Item 405 of
Regulation S-K (§229.405
of this chapter) 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 a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of
accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange
Act.
(Check one):
|
Large
accelerated filer £
|
Accelerated
filer R
|
Non-accelerated
filer £
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes £ No
R
Based
on
a closing price of $11.61 as reported by the NASDAQ Stock Market on March 31,
2007, the aggregate market value of the voting and non-voting common equity
held
by non-affiliates was $73,491,799 .
As
of
November 30 , 2007, the Registrant had outstanding 7,025,329 shares
of Common Stock.
DOCUMENTS
INCORPORATED BY REFERENCE – Portions of the issuer’s definitive Proxy Statement
to be filed pursuant to Regulation 14A within 120 days after the end of its
last
fiscal year are incorporated by reference into Part III of this
report.
ELECTRONIC
CLEARING HOUSE, INC.
2007
FORM 10-K ANNUAL REPORT
TABLE
OF CONTENTS
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PART
IV
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42
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ITEM
15.
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PART
I
CAUTIONARY
STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This
2007
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,
revenue sources and anticipated expenditures. 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, such factors
as
fluctuations in demand for our products and services, the introduction of new
products and services, our ability to maintain customer and strategic business
relationships, the underlying businesses of our customers, strategic
transactions or events (such as mergers, acquisitions or divestitures),
transactions or events that require us to revise our strategic objectives or
to
implement new strategies, transactions or events outside the ordinary course
of
business that divert management’s attention from our strategic
objectives, technological advancements and our ability to implement
new technologies, the impact of competitive products, services and pricing,
growth in targeted markets, the adequacy of our liquidity and financial strength
to support our growth and initiatives, and those other risk factors set
forth elsewhere in this Annual Report. See “Item 7. Management’s
Discussion and Analysis of Financial Condition and Results of Operations – Risk
Factors.”
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ITEM
1.
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Business
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OVERVIEW
Electronic
Clearing House, Inc. (ECHO) is an electronic payment processor that
provides for the payment processing needs of retail, online and recurring
payment merchants through its direct sales team as well as channel partners
that include technology companies, banks, collection agencies and other trusted
resellers. The company derives the majority of its 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 and process 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 (where we provide authorization, clearing and settlement for
all
major credit and debit card brands), 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), eCheck (the
processing of a payment generally originating from an internet or recurring
payment merchant wherein the direct debit from a consumer’s checking account
occurs via the 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
returned checks). We operate our services under the following
brands:
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·
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ECHO,
our retail and wholesale brand for credit card and check processing
services to merchants, banks, technology partners and other trusted
reseller channels;
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·
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MerchantAmerica,
Inc. our online presence for merchant reporting and web
services;
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·
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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; and
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·
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XPRESSCHEX,
Inc. for check collection services.
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We
discuss our services in greater detail below. Overall, our ability to
program and oversee the management of a merchant’s point-of-sale (POS) system,
provide credit card and debit card processing, provide multiple services for
the
processing of checks, provide both electronic and traditional collection
services, and integrate all of these services into an Internet-based reporting
capability allows us to provide for the majority of the payment processing
needs
of our customers.
Bankcard
and transaction processing services provide for the majority of our
revenues. We typically receive a percentage-based fee (“Discount
Rate”) on the dollar amount processed and a transaction fee on the number of
transactions processed. For the fiscal year 2007, the bankcard and
transaction processing business segment accounted for approximately 81.4% of
the
Company’s total revenue.
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. We
make
available, free of charge on our website, our annual report on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments
to
those reports filed or furnished pursuant to Section 13(a) or 15(d) of the
Exchange Act as soon as reasonably practicable after we electronically file
such
material with, or furnish it to the SEC through a link to the appropriate
section of the SEC’s website.
In
October 2006, the Unlawful Internet Gaming Enforcement Act was passed and signed
into law. As a result of the passed legislation, several of our
Internet Wallet merchants, all of which used our check services, had a
significant drop in processing activities during the quarter ended December
31,
2006 as we wound down the services we provided to them. During February 2007,
the Company decided to cease processing and collection services for all Internet
wallet customers. On March 27, 2007, the Company entered into a
Non-Prosecution Agreement pursuant to which the Office of the United States
Attorney for the Southern District of New York agreed not to pursue actions
against the Company and its subsidiaries for activities related to its provision
of payment processing services to Internet wallets that provided services to
online gaming websites during the period from January 2001 through and including
the date of the signing of the Non-Prosecution Agreement.
On
December 14, 2006, we entered into an Agreement and Plan of Merger (the Merger
Agreement) to be acquired by Intuit, Inc. (Intuit) in a merger transaction
in
which we would have become a wholly owned subsidiary of Intuit (the Intuit
merger). Pursuant to the terms of the Merger Agreement and subject to
the conditions thereof, Intuit would have acquired all of the outstanding shares
of our common stock and all outstanding equity awards (which would have vested
in connection with the transactions) for a cash amount of $18.75 per share,
for
a total purchase price of approximately $142 million on a fully diluted
basis. The transaction was subject to regulatory review, our
shareholder approval and other customary closing conditions. On March
26, 2007, the Company mutually agreed with Intuit and Elan Acquisition
Corporation, a Nevada corporation and wholly owned subsidiary of Intuit
(“Elan”), to terminate the Merger Agreement. The parties determined
that it was in the mutual best interest of each party to terminate the proposed
agreement. In connection with the termination, the Company, Intuit
and Elan agreed to release each other from all claims arising under or related
to the terminated merger agreement. The Company also cancelled its
previously adjourned special stockholders’ meeting relating to the proposed
acquisition, which was scheduled to reconvene on March 27, 2007. As
of result of the termination of the merger agreement, the Company recorded
approximately $934,000 for the year ended September 30, 2007 of costs related
to
the merger.
OUR
HISTORY
ECHO
has been offering bankcard and check services for over 20 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
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).
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.
OUR
SERVICES
Bankcard
and Transaction Processing Services
Services
With
our
bankcard and transaction processing services, we provide payment solutions
to
merchants that 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 connect to our host computers that are interfaced 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.
Other
Payment Processing Services
We
also
provide various services related to our debit and credit card payment
processing, including:
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·
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Internet
Processing – Utilizing our proprietary internet gateway or virtual
terminal, ECHO allows merchants to accept both card and eCheck
payment transactions in an online environment, providing immediate
processing and near real-time web based
reporting.
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·
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Batch
File Processing – ECHO allows mail order, telephone order or
direct marketing merchants to process and transmit payments by using
Microsoft Excel®, Access® 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.
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Deriving
Revenue
Bankcard
and transaction processing services provide for the majority of our
revenue. For the year ended September 30, 2007, bankcard and
transaction processing accounted for approximately 81.4% of our
revenue. Bankcard and transaction processing volume rose 11.2% in
fiscal 2007, from $1,775,063,000 in fiscal 2006 to $1,973,189,000 in fiscal
2007, and revenue increased approximately 9.8%, from $56,983,000 in fiscal
2006
to $62,580,000 in fiscal 2007.
During
the year ended September 30, 2007, one customer, Allegiant Travel Company
(“Allegiant”), accounted for 10.1% of total revenue. No customer
accounted for 10% or more of total revenue for the fiscal years 2006 and 2005.
At September 30, 2007 and 2006, Allegiant also accounted for 19.0% and 12.2%,
respectively, of the net accounts receivable balance.
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.
A
transaction fee is charged for each transaction processed by ECHO,
including MasterCard, Visa, American Express and Discover Card
transactions.
Interchange,
the discount rate and transaction fee charged by the card-issuing bank and
paid
each day when transactions are processed, normally constitutes 60% to 70% of
the
bankcard revenue. Other external costs, such as Visa and MasterCard dues and
bank fees, increase external fees we pay to 67% to 75% of the total bankcard
revenue.
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. In the
Technology Partner channel we see a good balance between both card present
and
card not present merchants. Our ability to effectively support this
processing diversity should allow us to be more effective in attracting key
technology companies as partners. Now that the Clearing module is installed
and
operational, we 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 merchants 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.
Sponsorship
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. ECHO also maintains a secondary sponsoring
relationship with National Bank of California, located in Los Angeles
California. As a result of these relationships, 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 July 2010. Our
relationship with National Bank of California extends to April 2012. Pursuant
to
the terms of these agreements, 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 $0.01 to $0.02 per transaction. The agreements
do 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”)
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
To
facilitate the acceptance of a check, 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.
The
NCN
database includes approximately 14 million negative check account records and
28
million positive records. Approximately 250 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 known national databases
that can serve this market need on a national scale. 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.
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 or a fraudulent check writer whose check transaction
was dishonored by his or her own bank. If we are unable to collect
the dishonored check, we incur a bad debt expense. On average, we
collect 60-70% 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.
Electronic
Check Conversion ("ECC")
Check
conversion is the ability to convert a paper check to an electronic item at
the
point of sale. 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 (eCheck), 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 pass-code 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 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 2007,
a
national merchant could expect connection to around 20%-30% of the nation’s
checking accounts from all locations and higher in some metropolitan
locations
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 to the Visa network. We are currently
one of the few 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.
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.
An
Acquirer Processor in the Visa Program is the party who accepts transactions
from the merchant’s point-of-sale system and reformats them for submission to
the Visa network. We act as an Acquirer Processor for
several banks in the Visa Program.
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 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.
As
a more
mature product offering, we continue to see value in the Visa POS Program as
a
competitive differentiator. We will continue to leverage this unique
capability throughout our direct and indirect sales channels, however, the
market potential of this service is still unproven and its success is largely
dependent on the continuing marketing support of Visa and Visa’s member
banks.
Deriving
Revenue
For
the
year ended September 30, 2007, check services accounted for approximately 18.6%
of our revenue. Revenue decreased approximately 22.0%, from
$18,328,000 in fiscal 2006 to $14,304,000 in fiscal 2007. The
decrease in check revenue primarily reflects the wind-down of the Company’s
Internet wallet business and the discontinuation of services to several merchant
categories that management determined were carrying unacceptable levels of
business or financial risk.
ECHO’s
revenue in check services can come from several sources. Typically,
the merchant pays either a fixed fee for each transaction (verification,
conversion, eCheck, etc.) or a fee based on the face amount of the check 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.
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 30%, depending on several
factors.
Sponsorship
In
order
to process electronic check transactions into the ACH network, a sponsoring
relationship with a Federal Reserve member bank is
required. ECHO currently maintains four such sponsoring
relationships, First Regional Bank, Los Angeles, California, National Bank
of
California, Los Angeles, California, First Community Bank, Albuquerque, New
Mexico and Regal Financial Bank, Seattle, Washington.
OUR
CUSTOMERS
ECHO’s
primary customer focus is in the area of niche markets, in particular, markets
that are not well understood by our larger competitors. Approximately
70% of ECHO’s
revenues come from merchants who operate their business 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 additional financial risk. ECHO has
historically been very successful in managing the risk associated with the
non-face-to-face merchant. We have specific merchant concentrations
in the following areas;
Specialty
Retail
Primarily
driven by our unique product set in check services, we’ve been successful in
gaining access to a number of markets within the retail merchant vertical,
including grocery, convenience store and apparel.
Online
Travel
As
a
result of one key relationship, ECHO has established a presence in the
dynamic online travel segment. Our current business includes an
online travel company selling travel packages to leisure destinations, both
on a
stand-alone basis (airfare only) and bundled with hotel rooms, rental cars
and
other travel related services.
Direct
Marketing
ECHO
has invested over 10 years in developing our reputation in the Direct Marketing
vertical. Our business consists of a wide range of merchant groups,
including seminars, direct sales and multi-level marketing organizations as
well
as number of web based product and service categories.
Cashing
Services
ECHO
has
established an integrated processing relationship with the largest check cashing
provider to the land-based gaming and casino market. Our services are
primarily centered on providing check verification (using our NCN database),
funds movement, collections and several sophisticated risk management services
that are used to assist the provider in confidently accepting
checks.
Specialty
Finance
Specialty
finance represents a diverse market. Our primary focus is in the area
of warranty, insurance and subscription services where there are significant
concentrations of recurring payments. Our warranty portfolio consists
mainly of auto warranties and the companies that serve this market, including
administrators, finance companies and sales agents. Our insurance
business includes merchants selling auto, watercraft, homeowners, condominium,
renters and umbrella products. Subscription Services include
merchants selling health club memberships, daycare and internet
services.
Small
Merchant Enterprise (SME)
Through
both internet based marketing initiatives as well as a number of key reseller
relationships, ECHO has built a solid business supporting small
merchants both in the internet and brick and mortar category.
OUR
STRATEGY
Overview
In
2007, ECHO has refocused on its sales and
service strategy which is to provide merchants, banks, technology partners
and
collection agencies with electronic payment services that combine credit card,
debit card and electronic check and collection services with quality customer
support. We believe this “All-In-One” offering represents a
significant competitive differentiator for ECHO.
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.
As
a
niche processor, our strategy is to continue building upon the success of our
core markets and focus our sales effort towards adjacent markets that offer
high
growth potential; that can drive processing volume and that have recurring
or
scheduled payments. We view the non-face-to-face environment as
one of our largest growth opportunities. This segment includes both
internet sites and recurring billing merchants. All of these
merchants benefit from our ability to handle both a retail or online credit
card
or eCheck transaction quickly and securely.
Sales
and Marketing
Our
sales
and marketing strategy is to pursue direct sales opportunities where there
is a
significant amount of card and check acceptance; to build processing
relationships with certain providers of POS software/hardware that serve select
merchant markets; to maximize cross-selling opportunities within our existing
base of retail merchants and financial institutions; to sell integrated suites
of check, credit and debit card processing services through small banks; and
to
pursue associations aggressively.
ECHO
offers its payment services through three sales channels.
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Direct
Sales– Direct sales personnel are dedicated to focused industries
and/or services. We employ approximately 20 people who serve in either
field or office positions that are dedicated to sales.
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Channel
Partnerships– We have a well established base of channel
partnerships. These include Banks, our network of nearly 250
NCN Collection Agencies, Independent Sales Agents and
Associations. These relationships offer lower margins to us due
to their participation in the overall revenue generated from the
payment
processing fees.
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Technology
Partnerships– ECHO has launched a new channel focused on
securing relationships with companies who provide technology solutions
to
our target merchant segments. This will be a new focus for the
company in 2008.
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Direct
Sales
We
currently employ approximately 20 direct sales executives. The field
sales force is dispersed geographically throughout the United States and is
tasked with securing processing relationships with merchants in our designated
niche markets. We also maintain a telesales force within the
corporate headquarters. This staff provides first line sales for all
business generated through our various marketing initiatives, including web,
mail and print. Additionally, the telesales team acts as a closing
channel for all new business referred by our Channel and Technology
partnerships.
Promote
Merchant Payment Processing for 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 fixed costs, most small
banks are either unable or unwilling to compete with national banks in providing
credit card and real time check 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.
ECHO
estimates that there are approximately 8,000 community banks in the United
States. Based on third-party research, we estimate that approximately 57% of
these banks offer payment solutions for their merchants. We believe these banks
will be very responsive to the ECHO value proposition when a comparison
of features and costs is reviewed.
Along
similar lines, we believe there are quality independent sales organizations,
many of which are focused on select markets, where we can establish a viable
and
mutually profitable relationship wherein they sell our processing
services.
Associations
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.
Technology
Partners Providing POS Systems
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 integrating 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 provide the POS system partner with some economic benefit from the processing
volume of the users of its system.
OUR
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.
Of
the
top 50 credit card acquirers in the nation, the majority are independent sales
organizations or banks that may manage the front-end authorization service
but
they outsource 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, Heartland Payments, Alliance
Data Systems and RBS Lynk. We believe we hold the distinction of
being the smallest public company who serves as a full service processor in
credit cards and check services. 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.
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 (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 when
competing for such business against these parties. 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