trust dated October 24, 1989, with respect to principal executive offices located at 730 Paseo
Camarillo, Camarillo, California 93010. [10]
11.1 Statement re computation of per share earnings, incorporated herein by reference to Note 10 of the
Notes to Consolidated Financial Statements.
21.0 Subsidiaries of Registrant as of September 30, 2005.
23.1 Consent of PricewaterhouseCoopers LLP
24.1 Power of Attorney [15]
31.1 Certificate of Joel M. Barry, Chief Executive Officer of Electronic Clearing House, Inc. pursuant to
Rule 13a-14(b) under the Securities and Exchange Act of 1934, as amended.
31.2 Certificate of Alice L. Cheung, Chief Financial Officer of Electronic Clearing House, Inc. pursuant to
Rule 13a-14(b) under the Securities and Exchange Act of 1934, as amended.
32.1 Certificate of Joel M. Barry, Chief Executive Officer of Electronic Clearing House, Inc. pursuant to
Rule 13a-14(b) under the Securities and Exchange Act of 1934, as amended.
32.2 Certificate of Alice L. Cheung, Chief Financial Officer of Electronic Clearing House, Inc. pursuant to
Rule 13a-14(b) under the Securities and Exchange Act of 1934, as amended.
42
---------------------
[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 Form S-1, Amendment No. 3,
effective November 13, 1990 and incorporated herein by reference.
[3] 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.
[4] 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.
[5] 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.
[6] 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.
[7] Filed as an Exhibit to Registrant's Annual Report on Form 10-K for
fiscal year ended September 30, 2002 and incorporated herein by
reference.
[8] Filed as an Exhibit to Registrant's Current Report on Form 8-K dated
October 30, 2003 and incorporated herein by reference.
[9] Filed as an Exhibit to Registrant's Annual Report on Form 10-K for
fiscal year ended September 30, 2003 and incorporated herein by
reference.
[10] Filed as an Exhibit to Registrant's Annual Report on Form 10-K for
fiscal year ended September 30, 2004 and incorporated herein by
reference.
[11] Filed as an Exhibit to Registrant's Form 8-A dated February 10, 2003
and incorporated herein by reference.
[12] Filed as an Exhibit to Registrant's Form 8-K dated September 30, 2004
and incorporated herein by reference.
[13] Filed as an Exhibit to Registrant's Notice of Annual Meeting of
Shareholders dated February 7, 2005 and incorporated herein by
reference.
[14] Filed as an Exhibit to Registrant's Notice of Annual Meeting of
Shareholders dated February 4, 1999 and incorporated herein by
reference.
[15] Included on signature page.
43
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this Report to be signed on its
behalf by the undersigned, thereunto duly authorized.
ELECTRONIC CLEARING HOUSE, INC.
By: /s/ Joel M. Barry
------------------------------
Joel M. Barry, Chief Executive
Officer and Chairman
POWER OF ATTORNEY
Each person whose signature appears below constitutes and appoints Joel M. Barry
and Alice L. Cheung, and each of them, as their true and lawful
attorneys-in-fact and agents with full power of substitution and resubstitution,
for them and in their name, place and stead, in any and all capacities, to sign
any or all amendments to this Annual Report on Form 10-K and to file the same,
with all exhibits thereto, and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorneys-in-fact and
agents, and each of them, full power and authority to do and perform each and
every act and thing requisite and necessary to be done in and about the
foregoing, as fully to all intents and purposes as he might or could do in
person, hereby ratifying and confirming all that said attorneys-in-fact and
agents, or either of them, or their substitutes, may lawfully do or cause to be
done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report
has been signed by the following persons in the capacities and on the dates
indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ Joel M. Barry Chairman of the Board ) December 21, 2005
------------------ and Chief Executive Officer )
Joel M. Barry )
)
/s/ Charles J. Harris Director, President and )
---------------------- Chief Operating Officer )
Charles J. Harris )
)
/s/ Aristides W. Georgantas Director )
---------------------------- )
Aristides W. Georgantas )
)
/s/ Herbert L. Lucas, Jr. Director )
-------------------------- )
Herbert L. Lucas, Jr. )
)
/s/ Carl R. Terzian Director )
-------------------- )
Carl R. Terzian )
)
/s/ Richard D. Field Director )
---------------------- )
Richard D. Field )
)
/s/ H.Eugene Lockhart Director )
-------------------- )
H. Eugene Lockhart )
)
/s/ Alice L. Cheung Chief Financial Officer )
-------------------- and Treasurer )
Alice L. Cheung )
)
/s/ Marjan Hewson Controller )
----------------- )
Marjan Hewson )
44
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and shareholders:
In our opinion, the consolidated financial statements listed in the index
appearing under Item 15(a)(1) present fairly, in all material respects, the
financial position of Electronic Clearing House, Inc. and its subsidiaries at
September 30, 2005 and 2004, and the results of their operations and their cash
flows for each of the three years in the period ended September 30, 2005 in
conformity with accounting principles generally accepted in the United States of
America. In addition, in our opinion, the financial statement schedule listed
in the index appearing under Item 15(a)(2) presents fairly, in all material
respects, the information set forth therein when read in conjunction with the
related consolidated financial statements. These financial statements and
financial statement schedule are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements and
financial statement schedule based on our audits. We conducted our audits of
these statements in accordance with standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
As discussed in Note 3 to the financial statements, effective October 1, 2002,
the Company adopted Financial Accounting Standards Board Statement No. 142,
"Goodwill and Other Intangible Assets" and changed its method of accounting for
goodwill.
/s/ PricewaterhouseCoopers LLP
PRICEWATERHOUSECOOPERS LLP
LOS ANGELES, CALIFORNIA
DECEMBER 7, 2005
F1
ELECTRONIC CLEARING HOUSE, INC.
CONSOLIDATED BALANCE SHEETS
---------------------------
September 30,
--------------------------
2005 2004
------------ ------------
ASSETS
------
Current assets:
Cash and cash equivalents $ 6,732,000 $ 7,576,000
Restricted cash 1,448,000 1,024,000
Settlement deposits 17,094,000 18,282,000
Settlement receivables less allowance of $25,000 and $22,000 981,000 451,000
Accounts receivable less allowance of $92,000 and $111,000 2,421,000 1,943,000
Prepaid expenses and other assets 385,000 368,000
Deferred tax asset 249,000 279,000
------------ ------------
Total current assets 29,310,000 29,923,000
Noncurrent assets:
Property and equipment, net 2,337,000 2,293,000
Software, net 8,876,000 6,844,000
Other assets, net 294,000 368,000
------------ ------------
Total assets $40,817,000 $39,428,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current liabilities:
Short-term borrowings and current portion of
long-term debt $ 426,000 $ 878,000
Accounts payable 305,000 305,000
Settlement payable 18,075,000 18,733,000
Accrued expenses 2,467,000 2,003,000
------------ ------------
Total current liabilities 21,273,000 21,919,000
Noncurrent liabilities:
Long-term debt 705,000 704,000
Deferred tax liability 1,067,000 565,000
------------ ------------
Total liabilities 23,045,000 23,188,000
------------ ------------
Commitments and contingencies
Stockholders' equity:
Common stock, $.01 par value, 36,000,000 shares authorized;
6,620,531 and 6,451,331 shares issued; 6,582,262 and 6,413,062
shares outstanding 66,000 64,000
Additional paid-in capital 25,574,000 24,658,000
Accumulated deficit (6,983,000) (8,016,000)
Less treasury stock at cost, 38,269 and 38,269 common shares (466,000) (466,000)
Less unearned stock compensation (419,000) -0-
------------ ------------
Total stockholders' equity 17,772,000 16,240,000
------------ ------------
Total liabilities and stockholders' equity $40,817,000 $39,428,000
============ ============
See accompanying notes to consolidated financial statements.
F2
ELECTRONIC CLEARING HOUSE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
-------------------------------------
Year ended September 30,
----------------------------------------
2005 2004 2003
------------ ------------ ------------
REVENUES $55,551,000 $48,320,000 $41,149,000
------------ ------------ ------------
COSTS AND EXPENSES:
Processing and transaction expense 35,867,000 30,370,000 27,173,000
Other operating costs 5,653,000 5,182,000 4,373,000
Research and development expense 1,609,000 1,465,000 1,464,000
Selling, general and administrative expenses 10,743,000 7,846,000 5,714,000
------------ ------------ ------------
53,872,000 44,863,000 38,724,000
------------ ------------ ------------
Income from operations 1,679,000 3,457,000 2,425,000
Interest income 136,000 71,000 28,000
Interest expense (113,000) (175,000) (200,000)
Gain on sale of building -0- 1,319,000 -0-
------------ ------------ ------------
Income before provision for income taxes
and cumulative effect of an accounting change 1,702,000 4,672,000 2,253,000
Provision for income taxes (669,000) (1,823,000) (925,000)
------------ ------------ ------------
Income before cumulative effect of an accounting change 1,033,000 2,849,000 1,328,000
Cumulative effect of an accounting change to adopt SFAS 142 -0- -0- (4,707,000)
------------ ------------ ------------
Net income (loss) $ 1,033,000 $ 2,849,000 $(3,379,000)
============ ============ ============
Basic net earnings (loss) per share
Before cumulative effect of accounting change $ 0.16 $ 0.45 $ 0.23
Cumulative effect of accounting change -0- -0- (0.81)
------------ ------------ ------------
Basic net earnings (loss) per share $ 0.16 $ 0.45 $ (0.58)
============ ============ ============
Diluted net earnings (loss) per share
Before cumulative effect of accounting change $ 0.15 $ 0.41 $ 0.22
Cumulative effect of accounting change -0- -0- (0.78)
------------ ------------ ------------
Diluted net earnings (loss) per share $ 0.15 $ 0.41 $ (0.56)
============ ============ ============
See accompanying notes to consolidated financial statements.
F3
ELECTRONIC CLEARING HOUSE, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
----------------------------------------------------------
Stock Additional Unearned
-------------------- Common Paid-in Treasury Stock Accumulated
Treasury Common Stock Capital Stock Compensation Deficit Total
--------- --------- ------- ----------- ---------- -------------- ------------- ------------
Balance at
September 30, 2002 39,269 5,835,331 $58,000 $21,435,000 $(469,000) $-0- $(7,486,000) $13,538,000
Exercise of stock options 75,750 1,000 157,000 158,000
Issuance of common
stock to outside
directors 9,093 21,000 21,000
Issuance of stock for
equipment purchase (1,000) 3,000 3,000
Expense related to stock
option issuance 28,000 28,000
Net loss (3,379,000) (3,379,000)
--------- --------- ------- ----------- ---------- -------------- ------------- ------------
Balance at
September 30, 2003 38,269 5,920,174 59,000 21,641,000 (466,000) -0- (10,865,000) 10,369,000
Private Placement 437,957 4,000 2,689,000 2,693,000
Exercise of stock options 93,200 1,000 220,000 221,000
Expense related to stock
option issuance 33,000 33,000
Tax benefit from exercise
of stock option 75,000 75,000
Net income 2,849,000 2,849,000
--------- --------- ------- ----------- ---------- -------------- ------------- ------------
Balance at
September 30, 2004 38,269 6,451,331 64,000 24,658,000 (466,000) -0- (8,016,000) 16,240,000
Exercise of stock options 119,200 1,000 393,000 394,000
Issuance of restricted
stock 50,000 1,000 424,000 (419,000) 6,000
Expense related to stock
option issuance 8,000 8,000
Tax benefit from stock
exercise 91,000 91,000
Net income 1,033,000 1,033,000
--------- --------- ------- ----------- ---------- -------------- ------------- ------------
Balance at
September 30, 2005 38,269 6,620,531 $66,000 $25,574,000 $(466,000) $ (419,000) $ (6,983,000) $17,772,000
========= ========= ======= =========== ========== ============== ============= ============
See accompanying notes to consolidated financial statements.
F4
ELECTRONIC CLEARING HOUSE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
Year ended September 30,
-----------------------------------------
2005 2004 2003
------------ ------------- ------------
Cash flows from operating activities:
Net income (loss) $ 1,033,000 $ 2,849,000 $(3,379,000)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
(Gain) loss on sale of building -0- (1,319,000) 16,000
Cumulative effect of an accounting change -0- -0- 4,707,000
Depreciation 776,000 634,000 512,000
Amortization of software 1,865,000 1,350,000 1,081,000
Provisions for losses on accounts and notes receivable 43,000 92,000 67,000
Provision for obsolete inventory 10,000 46,000 110,000
Write-down of real estate -0- -0- 55,000
Fair value of stock issued in connection
with director's compensation -0- -0- 21,000
Deferred income taxes 532,000 1,628,000 942,000
Stock option compensation 14,000 33,000 28,000
Tax benefit from exercise of stock option 91,000 75,000 -0-
Changes in assets and liabilities:
Restricted cash (424,000) (47,000) (71,000)
Settlement deposits 1,188,000 (15,549,000) (2,133,000)
Accounts receivable (518,000) (95,000) (389,000)
Settlement receivables (533,000) 244,000 (569,000)
Accounts payable -0- (474,000) 578,000
Settlement payables (658,000) 15,304,000 2,700,000
Accrued expenses 464,000 661,000 349,000
Prepaid expenses 5,000 (107,000) (76,000)
------------ ------------- ------------
Net cash provided by operating activities 3,888,000 5,325,000 4,549,000
------------ ------------- ------------
Cash flows from investing activities:
Other assets 4,000 141,000 (51,000)
Purchase of equipment (781,000) (744,000) (664,000)
Purchased and capitalized software (3,859,000) (3,534,000) (2,627,000)
Proceeds from sale of building -0- 2,233,000 71,000
------------ ------------- ------------
Net cash used in investing activities (4,636,000) (1,904,000) (3,271,000)
------------ ------------- ------------
Cash flows from financing activities:
Proceeds from issuance of notes payable 400,000 811,000 292,000
Repayment of notes payable (438,000) (1,916,000) (177,000)
Repayment of capitalized leases (452,000) (562,000) (452,000)
Proceeds from private placement -0- 2,693,000 -0-
Proceeds from exercise of stock options 394,000 221,000 158,000
------------ ------------- ------------
Net cash (used in) provided by financing activities (96,000) 1,247,000 (179,000)
------------ ------------- ------------
Net (decrease) increase in cash (844,000) 4,668,000 1,099,000
Cash and cash equivalents at beginning of period 7,576,000 2,908,000 1,809,000
------------ ------------- ------------
Cash and cash equivalents at end of period $ 6,732,000 $ 7,576,000 $ 2,908,000
============ ============= ============
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 bankcard authorizations, electronic deposit services, check
guarantee, check verification, check conversion, and check collection services.
The following comments describe the more significant accounting policies.
Principles of Consolidation
-----------------------------
The accompanying consolidated financial statements include the accounts of the
Company and its wholly owned subsidiaries. All significant intercompany
transactions and accounts have been eliminated.
Cash and Cash Equivalents
----------------------------
Cash and cash equivalents consist of unrestricted balances only. The Company
considers all highly liquid investments with original maturities of three months
or less to be cash equivalents.
Restricted Cash
----------------
Under the terms of the processing agreements with the Company's primary
processing banks, the Company maintains several cash accounts as a reserve
against chargeback losses. As processing fees are received by the processing
banks, they are allocated per the processing agreement to the reserve accounts.
Chargeback Losses
------------------
Chargeback losses occur when a credit card holder presents a valid claim against
one of the Company's merchants and the merchant has insufficient funds or is no
longer in business resulting in the charge being absorbed by the Company. The
Company records a receivable for those chargebacks for which the merchant is
liable but has not made payment. The Company records a provision for estimated
chargeback losses at the time bankcard transactions are processed. A reserve is
estimated based upon a historically-determined percentage of gross credit card
processing volume and actual losses experienced.
Settlement Deposits, Receivables and Payables
-------------------------------------------------
Settlement receivable/payable results from timing differences in the Company's
settlement process with merchants. These timing differences are primarily due to
the timing between the funds received in the Company's bank accounts and
settlement payments made to the merchants. Cash held by the Company associated
with this settlement process is classified as settlement deposits in the
consolidated balance sheets.
Property and Equipment
------------------------
Property and equipment are stated at cost, less accumulated depreciation and
amortization. Expenditures for additions and major improvements are
capitalized. Repair and maintenance costs are expensed as incurred. When
property and equipment are retired or otherwise disposed of, the related cost
and accumulated depreciation are removed from the accounts. Gains or losses
from retirements and disposals are credited or charged to income. Depreciation
and amortization are computed using the straight-line method over the shorter of
the estimated useful lives of the respective assets or terms of the related
leases. The useful lives and lease terms for depreciable assets are as follows:
F6
Note 1: (Continued)
-------
Computer equipment and software 3-5 years
Furniture, fixtures and equipment 5 years
Building improvements 5-10 years
Other Assets
-------------
Other assets consist primarily of deposits and intangible assets such as patents
and trademarks. Costs related to obtaining a patent and trademark are
capitalized and amortized over the estimated life of the patent and trademark.
Disclosures regarding intangible assets as required under SFAS No. 142 are
included in Note 6.
Software Development Costs
----------------------------
Under the provisions of Statement of Position 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use," the Company
capitalizes costs associated with software developed for internal use when both
the preliminary project stage is completed and management has authorized further
funding for the completion of the project. Capitalized costs include only (1)
external direct costs of materials and services consumed in developing or
obtaining internal-use software, (2) payroll and payroll-related costs for
employees who are directly associated with the software project, and (3)
interest costs incurred, when material, while developing internal-use software.
Capitalization of such costs ceases no later than the point at which the project
is substantially complete and ready for its intended purpose. Software developed
or obtained for internal use is tested for impairment whenever events or changes
in circumstance indicates that its carrying amount may not be recoverable.
Capitalized software development costs are amortized using the straight-line
method over the lesser of three years or estimated useful life.
Costs incurred to establish the technological feasibility of software and other
computer software maintenance costs are recorded as research and development
costs and are charged to expense when incurred.
Long-Lived Assets
------------------
When circumstances warrant, the Company reviews its long-lived assets for
impairment using estimated undiscounted future cash flows associated with such
assets. An impairment loss would be determined as the difference between the
fair values and the carrying amounts of the assets. Management believes no such
impairment has occurred as of September 30, 2005.
Revenue Recognition
--------------------
The Company earns revenue from services which include the following: debit and
credit card processing, check guarantee, check verification, check conversion,
check re-presentment, check collection and inventory tracking. All of these
services are performed pursuant to a contract with customers which states the
terms and fixed price for all contracted services. The price of a service may
be a fixed fee for each transaction and/or a percentage of the transaction
processed, depending on the service. At the time the guarantee revenue is
recognized, the Company provides a reserve for estimated guarantee losses based
upon its historical loss experience. The Company generally collects its fee at
the time it processes the transaction and accordingly, collectibility is
assured. Based on the Company's underwriting criteria and ongoing credit
monitoring of customers, collectibility on service transactions is reasonably
assured.
Revenue from debit and credit card (collectively called "bankcards") and
transaction processing revenue is based on a percentage of the transaction
value, commonly referred to as a discount fee on a credit and debit card
transaction processed by the Company. In addition, there is a per transaction
fee associated with each bankcard transaction which is charged to the merchant.
The Company recognizes the processing and transaction revenue when the services
are performed.
F7
NOTE 1: (Continued)
-------
Revenue from check guarantee is derived from a percentage of the gross amount of
the check and guarantees payment of the check to the merchant in the event the
check is not honored by the check writer's bank. Merchants typically present
customer checks for processing on a regular basis and, therefore, dishonored
checks are generally identified within a few days of the date the checks are
guaranteed by the Company. The Company recognizes revenue when the checks are
processed at the point of sale. In the event a check is dishonored, the Company
has the right to collect the full amount of the check from the check writer.
The Company establishes a receivable from the delinquent check writer for the
full amount of the guaranteed check. The Company establishes a reserve against
these receivables based on historical loss experience. The check guarantee
service also earns revenue based on fees collected from delinquent check
writers, which collection fee is recognized when collected, as collectibility is
not reasonably assured until that point.
Revenue from check verification is derived from fees collected from the
merchants when a check is verified against the Company's positive and negative
check database. This revenue is recognized when the transaction is processed,
since the Company has no further performance obligations.
Revenue from check conversion is derived from fees collected from merchants to
convert the paper check received by merchants into an ACH transaction, which
allows the Company to settle the transaction electronically for the merchant.
The Company recognizes the revenue related to check conversion fees when the
services are performed.
Revenue from check re-presentment is derived from fees charged to check writers.
Check re-presentment is a service that allows merchants to collect a paper check
through the Automated Clearing House ("ACH") network after a check has
previously been presented to the bank for collection unsuccessfully at least
once. The fees earned from check writer are recognized when collected, as
collectibility is not reasonably assured until that point.
Revenue from check collection is derived from collection activities performed on
behalf of a merchant on uncollected checks. The merchant usually keeps the face
amount of the uncollected checks if the collection effort is successful. The
Company's revenue is derived from the collection fee collected from the check
writer. If the Company refers the collection item to another collection agency,
the Company will receive a fee from the collection agency upon its successful
efforts. Collection fee revenue is recognized when collected, as collectibility
is not reasonably assured until that point.
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 are based on the weighted average number of common
shares and dilutive common equivalent shares outstanding during the period. The
shares issuable upon conversion of preferred stock and exercise of options and
warrants are included in the weighted average for the calculation of diluted net
income per share except where it would be anti-dilutive.
Stock-Based Compensation
-------------------------
The Company has elected to account for its stock-based compensation plans in
accordance with APB Opinion No. 25 and to adopt only the disclosure requirements
of FAS 123, as amended by SFAS No. 148.
The Company measures compensation expense for its employee stock-based
compensation under APB 25. The Company provides pro-forma disclosures of net
income and earnings per share as if a fair value method had been applied using
the Black Scholes option pricing model. Compensation expense is recognized in
association with the
F8
NOTE 1: (Continued)
-------
issuance of stock options for the difference, if any, between the trading price
of the stock at the time of issuance and the price to be paid by the optionee.
Compensation expense is recorded over the vesting period. Pro forma compensation
costs for employee stock and stock option awards are amortized over the related
service periods using the straight-line method.
The weighted average fair value of the options granted during the fiscal years
ended September 30, 2005, 2004 and 2003 were $5.20, $4.93 and $1.66,
respectively. For options granted in fiscal 2005, the risk free interest rate
was approximately 3%, the expected life was 6 years, the expected volatility was
approximately 76.6%, and the expected dividend yield was 0%, all calculated on a
weighted average basis. For options granted in fiscal 2004, the risk free
interest rate was approximately 3%, the expected life was 7 years, the expected
volatility was approximately 84.0%, and the expected dividend yield was 0%, all
calculated on a weighted average basis. For options granted in fiscal 2003, the
risk free interest rate was approximately 3%, the expected life was 5 years, the
expected volatility was approximately 90.8%, and the expected dividend yield was
0%, all calculated on a weighted average basis.
The following table compares net income and earnings per share as reported to
the pro forma amounts that would be reported had compensation expense been
recognized for the stock-compensation plans in accordance with the fair value
recognition provisions of SFAS No. 123, as amended by SFAS No. 148, Accounting
for Stock-Based Compensation:
For the Fiscal Years Ended
September 30,
2005 2004 2003
----------- ----------- ------------
Net income (loss)
As reported $1,033,000 $2,849,000 $(3,379,000)
Add: stock-based employee
compensation expense included
in reported net income, net of
tax effect 5,000 20,000 -0-
Deduct: total stock-based employee
compensation expense determined
under fair value-based method for
all awards, net of related tax effects (529,000) (395,000) (212,000)
----------- ----------- ------------
Pro forma net income (loss) $ 509,000 $2,474,000 $(3,591,000)
=========== =========== ============
Basic earnings (loss) per share:
As reported $ 0.16 $ 0.45 $ (0.58)
Pro forma $ 0.08 $ 0.39 $ (0.62)
Diluted earnings (loss) per share:
As reported $ 0.15 $ 0.41 $ (0.56)
Pro forma $ 0.07 $ 0.36 $ (0.60)
Accounting Estimates
---------------------
The preparation of financial statements in conformity with generally accepted
accounting principles in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities, the
disclosure of contingent liabilities, and the reported amounts of revenues and
expenses during the reporting period. Significant estimates include allowance
for chargeback losses and deferred tax assets. Actual results could differ from
those estimates.
F9
NOTE 1: (Continued)
-------
Fair Value of Financial Instruments
---------------------------------------
The amount recorded for financial instruments in the Company's consolidated
financial statements approximates fair value as defined in SFAS No. 107,
"Disclosures about Fair Value of Financial Instruments".
Reclassifications
-----------------
Certain amounts in the September 30, 2004 and 2003 consolidated financial
statements have been reclassified to conform to the current year presentation.
Beginning with the first fiscal quarter of 2005, the Company revised the way it
classifies certain commission expenses paid to its independent sales agents who
sell the Company's bankcard processing services to merchants. The gross
commissions paid are now recorded as processing and transaction expense in the
consolidated statements of operations. Previously, the commissions paid to the
independent sales agents were recorded as a reduction to the revenue earned on
the transaction.
For the presentation of the 2004 and 2003 financial statements, the Company has
revised amounts previously reported to conform to the revised classification.
None of the classification changes has an impact on the gross margin, operating
income, net income, net cash flow or any element of the Company's consolidated
balance sheets for all periods presented. The Company does not consider the
effect of these revisions in classification in 2004 or in prior periods,
individually or in the aggregate, to be material.
New Accounting Pronouncement
------------------------------
In December 2004, the FASB issued SFAS 123R, "Share-Based Payment, an amendment
of FASB Statements Nos. 123 and 95," that addresses the accounting for
share-based payment transactions in which a Company receives employee services
in exchange for either equity instruments of the Company or liabilities that are
based on the fair value of the Company's equity instruments or that may be
settled by the issuance of such equity instruments. SFAS 123R eliminates the
ability to account for share-based compensation transactions using the intrinsic
method that the Company currently uses and generally would require that such
transactions be accounted for using a fair-value-based method and recognized as
expense in the consolidated statement of operations. SFAS 123R is effective for
annual periods beginning after June 15, 2005. Management is currently evaluating
the impact of SFAS 123R and it is expected that it will have a significant
impact on the consolidated statement of operations as the Company will be
required to expense the fair value of stock option awards.
NOTE 2 - STATEMENT OF CASH FLOWS:
---------------------------------------
September 30
----------------------------
2005 2004 2003
-------- -------- --------
Cash paid for:
Interest $113,000 $175,000 $200,000
Income taxes 154,000 8,000 1,000
Significant non-cash transactions for fiscal 2005 are as follows:
- A note was issued for $39,000 for the purchase of capital equipment.
- Restricted stock valued at $425,000 was issued to an executive of the
company.
Significant non-cash transactions for fiscal 2004 are as follows:
- Software purchases of $285,000 and capital equipment of $152,000 were
acquired under capital leases.
F10
NOTE 2: (Continued)
-------
Significant non-cash transactions for fiscal 2003 are as follows:
- Capital equipment of $525,000 was acquired under capital leases.
NOTE 3 - CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE:
----------------------------------------------------------------------
Effective October 1, 2002, the Company adopted Statement of Financial Accounting
Standards No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets". SFAS 142
requires that goodwill no longer be amortized, but instead be tested for
impairment at least annually using a fair value-based approach. In the year of
adoption, SFAS No. 142 also required the Company to perform an initial
assessment of its reporting units to determine whether there is any indication
that the goodwill carrying value may be impaired. This transitional assessment
is made by comparing the fair value of each reporting unit, as determined in
accordance with the new standard, to its book value. To the extent the fair
value of any reporting unit is less than its book value, which would indicate
that potential impairment of goodwill exists, a second transitional test was
required to determine the amount of impairment.
The Company has determined that it has two reporting units, which correspond to
its two reportable business segments; the "Bankcard and Transaction Processing"
unit and the "Check Related Products" unit. All of the Company's goodwill
relates to business acquisition transactions, which apply exclusively to the
Check Related Products unit. The Company completed the transitional impairment
testing required by SFAS 142 in the first quarter of fiscal 2003. The Company
determined the estimated fair value of its reporting units using a discounted
cash flow technique and a market approach based upon the Company's total market
capitalization as of October 1, 2002. Based upon the valuation findings, the
Company determined that its goodwill was fully impaired and a non-cash charge
equal to the goodwill carrying amount of $4.7 million was recognized in the
Company's consolidated financial statements. As prescribed by SFAS 142, the
Company treated this non-cash goodwill impairment as a cumulative effect of
change in accounting principle. No income tax benefit has been recognized for
this charge as the goodwill is not deductible for income tax purposes.
NOTE 4 - PROPERTY AND EQUIPMENT:
--------------------------------
Property and equipment are comprised of the following:
September 30
--------------------------
2005 2004
------------ ------------
Computer equipment $ 4,231,000 $ 3,630,000
Furniture, fixtures and equipment 1,051,000 897,000
Building improvements 119,000 76,000
Auto 56,000 34,000
------------ ------------
Cost 5,457,000 4,637,000
Less: accumulated depreciation and amortization (3,120,000) (2,344,000)
------------ ------------
Net book value $ 2,337,000 $ 2,293,000
============ ============
Included in property and equipment are assets under capital lease of $627,000
and $1,062,000 at September 30, 2005 and 2004, with related accumulated
depreciation of $276,000 and $372,000, respectively. Amortization of assets
recorded under capital leases is included with depreciation expense.
In March 2004, the Company sold a building, which formerly held the Company's
corporate offices. The total sales price was $2,382,000, which resulted in a
pre-tax gain of $1,319,000. Proceeds from the sale were used in part to pay off
the two notes collateralized by the building.
F11
NOTE 5 - SOFTWARE
--------------------
The following table sets forth information regarding the costs associated with
software purchased and developed for internal use:
September 30
--------------------------
2005 2004
------------ ------------
Software $14,864,000 $11,005,000
Less: accumulated amortization (5,988,000) (4,161,000)
------------ ------------
Net book value $ 8,876,000 $ 6,844,000
============ ============
Included in software cost are assets under capital lease of $26,000 and $508,000
at September 30, 2005 and 2004, and related accumulated amortization of $13,000
and $132,000, respectively.
NOTE 6 - OTHER ASSETS
-------------------------
Other assets consist of the following at September 30, 2005:
Accumulated Net
Cost Amortization Book Value
-------- ------------- -----------
Patents $173,000 $ 88,000 $ 85,000
Trademarks 280,000 115,000 165,000
Other 163,000 119,000 44,000
-------- ------------- -----------
$616,000 $ 322,000 $ 294,000
======== ============= ===========
Other assets consist of the following at September 30, 2004:
Accumulated Net
Cost Amortization Book Value
-------- ------------- -----------
Patents $173,000 $ 78,000 $ 95,000
Trademarks 280,000 87,000 193,000
Other 199,000 119,000 80,000
-------- ------------- -----------
$652,000 $ 284,000 $ 368,000
======== ============= ===========
Amortization expense for the years ended September 30, 2005 and 2004 was $38,000
and $115,000, respectively. Based on the current amount of intangible assets
subject to amortization, the estimated amortization expense for each of the five
succeeding years is $38,000.
F12
NOTE 7 - INCOME TAXES
---------------------
The (provision) benefit for income taxes consists of the following components:
September 30
------------------------------------
2005 2004 2003
---------- ------------ ----------
Current federal taxes $ -0- $ (19,000) $ -0-
Current state taxes (5,000) (87,000) (5,000)
Deferred taxes (664,000) (1,717,000) (920,000)
---------- ------------ ----------
Total (provision) benefit for income taxes $(669,000) $(1,823,000) $(925,000)
========== ============ ==========
The effective tax rate varies from the U.S. Federal statutory tax rate
principally due to the following:
September 30
-------------------------
2005 2004 2003
------ ------- --------
U.S. Federal statutory tax rate 34.00% 34.00% (34.00%)
Add (deduct):
Non-deductible goodwill -0- -0- 65.00%
State and local taxes 5.12% 5.10% 4.50%
All other 0.18% (0.10%) 2.20%
------ ------- --------
Effective tax rate 39.30% 39.00% 37.70%
====== ======= ========
Components of the deferred tax asset (liabilities) include:
September 30
--------------------------
2005 2004
------------ ------------
Deferred tax assets (liabilities):
Capitalized software $(2,714,000) $(1,727,000)
Reserve for bad debts 72,000 60,000
Accrued bonus 94,000 -0-
Reserve on legal settlement -0- 125,000
State tax expense 129,000 103,000
Stock option exercise 83,000 94,000
Net operating loss carryforward 1,316,000 861,000
Business tax credit 113,000 113,000
AMT credit 89,000 85,000
------------ ------------
Total deferred tax assets (liabilities) $ (818,000) $ (286,000)
============ ============
The Company has a federal net operating loss carryforward of $3,370,000, which
expires in 2021 through 2024. The Company has not recorded a valuation allowance
against deferred tax assets because it expects to have future taxable income to
recognize these assets.
F13
NOTE 8 - SHORT-TERM BORROWINGS AND LONG-TERM DEBT:
--------------------------------------------------------
Short-term borrowings and long-term debt consist of the following:
September 30
------------------------
2005 2004
----------- -----------
Term loan, collateralized by equipment, bearing
interest at prime rate, repaid during 2005 -0- 26,000
Term loan, collateralized by various assets of the Company, due
2006, bearing interest at prime rate plus 1%, 7.50%
at September 30, 2005 26,000 269,000
Term loan, collateralized by various assets of the Company,
due October 2008, interest at prime rate plus .50%,
7.25% at September 30, 2005 462,000 600,000
Term loan, collateralized by an asset of the Company,
due March 2010, interest at 2% 36,000 -0-
Equipment lease line, collateralized by various assets of the
Company, interest at prime rate plus .50%, 7.25% at
September 30, 2005 400,000 -0-
Capital leases 207,000 687,000
----------- -----------
1,131,000 1,582,000
Less: current portion (426,000) (878,000)
----------- -----------
$ 705,000 $ 704,000
=========== ===========
The weighted average interest rate on the prime rate term loans for the period
they were outstanding during the year ended September 30, 2005 was 5.58%.
One of the term loans contains restrictive debt covenants consisting of debt
service coverage ratio and tangible net worth requirements. As of September 30,
2005, the Company is in compliance with all such covenants. The Company has a
$3,000,000 credit line with a bank, which was unused during fiscal year 2005.
The Company has a $2 million equipment lease line with Bank of the West which we
have drawn down $1,000,000 as of September 30, 2005.
Future maturities of debt are as follows:
Fiscal year ended September 30
------------------------------
2006 $ 426,000
2007 290,000
2008 290,000
2009 120,000
2010 5,000
thereafter -0-
----------
$1,131,000
==========
F14
NOTE 9 - ACCRUED EXPENSES:
-------------------------
September 30
----------------------
Accrued expenses are comprised of the following: 2005 2004
---------- ----------
Accrued bankcard fees $ 293,000 $ 235,000
Accrued compensation and payroll taxes 881,000 700,000
Accrued communication costs 124,000 138,000
Accrued professional fees 498,000 212,000
Accrued commission 310,000 220,000
Accrued litigation expense -0- 300,000
Other 361,000 198,000
---------- ----------
$2,467,000 $2,003,000
========== ==========
NOTE 10 - STOCKHOLDERS' EQUITY:
----------------------------------
Stockholders' Rights Plan
---------------------------
The Company has a Stockholders' Rights Plan, which was amended in September
2004. As amended, the rights plan provides that all stockholders have two
preferred share purchase rights (each a "Right") for each outstanding share of
common stock of the Company. Each Right entitles the registered holder to
purchase from the Company four one-hundredths of a share of series A Junior
Participating Preferred Stock, no par value ("Preferred Stock") of the Company
at a price of $2.00 per one one-hundredth of a share of Preferred Stock
("Purchase Price"). The description and terms of the Rights are set forth in a
Rights Agreement dated as of September 30, 1996 ("Rights Agreement"), as amended
in January 2003 and September 2004.
The Rights will separate from the Common Stock and a Distribution Date will
occur upon the earlier of (i) 10 days following a public announcement that,
without consent of the Board of Directors, a person or group of affiliated or
associated persons ("Acquired Person") have acquired beneficial ownership of
twenty-percent (20%) or more of the outstanding Common Stock, or (ii) 10
business days (or such later date as may be determined by action of the Board of
Directors prior to such time as any person becomes an Acquired Person) following
the commencement of, or announcement of an intention to make a tender offer or
exchange offer the consummation of which would result in the beneficial
ownership by a person or group of twenty-percent (20%) or more of such
outstanding Common Stock.
In the event that any person becomes the beneficial owner of twenty-percent
(20%) or more of the Common Stock of the Company, ten (10) days thereafter
("Flip-In Event") each Right would permit the holder of such Right to thereafter
have the right to receive, upon exercise thereof at the then current Purchase
Price of the Right, Common Stock which has a value of eight times the Purchase
Price of the Right (such right being called the "Flip-In Right"). In the event
the Company is acquired in a merger or other business combination transaction
where the Company is not the surviving corporation or in the event that 50% or
more of its assets or earning power is sold, proper provision shall be made so
that each Right would permit the holder of such Right to thereafter have the
right to receive, upon the exercise thereof at the then current Purchase Price
of the Right, common stock of the acquiring entity which has a value of eight
times the Purchase Price of the Right. Upon the occurrence of the Flip-In
Event, any Rights that are or were at any time owned by an Acquiring Person
shall become null and void insofar as they relate to the Flip-In Right.
The Rights are not exercisable until the Distribution Date. One of the Rights
will expire on September 30, 2006 and the other Right will expire on January 29,
2013, unless the Rights are earlier redeemed or exchanged by the Company, in
each case, as described in the Rights Agreement.
F15
NOTE 10: (Continued)
--------
Earnings (Loss) Per Share
----------------------------
The following table sets forth the computation of basic and diluted earnings
(loss) per share:
September 30
------------------------------------
2005 2004 2003
---------- ---------- ------------
Numerator:
Income before cumulative effect of
an accounting change $1,033,000 $2,849,000 $ 1,328,000
Cumulative effect of an accounting change
to adopt SFAS 142 -0- -0- (4,707,000)
---------- ---------- ------------
Net income (loss): $1,033,000 $2,849,000 $(3,379,000)
========== ========== ============
Denominator:
Weighted average shares outstanding for basic
earnings (loss) per share 6,485,125 6,311,643 5,812,005
Effect of dilutive stock options 454,256 588,608 212,035
---------- ---------- ------------
Adjusted weighted average shares outstanding
for diluted earnings (loss) per share 6,939,381 6,900,251 6,024,040
========== ========== ============
Basic net earnings (loss) per share:
Before cumulative effect of accounting change $ 0.16 $ 0.45 $ 0.23
Cumulative effect of accounting change -0- -0- (0.81)
---------- ---------- ------------
Basic net earnings (loss) per share $ 0.16 $ 0.45 $ (0.58)
========== ========== ============
Diluted net earnings (loss) per share:
Before cumulative effect of accounting change $ 0.15 $ 0.41 $ 0.22
Cumulative effect of accounting change -0- -0- (0.78)
---------- ---------- ------------
Diluted net earnings (loss) per share $ 0.15 $ 0.41 $ (0.56)
========== ========== ============
For the years ended September 30, 2005, 2004 and 2003, approximately 72,500,
77,500, and 270,000 shares, respectively, attributable to the exercise of
outstanding options were excluded from the calculation of diluted EPS because
the effect was antidilutive.
NOTE 11 - COMMON STOCK OPTIONS AND RESTRICTED STOCK:
-----------------------------------------------------------
The Company had a 1992 Incentive Stock Option Plan (the "1992 Plan"), which
provided for the issuance of up to 1,343,750 stock options, each to purchase one
share of the common stock at a price not less than 100% of the market price at
the date of grant. In May 2002, the 1992 Plan expired. The 2003 Incentive Stock
Option Plan was approved at the Annual Shareholders' Meeting in February 2003.
The 2003 Incentive Stock Option Plan has similar provisions as the 1992 Plan.
In February 2005, the shareholders approved an amendment and restatement of the
2003 Incentive Stock Option Plan to, among other matters, (i) increase the
number of shares to be issued under the 2003 Incentive Stock Option Plan from
900,000 shares to 1,150,000 shares, and (ii) permit the grant of restricted
stock under the plan.
F16
NOTE 11: (Continued)
--------
Stock option and restricted stock activity during 2005, 2004, and 2003 was as
follows:
Exercise
Price
----------------- ------------------
Options outstanding September 30, 2002 712,584 $ 1.29 - $16.48
=================
Granted 238,000 1.30 - 8.50
Forfeited (65,959) 2.00 - 5.88
Exercised (75,750) 2.00 - 4.84
-----------------
Options outstanding September 30, 2003 808,875 $ 1.29 - $16.48
=================
Granted 425,000 6.85 - 9.56
Forfeited (6,750) 1.30 - 8.48
Exercised (93,200) 1.29 - 7.00
-----------------
Options outstanding September 30, 2004 1,133,925 $ 1.29 - $16.48
=================
Granted 260,000 7.60 - 9.16
Forfeited (158,600) 1.29 - 9.56
Exercised (119,200) 1.30 - 7.00
-----------------
Options outstanding September 30, 2005 1,116,125 $ 1.30 - 16.48
=================
Options exercisable at September 30, 2003 321,000 $ 1.29 - $16.48
=================
Options exercisable at September 30, 2004 355,035 $ 1.29 - $16.48
=================
Options exercisable at September 30, 2005 440,500 $ 1.30 - $16.48
=================
Restricted stock granted in fiscal 2005 50,000
=================
Authorized shares available for grant
at September 30, 2003 614,500
=================
Authorized shares available for grant
at September 30, 2004 193,000
=================
Authorized shares available for grant
at September 30, 2005 285,600
=================
All officer and key employee options are granted under the 1992 Plan. Both
options and restricted stock are granted under the 2003 Plan. The exercise price
of the incentive stock options shall be 100% of the fair market value on the
date the option is granted. Options granted to officers and employees are
normally vested over a five-year period. Options are exercisable for a period of
five years from date of vest. Restricted stock grants are normally vested over a
five-year period.
The following table summarizes information about stock options outstanding at
September 30, 2005:
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, 2005 Life Price Sept. 30, 2005 Price
---------------- -------------- ----------- --------- -------------- ---------
$ 1.30 - $2.00 102,750 6.38 $ 1.39 48,850 $ 1.48
$ 2.15 - $3.50 263,625 6.48 $ 2.60 136,100 $ 2.56
$ 4.00 - $5.88 102,250 2.95 $ 4.19 102,250 $ 4.19
$ 6.85 - $16.48 647,500 8.00 $ 7.55 153,300 $ 8.27
-------------- ----------- --------- -------------- ---------
1,116,125 7.03 $ 5.51 440,500 $ 4.81
============== =========== ========= ============== =========
F17
NOTE 12 - COMMITMENTS, CONTINGENT LIABILITIES, AND GUARANTEES:
---------------------------------------------------------------------
The Company currently relies on cooperative relationships with, and sponsorship
by, one bank in order to process its Visa, MasterCard and other bankcard
transactions. The agreement between the bank and the Company requires the
Company to assume and compensate the bank for bearing the risk of "chargeback"
losses. Under the rules of Visa and MasterCard, when a merchant processor
acquires card transactions, it has certain contingent liabilities for the
transactions processed. This contingent liability arises in the event of a
billing dispute between the merchant and a cardholder that is ultimately
resolved in the cardholder's favor. In such a case, the disputed transaction is
charged back to the merchant and the disputed amount is credited or otherwise
refunded to the cardholder. If the Company is unable to collect this amount
from the merchant's account, and if the merchant refuses or is unable to
reimburse the Company for the chargeback due to merchant fraud, insolvency or
other reasons, the Company will bear the loss for the amount of the refund paid
to the cardholders. The Company is also exposed to financial risk in providing
Automated Clearing House ("ACH") services to the merchants. As the Third-Party
processor for multiple originating banks, the Company is liable for any
fraudulent activities committed by the merchants initiating the ACH activities.
The Company utilizes stringent underwriting guidelines combined with a number of
systems and procedures to manage merchant risk. In addition, the Company
requires cash deposits by certain merchants, which are held by the Company's
sponsoring banks to minimize the risk related to merchant frauds and
chargebacks.
A cardholder, through its issuing bank, generally has until the later of up to
four months after the date a transaction is processed or the delivery of the
product or service to present a chargeback to the Company's sponsoring bank as
the merchant processor. Therefore, management believes that the maximum
potential exposure for the chargebacks would not exceed the total amount of
transactions processed through Visa and MasterCard for the last four months and
other unresolved chargebacks in the process of resolution. For the last four
months through September 30, 2005, this potential exposure totaled approximately
$443 million. At September 30, 2005, the Company, through its sponsoring banks,
had approximately $106,000 of unresolved chargebacks that were in the process of
resolution. At September 30, 2005, the Company, through its sponsoring banks,
had access to $13.7 million belonging to our merchants. This money has been
deposited at the sponsoring bank by the merchants to cover any potential
chargeback losses.
For the fiscal years 2005 and 2004, the Company processed approximately $1,186
million (2005) and $1,053 million (2004) of Visa and MasterCard transactions,
which resulted in $7.1 million in gross chargeback activities for the fiscal
year ended 2005 and $7.6 million for the fiscal year ended 2004. Substantially
all of these chargebacks were recovered from the merchants.
The Company's contingent obligation with respect to chargebacks constitutes a
guarantee as defined in Financial Accounting Interpretation No. 45, "Guarantor's
Accounting and Disclosure requirements for Guarantees, Including Indirect
Guarantees of Others" ("FIN 45"). FIN 45 requires that guarantees issued or
modified subsequent to December 31, 2002 be initially recorded as liabilities in
the Statement of Financial Position at fair value. Since the Company's
agreement with its sponsoring bank which establishes the guarantee obligation
was entered into prior to December 31, 2002 and has not been modified since that
date, the measurement provisions of FIN 45 are not applicable to this guarantee
arrangement.
In accordance with SFAS No. 5, "Accounting for Contingencies", the Company
records a reserve for chargeback losses based on its processing volume and
historical trends and data. As of September 30, 2005 and 2004, the allowance
for chargeback losses, which is classified as a component of the allowance for
uncollectible accounts receivable, was $29,000 and $46,000, respectively. The
expense associated with the chargeback allowance is included in processing and
transaction expense in the accompanying consolidated statements of income. The
Company expensed $13,000, $50,000, and $44,000 for the years ended September 30,
2005, 2004 and 2003, respectively for bankcard processing chargeback losses.
The Company has a small check guarantee business. The Company charges the
merchant a percentage of the face amount of the check and guarantees payment of
the check to the merchant in the event the check is not honored by the check
writer's bank. Merchants typically present customer checks for processing on a
regular basis and, therefore, dishonored checks are generally identified within
a few days of the date the checks are guaranteed by the Company. Accordingly,
management believes that its best estimate of the Company's
F18
NOTE 12: (Continued)
--------
maximum potential exposure for dishonored checks at any given balance sheet date
would not exceed the total amount of checks guaranteed in the last 10 days prior
to the balance sheet date. As of September 30, 2005, the Company estimates that
its maximum potential dishonored check exposure was approximately $1,239,000.
For the fiscal years ended 2005 and 2004, the Company guaranteed approximately
$40,413,000 (2005) and $19,382,000 (2004) of merchant checks, which resulted in
$279,000 (2005) and $139,000 (2004) of dishonored checks presented to the
Company for payments. The Company has the right to collect the full amount of
the check from the check writer. The Company establishes a reserve for this
activity based on historical and projected loss experience. The expense
associated with the guarantee costs is included in processing and transaction
expense in the accompanying consolidated statements of income.
Lease Commitments
------------------
The Company leases equipment and real property under agreements, which expire at
various times over the next five years. The Company's future minimum rental
payments for capital and operating leases at September 30, 2005 are as follows:
Fiscal Year Capital Leases Operating Leases
------------------------------- ---------------- -----------------
2006 $ 160,000 $ 536,000
2007 36,000 499,000
2008 33,000 499,000
2009 -0- -0-
2010 -0- -0-
---------------- -----------------
Total minimum lease payments $ 229,000 $ 1,534,000
=================
Less: imputed interest of 7.10% ( 22,000)
----------------
Present value of net
minimum lease payment $ 207,000
================
Rent expense for the years ended September 30, 2005, 2004, and 2003 totaled
$663,000, $572,000 and $299,000, respectively. Certain operating leases have
renewal options at the end of the lease term solely at the Company's discretion.
In May 2003, the Company leased new corporate office space in Camarillo,
California. The lease is for a period of five years at a current monthly rate
of $38,000.
NOTE 13 - LITIGATION
-----------------------
The Company is involved in various legal cases arising in the ordinary course of
business. Based upon current information, management, after consultation with
legal counsel, believes the ultimate disposition thereof will have no material
effect upon either the Company's results of operations or its financial
position.
In July 2004, LML Patent Corporation, a wholly-owned subsidiary of LML Payment
Systems, Inc. ("LML"), filed a patent infringement claim against the Company,
its subsidiary, XPRESSCHEX, Inc. and others, relating with respect to the
Company and its subsidiary, to the alleged infringement by our check conversion
processes of three patents held by LML. In September 2005, the patent
infringement claims for two (2) of the patents were dropped. The suit was filed
in the U.S. District Court for the District of Delaware. The discovery process
and expert witness reports have been completed and claims construction briefs
and summary judgment briefs have been filed with the court in anticipation of a
December 19, 2005 hearing on these issues. LML seeks an undisclosed amount of
damages in connection with the alleged infringement.
The Company was aware of the LML patents prior to LML's initiation of the claims
and had previously obtained competent legal opinions from outside patent counsel
that neither the Company nor any of its subsidiaries infringe on any valid or
enforceable patent rights of LML being asserted in the litigation. No documents
came out of the
F19
NOTE 13: (Continued)
--------
discovery process to alter the Company's original belief that none of its check
conversion processes infringe upon any valid or enforceable patent rights of
LML, and the Company will continue to vigorously defend its position against the
remaining claims made.
Ultimately, the Company expects that it will not be held liable for any of the
alleged infringement, including for any treble punitive damages. The case is
scheduled to go to trial in April of 2006. Should the Company be held liable
for any alleged infringement, which is not expected, the ultimate liability we
may sustain may include a royalty payment primarily calculated on activity
commencing in the middle of calendar 2003 for only select conversion activity,
as that was the time period in which the Company actively began utilizing the
check conversion processes alleged to infringe the LML patents. In view of the
relatively short time period involved and the relatively small overall
transaction volume arising from the alleged infringing check conversion services
in comparison to the Company's total transaction volume, the Company believes
that any such alleged damages award should have a relatively minor impact on our
results of operations, financial position, or cash flows.
NOTE 14 - SEGMENT INFORMATION
---------------------------------
The Company has adopted FAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information" (FAS 131). FAS 131 established revised
standards for public companies related to the reporting of financial and
descriptive information about their operating segments in financial statements.
Certain information is disclosed, per FAS 131, based on the way management
organizes financial information for making operating decisions and assessing
performance.
The Company currently operates in two business segments: Bankcard and
Transaction Processing and Check Related Products, all of which are located in
the United States. The Company also has certain corporate expenses such as
salaries and benefits, legal and professional fees, rent, and litigation accrual
expenses which are not allocated to the two business segments.
The Company's reportable operating segments have been determined in accordance
with the Company's internal management structure, which is organized based on
operating activities. The accounting policies of the operating segments are the
same as those described in the summary of significant accounting policies. The
Company evaluates performance based upon two primary factors, one is the
segment's operating income and the other is based on the segment's contribution
to the Company's future strategic growth.
September 30,
----------------------------------------
Business Segments 2005 2004 2003
----------------- ------------ ------------ ------------
Revenues:
Bankcard and Transaction Processing $41,093,000 $36,897,000 $32,957,000
Check Related Products 14,458,000 11,423,000 8,192,000
------------ ------------ ------------
$55,551,000 $48,320,000 $41,149,000
============ ============ ============
Operating Income:
Bankcard and Transaction Processing $ 5,829,000 $ 5,977,000 $ 4,303,000
Check Related Products 2,204,000 1,644,000 591,000
Other - Corporate Expenses (6,354,000) (4,164,000) (2,469,000)
------------ ------------ ------------
$ 1,679,000 $ 3,457,000 $ 2,425,000
============ ============ ============
Depreciation and Amortization:
Bankcard and Transaction Processing $ 954,000 $ 966,000 $ 867,000
Check Related Products 1,702,000 1,255,000 727,000
------------ ------------ ------------
$ 2,656,000 $ 2,221,000 $ 1,594,000
============ ============ ============
F20
NOTE 14: (Continued)
--------
Capital Expenditures:
Bankcard and Transaction Processing $ 2,167,000 $ 2,258,000 $ 2,479,000
Check Related Products 2,505,000 2,513,000 1,365,000
------------ ------------ ------------
$ 4,672,000 $ 4,771,000 $ 3,844,000
============ ============ ============
Total Assets:
Bankcard and Transaction Processing $ 9,452,000 $ 8,014,000 $ 7,051,000
Check Related Products 24,719,000 23,933,000 6,794,000
Other 6,646,000 7,481,000 4,930,000
------------ ------------ ------------
$40,817,000 $39,428,000 $18,775,000
============ ============ ============
NOTE 15 - QUARTERLY FINANCIAL DATA (Unaudited)
----------------------------------------------------
The following summarizes the quarterly financial results of the Company for the
fiscal years ended September 30, 2005 and September 30, 2004 (in thousands,
except share data):
Year Ended September 30, 2005
---------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
-------- -------- --------- --------
Net revenues $ 12,760 $ 13,321 $ 14,281 $ 15,189
Gross profit 4,469 4,688 5,164 5,075
Profit from operations 87 238 703 651
Net income 52 144 433 404
Earnings per share - basic $ 0.01 $ 0.02 $ 0.07 $ 0.06
Earnings per share - diluted $ 0.01 $ 0.02 $ 0.06 $ 0.06
Year Ended September 30, 2004
---------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
-------- -------- --------- --------
Net revenues $ 11,483 $ 11,983 $ 12,356 $ 12,498
Gross profit 4,394 4,243 4,484 4,582
Profit from operations 1,013 706 1,082 656
Net income 589 1,206 651 403
Earnings per share - basic $ 0.10 $ 0.19 $ 0.10 $ 0.06
Earnings per share - diluted $ 0.09 $ 0.17 $ 0.09 $ 0.06
F21
ELECTRONIC CLEARING HOUSE, INC. AND CONSOLIDATED SUBSIDIARIES
SCHEDULE II TO FORM 10K
RULE 12-09 VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
REDUCTION IN REDUCTION IN
RESERVE AND RESERVE AND
BALANCE AT CHARGED TO ACCOUNTS BALANCE AT CHARGED TO ACCOUNTS BALANCE AT CHARGED TO
DESCRIPTION 09/30/2002 EXPENSE RECEIVABLE 09/30/2003 EXPENSE RECEIVABLE 09/30/2004 EXPENSE
--------------------- ----------- ----------- ------------- ----------- ----------- ------------- ----------- -----------
Allowance for
trade receivables/
chargeback $ 431,000 $ 67,000 $ 407,000 $ 91,000 $ 218,000 $ 176,000 $ 133,000 $ 295,000
receivables
Allowance for
obsolete inventories $ 300,000 $ 110,000 $ 410,000 $ -0- $ 46,000 $ -0- $ 46,000 $ 10,000
REDUCTION IN
RESERVE AND
ACCOUNTS BALANCE AT
DESCRIPTION RECEIVABLE 09/30/2005
--------------------- ------------- -----------
Allowance for
trade receivables/
chargeback $ 311,000 $ 117,000
receivables
Allowance for
obsolete inventories $ 56,000 $ -0-
S1
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.[4]
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.[5]
3.1 Articles of Incorporation of Bio Recovery Technology, Inc., filed with the Nevada Secretary of State on
December 11, 1981.[1]
3.1.1 Amendment to the Articles of Incorporation of Electronic Clearing House, Inc. filed with the Nevada
Secretary of State on June 21, 1990.
3.1.2 Amendment to the Articles of Incorporation of Electronic Clearing House, Inc. filed with the Nevada
Secretary of State on September 27, 1991.
3.1.3 Amendment to the Articles of Incorporation of Electronic Clearing House, Inc. filed with the Nevada
Secretary of State on August 5, 1993.
3.1.4 Amendment to the Articles of Incorporation of Electronic Clearing House, Inc. filed with the Nevada
Secretary of State on April 7, 1995.
3.1.5 Amendment to the Articles of Incorporation of Electronic Clearing House, Inc. filed with the Nevada
Secretary of State on April 7, 1997.
3.1.6 Amendment to the Articles of Incorporation of Electronic Clearing House, Inc. filed with the Nevada
Secretary of State on March 13, 1998.
3.1.7 Amendment to the Articles of Incorporation of Electronic Clearing House, Inc. filed with the Nevada
Secretary of State on June 21, 1999.
3.1.8 Amendment to the Articles of Incorporation of Electronic Clearing House, Inc. filed with the Nevada
Secretary of State on September 6, 2001.
3.2 By-Laws of Bio Recovery Technology, Inc.[1]
3.2.1 Amendment to the By-Laws of Electronic Clearing House, Inc., dated April 25, 2005.
3.2.2 Amendment to the By-Laws of Electronic Clearing House, Inc., dated September 9, 2005.
4.1 Amended and Restated Rights Agreement between Electronic Clearing House, Inc. and OTR, Inc.,
dated January 29, 2003.[11]
4.1.1 Amendment Number One to Amended and Restated Rights Agreement dated September 27, 2004.[12]
4.2 Specimen Common Stock Certificate. [2]
4.3 Amended and Restated 2003 Incentive Stock Option Plan.[13]
4.4 Amended and Restated Officers and Key Employees Incentive Stock Option Plan.[14]
10.35 Copy of Merchant Marketing and Processing Services Agreement between Electronic Clearing House,
Inc. and First Regional Bank, dated June 24, 1997. [3]
10.42 Copy of Addendum to Agreement between Electronic Clearing House, Inc. and U-Haul International,
dated January 1, 2000.[5]
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.[5]
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.[5]
10.48 Copy of POS Check Third-Party Services Agreement between Visa U.S.A., Inc. and Electronic Clearing
House, Inc., dated December 12, 2000.[6]
10.49 Copy of Asset Purchase Agreement between National Check Network, Inc. and Electronic Clearing
House, Inc., dated April 19, 2001. [6]
10.50 Copy of Addendum to Agreement between U-Haul International and Electronic Clearing House, Inc.,
dated October 1, 2001. [6]
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. [7]
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. [7]
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. [7]
10.54 Form of Securities Purchase Agreement by and among the Registrant and the Purchasers identified
therein. [8]
10.55 Form of Registration Rights Agreement by and among the Registrant and the Purchasers identified
therein. [8]
10.56 Office Lease dated May 21, 2003, by and between the Registrant and the 1989 Sheehan Family Trust
dated October 24, 1989, with respect to principal executive offices located at 730 Paseo Camarillo,
Camarillo, California 93010.[9]
10.57 First Amendment to Lease dated July 10, 2003, by and between the Registrant and the 1989 Sheehan
Family Trust dated October 24, 1989, with respect to principal executive offices located at 730 Paseo
Camarillo, Camarillo, California 93010.
10.58 Addendum to Office Lease dated July 7, 2004, by and between the Registrant and the 1989 Sheehan
Family Trust dated October 24, 1989, with respect to principal executive offices located at 730 Paseo
Camarillo, Camarillo, California 93010. [10]
11.1 Statement re computation of per share earnings, incorporated herein by reference to Note 10 of the
Notes to Consolidated Financial Statements.
21.0 Subsidiaries of Registrant as of September 30, 2005.
23.1 Consent of PricewaterhouseCoopers LLP
24.1 Power of Attorney [15]
31.1 Certificate of Joel M. Barry, Chief Executive Officer of Electronic Clearing House, Inc. pursuant to
Rule 13a-14(b) under the Securities and Exchange Act of 1934, as amended.
31.2 Certificate of Alice L. Cheung, Chief Financial Officer of Electronic Clearing House, Inc. pursuant to
Rule 13a-14(b) under the Securities and Exchange Act of 1934, as amended.
32.1 Certificate of Joel M. Barry, Chief Executive Officer of Electronic Clearing House, Inc. pursuant to
Rule 13a-14(b) under the Securities and Exchange Act of 1934, as amended.
32.2 Certificate of Alice L. Cheung, Chief Financial Officer of Electronic Clearing House, Inc. pursuant to
Rule 13a-14(b) under the Securities and Exchange Act of 1934, as amended.
----------------------
[1] Filed as an Exhibit to Registrant's Annual Report on Form 10-K for the
fiscal year ended September 30, 1988 and incorporated herein by
reference.
[2] Filed as an Exhibit to Registrant's Form S-1, Amendment No. 3,
effective November 13, 1990 and incorporated herein by reference.
[3] 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.
[4] 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.
[5] 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.
[6] 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.
[7] Filed as an Exhibit to Registrant's Annual Report on Form 10-K for
fiscal year ended September 30, 2002 and incorporated herein by
reference.
[8] Filed as an Exhibit to Registrant's Current Report on Form 8-K dated
October 30, 2003 and incorporated herein by reference.
[9] Filed as an Exhibit to Registrant's Annual Report on Form 10-K for
fiscal year ended September 30, 2003 and incorporated herein by
reference.
[10] Filed as an Exhibit to Registrant's Annual Report on Form 10-K for
fiscal year ended September 30, 2004 and incorporated herein by
reference.
[11] Filed as an Exhibit to Registrant's Form 8-A dated February 10, 2003
and incorporated herein by reference.
[12] Filed as an Exhibit to Registrant's Form 8-K dated September 30, 2004
and incorporated herein by reference.
[13] Filed as an Exhibit to Registrant's Notice of Annual Meeting of
Shareholders dated February 7, 2005 and incorporated herein by
reference.
[14] Filed as an Exhibit to Registrant's Notice of Annual Meeting of
Shareholders dated February 4, 1999 and incorporated herein by
reference.
[15] Included on signature page.