-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, SLCjwaOj1Cw4XgmLei6q2hWSfzXfY55IS55AeUxPCo/RQnstdfhXP4TMptiB0lYo 02bWj6rhT66GBSzQnCcTgA== 0001047469-99-012299.txt : 19990331 0001047469-99-012299.hdr.sgml : 19990331 ACCESSION NUMBER: 0001047469-99-012299 CONFORMED SUBMISSION TYPE: 10KSB PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990330 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ELECTRONIC PROCESSING INC CENTRAL INDEX KEY: 0001027207 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMPUTER PROGRAMMING SERVICES [7371] IRS NUMBER: 481056429 STATE OF INCORPORATION: MO FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10KSB SEC ACT: SEC FILE NUMBER: 000-22081 FILM NUMBER: 99577851 BUSINESS ADDRESS: STREET 1: 501 KANSAS AVENUE CITY: KANSAS CITY STATE: KS ZIP: 66105 BUSINESS PHONE: 9133216392 MAIL ADDRESS: STREET 1: 501 KANSAS AVENUE CITY: KANSAS CITY STATE: KS ZIP: 66105 10KSB 1 10KSB - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 ------------------------ FORM 10-KSB /X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 COMMISSION FILE NUMBER 0-22081 ------------------------ ELECTRONIC PROCESSING, INC. (Name of small business issuer in its charter) MISSOURI 48-1056429 (State or Other Jurisdiction of (IRS Employer Identification No.) Incorporation or Organization) 501 KANSAS AVENUE, 913-321-6392 KANSAS CITY, KANSAS 66105-1300 (Issuer's Telephone Number) (Address of principal executive offices) Securities Registered Under Section 12(b) of the Exchange Act: NONE Securities Registered Under Section 12(g) of the Exchange Act: COMMON STOCK, WITHOUT PAR VALUE ------------------------ Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months and (2) has been subject to such filing requirements for the past 90 days. Yes /X/ No / / Check if disclosure of delinquent filers in response to Item 405 of Regulation S-B is not contained in this form, and no disclosure will 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-KSB or any amendment to this Form 10-KSB. / / Revenues for the fiscal year ended December 31, 1998 were $11,546,273. The aggregate market value of the Common Stock held by non-affiliates (based upon the last reported price on the bid-ask average on the Nasdaq National Market) on March 11, 1999 was approximately $28,295,446. As of March 11, 1999 there were 4,634,468 shares of Common Stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE NONE - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- ELECTRONIC PROCESSING, INC. ANNUAL REPORT ON FORM 10-KSB TABLE OF CONTENTS PART 1 ITEM 1. Description of Business.................................................... 1 ITEM 2. Description of Properties.................................................. 7 ITEM 3. Legal Proceedings.......................................................... 7 ITEM 4. Submission of Matters to a Vote of Security Holders........................ 7 PART II ITEM 5. Market for the Registrant's Common Equity and Related Stockholder Matters.................................................................. 8 ITEM 6. Management's Discussion and Analysis or Plan of Operation.................. 8 ITEM 7. Financial Statements....................................................... 12 ITEM 8. Changes in and Disagreements with Accountants on Accounting And Financial Disclosure............................................................... 26 PART III ITEM 9. Directors, Executive Officers, Promoters, and Control Persons; Compliance with Section 16(a) of the Exchange Act................................... 27 ITEM 10. Executive Compensation..................................................... 28 ITEM 11. Security Ownership of Certain Beneficial Owners and Management............. 30 ITEM 12. Certain Relationships and Related Transactions............................. 30 ITEM 13. Exhibits and Reports on Form 8-K........................................... 31
i PART I ITEM 1. DESCRIPTION OF BUSINESS Electronic Processing, Inc. ("EPI" or the "Company") serves a national client base with specialty products that facilitate financial and administrative aspects of bankruptcy management, including legal noticing, claims management, funds distribution and government reporting. The Company develops, markets, licenses and supports internally developed and proprietary software products primarily to trustees under Chapter 7 and Chapter 13 of the federal bankruptcy system, as well as to other users of the federal bankruptcy system, including trustees in Chapter 11 and Chapter 12. EPI assimilates software development, network operations, value-added services and comprehensive post-installation support into an integrated environment that offers clients a high level of coordinated support. Today, the Company's business is centered around two primary software products: TCMS (Trustee Case Management System) for Chapter 7 trustees and CasePower for Chapter 13 trustees. Both products are compatible with current computer technologies and offer an array of bankruptcy-specific functions that are useful in the daily operations of a bankruptcy trustee's office. INDUSTRY OVERVIEW Title 11 of the U.S. Code establishes federal law governing bankruptcies. The participants in a bankruptcy proceeding include the debtor, the creditors, and a trustee, as well as the presiding judge. The trustee acts as an intermediary between the debtor and the creditors and is responsible for administering the bankruptcy case. The end user clients of the Company's products are trustees, not individual debtors or creditors. The United States Trustee's office, a division of the Justice Department, oversees bankruptcy trustees and establishes administrative rules concerning trustees' activities. Local bankruptcy judges also direct trustees' activities and have a high level of authority in a bankruptcy case. The trustees' activities are guided by the Bankruptcy Code, the Federal Rules of Bankruptcy Procedure, the trustee handbooks developed by the United States Trustee, and local rules established by the courts. There are five chapters of the Bankruptcy Code that define various configurations of bankruptcy cases: Chapter 7--Liquidation Chapter 9--Reorganization of Municipality Chapter 11--Reorganization of Corporation Chapter 12--Reorganization of Family Farm Chapter 13--Reorganization of Individual Debt The Company believes that Chapter 7 and Chapter 13 are the most attractive sectors in the bankruptcy industry to which it can provide service and has developed a strategic plan accordingly. In the aggregate, Chapters 9, 11, and 12 represent only approximately 1% of overall national bankruptcy filings. Chapter 7 and Chapter 13 bankruptcies serve different purposes and require different services and information. Chapter 7 of the Bankruptcy Code provides for liquidation of the assets of the debtor (which can be an individual, partnership or corporation) and for the disbursement of the resulting cash proceeds to the creditors. Chapter 13 provides for adjustments of debt whereby the debtor makes regular payments to the trustee, who in turn disburses the collected funds to the creditors. Assets are not liquidated in Chapter 13. Bankruptcy trustees in Chapters 7 and 13 are appointed by the United States Trustee. A United States Trustee is appointed in most federal court districts and generally has responsibility for overseeing the 1 integrity of the bankruptcy system. Bankruptcy trustees in Chapter 7 and Chapter 13 cases are charged with managing the administrative aspects of liquidation or reorganization bankruptcies. The trustee's primary responsibilities include collecting funds from the debtor (Chapter 13) or liquidating the debtor's assets (Chapter 7), distributing the collected funds to creditors pursuant to the orders of the bankruptcy court, and preparing regular status reports, including financial updates, for the United States Trustee and for the bankruptcy court. Trustees typically are attorneys or certified public accountants and manage many different bankruptcy cases simultaneously. A trustee client uses an EPI product to manage an entire caseload; the Company does not contract with trustees to manage specific individual cases. The Company estimates that Chapter 13 trustees typically manage over one thousand cases simultaneously and that Chapter 7 trustees can manage over one hundred cases simultaneously. It is possible for a given individual trustee to have caseloads in both Chapter 7 and Chapter 13 bankruptcies, but normally a trustee will specialize in one or the other. CHAPTER 7 BANKRUPTCY TRUSTEES For Chapter 7 liquidation bankruptcy, each region of the country has a rotating "panel" of trustees. Because Chapter 7 comprises the overwhelming majority of bankruptcies, multiple trustees are required in most parts of the country to accommodate the caseload. As assets are liquidated and the first funds are received in each asset case, the trustee opens bank accounts for the case. In Chapter 7, each case must have its own bank accounts so that interest earned can be segregated. Because asset liquidation and litigation regarding the case may be a lengthy process, the trustee will deposit cash proceeds into an interest-bearing account for the benefit of the creditors who will eventually receive distributions. Typically, the trustee makes a single distribution at the conclusion of the case. The administration of a Chapter 7 case can take several years. CHAPTER 13 BANKRUPTCY TRUSTEES There are fewer filings in Chapter 13 (individual debt reorganization) than in Chapter 7 (liquidation), so most areas of the country have a single standing Chapter 13 trustee who administers all Chapter 13 filings rather than the "panel" configuration associated with Chapter 7. In certain areas of the country, the trustee is responsible for sending various notices to the debtor, debtor's attorney, clerk of the court, United States Trustee and each creditor indicating that the case has been filed. Because the debtor's assets are not liquidated under Chapter 13, the trustee analyzes the debtor's income and expenses and directs the debtor to make regular cash payments to the trustee according to the court-approved plan of reorganization. Each month, the trustee disburses the monies received from the debtor to eligible creditors according to the plan. The trustee must provide regular status reports to the United States Trustee. Every six months, the trustee must also prepare a detailed ledger of financial activity in each bankruptcy case and mail it to each debtor and debtor's attorney. Chapter 13 reorganizations usually last between thirty-six and sixty months. Upon conclusion of the case, the trustee must submit a final report to the bankruptcy court outlining the financial history of the case. MARKET CONDITIONS The Company estimates that there is over $3 billion in cash proceeds being administered in Chapter 7 by approximately 1,700 trustees. The Company estimates there are in excess of 700,000 cases pending in Chapter 13 managed by approximately 180 standing Chapter 13 trustees. MARKET CONDITIONS IN CHAPTER 7 The Company believes that there are favorable market conditions for its Chapter 7 product and services. The Company has successfully entered key strategic markets with successive releases of its Windows-based TCMS software. In September, 1998, the Company announced that it was finalizing 2 development of TCMS Version 4.0, which incorporates substantial new features and technologies and projected a first quarter 1999 general release date. MARKET CONDITIONS IN CHAPTER 13 For the twelve-month period ended September 30, 1998, there was an all-time record number of new bankruptcy filings, approximately 28% of which were in Chapter 13. The Company believes that market conditions are favorable for growth in the Chapter 13 sector because of nationally growing caseloads and the availability of the CasePower product for Windows and Oracle. PRODUCTS The Company's products include TCMS (Trustee Case Management System) for Chapter 7 and CasePower for Chapter 13. The TCMS product can also track Chapter 11 cases, and the CasePower product can also track Chapter 12 cases. The Company produces its software applications internally with a full time staff of professional software developers. CHAPTER 7 PRODUCTS The Company's Chapter 7 product assists trustees to manage liquidation bankruptcies, whereby the trustee liquidates the debtor's assets and disburses the resulting funds to creditors. CURRENT CHAPTER 7 PRODUCT: TCMS TCMS (Trustee Case Management System) is a Windows based package of proprietary software, computer equipment and support services offered to Chapter 7 trustees through a national marketing arrangement with Bank of America. TCMS provides easy-to-use modules for asset management, financial record keeping and claims administration. An electronic banking link developed by the Company gives users an automated mechanism for entering banking transactions, and an electronic court interface allows users to download claim information into the trustee's database automatically. A typical TCMS system is provided to the end-user trustee client without direct charge and includes the following products and services: (i) a license to use the proprietary TCMS software and subsequent upgrades; (ii) computer hardware, laser printer, modem, tape backup and operating software, which are returned to EPI if the trustee's bankruptcy deposits leave the bank designated by EPI; (iii) database conversion from previous computer system; (iv) configuration and installation of hardware by EPI personnel; (v) on-site software training; (vi) customization of reports conforming to local bankruptcy court regulations; (vii) toll-free customer service; and (viii) remote diagnostics. The Company's revenues are based upon the total funds kept on deposit. See "Pricing--Chapter 7 Pricing." SOFTWARE FEATURES The TCMS software streamlines administrative tasks associated with Chapter 7 liquidation bankruptcies. Most trustees use the system on a daily basis for record keeping and to meet reporting requirements. ASSET MANAGEMENT. As assets are identified, the trustee enters them into TCMS through a convenient spreadsheet-like interface. The system automatically tracks the remaining values of assets as they are liquidated and provides a summary overview of properties within each case. BANKING. An online banking module developed by the Company allows the trustee to open and close bank accounts electronically as well as to enter funds transfers. Simple to sophisticated financial transactions can be recorded on an online computer screen that resembles a personal check register. The system prepares MICR encoded laser checks and deposit slips on demand. 3 CLAIMS ADMINISTRATION. TCMS categorizes each claim by class and desired priority level for distribution. Distribution checks are calculated and printed automatically, and all financial ledgers are updated. An extensive library of financial reports provides detailed information for each case. A proprietary feature allows information to be downloaded from the court into the trustee's database. CALENDARING AND DOCKETING. Key events in asset cases are posted automatically to a central trustee's calendar that can be printed regularly. The software automatically schedules tasks required to close cases in a timely fashion. CUSTOMIZED DISTRICT REPORTS. EPI develops custom tailored final reports and final accounts for each district where TCMS is marketed. Preparing these documents has traditionally been one of the most time consuming tasks in Chapter 7 case administration. With TCMS, trustees can quickly generate a fully formatted, polished report with all figures calculated and filled in. 180 DAY REPORTS. The United States Trustee requires the trustee to submit detailed status reports for each case every six months in a very specific reporting format. TCMS prints these reports in compliance with the most recent regulations. CHAPTER 13 PRODUCTS The Company's Chapter 13 products assist trustees in managing individual reorganization bankruptcies, whereby the debtor makes payments to the trustee, who in turn disburses the funds to creditors. CURRENT CHAPTER 13 PRODUCT: CASEPOWER The Company's Windows based CasePower product assists Chapter 13 trustees managing databases containing from approximately 500 to over 10,000 active bankruptcies simultaneously. Because Chapter 13 bankruptcy cases typically undergo thirty-six to sixty consecutive monthly distributions, Chapter 13 is considerably more transaction intensive and paperwork intensive than Chapter 7, where a single distribution is normally made at the end of the case. Chapter 13 trustee clients may out-source various activities to EPI to facilitate the preparation of large output jobs. Processing and report printing functions can be divided between the client-site and EPI's data center in Kansas City. Both products are installed in a multi-user configuration that allows each member of the trustee's office staff to access the database and enter transactions throughout the business day. The trustee's live database resides in his or her office. The size of a Chapter 13 trustee's office staff varies proportionally with the caseload managed. The trustee's office staff enters financial information into CasePower, including cash receipts, financial adjustments and payment instructions for each claim. EPI's proprietary program logic interprets a wide variety of court-directed payment scenarios and consolidates them into easy-to-understand codes that are entered by users. Daily reports and customized inquiries can be requested and printed inside the trustee's office. At the end of each month, the software prepares distribution checks for creditors to whom funds are due. EPI can print the checks and reports at its data center in Kansas City as a value-added service for the trustee. In certain parts of the country, the Chapter 13 trustee is responsible for noticing parties-in-interest of key developments in each bankruptcy case, including the setting of the mandatory first meeting of creditors. The Company's products automate this meeting notice for the trustees. Each evening, EPI's data center receives a modem transmission of daily noticing activity from the client-site. EPI prints and reviews the notices, inserts them into envelopes and mails them the next day. Trustees are billed directly for noticing services based upon the number of documents generated. 4 Some bankruptcy courts require additional information, such as a photocopy of the plan of reorganization, to be included with the notice. EPI offers such document reproduction and assembly services to trustees at an additional charge. SOFTWARE FEATURES CasePower helps trustees manage administrative aspects of Chapter 13 bankruptcy. The trustee and office staff typically use the system each day to monitor activity in their caseload. NOTICING. When new cases are entered on the system, the EPI data center in Kansas City can extract relevant information and prepare mandatory first meeting of creditors notices for each case. Subsequent forms, such as reset notices, correcting notices, motions to allow claims, motions to allow additional claims and motions to dismiss, can also be selected and prepared through the system. CASE MANAGEMENT. The products store and monitor key dates, names, addresses and text notes for every case in the system. A variety of retrieval mechanisms enable users to view case information from various perspectives. FINANCIAL HISTORY. The office staff enters cash receipts and financial adjustments in the system as part of the daily bank deposit. The software updates the balances in each case and summarizes the day's financial transactions. Each month, the software prepares a single-page summary of the receipts and disbursements in every case. MONTHLY DISTRIBUTION. The software's advanced distribution logic interprets payment orders from the bankruptcy court. Several different payment methodologies (e.g., pro rata, fixed monthly payment, per capita, etc.) may be spread over 99 separate distribution priority levels. Individual checks or voucher checks can be printed for each creditor. Claims having objections filed on them can continue to accrue distributions without releasing funds until the objection has been settled. INQUIRY. Chapter 13 offices receive a multitude of outside inquiries each day from creditors' and debtors' attorneys. The software provides instantaneous inquiry access to the financial status of each debtor and claim in the system. An optional creditor dial-in system gives outside parties inquiry only access to the system through a modem connection. CHAPTER 7 MARKETING ARRANGEMENT On November 22, 1993, the Company established an exclusive national marketing arrangement with NationsBank of Texas, N.A. ("NationsBank"), a subsidiary of NationsBank Corporation, for its Chapter 7 products. Since that time, the bank has been merged and the name of the bank changed to "Bank of America." In this marketing arrangement, EPI and Bank of America promote products and services to trustees in all states. Because Chapter 7 trustees are discouraged from incurring direct costs for computer services, it is essential for EPI to align with a bank or series of banks to earn revenues in Chapter 7. The agreement with Bank of America does not have an expiration date. The termination clause stipulates that either party must provide the other 90 days' notice if it wishes to end the agreement. The Company believes its representatives have developed positive, close working relationships with their counterparts at Bank of America, and the Company believes that it will maintain this relationship. However, were the relationship with Bank of America to end, there is no assurance that the Company would be able to establish a new banking relationship or series of relationships with comparable terms. EPI holds the primary responsibility for developing all facets of the TCMS system and for driving the national sales and marketing effort. Bank of America personnel provide additional assistance in the marketing effort and are responsible for administering the banking services provided to the trustee clients. Through this arrangement, EPI has a continual revenue stream from its Chapter 7 operations. The structure of the marketing alliance assists Bank of America to build its deposit base in this market. 5 The Company continues to support a limited number of trustee relationships through other banks that predate the exclusive agreement with Bank of America. PRICING CHAPTER 7 PRICING Unlike Chapter 13, the application of Chapter 7 bankruptcy regulations has the practical effect of discouraging trustees from incurring direct administrative costs for computer expenses. All nationally marketed Chapter 7 systems are provided to trustees without direct billing to the trustee because of traditional market conventions. Clients typically choose systems based upon the capability of the software and the quality of technical support services. EPI has aligned with Bank of America to provide computer services to Chapter 7 trustees without direct charges to the Chapter 7 trustee under an arrangement whereby (1) EPI licenses its proprietary software to the trustee and furnishes hardware, conversion services, training and customer support, all at no cost to the trustee, (2) the trustee agrees to deposit with Bank of America the cash proceeds from all asset liquidations; and (3) the Company collects from Bank of America a fee each month based upon the total deposits in the Chapter 7 bankruptcy portfolio. CHAPTER 13 PRICING The Company typically receives an initial licensing fee and conversion charge from the Chapter 13 trustee. It also receives monthly fees from each Chapter 13 trustee client based on the total number of cases in that trustee's database and the number of noticing documents generated. Variables affecting pricing for EPI Chapter 13 clients include the number of cases in the database, the type of equipment installed, the volume of noticing to be outsourced to EPI, and the level of support service selected by the trustee. EPI prepares individualized price quotes for each client. SALES AND DISTRIBUTION The Company's products and services are marketed directly to trustees through on-site sales calls by the Company's internal sales department and, in the case of Chapter 7, by supporting representatives of Bank of America. Trustees make their own decisions for software and service providers. The Company believes that the most important factors in attracting business are the quality of the software products and the quality of the post-installation support. The Company estimates that the typical cycle for Chapter 7 business lasts between two and four months. The Company's Chapter 7 and Chapter 13 service agreements with trustees typically include provisions for (i) descriptions of the products and services included in the agreement, (ii) a limited warranty and indemnification clauses, (iii) the trustee's agreement to deposit funds with Bank of America (applicable in Chapter 7 only), and (iv) termination information. The Executive Office of the United States Trustee in Washington, D.C., regularly issues a directory of all current bankruptcy trustees. The Company obtains this directory as it is issued and uses it as its prospect list. The Company's sales representatives attend approximately eight bankruptcy trade shows annually. The Company conducts direct mail campaigns and advertises in trade journals to heighten its exposure and to stimulate sales. COMPETITION The Company works in an industry with a limited number of Chapter 7 and Chapter 13 trustees. The Company estimates that there are in excess of 700,000 pending Chapter 13 cases being managed by approximately 180 Chapter 13 trustees, and that there is over $3 billion on deposit by approximately 1,700 Chapter 7 trustees. There are several companies in the market all competing for sales from this finite 6 group of customers, and some of the Company's competitors have substantially greater financial and marketing resources than the Company. For its Chapter 7 product, the Company competes with the Chase Manhattan Bank and Union Bank of California, as well as other regional competitors in selected markets. For its Chapter 13 product, the Company competes with DCS Corporation of Memphis, Tennessee, a private company, and other competitors. Although the Company believes that the requisite detailed knowledge of the bankruptcy system makes it difficult for new competitors to successfully enter the market, and there are presently a limited number of firms that offer services that directly compete with the Company's, there can be no assurance that other firms with resources significantly greater than the Company's will not enter the Company's industry. The Company's future financial performance will depend on its ability to maintain existing customer accounts and to attract business from customers who are currently using a competitor's software product. PROPRIETARY RIGHTS Historically, the Company has not protected its intellectual property rights through patents or formal copyright registration. It has relied on trade secret, copyright, and trademark law and non-disclosure agreements to establish and protect its proprietary rights in its products. The Company believes, however, that its financial performance will depend more upon the innovation, technological expertise and marketing abilities of its associates than upon such protection. There is no assurance that the Company will be able to protect its trade secrets or that others will not independently develop substantially equivalent proprietary information and techniques or otherwise gain access to the Company's trade secrets. There is no assurance that intellectual property laws will protect the Company's intellectual property rights. In addition, litigation may be necessary to enforce the Company's intellectual property rights, to protect the Company's trade secrets, to determine the validity and scope of the proprietary rights of others or to defend against claims of infringements. Such litigation could result in substantial costs and diversion of management and other resources and could have a material adverse effect on the Company's business, financial condition and results of operation. EMPLOYEES The Company employs approximately 80 full-time employees and believes its relationships with its employees are good. ITEM 2. PROPERTIES The Company's corporate offices are located in a 30,000-square-foot facility leased in Kansas City, Kansas. In connection with corporate growth and the development of new products, this facility has been recently renovated with additional office space. The Company believes that this facility will be adequate for use for at least the next full year. The leased facility is partially owned by a related party. See Item 12 "Certain Relationships and Related Transactions." ITEM 3. LEGAL PROCEEDINGS The Company presently is not a party to any material litigation, although it occasionally becomes involved in litigation arising in the normal course of business. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted in the fourth quarter of 1998 to a vote of security holders. 7 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS. MARKET INFORMATION The Company's Common Stock is traded on the Nasdaq National Market-TM- under the symbol "EPIQ." Trading in the Common Stock commenced on February 4, 1997, the date on which the Company closed the initial public offering of its Common Stock. The following table shows the reported high and low sales prices for the common stock for the calendar quarters of 1998 and 1997 as reported by Nasdaq:
1998 1997 -------------------- -------------------- HIGH LOW HIGH LOW --------- --------- --------- --------- First Quarter................................................................... $ 20 $ 9 1/4 $ 4 $ 3 Second Quarter.................................................................. $ 15 3/8 $ 11 $ 4 7/8 $ 3 Third Quarter................................................................... $ 15 1/2 $ 8 1/2 $ 7 1/4 $ 4 1/2 Fourth Quarter.................................................................. $ 11 3/4 $ 8 1/16 $ 12 1/8 $ 6 1/4
HOLDER As of March 11, 1999, there were approximately 2,100 holders of record of the Common Stock. DIVIDENDS The Company elected to be treated as an S Corporation for federal and certain state income tax purposes commencing July 15, 1988. Unlike a C Corporation, an S Corporation is generally not subject to income tax at the corporate level. Instead, the S Corporation's income generally passes through to the stockholders and is taxed on their personal income tax returns. The Company terminated its status as an S Corporation and became a C Corporation as of February 4, 1997 (the "Termination Date"). After the Termination Date, the Company will no longer be treated as an S Corporation and will, accordingly, be fully taxable under federal and state income tax laws. The Company paid a final S Corporation distribution to certain stockholders following termination of the Company's S Corporation status which represented the Company's previously undistributed earnings only since January 1, 1996 through the Termination Date. The amount of this final S Corporation distribution was $250,000 and it was paid on March 6, 1997. The Company has not paid any cash dividends since March 6, 1997, and does not expect to declare or pay any cash dividends in the foreseeable future. The Company currently intends to retain any earnings for use in the operation and expansion of its business. The payment of future dividends is within the discretion of the Board of Directors and will depend upon the Company's future earnings, if any, its capital requirements, financial condition and other relevant factors. ITEM 6: MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS Operating revenues increased 37.6%, or $3,157,129, to $11,546,273 in fiscal 1998, compared to $8,389,144 in fiscal 1997. Approximately 97.0% of the growth in operating revenues were attributable to revenues generated by Chapter 7. Chapter 7 sales increased 94.5%, or $3,088,268 to $6,355,429 in fiscal 1998, compared to $3,267,161 in fiscal 1997. The Company has an exclusive national marketing arrangement with Bank of America. The bank pays EPI a monthly fee based on the total dollar amount of Chapter 7 deposits at Bank of America and a fee for each new account installed. The increase in Chapter 7 revenue was due in part to the growth in new Chapter 7 trustee business for the Company resulting in higher 8 monthly fees paid to EPI. Chapter 13 revenue increased 5.5%, or $268,672 to $5,190,853 in fiscal 1998 compared to $4,922,281 in fiscal 1997. The relatively lower growth in Chapter 13 was primarily due to the Company's focus on converting existing Chapter 13 trustee clients to CASEPOWER and to a constant level of revenue from legal noticing caused by a change in service mix. Total cost of goods sold and direct costs increased 32.0%, or $1,278,990, to $5,276,835 in the fiscal 1998, compared to $3,997,845 in fiscal 1997. Total cost of goods sold and direct costs as a percentage of operating revenues decreased to 45.7% in fiscal 1998 compared to 47.7% in fiscal 1997, primarily due to TCMS for Chapter 7, which has higher gross margins, comprising a greater percentage of operating revenues in 1998. Chapter 7 as a percentage of operating revenues increased to 54.8% in fiscal 1998 from 38.9% in fiscal 1997. Processing costs increased 29.8%, or $877,533, to $3,824,075 in fiscal 1998, compared to $2,946,542 in fiscal 1997. The increase in 1998 resulted principally from an increase in customer service expense to support the growth in Chapter 7 sales and to support the new Chapter 13 product, CASEPOWER. Processing costs as a percentage of operating revenues decreased to 33.1% in fiscal 1998 compared to 35.1% in fiscal 1997. Depreciation and amortization increased 38.2%, or $401,457, to $1,452,760 in fiscal 1998, compared to $1,051,303 in fiscal 1997, primarily due to the purchase of computer equipment for the Company's Chapter 7 product. Operating expenses increased 36.7%, or $1,177,515 to $4,386,081 in fiscal 1998, compared to $3,208,566 in fiscal 1997. Operating expenses as a percentage of operating revenues was 38.0% in fiscal 1998 compared to 38.2% in fiscal 1997. The dollar increase in operating expenses was due to increases in general and administrative infrastructure necessary to support a higher level of revenues, including additional sales and marketing expenses related to growth of the Company's Chapter 7 product. Sales and marketing expenses include sales and marketing salaries, trade show costs, travel associated with Chapter 7 installations, and advertising costs. Sales and marketing expenses increased 34.9%, or $351,771 to $1,358,716 in fiscal 1998, compared to $1,006,945 in fiscal 1997. Other income (expense) which includes interest income and interest expense, was $266,500 in fiscal 1998 compared to ($92,645) in fiscal 1997. This resulted from a reduction in net interest expense due to interest income from the investment of the net proceeds from the sale of 1,140,500 shares of Common Stock in a secondary public offering completed in June 1998. Outstanding debt was paid off with a portion of the net proceeds from the 1998 stock offering resulting in a reduction in interest expense. In connection with the Company's initial public offering, the Company changed its income tax status to a C corporation. Pro forma earnings information for the year ended December 31, 1997 reflects the effects of corporate income taxes on historical earnings as if the Company had been subject to federal taxes for that period. The Company's effective tax rates were 38.6% and 41.4% (pro-forma) for 1998 and 1997, respectively. Pro forma Net income increased 106.9%, or $682,219, to $1,320,618 in fiscal 1998, compared to pro forma net income of $638,399 in fiscal 1997. Pro forma net income as a percentage of operating revenues increased to 11.4% in fiscal 1998 from 7.6% in fiscal 1997. LIQUIDITY AND CAPITAL RESOURCES The Company's liquidity position is strong with total cash and short-term investments of $11,520,256 at December 31, 1998 and working capital of $12,190,920. The Company completed a public offering in June 1998 of 1,140,500 shares of Common Stock at $12.875 a share to raise $12,727,980 in net proceeds. The Company paid $1,724,089 of debt with a portion of these net proceeds. Net cash provided by operating activities was $2,937,735 during 1998 and $1,608,257 during 1997. The net cash provided by operating activities in fiscal 1998 consisted primarily of net income before deferred taxes of $1,509,129, depreciation and amortization of $1,606,854, and an increase of $385,329 in accounts 9 payable and accrued expenses, offset by an increase in accounts receivable of $471,879 and an increase in prepaid expenses and other assets of $107,272. The increase in depreciation and amortization relates primarily to the purchase of computer equipment for the installations of the Company's Chapter 7 product. The outstanding accounts receivable balance has increased primarily due to the growth in revenue. The net cash provided by operating activities in fiscal 1997 consisted primarily of net income before deferred taxes of $667,128, depreciation and amortization of $1,158,184, and an increase in accounts payable and accrued expenses of $100,157 offset primarily by an increase in accounts receivable of $316,194. The increase in depreciation and amortization relates primarily to the purchase of computer equipment for the installations of the Company's Chapter 7 product. The outstanding accounts receivable balance has increased primarily due to the growth in revenue. At December 31, 1998, short-term investments of $10,700,000 consisted of Auction Rate Certificates, which are floating rate investments based on pooled State and Federal agency securities. Such investments trade at par and are AAA rated due to bond insurance. Auctions are every 35 days. Proceeds from the sale of short-term investments totaled $51,403,000 for the year ended December 31, 1998. The Company invested in property and equipment totaling $3,421,690 and $1,042,383 for 1998 and 1997, respectively, which related principally to the installation of computer equipment for the Company's Chapter 7 product. The Company incurred expenditures for software development costs totaling $1,041,960 and $498,392 for 1998 and 1997, respectively. In April of 1998 the Company acquired a PC-based product for Chapter 13 trustees and this purchase is reflected in the December 31, 1998 software expenditures. These expenditures are capitalized and are being amortized on a straight-line basis over a maximum five-year period. Internal software costs incurred in the creation of computer software products are capitalized as soon as technological feasibility has been established. Prior to the completion of a detailed program design, development costs are expensed. Capitalized costs are amortized based on current and future revenue for each product with an annual minimum equal to straight-line amortization over the remaining estimated economic life of the product, not to exceed five years. Additionally, the Company anticipates future software development will be at or above the spending levels of prior years. The Company believes that the net proceeds from the June 1998 stock offering, together with funds that may be generated from operations, will be sufficient to finance the Company's currently anticipated working capital and property and equipment expenditures for the foreseeable future. YEAR 2000 Many currently installed computer systems and software products are coded to accept only two-digit entries to represent years. For example, the year "1998" would be represented by "98." These systems and products will need to be able to accept four digit entries to distinguish 21(st) century dates from 20(th) century dates. Any programs that have time sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in the computer shutting down or performing incorrect computations. As a result, in less than one year, computer systems and software products used by many companies, that do not accept four-digit year entries, will need to be upgraded or replaced to comply with such "Year 2000" requirements. The Company believes that its currently marketed software products are Year 2000 compliant. In the first quarter of 1998, the Company began shipping release 3.0 of TCMS, as part of the Company's continual process of enhancing and upgrading its existing software products. Although release 3.0 of TCMS was written to be Year 2000 compliant, the impetus for its design was the Company's desire to further streamline Chapter 7 case administration for trustees. Similarly, in 1997 the Company began shipping CASEPOWER, a new proprietary Windows95/NT-based client-server software application for Chapter 13 10 trustees. Like TCMS, CASEPOWER was written to be Year 2000 compliant. Also like TCMS, the impetus for CASEPOWER'S design was the Company's commitment to the development and marketing of new and competitive bankruptcy case management conventions. The Company estimates that its national upgrade program for existing Chapter 13 customers, from its older AS/400 legacy product to CASEPOWER, is 90% completed. All Chapter 13 trustees are scheduled to be upgraded by June 1999. The Company is also in the process of discussing with its vendors and customers the potential impact the Year 2000 issue may have on their systems. More specifically, the Company has reviewed and assessed the probability of a material adverse effect from the Year 2000 issue on the Company's exclusive national marketing arrangement with Bank of America. Bank of America has reported that it undertook a process of software inventory, analysis, modification, testing and verification to assess the potential impact of the Year 2000 issue on its systems. Bank of America expects to substantially complete the Year 2000 software conversion projects for its systems by the end of 1999. Bank of America's management believes that its plans for dealing with the Year 2000 issue will result in timely and adequate modifications of systems and technology. Over the next 9 months, the plans of other third parties to address the Year 2000 issue will be monitored and any identified impact on the Company will be evaluated. The Year 2000 issue also affects the Company's internal systems, including information technology (IT) and non-IT systems. The Company has assessed the readiness of its systems for handling the Year 2000. Management currently believes that all material systems are either compliant, or will be upgraded or replaced by the Year 2000. The costs associated with this project are being expensed as incurred and are not expected to be material to the Company's financial position or results of operations. As previously discussed, the Company believes their currently marketed software products and internal systems are Year 2000 compliant or will be by the end of 1999. Additionally, they are not aware of any vendors or customers with Year 2000 problems which could materially impact their operations. Accordingly, the Company has not specifically evaluated a worst-case scenario, nor has it developed contingency plan of such scenario. FORWARD-LOOKING STATEMENTS This Form 10-KSB contains 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, including those relating to the possible or assumed future results of operations and financial condition of the Company. Because those statements are subject to a number of uncertainties and risks, actual results may differ materially from those expressed or implied by the forward-looking statements. Factors that could cause actual results to differ from those expressed or implied include, but are not limited to, any material changes in the total asset proceeds on deposit by Chapter 7 trustees served by the Company, changes in the number of bankruptcy filings each year, the Company's reliance on its marketing arrangement for Chapter 7 revenue, the Company's ability to achieve or maintain technological advantages, and any material adverse effect of the Year 2000 issue. The Company undertakes no obligation to update any forward-looking statements contained herein to reflect future events or developments. ITEM 7. FINANCIAL STATEMENTS Following are the report of Baird, Kurtz & Dobson, Kansas City, Missouri, independent auditors for the Company, and the financial statements of the Company as of and for the 12 month periods ended December 31, 1998 and 1997. 11 INDEPENDENT ACCOUNTANTS' REPORT Board of Directors Electronic Processing, Inc. Kansas City, Kansas We have audited the accompanying balance sheets of ELECTRONIC PROCESSING, INC. as of December 31, 1998 and 1997, and the related statements of income, changes in stockholders' equity and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of ELECTRONIC PROCESSING, INC. as of December 31, 1998 and 1997, and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles. /s/ BAIRD, KURTZ & DOBSON Kansas City, Missouri February 8, 1999 12 ELECTRONIC PROCESSING, INC. BALANCE SHEETS DECEMBER 31, 1998 AND 1997 ASSETS
1998 1997 ------------- ------------ CURRENT ASSETS Cash and cash equivalents.......................................................... $ 820,256 $ 1,835,233 Short-term investments............................................................. 10,700,000 Accounts receivable, trade, less allowance for doubtful accounts of $5,000......... 1,586,303 1,114,424 Prepaid expenses and other......................................................... 294,024 159,845 Deferred income taxes.............................................................. 39,345 18,823 ------------- ------------ Total Current Assets........................................................... 13,439,928 3,128,325 ------------- ------------ PROPERTY AND EQUIPMENT, At cost Furniture and fixtures............................................................. 526,862 551,832 Computer equipment................................................................. 7,254,072 5,152,228 Office equipment................................................................... 329,775 325,429 Leasehold improvements............................................................. 864,184 834,806 Transportation equipment........................................................... 14,969 14,969 ------------- ------------ 8,989,862 6,879,264 Less accumulated depreciation.................................................. 3,233,510 3,338,301 ------------- ------------ 5,756,352 3,540,963 ------------- ------------ SOFTWARE DEVELOPMENT COSTS, Net of amortization...................................... 2,016,946 1,397,375 ------------- ------------ OTHER ASSETS Excess of cost over fair value of net assets acquired.............................. 59,473 61,486 Other.............................................................................. 5,912 32,819 ------------- ------------ 65,385 94,305 ------------- ------------ $ 21,278,611 $ 8,160,968 ------------- ------------ ------------- ------------
See Notes to Financial Statements 13 ELECTRONIC PROCESSING, INC. LIABILITIES AND STOCKHOLDERS' EQUITY
1998 1997 ------------- ------------ CURRENT LIABILITIES Note payable--line of credit....................................................... $ 1,000 Current maturities of long-term debt............................................... $ 159,151 626,665 Accounts payable................................................................... 626,577 491,217 Accrued expenses................................................................... 450,608 200,639 Income taxes payable............................................................... 12,672 32,960 ------------- ------------ Total Current Liabilities...................................................... 1,249,008 1,352,481 ------------- ------------ LONG-TERM DEBT....................................................................... 109,300 889,046 ------------- ------------ DEFERRED INCOME TAXES................................................................ 529,485 320,452 ------------- ------------ STOCKHOLDERS' EQUITY Common stock, $.01 par value; authorized 10,000,000 shares; issued and outstanding--4,633,268 and 3,400,000 shares at 1998 and 1997, respectively....... 46,333 34,000 Additional paid-in capital......................................................... 17,660,878 5,202,000 Retained earnings.................................................................. 1,683,607 362,989 ------------- ------------ 19,390,818 5,598,989 ------------- ------------ $ 21,278,611 $ 8,160,968 ------------- ------------ ------------- ------------
14 ELECTRONIC PROCESSING, INC. STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 1998 AND 1997
1998 1997 ------------- ------------ OPERATING REVENUES................................................................... $ 11,546,273 $ 8,389,144 ------------- ------------ COST OF GOODS SOLD AND DIRECT COSTS Processing costs................................................................... 3,824,075 2,946,542 Depreciation and amortization...................................................... 1,452,760 1,051,303 ------------- ------------ 5,276,835 3,997,845 ------------- ------------ GROSS PROFIT......................................................................... 6,269,438 4,391,299 ------------- ------------ OPERATING EXPENSES General and administrative......................................................... 4,231,987 3,101,685 Depreciation and amortization...................................................... 154,094 106,881 ------------- ------------ 4,386,081 3,208,566 ------------- ------------ INCOME FROM OPERATIONS............................................................... 1,883,357 1,182,733 ------------- ------------ OTHER INCOME (EXPENSE) Interest income.................................................................... 392,114 66,667 Interest expense................................................................... (89,755) (160,393) Other.............................................................................. (35,859) 1,081 ------------- ------------ 266,500 (92,645) ------------- ------------ INCOME BEFORE INCOME TAXES........................................................... 2,149,857 1,090,088 PROVISION FOR INCOME TAXES........................................................... 829,239 724,589 ------------- ------------ NET INCOME........................................................................... $ 1,320,618 $ 365,499 ------------- ------------ ------------- ------------ EARNINGS PER SHARE INFORMATION Basic.............................................................................. $ .32 $ .11 ------------- ------------ ------------- ------------ Diluted............................................................................ $ .31 $ .11 ------------- ------------ ------------- ------------ PRO FORMA DATA Income before income taxes......................................................... $ 2,149,857 $ 1,090,088 Provision for income taxes......................................................... 829,239 451,689 ------------- ------------ Net income......................................................................... $ 1,320,618 $ 638,399 ------------- ------------ ------------- ------------ Per share information Basic............................................................................ $ .32 $ .20 ------------- ------------ ------------- ------------ Diluted.......................................................................... $ .31 $ .19 ------------- ------------ ------------- ------------
See Notes to Financial Statements 15 ELECTRONIC PROCESSING, INC. STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1998 AND 1997
ADDITIONAL COMMON PAID-IN RETAINED TOTAL STOCK CAPITAL EARNINGS ------------- --------- ------------- ------------- BALANCE, DECEMBER 31, 1996............................... $ 990,030 $ 18,000 $ 282,000 $ 690,030 Dividends.............................................. (250,000) (250,000) Recapitalization prior to public offering.............. 442,540 (442,540) Net proceeds from public offering...................... 4,493,460 16,000 4,477,460 0 Net income............................................. 365,499 365,499 ------------- --------- ------------- ------------- BALANCE, DECEMBER 31, 1997............................... 5,598,989 34,000 5,202,000 362,989 Net proceeds from public offering...................... 12,409,311 11,405 12,397,906 Proceeds from the exercise of stock options and warrants............................................. 61,900 928 60,972 Net income............................................. 1,320,618 1,320,618 ------------- --------- ------------- ------------- BALANCE, DECEMBER 31, 1998............................... $ 19,390,818 $ 46,333 $ 17,660,878 $ 1,683,607 ------------- --------- ------------- ------------- ------------- --------- ------------- -------------
See Notes to Finacial Statements 16 ELECTRONIC PROCESSING, INC. STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1997 AND 1996
1998 1997 ------------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES Net income......................................................................... $ 1,320,618 $ 365,499 Items not requiring (providing) cash: Depreciation..................................................................... 1,182,452 820,570 Amortization of software development costs....................................... 422,389 335,601 Amortization of intangible assets................................................ 2,013 2,013 (Gain) loss on disposal of equipment............................................. 35,862 (4,406) Deferred income taxes............................................................ 188,511 301,629 Changes in: Accounts receivable.............................................................. (471,879) (316,194) Prepaid expenses and other assets................................................ (107,272) 3,388 Accounts payable and accrued expenses............................................ 385,329 100,157 Income taxes payable............................................................. (20,288) ------------- ----------- Net cash provided by operating activities...................................... 2,937,735 1,608,257 ------------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES Sale of short-term investments..................................................... 51,403,000 Purchase of short-term investments................................................. (62,103,000) Proceeds from sale of property and equipment....................................... 16,814 20,818 Purchase of property and equipment................................................. (3,421,690) (1,042,383) Expenditures for software development costs........................................ (1,041,960) (498,392) ------------- ----------- Net cash used in investing activities.......................................... (15,146,836) (1,519,957) ------------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES Net payments under line-of-credit agreement........................................ (1,000) (499,000) Proceeds from long-term debt....................................................... 968,270 Principal payments under capital lease obligation.................................. (368,435) (777,023) Principal payments on long-term debt............................................... (1,875,922) (1,096,949) Repayment of subordinated debt..................................................... (400,000) Dividends paid..................................................................... (250,000) Stock issuance costs............................................................... (318,669) (172,977) Proceeds from exercise of stock options and warrants............................... 61,900 Proceeds from public offering...................................................... 12,727,980 4,938,000 ------------- ----------- Net cash provided by financing activities...................................... 11,194,124 1,742,051 ------------- ----------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS..................................... (1,014,977) 1,830,351 CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR......................................... 1,835,233 4,882 ------------- ----------- CASH AND CASH EQUIVALENTS, END OF YEAR............................................... $ 820,256 $ 1,835,233 ------------- ----------- ------------- -----------
See Notes to Financial Statements 17 ELECTRONIC PROCESSING, INC. NOTES TO FINANCIAL STATEMENTS NOTE 1: NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES NATURE OF OPERATIONS Electronic Processing, Inc. (the Company) develops, markets and licenses proprietary software products and provides support services for Chapter 7 and Chapter 13 bankruptcy trustees and other users of the federal bankruptcy system. OPERATING SEGMENTS The Company has two segments in which it allocates resources and assesses performance: Chapter 7 and Chapter 13 bankruptcy services. For each of these segments, the Company serves a national client base by developing specialty software products and providing coordinated support (network integration, post-installation support and other value-added services), which facilitate the administrative aspects of bankruptcy management for court-appointed trustees. The individual segments have similar operating and economic characteristics and have been reported as one aggregated operating segment. The Company's major revenue source, which exceeds 10% of revenues, is discussed in Note 11. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. PROPERTY AND EQUIPMENT Property and equipment are depreciated on a straight-line basis over the estimated useful life of each asset as follows: Furniture and fixtures........................................... 10 years Computer equipment............................................... 5 years 5-10 Office equipment................................................. years Transportation equipment......................................... 3-5 years
Leasehold improvements are depreciated over the shorter of the lease term or the estimated useful lives (5-10 years) of the improvements. SOFTWARE DEVELOPMENT COSTS Certain internal software development costs incurred in the creation of computer software products are capitalized once technological feasibility has been established. Prior to the completion of a detail program design, development costs are expensed. Capitalized costs are amortized based on current and future revenue for each product with an annual minimum equal to the straight-line amortization over the remaining estimated economic life of the product, not to exceed five years. 18 ELECTRONIC PROCESSING, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 1: NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) INTANGIBLE ASSETS The excess of cost over fair value of net assets acquired is being amortized on a straight-line basis over 40 years. REVENUE RECOGNITION For the Company's Chapter 7 bankruptcy software product, monthly fees are received from a national financial institution after the product is installed and deposits are transferred based on the level of trustees' deposits with that institution. Revenues for Chapter 13 processing and noticing are recorded monthly at the completion of the services based on the trustees' month-end caseloads. All ancillary fees are recognized as the services are provided. INCOME TAXES Deferred tax liabilities and assets are recognized for the tax effects of differences between the financial statement and tax bases of assets and liabilities. A valuation allowance is established to reduce deferred tax assets if it is more likely than not that a deferred tax asset will not be realized. CASH EQUIVALENTS The Company considers all liquid investments with original maturities of three months or less (primarily money market accounts) to be cash equivalents. SHORT-TERM INVESTMENTS Debt and marketable equity securities which the Company holds for short-term investment purposes are classified as available-for-sale securities and are carried at fair value. At December 31, 1998, short-term investments consist of Auction Rate Certificates, which are floating rate investments based on pooled State and Federal agency securities. Such investments trade at par so no realized or unrealized gains or losses were present during 1998. Proceeds from the sale of short-term investments totalled $51,403,000 for the year ended December 31, 1998. FUTURE CHANGES IN ACCOUNTING PRINCIPLES In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This Statement establishes the accounting for derivative instruments, including certain derivative instruments imbedded in other contracts and hedging activities. This Statement is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. Management has not yet determined the applicability of this pronouncement on the Company's results of operations or financial position. 19 ELECTRONIC PROCESSING, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 2: SOFTWARE DEVELOPMENT COSTS The following is a summary of software development costs capitalized:
1998 1997 ------------- ------------- Amounts capitalized, net of retirements......................... $ 2,670,196 $ 2,854,876 ------------- ------------- Accumulated amortization, Beginning of year..................... (1,457,501) (1,121,900) Amortization expense............................................ (422,389) (335,601) Software retired................................................ 1,226,640 ------------- Accumulated amortization, end of year........................... (653,250) (1,457,501) ------------- ------------- Net software development costs.................................. $ 2,016,946 $ 1,397,375 ------------- ------------- ------------- -------------
Included in the above are development costs relating to products not yet released. Such costs totaled $521,164 and $391,155 at December 31, 1998 and 1997, respectively. NOTE 3: NOTE PAYABLE AND LONG-TERM DEBT Note payable represents advances against a $500,000 operating line of credit. Interest is 1% in excess of the bank's base lending rate per annum and is adjusted and payable on a quarterly basis, with the outstanding balance being due on March 4, 1999. The note is collateralized by accounts receivable and customer contracts. Long-term debt includes the following at December 31, 1998 and 1997:
1998 1997 ---------- ------------ Note payable, bank(A)............................................... $ 436,372 Note payable, bank(B)............................................... 468,119 Capital lease obligations(C)........................................ $ 264,879 604,487 Other............................................................... 3,572 6,733 ---------- ------------ 268,451 1,515,711 Less current maturities............................................. 159,151 626,665 ---------- ------------ $ 109,300 $ 889,046 ---------- ------------ ---------- ------------
- ------------------------ (A) Revolving equipment line of credit of $500,000, with interest (1% in excess of bank's base lending rate) payable monthly, in addition to monthly principal reductions equal to one thirty-sixth of the outstanding principal balance, with the unpaid balance being due in 1999; collateralized by equipment. The line of credit was paid off during the year ended December 31, 1998. (B) Revolving equipment line of credit of $1,000,000 with interest ( 1/2% in excess of bank's base lending rate--9% at December 31, 1997), payable monthly, in addition to monthly principal reductions equal to one thirty-sixth of the outstanding principal balance, with any unpaid balance being due in 1999. (C) Obligations include leases for the use of computer equipment for no more than five years, expiring in 2003. For the above obligations, the carrying value approximates fair value. 20 ELECTRONIC PROCESSING, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 3: NOTE PAYABLE AND LONG-TERM DEBT (CONTINUED) Aggregate annual maturities of long-term debt and payments on capital lease obligations at December 31, 1998 are as follows:
LONG-TERM DEBT CAPITAL (EXCLUDING LEASE LEASES) OBLIGATIONS ----------- ----------- 1999................................................................. $ 3,572 $ 176,883 2000................................................................. 51,899 2001................................................................. 42,358 2002................................................................. 29,523 2003................................................................. 2,096 ----------- ----------- $ 3,572 302,759 ----------- ----------- Less amount representing interest.................................... 37,880 ----------- Present value of future minimum lease payments....................... 264,879 Less current maturities.............................................. 155,579 ----------- Noncurrent portion................................................... $ 109,300 ----------- -----------
Property and equipment include the following property under capital leases:
1998 1997 ---------- ------------ Computer equipment.................................................. $ 993,991 $ 1,293,779 Less accumulated depreciation....................................... 474,696 461,239 ---------- ------------ $ 519,295 $ 832,540 ---------- ------------ ---------- ------------
NOTE 4: OPERATING LEASES The Company has a noncancellable operating lease for office space, which expires in February 2011. A principal shareholder of the Company is a partner in the partnership that leases office space to the Company. The lease requires the Company to pay all executory costs (property taxes, maintenance and insurance). Future minimum lease payments at December 31, 1998 are as follows: 1999.................................................... $ 157,800 2000.................................................... 162,400 2001.................................................... 167,200 2002.................................................... 173,000 2003 and thereafter..................................... 1,602,200 --------- $2,262,600 --------- ---------
Rental expense under this lease was $154,000 and $149,250 for the years ended December 31, 1998 and 1997, respectively. 21 ELECTRONIC PROCESSING, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 5: RELATED PARTY TRANSACTIONS The Company was reimbursed for property taxes from the related party disclosed at Note 4. Reimbursement for property taxes amounted to approximately $30,000 for each of the years ended December 31, 1998 and 1997. In addition, the related party reimbursed the Company for consulting services in the amount of $19,000 for the year ended December 31, 1998. A principal shareholder reimbursed the Company for expenses paid on his behalf in the amount of $30,000 for the year ended December 31, 1998. NOTE 6: PROFIT SHARING PLAN The Company has adopted a 401(k) plan covering substantially all employees. The Company matches the first 10% of employee contributions and also has the option of making discretionary contributions. Employees are fully vested in such contributions after four years. Contributions amounted to $96,825 and $63,182 for the years ended December 31, 1998 and 1997, respectively. NOTE 7: PUBLIC OFFERINGS In February 1997, the Company completed a public offering of 1,600,000 shares of common stock (the IPO) and received net proceeds (prior to stock issuance costs) of $4,938,000. In connection with the issuance of common stock to the public, the Company changed its income tax status to a C corporation. At the time of becoming a C corporation, the Company accrued an income tax provision of $272,900 to record the deferred tax effects of temporary differences between financial statement and tax bases of assets and liabilities as follows: Deferred tax assets: Allowance for doubtful accounts................................ $ 1,900 Accrued compensated absences................................... 4,200 Other.......................................................... 1,200 --------- 7,300 Deferred tax liabilities: Property and equipment......................................... (280,200) --------- Net deferred tax liability....................................... $(272,900) --------- ---------
Pro forma earnings information has been provided to reflect the effects of corporate income taxes on historical earnings, including the effects of permanent and temporary differences in reporting income and expenses for tax and financial reporting purposes, as if the Company had been subject to income taxes for all the periods presented, including the period in 1997 prior to the IPO. Pro forma adjustments reflect the provision for corporate income taxes for the year ended December 31, 1997, as discussed above. In May 1998, the Company completed a secondary public offering of 1,000,000 shares of common stock and received net proceeds (prior to stock issuance costs) of $11,160,000. In June 1998, the underwriter exercised its over-allotment option associated with the secondary offering by purchasing 140,500 additional shares at a net price of $1,567,980. 22 ELECTRONIC PROCESSING, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 8: INCOME TAXES The provision for income taxes includes the following components:
1998 1997 ---------- ---------- Taxes currently payable............................................... $ 640,728 $ 422,960 Deferred income taxes................................................. 188,511 28,729 ---------- ---------- $ 829,239 $ 451,689 ---------- ---------- ---------- ----------
A reconciliation of the provision for income taxes at the statutory rate to provision for income taxes at the Company's effective rate is shown below:
1998 1997 ---------- ---------- Computed at the statutory rate (34%).................................. $ 731,000 $ 370,600 Increase in taxes resulting from: Nondeductible expenses.............................................. 29,300 24,300 State income taxes, net of federal tax effect and other............. 68,939 56,789 ---------- ---------- Tax Provision..................................................... $ 829,239 $ 451,689 ---------- ---------- ---------- ----------
Also included in the provision for the year ended 1997, is the initial income tax provision of $272,900 to record the effects of temporary differences at the date of the change in tax status (SEE NOTE 7). The tax effects of temporary differences related to deferred taxes shown on the accompanying balance sheets are as follows:
1998 1997 ----------- ----------- Deferred tax assets: Allowance for doubtful accounts................................... $ 1,900 $ 1,900 Accrued compensated absences...................................... 37,445 16,923 Accrued stock options............................................. 13,035 ----------- 52,380 18,823 Deferred tax liabilities: Property and equipment............................................ 542,520 320,452 ----------- ----------- $ (490,140) $ (301,629) ----------- ----------- ----------- -----------
The above net deferred tax liability is presented on the balance sheets as follows:
1998 1997 ----------- ----------- Deferred tax asset--current......................................... $ 39,345 $ 18,823 Deferred tax liability--long-term................................... (529,485) (320,452) ----------- ----------- $ (490,140) $ (301,629) ----------- ----------- ----------- -----------
23 ELECTRONIC PROCESSING, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 9: NET INCOME PER SHARE The details of the basic and diluted net income per share calculations are as follows:
1998 1997 -------------------------------------- ------------------------------------- WEIGHTED WEIGHTED AVERAGE AVERAGE SHARES PER SHARE SHARES PER SHARE NET INCOME OUTSTANDING AMOUNT NET INCOME OUTSTANDING AMOUNT ------------ ----------- ----------- ----------- ----------- ----------- Net income.......................... $ 1,320,618 $ 365,499 ------------ ----------- Net income per share: Income available to common shareholders.................... $ 1,320,618 4,126,679 $ .32 $ 365,499 3,250,959 $ .11 ------------ ----- ----------- ----- ------------ ----- ----------- ----- Effect of dilutive securities: Warrants.......................... 30,979 40,214 Stock options..................... 125,436 76,210 ----------- ----------- Net income per share--Diluted: Income available to common shareholders and assumed conversions..................... $ 1,320,618 4,283,094 $ .31 $ 365,499 3,367,383 $ .11 ------------ ----------- ----- ----------- ----------- ----- ------------ ----------- ----- ----------- ----------- -----
Pro forma earnings per share information has been provided to reflect the effects of corporate income taxes on a consistent basis for both years (SEE NOTE 7). For 1998 and 1997, the pro forma earnings per share information was as follows:
1998 1997 ----- ----- Basic........................................................................... .32 .20 -- -- -- -- Diluted......................................................................... .31 .19 -- -- -- --
As of December 31, 1998, the Company had 69,500 options outstanding, which were anti-dilutive and, therefore, not considered in the diluted earnings per share calculation above. NOTE 10: STOCK OPTIONS The Company's 1995 Stock Option Plan (the Plan) permits the issuance of stock options for up to 500,000 shares of common stock to selected employees and outside directors of the Company. The terms of each award shall be determined by the Board of Directors. Under the terms of the Plan, options granted may be either nonqualified or incentive stock options (ISOs). The exercise price for ISOs may not be less than the fair value on the date of the grant. 24 ELECTRONIC PROCESSING, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 10: STOCK OPTIONS (CONTINUED) A summary of the Company's stock options outstanding as of December 31, 1998 and 1997 is presented below:
1998 1997 ----------------------- ----------------------- WEIGHTED WEIGHTED AVERAGE AVERAGE EXERCISE EXERCISE SHARES PRICE SHARES PRICE ---------- ----------- ---------- ----------- Outstanding, beginning of year.................. 225,000 $ 4.65 Granted......................................... 171,250 10.53 237,000 $ 4.59 Forfeited....................................... (30,200) 6.53 (12,000) 3.50 Exercised....................................... (7,400) 3.82 Outstanding, end of year........................ 358,650 7.26 225,000 4.65
The following table summarizes information about stock options under the plan outstanding at December 31, 1998:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ---------------------------- ------------------------ WEIGHTED- AVERAGE WEIGHTED- WEIGHTED- REMAINING AVERAGE AVERAGE RANGE OF NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE EXERCISE PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE - --------------------------- ----------- --------------- ----------- ----------- ----------- $3.85 to $ 4.95............ 50,000 3.5 years $ 4.40 50,000 $ 4.40 $6.80 to $12.00............ 80,000 9.5 years $ 9.25 25,000 $ 6.80 $3.50 to $ 9.50............ 156,150 9.0 years $ 5.51 $7.86 to $12.63............ 72,500 9.5 years $ 11.06
The Company accounts for this plan under APB Opinion No. 25, under which only an immaterial amount of compensation cost has been recognized. Had compensation cost been determined based on the fair value at the grant dates using FASB Statement No. 123, the Company's December 31, 1998 and 1997 net income and earnings per share would have been reduced to the following pro forma amounts:
1998 1997 ------------ ---------- Net income......................................... As Reported $ 1,320,618 $ 365,499 Pro forma $ 820,925 $ 178,024 Net income per share--Basic........................ As reported $ .32 $ .11 Pro forma $ .20 $ .05 Net income per share--Diluted...................... As reported $ .31 $ .11 Pro forma $ .19 $ .05
Proforma amounts presented here are based on actual earnings and consider only the effects of estimated fair values of stock options. The fair value of the above options was estimated at the date of grant using the Black-Scholes option-pricing model with the key assumptions being risk-free interest rates of 5.0%--6.7%, no expected dividends and expected volatility of 238% and 367% for the years ended December 31, 1998 and 1997, respectively. 25 ELECTRONIC PROCESSING, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 10: STOCK OPTIONS (CONTINUED) The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferrable. In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. In connection with the initial public offering (SEE NOTE 8), the Company issued warrants to purchase 160,000 shares of stock at $4.20 per share to its underwriters. During the year ended December 31, 1998, 104,200 warrants were converted in a cashless exercise, resulting in 77,368 shares of stock being issued. In addition, 8,000 warrants were exercised for their exercise price, resulting in the issuance of an additional 8,000 shares of common stock. At December 31, 1998, warrants to purchase 47,800 shares of stock remain outstanding. NOTE 11: SIGNIFICANT ESTIMATES AND CONCENTRATIONS Generally accepted accounting principles require disclosure of certain significant estimates and current vulnerabilities due to certain concentrations. Those matters include the following: - The Company capitalizes and amortizes costs incurred in the development of software products. Ultimate recoverability is dependent upon future revenues over the life of each product. For its Chapter 7 software product, the Company collects revenue from its Chapter 7 trustee clients through a marketing agreement with a national financial institution in which the Company receives revenues based on the level of trustees' deposits with that institution. Revenues generated by Chapter 7 trustee clients, that are collected through the agreement with the financial institution, totalled $6,288,585 and $3,219,255 for the years ended December 31, 1998 and 1997, respectively. Additionally, that institution represented 57% of the Company's December 31, 1998 accounts receivable balance. NOTE 12: ADDITIONAL CASH FLOWS INFORMATION
1998 1997 --------- ------------ NONCASH INVESTING AND FINANCING ACTIVITIES Capital lease obligation and notes payable Incurred for equipment...................... $ 28,828 $ 1,138,134 ADDITIONAL CASH INFORMATION Interest paid.......................................................................... 97,780 181,410 Income taxes paid...................................................................... 654,438 390,000
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. 26 PART III ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT DIRECTORS AND EXECUTIVE OFFICERS The executive officers and directors of the Company, their ages as of March 11, 1999, and their positions with the Company are set forth below.
NAME AGE POSITION - ------------------------------------------------- --- -------------------------------------------------------- Tom W. Olofson*.................................. 57 Chairman, Chief Executive Officer, and Director Christopher E. Olofson........................... 29 President, Chief Operating Officer, and Director Richard A. Winegar............................... 58 Senior Vice President Albert T. Annillo................................ 48 Senior Vice President Reve Butler...................................... 48 Vice President--Human Resources Reed A. Eichner.................................. 41 Vice President--Operations Nanci R. Trutna.................................. 45 Vice President-Finance and Secretary Robert C. Levy*.................................. 51 Director W. Bryan Satterlee*.............................. 63 Director
- ------------------------ * Member of Audit Committee TOM W. OLOFSON led a private investor group that acquired the Company in July 1988, and has served as Chief Executive Officer and Chairman of the Board since that time. During his business career, Mr. Olofson has held various management positions with Xerox Corporation and was a Senior Vice President and member, Office of the President of Marion Laboratories, Inc. Mr. Olofson is a director of Saztec International, Inc., a provider of information management services, and also serves as a director of various private companies in which he is an investor. He earned a BBA from the University of Pittsburgh in 1963, and is currently a member of the Board of Visitors of the Katz Graduate School of Business at the University of Pittsburgh. He is the father of Christopher E. Olofson. CHRISTOPHER E. OLOFSON joined EPI as a Vice President in June 1993, and was a part-time employee of the Company from 1988 to 1993. In January 1994, he was named Senior Vice President--Operations, and became Executive Vice President and a member of the Board of Directors effective January 1, 1995. Effective July 1, 1996, Mr. Olofson also assumed the duties of Chief Operating Officer, and effective October 1, 1998, Mr. Olofson was named President of the Company. He earned an AB degree from Princeton University in 1992, SUMMA CUM LAUDE. He was named a Fulbright Scholar and he completed a one-year program of study at the Stanford University Center in Taipei, Taiwan in 1993. He is the son of Tom W. Olofson. ALBERT T. ANNILLO has been Senior Vice President since January 1995. Mr. Annillo joined the Company in October 1992 as a corporate Vice President. He was Assistant Director, Executive Office for United States Trustees, Department of Justice, Washington, D.C. for six years before his association with the Company. He earned an MBA and an MED from William Patterson College in 1975 and 1979, respectively. REED A. EICHNER joined the Company as Vice President--Sales and Marketing in September 1995. He became Vice President--Operations on September 1, 1996. From May 1991 through August 1995 he served as President and owner of Connexions, Inc., a company which provided system integration and document conversion services. He was General Manager of Innovision Systems, Inc. from September 1989 to May 1991. Mr. Eichner earned a BA from the University of North Carolina in 1982. 27 ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT (CONTINUED) REVE BUTLER joined EPI as Vice President Human Resources in June, 1998. During 1998, Ms. Butler was Human Resources Manager in the corporate office at Sprint Corp. She was Human Resources Manager for Investors Fiduciary Trust Company from 1986 to 1998 and Employee Development Manager of DST Systems, Inc. from 1981 to 1986. Ms. Butler has a BS in Business Administration from Culver Stockton College, and an MS in Counseling from Central Missouri State University. NANCI R. TRUTNA assumed her present position as Vice President--Finance in June 1993. In 1998, she assumed the position of Corporate Secretary. She was with Merchants Bank, Kansas City, Missouri from 1981 to June 1993 where she became a Senior Vice President. Ms. Trutna is a Certified Public Accountant and earned a BSBA in 1975 from the University of North Dakota. RICHARD A. WINEGAR joined EPI in October 1998 as a Senior Vice President. Mr. Winegar was previously President of CFDS Limited, a Toronto based subsidiary of Boston Financial Data Services from 1994 to 1997, and Executive Vice President/Chief Operations Officer with Investors Fiduciary Trust Company from 1981 to 1994, a Kansas City based unit of State Street Corporation. Mr. Winegar earned a BS from Central Missouri State University. ROBERT C. LEVY is a director, stockholder and executive committee member of the law firm of Seigfreid, Bingham, Levy, Selzer & Gee in Kansas City, Missouri. He has been a Director of the Company since July 1988. He earned a BS from Northwestern University in 1968, and a J.D. from the University of California at Berkeley in 1971. Mr. Levy formerly was Chairman of the Board of Directors of Blue Cross and Blue Shield of Kansas City. W. BRYAN SATTERLEE was elected to the Company's Board of Directors on February 7, 1997. Mr. Satterlee has been a partner since 1989 in NorthEast Ventures, a consulting firm based in Hartford, Connecticut which specializes in business development services for and evaluations of technology-based venture companies. He has extensive general management and marketing experience in technology-based firms. Mr. Satterlee's background includes ten years of management experience with IBM, as well as having been a founder of a computer leasing/software business, telecommunications company and a venture investment services business. He earned a BS in 1956 from Lafayette College. SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Based upon the Company's review of Forms 3, 4 and 5 filed by directors, officers and beneficial owners of more than 10% of the Common Stock of the Company with respect to calendar year 1998, the Company has determined that Ms. Butler and Mr. Winegar failed to file on a timely basis an initial statement of beneficial ownership of securities in the Company on Form 3 after each was named an officer of the Company. The required Form 3's were filed by Ms. Butler and Mr. Winegar at the time Form 5's were filed on behalf of certain other directors and officers of the Company. ITEM 10. EXECUTIVE COMPENSATION EXECUTIVE COMPENSATION The following table sets forth the cash and other compensation paid in 1998, 1997, and 1996 to the Company's Chief Executive Officer and each other executive officer of the Company who earned in excess of $100,000 in 1998. 28 ITEM 10. EXECUTIVE COMPENSATION (CONTINUED) SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION OTHER ANNUAL ALL OTHER NAME AND PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION(1) COMPENSATION(2)(3) - -------------------------------------------- --------- ---------- --------- ---------------- ------------------ Tom W. Olofson.............................. 1998 $ 100,114 $ 0 $ 2,688 $ 11,026 Chairman/CEO 1997 $ 100,489 $ 0 $ 31,573 $ 11,537 1996 $ 50,000 $ 24,000 $ 36,827 $ 11,434 Christopher E. Olofson...................... 1998 $ 138,102 $ 0 $ 3,063 $ 6,000 President/COO 1997 $ 120,101 $ 0 $ 2,754 $ 3,600 1996 $ 108,101 $ 0 $ 3,349 $ 1,620
- ------------------------ (1) Includes $28,562 in 1997, and $33,782 in 1996 for payment of annual life insurance premiums on policies owned by Tom W. Olofson, which designate Jeanne H. Olofson, his wife, as the beneficiary, and $2,688 in 1998, $3,011 in 1997 and $3,045 in 1996 for personal use of a Company automobile. Includes $3,063 for 1998, $2,754 for 1997 and $3,349 for 1996 for Christopher E. Olofson for personal use of Company automobile. (2) Includes $5,026 in 1998, $6,789 in 1997 and $9,075 in 1996 for group insurance and $6,000 in 1998, $4,748 in 1997 and $2,359 in 1996 for Company matching contributions under the 401(k) plan for Tom W. Olofson. Includes $6,000 in 1998, $3,600 in 1997 and $1,620 in 1996 for Company matching contributions under the 401(k) plan for Christopher E. Olofson. (3) Does not include interest of $7,778 in 1997 and $40,000 in 1996 on amounts borrowed by the Company from Tom W. Olofson. See "Certain Transactions." The Company does not have a long-term incentive compensation plan. STOCK OPTIONS ISSUED As shown in the table below Christopher E. Olofson was granted options for 55,000 shares of common stock during the year-ended December 31, 1998. Tom W. Olofson was not granted any stock options in 1998. The table also includes information regarding grants of options to other executive officers in 1998.
NUMBER OF SECURITIES UNDERLYING EXERCISE EXPIRATION NAME OPTIONS GRANTED PRICE DATE - ------------------------------------------------------ --------------- ----------- ------------- Reve Butler........................................... 5,000 $ 12.00 2008 5,000 $ 9.00 2008 1,000 $ 9.50 2008 Christopher Olofson................................... 25,000 $ 12.00 2008 30,000 $ 9.00 2008 Nanci Trutna.......................................... 5,000 $ 12.00 2008 1,000 $ 9.50 2008 Richard Winegar....................................... 10,000 $ 8.25 2008 10,000 $ 9.50 2008 Reed Eichner.......................................... 1,000 $ 9.50 2008 Al Annillo............................................ 1,000 $ 9.50 2008 TOTAL................................................. 94,000
29 ITEM 10. EXECUTIVE COMPENSATION (CONTINUED) The percent of total options granted to the above officers was 54.9% of the total number of options granted in 1998. No stock options were exercised during 1998 by the named executives. COMPENSATION OF DIRECTORS The Company pays its non-employee directors a fee of $750 per quarter and $750 per meeting attended. ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth certain information regarding the beneficial ownership of shares of Common Stock as of the March 11, 1999 for (i) each director of the Company; (ii) each person known to the Company to be the beneficial owner of more than 5% of the outstanding shares; and (iii) all directors and executive officers as a group. Except pursuant to applicable community property laws or as otherwise indicated, each stockholder has sole voting and investment power with respect to the shares beneficially owned.
NUMBER OF NAME AND ADDRESS OF BENEFICIAL OWNER(1) SHARES PERCENTAGE OWNED - -------------------------------------------------------------- ---------- ----------------- Tom W. Olofson................................................ 1,400,000(2) 30.2% Christopher E. Olofson........................................ 209,500(3) 4.5% Robert C. Levy................................................ 22,500 1.0% W. Bryan Satterlee............................................ 10,000(4) * All directors and executive officers as a group (9 persons)...................................... 1,656,000(5) 35.7%
- ------------------------ * Less than 1% (1) The address of all of the named individuals is c/o Electronic Processing, Inc., 501 Kansas Avenue, Kansas City, Kansas 66105. (2) Excludes 40,500 shares owned by Mr. Olofson's adult son, Scott W. Olofson, as to which shares Mr. Olofson disclaims beneficial ownership. (3) Includes 130,000 shares of Common Stock issuable upon exercise of options that are currently exercisable. (4) Includes 3,000 shares of Common Stock issuable upon exercise of options that are currently exercisable. Excludes 4,500 shares of Common Stock issuable upon exercise of options held by Mr. Satterlee that are not currently exercisable and will not become exercisable within 60 days. (5) Includes 146,000 shares of Common Stock issuable upon exercise of options that are currently exercisable. Excludes 78,000 shares of Common Stock issuable upon exercise of options held by directors and executive officers that are not currently exercisable and will not become exercisable within 60 days. ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS In July 1988, an unaffiliated venture capital firm purchased a $400,000 subordinated note and a stock purchase warrant from the Company. In October 1991, the Company's Board of Directors deemed it in the best interest of the Company to purchase the subordinated note and stock purchase warrant from the venture capital firm. Because the Company could not then complete this transaction without incurring 30 ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (CONTINUED) additional debt, Tom W. Olofson, Chairman and Chief Executive Officer, purchased the subordinated note and stock purchase warrant. The note provided for interest at the rate of 10% with a maturity date of July 1998. The stock purchase warrant provided for the acquisition of 969,228 shares of the Company's Common Stock at $.4125 per share at any time prior to July 14, 1998 (giving retroactive effect to a six-for-one stock split). The Company recorded a value of such stock purchase warrant in the amount of $41,000, with the value being calculated using the difference between net book value and exercise price per share. In an October 11, 1996 agreement between the Company and Mr. Olofson, it was agreed that the Company would pay $41,000 to Mr. Olofson on or before December 31, 1996, at which time the stock purchase warrant would be retired. The Company repaid the $400,000 outstanding face value of the subordinated note to Mr. Olofson from the proceeds of its Common stock offering in February, 1997. The Company has a noncancellable operating lease for its corporate headquarters which expires in February 28, 2001 with options if exercised, to extend the lease to February 28, 2011. Tom W. Olofson holds a 50% interest, as a general partner, in T & J Investment Company, a Kansas general partnership ("T & J Investment Company") that leases this facility to the Company. The lease requires the Company to pay all executory costs (property taxes, maintenance and insurance). ITEM 13 EXHIBITS AND REPORTS ON FORM 8-K EXHIBITS The following exhibits are filed with this Form 10-KSB or are incorporated herein by reference:
EXHIBIT NUMBER DESCRIPTION - ----------- -------------------------------------------------------------------------------------------------------- 3.1 Articles of Incorporation, dated July 13, 1988; incorporated by reference to Exhibit 3.1 to the Registration Statement on Form SB-2 dated February 4, 1997. (Registration Number 333-16805) (the "1997 Registration Statement") 3.1a Amendment of Articles of Incorporation, dated August 10, 1988; incorporated by reference to Exhibit 3.1a to the 1997 Registration Statement. 3.1b Amendment of Articles of Incorporation, dated October 31, 1995; incorporated by reference to Exhibit 3.1b to the 1997 Registration Statement. 3.1c Amendment of Articles of Incorporation, dated April 1, 1996; incorporated by reference to Exhibit 3.1c to the 1997 Registration Statement. 3.1d Amendment of Articles of Incorporation dated February 24, 1998; incorporated by reference to Exhibit 3.1d to the annual report on Form 10-KSB for the year ended December 31, 1997 (the "1997 Form 10-KSB.") 3.2 Bylaws, as amended and restated; incorporated by reference to Exhibit 3.2 to the Company's Registration Statement on Form SB-2 dated May 1, 1998 (Registration Number 333-51525) (the "1998 Registration Statement"). 10.1 Agreement for Computerized Trustee Case Management System between the Company and NationsBank of Texas, N.A., dated November 22, 1993; incorporated by reference to Exhibit 10.1 to the 1997 Registration Statement. 10.2 Lease between T&J Investment Company and the Company, dated February 20, 1996; incorporated by reference to Exhibit 10.2 to the 1997 Registration Statement.
31 ITEM 13 EXHIBITS AND REPORTS ON FORM 8-K (CONTINUED)
EXHIBIT NUMBER DESCRIPTION - ----------- -------------------------------------------------------------------------------------------------------- 10.2a Amendment to Lease referred to in Exhibit 10.2 dated December 9, 1997; incorporated by reference to Exhibit 10.2a to the 1997 Form 10-KSB. 10.3 Form of Underwriters Warrant; incorporated by reference to Exhibit 4.1 to the 1997 Registration Statement. 10.4 Loan Agreement between Industrial State Bank and the Company dated March 4, 1997; incorporated by reference to Exhibit 10.4b to the 1997 Form 10-KSB. 10.5 Loan Agreement between Industrial State Bank and the Company, dated June 4, 1997; incorporated by reference to Exhibit 10.6b to the 1997 Form 10-KSB. 10.6 Loan Agreement between Exchange National Bank and the Company, dated July 21, 1997; incorporated by reference to Exhibit 10.7 to the 1997 Form 10-KSB. 10.7 1995 Stock Option Plan, as amended, incorporated by reference to Exhibit 10.7 to the 1998 Registration Statement. 23.1 Consent of Baird, Kurtz & Dobson, Certified Public Accountants 27.1 Financial Data Schedule
- FILED HEREWITH. REPORTS ON FORM 8-K NONE 32 SIGNATURES In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed by the undersigned, thereunto duly authorized. Dated: March 26, 1999 ELECTRONIC PROCESSING, INC. By: /s/ TOM W. OLOFSON ----------------------------------------- Tom W. Olofson CHAIRMAN/CEO
In accordance with the Exchange Act this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 26, 1998. SIGNATURE CAPACITY - ------------------------------ -------------------------- Chairman of the Board /s/ TOM W. OLOFSON Chief Executive Officer - ------------------------------ (Principal Executive Tom W. Olofson Officer) Director /s/ CHRISTOPHER E. OLOFSON President - ------------------------------ Chief Operating Officer Christopher E. Olofson Director Vice President of Finance /s/ NANCI R. TRUTNA (Principal Financial - ------------------------------ Officer and Principal Nanci R. Trutna Accounting Officer) /s/ ROBERT C. LEVY - ------------------------------ Director Robert C. Levy /s/ W. BRYAN SATTERLEE - ------------------------------ Director W. Bryan Satterlee 33 EX-23.1 2 EX 23.1 CONSENT OF INDEPENDENT ACCOUNTANTS Electronic Processing, Inc. 501 Kansas Avenue Kansas City, Kansas 66105 We consent to the incorporation by reference in the Registration Statement of Electronic Processing, Inc. on Form S-8 (File No. 333-30847) for the registration of 270,000 shares of its common stock and options to acquire common stock, of our reports dated February 8, 1999, on our audits of the financial statements of Electronic Processing, Inc. as of December 31, 1998 and 1997, and for each of the years then ended, which reports are included in the Company's 1998 Annual Report on Form 10-KSB, filed with the Securities and Exchange Commission. BAIRD, KURTZ & DOBSON Kansas City, Missouri March 25, 1999 EX-27 3 EX 27
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM ELECTRONIC PROCESSING, INC. STATEMENT OF INCOME FOR THE YEARS ENDED DECEMBER 31, 1998 AND BALANCE SHEET AS AT DECEMBER 31, 1998, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 820,256 10,700,000 1,591,303 5,000 0 13,439,928 8,989,862 3,233,510 21,278,611 1,249,008 0 0 0 17,707,211 0 21,278,611 11,546,273 11,546,273 5,276,835 5,276,835 4,029,826 0 89,755 2,149,857 829,239 1,320,618 0 0 0 1,320,618 .32 .31
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