-----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, GyiOSvAge6AxmYUpWh/kjMw+TV31Npbi7a8r1TTBfvCRt6SimmkNg8Xh8vsYEBTi kv0kGgSvm6s0X2gjBa+/7g== 0001015402-03-005073.txt : 20031229 0001015402-03-005073.hdr.sgml : 20031225 20031229151933 ACCESSION NUMBER: 0001015402-03-005073 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20030930 FILED AS OF DATE: 20031229 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ELECTRONIC CLEARING HOUSE INC CENTRAL INDEX KEY: 0000721773 STANDARD INDUSTRIAL CLASSIFICATION: FUNCTIONS RELATED TO DEPOSITORY BANKING, NEC [6099] IRS NUMBER: 930946274 STATE OF INCORPORATION: NV FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-15245 FILM NUMBER: 031075394 BUSINESS ADDRESS: STREET 1: 28001 DOROTHY DR CITY: AGOURA HILLS STATE: CA ZIP: 91301-2697 BUSINESS PHONE: 8187068999 MAIL ADDRESS: STREET 1: 28001 DOROTHY DRIVE CITY: AGOURA HILLS STATE: CA ZIP: 91301 FORMER COMPANY: FORMER CONFORMED NAME: BIO RECOVERY TECHNOLOGY INC DATE OF NAME CHANGE: 19860122 10-K 1 doc1.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K X Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange - --- Act of 1934 for the fiscal year ended Sept. 30, 2003 Transition Report Pursuant to Section 13 or 15(d) of the Securities - --- Exchange Act of 1934 Commission File Number 0-15245 ELECTRONIC CLEARING HOUSE, INC. (Exact name of registrant as specified in its charter)
NEVADA 93-0946274 (State or other jurisdiction of incorporation or organization) (IRS Employer Identification No.) 730 PASEO CAMARILLO, CAMARILLO, CALIFORNIA 93010 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (805) 419-8700, fax number: (805) 419-8689
Securities registered pursuant to Section 12(b) of the Act: Name of each exchange TITLE OF EACH CLASS ON WHICH REGISTERED ------------------- --------------------- None None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.01 par value (Title of class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ___ Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes No X --- --- The aggregate market value of the voting stock held by non-affiliates of the Registrant, based upon the closing sale price of the Common Stock on March 31, 2003 as reported on the NASDAQ SmallCap Market, was approximately $13,644,810. Shares of Common Stock held by each officer and director have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. As of December 22, 2003, Registrant had outstanding 6,325,012 shares of Common Stock. DOCUMENTS INCORPORATED BY REFERENCE - NONE
ELECTRONIC CLEARING HOUSE, INC. 2003 FORM 10-K ANNUAL REPORT ---------------------------- TABLE OF CONTENTS ----------------- PART I. Page - -------- ---- ITEM 1. Business . . . . . . . . . . . . . . . . . . . . . . . . . . 3 ITEM 2. Properties . . . . . . . . . . . . . . . . . . . . . . . . . 14 ITEM 3. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . 15 ITEM 4. Submission of Matters to a Vote of Security Holders . . . . 15 PART II - -------- ITEM 5. Market for Registrant's Common Equity and Related Stockholder Security Matters . . . . . . . . . . . . . . . . 16 ITEM 6. Selected Consolidated Financial Data . . . . . . . . . . . . 17 ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations . . . . . . . . . . . . 18 ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk . 31 ITEM 8. Financial Statements and Supplemental Data . . . . . . . . . 31 ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures . . . . . . . . . . . . 31 ITEM 9A. Controls and Procedures . . . . . . . . . . . . . . . . . . 31 PART III - -------- ITEM 10. Directors and Executive Officers of the Registrant . . . . 32 ITEM 11. Executive Compensation . . . . . . . . . . . . . . . . . . 35 ITEM 12. Security Ownership of Certain Beneficial Owners and Management . . . . . . . . . . . . . . . . . . . . . . 38 ITEM 13. Certain Relationships and Related Transactions . . . . . . 40 ITEM 14. Principal Accounting Fees and Services . . . . . . . . . . 40 PART IV - -------- ITEM 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K . . . . . . . . . . . . . . . . . . . . 41
2 PART 1 CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS --------------------------------------------------------- This 2003 Annual Report on Form 10-K contains statements which constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Those statements include statements regarding our intent, belief or current expectations. Examples of forward-looking statements include statements regarding our strategy, financial performance and revenue sources. Prospective investors are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and that actual results may differ materially from those projected in the forward-looking statements as a result of various factors, including, but not limited to, those set forth elsewhere in this Annual Report. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Risk Factors." ITEM 1. BUSINESS OVERVIEW Electronic Clearing House, Inc. is an electronic payment processor that provides for the payment processing needs of merchants, banks and collection agencies. We derive the majority of our revenues from two main business segments, bankcard and transaction processing services ("bank card services"), whereby we provide solutions to merchants and banks to allow them to accept credit and debit card payments from consumers, and check-related products ("check services"), whereby we provide various services to merchants and banks to allow them to accept and process check payments from consumers. The principal services we offer within these two segments include, with respect to our bank card services, debit and credit card processing, and U-Haul transaction processing, and with respect to our check services, check guarantee (where, if we approve a check transaction and a check is subsequently dishonored by the check writer's bank, the merchant is reimbursed by us), check verification (where, prior to approving a check, we search our negative and positive check writer database to determine whether the check writer has current, delinquent check-related debts), electronic check conversion (the conversion of a paper check at the point of sale to a direct bank debit which is processed for settlement through the Federal Reserve System's Automated Clearing House ("ACH") network. The ACH is the electronic banking network through which all electronic funds transfers are made in the United States), check re-presentment (where we attempt to clear a check on multiple occasions via the ACH network prior to returning the check to the merchant so as to increase the number of cleared check transactions), and check collection (where we provide national scale collection services for a merchant or bank). We operate our services under the following brands: - MerchantAmerica, our retail provider of payment processing services to both the merchant and bank markets; - National Check Network ("NCN"), our proprietary database of negative and positive check writer accounts (i.e., accounts that show delinquent history in the form of non-sufficient funds and other negative transactions), for back-end check verification, check authorization and check capture services, and for membership to collection agencies; and - XPRESSCHEX, Inc. for retail check verification, check conversion, Automated Clearing House services (which we describe in greater detail below), check collection and check guarantee services. We discuss our services in greater detail below. Overall, our ability to program and oversee the management of a merchant's point of sale system, provide credit card and debit card processing, provide multiple check services for the processing of checks, provide both electronic and traditional collection services, and fully integrate all of these services into a single internet-based reporting capability allows us to provide for the majority of the payment processing needs of our customers. We were incorporated in Nevada in December 1981. Our executive offices are located at 730 Paseo Camarillo, Camarillo, California 93010, and our telephone number is (805) 419-8700. Our common stock is traded on the NASDAQ SmallCap Market under the ticker symbol "ECHO." Information on our website, www.echo-inc.com, does not constitute part of this annual report. 3 HISTORY OF THE COMPANY ECHO has been offering bankcard and check services for over 20 years. We were incorporated in Nevada in 1981 under the name Bio Recovery Technology, Inc. and changed our name to Electronic Clearing House, Inc. with the acquisition of a credit card processing company, Electronic Financial Systems, Inc. in January 1986. In 1986, ECHO developed the capability, utilizing the Federal Reserve System's Automated Clearing House ("ACH"), a network which serves as a nationwide, wholesale electronic payment and collection system by way of transferring funds between banks via the Federal Reserve System, to deposit funds into any U.S. bank of the merchant's choice. This development made it possible for remote banks and processors to provide the same processing services previously available only through the merchant's local bank. In 1999, ECHO acquired Magic Software Development, Inc., a check processing company located in Albuquerque, New Mexico, that serviced National Check Network, an association of approximately 60 affiliated collection agencies across the nation. At the time, we provided a check guarantee service that only served California merchants, but with the addition of Magic's check processing capabilities, our check guarantee services have been offered on a national basis since 1999. In fiscal 2000, Magic's corporate name was changed to XPRESSCHEX and all XPRESSCHEX activity was moved to our XPRESSCHEX subsidiary. XPRESSCHEX provides and promotes its check and Automated Clearing House ("ACH") services to other processors and sales organizations in addition to ECHO. In November 1999, we acquired Peak Collection Services, a collection agency in Albuquerque, New Mexico, and incorporated Peak into our XPRESSCHEX operations as our Collection Division in December of 1999. Through filings and individual testing, the XPRESSCHEX Collection Division has completed registration as a collection agency in 48 of 50 states to date. Having a fully integrated, nationally approved collection service allows XPRESSCHEX to operate as a central check clearing facility for NCN's 260 collection agencies without each agency having to authorize such activity. In January 2000, we acquired Rocky Mountain Retail Systems ("RMRS") located in Boulder, Colorado, which provided a national check verification service to over 200 collection agencies across the nation. RMRS maintained a national check database of negative and positive check writer records. In December 2000, we signed an agreement with Visa U.S.A. to participate in a point of sale check processing pilot program as both an "Acquirer Processor" (a role that accepts transactions from a merchant's point of sale terminal (i.e., the merchant's store) and reformats them for submission to the Visa network) and as a "Third-Party Processor" (a role that approves or declines checks written on accounts of banks not yet participating in the VISA Program and deposits approved funds utilizing the Federal Reserve System's Automated Clearing House). Under the program, any one of over 14,000 Visa member banks can offer various check processing services to their merchants and utilize Visa's dedicated communications network and banking relationships to clear check activity using direct debits from the check writer's account. In July 2001, several major financial institutions began participating in the pilot program. As of September 2003, eight of the thirteen financial institutions actively participating in the program were using ECHO's services as a Third-Party Processor, and two additional participating institutions intend to use ECHO's services as a Third-Party Processor in 2004. In May 2001, we acquired the assets of National Check Network ("NCN") and combined the NCN negative check writer records with the RMRS database, resulting in a combined database of over 100 million check writer records which identify the positive and negative check writing activities occurring with individual check writers (including information related to accepted checks, bounced checks, and the frequency of delinquent transactions). This database is ever-growing with additional contributions daily. Also in May 2001, ECHO launched MerchantAmerica.com, a web-based source of financial information whereby an ECHO merchant can access its transactional history, bank information, significant business and office-related services and even build an online store and accept payment in the form of credit cards or checks. The site also contains a national Merchant Directory of over 1.4 million merchants that is free to any merchant in the U.S.A. It also provides any merchant in the U.S.A. with the ability to edit and enhance their directory listing. While we believe that MerchantAmerica.com is a valuable and cost-effective resource for merchants, it also provides us with a low-cost method of keeping our merchants informed and involved with us. 4 OUR SERVICES BANKCARD AND TRANSACTION PROCESSING SERVICES Services - -------- With our bankcard and transaction processing services, we provide payment solutions to merchants and banks to allow them to accept credit and debit card payments from consumers. Our bankcard and transaction processing services include the following: Debit and Credit Card Payment Processing MerchantAmerica, our retail provider of payment processing services to both the merchant and bank markets, currently provides 24-hour daily payment processing, "800" number access to customer service personnel and, as needed, various field support services. Utilizing one of several methods of access to us, the merchants' systems dial our host computers and receive credit card and debit card authorizations, which have been electronically verified. Electronic files are then transmitted daily by MerchantAmerica to the major credit card organizations or to the ACH, which subsequently transfer funds from the banks to MerchantAmerica's processing bank, which then deposits the funds into the bank of the merchant's choice. On average, ECHO deposits funds to over 600 banks across the nation on behalf of its merchant base each day. Our software programs capture the transactions, retain data and enable merchants to review, reconcile and edit transactions. MerchantAmerica's customer service efforts include a terminal loaner program to minimize downtime, frequent sales and activity reports, and sophisticated security services utilizing the merchant's terminal, our host computers and assistance in the field. Additionally, MerchantAmerica utilizes several advanced telecommunications capabilities to provide consistent and reliable services to its merchants. Other Payment Processing Services We also provide various services related to our debit and credit card payment processing, including: - Internet Processing - ECHO allows merchants to process payment transactions online with security services that protect the cardholder, merchant and Internet Service Provider ("ISP") from fraud, immediate processing and online reporting; and - Batch File Processing - ECHO allows mail order, telephone order or direct marketing merchants, to process and transmit hundreds of thousands of payments at a time by using Microsoft Excel(R), Access(R) or any other program that can create a "flat file" of data. In this process, the merchant can visit the ECHO Merchant Center, log on with its PIN and merchant number, and then upload the file to ECHO's processing center. The transactions are processed immediately, with reporting available almost immediately to provide data on each transaction. Deriving Revenues - ------------------ Bankcard and transaction processing services provide for the majority of our revenues. For the year ended September 30, 2003, bankcard and transaction processing accounted for approximately 80% of our revenues. Bankcard and transaction processing volume rose 26.4% in fiscal 2003, from $760,501,000 in fiscal 2002 to $961,248,000 in fiscal 2003, and revenue increased approximately 18.2%, from $27,456,000 in fiscal 2002 to $32,444,000 in fiscal 2003. In a typical transaction, ECHO receives a percentage-based fee on the dollar amount processed and a transaction fee on the number of transactions processed. ECHO's revenue for debit/credit card processing is derived primarily from three sources: the merchant's discount rate, the merchant's transaction fee and set monthly fees. The discount rate is expressed as a percentage of the amount being processed and is deducted from the amount of each transaction submitted by the merchant, while the net amount is deposited into the merchant's bank account. Discount rates range between 1.5% and 4.5%, and our average discount rate is 2.1%, which is consistent with our rates for the year ended September 30, 2002. Depending upon the discount rate and the cost of clearing interchange, about 75% to 90%, and about 85% on average, of the discount rate revenue is paid to card-issuing banks and organizations and the sponsoring bank. 5 A transaction fee is charged for each transaction processed and ECHO's average transaction fee in fiscal 2003 was $0.19 per transaction, compared to $0.18 in fiscal 2002. We charge our bankcard merchants a range from $0.15 up to $0.32 per transaction, depending on the type of transaction and merchant. Larger customers tend to pay lower transaction fees given the volume of business they provide. Both Visa and MasterCard have instituted $0.05 to $0.10 transaction fees on each transaction processed that ECHO is required to pay. However, due to lower costs of communications and negotiated contracts, ECHO's communication costs have been lowered to a range of between $0.01 and $0.02 per transaction. Therefore, on average, ECHO pays approximately $0.012 per transaction, depending upon the duration and method of transmission. The market size for credit card processing is approximately 1.2 trillion transactions per year, and this number is growing annually. ECHO has a very small percentage of this market share, but we are one of the top 50 credit card processors according to The Nilson Report, a monthly financial subscription-based newsletter. Our competitors include First Data Corporation ("FDC"), the biggest credit card processor in the U.S., NPC, Global Payments, and Payment Tech. The credit card processing market has undergone rapid consolidation, which has raised unique challenges, including supporting and integrating numerous processing methodologies, initiating quality customer support and field support services and maintaining merchant relationships. While merchant portfolios can be purchased by a processor or a credit card agent bank, merchants are generally under no contractual obligation to utilize the services of the new owner so many of the most active consolidators have been experiencing difficulty in maintaining their number of active merchants. In an effort to enhance the bankcard transaction processing business segment's processing infrastructure and control processing costs, we licensed several payment processing systems from Oasis Technologies in 2002 and a full integration of this system is currently projected for late 2004. While we believe that our data center is reliable and the costs to operate the MerchantAmerica program are currently reasonable, no assurance can be made that such favorable conditions will continue. In order to engage in Visa and MasterCard processing, a cooperative relationship is required with a bank that sponsors the Visa and MasterCard transactions. ECHO's primary processing bank relationship is with First Regional Bank of Los Angeles, California. As a result of its relationship, ECHO is a registered Independent Sales Organization and Merchant Service Provider with Visa and MasterCard, respectively, which allows us to solicit and support merchants utilizing our services. We have an agreement with First Regional Bank, which continues our relationship through 2005. Pursuant to the terms of the agreement, among other matters, we market and sell merchant services and the bank provides various support services in connection with individual transactions, in exchange for our payment to the bank, on a monthly basis, either a payment of $0.02 per transaction, or 10 basis points of the bankcard processing volume, depending on the merchant. The agreement does not allow either party to terminate other than for cause (as defined in the agreement) without incurring liability for breach of the agreement. CHECK-RELATED PRODUCTS (OR "CHECK SERVICES") Overview - -------- ECHO has invested significant resources and management focus in its check services business. Check services revenue increased approximately 40.4% in fiscal 2003, from $5,835,000 for fiscal 2002 to $8,192,000 for fiscal 2003. Revenues from check conversion and check re-presentment are all increasing significantly. Visa officially released its POS Check Service as of December 2002 and several national banks have since approved the program to be offered to their merchants. Therefore, ECHO anticipates continued growth in check services as the marketing efforts of participating banks in the Visa Program become more widely implemented. (See also the discussion of the Visa POS Check Service Program below.) Services - -------- With our check services, we provide various services to merchants and banks to allow them to accept and process check payments from consumers. Our check services include the following: Check Verification For a fee, we will search NCN, our proprietary database of negative and positive check writer accounts, attempting to match a specific piece of information, such as a driver's license number or Magnetic Ink Character Recognition ("MICR") number (the numeric data along the bottom of a check), provided by a 6 merchant. A match identifies the check writer as having current, delinquent check-related debts. Upon notification of this match (via a coded response from the provider), the merchant decides whether to accept or decline the check. Verification reduces the risk of accepting a bad check for the merchant, however, in providing this program alone, we typically offer no guarantee that the check will be honored by the check writer's bank and make no promise of reimbursement if the check is dishonored by the bank. Revenue from check verification is derived from fees collected from the merchants when a check is verified against our positive and negative check database. This revenue is recognized when the transaction is processed, since we have no further performance obligations. Check Guarantee With this service, if we approve a check transaction and a check is subsequently dishonored by the check writer's bank, the merchant is reimbursed by us and we acquire rights to collect the delinquent amount from the check writer. The principal risk of providing this service is the risk of ever collecting the amount we guarantee from a delinquent check writer whose check transaction was dishonored by his or her own bank. If we are unable to collect the amount, we lose that amount. On average, we usually collect on 60% of the amounts we guarantee that have become delinquent. Given the risks associated with check guarantee, especially for large volume merchants, we exercise strict risk parameters with the merchants to which this service is offered. We typically apply several risk management approaches with this service, which include searching NCN's database against the data provided by the merchant, and "scoring" each transaction according to several factors such as velocity (the number of times a check writer has been searched in a certain period of time), prior activity (historic negative or positive transactions with the check writer), check writer's presence in other databases (these national databases are selectively searched based upon the size of the check and the prior activity with the check writer), size of the check, and historic bad check activity by geographic and/or merchant specific locations. If our scoring system concludes that the risk is too high, we issue a coded response instructing the merchant to refuse to accept the check. If our scoring system results in a positive result, a coded response advises the merchant that we have guaranteed payment on that item. Electronic Check Conversion ("ECC") Check conversion is the ability to convert a paper check to an electronic item at the point of sale. ECC is a relatively new system of check settlement that is quickly gaining merchant acceptance. Under the program, the merchant slips a customer's check either through a check reader that reads the MICR line on the check or a check imager that records the total image of the face of the check and the merchant enters the amount of the check into the system. The merchant then returns the check to the customer and the electronic image, captured by the reader, allows us to settle the check transaction electronically. Customers like this new system because they get their check back immediately and still have their hard copy of the transaction. Banks like ECC because no paper has to be handled by the bank to settle the transaction. While large national merchants already have check-reading equipment, small merchants will adopt the system only if their check volume justifies the capital investment in equipment, ranging from $150 to $600 per reader. Check Re-Presentment The Federal Reserve System's Automated Clearing House ("ACH") provides the tools to electronically present, re-present and settle funds between banks. Our check re-presentment program allows a merchant to advise its bank that a returned check should be sent to the XPRESSCHEX data processing center in Albuquerque, New Mexico, rather than returned to the merchant. Upon receipt, XPRESSCHEX converts the check to an electronic ACH transaction for resubmission through the ACH network and marks the check for possible collection activity, should it become necessary. One feature a merchant may choose is to time the re-presentment so as to coincide with a check writer's typical payday to better the odds of collection. The full face value of the check is returned to the merchant upon collection and a collection fee charged to the check writer, usually in the range of $15 to $25, is retained by XPRESSCHEX as payment for its services. Internet Check, Batch Check and Virtual Terminal A check can be presented as a form of payment over the Internet and we support the multiple types of ACH entry classes. XPRESSCHEX allows an e-commerce site to accept a check as payment, allows a batch of check data to be sent electronically for processing (this is commonly used by mail order or phone order businesses) and allows both verification-only and ACH transactions to be submitted by merchants via a secure logon and passcode connection over the Internet. 7 Visa POS Check Service Program ("Visa Program") - ----------------------------------------------------- The Visa Program represents a major new initiative by Visa to enable merchants to receive direct online authorization for checks written against consumer checking accounts, similar to the authorizations provided for credit and debit card transactions. The Visa Program was offered as a pilot program by Visa to its member banks from December of 2000 to December of 2002 over which time several banks electronically connected their check writer data to the Visa network, making verification of the check writer's bank account balance possible when checks drawn on these select banks were processed. In December of 2002, the program was officially released out of pilot and, as of December 2003, approximately 10% of checking accounts in the USA are electronically connected to the Visa network through the banks that are now participating in the Visa Program. This number is expected to increase to 20% or higher over the coming year as more banks connect their check writer data with Visa. ECHO has invested significant resources and management focus in its check services business, particularly with respect to the Visa Program, and anticipates continued growth in check services as the marketing efforts of participating banks in the Visa Program become more widely implemented. As described above, "check conversion" is the ability to convert a paper check to an electronic item at the point of sale. The Visa Program provides Visa member banks with a check conversion service that they can sell to their bank merchants. The Visa check conversion service allows the merchant to get an immediate authorization or decline on a check while the check writer is at the checkout counter. If the check is approved, the service allows the merchant to immediately return the paper check to the check writer since the funds will be electronically withdrawn from the check writer's account and deposited into the merchant's account. Being able to approve or decline a check in real time at the point of sale requires some method to verify the check writer has either an adequate balance in the bank to cover the check or, if that is not possible, to verify if the check written has a match in a negative check account database. In order to provide this check service on 100% of the checks received by a merchant, Visa needed a solution to approve or decline (and for those approved, electronically deposit) the checks that processed through the program on a bank that had not yet connected its check writer data to the Visa network. We are currently one of two companies that provide this service to Visa as a Third Party Processor. When a Visa member bank signs up to offer the Visa Program to its merchants, it chooses a Third Party Processor from the certified providers and, to date, eight of the thirteen financial institutions actively participating in the program were using ECHO's services as a Third-Party Processor and are beginning to actively sell check services to their merchants, and two additional participating institutions currently in the program intend to actively market this program to their merchants and use ECHO's services as a Third-Party Processor in 2004. When Visa receives electronic check data from a merchant and the bank upon which the check is drawn has not connected its check writer data to the Visa network, Visa routes that check to the Third Party Processor that was chosen by the merchant's bank when they set up the program. The Third Party Processor authorizes or declines a check based upon the negative and positive data contained in several national check account databases that are commercially available and, for those transactions that are approved, the Third Party Processor will electronically move the funds from the check writer's account to either the merchant bank's master clearing account or directly to the merchant's banking account (depending on the bank's desired settlement method) utilizing the Automated Clearing House (ACH), a funds settlement service offered through the Federal Reserve Bank. In addition to being a Third Party Processor, we are one of only five companies that are currently certified as an Acquirer Processor with Visa, a role that accepts transactions from the merchant's point of sale terminal/systems and reformats them for submission to the Visa network. We were chosen by two of the seventeen banks currently in the program to serve as their Acquirer Processor. Most banks presently in the Visa Program are large national or regional banks and already had terminal management service providers that could act as Acquirer Processor for the Visa Program. In the future, as smaller banks make the decision to enter the Visa Program, it is expected that many will have no prior relationship with a terminal management provider and therefore, may potentially choose us as their Acquirer Processor. 8 We derive transaction revenue in our role as a Third Party Processor and /or Acquirer Processor by negotiating a transaction fee with Visa and/or the bank that chose us as its Third Party Processor and/or Acquirer Processor. This transaction fee averages $0.09 per transaction. The party that sells the service to the merchant (usually the bank) enjoys the largest mark-up on the product, offering the service in the range of $0.30 to $0.60 per check, with external cost in the $0.12 to $0.20 range, depending on what the bank negotiates with Visa and any Third Party providers. We entered into a sponsorship agreement with our primary credit card processing bank, First Regional Bank, to enable us to sell the Visa Program directly to merchants with an obligation to pay a small transaction fee per check to the bank. This allows the bank to realize added revenue, allows us to realize higher revenues in a marked-up pricing model, and a portion of the mark-up to be used to compensate and motivate resellers of our products and services to offer the Visa Program to merchants in the marketplace. The balance of the mark-up after paying the bank and the sales organization would be additional revenue to us. This will also enable us to use our direct sales channels to provide the Visa Program to ECHO's current and potential merchant base. The Visa infrastructure requires ECHO to coordinate and integrate its services with several parties and systems. As part of the Visa Program, we have written, tested and installed special merchant terminal software that meets specified Visa Program requirements and certified our terminal and host response code with Vital Processing Services, a major provider of terminal services to many major banks. ECHO has also developed special add-on services and reporting for specific banks or select merchants that desired to participate in the Visa Program. Additionally, ECHO has designed and is implementing several risk management tools that contribute to the significant reduction in net bad debt seen by a retailer, making the Visa Program a true competitive alternative to guarantee services. As of September 30, 2003, we have spent approximately $2,500,000 to integrate our check services with the requirements of the Visa infrastructure and to increase our technology infrastructure, and to design and implement our risk management tools in connection with the program. Deriving Revenues - ------------------ For the past three years, we have invested significant resources and management focus in our check services business which provides various services to merchants and banks to allow them to accept and process check payments from consumers. This business segment comprised approximately 20% of our total revenues for the fiscal year ended September 30, 2003. As an individual segment, check-related revenue increased by 40.4% to $8,192,000 from $5,835,000 for fiscal 2002. ECHO's revenue in check services can come from several sources. Typically, the merchant pays either a fixed fee for each transaction (verification, conversion, etc.) or a fee based on the face amount of the check (check guarantee) or both (check guarantee). In the Visa model, ECHO can receive transaction fees for providing "third-party" services to Visa banks, whereby ECHO assists them in processing checks from banks not participating in the Visa Program. In addition, ECHO may serve a Visa bank by being a collector of the transaction data for the merchant and submitting it to VisaNet, a process referred to as an "Acquiring Processor". Finally, ECHO can also participate in the mark-up that is charged on the sales price to a merchant, although this is only earned by ECHO if its primary sales channels secured the relationship. Additional revenue is earned if the merchant utilizes ECHO's collection services and it is primarily derived from the collection fee associated with successful collection of an item. If ECHO refers a collection item to an NCN member, a small participation in the collection fee is returned to ECHO through agreement with the NCN member. Finally, when ECHO provides a guarantee service to a merchant or a bank, it earns a percentage of every check processed from the merchant or bank and ECHO's earnings related thereto are directly tied to its success in collection and its risk management capability. The NCN database includes over 20 million negative check account records and 100 million positive records. Over 260 affiliated collection agencies continually contribute to the database to enrich its depth and value. Through its network of NCN members, ECHO can offer regional collection services and distribute collection items to one or more of a select group of NCN's member agencies to maximize a merchant's or bank's ability to collect amounts on a local level. NCN provides an ongoing revenue stream for ECHO as collection agencies, major national merchants, banks, other transaction processors, and thousands of small merchants access the NCN database daily to verify the status of a check writer in real time. Check verification has been recognized as one of the lowest cost and most effective ways for retailers to lower the risks and losses experienced in accepting checks as a form of payment. Our NCN database is one of only four major databases in the nation 9 that can serve this market need on a national scale, and we are currently the fifth largest check verification processor in the United States according to the July 2003 issue of The Nilson Report, a monthly financial subscription-based newsletter. In addition to operating NCN, we provide a common platform where a business can also access other major negative check writer databases that are currently available in the nation. XPRESSCHEX revenues are growing due to the increased use of our check conversion services, which include the capture (through digital imaging, or the retention of specified personal information) of the necessary check data at the point of sale and submission of the transaction electronically to the Federal Reserve System's Automated Clearing House for settlement of funds. XPRESSCHEX also maintains an active collection agency, registered in 48 states, that serves primarily as a referral agent to select NCN members that are collection agencies and are located in various regions of the country. OTHER SERVICES Overview - -------- ECHO has historically generated a small percentage of its revenue from its terminal business whereby ECHO deploys proprietary software and terminal hardware in a comprehensive system for real-time credit card authorization, capture and compilation of compensation data, and in some cases, active management of rental equipment information. However, we are currently not pursuing the sale of our proprietary terminal system but rather focusing on our core bankcard and check services business segments, and with respect to our U-Haul relationship described below, we now receive lower transaction fees from that customer as a result of our revised agreement entered into in fiscal 2001. U-Haul Relationship - -------------------- The biggest buyer of our terminal systems in the past five years has been U-Haul International, which has acquired in excess of 15,000 systems and deployed them to their dealers across the country. ECHO acts as the central clearing agent for these systems and intends to continue to support the U-Haul deployed base of terminals. We have been working with U-Haul International since 1995, when ECHO developed and deployed a comprehensive system for real-time credit card authorization, capture and compilation of compensation data, and active management of rental equipment information. The software, which operates on ECHO's proprietary EB920 terminal, prepares the rental contract between the dealer and the customer and reports the activity electronically to the corporate office, thereby eliminating the need for a U-Haul dealer to manually prepare weekly summary reports of rental activity. The system tracks all financial data and forwards both rental and financial data daily to ECHO's data center, where it distributes the rental data on an hourly basis around the nation to the points of destination. This allows a receiving dealer to accept reservations for rental of the specific equipment prior to the equipment's actual arrival. ECHO's revenues are derived from equipment sales to U-Haul, custom development work, and income resulting from daily transaction processing services provided to dealers and U-Haul Corporate. While we have experienced a declining trend in transaction volume, due in part to U-Haul's development of a web-based processing service, we have been able to cross-sell our credit card and check services into the terminal base of more than 15,000 dealers for use in their non-U-Haul business (rental yard, gas station, etc.). In fiscal 2001, we entered into a revised three-year contract with U-Haul International, which covered processing services, software development, data distribution, equipment purchases/warranty, customer support and consulting, and which resulted in a reduction in transaction fees that we now receive from this customer. STRATEGY Overview - -------- ECHO's strategy is to provide merchants, banks and industry-specific resellers with electronic connectivity to various payment services in the credit card, debit card and check-related markets. Our platform of services is very flexible, enabling merchant customization and scalability to meet the requirements of high transaction volumes, as well as access to the Visa Program. ECHO's services enable merchants to maximize revenues by offering a wide variety of payment options, reducing the costs associated with processing and handling checks, 10 improving collections and managing risk more effectively. Additionally, ECHO is committed to customer service and a recent survey of customer satisfaction rates showed an improvement to 4.43 out of a possible 5.0, from approximately 4.15 in a similar survey taken three years prior. We have targeted several areas as significant opportunities for growth, including focusing on middle market retail accounts for check services and developing a scalable infrastructure to support widespread implementation of the Visa Program. We also seek to increase profitability of our principal merchant services by enhancing our back-end technology and identifying and targeting new low-cost, incremental revenue opportunities, such as active promotion of our payment services to non-profit organizations. Promote Check Services for Middle Market Retail Accounts - --------------------------------------------------------------- While ECHO focuses its credit card services to the middle market of retail and non-face-to-face merchants, our check services business, through various sales channels like direct sales and sales through authorized resellers, has the ability to target the full scope of merchants in the marketplace, from the small merchant that may only require check verification to the national retailers that require check conversion and national collection services. With approximately four million merchants in the U.S. and over 95% currently accepting credit cards as payment, ECHO estimates that approximately 60% of merchants, or about 2.3 million merchants, that accept credit cards also accept checks as a form of payment. Furthermore, of the group that accepts checks as a form of payment, we estimate that only 17% of them have an electronic method to accept checks and the other 83% accept a paper check and process it in the traditional manner by taking the check to the bank. ECHO's estimated market potential for check services is: - - Approximately 1.7 million merchants currently accept credit cards, but do not currently accept checks as a form of payment; - - Approximately 1.9 million merchants currently accept paper checks and may consider an electronic form of payment; - - Approximately 400,000 merchants currently converting paper checks to electronic format at the point of sale may consider changing to a better service and/or lower-cost provider. While we have the ability to approach all sizes of merchants, efforts will be focused on working with our sales channels, like direct sales and sales through authorized resellers, to approach mid-size retail chains that can benefit most from automating check processing and verification or participation in the Visa Program. These mid-size accounts typically offer higher margins than larger accounts and provide a less competitive marketplace. ECHO has recently signed agreements with several middle market retailers and believes that the pipeline for prospective customers is growing. Promote Visa POS Check Service Program - -------------------------------------- The Visa Program represents a major new initiative by Visa to enable merchants to receive direct online authorization for checks written against consumer checking accounts, similar to the authorizations provided for credit and debit card transactions. Given ECHO's role in the early stages of the program and our investment of significant resources and management focus in our check services business as a whole, and specifically with respect to the Visa Program, we anticipate continued growth in check services as the marketing efforts of participating banks in the Visa Program become more widely implemented. Overall, as the market gains acceptance of the Visa Program, our opportunities to market our check collection services, our stand alone verification services (not currently part of the Visa Program) and any other check services that we are able to provide will further solidify our relationships with the various financial institutions that have chosen us as their Acquirer Processor and/or Third-Party Processor under the Visa Program. We intend to utilize these opportunities to expand our check services business. As of September 2003, eight of the thirteen financial institutions actively participating in the program were using ECHO's services as a Third-Party Processor and are beginning to actively sell check services to their merchants, and two additional participating institutions intend to use ECHO's services as a Third-Party Processor in 2004. One of the current participating banks sold the Visa Program to a national specialty-clothing retailer that became active in the Visa Program in June 2003 and now constitutes the largest single user of the Visa Program to date. This national merchant participates in the Visa program by submitting the 11 MICR data in real time and then returning the paper check to the check writer at the point of sale. All deposit and collection activity on approved checks is derived from the use of the numeric check data and, to date, we have been successful in lowering the retailer's return check percentage to, or below, a competitive level with rates normally charged by national check guarantee services. Significant savings to the retailer are therefore derived (1) from the elimination of having to handle and process paper checks and (2) from the net financial benefit seen from the bad check write-off percentage falling below the rates charged by the national guarantee services. Altogether, ECHO has grown in its knowledge and capability of facilitating the integration and implementation of the Visa Program for new banks and developing a standardized, but customizable platform of options based upon its experience with the banks participating in the Visa Program. The number of project implementation staff dedicated to the Visa Program has been increased to assist current and future banks in making the fastest and easiest conversion to the Visa Program. However, implementation of new banks, at least in the near term, will rely on the bank's ability to coordinate the integration of its internal deposit account management system to the Visa Program and this process is outside of ECHO's realm of responsibilities. While ECHO believes that the Visa Program has the potential to generate significant revenues for us in the future, the market potential of this service is still unproven and its success is dependent on the continuing marketing support of Visa and its member banks. Promote Merchant Payment Processing for Regional and Community Banks - -------------------------------------------------------------------- ECHO has identified an under-served, niche market of smaller regional and community banks for credit card and check payment programs. These banks are characterized by having an asset base in the $500 million range or less, and/or equity capital in the $10 to $50 million range. ECHO has developed a service that allows smaller banks to offer credit card and check processing services on a private-label basis using our back-end infrastructure with little or no technical involvement by the bank. Much of the reporting to the merchant utilizes the Internet as a delivery channel, an environment in which we have significant experience and knowledge. We estimate that approximately 80% of merchants are familiar with or connected to the Internet, many from their personal residences. Due to the high costs and the perceived high risk, most small banks are either unable or unwilling to compete with national banks in providing online transaction processing and Internet-based reporting tools to their merchants. We have designed the program to be adopted by a bank at little or no cost while it allows the bank to generate revenues and earnings in competition to those earned by much larger banks that have had to make major investments in the technology. This merchant payment processing service, which is marketed under the MerchantAmerica name, incorporates all of ECHO's web-based features and functionalities and our full set of services and payment options for the retail channel. We believe that our fully integrated payment and reporting system allows smaller banks to enjoy competitive equality with much bigger banks without making significant investments in technology. It enables banks to compete feature by feature with the offering of the major banks with no set-up fee or annual charge to participate. We, in turn, benefit from the increased processing and transaction revenues. Additional benefits of the MerchantAmerica program to regional and community banks include the: - Ability for banks to set processing fees for each merchant; - Assurance that the bank controls the merchant relationship and maintains any financial asset value related to ownership; and - Reduction of fraud risk. In addition to the benefits that the bank receives from the MerchantAmerica program, the bank's merchants also receive numerous benefits, including a retail merchant account for credit cards, debit cards and checks; an online shopping cart and check-out payment system; sales tracking and online transaction history; automatic referral to collection agencies; and dedicated customer service available 24 hours a day, seven days a week. The program was launched in August 2002 and at the end of fiscal 2003 had 15 participating banks. ECHO estimates that there are 10,000 community banks in the U.S. and no one provider of services has over 10% of the market. Based on third-party research, we estimate that approximately 6,000 of these banks do not directly offer bankcard services and the approximately 4,000 that are affiliated with a service may be responsive to the MerchantAmerica value proposition. 12 SALES AND MARKETING ECHO sells its merchant and check services through several marketing channels, including independent sales organizations (i.e, authorized resellers of our products and services), its own internal sales force and direct merchant referrals by existing merchants. We also offer Merchant Services through a direct online sales channel, MerchantAmerica. Approximately 20% of our new accounts have historically been generated through the authorized resellers of our products and services. In fiscal 2002, ECHO restructured its sales force by hiring more sales people for its Check Services National Sales Group, which focuses on selling to major accounts and mid-sized retail chains, and implementing an incentive-based commission structure with the goal of targeting specific accounts and shortening the sales cycle. Due to the growing interest in the Visa Program and being the Third Party Processor of a national clothing retailer, we have redirected much of our marketing and sales resources to aggressively promote the Visa Program. ECHO offers its payment services through several sales channels, including: - MerchantAmerica - Payment services offered directly to merchants and to regional and community banks to offer to their local merchants. MerchantAmerica combines the ECHO credit card services with a full set of check and collection services. - Primary Sales Channels - These channels, which include First Regional Bank sponsored Visa POS Check, direct merchant sales, Check Services National Sales, group sales and MerchantAmerica direct merchant sales, provide the highest margin opportunities. - Secondary Sales Channels - Banks in the Visa POS Check Program, authorized resellers, NCN Collection Agency Members and MerchantAmerica Agent Banks are part of the secondary sales channel. These channels offer lower margins due to the added participation in the overall revenue such channels require. Currently ECHO has 138 authorized resellers registered to sell ECHO's check products. NCN has over 260 member collection agencies that serve over 85,000 merchants and many agencies are acting as sales agents for ECHO's check services. Management believes that we are distinctive in the number of payment methods that we allow, the combination of transaction types that we manage directly, our ability to integrate additional services and our ability to support each merchant through one vertically integrated source. Our marketing strategy is to maximize cross-selling opportunities to our existing base of retail merchants and financial institutions, including those merchants and financial institutions in the Visa Program; sell integrated suites of check, credit and debit card processing services through small banks and industry-specific resellers; enhance and market MerchantAmerica.com; and develop the private label check service program that allows appropriate identification between the customer and the vendor. ECHO intends to: - Market the MerchantAmerica service to regional and community banks, through direct sales to merchants and to Not-For-Profit organizations; - Promote the Visa Program by working with Visa-referred banks to assist them in initiating the service and also, selling the Visa service directly to merchants through the sponsorship of ECHO's primary bank, First Regional Bank. - Educate national merchants, processors, banks and industry-specific resellers on the benefits associated with our NCN services, including check conversion, verification, ACH payments, collection and our positive and negative database capability and enlist their active sales thereof. COMPETITION Bankcard processing and check processing services are highly competitive industries and are characterized by consolidation, rapid technological change, rapid rates of product obsolescence and introductions of competitive products often at lower prices and/or with greater functionality than those currently on the market. Credit card and debit card processors have similar direct costs and therefore their products are becoming somewhat of a commodity product where a natural advantage accrues to the highest volume processors. To offset this fact, we have focused on marketing to niche markets where we can maintain the margins we deem necessary to operate profitably but no assurance can be given that this strategy will be successful in the future. 13 There are a number of competitors in the check services industry, the largest of which are TeleCheck (the leading provider of conversion and guarantee services and a subsidiary of First Data Corporation), SCAN/eFunds (the largest verification provider in the nation), Certegy (a spin-off of Equifax), and Global Payments. While all four have major national accounts, the last two are now actively moving into the smaller merchant and middle market where ECHO has historically positioned itself. ECHO believes that it can effectively compete due to its ownership of the NCN database, its integrated set of check and collection services and the technological advantage of having certified as both a Third-Party Processor and Acquirer Processor in the early stages of the Visa Program. ECHO is not currently a major player in the credit card processing market but we do believe we are among the top 50 in the nation. We believe we hold a significant competitive position in the check services market due largely to our investment to date in the Visa POS Check program and the integration of our check and collection capabilities. Despite this fact, many of our competitors have greater financial and marketing resources than us. As a result, they may be better able to respond more quickly to new or emerging technologies and changes in customer requirements. Competitors also may enjoy per transaction cost advantages due to their high processing volumes that may make it difficult for ECHO to compete. In addition, major players in the check services industry have developed sophisticated risk assessment technology that may provide a competitive advantage in providing check guarantee services. We believe that our success will depend upon our ability to continuously develop new products and services and to enhance our current products and to introduce them promptly into the market. EMPLOYEES As of September 30, 2003, we employed 209 individuals, 173 of whom were full time employees. REPORTABLE SEGMENTS Refer to Note 14 "Reportable Segments" in the accompanying Notes to Consolidated Financial Statements for reportable segment information. ITEM 2. PROPERTIES In October 1994, we purchased a three-story, 13,500 square foot building in Agoura Hills, California for $880,000. We currently have two notes collateralized by this building and the current monthly debt service for these two notes is approximately $19,000. This building housed the majority of our executive staff, day-to-day operational departments and computer facilities at fiscal year end. In October 2003, we leased 21,500 square feet of a 40,000 square foot building in Camarillo, California with an option to purchase the building in two years. Subsequent to fiscal year end, our principal executive offices and most operational departments were moved to this Camarillo location, however, in light of anticipated increases in holiday volume and our desire to ensure that no disruption in service occurs for our merchants, the Customer Support and Data Center Operation departments remained at the Agoura Hills location and will remain there until January 2004 when a final move of those departments will be coordinated. The current lease payment for this facility is $23,700 per month. We have put our Agoura Hills building on the market and, in November 2003, signed a letter of intent to sell the building. We anticipate completing the sale of this property in the third quarter of fiscal 2004. We additionally lease real property in Agoura Hills and Westlake Village, California; Albuquerque, New Mexico; Boulder, Colorado; and Lawrence, Kansas for sales, data center and other operations, under various agreements, which expire at various times over the next year. The total lease payments are approximately $18,000 per month. We own several pieces of raw land for investment purposes. 14 ITEM 3. LEGAL PROCEEDINGS We are involved in various lawsuits arising in the ordinary course of business. Based upon current information, management, after consultation with legal counsel, believes the ultimate disposition of these lawsuits will have no material effect upon either our results of operations or financial position. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of ECHO's shareholders in the quarter ended September 30, 2003. 15 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER SECURITY MATTERS Since January 17, 1986, we have been trading on the over-the-counter market under the name Electronic Clearing House, Inc. On October 2, 1989, we were accepted for listing on the National Association of Securities Dealers Automated Quotation System ("NASDAQ") and trade under the symbol of "ECHO" on the Nasdaq SmallCap Market. The following table sets forth the range of high and low prices for our common stock during the fiscal periods indicated. The prices set forth below represent quotations between dealers and do not include retail markups, markdowns or commissions and may not represent actual transactions. Moreover, due to the lack of an established trading market for our common stock, such quotations may bear no relationship to the fair market value of our common stock and may not indicate prices at which our common stock would trade in an established public trading market.
FISCAL YEAR ENDED SEPTEMBER 30 High Low ------------------------------ ----- ----- 2003 ---- First Quarter $2.85 $1.09 Second Quarter $2.75 $1.72 Third Quarter $4.40 $2.47 Fourth Quarter $9.59 $3.20 2002 ---- First Quarter $2.92 $1.88 Second Quarter $2.44 $2.00 Third Quarter $2.10 $1.16 Fourth Quarter $1.58 $1.08
The prices set forth above are not necessarily indicative of liquidity of the trading market. Trading in our common stock is limited and sporadic, as indicated by the average monthly trading volume of 454,316 shares for the period from October 2002 to September 2003. On December 22, 2003, the closing representative price per share of our common stock, as reported on the Nasdaq SmallCap Market, was $9.75. HOLDERS OF COMMON STOCK As of November 20, 2003, there were approximately 845 record holders and 3,741 beneficial holders of our common stock, with 6,319,863 shares outstanding. The number of holders of record is based on the actual number of holders registered on the books of our transfer agent and does not reflect holders of shares in "street name" or persons, partnerships, associations, corporations or other entities identified in security position listings maintained by depository trust companies. DIVIDEND POLICY We have not paid any dividends in the past and have no current plan to pay any dividends. We intend to devote all funds to the operation of our businesses. EQUITY COMPENSATION PLAN INFORMATION The Equity Compensation Plan Information identified in Item 11 of this Annual Report on Form 10-K is incorporated herein by this reference. 16 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA The following table sets forth certain selected consolidated financial data, which should be read in conjunction with the Consolidated Financial Statements and Management's Discussion and Analysis of Financial Condition and Results of Operations included at items 7 and 8 below. The following data, insofar as it relates to each of the five years ended September 30, has been derived from our annual financial statements, including the consolidated balance sheets at September 30, 2003 and 2002, and the related consolidated statements of operations and of cash flows for the three years ended September 30, 2003, 2002 and 2001, and notes thereto appearing elsewhere herein.
Year Ended September 30 ---------------------------- 2003 2002 2001 2000 1999 -------- -------- -------- -------- ------- ( ----- AMOUNTS IN THOUSANDS, EXCEPT PER SHARE ----- ) STATEMENT OF OPERATIONS DATA: - ----------------------------- Revenues . . . . . . . . . . . . . . $40,636 $33,291 $29,943 $28,340 $23,828 Costs and expenses . . . . . . . . . 38,211 36,960 29,380 28,324 22,636 -------- -------- -------- -------- ------- Income (loss) from operations . . . 2,425 (3,669) 563 16 1,192 Interest income (expense), net . . . (172) (74) 106 196 95 Other income (expense), net . . . . -0- -0- 350 312 -0- -------- -------- -------- -------- ------- Income (loss) before income tax (provision) benefit and cumulative effect of an accounting change . . 2,253 (3,743) 1,019 524 1,287 (Provision) benefit for income taxes (925) 1,367 (585) (233) 1,331 -------- -------- -------- -------- ------- Income (loss) before cumulative effect of an accounting change . . 1,328 (2,376) 434 291 2,618 Cumulative effect of an accounting change to adopt SFAS 142 . . . . . (4,707) -0- -0- -0- -0- -------- -------- -------- -------- ------- Net (loss) income . . . . . . . . . $(3,379) $(2,376) $ 434 $ 291 $ 2,618 ======== ======== ======== ======== ======= (Loss) earnings per share-basic . . $ (0.58) $ (0.41) $ 0.07 $ 0.06 $ 0.58 (Loss) earnings per share-diluted . $ (0.56) $ (0.41) $ 0.07 $ 0.05 $ 0.45 Weighted average number of common shares and equivalents outstanding-basic 5,812 5,788 5,797 5,257 4,536 Weighted average number of common shares and equivalents outstanding-diluted 6,024 5,788 5,964 5,825 5,825 BALANCE SHEET DATA: - ------------------ Working capital . . . . . . . . . . $ 3,201 $ 3,234 $ 5,821 $ 6,029 $ 5,010 Current assets . . . . . . . . . . . 9,646 5,728 8,259 7,595 6,159 Total assets . . . . . . . . . . . . 18,775 18,191 18,921 17,013 12,932 Current liabilities . . . . . . . . 6,445 2,494 2,438 1,566 1,149 Long-term debt, and payable to stockholders and related parties, less current portion . . . . . . . 1,961 2,159 744 767 599 Total stockholders' equity . . . . . $10,369 $13,538 $15,739 $14,680 $11,184
17 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Electronic Clearing House, Inc. is an electronic payment processor that provides for the payment processing needs of merchants, banks and collection agencies. We derive the majority of our revenues from two main business segments, bankcard and transaction processing services ("bank card services"), whereby we provide solutions to merchants and banks to allow them to accept credit and debit card payments from consumers, and check-related products ("check services"), whereby we provide various services to merchants and banks to allow them to accept and process check payments from consumers. The principal services we offer within these two segments include, with respect to our bank card services, debit and credit card processing, and with respect to our check services, check guarantee, check verification, electronic check conversion, check re-presentment, and check collection. We organize our service offerings under the following brand names: - MerchantAmerica; ECHO's retail provider of payment processing services to both merchant and bank markets; - National Check Network ("NCN") for wholesale check verification, check authorization and capture services, and for referral to member collection agencies; - XPRESSCHEX, Inc. for retail check verification, check conversion, ACH services, check collection and check guarantee services. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Management's discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, management evaluates its estimates, including those related to revenue recognition, deferred taxes, reserve for doubtful accounts, goodwill amortization, capitalization of software costs, contingencies and litigation. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates. Management applies the following critical accounting policies in the preparation of our consolidated financial statements: - - REVENUE RECOGNITION POLICY. We earn revenue from services which include the following: debit and credit card processing, check guarantee, check verification, check conversion, check re-presentment, check collection and inventory tracking. All of these services are performed pursuant to a contract with customers, which states the terms and fixed price for all contracted services. The price of a service may be a fixed fee for each transaction (verification, conversion and check guarantee) and / or a percentage of the transaction processed (check guarantee), depending on the service. We generally collect our fee at the time we process the transaction and accordingly, collectibility is assured. Based on our underwriting criteria and ongoing credit monitoring of customers, collectibility on service transactions is reasonably assured. Revenue from debit and credit card (collectively called bankcards) and transaction processing revenue is based on a percentage of the transaction value, commonly referred to as a discount fee on a credit and debit card transaction processed by us. In addition, there is a per transaction fee associated with each bankcard transaction which is charged to the merchant. We recognize the processing and transaction revenue when the services are performed. Revenue from check guarantee is derived from a percentage of the gross amount of the check and guarantees payment of the check to the merchant in the event the check is not honored by the check writer's bank. Merchants typically present customer checks for processing on a regular basis and, therefore, dishonored 18 checks are generally identified within a few days of the date the checks are guaranteed by us. We recognize revenue when the checks are processed at the point of sale. At the time the guarantee revenue is recognized, we provide a reserve for estimated guarantee losses based upon our historical loss experience. In the event the check is dishonored, we have the right to collect the full amount of the check from the check writer but have historically recovered approximately 60% of the guaranteed checks. We establish a receivable from the delinquent check writer for the full amount of the guaranteed check. The check guarantee service also earns revenue based on fees collected from delinquent check writers, which collection fee is recognized when collected, as collectibility is not reasonably assured until that point. Revenue from check verification is derived from fees collected from the merchants when a check is verified against our positive and negative check database. This revenue is recognized when the transaction is processed, since we have no further performance obligations. Revenue from check conversion is derived from fees collected from merchants to convert the paper check received by merchants into an ACH transaction, which allows us to settle the transaction electronically for the merchant. We recognize the revenue related to check conversion fees when the services are performed. Revenue from check re-presentment is derived from fees charged to check writers. Check re-presentment is a service that allows merchants to collect a paper check through the Automated Clearing House ("ACH") network after a check has previously been presented to the bank for collection unsuccessfully at least once. The fees earned from the check writer are recognized when collected, as collectibility is not reasonably assured until that point. Revenue from check collection is derived from collection activities performed on behalf of a merchant on uncollected checks. The merchants usually keep the face amount of the uncollected checks if the collection effort is successful. Our revenue is derived from the collection fee collected from the check writer. If we refer the collection item to another collection agency, we will receive a fee from the collection agency upon its successful efforts. Collection fee revenue is recognized when collected, as collectibility is not reasonably assured until that point. Revenue from inventory tracking is derived from transaction fees for processing and tracking U-Haul's daily inventory activities. This revenue is recognized when the transaction is processed, since we have no further performance obligations. - - DEFERRED TAXES. Deferred taxes are determined based on the differences between the financial statement and tax basis of assets and liabilities, using enacted tax rates in effect for the year in which the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized. In assessing the need for a valuation allowance, management considers estimates of future taxable income and ongoing prudent and feasible tax planning strategies. - - CHARGEBACK LOSSES. Chargeback losses occur when a credit card holder presents a valid claim against one of our merchants and the merchant has insufficient funds or is no longer in business resulting in the charge being absorbed by us. We record a receivable for those chargebacks for which the merchant is liable but has not made payment. We record a provision for estimated chargeback losses at the time bankcard transactions are processed. A reserve is estimated based upon a historically-determined percentage of gross credit card processing volume and actual losses experienced. - - RESEARCH AND DEVELOPMENT EXPENSE. Expenditures for research activities relating to product development and improvement are charged to expense as incurred. Such expenditures amounted to $1,405,000 in fiscal year 2003 and $1,719,000 in fiscal year 2002. - - CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE. Effective October 1, 2002, we adopted Statement of Financial Accounting Standards No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets". SFAS 142 requires that goodwill no longer be amortized, but instead be tested for impairment at least annually using a fair value-based approach. In the year of adoption, SFAS No. 142 also requires us to perform an initial assessment of its reporting units to determine whether there is any indication that the goodwill carrying value may be impaired. This transitional assessment is made by comparing the fair value of each reporting unit, as determined in accordance with the new standard, to its book value. To the extent the fair value of any reporting unit is less than its book value, which would indicate that potential impairment of goodwill exists, a second transitional test is required to determine the amount of impairment. In 2003, we 19 determined that our goodwill was impaired under SFAS No. 142 and accordingly took a charge to write down the amount of that impairment. - - CAPITALIZATION OF SOFTWARE COSTS. The costs of purchased and internally developed software used to provide services to customers or for the process of internal administration are capitalized and amortized on a straight-line basis over the lesser of three years or estimated useful life. Under the provisions of Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use," we capitalize software costs when both the preliminary project stage is completed and management has authorized further funding for the completion of the project. Capitalization of costs ceases when the project is substantially complete and the software is ready for its intended use. Software developed or obtained for internal use is tested for impairment whenever events or changes in circumstance indicates that its carrying amount may not be recoverable. RESULTS OF OPERATIONS FISCAL YEARS 2003 AND 2002 - ------------------------------ Financial highlights for fiscal 2003 as compared to fiscal 2002 were as follows: - -- Total revenue increased 22.1% to $40.6 million - -- Gross margin from processing and transaction revenue improved to 34.6% from 30.8% - -- Operating income increased to $2.4 million from a loss of $3.7 million (which included $2.9 million of litigation related expenses). - -- Diluted earnings per share before cumulative effect of accounting change were $0.22 as compared to diluted loss per share before cumulative effect of accounting change of $0.41. - -- Bankcard and transaction processing revenue increased by 18.2% to $32.4 million - -- Bankcard processing volume increased 26.4% to $961 million - -- Check-related revenue increased by 40.4% to $8.2 million - -- ACH processing volume increased 403.8% to 11.3 million transactions REVENUE. Total revenue increased 22.1% to $40,636,000 for fiscal 2003, from $33,291,000 for fiscal 2002. The increase can be primarily attributable to the growth in the processing and transaction business. Total processing and transaction revenue for fiscal 2003 increased 22.6%, from $32,889,000 in fiscal 2002 to $40,313,000 in fiscal 2003. The increase was attributable to an 18.2% increase in bankcard and transaction processing revenue and a 40.2% increase in check-related revenue. The bankcard and transaction processing revenue increase was mainly attributable to an approximate 26.4% increase in bankcard processing volume as compared to last fiscal year. This increase was also affected by a rate adjustment to the bankcard merchant base during fiscal 2003 and the fact that we continue to grow our bankcard processing business organically through our various sales and marketing programs. The check-related processing revenue increase was attributable to a 9.8% increase in check verification revenue and a 246.0% increase in electronic check conversion and electronic check presentment revenue. The high growth in the check conversion revenue was due to the increasing market acceptance of this product. Additionally, it was attributable to the transactions generated by the Visa Program. Terminal sales decreased by 50.8%, from $252,000 in fiscal 2002 to $124,000 in fiscal 2003. During fiscal 2003, U-Haul stopped sending its terminals to us for repair. We have gradually shut down our terminal deployment operations during fiscal 2003. 20 COST OF SALES. Bankcard processing expenses are directly related to the changes in processing revenue. A majority of our bankcard processing expenses are fixed costs and reflected as a percentage of the total face amount of each bankcard transaction, and the remaining costs are based on a fixed rate applied to the number of transactions processed. Processing-related expenses, consisting of bankcard processing expense and transaction and check processing expense, increased 15.9% for the year, from $22,747,000 in fiscal 2002 to $26,360,000 in fiscal 2003. The increase reflects a 22.6% increase in processing and transaction revenues for the year. Gross margin from processing and transaction services improved from 30.8% in fiscal 2002 to 34.6% in fiscal 2003. This improvement in gross margin was mainly due to: 1) check-related revenue which has a higher gross margin made up 20.2% of the total revenue in fiscal 2003 as compared to 17.5% of the total revenue in fiscal 2002; 2) a rate adjustment was applied to a broad base of bankcard merchants during fiscal 2003 to offset increases in direct bankcard processing expenses; 3) loss on chargeback decreased substantially, from $261,000 in fiscal 2002 to $44,000 in fiscal 2003. EXPENSE. Other operating costs such as personnel costs, telephone and depreciation expenses increased 11.5%, from $3,012,000 in fiscal 2002 to $3,358,000 in fiscal 2003 primarily due to the 22.1% increase in revenue. Research and development expenses decreased 18.3% from $1,719,000 in fiscal 2002 to $1,405,000 in fiscal 2003, as most of our development projects have entered into coding and testing phases. We need to continue to invest in research and development in both the bankcard processing business segment and the check-related products segment in order to remain competitive in this financial services market, given that the technology in this industry changes rapidly. Selling, general and administrative expenses increased 9.2% from $6,493,000 in fiscal 2002 to $7,088,000 in fiscal 2003. This increase was mainly due to the addition of management personnel to support our continuous growth, the increase in employee benefits costs such as medical insurance, workers compensation insurance and the increase in cost of living adjustments. As a percentage of total revenue, selling, general and administrative expenses decreased from 19.5% in the fiscal 2002 to 17.4% in fiscal 2003. Amortization of goodwill expense was eliminated in fiscal 2003 due to the implementation of SFAS No. 142. INTEREST EXPENSE. Interest expense increased to $200,000 for fiscal 2003, from $129,000 last year. The increase is due to the $1.3 million long-term note from a legal settlement in fiscal 2002 and increase in capitalized leases from equipment purchases. Interest income decreased from $55,000 in fiscal 2002 to $28,000 in fiscal 2003 due to a decline in interest rates and lower average cash balances. EFFECTIVE TAX RATE. The income tax provision was $925,000 for fiscal 2003 as compared to an income taxes benefit of $1,367,000 for fiscal 2002. Our effective tax benefit rate was 36.5% for fiscal 2002 and a tax provision rate was 37.7% for fiscal 2003. See Notes to Consolidated Financial Statements included elsewhere herein for further explanation of the income tax expense and a reconciliation of reported income taxes to the amount utilizing the statutory rate. NET LOSS. Net loss for fiscal 2003 was $3,379,000, as compared to a net loss of $2,376,000 for fiscal 2002. The higher net loss in fiscal 2003 was primarily due to the $4.7 million goodwill write-off on our adoption of SFAS 142 in October 2002. Income from operations improved substantially this fiscal year, from a $3,669,000 operating loss in fiscal 2002 to $2,425,000 in operating income for fiscal 2003. The improvement in income from operations between fiscal 2002 and fiscal 2003 comprise the following: 1) a 22.1% increase in revenue; 2) a 3.8% improvement in gross margin; 3) the elimination of $489,000 in goodwill amortization expense; and 4) a one-time $2.5 million legal settlement cost was incurred in fiscal 2002. SEGMENT RESULTS Bankcard and Transaction Processing. For the year ended September 30, 2003, MerchantAmerica, our primary generator of bankcard process and transaction revenue, accounted for approximately 80% of our revenues, compared to 82% in fiscal 2002. Bankcard processing and transaction revenue increased 18.2%, from $27,456,000 in fiscal 2002 to $32,444,000 in fiscal 2003. This increase was mainly attributable to an approximate 26.4% increase in bankcard processing volume as compared to last fiscal year. This increase was also affected by a rate adjustment to our bankcard merchant base during fiscal 2003 and the fact that we continue to grow our bankcard processing business organically through our various sales and marketing programs. 21 In fiscal 2003, the bankcard and transaction processing segment generated operating income of $4,303,000, or 13.3% of the related revenues, as compared to $1,996,000, or 7.3% of the related revenues in fiscal 2002. This increase in operating income was reflective of the increase in revenue and the higher gross margin as a result of the rate adjustment to merchants and the lower chargeback losses. We purchased a fully integrated, multi-modular bankcard processing system from Oasis Technology in 2001 for approximately $1.3 million. This Oasis system is expected to reduce a key component of our cost structure by eliminating a third-party processor, a savings of approximately ten basis points for every credit card dollar processed. The implementation of this system will give us greater flexibility to price our credit card processing services, allowing us to attract and retain larger merchants as well as the small and mid-market merchants that have been our target market. This project was expected to be completed by the last quarter of 2003, however, due to vendor software delivery delays, management now anticipates that portions of the Oasis system will begin productive use in early 2004 and be fully implemented in late 2004. Check Related Products. Check-related revenues increased from $5,835,000 for fiscal 2002 to $8,192,000 for fiscal 2003, an increase of 40.4%. Check verification revenue increased 9.8% to $3,097,000 for fiscal 2003, from $2,821,000 for fiscal 2002. Check conversion and check re-presentment revenue increased 246.0% to $2,892,000 for fiscal 2003, from $836,000 for fiscal 2002. Additionally, check collection revenue increased 5.1%, from $1,453,000 in fiscal 2002 to $1,526,000 in fiscal 2003. The high growth in the check conversion revenue was due to the increasing market acceptance of this product and attributable to the transaction revenue generated by the Visa Program. Check services revenue made up 20.2% of the total processing and transaction revenues for fiscal 2003 as compared to 17.5% in the prior year. Check-related operating income was $591,000 for fiscal 2003, as compared to operating loss of $872,000 in fiscal 2002. The increase in operating income was mainly due to the 40.4% increase in check-related revenues. The Visa Program is continuing to expand and is starting to gain market acceptance. We are currently working with ten Visa member banks that have signed up to participate in this Visa Program. One of the Visa acquiring banks, using us as the Third-Party Processor, rolled out this Program to a national retailer in June 2003. This one merchant has tripled the number of ACH transactions generated by us from May 2003 to June 2003. As a result of this merchant deployment and the anticipated growth, we had to increase the level of customer support staff and also increased our overall network infrastructure to support such growth. At the present time, the Visa Program is beginning to generate a significant portion of our total check-related revenue. Management believes that the Visa Program will provide us with numerous opportunities to develop strategic relationships with the banks who have chosen us to be their third-party processor and acquirer processor under the Visa Program. These relationships could play a major role in increasing our check services revenue in the coming years. FISCAL YEARS 2002 AND 2001 - ------------------------------ Financial highlights for fiscal 2002 as compared to fiscal 2001 were as follows: - -- Total revenue increased 11.2% to $33.3 million - -- Gross margin from processing and transaction revenue declined to 30.8% from 33.9% - -- Operating income moved into negative territory to $(3.7) million from $563,000 - -- Diluted loss per share of $(0.41) as compared to diluted earnings per share of $0.07 - -- Fiscal 2002 results reflect one-time legal settlement of $2.5 million - -- Bankcard and transaction processing revenue rose 7.7% to $27.5 million - -- Check-related revenue increased by 31.4% to $5.8 million 22 REVENUE. Total revenue increased 11.2% to $33,291,000 for fiscal 2002, from $29,943,000 for fiscal 2001. The increase was primarily attributed to growth in the processing and transaction business. Total processing and transaction revenue for fiscal 2002 increased 13.0%, from $29,096,000 in fiscal 2001 to $32,889,000 in fiscal 2002. This increase was mainly attributable to a 13.2% increase in bankcard processing volume and 8.4% increase in bankcard processing and transaction revenue as compared to the prior year. This was due to our merchants' organic growth and the success in our marketing strategy. In addition, check-related revenue increased 34.2% as our ACH services and check presentment services started to gain market acceptance. COST OF SALES. Bankcard processing expenses are largely a reflection of changes in processing revenue. A majority of our bankcard processing expenses are fixed as a percentage of each transaction amount, with the remaining costs being based on a fixed rate applied to the transactions processed. Processing-related expenses, consisting of bankcard processing expense and transaction and check processing expense, increased 18.2% during fiscal 2002, from $19,239,000 in fiscal 2001 to $22,747,000 in fiscal 2002. The increase reflected a 13.0% increase in processing and transaction revenues for the year, as well as the higher costs of processing. Gross margin from processing and transaction services decreased from 33.9% in fiscal 2001 to 30.8% in fiscal 2002. This decrease in gross margin was due to a combination of factors, including most significantly, higher personnel and infrastructure costs, as well as, increased costs paid to a third-party service provider, the departure of several higher volume/high margin credit card merchants, and a lower rate charged to U-Haul as a result of a contract negotiation. While bankcard and transaction processing revenue increased by 7.7% in fiscal 2002, as compared to fiscal 2001, cost of sales such as personnel costs increased from $840,000 in fiscal 2001 to $1,251,000 in fiscal 2002, a 49% increase. Additionally, depreciation and amortization expense related to computer software and hardware increased from $598,000 in fiscal 2001 to $844,000 in fiscal 2002, a 41% increase. Over the past couple of years, we have capitalized $3,914,000 of software development costs and computer equipment, which are being amortized over its useful lives. This was primarily attributable to the increase in depreciation and amortization expense. Cost of terminals sold was $588,000 during fiscal 2002, as compared to $419,000 in fiscal 2001. The cost of terminals continued to exceed the terminal sales as a result of a $300,000 inventory allowance provision for fiscal 2002. This allowance was related to the write-down of certain obsolete customized printers and other slow-moving inventory. EXPENSE. Other operating costs such as personnel costs, telephone and depreciation expenses decreased 1.8%, from $2,468,000 in fiscal 2001 to $2,424,000 in fiscal 2002 due to stringent cost controls instituted by us. Research and development expenses increased 60.7% from $1,070,000 in fiscal 2001 to $1,719,000 in fiscal 2002 because we continued to invest in research and development related to our various check service products. Additionally, we incurred operational expenses related to the management of the Visa Program without any offsetting revenue during this period. Selling, general and administrative expenses increased 12.7% from $5,760,000 in fiscal 2001 to $6,493,000 in fiscal 2002. This increase was mainly due to the hiring of additional sales personnel in support of both merchant and check services and additional administrative staff to support our growth. In fiscal 2002, we hired a new COO/CIO. As a percentage of total revenue, selling, general and administrative expenses increased slightly from 19.2% in fiscal 2001 to 19.5% in fiscal 2002. Amortization of goodwill expense remained relatively constant, from $424,000 in fiscal 2001 to $489,000 in fiscal 2002. INTEREST EXPENSE. Interest expense increased to $129,000 for fiscal 2002, from $81,000 in fiscal 2001. The increase was due to the $1.3 million long-term note portion of the legal settlement expense related to a lawsuit settled in fiscal 2002, which carries an 8% interest rate. Interest income declined from $187,000 in fiscal 2001 to $55,000 in fiscal 2002 due to a decline in interest rates and lower average cash balances. EFFECTIVE TAX RATE. Benefit for income taxes of $1,367,000 in fiscal 2002 was due to the operating loss incurred of $3,743,000. Our effective tax benefit rate was 36.5% for fiscal 2002 and a tax provision rate of 57.4% for fiscal 2001. See Notes to Consolidated Financial Statements included elsewhere herein for further explanation of the income tax expense and a reconciliation of reported income taxes to the amount utilizing the statutory rate. 23 NET INCOME (LOSS). Net loss for fiscal 2002 was $2,376,000, as compared to net income of $434,000 in fiscal 2001. The decline was primarily due to the $2.5 million legal settlement on a pre-tax basis. We made a one-time cash payment of $1,200,000 to the plaintiff in the lawsuit and executed a long-term promissory note collateralized by our Agoura Hills, California office building in favor of that plaintiff for an additional $1,300,000, payable over 15 years, with an interest rate of 8%. Additionally, we incurred approximately $400,000 in legal fees defending the lawsuit in fiscal 2002. Not including the $2.5 million legal settlement and the legal fees paid, net loss would have been $535,000 in fiscal 2002. In addition, operating income fell in fiscal 2002 primarily due to a $649,000 increase in research and development expense, a $300,000 increase in provision for inventory allowance and a $445,000 decrease in other revenue. SEGMENT RESULTS Bankcard and Transaction Processing. Bankcard processing and transaction revenue increased 7.7%, from $25,503,000 in fiscal 2001 to $27,456,000 for fiscal 2002. This increase was mainly attributable to an approximately 13.2% increase in bankcard processing volume as compared to 2001 and was the result of our successful marketing programs, including the MerchantAmerica web offerings and other sales programs. The increase in bankcard processing revenue was partially offset by a decrease in revenue as a result of a rate reduction offered to U-Haul, a major transaction processing customer, and the loss of several high volume, high margin merchants. In fiscal 2002, the bankcard and transaction processing segment generated operating income of $1,996,000, or 7.3% of associated revenues, as compared to $3,183,000, or 12.5% of revenues, in fiscal 2001. The 59.5% decrease in operating income is attributable to a $303,000 increase in research and development expense, a $300,000 increase in inventory allowance and a $168,000 decrease in other revenue. Additionally, gross margin decreased due to the departure of several high margin merchants combined with higher overall operating costs. We implemented a rate increase in October 2002 to our credit card processing merchants, which was expected to offset the higher operating costs and to improve the gross margin from credit card processing activities in fiscal 2003. Check Related Products. Check-related revenues increased from $4,440,000 for fiscal 2001 to $5,835,000, an increase of 31.4%. This was attributable to a 16.6% increase in check verification revenue and a 205.9% increase in electronic check conversion and electronic check presentment revenue. Check services revenue made up 17.5% of the total processing and transaction revenues for fiscal 2002 as compared to 14.8% in the prior year. Check-related operating loss was $872,000 in fiscal 2002, as compared to operating loss of $234,000 in fiscal 2001. The increase was due to the costs associated with the development of the Visa Program and our other products, as well as an increase in staffing to support current and anticipated processing volume. LIQUIDITY AND CAPITAL RESOURCES As of September 30, 2003, we had available cash and cash equivalents of $5,641,000, restricted cash of $977,000 in reserve with our primary processing banks and working capital of $3,201,000. Accounts receivable, net of allowance for doubtful accounts, increased to $1,918,000 at September 30, 2003 from $1,596,000 at the end of fiscal 2002. This increase in accounts receivable was attributable to the higher billings generated at the end of the fiscal year due to increases in processing volume and the number of customers in general, which drove our revenue growth. Allowance for doubtful accounts, which reflects chargeback losses and dues to Visa and MasterCard decreased to $91,000 at the end of fiscal 2003 from $431,000 at September 30, 2002. This decrease was due to the write-off of accounts receivable, which were deemed to be uncollectible. Net cash provided by operating activities for the year ended September 30, 2003 was $6,682,000 as compared to net cash provided by operating activities of $62,000 for fiscal 2002. The increase in cash from operations was primarily attributable to the $6,094,000 increase in operating income between fiscal 2003 and 2002, and an increase in net settlement payable of $2,131,000 as of September 30, 2003. Settlement payable as of September 30, 2003 was $3,429,000 as compared to $729,000 at September 30, 2002. 24 Settlement payable results from timing differences in our settlement process with merchants. These timing differences account for the difference between the time that funds are received in our bank accounts and the time that settlement payments are made to merchants. Therefore, at any given time, settlement payable may vary and ultimately depends on the volume of transactions processed. The increase in settlement payable in fiscal 2003 is primarily attributable to the high volume of transactions experienced from our check services. As our business grows, settlement payable will likely increase. Net cash used in investing activities was $3,271,000 for the fiscal 2003 as compared to $1,835,000 for fiscal year 2002. During fiscal 2003, we used $3,291,000 for purchases of equipment and capitalized software costs as compared to $1,754,000 for fiscal 2002. We anticipate the need to build a more robust infrastructure in order to support the level of transaction growth in the coming years. Additionally, we are in the process of strengthening our business continuation plan and disaster recovery sites, all of which will require substantial capital investments in fiscal 2004. We also need to continue to invest in software development costs in fiscal 2004 to remain competitive. Net cash used by financing activities was $179,000 for the current fiscal year as compared to net cash provided by financing activities of $35,000 for fiscal year 2002. During fiscal 2003, we received $292,000 from the issuance of notes payable to fund certain payments for the Oasis system. We used $629,000 for the repayment of capitalized leases and notes payable. We also received $158,000 from the exercise of employee stock options. In light of our significant capital requirements anticipated in 2004, during October 2003, we completed a $3 million private equity placement with several institutional investors. This equity financing raised approximately $2,800,000 of net proceeds to us. Additionally, as of November 2003, we negotiated a $1,000,000 equipment lease line and a $3,000,000 credit line with Bank of the West for working capital needs. At September, 2003, we had the following cash commitments:
Payment Due By Period --------------------- Contractual Less than After Obligations Total 1 year 2-3 years 4-5 years 5 years - ------------------- ---------- ---------- ---------- ---------- ---------- Long-term debt including interest $2,846,000 $ 563,000 $ 531,000 $ 455,000 $1,297,000 Capital lease Obligations 991,000 524,000 467,000 -0- -0- Operating leases 1,835,000 485,000 744,000 606,000 -0- ---------- ---------- ---------- ---------- ---------- Total contractual cash obligations $5,672,000 $1,572,000 $1,742,000 $1,061,000 $1,297,000 ========== ========== ========== ========== ==========
Our primary source of liquidity is expected to be cash flow generated from operations and cash and cash equivalents currently on hand. Management believes that our cash flow from operations together with cash on hand, our lease line, our established line of credit with Bank of the West, and cash received from our private placement financing will be sufficient to meet our working capital and other commitments. 25 RISK FACTORS We are subject to a number of risks, which could affect operating results and liquidity, including, among others, the following: RISKS RELATED TO OUR BUSINESS - --------------------------------- WE RELY ON COOPERATIVE RELATIONSHIPS WITH, AND SPONSORSHIP BY, BANKS, THE ABSENCE OF WHICH MAY AFFECT OUR OPERATIONS. We currently rely on cooperative relationships with, and sponsorship by, banks in order to process our Visa, MasterCard and other bankcard transactions. We also rely on several banks for access to the Automated Clearing House ("ACH") for submission of both credit card and check settlements. Our banking relationships are currently with smaller banks (with assets of less than $500,000,000). Even though smaller banks tend to be more susceptible to mergers or acquisitions and are therefore less stable, these banks find the programs we offer more attractive and we believe we cannot obtain similar relationships with larger banks at this time. A bank could at any time curtail or place restrictions on our processing volume because of its internal business policies or due to other adverse circumstances. If a volume restriction is placed on us, it could materially adversely affect our business operations by restricting our ability to process credit card transactions and receive the related revenue. Our relationships with our customers and merchants would also be adversely affected by our inability to process these transactions. We currently maintain one primary bankcard processing and sponsorship relationship with First Regional Bank in Agoura Hills, California. Our agreement with First Regional Bank continues through 2005. Additionally, we have reached a tentative agreement with Woodforest Bank in Woodforest, Texas, to sponsor our bankcard activity. Once finalized, we expect this agreement will continue through 2009. We also maintain several banking relationships for ACH processing. While we believe our current bank relationships are sound, we cannot assure that these banks will not restrict our increasing processing volume or that we will always be able to maintain these relationships or establish new banking relationships. Even if new banking relationships are available, they may not be on terms acceptable to us. With respect to First Regional Bank and Woodforest Bank, while we believe their respective ability to terminate our respective relationships is cost-prohibitive, they may independently determine that the cost of terminating their agreements is less than the cost of continuing to perform in accordance with their terms, and may therefore determine to terminate those agreements prior to their expiration. Ultimately, our failure to maintain these banking relationships and sponsorships may have a material adverse effect on our business and results of operations. MERCHANT FRAUD WITH RESPECT TO BANKCARD AND ACH TRANSACTIONS COULD CAUSE US TO INCUR SIGNIFICANT LOSSES. We significantly rely on the processing revenue derived from bankcard and ACH transactions. If any merchants were to submit or process unauthorized or fraudulent bankcard or ACH transactions, depending on the dollar amount, ECHO could incur significant losses which could have a material adverse effect on our business and results of operations. ECHO assumes and compensates the sponsoring bank for bearing the risk of these types of transactions. We have implemented systems and software for the electronic surveillance and monitoring of fraudulent bankcard and ACH use. As of September 30, 2003, we maintained a dedicated chargeback reserve of $603,000 at our primary bank specifically earmarked for such activity. Additionally, through our sponsoring bank, we had access to approximately $9.2 million in merchant deposits to cover any potential chargeback losses. Despite a long history of managing such risk, we cannot guarantee that these systems will prevent fraudulent transactions from being submitted and processed or that the funds set aside to address such activity will be adequate to cover all potential situations that might occur. We do not have insurance to protect us from these losses. There is no assurance that our chargeback reserve will be adequate to offset against any unauthorized or fraudulent processing losses that we may incur. Depending on the size of such losses, our results of operations could be immediately and materially adversely affected. 26 FAILURE TO PARTICIPATE IN THE VISA POS CHECK SERVICE PROGRAM WOULD CAUSE US TO SIGNIFICANTLY SHIFT OUR OPERATING AND MARKETING STRATEGY. We have significantly increased our infrastructure, personnel and marketing strategy to focus on the potential growth of our check services through the Visa POS Check Service Program. We currently provide critical back-end infrastructure for the service, including our NCN database for verification and our access to the Federal Reserve System's Automated Clearing House for funds settlement, and for checks written on bank accounts with banks not participating in the program. Because we believe the market will continue to gain acceptance of the Visa POS Check Service Program, we have expended significant resources to market our check conversion services and verification services to our merchant base, to solidify our strategic relationships with the various financial institutions that have chosen us as their acquirer processor and third-party processor under the program, and to sell our other check products such as electronic check re-presentments and check guarantee to the Visa member banks. We have also increased our personnel to handle the increased volume of transactions arising directly from our participation in the program. If we fail to adequately market our services through this relationship, this could materially affect our marketing strategy going forward. Additionally, if we fail to adequately grow our infrastructure to address increases in the volume of transactions, cease providing services as a third-party processor or acquirer processor or are otherwise removed or terminated from the VISA Program, this would require us to dramatically shift our current operating strategy. THE BUSINESS IN WHICH WE COMPETE IS HIGHLY COMPETITIVE AND THERE IS NO ASSURANCE THAT OUR CURRENT PRODUCTS AND SERVICES WILL STAY COMPETITIVE OR THAT WE WILL BE ABLE TO INTRODUCE NEW PRODUCTS AND SERVICES TO COMPETE SUCCESSFULLY. We are in the business of processing payment transactions and designing and implementing integrated systems for our customers so that they can better use our services. This business is highly competitive and is characterized by rapid technological change, rapid rates of product obsolescence, and rapid rates of new products introduction. Our market share is relatively small as compared to most of our competitors and most of these competitors have substantially more financial and marketing resources to run their businesses. While we believe our small size provides us the ability to move quickly in some areas, our competitors' greater resources enable them to investigate and embrace new and emerging technologies, quickly to respond to changes in customers needs, and to devote more resources to product and services development and marketing. We may face increased competition in the future and there is no assurance that current or new competition will allow us to keep our customers. If we lose customers, our business operations may be materially adversely affected, which could cause us to cease our business or curtail our business to a point where we are no longer able to generate sufficient revenues to fund operations. There is no assurance that our current products and services will stay competitive with those of our competitors or that we will be able to introduce new products and services to compete successfully in the future. IF WE ARE UNABLE TO PROCESS SIGNIFICANTLY INCREASED VOLUME ACTIVITY, THIS COULD AFFECT OUR OPERATIONS AND WE COULD LOSE OUR COMPETITIVE POSITION. We have built transaction processing systems for check verification, check conversion, ACH processing, and bank card processing activities. While current estimates regarding increased volume are within the capabilities of each system, it is possible that a significant increase in volume in one of the markets would exceed a specific system's capabilities. To minimize this risk, ECHO has redesigned and upgraded its check related processing systems and has purchased a high end system to process bankcard activity. This system is not yet operational, and even when it becomes operational, no assurance can be given that it would be able to handle a significant increase in volume or that the operational enhancements and improvements will be completed in such time to avoid such a situation. In the event we are unable to process increases in volume, this could significantly adversely affect our banking relationships, our merchant customers, and our overall competitive position, and could potentially result in violations of service level agreements which would require us to pay penalty fees to the other parties to those agreements. Losses of such relationships, or the requirement to pay penalties, may severely impact our results of operations and financial condition. 27 WE INCUR FINANCIAL RISK FROM OUR CHECK GUARANTEE SERVICE. The check guarantee business is essentially a risk management business. Any limitation of a risk management system could result in financial obligations being incurred by ECHO relative to our check guarantee activity. While ECHO has provided check guarantee services for several years, there can be no assurance that our current risk management systems are adequate to assure against any financial loss relating to check guarantee. ECHO is enhancing its current risk management systems and it is being conservative with reference to the type of merchants to which it offers guarantee services in order to minimize this risk but no assurance can be given that such measures will be adequate. During the year ended September 30, 2003, we incurred $206,000 in losses from uncollected guaranteed checks. SECURITY BREACHES COULD IMPACT OUR CONTINUED OPERATIONS. We process confidential financial information and maintain several levels of security to protect this data. Security includes hand and card-based identification systems at our data center locations that restrict access to the specific facilities, various employee monitoring and access restriction policies, and various firewall and network management methodologies that restrict unauthorized access through the Internet. While these systems have worked effectively in the past, there can be no assurance that they will continue to operate without a security breach in the future. Depending upon the nature of the breach, the consequences of security breaches could be significant and dramatic to ECHO's continued operations. THE INDUSTRY IN WHICH WE OPERATE INVOLVES RAPIDLY CHANGING TECHNOLOGY AND OUR FAILURE TO IMPROVE OUR PRODUCTS AND SERVICES OR TO OFFER NEW PRODUCTS AND SERVICES COULD CAUSE US TO LOSE CUSTOMERS. Our business industry involves rapidly changing technology. Recently, we have observed rapid changes in technology as evidenced by the Internet and Internet-related services and applications, new and better software, and faster computers and modems. As technology changes, ECHO's customers desire and expect better products and services. Our success depends on our ability to improve our existing products and services and to develop and market new products and services. The costs and expenses associated with such an effort could be significant to us. There is no assurance that we will be able to find the funds necessary to keep up with new technology or that if such funds are available that we can successfully improve our existing products and services or successfully develop new products and services. Our failure to provide improved products and services to our customers or any delay in providing such products and services could cause us to lose customers to our competitors. Loss of customers could have a material adverse effect on ECHO. OUR INABILITY TO PROTECT OR DEFEND OUR TRADE SECRETS AND OTHER INTELLECTUAL PROPERTY COULD HURT OUR BUSINESS. We have expended a considerable amount of time and money to develop information systems for our merchants. We regard these information systems as trade secrets that are extremely important to our payment processing operations. We rely on trade secret protection and confidentiality and/or license agreements with employees, customers, partners and others to protect this intellectual property and have not otherwise taken steps to obtain additional intellectual property protection or other protection on these information systems. We cannot be certain that we have taken adequate steps to protect our intellectual property. In addition, our third-party confidentiality agreements can be breached and, if they are, there may not be an adequate remedy available to us. If our trade secrets become known, we may lose our competitive position, including the loss of our merchant and bank customers. Such a loss could severely impact our results of operations and financial condition. Additionally, while we believe that the technology underlying our information systems does not infringe upon the rights of any third parties, there is no assurance that third parties will not bring infringement claims against us. We also have the right to use the technology of others through various license agreements. If a third party claimed our activities and/or these licenses were infringing their technology, while we may have some protection from our third party licensors, we could face additional infringement claims or otherwise be obligated to stop utilizing intellectual property critical to our technology infrastructure. If we are not able to implement other technology to substitute the intellectual property underlying a claim, our business operations could be severely effected. Additionally, infringement claims would require us to incur significant defense costs and expenses and, to the extent we are unsuccessful in defending these claims, could cause us to pay 28 monetary damages to the person or entity making the claim. Continuously having to defend such claims or otherwise making monetary damages payments could materially adversely affect our results of operations. IF WE DO NOT CONTINUE TO INVEST IN RESEARCH AND DEVELOPMENT, WE COULD LOSE OUR COMPETITIVE POSITION. Because technology in the payment processing industry evolves rapidly, we need to continue to invest in research and development in both the bankcard processing business segment and the check-related products segment in order to remain competitive. Although research and development expenses decreased 18.3% from $1,719,000 in fiscal 2002 to $1,405,000 in fiscal 2003, because of the fact that most of our development project costs were capitalized once we entered into coding and testing phases, we continue to evaluate projects, which we believe will assist us in our efforts to stay competitive. Although we believe that our investment in these projects will ultimately increase earnings, there is no assurance as to when or if these new products will show profitability or if we will ever be able to recover the costs invested in these projects. Additionally, if we fail to commit adequate resources to grow our technology on pace with market growth, we could quickly lose our competitive position, including the loss of our merchant and bank customers. FAILURE TO OBTAIN ADDITIONAL FUNDS CAN IMPACT OUR OPERATIONS AND FUTURE GROWTH. We use funds generated from operations, as well as funds obtained through credit facilities and equity financing, to finance our operations. In light of our recent financing efforts, and as a result of the cash flow generated from operations, we believe we have sufficient cash to support our business activities, including research, development and marketing costs. However, future growth may depend on our ability to continue to raise additional funds, either through operations, bank borrowings, or equity or debt financings. There is no assurance that we will be able to continue to raise the funds necessary to finance growth or continue to generate the funds necessary to finance operations, and even if such funds are available, that the terms will be acceptable to us. The inability to generate the necessary funds from operations or from third parties in the future may require us to scale back our research, development and growth opportunities, which could harm our overall operations. WHILE WE MAINTAIN INSURANCE PROTECTION AGAINST CLAIMS RELATED TO OUR SERVICES, THERE IS NO ASSURANCE THAT SUCH PROTECTION WILL BE ADEQUATE TO COVER POTENTIAL CLAIMS AND OUR INABILITY TO OTHERWISE PAY SUCH CLAIMS COULD HARM OUR BUSINESS. We maintain errors and omissions insurance for the services we provide. While we believe the limit on our errors and omissions insurance policy is adequate and consistent with industry practice, if claims are brought by our customers or other third parties, we could be required to pay the required claim or make significant expenditures to defend against such claims in amounts that exceed our current insurance coverage. There is no assurance that we will have the money to pay potential plaintiffs for such claims if they arise beyond the amounts insured by us. Making these payments could have a material adverse effect on our business. INVOLVEMENT IN LITIGATION COULD HARM OUR BUSINESS. We are involved in various lawsuits arising in the ordinary course of business. Although we believe that the claims asserted in such lawsuits are without merit, the cost to us for the fees and expenses to defend such lawsuits could have a material adverse effect on our financial condition, results of operations or cash flow. In addition, there can be no assurance that we will not at some time in the future experience significant liability in connection with such claims. As of September 30, 2003, we have spent approximately $50,000 in legal fees and expenses defending these claims. Litigation costs and expenses, including the cost to settle claims, significantly affected our results of operations during the year ended September 30, 2002. Net loss for fiscal 2002 was $2,376,000, as compared to net income of $434,000 in fiscal 2001. The decline was primarily due to a $2.5 million legal settlement paid to Premiere Lifestyles International Corporation, Inc. In connection with the settlement, we made a one-time cash payment of $1,200,000 to Premier and executed a long-term promissory note collateralized by our Agoura Hills, California office building in favor of that plaintiff for an additional $1,300,000, payable over 15 years, with an interest rate of 8%. Additionally, we incurred approximately $1,000,000 in legal fees in connection with the suit of which $400,000 were incurred in fiscal 2002. 29 OUR INABILITY TO RECOVER FROM NATURAL DISASTERS COULD HARM OUR BUSINESS. We currently maintain four data centers: one in Agoura Hills, California, one in Camarillo, California, one in Albuquerque, New Mexico and one in Boulder, Colorado. Should a natural disaster occur in any of the locations, it is possible that ECHO would not be able to fully recover full functionality at one of its data centers. To minimize this risk, ECHO will centralize its data processing functionality in Camarillo in 2004 and will make Albuquerque a fully redundant site. Prior to that time, it is possible a natural disaster could limit or completely disable a specific service offered by ECHO until such time that the specific location could resume its functionality. Our inability to provide such service could have a material adverse effect on our business and results of operations. INCREASES IN THE COSTS OF TECHNICAL COMPLIANCE COULD HARM OUR BUSINESS. The services which ECHO offers require significant technical compliance. This includes compliance to both Visa and MasterCard regulations and association rules, NACHA guidelines and regulations with regard to the Federal Reserve System's Automated Clearing House and check related issues, and various banking requirements and regulations. ECHO has personnel dedicated to monitoring our compliance to the specific industries we serve and, when possible, ECHO is moving the technical compliance responsibility to other parties, as is the case with the recent purchase of the Oasis Technologies bankcard processing system wherein the vendor, Oasis Technologies, assumes much of the compliance obligations regularly updated by Visa and MasterCard. As the compliance issues become more defined in each industry, the costs associated with that compliance may present a risk to ECHO. These costs could be in the form of additional hardware, software or technical expertise that ECHO must acquire and/or maintain. While ECHO currently has these costs under control, we have no control over those entities that set the compliance requirements so no assurance can be given that ECHO will always be able to underwrite the costs of compliance in each industry wherein we compete. RISKS ASSOCIATED WITH OUR COMMON STOCK - -------------------------------------- IF WE NEED TO SELL OR ISSUE ADDITIONAL SHARES OF COMMON STOCK OR ASSUME ADDITIONAL DEBT TO FINANCE FUTURE GROWTH, OUR STOCKHOLDERS' OWNERSHIP COULD BE DILUTED OR OUR EARNINGS COULD BE ADVERSELY IMPACTED. Our business strategy may include expansion through internal growth, by acquiring complementary businesses or by establishing strategic relationships with targeted customers and suppliers. In order to do so, or to fund our other activities, we may issue additional equity securities that could dilute our stockholders' stock ownership. We may also assume additional debt and incur impairment losses related to goodwill and other tangible assets if we acquire another company and this could negatively impact our results of operations. As of the date of this report, management has no plan to raise additional capital through the sale of securities and believes that our cash flow from operations together with cash on hand and our established line of credit with Bank of the West will be sufficient to meet our working capital and other commitments. WE HAVE ADOPTED A NUMBER OF ANTI-TAKEOVER MEASURES THAT MAY DEPRESS THE PRICE OF OUR COMMON STOCK. Our rights agreement, our ability to issue additional shares of preferred stock and some provisions of our articles of incorporation and bylaws could make it more difficult for a third party to make an unsolicited takeover attempt of us. These anti-takeover measures may depress the price of our common stock by making it more difficult for third parties to acquire us by offering to purchase shares of our stock at a premium to its market price. OUR STOCK PRICE HAS BEEN VOLATILE. Our common stock is quoted on the NASDAQ SmallCap Market, and there can be substantial volatility in the market price of our common stock. Over the course of the quarter ended September 30, 2003, the market price of our common stock has been as high as $9.59, which is the highest market price our common stock has had over the course of the year ended September 30, 2003, and as low as $3.20. Additionally, over the course of the year ended September 30, 2003, the market price of our common stock has been as low as $1.09. The market price of our common stock has been, and is likely to continue to be, subject to significant fluctuations due to a variety of factors, including quarterly variations in operating results, operating results 30 which vary from the expectations of securities analysts and investors, changes in financial estimates, changes in market valuations of competitors, announcements by us or our competitors of a material nature, loss of one or more customers, additions or departures of key personnel, future sales of common stock and stock market price and volume fluctuations. In addition, general political and economic conditions such as a recession, or interest rate or currency rate fluctuations may adversely affect the market price of our common stock. WE HAVE NOT PAID AND DO NOT CURRENTLY PLAN TO PAY DIVIDENDS, AND YOU MUST LOOK TO PRICE APPRECIATION ALONE FOR ANY RETURN ON YOUR INVESTMENT. Some investors favor companies that pay dividends, particularly in general downturns in the stock market. We have not declared or paid any cash dividends on our common stock. We currently intend to retain any future earnings for funding growth, and we do not currently anticipate paying cash dividends on our common stock in the foreseeable future. Because we may not pay dividends, your return on this investment likely depends on your selling our stock at a profit. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are currently not exposed to any significant financial market risks from changes in foreign currency exchange rates or changes in interest rates and do not use derivative financial instruments. All of our revenue and capital spending is transacted in U.S. dollars. However, in the future, we may enter into transactions in other currencies. An adverse change in exchange rates would result in a decline in income before taxes, assuming that each exchange rate would change in the same direction relative to the U.S. dollar. In addition to the direct effects of changes in exchange rates, such changes typically affect the volume of sales or foreign currency sales price as competitors' products become more or less attractive. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA The Financial Statements and Supplementary Data are listed under "Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8K". ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES None. ITEM 9A. CONTROLS AND PROCEDURES As of September 30, 2003, the end of the period covered by this report, under the supervision and with the participation of management, including our Chief Executive Officer and our Chief Financial Officer, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rules 13a-15 and 15d-15. Based upon that evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that our disclosure controls and procedures are effective in causing material information to be recorded, processed, summarized and reported by our management on a timely basis and to ensure that the quality and timeliness of our public disclosures complies with its Securities and Exchange Commission disclosure obligations. As of September 30, 2003, there have been no significant changes in our internal controls or in other factors that could significantly affect internal controls. 31 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The officers and directors of ECHO are: Date first became Name Position Officer or Director -------------------------------- ------------------------- ------------------- Joel M. Barry Chairman of the Board, 1986 Chief Executive Officer, Alice L. Cheung Chief Financial Officer, 1996 Treasurer Alex Seltzer Chief Operating Officer/ 2002 Chief Information Officer Jesse Fong Vice President 1994 David Griffin Vice President 1990 Sharat Shankar Vice President 2003 Rick Slater Vice President 1998 Patricia M. Williams Vice President 1997 Jack Wilson Vice President 1994 Donna L. Rehman Corporate Secretary 1990 Aristides W. Georgantas[1][2][3] Director 1999 Carl R. Terzian[1][2][3] Director 2002 Herbert L. Lucas [1][2][3] Director 1991 _______________________________________ [1] Member, Audit Committee [2] Member, Nominating Committee [3] Member, Executive Compensation Committee
JOEL M. BARRY, age 53, has been a Director of ECHO since July 1986, and Chairman of the Board since December 1986. Mr. Barry served as Chief Financial Officer from May 1987 to June 1990, and Executive Vice President from October 1987 to June 1990, when he was designated Chief Executive Officer of ECHO. Mr. Barry is also a Director and Chief Executive Officer of the MerchantAmerica and XPRESSCHEX, Inc. wholly-owned subsidiaries. From August 1981 to June 1991, Mr. Barry was a lecturer and investment counselor for Dynamic Seminars, a firm he founded in 1981, and Basics Financial Planning and Investments, a firm he founded in 1983. From 1972 to 1974, Mr. Barry owned and operated a recording business and from 1975 to 1981 was employed as the Director of Marketing and Sales with Financial Dynamics, a financial planning firm located in Covina, California. Mr. Barry attended Oklahoma State University from 1969 to 1970, majoring in Accounting and Ozark Bible College from 1970 to 1972, majoring in music. 32 ALICE L. CHEUNG, age 46, has served as Treasurer and Chief Financial Officer since July 1996. Ms. Cheung received her BS degree in business administration/accounting from California State University in Long Beach, California and became a Certified Public Accountant in May 1982. Prior to joining ECHO, Ms. Cheung was the Treasurer and Chief Financial Officer of American Mobile Systems from February 1988 to January 1996, prior to its merger with Nextel Communications, Inc. Ms. Cheung is an active member of the American Institute of Certified Public Accountants and Financial Executive Institute. JESSE FONG, age 52, has served as Vice President of Information Systems since September 1994. Mr. Fong joined ECHO in 1984 and has served as programmer, Data Processing manager and MIS director. He received a degree major in M.E. and minor in Computer Science in 1972, received an International Marketing certificate in 1975 and a Business Administration certificate in 1976. Mr. Fong worked as Marketing manager, Sales manager and Trainer with the Xerox Corporation in Taiwan from 1974 to 1978. After that, he joined Abbott Laboratory as Country manager for two years. After immigrating to the United States in 1980, he worked as International Marketing manager in a trading firm for four years. DAVID GRIFFIN, age 55, has served as Vice President of Check Guarantee since October 2001. Previous to this capacity, he was Vice President of Check Services for ECHO from June 1990 to October 2001 and Vice President of Operations from January 1986 until September 1989, at which time he became a consultant to ECHO. Mr. Griffin has served as Senior Vice President and General Manager for TeleCheck, Los Angeles and TeleCheck, San Diego, from May 1983 to August 1985. Prior to these appointments, he was Regional Manager of TeleCheck Services, a franchiser of check guarantee services, a division of Tymshare Corporation, which was subsequently acquired by McDonnell Douglas Corporation. Mr. Griffin holds a business administration degree with a major in accounting from the University of Houston. ALEX SELTZER, age 51, joined ECHO in August 2002 as Chief Operating Officer and Chief Information Officer. Prior to joining ECHO, Mr. Seltzer was the CIO and co-founder of Online Resources Corporation, an e-financial services outsourcer providing home banking, bill payment, and integrated third-party financial services to small and medium-sized U.S. banks. Mr. Seltzer holds a BS degree in Applied Math and Computer Science from MIT in Cambridge, Massachusetts and an MBA from Stanford Graduate School of Business in Stanford, California. SHARAT SHANKAR, age 33, joined ECHO in June 2003 as Vice President of Risk Management and Business Intelligence. Prior to joining ECHO, Mr. Shankar worked at TeleCheck for approximately eight years where he held a variety of positions leading up to Vice President of Risk Management. Prior to TeleCheck, Mr. Shankar held positions at MetLife as well as Hong Kong and Shanghai Bank, Madras, India. Mr. Shankar holds a Bachelor of Commerce degree from Loyola College, India, and a Master of Business Administration degree from James Madison University, Virginia. RICK SLATER, age 43, joined ECHO in May 1995 as Vice President of Computer Based Controls, Inc. (CBC). Mr. Slater was appointed President of CBC in December 1995, Vice President of ECHO in November 1998 and Chief Technology Officer in October 1999. Prior to joining ECHO, Mr. Slater was President of Slater Research, which provided contract engineering services to various institutions. During this time, Mr. Slater directly participated in the U.S. Coast Guard COMSTA upgrade project including site surveys, systems design and system upgrade integration in a number of sites within the U.S. Prior to this position, Mr. Slater served as a group leader at Aiken Advanced Systems. Mr. Slater holds a BS degree in electrical engineering technology from Old Dominion University, Norfolk, Virginia. PATRICIA M. WILLIAMS, age 38, joined ECHO in September 1996, serving as Director of Program Management, Ms. Williams was appointed Vice President of Corporate Program Management in October 1997 and Vice President of Check Services in October 2001. In June of 2003, Ms. Williams was appointed to the position of Vice President of Sales and Marketing. Prior to joining ECHO, Ms. Williams was an Operations Manager for Bank of America Systems Engineering in San Francisco. Ms. Williams has also served as a Senior Program manager for the Los Angeles office of LANSystems, Inc., a nationwide systems integrator as well as a Senior Project Manager and Systems Engineer for Bank of America Systems Engineering in Los Angeles. Ms. Williams holds a B.A. degree in communications from the University of California, Los Angeles. JACK WILSON, age 59, has served as Vice President of Merchant Services since June 1994 and was Director of Bankcard Relations for ECHO from October 1992 until May 1994. Mr. Wilson served as Vice President for Truckee River Bank from August 1989 until September 1992. Previously, he was Senior Vice President/Cashier 33 of Sunrise Bancorp and a Vice President of First Interstate Bank. Mr. Wilson holds a teaching credential from the California Community College System in business and finance. DONNA L. REHMAN, age 54, joined ECHO in 1988 and has served as Corporate Secretary since 1990. For three years prior thereto, she was self-employed in Woodland Hills, California in educational books and toys. She attended Southern Illinois University in Carbondale and was employed as an administrative assistant in Chicago for 4 years and Los Angeles for 5 years. ARISTIDES W. GEORGANTAS, age 59, has served as a Director since February 1999. Mr. Georgantas, prior to his retirement, was Executive Vice President and Chief Operating Officer at Chase Manhattan Bank's Global Asset Management/Private Banking Division. He serves as a director of Horizon Blue Cross Blue Shield of New Jersey, the Glenmede Trust Company, the Foundation for Public Broadcasting in New Jersey, and Mathematica Policy Research, Inc. Mr. Georgantas is a graduate of the University of Massachusetts and the Columbia University Graduate School of Business. HERBERT L. LUCAS, age 77, has been a Director since 1991. Mr. Lucas received a BA degree in History in 1950 from Princeton University and an MBA degree in 1952 from Harvard University Graduate School of Business Administration. He served as President from 1972 to 1981 of Carnation International in Los Angeles and as a member of the Board of Directors of the Carnation Company. Since 1982, Mr. Lucas has managed his family investment business. He has served on the Board of Directors of various financial and business institutions including Wellington Trust Company, Arctic Alaska Fisheries, Inc., Nutraceutix, and Sunworld International Airways, Inc. Mr. Lucas has served as a Trustee of The J. Paul Getty Trust, the Los Angeles County Museum of Art, and Winrock International Institute for Agricultural Research and Development. He was formerly a member of the Board of Trustees of Princeton University. CARL R. TERZIAN, age 68, has served as a Director since December, 2002. Mr. Terzian graduated magna cum laude from the University of Southern California in 1957. Following his USC education, Mr. Terzian served as an international good will ambassador for President Eisenhower and Secretary of State John Foster Dulles; director of public and church relations for the Lutheran Hospital Society of Southern California; civic affairs consultant to the California savings and loan industry; and dean and professor of government and speech at Woodbury University. In 1965, Mr. Terzian joined Charles Luckman Associates, an architectural firm, to handle its public relations throughout the United States and worldwide and began his own public relations firm, Carl Terzian Associates, in 1969. Mr. Terzian currently serves as a director on the board of Transamerica Investors, Inc. and Mercantile National Bank along with various non-profit boards, commissions, advisory groups, and task forces. All directors are to be elected to specific terms, from one year to three years, by the stockholders and serve until the next annual meeting or until their terms have expired. The Annual Meeting of Stockholders was held on February 3, 2003, and the election of directors was held at that time. CODE OF ETHICAL CONDUCT Our Board of Directors recently adopted a Code of Ethical Conduct (the "Code of Conduct"). We require all employees, directors and officers, including our Chief Executive Officer and Chief Financial Officer, to adhere to the Code of Conduct in addressing legal and ethical issues encountered in conducting their work. The Code of Conduct requires that these individuals avoid conflicts of interest, comply with all laws and other legal requirements, conduct business in an honest and ethical manner and otherwise act with integrity and in our best interest. The Code of Conduct contains additional provisions that apply specifically to our Chief Financial Officer and other financial officers with respect to full and accurate reporting. The Code of Conduct is available on our website at www.echo-inc.com. AUDIT COMMITTEE FINANCIAL EXPERT Our Board of Directors has determined that Aristides W. Georgantas, the Chairman of the Audit Committee of the Board of Directors, is an "audit committee financial expert" as defined in Item 401(h) of Regulation S-K. Mr. Georgantas is "independent" for purposes of Rule 4200(a)(15) of the Nasdaq Marketplace Rules. 34 IDENTIFICATION OF AUDIT COMMITTEE Our Board of Directors has a separately standing Audit Committee. The Audit Committee currently consists of Messrs. Herbert L. Lucas, Jr., Aristides W. Georgantas, and Carl R. Terzian. Messrs. Lucas, Georgantas and Terzian are "independent directors" within the meaning of Rule 10A-3 promulgated under the Securities Exchange Act of 1934, as amended, and the NASDAQ Marketplace Rules. The Audit Committee's primary duties and responsibilities include appointment of the independent auditors, evaluation of the performance and independence of such auditors and review of the annual audited financial statements and the quarterly financial statements, as well as the adequacy of our internal controls. SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Section 16(a) of the Securities Exchange Act of 1934, as amended, requires our directors and executive officers and the holders of 10% or more of our Common Stock to file with the Securities and Exchange Commission initial reports of ownership and reports of changes in ownership of our equity securities. Based solely on our review of the copies of the forms received by us and written representations from certain reporting persons that they have complied with the relevant filing requirements, we believe that, during the year ended September 30, 2003, all of our executive officers and directors complied with all Section 16(a) filing requirements. To our knowledge, based upon our review of Schedules 13D and 13G filed with the Securities and Exchange Commission, no individual has beneficial ownership or control over 10% or more of our outstanding Common Stock. ITEM 11. EXECUTIVE COMPENSATION The following table sets forth the total compensation paid and stock options offered by us to our Chief Executive Officer and to each of its most highly compensated executive officers, other than the Chief Executive Officer, whose compensation exceeded $100,000 during the fiscal years ended September 30, 2003, 2002 and 2001 (together with the Chief Executive Officer, the "Named Executive Officers").
SUMMARY COMPENSATION TABLE Annual Long Term Compensation Compensation ------------ ------------ Securities Capacities in Underlying Name Which Served Year Salary [1] Bonus Options [2] Other [3] - -------------------- ----------------- ------- ---------- ------- ------------ --------- Joel M. Barry Chairman/Chief 2003 $ 223,125 $ -0- 40,000 -0- Executive Officer 2002 209,000 -0- 50,000 -0- 2001 203,000 25,500 12,500 -0- Alex Seltzer Chief Information 2003 $ 148,295 $ -0- 5,000 $ 2,250 Officer/Chief 2002 14,230 -0- 50,000 -0- Operating Officer 2001 -0- -0- -0- -0- Alice L. Cheung Chief Financial 2003 $ 125,500 $15,000 15,000 4,175 Officer/Treasurer 2002 110,500 11,500 5,000 3,450 2001 104,750 10,000 5,000 2,600 Rick Slater Vice President 2003 $ 121,600 $ 5,000 2,500 2,512 2002 119,000 5,000 5,000 1,450 2001 117,850 7,000 2,500 600 Jack Wilson Vice President 2003 $ 111,190 $15,000 15,000 2,998 2002 103,750 16,500 5,000 2,250 2001 91,250 10,000 7,500 2,600 35 Patricia M. Williams Vice President 2003 $ 111,190 $15,000 15,000 -0- 2002 103,750 16,500 10,000 3,000 2001 96,500 10,000 10,000 2,400 Jesse Fong Vice President 2003 $ 98,880 $ 4,000 2,500 $ 2,526 2002 94,000 5,000 5,000 2,540 2001 93,400 4,000 2,500 2,396 _______________________ [1] We provide Mr. Barry and Mr. Wilson with an automobile. There has been no compensation paid other than that indicated in the above table. [2] None of these options have been exercised (see "Stock Option Plan"). [3] Represents our match of contributions to our 401(k) Plan. We contribute 25% of each employee's contribution to the 401(k) Plan.
FISCAL 2003 OPTION GRANTS TABLE The following table sets forth the stock options granted to our Chief Executive Officer and each of its executive officers, other than the Chief Executive Officer, whose compensation exceeded $100,000 during fiscal 2003. Under applicable Securities and Exchange Commission regulations, companies are required to project an estimate of appreciation of the underlying shares of stock during the option term. We have chosen to project this estimate using the potential realizable value at assumed annual rates of stock price appreciation for the option term at assumed rates of appreciation of 5% and 10%. However, the ultimate value will depend upon the market value of our stock at a future date, which may or may not correspond to projections below.
Potential Realization Value at Assumed Annual Rates of Percent of Stock Price Total Granted Exercise Appreciation for Options to Employees in Price Expiration Option Term -------------------------- Name Granted[1] Fiscal Year per share Date 5% 10% - -------------------- ---------- ---------------- ---------- ---------- ----------- ------------- Joel M. Barry 40,000 16.80% $ 2.31 02/03/13 $ 25,600 $ 56,400 Alex Seltzer 5,000 2.10% $ 1.30 12/09/12 $ 1,800 $ 3,950 Alice L. Cheung 15,000 6.30% $ 1.30 12/09/12 $ 5,400 $ 11,850 Rick Slater 2,500 1.05% $ 1.30 12/09/12 $ 900 $ 1,975 Jack Wilson 15,000 6.30% $ 1.30 12/09/12 $ 5,400 $ 11,850 Patricia M. Williams 15,000 6.30% $ 1.30 12/09/12 $ 5,400 $ 11,850 Jesse Fong 2,500 1.05% $ 1.30 12/09/12 $ 900 $ 1,975 ___________________ [1] All options vest in five equal annual installments beginning 12 months following the date of the grant.
AGGREGATED OPTION/SAR EXERCISES AND FISCAL-YEAR OPTION/SAR VALUE TABLE The following table sets forth information concerning the exercise of stock options during the fiscal year ended September 30, 2003 by each of our Named Executive Officers and the number and value of unexercised options held by each of our Named Executive Officers as of the fiscal year ended September 30, 2003. 36
Value of Number of unexercised Shares unexercised in-the-money acquired on Value options/SARS Options/SARS Name exercise realized at FY-end at FY-end[1] - -------------------- ----------- --------- ------------ ------------- Joel M. Barry 32,500 $ 40,018 222,500 $ 891,000 Alice L. Cheung 5,000 $ -0- 57,500 $ 230,050 Jesse Fong -0- $ -0- 21,500 $ 69,240 Alex Seltzer -0- $ -0- 55,000 $ 316,200 Rick Slater 10,000 $ 24,406 40,000 $ 165,500 Jack Wilson 7,500 $ 39,450 45,000 $ 195,250 Patricia M. Williams 4,000 $ 17,020 55,000 $ 204,860 _____________________ [1] Based on the closing sales price of the Common Stock on September 30, 2003 of $7.04 per share, less the option exercise price.
EQUITY COMPENSATION PLAN INFORMATION The following table sets forth information concerning our equity compensation plans as of September 30, 2003.
(c) Number of securities (a) Number of remaining available for securities to be future issuance under issued upon (b) Weighted-average equity compensation exercise of exercise price of (excluding securities Plan Category outstanding options outstanding options reflected in column (a)) - ------------------- ------------------- --------------------- ------------------------- Equity compensation plans approved by security holders[1] 808,875 $3.39 614,500 _____________________ [1] Plan represents the Officers and Key Employees Incentive Stock Option Plan, which expired in May 2002, and our 2003 Incentive Stock Option Plan.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION No interlocking relationship exists between our Board of Directors or Executive Officers Compensation Committee and the board of directors or compensation committee of any other company. DIRECTOR COMPENSATION Each outside director received $28,000 and 3,031 shares of Common Stock in fiscal 2003; $15,000 and 6,912 shares of Common Stock in fiscal 2002; and $15,000 and 3,750 shares of Common Stock in fiscal 2001. Directors are compensated for all reasonable expenses and are not compensated for special meetings other than regular meetings. EMPLOYMENT AGREEMENTS None. 37 BONUS, PROFIT-SHARING AND OTHER REMUNERATION PLANS AND PENSION AND RETIREMENT PLANS We have established a bonus program to reward extraordinary performance that exceeds pre-set goals established for executive officers and key personnel. We believe that such a bonus program provides the incentive to exceed such goals, thereby building shareholder value. We have a contributory 401(K) Retirement Pension Plan, which covers all employees who are qualified under the plan provisions. STOCK OPTION PLAN On May 13, 1992, our Board of Directors authorized adoption of an Officers and Key Employees Incentive Stock Option Plan (the "1992 Plan"), ratified by the shareholders at the Annual Meeting held July 10, 1992. The 1992 Plan provided for the issuance of up to 81,250 shares of our Common Stock to be subject to stock options, each to purchase one share of the Common Stock for $3.40 per share, subject to adjustment in the event of stock splits, combinations of shares, stock dividends or the like. On November 18, 1996, our Board of Directors authorized an increase in the 1992 Plan to 843,750 shares to be subject to stock options, which action was ratified by the shareholders at the Annual Meeting held in February 1997. On February 4, 1999, our Board of Directors authorized an increase in the 1992 Plan to 1,343,750 shares to be subject to stock options, which action was ratified by the shareholders at the Annual Meeting held in February 1999. On May 13, 2002, the 1992 Plan expired. On July 25, 2002, the Board of Directors authorized adoption of the 2003 Incentive Stock Option Plan (the "2003 Plan"), subject to shareholder approval. On February 3, 2003, our shareholders approved adoption of the 2003 Plan at the Annual Meeting of Shareholders. The 2003 Plan provides for the issuance of up to 900,000 shares of our Common Stock to be subject to stock options, each to purchase one share of the Common Stock as may be determined on the date of grant by our Executive Compensation Committee, but which is no event may be less than 100% of the fair market value of our Common Stock on the date of grant. With the exception of the foregoing, we have no stock option plans or other similar or related plans in which any of our officers or directors participate. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT As of November 20, 2003, there were 6,319,863 shares of our Common Stock outstanding. Based on a Schedule 13D/A filed with the Securities and Exchange Commission, the following individual has beneficial ownership or control over 5% or more of our outstanding Common Stock:
Amount and Percentage of Nature of Beneficial Outstanding Stock[1] Name and Address Ownership At 11/20/03 - ---------------------- -------------------- --------------------- Melvin Laufer 400,000 6.82% 136 Beach 140th Street Far Rockaway, NY 11694
38 The following table sets forth the number of shares of Common Stock owned beneficially by our (i) directors, (ii) the Named Executive Officers (as defined below), and (iii) the executive officers and directors as a group, as of the record date, December 15, 2003. Such figures are based upon information furnished by the persons named.
Amount and Percentage of Nature of Beneficial Outstanding Stock[1] Name and Address Ownership At 11/20/03 - --------------------------- -------------------- --------------------- Joel M. Barry 290,619[2] 4.44% 730 Paseo Camarillo Camarillo, CA 93010 Alice L. Cheung 67,000[2] 1.05% 730 Paseo Camarillo Camarillo, CA 93010 Jesse Fong 22,778[2] 0.36% 730 Paseo Camarillo Camarillo, CA 93010 Alex Seltzer 62,900[2] 0.99% 730 Paseo Camarillo Camarillo, CA 93010 Rick Slater 40,500[2] 0.64% 730 Paseo Camarillo Camarillo, CA 93010 Patricia M. Williams 55,675[2] 0.87% 730 Paseo Camarillo Camarillo, CA 93010 Jack Wilson 49,045[2][4] 0.77% 730 Paseo Camarillo Camarillo, CA 93010 Aristides W. Georgantas 16,521 0.26% 180 Springdale Road Princeton, NJ 08540 Herbert L. Lucas, Jr. 27,408[3] 0.43% 12011 San Vicente Blvd. Los Angeles, CA 90049 Carl R. Terzian 3,031 0.05% 12400 Wilshire Blvd. Los Angeles, CA 90025 All officers and directors as a group (13 persons) [5] 719,163 10.43% ______________________________ 39 [1] Outstanding Common Shares with effect given to individual shareholder's exercise of stock options described in footnotes 2 through 4. [2] Includes stock options according to the terms of the Officers and Key Employees Incentive Stock Option Plan and the 2003 Incentive Stock Option Plan, which for the following number of shares for the following individuals could be acquired within 60 days through the exercise of stock options: Joel M. Barry, 153,000 shares; Alice Cheung, 40,000 shares; Jesse Fong, 15,000 shares; Alex Seltzer, 11,000 shares; Rick Slater, 33,000 shares; Patricia Williams, 32,000 shares; and Jack Wilson, 26,000 shares. See "Item 11. Executive Compensation". [3] Includes 17,972 shares indirectly owned by Mr. Lucas through a trust for his wife. [4] Includes 530 shares indirectly owned by Mr. Wilson through his wife. [5] Includes shares and stock options according to the terms of the Officers and Key Employees Incentive Stock Option Plan and the 2003 Incentive Stock Option Plan, which for the following number of shares for the following individuals could be acquired within 60 days through the exercise of stock options: David Griffin, 18,000 shares; Sharat Shankar, 0 shares; and Donna Rehman, 4,900 shares.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS There were no related-party transactions. ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES. AUDIT FEES PricewaterhouseCoopers, LLP, our independent accountants ("PricewaterhouseCoopers") billed us an aggregate of approximately $113,000 and $111,000 in fees for professional services rendered for the audit of our annual financial statements for the fiscal years ended September 30, 2003 and September 30, 2002, respectively, and the reviews of the financial statements included in our Form 10-Q's for fiscal 2003 and 2002. AUDIT-RELATED FEES PricewaterhoueCoopers billed us an aggregate of approximately $7,000 and $3,000 in fees for assurance and related services related to the audit of our annual financial statements for the fiscal years ended September 30, 2003 and September 30, 2002, respectively, and the reviews of the financial statements included in our Form 10-Q's for fiscal 2003 and 2002. TAX FEES PricewaterhouseCoopers billed us an aggregate of approximately $0 and $3,000 in fees for tax compliance, tax advice, and tax planning services for the fiscal years ended September 30, 2003 and 2002. ALL OTHER FEES PricewaterhouseCoopers billed us an aggregate of approximately $0 and $42,000 for all other services performed in fiscal 2003 and 2002, respectively. These other services consisted primarily of litigation support and consulting services. Our Audit Committee is directly responsible for interviewing and retaining our independent accountant, considering the accounting firm's independence and effectiveness, and pre-approving the engagement fees and other compensation to be paid to, and the services to be conducted by, the independent accountant. The Audit Committee does not delegate these responsibilities. During each of the fiscal years ended September 30, 2002 and 2003, respectively, our Audit Committee pre-approved 100% of the services described above. 40 PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8K (a) The following documents are filed as part of this report:
(1) Consolidated Financial Statements Page ---- Report of Independent Auditors . . . . . . . . . . . . . . . . . F-1 Consolidated Balance Sheets at September 30, 2003 and 2002 . . . F-2 Consolidated Statements of Operations for each of the three years in the period ended September 30, 2003 . . . . . . . . . . . . . F-3 Consolidated Statements of Changes in Stockholders' Equity for each of the three years in the period ended September 30, 2003 F-4 Consolidated Statements of Cash Flows for each of the three years in the period ended September 30, 2003 . . . . . . . . . . . . . F-5 Notes to Consolidated Financial Statements . . . . . . . . . . . F-6 (2) Financial Statement Schedule: Schedule II - Valuation and Qualifying Accounts and Reserves . . S-1
All other schedules are omitted because they are not applicable or the required information is shown in the Consolidated Financial Statements or Notes thereto. (b) Reports on Form 8K for fourth quarter ending September 30, 2003: Current Report on Form 8-K dated August 4, 2003, filed with the Securities and Exchange Commission on August 7, 2003. (c) Exhibits:
Exhibit Number Description of Document - ------- ----------------------- 2.1 Copy of Merger Agreement and Plan of Reorganization between Electronic Clearing House, Inc., ECHO Acquisition Corporation, and Magic Software Development, Inc., dated April 20, 1999.[5] 2.2 Copy of Merger Agreement and Plan of Reorganization between Electronic Clearing House, Inc., ECHO Acquisition Corporation, and Rocky Mountain Retail Systems, Inc., dated January 4, 2000.[6] 3.1 Articles of Incorporation of Bio Recovery Technology, Inc., filed with the Nevada Secretary of State on December 11, 1981. [1] 3.4 By-Laws of Bio Recovery Technology, Inc. [1] 4.2 Specimen Common Stock Certificate. [3] 10.35 Copy of Merchant Marketing and Processing Services Agreement between Electronic Clearing House, Inc. and First Regional Bank, dated June 24, 1997. [4] 10.36 Copy of Merchant Marketing and Processing Services Agreement between Electronic Clearing House, Inc. and The Berkshire Bank, dated July 31, 1997. [4] 10.41 Copy of Processing and Software Development and License Agreement between Electronic Clearing House, Inc. and National Bank Drafting Systems, Inc., dated October 22, 1999.[6] 10.42 Copy of Addendum to Agreement between Electronic Clearing House, Inc. and U-Haul International, dated January 1, 2000.[6] 41 10.44 Copy of Electronic Check Services Agreement between Electronic Clearing House, Inc. and National Bank Drafting Systems, Inc., dated May 17, 2000.[6] 10.46 Copy of Amended and Restated Merchant Marketing and Processing Services Agreement between Electronic Clearing House, Inc. and First Regional Bank, dated August 1, 2000.[6] 10.47 Copy of Addendum to Amended and Restated Merchant Marketing and Processing Services Agreement between Electronic Clearing House, Inc. and First Regional Bank, dated August 1, 2000.[6] 10.48 Copy of POS Check Third Party Services Agreement between Visa U.S.A., Inc. and Electronic Clearing House, Inc., dated December 12, 2000.[7] 10.49 Copy of Asset Purchase Agreement between National Check Network, Inc. and Electronic Clearing House, Inc., dated April 19, 2001. [7] 10.50 Copy of Addendum to Agreement between U-Haul International and Electronic Clearing House, Inc., dated October 1, 2001. [7] 10.51 Copy of First Amendment to the POS Check Third Party Servicer Agreement between Visa U.S.A., Inc. and Electronic Clearing House, Inc. dated December 12, 2000. [8] 10.52 Copy of Second Amendment to the POS Check Third Party Servicer Agreement between Visa U.S.A., and Electronic Clearing House, Inc. dated December 12, 2000. [8] 10.53 Copy of Third Amendment to the POS Check Third Party Servicer Agreement between Visa U.S.A., and Electronic Clearing House, Inc. dated December 12, 2000. [8] 10.54 Form of Securities Purchase Agreement by and among the Registrant and the Purchasers identified therein. [9] 10.55 Form of Registration Rights Agreement by and among the Registrant and the Purchasers identified therein. [9] 10.56 Office Lease dated May 21, 2003, by and between the Registrant and the 1989 Sheehan Family Trust dated October 24, 1989, with respect to principal executive offices located at 730 Paseo Camarillo, Camarillo, California 93010. 21.0 Subsidiaries of Registrant. [2] 24.1 Power of Attorney [10] 31.1 Certificate of Joel M. Barry, Chief Executive Officer of Electronic Clearing House, Inc. pursuant to Rule 13a-14(a) under the Securities and Exchange Act of 1934, as amended. 31.2 Certificate of Alice L. Cheung, Chief Financial Officer of Electronic Clearing House, Inc. pursuant to Rule 13a-14(a) under the Securities and Exchange Act of 1934, as amended. 32.1 Certificate of Joel M. Barry, Chief Executive Officer of Electronic Clearing House, Inc. pursuant to Rule 13a-14(a) under the Securities and Exchange Act of 1934, as amended. 32.2 Certificate of Alice L. Cheung, Chief Financial Officer of Electronic Clearing House, Inc. pursuant to Rule 13a-14(a) under the Securities and Exchange Act of 1934, as amended. _______________________ [1] Filed as an Exhibit to Registrant's Annual Report on Form 10-K for the fiscal year ended September 30, 1988 and incorporated herein by reference. [2] Filed as an Exhibit to Registrant's Annual Report on Form 10-K for the fiscal year ended September 30, 1989 and incorporated herein by reference. [3] Filed as an Exhibit to Registrant's Form S-1, Amendment No. 3, effective November 13, 1990 and incorporated herein by reference. [4] Filed as an Exhibit to Registrant's Annual Report on Form 10-K for fiscal year ended September 30, 1997 and incorporated herein by reference. [5] Filed as an Exhibit to Registrant's Annual Report on Form 10-K for fiscal year ended September 30, 1999 and incorporated herein by reference. [6] Filed as an Exhibit to Registrant's Annual Report on Form 10-K for fiscal year ended September 30, 2000 and incorporated herein by reference. [7] Filed as an Exhibit to Registrant's Annual Report on Form 10-K for fiscal year ended September 30, 2001 and incorporated herein by reference. [8] Filed as an Exhibit to Registrant's Annual Report on Form 10-K for fiscal year ended September 30, 2002 and incorporated herein by reference. [9] Filed as an Exhibit to Registrant's Current Report on Form 8-K dated October 30, 2003 and incorporated herein by reference. [10] Included on signature page.
42 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. ELECTRONIC CLEARING HOUSE, INC. By: /s/ Joel M. Barry ----------------------------------- Joel M. Barry, Chief Executive Officer and Chairman POWER OF ATTORNEY Each person whose signature appears below constitutes and appoints Joel M. Barry and Alice L. Cheung, and each of them, as their true and lawful attorneys-in-fact and agents with full power of substitution and resubstitution, for them and in their name, place and stead, in any and all capacities, to sign any or all amendments to this Annual Report on Form 10-K and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the foregoing, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or either of them, or their substitutes, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed by the following persons in the capacities and on the dates indicated.
SIGNATURE TITLE DATE - ----------------------------- --------------------------- ----------------- /s/ Joel M. Barry Chairman of the Board ) December 26, 2003 - ----------------------------- and Chief Executive Officer ) Joel M. Barry ) ) ) /s/ Aristides W. Georgantas Director ) - ----------------------------- ) Aristides W. Georgantas ) ) ) /s/ Herbert L. Lucas, Jr. Director ) - ----------------------------- ) Herbert L. Lucas, Jr. ) ) ) /s/ Carl R. Terzian Director ) - ----------------------------- ) Carl R. Terzian ) ) ) /s/ Alice L. Cheung Chief Financial Officer ) - ----------------------------- and Treasurer ) Alice L. Cheung ) ) ) /s/ Marjan Hewson Controller ) - ----------------------------- Marjan Hewson )
43 REPORT OF INDEPENDENT AUDITORS To the Board of Directors and Stockholders of Electronic Clearing House, Inc.: In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) on page 41 present fairly, in all material respects, the financial position of Electronic Clearing House, Inc. and its subsidiaries at September 30, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 2003 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(a)(2) on page 41 presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. As discussed in Note 3 to the financial statements, effective October 1, 2002, the Company adopted Financial Accounting Standards Board Statement No. 142 "Goodwill and Other Intangible Assets" and changed its method of accounting for goodwill. /S/ PRICEWATERHOUSECOOPERS LLP Los Angeles DECEMBER 5, 2003 F1
ELECTRONIC CLEARING HOUSE, INC. CONSOLIDATED BALANCE SHEETS --------------------------- September 30, --------------------------- 2003 2002 ------------- ------------ ASSETS ------ Current assets: Cash and cash equivalents $ 5,641,000 $ 2,409,000 Restricted cash 977,000 906,000 Settlement receivable 717,000 148,000 Accounts receivable less allowance of $91,000 and $431,000 1,918,000 1,596,000 Prepaid expenses and other assets 307,000 403,000 Deferred tax asset 86,000 266,000 ------------- ------------ Total current assets 9,646,000 5,728,000 Noncurrent assets: Property and equipment, net 2,928,000 2,248,000 Software, net 4,445,000 2,853,000 Deferred tax asset 1,256,000 2,018,000 Other assets less accumulated amortization of $305,000 and $259,000 500,000 637,000 Goodwill, net -0- 4,707,000 ------------- ------------ Total assets $ 18,775,000 $18,191,000 ============= ============ LIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------ Current liabilities: Short-term borrowings and current portion of long-term debt $ 901,000 $ 515,000 Accounts payable 779,000 201,000 Settlement payable 3,429,000 729,000 Accrued expenses 1,336,000 987,000 Deferred income -0- 62,000 ------------- ------------ Total current liabilities 6,445,000 2,494,000 Long-term debt 1,961,000 2,159,000 ------------- ------------ Total liabilities 8,406,000 4,653,000 ------------- ------------ Commitments and contingencies Stockholders' equity: Common stock, $.01 par value, 36,000,000 shares authorized; 5,920,174 and 5,835,331 shares issued; 5,881,906 and 5,796,062 shares outstanding 59,000 58,000 Additional paid-in capital 21,641,000 21,435,000 Accumulated deficit (10,865,000) (7,486,000) Less treasury stock at cost, 38,269 and 39,269 common shares (466,000) (469,000) ------------- ------------ Total stockholders' equity 10,369,000 13,538,000 ------------- ------------ Total liabilities and stockholders' equity $ 18,775,000 $18,191,000 ============= ============
See accompanying notes to consolidated financial statements. F2
ELECTRONIC CLEARING HOUSE, INC. CONSOLIDATED STATEMENTS OF OPERATIONS ------------------------------------- Year ended September 30, ------------------------ 2003 2002 2001 ------------ ------------ ------------ REVENUES: Processing revenue $21,151,000 $16,363,000 $14,719,000 Transaction revenue 19,162,000 16,526,000 14,377,000 Other revenue 323,000 402,000 847,000 ------------ ------------ ------------ 40,636,000 33,291,000 29,943,000 ------------ ------------ ------------ COSTS AND EXPENSES: Processing and transaction expense 26,360,000 22,747,000 19,239,000 Other operating costs 3,358,000 3,012,000 2,887,000 Research and development expense 1,405,000 1,719,000 1,070,000 Selling, general and administrative expenses 7,088,000 6,493,000 5,760,000 Amortization expense - goodwill -0- 489,000 424,000 Legal settlement -0- 2,500,000 -0- ------------ ------------ ------------ 38,211,000 36,960,000 29,380,000 ------------ ------------ ------------ Income (loss) from operations 2,425,000 (3,669,000) 563,000 Interest income 28,000 55,000 187,000 Interest expense (200,000) (129,000) (81,000) Gain on sale of asset -0- -0- 350,000 ------------ ------------ ------------ Income (loss) before (provision) benefit for income taxes and cumulative effect of an accounting change 2,253,000 (3,743,000) 1,019,000 (Provision) benefit for income taxes (925,000) 1,367,000 (585,000) ------------ ------------ ------------ Income (loss) before cumulative effect of an accounting change 1,328,000 (2,376,000) 434,000 Cumulative effect of an accounting change to adopt SFAS 142 (4,707,000) -0- -0- ------------ ------------ ------------ Net (loss) income $(3,379,000) $(2,376,000) $ 434,000 ============ ============ ============ Basic net (loss) earnings per share Before cumulative effect of accounting change $ 0.23 $ (0.41) $ 0.07 Cumulative effect of accounting change (0.81) -0- -0- ------------ ------------ ------------ Basic net (loss) earnings per share $ (0.58) $ (0.41) $ 0.07 ============ ============ ============ Diluted net (loss) earnings per share Before cumulative effect of accounting change $ 0.22 $ (0.41) $ 0.07 Cumulative effect of accounting change (0.78) -0- -0- ------------ ------------ ------------ Diluted net (loss) earnings per share $ (0.56) $ (0.41) $ 0.07 ============ ============ ============
See accompanying notes to consolidated financial statements. F3
ELECTRONIC CLEARING HOUSE, INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY ---------------------------------------------------------- Stock --------------------------------- Additional Paid-in Treasury Accumulated Treasury Common Preferred Amount Capital Stock Deficit --------- ---------- ---------- ------- ----------- --------- ------------ Balance at September 30, 2000 39,275 5,471,983 25,000 55,000 20,638,000 (469,000) (5,544,000) Exercise of stock options 15,000 47,000 Issuance of common stock to outside directors 11,250 45,000 Issuance of common stock - acquisition 21,166 85,000 Issuance of performance stock 375,000 4,000 776,000 Issuance of treasury stock (6) Exchange of stock for note receivable (85,304) (1,000) (331,000) Net income 434,000 --------- ---------- ---------- ------- ----------- --------- ------------ Balance at September 30, 2001 39,269 5,809,095 25,000 58,000 21,260,000 (469,000) (5,110,000) Exercise of stock options 5,500 11,000 Issuance of common stock to outside directors 20,736 45,000 Conversion of preferred to common 25,000 (25,000) Exchange of stock for note receivable (25,000) (54,000) Tax benefit from exercise of stock options 173,000 Net loss (2,376,000) --------- ---------- ---------- ------- ----------- --------- ------------ Balance at September 30, 2002 39,269 5,835,331 -0- 58,000 21,435,000 (469,000) (7,486,000) Exercise of stock options 75,750 1,000 157,000 Issuance of common stock to outside directors 9,093 21,000 Issuance of stock for equipment purchase (1,000) 3,000 Expense related to stock option issuance 28,000 Net loss (3,379,000) --------- ---------- ---------- ------- ----------- --------- ------------ Balance at September 30, 2003 38,269 5,920,174 -0- 59,000 21,641,000 (466,000) (10,865,000) ========= ========== ========== ======= =========== ========= ============ Total ----------- Balance at September 30, 2000 14,680,000 Exercise of stock options 47,000 Issuance of common stock to outside directors 45,000 Issuance of common stock - acquisition 85,000 Issuance of performance stock 780,000 Issuance of treasury stock -0- Exchange of stock for note receivable (332,000) Net income 434,000 ----------- Balance at September 30, 2001 15,739,000 Exercise of stock options 11,000 Issuance of common stock to outside directors 45,000 Conversion of preferred to common Exchange of stock for note receivable (54,000) Tax benefit from exercise of stock options 173,000 Net loss (2,376,000) ----------- Balance at September 30, 2002 13,538,000 Exercise of stock options 158,000 Issuance of common stock to outside directors 21,000 Issuance of stock for equipment purchase 3,000 Expense related to stock option issuance 28,000 Net loss (3,379,000) ----------- Balance at September 30, 2003 10,369,000 ===========
See accompanying notes to consolidated financial statements. F4
ELECTRONIC CLEARING HOUSE, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS ------------------------------------- Year ended September 30, ------------------------ 2003 2002 2001 ------------ ------------ ------------ Cash flows from operating activities: Net (loss) income $(3,379,000) $(2,376,000) $ 434,000 Adjustments to reconcile net (loss) income to net cash provided by operating activities: Depreciation 512,000 480,000 384,000 Amortization of software 1,081,000 697,000 537,000 Amortization of goodwill -0- 489,000 414,000 Provisions for losses on accounts and notes receivable 67,000 302,000 326,000 Provision for obsolete inventory 110,000 300,000 -0- Write-down of real estate 55,000 100,000 -0- Fair value of stock issued in connection with director's compensation 21,000 45,000 45,000 Deferred income taxes 942,000 (1,375,000) 436,000 Stock option compensation 28,000 -0- -0- Legal settlement -0- 1,300,000 -0- Gain (loss) on sale of asset 16,000 -0- (350,000) Cumulative effect of an accounting change 4,707,000 -0- -0- Changes in assets and liabilities: Restricted cash (71,000) 504,000 (393,000) Accounts receivable (389,000) (226,000) (307,000) Settlement receivable (569,000) (42,000) -0- Accounts payable 578,000 66,000 15,000 Settlement payable 2,700,000 111,000 448,000 Accrued expenses 349,000 (376,000) 349,000 Prepaid expenses (76,000) 63,000 11,000 ------------ ------------ ------------ Net cash provided by operating activities 6,682,000 62,000 2,349,000 ------------ ------------ ------------ Cash flows from investing activities: Other assets (51,000) (81,000) (458,000) Purchase of equipment (664,000) (253,000) (280,000) Purchased and capitalized software (2,627,000) (1,501,000) (1,124,000) Proceeds from sale of asset 71,000 -0- 350,000 Cash used in acquisition -0- -0- (169,000) ------------ ------------ ------------ Net cash used in investing activities (3,271,000) (1,835,000) (1,681,000) ------------ ------------ ------------ Cash flows from financing activities: Proceeds from issuance of notes payable 292,000 -0- -0- Repayment of notes payable (177,000) (151,000) (130,000) Repayment of capitalized leases (452,000) (215,000) (47,000) Proceeds from sales and leaseback of equipment -0- 390,000 -0- Proceeds from exercise of stock options 158,000 11,000 47,000 Repurchase of common stock -0- -0- (332,000) ------------ ------------ ------------ Net cash (used in) provided by financing activities (179,000) 35,000 (462,000) ------------ ------------ ------------ Net increase (decrease) in cash 3,232,000 (1,738,000) 206,000 Cash and cash equivalents at beginning of period 2,409,000 4,147,000 3,941,000 ------------ ------------ ------------ Cash and cash equivalents at end of period $ 5,641,000 $ 2,409,000 $ 4,147,000 ============ ============ ============
See accompanying notes to consolidated financial statements. F5 ELECTRONIC CLEARING HOUSE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------ NOTE 1 - NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: - ------------------------------------------------------------------------------- Electronic Clearing House, Inc. (ECHO or the Company) is a Nevada corporation. The Company provides bank card authorizations, electronic deposit services, check guarantee, check verification, check conversion, and check collection services. In addition, the Company sells electronic terminals for use by its customers and other processing companies. The following comments describe the more significant accounting policies. Principles of Consolidation - ----------------------------- The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany transactions and accounts have been eliminated. Cash and Cash Equivalents - ---------------------------- Cash and cash equivalents consist of unrestricted balances only. The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents. Restricted Cash - ---------------- Under the terms of the processing agreements with the Company's primary processing banks, the Company maintains several cash accounts as a reserve against chargeback losses. As processing fees are received by the processing banks, they are allocated per the processing agreement to the reserve accounts. Chargeback Losses - ------------------ Chargeback losses occur when a credit card holder presents a valid claim against one of the Company's merchants and the merchant has insufficient funds or is no longer in business resulting in the charge being absorbed by the Company. The Company records a receivable for those chargebacks for which the merchant is liable but has not made payment. The Company records a provision for estimated chargeback losses at the time bankcard transactions are processed. A reserve is estimated based upon a historically-determined percentage of gross credit card processing volume and actual losses experienced. Settlement Receivable/Payable - ------------------------------ Settlement receivable/payable results from timing differences in the Company's settlement process with merchants. These timing differences are primarily due to the timing between the funds received in the Company's bank accounts and settlement payments made to the merchants. Property and Equipment - ------------------------ Property and equipment are stated at cost, less accumulated depreciation and amortization. Expenditures for additions and major improvements are capitalized. Repair and maintenance costs are expensed as incurred. When property and equipment are retired or otherwise disposed of, the related cost and accumulated depreciation are removed from the accounts. Gains or losses from retirements and disposals are credited or charged to income. Depreciation and amortization are computed using the straight-line method over the shorter of the estimated useful lives of the respective assets or terms of the related leases. The useful lives and lease terms for depreciable assets are as follows: F6 Note 1: (Continued) - -------
Building 39 years Computer equipment and software 3-5 years Furniture, fixtures and equipment 5 years Building improvements 10 years
Other Assets - ------------- Other Assets consist primarily of deposits and intangible assets such as patents and trademarks. Costs related to obtaining a patent and trademark are capitalized and amortized over the estimated life of the patent and trademark. Disclosures regarding intangible assets as required under SFAS No. 142 are included in Note 6. Software Development Costs - ---------------------------- Under the provisions of Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use," the Company capitalizes costs associated with software developed for internal use when both the preliminary project stage is completed and management has authorized further funding for the completion of the project. Capitalized costs include only (1) external direct costs of materials and services consumed in developing or obtaining internal-use software, (2) payroll and payroll-related costs for employees who are directly associated with the software project, and (3) interest costs incurred, when material, while developing internal-use software. Capitalization of such costs ceases no later than the point at which the project is substantially complete and ready for its intended purpose. Software developed or obtained for internal use is tested for impairment whenever events or changes in circumstance indicates that its carrying amount may not be recoverable. Capitalized software development costs are amortized using the straight-line method over the lesser of three years or estimated useful life. Costs incurred to establish the technological feasibility of software and other computer software maintenance costs are recorded as research and development costs and are charged to expense when incurred. Goodwill - -------- Goodwill represents the excess of purchase price over net assets acquired in the acquisition of XPRESSCHEX and Rocky Mountain Retail Systems. In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 142, "Goodwill and Other Intangible Assets", which is effective for fiscal years beginning after December 15, 2001. SFAS 142 requires, among other things, the discontinuance of goodwill amortization. The Company adopted SFAS 142 in the first quarter of fiscal 2003. Based upon the evaluation findings, the Company determined that its goodwill was fully impaired and a non-cash charge equal to the goodwill carrying amount of $4.7 million was recognized during the first quarter of fiscal 2003. See Note 3. Long-Lived Assets - ------------------ When circumstances warrant, the Company reviews its long-lived assets for impairment using estimated undiscounted future cash flows associated with such assets. An impairment loss would be determined as the difference between the fair values and the carrying amounts of the assets. Management believes no such impairment has occurred as of September 30, 2003. Revenue Recognition - -------------------- The Company earns revenue from services which include the following: debit and credit card processing, check guarantee, check verification, check conversion, check re-presentment, check collection and inventory tracking. All of these services are performed pursuant to a contract with customers which states the terms and fixed price for all contracted services. The price of a service may be a fixed fee for each transaction (verification, conversion and check guarantee) and or a percentage of the transaction processed (check guarantee), depending on the service. At the time the guarantee revenue is recognized, the Company provides a reserve for estimated guarantee losses based upon its historical loss experience. The Company generally collects its fee at the time it processes the transaction and accordingly, collectibility is assured. Based on the Company's underwriting criteria and ongoing credit monitoring of customers, collectibility on service transactions is reasonably assured. Revenue from debit and credit card (collectively called "bankcards") and transaction processing revenue is based on a percentage of the transaction value, commonly referred to as a discount fee on a credit and debit card transaction processed by the Company. In addition, there is a per transaction fee associated with each bankcard transaction which is charged to the merchant. The Company recognizes the processing and transaction revenue when the services are performed. F7 Note 1: (Continued) - ------- Revenue from check guarantee is derived from a percentage of the gross amount of the check and guarantees payment of the check to the merchant in the event the check is not honored by the check writer's bank. Merchants typically present customer checks for processing on a regular basis and, therefore, dishonored checks are generally identified within a few days of the date the checks are guaranteed by the Company. The Company recognizes revenue when the checks are processed at the point of sale. In the event a check is dishonored, the Company has the right to collect the full amount of the check from the check writer but has historically recovered approximately 60% of the guaranteed checks. The Company establishes a receivable from the delinquent check writer for the full amount of the guaranteed check. The Company establishes a reserve against these receivable based on historical loss experience. The check guarantee service also earns revenue based on fees collected from delinquent check writers, which collection fee is recognized when collected, as collectibility is not reasonably assured until that point. Revenue from check verification is derived from fees collected from the merchants when a check is verified against the Company's positive and negative check database. This revenue is recognized when the transaction is processed, since the Company has no further performance obligations. Revenue from check conversion is derived from fees collected from merchants to convert the paper check received by merchants into an ACH transaction, which allows the Company to settle the transaction electronically for the merchant. The Company recognizes the revenue related to check conversion fees when the services are performed. Revenue from check re-presentment is derived from fees charged to check writers. Check re-presentment is a service that allows merchants to collect a paper check through the Automated Clearing House ("ACH") network after a check has previously been presented to the bank for collection unsuccessfully at least once. The fees earned from check writer are recognized when collected, as collectibility is not reasonably assured until that point. Revenue from check collection is derived from collection activities performed on behalf of a merchant on uncollected checks. The merchant usually keeps the face amount of the uncollected checks if the collection effort is successful. The Company's revenue is derived from the collection fee collected from the check writer. If the Company refers the collection item to another collection agency, the Company will receive a fee from the collection agency upon its successful efforts. Collection fee revenue is recognized when collected, as collectibility is not reasonably assured until that point. Revenue from inventory tracking is derived from transactions fee for processing and tracking U-Haul's daily inventory activities. This revenue is recognized when the transaction is processed, since the Company has no further performance obligations. Income Taxes - ------------- The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" (FAS 109). FAS 109 requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities. A valuation allowance is established, when necessary, to reduce deferred tax assets to the amount expected to be realized. Earnings (loss) Per Share - ---------------------------- Earnings (loss) per share is based on the weighted average number of common shares and dilutive common equivalent shares outstanding during the period. The shares issuable upon conversion of preferred stock and exercise of options and warrants are included in the weighted average for the calculation of diluted net income per share except where it would be anti-dilutive. For the basic net income per common share, the convertible preferred stock is not considered to be equivalent to common stock. Stock-Based Compensation - ------------------------- The Company has elected to account for its stock-based compensation plans in accordance with APB Opinion No. 25 and to adopt only the disclosure requirements of FAS 123, as amended by SFAS No. 148. The Company measures compensation expense for its employee stock-based compensation under APB 25. The Company provides pro-forma disclosures of net income and earnings per share as if a fair value method had been applied using the Black Scholes option pricing model. Therefore, pro forma compensation costs for employee stock and stock option awards is measured as the excess, if any, of the fair value of the common stock at the grant date over the amount an employee must pay to acquire the stock and is amortized over the related service periods using the straight-line method. F8 Note 1: (Continued) - ------- The weighted average fair value of the options granted during the fiscal years ended September 30, 2003, 2002 and 2001 were $1.66, $1.52, and $1.89, respectively. Fair value was determined using the Black Scholes options pricing model. For options granted in fiscal 2003, the risk free interest rate was approximately 3%, the expected life was 3-5 years, the expected volatility was approximately 90.8%, and the expected dividend yield was 0%, all calculated on a weighted average basis. For options granted in fiscal 2002, the risk free interest rate was approximately 4%, the expected life was 3-5 years, the expected volatility was approximately 90.6%, and the expected dividend yield was 0%, all calculated on a weighted average basis. For options granted in fiscal 2001, the risk free interest rate was approximately 5%, the expected life was 3-5 years, the expected volatility was approximately 80.0% and the expected dividend yield was 0%, all calculated on a weighted average basis. The following table compares net income and earnings per share as reported to the pro forma amounts that would be reported had compensation expense been recognized for the stock-compensation plans in accordance with the fair value recognition provisions of SFAS No. 123, as amended by SFAS No. 148, Accounting for Stock-Based Compensation:
September 30, 2003 2002 2001 ------------- ------------- ----------- Net (loss) income As reported $ (3,379,000) $ (2,376,000) $ 434,000 Total stock-based employee compensation expense determined under fair value-based method for all awards, net of related tax effects $( 211,643) $( 269,427) $( 157,972) ------------- ------------- ----------- Pro forma net (loss) income $ (3,590,643) $ (2,645,427) $ 276,028 ============= ============= =========== Basic (loss) earnings per share: As reported $ (0.58) $ (0.41) $ 0.07 Pro forma $ (0.62) $ (0.46) $ 0.05 Diluted (loss) earnings per share: As reported $ (0.56) $ (0.41) $ 0.07 Pro forma $ (0.60) $ (0.46) $ 0.05
Compensation expense is recognized in association with the issuance of stock options for the difference, if any, between the trading price of the stock at the time of issuance and the price to be paid by an officer or director. Compensation expense is recorded over the vesting period. Accounting Estimates - --------------------- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the reported amounts of revenues and expenses during the reporting period. Significant estimates include allowance for chargeback losses and deferred tax assets. Actual results could differ from those estimates. Fair Value of Financial Instruments - --------------------------------------- The amount recorded for financial instruments in the Company's consolidated financial statements approximates fair value as defined in SFAS No. 107, "Disclosures about Fair Value of Financial Instruments". F9 NOTE 2 - STATEMENT OF CASH FLOWS: - --------------------------------------
September 30 ------------ 2003 2002 2001 -------- -------- ------- Cash paid for: Interest $200,000 $129,000 $81,000 Income taxes 1,000 137,000 72,000
Significant non-cash transactions for fiscal 2003 are as follows: - Capital equipment of $525,000 was acquired under capital leases. Significant non-cash transactions for fiscal 2002 are as follows: - A refund and tax credit totaling $173,000 was recognized due to the filing of amended tax returns for cashless options exercised in fiscal years 1999 and 2000. - A $1.3 million 15-year long-term promissory note was issued as part of the Premiere Lifestyles International Corporation vs. ECHO legal settlement. - Capital equipment of $663,000 was acquired under capital leases. - A software license scheduled payment of $93,000 was paid directly by a leasing company. - The Company acquired 25,000 shares of ECHO's common stock, valued at $54,000 for satisfaction of a chargeback receivable owed to the Company. Significant non-cash transactions for fiscal 2001 are as follows: - 21,116 shares of common stock valued at $85,000 were issued for the purchase of certain National Check Network, Inc. assets. - In September 2001, the Company's Board of Directors approved a one-for-four (1:4) reverse stock split. As stipulated in the Merger Agreement, this event triggered the issuance of the remaining 375,000 performance shares to the RMRS selling shareholders. The performance shares were valued at $780,000, based on the market price on the date of stock issuance, and recorded on the books as goodwill to be amortized over fifteen years. - Capital equipment of $216,000 was acquired under capital leases. NOTE 3 - CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE: - ---------------------------------------------------------------------- Effective October 1, 2002, the Company adopted Statement of Financial Accounting Standards No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets". SFAS 142 requires that goodwill no longer be amortized, but instead be tested for impairment at least annually using a fair value-based approach. In the year of adoption, SFAS No. 142 also requires the Company to perform an initial assessment of its reporting units to determine whether there is any indication that the goodwill carrying value may be impaired. This transitional assessment is made by comparing the fair value of each reporting unit, as determined in accordance with the new standard, to its book value. To the extent the fair value of any reporting unit is less than its book value, which would indicate that potential impairment of goodwill exists, a second transitional test is required to determine the amount of impairment. The Company has determined that it has two reporting units, which correspond to its two reportable business segments; the "Bankcard and Transaction Processing" unit and the "Check Related Products" unit. All of the Company's goodwill relates to business acquisition transactions, which apply exclusively to the Check Related Products unit. The Company completed the transitional impairment testing required by SFAS 142 in the first quarter of fiscal 2003. The Company determined the estimated fair value of its reporting units using a discounted cash flow technique and a market approach based upon the Company's total market capitalization as of October 1, 2002. Based upon the valuation findings, the Company determined that its goodwill was fully impaired and a non-cash charge equal to the goodwill carrying amount of $4.7 million was recognized in the F10 Note 3: (Continued) - ------- Company's consolidated financial statements. As prescribed by SFAS 142, the Company treated this non-cash goodwill impairment as a cumulative effect of change in accounting principle. No income tax benefit has been recognized for this charge as the goodwill is not deductible for income tax purposes. Had the provisions of SFAS No. 142 been applied for the years ended September 30, 2002 and September 30, 2001, the Company's net income before the cumulative effect of a change in accounting principle, and net income (loss) per share would have been as follows:
For the Fiscal Years Ended 2003 2002 2001 ------------ ------------ -------- Net (loss) income, as reported $(3,379,000) $(2,376,000) $434,000 Add: Goodwill amortization -0- 489,000 414,000 ------------ ------------ -------- Adjusted net (loss) income $(3,379,000) $(1,887,000) $848,000 ============ ============ ======== Basic (loss) earnings per share, as reported $ (0.58) $ (0.41) $ 0.07 Effect of SFAS No. 142 0.81 0.08 0.07 ------------ ------------ -------- Adjusted basic earnings (loss) per share $ 0.23 $ (0.33) $ 0.14 ============ ============ ======== Diluted (loss) earnings per share, as reported $ (0.56) $ (0.41) $ 0.07 Effect of SFAS No. 142 .78 0.08 0.07 ------------ ------------ -------- Adjusted diluted earnings (loss) per share $ 0.22 $ (0.33) $ 0.14 ============ ============ ========
NOTE 4 - PROPERTY AND EQUIPMENT: - ------------------------------------ Property and equipment are comprised of the following:
September 30 ------------- 2003 2002 ------------- ------------ Land and building $ 880,000 $ 880,000 Computer equipment 3,973,000 3,036,000 Furniture, fixtures and equipment 1,240,000 995,000 Building improvements 291,000 281,000 Tooling equipment 285,000 285,000 Auto 16,000 16,000 ------------- ------------ Cost 6,685,000 5,493,000 Less: accumulated depreciation and amortization ( 3,757,000) (3,245,000) ------------- ------------ Net book value $ 2,928,000 $ 2,248,000 ============= ============
Included in property and equipment are assets under capital lease of $1,098,000 and $699,000 at September 30, 2003 and 2002, with related accumulated depreciation of $236,000 and $173,000, respectively. Amortization of assets recorded under capital leases is included with depreciation expense. F11 NOTE 5 - SOFTWARE COST - -------------------------- The following table sets forth information regarding the costs associated with software purchased and developed for internal use:
September 30 ------------- 2003 2002 ------------ ------------ Software cost $ 7,495,000 $ 4,868,000 Less: accumulated amortization (3,050,000) (2,015,000) ------------ ------------ Net book value $ 4,445,000 $ 2,853,000 ============ ============
Included in software cost are assets under capital lease of $399,000 and $373,000 at September 30, 2003 and 2002, and related accumulated amortization of $109,000 and $51,000, respectively. NOTE 6 - INTANGIBLE ASSETS - ------------------------------ Intangible assets consist of the following at September 30, 2003:
Accumulated Net Cost Amortization Book Value -------- ------------- ----------- Patents $173,000 $ 68,000 $ 105,000 Trademarks 276,000 59,000 217,000 Other 256,000 178,000 78,000 -------- ------------- ----------- $705,000 $ 305,000 $ 400,000 ======== ============= ===========
Intangible assets consist of the following at September 30, 2002:
Accumulated Net Cost Amortization Book Value -------- ------------- ----------- Patents $173,000 $ 58,000 $ 115,000 Trademarks 251,000 34,000 217,000 Other 256,000 167,000 89,000 -------- ------------- ----------- $680,000 $ 259,000 $ 421,000 ======== ============= ===========
Amortization expense for the years ended September 30, 2003 and 2002 was $46,000 and $47,000 respectively. Based on the current amount of intangible assets subject to amortization, the estimated amortization expense for each of the five succeeding years is as follows:
Year Ending September 30: ------------ 2004 $116,000 2005 38,000 2006 38,000 2007 38,000 2008 38,000
F12 NOTE 7 - INCOME TAXES - ------------------------- The (provision) benefit for income taxes consists of the following components:
September 30 ------------- 2003 2002 2001 ---------- ----------- ---------- Current federal taxes $ -0- $ -0- $ (29,000) Current state taxes (5,000) (5,000) (120,000) Deferred taxes (920,000) 1,372,000 (436,000) ---------- ----------- ---------- Total (provision) benefit for income taxes $(925,000) $1,367,000 $(585,000) ========== =========== ==========
The effective tax rate varies from the U.S. Federal statutory tax rate principally due to the following:
September 30 ------------- 2003 2002 2001 -------- -------- ------ U.S. Federal statutory tax rate (34.00%) (34.00%) 34.00% Add (deduct): Non-deductible goodwill 65.00% 4.3% 14.3% State and local taxes 4.5% (6.9%) 8.3% All other 2.2% 0.1% 0.8% -------- -------- ------ Effective tax rate 37.70% (36.50%) 57.40% ======== ======== ======
Components of the deferred tax asset include:
September 30 ------------- 2003 2002 2001 ----------- ---------- -------- Deferred tax assets: Capitalized software $ (715,000) $ -0- $ -0- Reserve for bad debts 35,000 34,000 25,000 Inventory reserve -0- 120,000 8,000 Reserve on real estate -0- 160,000 109,000 Inventory cost capitalized 52,000 52,000 54,000 State tax expense -0- 39,000 41,000 Installment note expense 513,000 543,000 -0- Net operating loss carryforward 1,299,000 1,178,000 390,000 Business tax credit 113,000 113,000 113,000 AMT credit 45,000 45,000 38,000 ----------- ---------- -------- Total deferred tax assets $1,342,000 $2,284,000 $778,000 =========== ========== ========
The Company has a federal net operating loss carryforward of $3,560,000, which expires in 2007 through 2022. The Company has not recorded a valuation allowance against deferred tax assets because it expects to have future taxable income to recognize these assets. F13 NOTE 8 - SHORT-TERM BORROWINGS AND LONG-TERM DEBT: - -------------------------------------------------------- Short-term borrowings and long-term debt consist of the following:
September 30 ------------ 2003 2002 ----------- ----------- Long-term promissory note collateralized by corporate headquarters building, due March 25, 2017, bearing interest at 8% per annum $1,229,000 $1,277,000 Term loan collateralized by corporate headquarters building, due February 15, 2009, bearing interest at 7.87% per annum 343,000 392,000 Term loan, collateralized by equipment, due 2005, bearing interest at prime rate, 4.00% at September 30, 2003 107,000 187,000 Term loan, collateralized by various assets of the Company, due June 19, 2006, bearing interest at prime rate plus 1%, 5.00% at September 30, 2003 292,000 -0- Capital leases 891,000 818,000 ----------- ----------- 2,862,000 2,674,000 Less: current portion (901,000) (515,000) ----------- ----------- $ 1,961,00 $2,159,000 =========== ===========
The weighted average interest rate on the prime rate term loans for the period they were outstanding during the year ended September 30, 2003 was 4.70% One of the term loans contains restrictive debt covenants consisting of debt service coverage ratio and tangible net worth requirements. The Company has an $800,000 credit line with a bank which was unused during fiscal year 2003. During November 2002, the Company negotiated a $500,000 lease line with a leasing company to fund certain computer equipment needs. The Company has financed $428,000 of computer equipment through this lease line as of September 30, 2003. In January 2003, an $800,000 line of credit and a $700,000 lease line for Oasis software installment payments were secured from First Regional Bank, at a borrowing rate of prime + 1%. The Company has drawn down $292,000 of the Oasis lease line as of September 30, 2003 and plans to complete the draw down when the various modules are delivered and accepted by the Company. In October 2003, the Company secured a $3 million credit line for working capital needs and a $1 million equipment lease line with Bank of the West. Future maturities of debt are as follows:
Fiscal year ended September 30 ------------------------------ 2004 $ 901,000 2005 498,000 2006 237,000 2007 134,000 2008 146,000 thereafter 946,000 ---------- $2,862,000 ==========
F14 NOTE 9 - ACCRUED EXPENSES: - -----------------------------
September 30 ------------ Accrued expenses are comprised of the following: 2003 2002 ---------- -------- Accrued bankcard fees $ 178,000 $200,000 Accrued compensation and payroll taxes 535,000 281,000 Accrued communication costs 215,000 234,000 Accrued professional fees 168,000 115,000 Accrued commission 88,000 111,000 Other 152,000 46,000 ---------- -------- $1,336,000 $987,000 ========== ========
NOTE 10 - STOCKHOLDERS' EQUITY: - ---------------------------------- Stockholders' Rights Plan - --------------------------- The Company has a Stockholders' Rights Plan. All stockholders have one preferred share purchase right ("Right") for each outstanding share of common stock of the Company. Each Right entitles the registered holder to purchase from the Company one-hundredth of a share of series A Junior Participating Preferred Stock, no par value ("Preferred Stock") of the Company at a price of $2.00 per one one-hundredth of a share of Preferred Stock ("Purchase Price"), after adjustment for the one-for-four (1:4) reverse stock split in September 2001. The description and terms of the Rights are set forth in a Rights Agreement dated as of September 30, 1996 ("Rights Agreement"), as amended January 2003. The Rights will separate from the Common Stock and a Distribution Date will occur upon the earlier of (i) 10 days following a public announcement that, without consent of the Board of Directors, a person or group of affiliated or associated persons ("Acquired Person") have acquired beneficial ownership of twenty-percent (20%) or more of the outstanding Common Stock, or (ii) 10 business days (or such later date as may be determined by action of the Board of Directors prior to such time as any person becomes an Acquired Person) following the commencement of, or announcement of an intention to make a tender offer or exchange offer the consummation of which would result in the beneficial ownership by a person or group of twenty-percent (20%) of more such outstanding Common Stock. In the event that any person becomes the beneficial owner of twenty-percent (20%) or more of the Common Stock of the Company, ten (10) days thereafter ("Flip-In Event") each holder of a Right will thereafter have the right to receive, upon exercise thereof at the then current Purchase Price of the Right, Common Stock which has a value of two times the Purchase Price of the Right (such right being called the "Flip-In Right"). In the event the Company is acquired in a merger or other business combination transaction where the Company is not the surviving corporation or in the event that 50% or more of its assets or earning power is sold, proper provision shall be made so that each holder of a Right will thereafter have the right to receive, upon the exercise thereof at the then current Purchase Price of the Right, common stock of the acquiring entity which has a value of two times the Purchase Price of the Right. Upon the occurrence of the Flip-In Event, any Rights that are or were at any time owned by an Acquiring Person shall become null and void insofar as they relate to the Flip-In Right. The Rights are not exercisable until the Distribution Date. The Rights will expire on September 30, 2006 ("Final Expiration Date"), unless the Rights are earlier redeemed or exchanged by the Company, in each case, as description in the Rights Agreement. (Loss) Earnings Per Share - ---------------------------- The following table sets forth the computation of basic and diluted (loss) earnings per share: F15 Note 10: (Continued) - --------
September 30 ------------- 2003 2002 2001 ------------ ------------ ---------- Numerator: Income (loss) before cumulative effect of an accounting change $ 1,328,000 $(2,376,000) $ 434,000 Cumulative effect of an accounting change to adopt SFAS 142 (4,707,000) -0- -0- ------------ ------------ ---------- Net (loss) income: $(3,379,000) $(2,376,000) $ 434,000 ============ ============ ========== Denominator: Weighted average shares outstanding for basic (loss) earnings per share 5,812,005 5,788,071 5,797,120 Effect of dilutive stock options 212,035 -0- 141,688 Series K Convertible Preferred Stock -0- -0- 25,000 ------------ ------------ ---------- Adjusted weighted average shares outstanding for diluted (loss) earnings per share 6,024,040 5,788,071 5,963,808 ============ ============ ========== Basic net (loss) earnings per share: Before cumulative effect of accounting change $ 0.23 $ (0.41) $ 0.07 Cumulative effect of accounting change (0.81) -0- -0- ------------ ------------ ---------- Basic net (loss) earnings per share $ (0.58) $ (0.41) $ 0.07 ============ ============ ========== Diluted net (loss) earnings per share: Before cumulative effect of accounting change $ 0.22 $ (0.41) $ 0.07 Cumulative effect of accounting change (0.78) -0- -0- ------------ ------------ ---------- Diluted net (loss) earnings per share $ (0.56) $ (0.41) $ 0.07 ============ ============ ==========
For the years ended September 30, 2003, 2002 and 2001, approximately 270,000, 597,584 and 337,500 shares, respectively, attributable to the exercise of outstanding options were excluded from the calculation of diluted EPS because the effect was antidilutive. NOTE 11 - COMMON STOCK OPTIONS: - ----------------------------------- The Company had a 1992 Incentive Stock Option Plan (the "1992 Plan"), which provided for the issuance of up to 1,343,750 stock options, each to purchase one share of the common stock at a price not less than 100% of the market price at the date of grant. In May 2002, the 1992 Plan expired. The 2003 Incentive Stock Option Plan was approved at the Annual Shareholders' Meeting in February 2003. The 2003 Incentive Stock Option Plan has similar provisions as the 1992 Plan. Stock option activity during 2003, 2002, and 2001 was as follows:
Exercise Options Price -------- -------------- Outstanding September 30, 2000 786,333 $1.60 - $16.48 Granted 88,750 2.84 - 3.24 Forfeited (165,416) 1.60 - 8.48 Exercised (15,000) 2.00 - 3.40 --------- Outstanding September 30, 2001 694,667 $1.60 - $16.48 ========= F16 Note 11: (Continued) - ------- Granted 197,000 1.29 - 2.17 Forfeited (173,583) 1.60 - 10.24 Exercised (5,500) 2.00 --------- Outstanding September 30, 2002 712,584 $1.29 - $16.48 ========= Granted 238,000 $1.30 - $ 8.50 Forfeited (65,959) $2.00 - $ 5.88 Exercised (75,750) $2.00 - $ 4.84 --------- Outstanding September 30, 2003 808,875 $1.29 - $16.48 ========= Exercisable at September 30, 2001 437,000 $1.60 - $16.48 ========= Exercisable at September 30, 2002 318,000 $1.29 - $16.48 ========= Exercisable at September 30, 2003 321,000 $1.29 - $16.48 ========= Options available for grant at September 30, 2002 374,750 ========= Options available for grant at September 30, 2003 614,500 =========
All officer and key employee options are granted under the 1992 Plan and the 2003 Plan. The exercise price of the incentive stock options shall be 100% of the fair market value on the date the option is granted. Options granted to officers and employees are normally vested over a five-year period. Options are exercisable for a period of five years from date of vest. The following table summarizes information about stock options outstanding at September 30, 2003:
Options Outstanding Options Exercisable ----------------------------------- --------------------- Weighted Average Weighted Weighted Number Remaining Average Number Average Range of Outstanding at Contractual Exercise Exercisable at Exercise Exercise Prices Sept. 30, 2003 Life Price Sept. 30, 2003 Price - ---------------- -------------- -------------- ------------ -------------- --------------- 1.29 - $2.00 241,000 6.9 $ 1.55 85,000 $ 1.76 2.15 - $3.50 317,000 8.3 $ 2.65 52,000 $ 2.83 4.00 - $5.88 157,000 4.8 $ 4.28 132,000 $ 4.32 7.00 - $16.48 94,000 6.5 $ 9.11 52,000 $ 9.16 -------------- -------------- 809,000 7.0 $ 3.39 321,000 ============== ==============
NOTE 12 - COMMITMENTS, CONTINGENT LIABILITIES, AND GUARANTEES: - --------------------------------------------------------------------- The Company currently relies on cooperative relationships with, and sponsorship by, one bank in order to process its Visa, MasterCard and other bankcard transactions. The agreement between the bank and the Company requires the Company to assume and compensate the bank for bearing the risk of "chargeback" losses. Under the rules of Visa and MasterCard, when a merchant processor acquires card transactions, it has certain contingent liabilities for the transactions processed. This contingent liability arises in the event of a billing dispute between the merchant and a cardholder that is ultimately resolved in the cardholder's favor. In such a case, the disputed transaction is charged back to the merchant and the disputed amount is credited or otherwise refunded to the cardholder. If the Company is unable to collect this amount from the merchant's account, and if the merchant refuses or is unable to reimburse the Company for the chargeback due to merchant fraud, insolvency or other reasons, the Company will bear the loss for the amount of the refund paid to the cardholders. The Company is also exposed to financial risk in providing Automated Clearing House ("ACH") services to the merchants. As the third-party processor for multiple originating banks, the Company is liable for any fraudulent activities committed by the merchants initiating the ACH activities. The Company utilizes stringent underwriting guidelines combined with a number of systems and procedures to manage merchant risk. In addition, the Company requires cash deposits by certain merchants, which are held by the Company's sponsoring banks to minimize the risk related to merchant frauds and chargebacks. F17 Note 12: (Continued) - -------- A cardholder, through its issuing bank, generally has until the later of up to four months after the date a transaction is processed or the delivery of the product or service to present a chargeback to the Company's sponsoring bank as the merchant processor. Therefore, management believes that the maximum potential exposure for the chargebacks would not exceed the total amount of transactions processed through Visa and MasterCard for the last four months and other unresolved chargebacks in the process of resolution. For the last four months through September 30, 2003, this potential exposure totaled approximately $336 million. At September 30, 2003, the Company, through its sponsoring banks, had approximately $85,000 of unresolved chargebacks that were in the process of resolution. At September 30, 2003, the Company, through its sponsoring banks, had access to $9.2 million in merchant deposits to cover any potential chargeback losses. For the fiscal years 2003 and 2002, the Company processed approximately $961 million (2003) and $760 million (2002) of Visa and MasterCard transactions, which resulted in $9.3 million in gross chargeback activities for the fiscal year ended 2003 and $8.9 million for the fiscal year ended 2002. Substantially all of these chargebacks were recovered from the merchants. The Company's contingent obligation with respect to chargebacks constitutes a guarantee as defined in Financial Accounting Interpretation No. 45, "Guarantor's Accounting and Disclosure requirements for Guarantees, Including Indirect Guarantees of Others" ("FIN 45"). FIN 45 requires that guarantees issued or modified subsequent to December 231, 2002 be initially recorded as liabilities in the Statement of Financial Position at fair value. Since the Company's agreement with its sponsoring bank which establishes the guarantee obligation was entered into prior to December 31, 2002 and has not been modified since that date, the measurement provisions of FIN 45 are not applicable to this guarantee arrangement. In accordance with SFAS No. 5, "Accounting for Contingencies", the Company records a reserve for chargeback losses based on its processing volume and historical trends and data. As of September 30, 2003 and 2002, the allowance for chargeback losses, which is classified as a component of the allowance for uncollectible accounts receivable, was $32,000 and $350,000, respectively. The expense associated with the chargeback allowance is included in processing and transaction expense in the accompanying consolidated statements of income. The Company expensed $44,000, $261,000, and $272,000 for the years ended September 30, 2003, 2002 and 2001, respectively for bankcard processing chargeback losses. The Company has a small check guarantee business. The Company charges the merchant a percentage of the face amount of the check and guarantees payment of the check to the merchant in the event the check is not honored by the check writer's bank. Merchants typically present customer checks for processing on a regular basis and, therefore, dishonored checks are generally identified within a few days of the date the checks are guaranteed by the Company. Accordingly, management believes that its best estimate of the Company's maximum potential exposure for dishonored checks at any given balance sheet date would not exceed the total amount of checks guaranteed in the last 10 days prior to the balance sheet date. As of September 30, 2003, the Company estimates that its maximum potential dishonored check exposure was approximately $372,000. For the fiscal years ended 2003 and 2002, the Company guaranteed approximately $15,338,000 (2003) and $11,223,000 (2002) of merchant checks, which resulted in $468,000 (2003) and $791,000 (2002) of dishonored checks presented to the Company for payments. The Company has the right to collect the full amount of the check from the check writer. Based on its actual collection experience, the Company collects approximately 50-60% of the total dishonored checks. The Company establishes a reserve for this activity based on historical and projected loss experience. As of September 30, 2003 and 2002, the reserve for check guarantee loss was $24,000 (2003) and $152,000 (2002). The expense associated with the guarantee costs is included in processing and transaction expense in the accompanying consolidated statements of income. Lease Commitments - ------------------ The Company leases real property under agreements, which expire at various times over the next five years. The Company's future minimum rental payments for capital and operating leases at September 30, 2003 are as follows:
Fiscal Year Capital Leases Operating Leases ----------- ---------------- ----------------- 2004 $ 524,000 $ 485,000 2005 343,000 425,000 2006 124,000 319,000 2007 -0- 297,000 2008 -0- 309,000 ---------------- ----------------- Total minimum lease payments $ 991,000 $ 1,835,000 ================= F18 Note 12: (Continued) Less: imputed interest of 8.7% (100,000) --------------- Present value of net minimum lease payment $ 891,000 ===============
Rent expense for the years ended September 30, 2003, 2002, and 2001 totaled $299,000, $212,000, and $193,000, respectively. Certain operating leases have renewal options at the end of the lease term solely at the Company's discretion. In May 2003, the Company leased new corporate office space in Camarillo, California. The lease is for a period of five years at a monthly rate of $24,000. The lease grants us a right of first refusal with respect to additional space in the building that is not currently rented, and includes an option for us to purchase the property, at fair value, during the first two years of the lease. NOTE 13 - LITIGATION - ----------------------- The Company is involved in various legal cases arising in the ordinary course of business. Based upon current information, management, after consultation with legal counsel, believes the ultimate disposition thereof will have no material effect upon either the Company's results of operations or its financial position. NOTE 14 - SEGMENT INFORMATION - --------------------------------- The Company has adopted FAS No. 131, "Disclosures about Segments of an Enterprise and Related Information" (FAS 131). FAS 131 established revised standards for public companies related to the reporting of financial and descriptive information about their operating segments in financial statements. Certain information is disclosed, per FAS 131, based on the way management organizes financial information for making operating decisions and assessing performance. The Company currently operates in two business segments: Bankcard and Transaction Processing and Check Related Products, all of which are located in the United States. The Company also has certain corporate expenses which are not allocated to the two business segments. The Company's reportable operating segments have been determined in accordance with the Company's internal management structure, which is organized based on operating activities. The accounting policies of the operating segments are the same as those described in the summary of significant accounting policies. The Company evaluates performance based upon two primary factors, one is the segment's operating income and the other is based on the segment's contribution to the Company's future strategic growth. Certain segment information for fiscal year 2001 were reclassified as a result of the elimination of the terminal sale business segment in fiscal 2002.
September 30 ------------- Business Segments 2003 2002 2001 - ----------------- ------------ ------------ ------------ Revenues: Bankcard and Transaction Processing $32,444,000 $27,456,000 $25,503,000 Check Related Products 8,192,000 5,835,000 4,440,000 ------------ ------------ ------------ $40,636,000 $33,291,000 $29,943,000 ============ ============ ============ Operating Income (loss): Bankcard and Transaction Processing $ 4,303,000 $ 1,996,000 $ 3,183,000 Check Related Products 591,000 (872,000) (234,000) Other - Corporate Expenses (2,469,000) (2,293,000) (2,386,000) Legal Settlement -0- (2,500,000) -0- ------------ ------------ ------------ $ 2,425,000 $(3,669,000) $ 563,000 ============ ============ ============ F19 Note 14: (Continued) - ------- Depreciation and Amortization: Bankcard and Transaction Processing $ 867,000 $ 727,000 $ 571,000 Check Related Products 727,000 938,000 764,000 ------------ ------------ ------------ $ 1,594,000 $ 1,665,000 $ 1,335,000 ============ ============ ============ Capital Expenditures: Bankcard and Transaction Processing $ 2,479,000 $ 1,474,000 $ 823,000 Check Related Products 1,365,000 712,000 859,000 ------------ ------------ ------------ $ 3,844,000 $ 2,186,000 $ 1,682,000 ============ ============ ============ Total Assets: Bankcard and Transaction Processing $ 7,051,000 $ 5,399,000 $ 5,268,000 Check Related Products 6,794,000 7,710,000 7,934,000 Other 4,930,000 5,082,000 5,719,000 ------------ ------------ ------------ $18,775,000 $18,191,000 $18,921,000 ============ ============ ============
NOTE 15 - NEW ACCOUNTING PRONOUNCEMENTS - -------------------------------------------- In May 2003, the FASB issued Statement of Financial Accounting Standards, or SFAS, No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity," which established standards for how a company classifies and measures certain financial instruments with characteristics of both liabilities and equity. SFAS 150 requires certain financial instruments to be classified as liabilities, which were previously classified as equity. SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the Company's fourth quarter. The adoption of this statement will not have an impact on the Company's results of operations, financial position or cash flows. NOTE 16 - QUARTERLY FINANCIAL DATA (Unaudited) - ---------------------------------------------------- The following summarizes the quarterly financial results of the Company for the fiscal years ended September 30, 2003 and September 30, 2002 (in thousands, except share data):
Year Ended September 30, 2003 --------------------------------- First Second Third Fourth Quarter Quarter Quarter Quarter --------- --------- --------- --------- Net revenues $ 9,301 $ 9,767 $ 10,578 $ 10,990 Gross profit 2,973 3,360 3,467 4,153 Profit from operations 527 465 564 869 Net (loss) income (4,473) 268 308 518 (Loss) earnings per share - basic $ (0.77) $ 0.05 $ 0.05 $ 0.09 (Loss) earnings per share - diluted $ (0.77) $ 0.05 $ 0.05 $ 0.08 Year Ended September 30, 2003 --------------------------------- First Second Third Fourth Quarter Quarter Quarter Quarter --------- --------- --------- --------- Net revenues $ 7,921 $ 8,386 $ 8,415 $ 8,569 Gross profit 2,796 2,360 2,535 2,265 (Loss) from operations (76) (3,129) (143) (321) Net (loss) (93) (1,908) (168) (207) (Loss) per share - basic $ (0.02) $ (0.33) $ (0.03) $ (0.03) (Loss) per share - diluted $ (0.02) $ (0.33) $ (0.03) $ (0.03)
F20 NOTE 17 - SUBSEQUENT EVENTS - ------------------------------- On October 30, 2003, the Company completed a private placement of 437,957 shares of common stock to institutional investors, resulting in gross proceeds of approximately $3 million. After commissions and expenses, the net proceeds to the Company will be approximately $2.8 million. The Company intends to use the proceeds to increase the capacity of its payment processing infrastructure, expedite certain development efforts and other working capital needs. In connection with the $3 million private placement financing transaction, the Company entered into a registration rights agreement with the investors. Pursuant to the registrant rights agreement, the company agreed to file a registration statement on Form S-3 registering the resale by the investors of the shares of common stock purchased by them in the transaction and to keep the registration statement effective until the earlier of two years and the date that all the common shares may be sold by the investors pursuant to Rule 144 promulgated under the Securities Act of 1933. This registration rights agreement also provides that if the Company does not register for resale the common shares by January 28, 2004, which date may be extended to March 27, 2004 in certain circumstances, then upon such failure to register the shares, the Company must pay each of the investors a fee equal to 1% of the aggregate purchase price paid by each such investor pursuant to the Securities Purchase Agreement for the shares of common stock then held by each such investor, and for each month after such date that the common shares are not registered, the Company must additionally pay each of the investors a fee equal to 1% of the aggregate purchase price paid by each such investor pursuant to the securities Purchase Agreement for the shares of common stock then held by each such investor. Pursuant to this agreement, the company filed a registration statement with the Securities and Exchange Commission to register for resale the shares of common stock. Additionally, in October 2003, the Company secured a $3 million line of credit for general working capital purposes and a $1 million equipment lease line with Bank of the West. The Company has put its Agoura Hills building on the market and, in November 2003, signed a letter of intent to sell the building. The Company anticipates completing the sale of this property in the third quarter of fiscal 2004. F21
ELECTRONIC CLEARING HOUSE, INC. AND CONSOLIDATED SUBSIDIARIES SCHEDULE II TO FORM 10K RULE 12-09 VALUATION AND QUALIFYING ACCOUNTS AND RESERVES WRITE-OFF WRITE-OFF AGAINST AGAINST BALANCE BALANCE AT CHARGED TO ACCOUNTS BALANCE AT CHARGED TO ACCOUNTS AT CHARGED TO DESCRIPTION 09/30/2000 EXPENSE RECEIVABLE 09/30/2001 EXPENSE RECEIVABLE 09/30/2002 EXPENSE - --------------------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- Allowance for trade receivables/ chargeback receivables $ 380,000 $ 326,000 $ 393,000 $ 313,000 $ 302,000 $ 184,000 $ 431,000 $ 67,000 Allowance for notes receivable $ 177,000 $ 0 $ 177,000 $ 0 $ 0 $ 0 $ 0 $ 0 Allowance for obsolete inventories $ 3,000 $ 15,000 $ 0 $ 18,000 $ 300,000 $ 18,000 $ 300,000 $ 110,000 WRITE-OFF AGAINST ACCOUNTS BALANCE AT DESCRIPTION RECEIVABLE 09/30/2003 - --------------------- ----------- ----------- Allowance for trade receivables/ chargeback receivables $ 407,000 $ 91,000 Allowance for notes receivable $ 0 $ 0 Allowance for obsolete inventories $ 410,000 $ 0
Exhibit Number Description of Document - ------- ----------------------- 2.1 Copy of Merger Agreement and Plan of Reorganization between Electronic Clearing House, Inc., ECHO Acquisition Corporation, and Magic Software Development, Inc., dated April 20, 1999.[5] 2.2 Copy of Merger Agreement and Plan of Reorganization between Electronic Clearing House, Inc., ECHO Acquisition Corporation, and Rocky Mountain Retail Systems, Inc., dated January 4, 2000.[6] 3.1 Articles of Incorporation of Bio Recovery Technology, Inc., filed with the Nevada Secretary of State on December 11, 1981. [1] 3.4 By-Laws of Bio Recovery Technology, Inc. [1] 4.2 Specimen Common Stock Certificate. [3] 10.35 Copy of Merchant Marketing and Processing Services Agreement between Electronic Clearing House, Inc. and First Regional Bank, dated June 24, 1997. [4] 10.36 Copy of Merchant Marketing and Processing Services Agreement between Electronic Clearing House, Inc. and The Berkshire Bank, dated July 31, 1997. [4] 10.41 Copy of Processing and Software Development and License Agreement between Electronic Clearing House, Inc. and National Bank Drafting Systems, Inc., dated October 22, 1999.[6] 10.42 Copy of Addendum to Agreement between Electronic Clearing House, Inc. and U-Haul International, dated January 1, 2000.[6] 10.44 Copy of Electronic Check Services Agreement between Electronic Clearing House, Inc. and National Bank Drafting Systems, Inc., dated May 17, 2000.[6] 10.46 Copy of Amended and Restated Merchant Marketing and Processing Services Agreement between Electronic Clearing House, Inc. and First Regional Bank, dated August 1, 2000.[6] 10.47 Copy of Addendum to Amended and Restated Merchant Marketing and Processing Services Agreement between Electronic Clearing House, Inc. and First Regional Bank, dated August 1, 2000.[6] 10.48 Copy of POS Check Third Party Servicer Agreement between Visa U.S.A., Inc. and Electronic Clearing House, Inc., dated December 12, 2000.[7] 10.49 Copy of Asset Purchase Agreement between National Check Network, Inc. and Electronic Clearing House, Inc., dated April 19, 2001.[7] 10.50 Copy of Addendum to Agreement between U-Haul International and Electronic Clearing House, Inc., dated October 1, 2001.[7] 10.51 Copy of First Amendment to the POS Check Third Party Servicer Agreement between Visa U.S.A., Inc. and Electronic Clearing House, Inc. dated December 12, 2000. [8] 10.52 Copy of Second Amendment to the POS Check Third Party Servicer Agreement between Visa U.S.A., and Electronic Clearing House, Inc. dated December 12, 2000. [8] 10.53 Copy of Third Amendment to the POS Check Third Party Servicer Agreement between Visa U.S.A., and Electronic Clearing House, Inc. dated December 12, 2000. [8] 10.54 Form of Securities Purchase Agreement by and among the Registrant and the Purchasers identified therein. [9] 10.55 Form of Registration Rights Agreement by and among the Registrant and the Purchasers identified therein. [9] 10.56 Office Lease dated May 21, 2003, by and between the Registrant and the 1989 Sheehan Family Trust dated October 24, 1989, with respect to principal executive offices located at 730 Paseo Camarillo, Camarillo, California 93010. 21.0 Subsidiaries of Registrant. [2] 24.1 Power of Attorney [10] 31.1 Certificate of Joel M. Barry, Chief Executive Officer of Electronic Clearing House, Inc. pursuant to Rule 13a-14(a) under the Securities and Exchange Act of 1934, as amended. 31.2 Certificate of Alice L. Cheung, Chief Financial Officer of Electronic Clearing House, Inc. pursuant to Rule 13a-14(a) under the Securities and Exchange Act of 1934, as amended. 32.1 Certificate of Joel M. Barry, Chief Executive Officer of Electronic Clearing House, Inc. pursuant to Rule 13a-14(a) under the Securities and Exchange Act of 1934, as amended. 32.2 Certificate of Alice L. Cheung, Chief Financial Officer of Electronic Clearing House, Inc. pursuant to Rule 13a-14(a) under the Securities and Exchange Act of 1934, as amended. ________________________ [1] Filed as an Exhibit to Registrant's Annual Report on Form 10-K for the fiscal year ended September 30, 1988 and incorporated herein by reference. [2] Filed as an Exhibit to Registrant's Annual Report on Form 10-K for the fiscal year ended September 30, 1989 and incorporated herein by reference. [3] Filed as an Exhibit to Registrant's Form S-1, Amendment No. 3, effective November 13, 1990 and incorporated herein by reference. [4] Filed as an Exhibit to Registrant's Annual Report on Form 10-K for fiscal year ended September 30, 1997 and incorporated herein by reference. [5] Filed as an Exhibit to Registrant's Annual Report on Form 10-K for fiscal year ended September 30, 1999 and incorporated herein by reference. [6] Filed as an Exhibit to Registrant's Annual Report on Form 10-K for fiscal year ended September 30, 2000 and incorporated herein by reference. [7] Filed as an Exhibit to Registrant's Annual Report on Form 10-K for fiscal year ended September 30, 2001 and incorporated herein by reference. [8] Filed as an Exhibit to Registrant's Annual Report on Form 10-K for fiscal year ended September 30, 2002 and incorporated herein by reference. [9] Filed as an Exhibit to Registrant's Current Report on Form 8-K dated October 30, 2003 and incorporated herein by reference. [10] Included on signature page.
EX-10.56 3 doc2.txt EXHIBIT 10.56 EXHIBIT 10.56 STANDARD MULTI-TENANT OFFICE LEASE - GROSS AMERICAN INDUSTRIAL REAL ESTATE ASSOCIATION 1. BASIC PROVISIONS ("BASIC PROVISIONS"). 1.1 PARTIES: This Lease ("Lease"), dated for reference purposes only May ----- 21, 2003 , is made - ----------------------------------------------------------------------- by and between 1989 Sheehan Family Trust dated October 24, 1989 ("LESSOR") ----------------------------------------------------------------- and Electronic Clearing House, Inc., a Nevada Corporation("LESSEE"), - -------------------------------------------------------------------------------- (Collectively the "PARTIES", or individually a "PARTY"). 1.2(a) PREMISES: That certain portion of the Project (as defined below), known as Suite Numbers(s) 200 , ----------------------------------------------------- 2nd floor(s), consisting of approximately 20, 030 rentable square feet and - --- ------------ approximately 20, 030 ------------------------------------------------------------------ useable square feet("PREMISES"). The Premises are located at: 730 Paseo ---------- Camarillo , in the City of - ------------------------------------------------------------ Camarillo , County of Ventura , State of California , - ------------------ ------------------ ---------------- with zip code 93010. In addition to Lessee's rights to use and occupy the ------- Premises as hereinafter specified, Lessee shall have non-exclusive rights to the Common Areas (as defined in Paragraph 2.7 below) as hereinafter specified, but shall not have any rights to the roof (see Rules & Regulations #15), the exterior walls, the area above the dropped ceilings, or the utility raceways of the building containing the Premises ("BUILDING") or to any other buildings in the Project. The Premises, the Building, the Common Areas, the land upon which they are located, along with all other buildings and improvements thereon, are herein collectively referred to as the "PROJECT." The Project consists of approximately 40,030 rentable square feet. (See also Paragraph 2) ---------------- 1.2(b) PARKING: 136 unreserved and ------------reserved vehicle parking --- ------------ spaces at a monthly cost of $-------------------per unreserved space and ------------------- $------------------ per reserved space. (See Paragraph 2.6) - ------------------- 1.3 TERM: Five (5) years and Zero (0) months ("ORIGINAL TERM") commencing -------- --------- October 1, 2003("COMMENCEMENT DATE") and ending September 30, 2008("EXPIRATION - ----------------- ------------------ DATE"). (See also Paragraph 3) 1.4 EARLY POSSESSION: May 26, 2003 ("EARLY POSSESSION DATE"). (See also ------------ Paragraphs 3.2 and 3.3) 1.5 BASE RENT: $22, 033.00 per month ("BASE RENT)", payable on the 1st day ----------- --- or each month Commencing November 1, 2003. (See also Paragraph 4) ------------------ [X] If this box is checked, there are provisions in this Lease for the Base Rent to be adjusted. 1.6 LESSEE'S SHARE OF OPERATING EXPENSE INCREASE: Fifty percent (50%) ----- --- ("LESSEE'S SHARE"). Lessee's Share has been calculated by dividing the approximate rentable square footage of the Premises by the total approximate square footage of the rentable space contained in the Project and shall not be subject to revision except in connection with an actual change in the size of the Premises or a change in the space available for lease in the Project. 1.7 BASE RENT AND OTHER MONIES PAID UPON EXECUTION: (a) BASERENT:$22, 033.00 for the period October 2003 ------------ ------------------------ (b) SECURITY DEPOSIT: $22,033.00 ("SECURITY DEPOSIT"). (See also ------------ Paragraph 5) (c) PARKING:$-------------- for the period --------------- ----------------------- (d) OTHER:$3,000.00 for Furniture/ Equipment Fee for October 2003 --------- ------------------------------------------- (e) TOTAL DUE UPON EXECUTION OF THIS LEASE: $47,066.00 ------------------ 1.8 AGREED USE: General office use with "call center" operations. ---------------------------------------------------------- - -------------------------------------------------------------------------------- - --------------------------------------------------------- (See also Paragraph 6) 1.9 BASE YEAR; INSURING PARTY. The Base Year is 2000. Lessor is the ---- "INSURING PARTY". (See also Paragraphs 4.2 and 8) 1.10 REAL ESTATE BROKERS: (See also Paragraph 15) (a) REPRESENTATION: The following real estate brokers (the "BROKERS") and brokerage relationships exist in this transaction (check applicable boxes): [X] CB Richard Ellis, Inc. represents Lessor exclusively ("LESSOR'S BROKER"); ---------------------- [X] DAUt4 Commercial Real Estate Services represents Lessee exclusively ------------------------------------- ("LESSEE'S BROKER"); or [ ] represents both Lessor and Lessee ("DUAL AGENCY") ------------------------- (b) PAYMENT TO BROKERS: Upon execution and delivery of this Lease by both Parties, Lessor shall pay to the Brokers the brokerage fee agreed to in a separate written agreement for the brokerage services rendered by the Brokers). 1.11 GUARANTOR: The obligations of the Lessee under this Lease shall be guaranteed by ------------------------------------------------------------------ - ------------------------------------------ ("GUARANTOR"): (See also Paragraph 7) 1.12 BUSINESS HOURS FOR THE BUILDING: SEE ADDENDUM : 7:00 am. to 7:00 p.m., Mondays through Fridays (except Building ---- ----- Holidays) and 8:00 a.m. to 1:00 p.m. on Saturdays (except Building -------- --------- Holidays). "BUILDING HOLIDAYS" shall mean the dates of observation of New Year's Day, President's Day, Memorial Day, Independence Day, Labor Day, Thanksgiving Day, Christmas Day, and -------------------------------------------------------- 1.13 LESSOR SUPPLIED SERVICES. Notwithstanding the provisions of Paragraph 11.1, Lessor is NOT obligated to provide the following: [X] Janitorial services [X] Electricity [X] Other (specify): See Section 11 ---------------------------------------------------------- 1.14 ATTACHMENTS. Attached hereto are the following, all of which constitute a part of this Lease: [X] an Addendum consisting of Paragraphs 51 through 67 ; ------------- --------------- [X] a plot plan depicting the Premises; [X] a current set of the Rules and Regulations; [ ] a Work Letter; [ ] a janitorial schedule: [X] other (specify): Standard Offer, Agreement and Escrow Instructions for -------------------------------------------------------- Purchase of Real Estate, Addendum, Seller's Mandatory Disclosure Statement - -------------------------------------------------------------------------------- 2. PREMISES. 2.1 LETTING Lessor hereby leases to Lessee, and Lessee hereby leases from Lessor, the Premises, for the term, at the rental, and upon all of the terms, covenants and conditions set forth in this Lease. Unless otherwise provided herein, any statement of size set forth in this Lease, or that may have been used in calculating Rent, is an approximation which the Parties agree is reasonable and any payments based thereon are not subject to revision whether or not the actual size is more or less. NOTE: LESSEE IS ADVISED TO VERITY THE ACTUAL SIZE PRIOR TO EXECUTING THIS LEASE. 2.2 CONDITION. Lessor shall deliver the Premises to Lessee in a clean condition on the Commencement Date or the Early Possession Date, whichever first occurs ("START DATE"), and warrants that the existing electrical, plumbing, fire sprinkler, lighting, heating, ventilating and air conditioning systems ("HVAC"), and all other items which the Lessor is obligated to construct pursuant to the Work Letter attached hereto, if any, other than those constructed by Lessee, shall be in good operating condition on said date. 2.3 COMPLIANCE. Lessor warrants that the improvements comprising the Premises and the Common Areas comply with the building codes that were in effect at the time that each such improvement, or portion thereof, was constructed, and also with all applicable laws, covenants or restrictions of record, regulations, and ordinances ("Applicable Requirements") in effect on the Start Date. Said warranty does not apply to the use to which Lessee will put the Premises, modifications which may be required by the Americans with Disabilities Act or any similar laws as a result of Lessee's use (see Paragraph 50), or to any Alterations or Utility Installations (as defined in Paragraph 7.3(a)) made or to be made by Lessee. NOTE: LESSEE IS RESPONSIBLE FOR DETERMINING WHETHER OR NOT THE ZONING AND OTHER APPLICABLE REQUIREMENTS ARE APPROPRIATE FOR LESSEE'S INTENDED USE, AND ACKNOWLEDGES THAT PAST USES OF THE PREMISES MAY NO LONGER BE ALLOWED. IF THE Premises do not comply with said warranty, Lessor shall, except as otherwise provided, promptly after receipt of written notice from Lessee setting forth with specificity the nature and extent of such non-compliance, rectify the same. If the Applicable Requirements are hereafter changed so as to require during the term of this Lease the construction of an addition to or an alteration of the Premises, the remediation of any Hazardous Substance, or the reinforcement or other physical modification of the Premises ("Capital Expenditure"), Lessor and Lessee shall allocate the cost of such work as follows: (a) Subject to Paragraph 2.3(c) below, if such Capital Expenditures are required as a result of the specific and unique use of the Premises by Lessee as compared with uses by tenants in general, Lessee shall be fully responsible for the cost thereof, provided, however that if such Capital Expenditure is required during the last 2 years of this Lease and the cost thereof exceeds 6 months' Base Rent, Lessee may instead terminate this Lease unless Lessor notifies Lessee, in writing, within 10 days after receipt of Lessee's termination notice that Lessor has elected to pay the difference between the actual cost thereof and the amount equal to 6 months' Base Rent. If Lessee elects termination, Lessee shall immediately cease the use of the Premises which requires such Capital Expenditure and deliver to Lessor written notice specifying a termination date at least 90 days thereafter. Such termination date shall, however, in no event be earlier than the last day that Lessee could legally utilize the Premises without commencing such Capital Expenditure. (b) If such Capital Expenditure is not the result of the specific and unique use of the Premises by Lessee (such as, governmentally mandated seismic modifications), then Lessor and Lessee shall allocate the cost of such Capital Expenditure as follows: Lessor shall advance the funds necessary for such Capital Expenditure but Lessee shall be obligated to pay, each month during the remainder of the term of this Lease, on the date on which Base Rent is due, an amount equal to the product of multiplying Lessee's share of the cost of such Capital Expenditure (the percentage specified in Paragraph 1.6 by a fraction, the numerator of which is one, and the denominator of which is 144 (le. 1/144th of the cost per month). Lessee shall pay interest on the unamortized balance of Lessee's share at a rate that is commercially reasonable in the judgment of Lessor's accountants. Lessee may, however, prepay its obligation at any time. Provided, however, that if such Capital Expenditure is required during the last 2 years of this Lease or if Lessor reasonably determines that it is not economically feasible to pay its share thereof, Lessor shall have the option to terminate this Lease upon 90 days prior written notice to Lessee unless Lessee notifies Lessor, in writing, within 10 days after receipt of Lessor's termination notice that Lessee will pay for such Capital Expenditure. If Lessor does not elect to terminate, and fails to tender its share of any such Capital Expenditure, Lessee may advance such funds and deduct same, with Interest, from Rent until Lessor's share of such costs have been fully paid. If Lessee is unable to finance Lessor's share, or if the balance of the Rent due and payable for the remainder of this Lease is not sufficient to fully reimburse Lessee on an offset basis, Lessee shall have the right to terminate this Lease upon 30 days written notice to Lessor. (c) Notwithstanding the above, the provisions concerning Capital Expenditures are intended to apply only to nonvoluntary, unexpected, and new Applicable Requirements. If the Capital Expenditures are instead triggered by Lessee as a result of an actual or proposed change in use, change in intensity of use, modification to the Premises then, and in that event, Lessee shall be fully responsible for the cost thereof, and Lessee shall not have any right to terminate this Lease. 2.4 ACKNOWLEDGEMENTS. Lessee acknowledges that: (a) Lessee has been advised by Lessor and/or Brokers to satisfy itself with respect to the condition of the Premises (including but not limited to the electrical, HVAC and fire sprinkler systems, security, environmental aspects, and compliance with Applicable Requirements), and their suitability for Lessee's intended use, (b) Lessee has made such investigation as it deems necessary with reference to such matters and assumes all responsibility therefor as the same relate to its occupancy of the Premises, and (C) neither Lessor, Lessor's agents, nor Brokers have made any oral or written representations or warranties with respect to said matters other than as set forth in this Lease. In addition, Lessor acknowledges that: (i) Brokers have made no representations, promises or warranties concerning Lessee's ability to honor the Lease or suitability to occupy the Premises, and (ii) it is Lessor's sole responsibility to investigate the financial capability and/or suitability of all proposed tenants. 2.5 LESSEE AS PRIOR OWNER/OCCUPANT. The warranties made by Lessor in Paragraph 2 shall be of no force or effect if immediately prior to the Start Date, Lessee was the owner or occupant of the Premises. In such event, Lessee shall be responsible for any necessary corrective work. 2.6 VEHICLE PARKING. So long as Lessee is not in default, and subject to the Rules and Regulations attached hereto, and as established by Lessor from time to time, Lessee shall be entitled to rent and use the number of parking spaces specified in Paragraph 1.2(b) at the rental rate applicable from time to time for monthly parking as set by Lessor and/or its licensee. (a) If Lessee commits, permits or allows any of the prohibited activities described in the Lease or the rules then in effect, then Lessor shall have the right, without notice, in addition to such other rights and remedies that it may have, to remove or tow away the vehicle involved and charge the cost to Lessee, which cost shall be immediately payable upon demand by Lessor. (b) The monthly rent per parking space specified in Paragraph 1.2(b) is subject to change upon 30 days prior written notice to Lessee. The rent for the parking is payable one month in advance prior to the first day of each calendar month. 2.7 COMMON AREAS - DEFINITION. THE term "COMMON AREAS" is defined as all areas and facilities outside the Premises and within the exterior boundary line of the Project and interior utility raceways and installations within the Premises that are provided and designated by the Lessor from time to time for the general nonexclusive use of Lessor, Lessee and other tenants of the Project and their respective employees, suppliers, shippers, customers, contractors and invitees, including, but not limited to, common entrances, lobbies, corridors, stairwells, public restrooms, elevators, parking areas, loading and unloading areas, trash areas, roadways, walkways, driveways and landscaped areas. 2.8 COMMON AREAS - Lessee's Rights. Lessor grants to Lessee, for the benefit of Lessee and its employees, suppliers, shippers, contractors, customers and invitees, during the term of this Lease, the nonexclusive right to use, in common with others entitled to such use, the Common Areas as they exist from time to time, subject to any rights, powers, and privileges reserved by Lessor under the terms hereof or under the terms of any rules and regulations or restrictions governing the use of the Project. Under no circumstances shall the right herein granted to use the Common Areas be deemed to include the right to store any property, temporarily or permanently, in the Common Areas. Any such storage shall be permitted only by the prior written consent of Lessor or Lessor's designated agent, which consent may be revoked at any time. In the event that any unauthorized storage shall occur then Lessor shall have the right, without notice, in addition to such other rights and remedies that it may have, to remove the property and charge the cost to Lessee, which cost shall be immediately payable upon demand by Lessor. 2.9 COMMON AREAS - Rules and Regulations. Lessor or such other person(s) as Lessor may appoint shall have the exclusive control and management of the Common Areas and shall have the right, from time to time, to adopt, modify, amend and enforce reasonable rules and regulations ("Rules and Regulations") for the management, safety, care, and cleanliness of the grounds, the parking and unloading of vehicles and the preservation of good order, as well as for the convenience of other occupants or tenants of the Building and the Project and their invitees. The Lessee agrees to abide by and conform to all such Rules and Regulations, and to cause its employees, suppliers, shippers, customers, contractors and invitees to so abide and conform, Lessor shall not be responsible to Lessee for the noncompliance with said Rules and Regulations by other tenants of the Project. 2.10 COMMON AREAS - Changes. Lessor shall have the right, in Lessor's sole discretion, from time to time: (a) To make changes to the Common Areas, including, without limitation, changes in the location, size, shape and number of the lobbies, windows, stairways, air shafts, elevators, escalators, restrooms, driveways, entrances, parking spaces, parking areas, loading and unloading areas, ingress, egress, direction of traffic, landscaped areas, walkways and utility raceways; (b) To close temporarily any of the Common Areas for maintenance purposes so long as reasonable access to the Premises remains available; (c) To designate other land outside the boundaries of the Project to be a part of the Common Areas; (d) To add additional buildings and improvements to the Common Areas; (e) To use the Common Areas while engaged in making additional improvements, repairs or alterations to the Project, or any portion thereof; and (f) To do and perform such other acts and make such other changes in, to or with respect to the Common Areas and Project as Lessor may, in the exercise of sound business judgment, deem to be appropriate. 3. TERM. 3.1 TERM. The Commencement Date, Expiration Date and Original Term of this Lease are as specified in Paragraph 1.3. 3.2 EARLY POSSESSION. If Lessee totally or partially occupies the Premises prior to the Commencement Date, the obligation to pay Base Rent shall be abated for the period of such early possession. All other terms of this Lease (including but not limited to the obligations to pay Lessee's Share of the Operating Expense Increase) shall, however, be in effect during such period. Any such early possession shall not affect the Expiration Date. 3.3 DELAY IN POSSESSION. Lessor agrees to use its best commercially reasonable efforts to deliver possession of the Premises to Lessee by the Commencement Date. If, despite said efforts, Lessor is unable to deliver possession by such date, Lessor shall not be subject to any liability therefor, nor shall such failure affect the validity of this Lease. Lessee shall not, however, be obligated to pay Rent or perform its other obligations until Lessor delivers possession of the Premises and any period of rent abatement that Lessee would otherwise have enjoyed shall run from the date of delivery of possession and continue for a period equal to what Lessee would otherwise have enjoyed under the terms hereof, but minus any days of delay caused by the acts or omissions of Lessee. If possession is not delivered within 60 days after the Commencement Date, as the same may be extended under the terms of any Work Letter executed by Parties, Lessee may, at its option, by notice in writing within 10 days after the end of such 60 day period, cancel this Lease, in which event the Parties shall be discharged from all obligations hereunder. If such written notice is not received by Lessor within said 10 day period, Lessee's right to cancel shall terminate. If possession of the Premises is not delivered within 120 days after the Commencement Date, this Lease shall terminate unless other agreements are reached between Lessor and Lessee, in writing. 3.4 LESSEE COMPLIANCE. Lessor shall not be required to deliver possession of the Premises to Lessee until Lessee complies with its obligation to provide evidence of insurance (Paragraph 8.5). Pending delivery of such evidence, Lessee shall be required to perform all of its obligations under this Lease from and after the Start Date, including the payment of Rent, notwithstanding Lessor's election to withhold possession pending receipt of such evidence of insurance. Further, if Lessee is required to perform any other conditions prior to or concurrent with the Start Date, the Start Date shall occur but Lessor may elect to withhold possession until such conditions are satisfied. 4. RENT. 4.1 RENT DEFINED. All monetary obligations of Lessee to Lessor under the terms of this Lease (except for the Security Deposit) are deemed to be rent ("Rent"). 4.2 OPERATING EXPENSE INCREASE. If the building is less than 95% occupied, the base year expenses shall be grossed up to a 95% occupancy level arid fully assessed for real estate tax purposes. Lessee shall pay to Lessor during the term hereof, in addition to the Base Rent, Lessee's Share of the amount by which all Operating Expenses for each Comparison Year exceeds the amount of all Operating Expenses for the Base Year, such excess being hereinafter referred to as the "OPERATING EXPENSE LNCREASE", in accordance with the following provisions: (a) "BASE YEAR" is as specified in Paragraph 1.9. (b) "COMPARISON YEAR" is defined as each calendar year during the term of this Lease subsequent to the Base Year; provided, however, Lessee shall have no obligation to pay a share of the Operating Expense Increase applicable to the first 12 months of the Lease Term (other than such as are mandated by a governmental authority, as to which government mandated expenses Lessee shall pay Lessee's Share, notwithstanding they occur during the first twelve (12) months). Lessee's Share of the Operating Expense Increase for the first and last Comparison Years of the Lease Term shall be prorated according to that portion of such Comparison Year as to which Lessee is responsible for a share of such increase. (c) "OPERATING EXPENSES" include all costs incurred by Lessor relating to the ownership and operation of the Project, calculated as if the Project was at least 95% occupied. including, but not limited to, the following: (i) The operation, repair, and maintenance in neat, clean, safe, good order and condition, but not the replacement (see subparagraph (g)), of the following: (aa) The Common Areas, including their surfaces, coverings, decorative items, carpets, drapes and window coverings, and including parking areas, loading and unloading areas, trash areas, roadways, sidewalks, walkways, stairways, parkways, driveways, landscaped areas, striping, bumpers, irrigation systems, Common Area lighting facilities, building exteriors and roofs, fences and gates; (bb) All heating, air conditioning, plumbing, electrical systems, life safety equipment, communication systems and other equipment used in common by, or for the benefit of, lessees or occupants of the Project, including elevators and escalators, tenant directories, fire detection systems including sprinkler system maintenance and repair. (ii) Trash disposal, janitorial and security services, pest control services, and the costs of any environmental inspections; (iii) Any other service to be provided by Lessor that is elsewhere in this Lease stated to be an "Operating Expense"; (iv) The cost of the premiums for the insurance policies maintained by Lessor pursuant to paragraph 8 and any deductible portion of an insured loss concerning the Building or the Common Areas; (v) The amount of the Real Property Taxes payable by Lessor pursuant to paragraph 10; (vi) The cost of water, sewer, gas, electricity, and other publicly mandated services not separately metered; (vii) Labor, salaries, and applicable fringe benefits and costs, materials, supplies and tools, used in maintaining and/or cleaning the Project and accounting and management fees attributable to the operation of the Project; (viii) The cost of any Capital Expenditure to the Building or the Project not covered under the provisions of Paragraph 2.3 provided; however, that Lessor shall allocate the cost of any such Capital Expenditure over a 12 year period and Lessee shall not be required to pay more than Lessee's Share of 1/144th of the cost of such Capital Expenditure in any given month; (ix) Replacement of equipment or improvements that have a useful life for accounting purposes of 5 years or less. (d) Any item of Operating Expense that is specifically attributable to the Premises, the Building or to any other building in the Project or to the operation, repair and maintenance thereof, shall be allocated entirely to such Premises, Building, or other building. However, any such item that is not specifically attributable to the Building or to any other building or to the operation, repair and maintenance thereof, shall be equitably allocated by Lessor to all buildings in the Project. (e) The inclusion of the improvements, facilities and services set forth in Subparagraph 4.2(c) shall not be deemed to impose an obligation upon Lessor to either have said improvements or facilities or to provide those services unless the Project already has the same, Lessor already provides the services, or Lessor has agreed elsewhere in this Lease to provide the same or some of them. (9 Lessee's Share of Operating Expense Increase shall be payable by Lessee within 10 days after a reasonably detailed statement of actual expenses is presented to Lessee by Lessor. At Lessor's option, however, an amount may be estimated by Lessor from time to time in advance of Lessee's Share of the Operating Expense Increase for any Comparison Year, and the same shall be payable monthly during each Comparison Year of the Lease term, on the same day as the Base Rent is due hereunder. In the event that Lessee pays Lessor's estimate of Lessee's Share of Operating Expense Increase as aforesaid, Lessor shall deliver to Lessee within 60 days after the expiration of each Comparison Year a reasonably detailed statement showing Lessee's Share of the actual Operating Expense Increase incurred during such year. If Lessee's payments under this paragraph (9 during said Comparison Year exceed Lessee's Share as indicated on said statement, Lessee shall be entitled to credit the amount of such overpayment against Lessee's Share of Operating Expense Increase next falling due. If Lessee's payments under this paragraph during said Comparison Year were less than Lessee's Share as indicated on said statement, Lessee shall pay to Lessor the amount of the deficiency within 10 days after delivery by Lessor to Lessee of said statement. Lessor and Lessee shall forthwith adjust between them by cash payment any balance determined to exist with respect to that portion of the last Comparison Year for which Lessee is responsible as to Operating Expense Increases, notwithstanding that the Lease term may have terminated before the end of such Comparison Year. (g) Operating Expenses shall not include the costs of replacement for equipment or capital components such as the roof, foundations, exterior walls or a Common Area capital improvement, such as the parking lot paving, elevators, fences that have a useful life for accounting purposes of 5 years or more unless it is of the type described in paragraph 4.2(c) (viii), in which case their cost shall be included as above provided. (h) Operating Expenses shall not include any expenses paid by any tenant directly to third parties, or as to which Lessor is otherwise reimbursed by any third party, other tenant, or by insurance proceeds. 4.3 PAYMENT. Lessee shall cause payment of Rent to be received by Lessor in lawful money of the United States on or before the day on which it is due, without offset or deduction (except as specifically permitted in this Lease). Rent for any period during the term hereof which is for less than one full calendar month shall be prorated based upon the actual number of days of said month. Payment of Rent shall be made to Lessor at its address stated herein or to such other persons or place as Lessor may from time to time designate in writing. Acceptance of a payment which is less than the amount then due shall not be a waiver of Lessor's rights to the balance of such Rent, regardless of Lessor's endorsement of any check so stating. In the event that any check, draft, or other instrument of payment given by Lessee to Lessor is dishonored for any reason, Lessee agrees to pay to Lessor the sum or ~25 in addition to any Late Charge. Payments will be applied first to accrued late charges and attorney's fees, second to accrued interest, then to Base Rent and Operating Expense increase, and any remaining amount to any other outstanding charges or costs. 5. SECURITY DEPOSIT. Lessee shall deposit with Lessor upon execution hereof the Security Deposit as security for Lessee's faithful performance of its obligations under this Lease. If Lessee fails to pay Rent, or otherwise Defaults under this Lease, Lessor may use, apply or retain all or any portion of said Security Deposit for the payment of any amount due Lessor or to reimburse or compensate Lessor for any liability, expense, loss or damage which Lessor may suffer or incur by reason thereof. If Lessor uses or applies all or any portion of the Security Deposit, Lessee shall within 10 days after written request therefor, deposit monies with Lessor sufficient to restore said Security Deposit to the full amount required by this Lease. If the Base Rent increases during the term of this Lease, Lessee shall, upon written request from Lessor, deposit additional moneys with Lessor so that the total amount of the Security Deposit shall at all times bear the same proportion to the increased Base Rent as the initial Security Deposit bore to the initial Base Rent. Should the Agreed Use be amended to accommodate a material change in the business of Lessee or to accommodate a sublessee or assignee, Lessor shall have the right to increase the Security Deposit to the extent necessary, in Lessor's reasonable judgment, to account for any increased wear and tear that the Premises may suffer as a result thereof. If a change in control of Lessee occurs during this Lease and following such change the financial condition of Lessee is, in Lessor's reasonable judgment, significantly reduced, Lessee shall deposit such additional monies with Lessor as shall be sufficient to cause the Security Deposit to be at a commercially reasonable level based on such change in financial condition. Lessor shall not be required to keep the Security Deposit separate from its general accounts. Within 14 days after the expiration or termination of this Lease, if Lessor elects to apply the Security Deposit only to unpaid Rent, and otherwise within 30 days after the Premises have been vacated pursuant to Paragraph 7.4(c) below, Lessor shall return that portion of the Security Deposit not used or applied by Lessor. No part of the Security Deposit shall be considered to be held in trust, to bear interest or to be prepayment for any monies to be paid by Lessee under this Lease. 6. USE. 6.1 USE. Lessee shall use and occupy the Premises only for the Agreed Use, or any other legal use which is reasonably comparable thereto, and for no other purpose. Lessee shall not use or permit the use of the Premises in a manner that is unlawful, creates damage, waste or a nuisance, or that disturbs occupants of or causes damage to neighboring premises or properties. Lessor shall not unreasonably withhold or delay its consent to any written request for a modification of the Agreed Use, so long as the same will not impair the structural integrity of the improvements of the Building, will not adversely affect the mechanical, electrical, HVAC, and other systems of the Building, and/or will not affect the exterior appearance of the Building. If Lessor elects to withhold consent, Lessor shall within 7 days after such request give written notification of same, which notice shall include an explanation of Lessor's objections to the change in the Agreed Use. 6.2 HAZARDOUS SUBSTANCES. See Addendum (a) REPORTABLE USES REQUIRE CONSENT. The term "Hazardous Substance" as used in this Lease shall mean any product, substance, or waste whose presence, use, manufacture, disposal, transportation, or release, either by itself or in combination with other materials expected to be on the Premises, is either: (i) potentially injurious to the public health, safety or welfare, the environment or the Premises, (ii) regulated or monitored by any governmental authority, or (iii) a basis for potential liability of Lessor to any governmental agency or third party under any applicable statute or common law theory. Hazardous Substances shall include, but not be limited to, hydrocarbons, petroleum, gasoline, and/or crude oil or any products, byproducts or fractions thereof. Lessee shall not engage in any activity in or on the Premises which constitutes a Reportable Use of Hazardous Substances without the express prior written consent of Lessor and timely compliance (at Lessee's expense) with all Applicable Requirements. "Reportable Use" shall mean (I) the installation or use of any above or below ground storage tank, (ii) the generation, possession, storage, use, transportation, or disposal of a Hazardous Substance that requires a permit from, or with respect to which a report, notice, registration or business plan is required to be filed with, any governmental authority, and/or (iii) the presence at the Premises of a Hazardous Substance with respect to which any Applicable Requirements requires that a notice be given to persons entering or occupying the Premises or neighboring properties. Notwithstanding the foregoing, Lessee may use any ordinary and customary materials reasonably required to be used in the normal course of the Agreed Use such as ordinary office supplies (copier toner, liquid paper, glue, etc.) and common household cleaning materials, so long as such use is in compliance with all Applicable Requirements, is not a Reportable Use, and does not expose the Premises or neighboring property to any meaningful risk of contamination or damage or expose Lessor to any liability therefor. In addition, Lessor may condition its consent to any Reportable Use upon receiving such additional assurances as Lessor reasonably deems necessary to protect itself, the public, the Premises and/or the environment against damage. contamination, injury and/or liability, including, but not limited to, the installation (and removal on or before Lease expiration or termination) of protective modifications (such as concrete encasements) and/or increasing the Security Deposit. (b) Duty to Inform Lessor. If Lessee knows, or has reasonable cause to believe, that a Hazardous Substance has come to be located in, on, under or about the Premises, other than as previously consented to by Lessor, Lessee shall immediately give written notice of such fact to Lessor, and provide Lessor with a copy of any report, notice, claim or other documentation which it has concerning the presence of such Hazardous Substance. (c) Lessee Remediation. Lessee shall not cause or permit any Hazardous Substance to be spilledor releasedin,on,under, or about the Premises (including through the plumbing or sanitary sewer system) and shall promptly, at Lessee's expense, comply with all Applicable Requirements and take all investigatory and/or remedial action reasonably recommended, whether or not formally ordered or required, for the cleanup of any contamination of, and for the maintenance, security and/or monitoring of the Premises or neighboring properties, that was caused or materially contributed to by Lessee, or pertaining to or involving any Hazardous Substance brought onto the Premises during the term of this Lease, by or for Lessee, or any third party. (d) Lessee Indemnification. Lessee shall indemnify, defend and hold Lessor, its agents, employees, lenders and ground lessor, if any, harmless from and against any and all loss of rents and/or damages, liabilities, judgments, claims, expenses, penalties, and attorneys' and consultants' fees arising out of or involving any Hazardous Substance brought onto the Premises by or for Lessee, or any third party (provided, however, that Lessee shall have no liability under this Lease with respect to underground migration of any Hazardous Substance under the Premises from areas outside of the Project not caused or contributed to by Lessee). Lessee's obligations shall include, but not be limited to, the effects of any contamination or injury to person, property or the environment created or suffered by Lessee, and the cost of investigation, removal, remediation, restoration and/or abatement, and shall survive the expiration or termination of this Lease. No termination, cancellation or release agreement entered into by Lessor and Lessee shall release Lessee from its obligations under this Lease with respect to Hazardous Substances, unless specifically so agreed by Lessor in writing at the time of such agreement. (e) Lessor Indemnification. Lessor and its successors and assigns shall indemnify, defend, reimburse and hold Lessee, its employees and lenders, harmless from and against any and all environmental damages, including the cost of remediation, which result from Hazardous Substances which existed on the Premises prior to Lessee's occupancy or which are caused by the gross negligence or willful misconduct of Lessor, its agents or employees. Lessor's obligations, as and when required by the Applicable Requirements, shall include, but not be limited to, the cost of investigation, removal, remediation, resto.r.ation and/or abatement, and shall survive the expiration or termination of this Lease. (f) Investigations and Remediations. Lessor shall retain the responsibility and pay for any investigations or remediation measures required by governmental entities having jurisdiction with respect to the existence of Hazardous Substances on the Premises prior to Lessee's occupancy, unless such remediation measure is required as a result of Lessee's use (including "Alterations", as defined in paragraph 7.3(a) below) of the Premises, in which event Lessee shall be responsible for such payment. Lessee shall cooperate fully in any such activities at the request of Lessor, including allowing Lessor and Lessor's agents to have reasonable access to the Premises at reasonable times in order to carry out Lessor's investigative and remedial responsibilities. (g) Lessor Termination Option. If a Hazardous Substance Condition (see Paragraph 9.1(e)) occurs during the term of this Lease, unless Lessee is legally responsible therefor (in which case Lessee shall make the investigation and remediation thereof required by the Applicable Requirements and this Lease shall continue in full force and effect, but subject to Lessor's rights under Paragraph 6.2(d) and Paragraph 13), Lessor may, at Lessor's option, either (i) investigate and remediate such Hazardous Substance Condition, if required, as soon as reasonably possible at Lessor's expense, in which event this Lease shall continue in full force and effect, or (ii) if the estimated cost to remediate such condition exceeds 12 times the then monthly Base Rent or $100,000, whichever is greater, give written notice to Lessee, within 30 days after receipt by Lessor of knowledge of the occurrence of such Hazardous Substance Condition, of Lessor's desire to terminate this Lease as of the date 60 days following the date of such notice. in the event Lessor elects to give a termination notice, Lessee may, within 10 days thereafter, give written notice to Lessor of Lessee's commitment to pay the amount by which the cost of the remediation of such Hazardous Substance Condition exceeds an amount equal to 12 times the then monthly Base Rent or $100,000, whichever is greater. Lessee shall provide Lessor with said funds or satisfactory assurance thereof within 30 days following such commitment. In such event, this Lease shall continue in full force and effect, and Lessor shall proceed to make such remediation as soon as reasonably possible after the required funds are available, if Lessee does not give such notice and provide the required funds or assurance thereof within the time provided, this Lease shall terminate as of the date specified in Lessor's notice of termination. 6.3 Lessee's Compliance with Applicable Requirements. Except as otherwise provided in this Lease, Lessee shall, at Lessee's sole expense, fully, diligently and in a timely manner, materially comply with all Applicable Requirements, the requirements of any applicable fire insurance underwriter or rating bureau, and the recommendations of Lessor's engineers and/or consultants which relate in any manner to the Premises, without regard to whether said requirements are now in effect or become effective after the Start Date. Lessee shall, within 10 days after receipt of Lessor's written request, provide Lessor with copies of all permits and other documents, and other information evidencing Lessee's compliance with any Applicable Requirements specified by Lessor, and shall immediately upon receipt, notify Lessor in writing (with copies of any documents involved) of any threatened or actual claim, notice, citation, warning, complaint or report pertaining to or involving the failure of Lessee or the Premises to comply with any Applicable Requirements. 6.4 Inspection; Compliance. Lessor and Lessor's "Lender" (as defined in Paragraph 30) and consultants shall have the right to enter into Premises at any time, in the case of an emergency, and otherwise at reasonable times, for the purpose of inspecting the condition of the Premise and for verifying compliance by Lessee with this Lease. The cost of any such inspections shall be paid by Lessor, unless a violation of Applicable Requirements, or a Hazardous Substance Condition (see paragraph 9.le) is found to exist or be imminent, or the inspection is requested or ordered by a governmental authority. In such case, Lessee shall upon request reimburse Lessor for the cost of such inspection, so long as such inspection is reasonably related to the violation or contamination. 7. MAINTENANCE; REPAIRS; UTILITY INSTALLATIONS; TRADE FIXTURES AND ALTERATIONS. 7.1 LESSEE'S OBLIGATIONS. Notwithstanding Lessor's obligation to keep the Premises in good condition and repair, Lessee shall be responsible for payment of the cost thereof to Lessor as additional rent for that portion of the cost of any maintenance and repair of the Premises, or any equipment (wherever located) that serves only Lessee or the Premises, to the extent such cost is attributable to causes beyond normal wear and tear. Lessee shall be responsible for the cost of painting, repairing or replacing wall coverings, and to repair or replace any improvements with the Premises. Lessor may, at its option, upon reasonable notice, elect to have Lessee perform any particular such maintenance or repairs the cost of which is otherwise Lessee's responsibility hereunder. 7.2 LESSOR'S OBLIGATIONS. Subject to the provisions of Paragraphs 2.2 (Condition), 2.3 (Compliance), 4.2 (Operating Expenses), 6 (Use), 7.1 (Lessee's Obligations), 9 (Damage or Destruction) and 14 (Condemnation), Lessor, subject to reimbursement pursuant to Paragraph 4.2, shall keep in good order, condition and repair the foundations, exterior walls, structural condition of interior bearing walls, exterior roof, fire sprinkler system, fire alarm and/or smoke detection systems, fire hydrants, and the Common Areas. Lessee expressly waives the benefit of any statute now or hereafter in effect to the extent it is inconsistent with the terms of this Lease. 7.3 "UTILITY INSTALLATIONS; TRADE FIXTURES; ALTERATIONS. (a) DEFINITIONS. The term "Utility Installations" refers to all floor and window coverings, air lines, vacuum lines, power panels, electrical distribution, security and fire protection systems, communication cabling, lighting fixtures, HVAC equipment, and plumbing in or on the Premises. The term "Trade Fixtures" shall mean Lessee's machinery and equipment that can be removed without doing material damage to the Premises. The term Alterations" shall mean any modification of the improvements, other than Utility Installations or Trade Fixtures, whether by addition or deletion. "Lessee Owned Alterations and or Utility Installations" are defined as Alterations and/or Utility Installations made by Lessee that are not yet owned by Lessor pursuant to Paragraph 7.4(a). (b) CONSENT. Lessee shall not make any Alterations or Utility Installations to the Premises without Lessor's prior written consent. Lessee may, however, make non-structural Utility Installations to the interior of the Premises (excluding the roof) without such consent but upon notice to Lessor, as long as they are not visible from the outside, do not involve puncturing, relocating or removing the roof, ceilings, floors or any existing walls, will not affect the electrical, plumbing, HVAC, and/or life safety systems, and the cumulative cost thereof during this Lease as extended does not exceed $2000. Notwithstanding the foregoing, Lessee shall not make or permit any roof penetrations and/or install anything on the roof without the prior written approval of Lessor. Lessor may, as a precondition to granting such approval, require Lessee to utilize a contractor chosen and/or approved by Lessor. Any Alterations or Utility Installations that Lessee shall desire to make and which require the consent of the Lessor shall be presented to Lessor in written form with detailed plans. Consent shall be deemed conditioned upon Lessee's: (i) acquiring all applicable governmental permits, (ii) furnishing Lessor with copies of both the permits and the plans and specifications prior to commencement of the work, and (iii) compliance with all conditions of said permits and other Applicable Requirements in a prompt and expeditious manner. Any Alterations or Utility Installations shall be performed in a workmanlike manner with good and sufficient materials. Lessee shall promptly upon completion furnish Lessor with asbuilt plans and specifications. For work which costs an amount in excess of one month's Base Rent, Lessor may condition its consent upon Lessee providing a lien and completion bond in an amount equal to 150% of the estimated cost of such Alteration or Utility Installation and/or upon Lessee's posting an additional Security Deposit with Lessor. (c) LIENS; Bonds. Lessee shall pay, when due, all claims for labor or materials furnished or alleged to have been furnished to or for Lessee at or for use on the Premises, which claims are or may be secured by any mechanic's or materialmen's lien against the Premises or any interest therein. Lessee shall give Lessor not less than 10 days notice prior to the commencement of any work in, on or about the Premises, and Lessor shall have the right to post notices of non-responsibility. If Lessee shall contest the validity of any such lien, claim or demand, then Lessee shall, at its sole expense defend and protect itself, Lessor and the Premises against the same and shall pay and satisfy any such adverse judgment that may be rendered thereon before the enforcement thereof. If Lessor shall require, Lessee shall furnish a surety bond in an amount equal to 150% of the amount of such contested lien, claim or demand, indemnifying Lessor against liability for the same. If Lessor elects to participate in any such action, Lessee shall pay Lessor's attorneys' fees and costs. 7.4 OWNERSHIP; REMOVAL; SURRENDER; AND RESTORATION. (a) Ownership. Subject to Lessor's right to require removal or elect ownership as hereinafter provided, all Alterations and Utility Installations made by Lessee shall be the property of Lessee, but considered a part of the Premises. Lessor may, at any time, elect in writing to be the owner of all or any specified part of the Lessee Owned Alterations and Utility Installations. Unless otherwise instructed per paragraph 7.4(b) hereof, all Lessee Owned Alterations and Utility Installations shall, at the expiration or termination of this Lease, become the property of Lessor and be surrendered by Lessee with the Premises. (b) REMOVAL. By delivery to Lessee of written notice from Lessor not earlier than 90 and not later than 30 days prior to the end of the term of this Lease, Lessor may require that any or all Lessee Owned Alterations or Utility Installations be removed by the expiration or termination of this Lease. Lessor may require the removal at any time of all or any part of any Lessee Owned Alterations or Utility Installations made without the required consent. (c) SURRENDER; Restoration. Lessee shall surrender the Premises by the Expiration Date or any earlier termination date, with all of the improvements, parts and surfaces thereof clean and free of debris, and in good operating order, condition and state of repair, ordinary wear and tear excepted. "Ordinary wear and tear" shall not include any damage or deterioration that would have been prevented by good maintenance practice. Notwithstanding the foregoing, if this Lease is for 12 months or less, then Lessee shall surrender the Premises in the same condition as delivered to Lessee on the Start Date with NO allowance for ordinary wear and tear. Lessee shall repair any damage occasioned by the installation, maintenance or removal of Trade Fixtures, Lessee owned Alterations and/or Utility Installations, furnishings, and equipment as well as the removal of any storage tank installed by or for Lessee. Lessee shall also completely remove from the Premises any and all Hazardous Substances brought onto the Premises by or for Lessee, or any third party (except Hazardous Substances which were deposited via underground migration from areas outside of the Project) even if such removal would require Lessee to perform or pay for work that exceeds statutory requirements. Trade Fixtures shall remain the property of Lessee and shall be removed by Lessee. The failure by Lessee to timely vacate the Premises pursuant to this Paragraph 7.4(c) without the express written consent of Lessor shall constitute a holdover under the provisions of Paragraph 26 below. 8. INSURANCE; INDEMNITY. 8.1 INSURANCE PREMIUMS. The cost of the premiums for the insurance policies maintained by Lessor pursuant to paragraph 8 are included as Operating Expenses (see paragraph 4.2 (c)(iv)). Said costs shall include increases in the premiums resulting from additional coverage related to requirements of the holder of a mortgage or deed of trust covering the Premises, Building and/or Project, increased valuation of the Premises, Building and/or Project, and/or a general premium rate increase. Said costs shall not, however, include any premium increases resulting from the nature of the occupancy of any other tenant of the Building. If the Project was not insured for the entirety of the Base Year, then the base premium shall be the lowest annual premium reasonably obtainable for the required insurance as of the Start Date, assuming the most nominal use possible of the Building and/or Project. In no event, however, shall Lessee be responsible for any portion of the premium cost attributable to liability insurance coverage in excess of $2,000,000 procured under Paragraph 8.2(b). 8.2 LIABILITY INSURANCE. (a) CARRIED BY LESSEE. Lessee shall obtain and keep in force a Commercial General Liability policy of insurance protecting Lessee and Lessor as an additional insured against claims for bodily injury, personal injury and property damage based upon or arising out of the ownership~ use, occupancy or maintenance of the Premises and all areas appurtenant thereto. Such insurance shall be on an occurrence basis providing single limit coverage in an amount not less than $1,000,000 per occurrence with an annual aggregate of not less than $2,000,000, an "Additional Insured-Managers or Lessors of Premises Endorsement" and contain the "Amendment of the Pollution Exclusion Endorsement" for damage caused by heat, smoke or fumes from a hostile fire. The policy shall not contain any intra-insured exclusions as between insured persons or organizations, but shall include coverage for liability assumed under this Lease as an "insured contract" for the performance of Lessee's indemnity obligations under this Lease. The limits of said insurance shall not, however, limit the liability of Lessee nor relieve Lessee of any obligation hereunder. All insurance carried by Lessee shall be primary to and not contributory with any similar insurance carried by Lessor, whose insurance shall be considered excess insurance only. (b) CARRIED BY LESSOR Lessor shall maintain liability insurance as described in Paragraph 8.2(a), in addition to, and not in lieu of, the insurance required to be maintained by Lessee. Lessee shall not be named as an additional insured therein. 8.3 PROPERTY INSURANCE - BUILDING, IMPROVEMENTS AND RENTAL VALUE. (a) BUILDING AND IMPROVEMENTS. Lessor shall obtain and keep in force a policy or policies of insurance in the name of Lessor, with loss payable to Lessor, any ground-lessor, and to any Lender insuring loss or damage to the Building and/or Project. The amount of such insurance shall be equal to the full replacement cost of the Building and/or Project, as the same shall exist from time to time, or the amount required by any Lender, but in no event more than the commercially reasonable and available insurable value thereof. Lessee Owned Alterations and Utility Installations, Trade Fixtures, and Lessee's personal property shall be insured by Lessee under Paragraph 8.4. If the coverage is available and commercially appropriate, such policy or policies shall insure against all risks of direct physical loss or damage (except the perils of flood and/or earthquake unless required by a Lender), including coverage for debris removal and the enforcement of any Applicable Requirements requiring the upgrading, demolition, reconstruction or replacement of any portion of the Premises as the result of a covered loss. Said policy or policies shall also contain an agreed valuation provision in lieu of any coinsurance clause, waiver of subrogation, and inflation guard protection causing an increase in the annual property insurance coverage amount by a factor of not less than the adjusted U.S. Department of Labor Consumer Price Index for All Urban Consumers for the city nearest to where the Premises are located. If such insurance coverage has a deductible clause, the deductible amount shall not exceed $1 000 per occurrence. (b) RENTAL VALUE. Lessor shall also obtain and keep in force a policy or policies in the name of Lessor with loss payable to Lessor and any Lender, insuring the loss of the full Rent for one year with an extended period of indemnity for an additional 180 days ("Rental Value insurance"). Said insurance shall contain an agreed valuation provision in lieu of any coinsurance clause, and the amount of coverage shall be adjusted annually to reflect the projected Rent otherwise payable by Lessee, for the next 12 month period. (c) ADJACENT PREMISES Lessee shall pay for any increase in the premiums for the property insurance of the Building and for the Common Areas or other buildings in the Project if said increase is caused by Lessee's acts, omissions, use or occupancy of the Premises. (d) LESSEE'S IMPROVEMENTS. Since Lessor is the Insuring Party, Lessor shall not be required to insure Lessee Owned Alterations and Utility Installations unless the item in question has become the property of Lessor under the terms of this Lease. 8.4 LESSEE'S PROPERTY; BUSINESS INTERRUPTION INSURANCE. (a) PROPERTY DAMAGE. Lessee shall obtain and maintain insurance coverage on all of Lessee's personal property, Trade Fixtures, and Lessee Owned Alterations and Utility Installations. Such insurance shall be full replacement cost coverage with a deductible of not to exceed $1,000 per occurrence. The proceeds from any such insurance shall be used by Lessee for the replacement of personal property, Trade Fixtures and Lessee Owned Alterations and Utility Installations. Lessee shall provide Lessor with written evidence that such insurance is in force. (b) BUSINESS INTERRUPTION. Lessee shall obtain and maintain loss of income and extra expense insurance in amounts as will reimburse Lessee for direct or indirect loss of earnings attributable to all perils commonly insured against by prudent lessees in the business of Lessee or attributable to prevention of access to the Premises as a result of such perils. (c) NO REPRESENTATION OF ADEQUATE COVERAGE. Lessor makes no representation that the limits or forms of coverage of insurance specified herein are , adequate to cover Lessee's property, business operations or obligations under this Lease. 8.5 INSURANCE POLICIES. Insurance required herein shall be by companies duly licensed or admitted to transact business in the state where the Premises are located, and maintaining during the policy term a "General Policyholders Rating" of at least B+, V, as set forth in the most current issue of "Best's Insurance Guide", or such other rating as may be required by a Lender. Lessee shall not do or permit to be done anything which invalidates the required insurance policies. Lessee shall, prior to the Start Date, deliver to Lessor certified copies of policies of such insurance or certificates evidencing the existence and amounts of the required insurance. No such policy shall be cancelable or subject to modification except after 30 days prior written notice to Lessor. Lessee shall, at least 30 days prior to the expiration of such policies, furnish Lessor with evidence of renewals or "insurance binders" evidencing renewal thereof, or Lessor may order such insurance and charge the cost thereof to Lessee, which amount shall be payable by Lessee to Lessor upon demand. Such policies shall be for a term of at least one year, or the length of the remaining term of this Lease, whichever is less. If either Party shall fail to procure and maintain the insurance required to be carried by it, the other Party may, but shall not be required to, procure and maintain the same. 8.6 WAIVER OF SUBROGATION. Without affecting any other rights or remedies, Lessee and Lessor each hereby release and relieve the other, and waive their entire right to recover damages against the other, for loss of or damage to its property arising out of or incident to the perils required to be insured against herein. The effect of such releases and waivers is not limited by the amount of insurance carried or required, or by any deductibles applicable hereto. The Parties agree to have their respective property damage insurance carriers waive any right to subrogation that such companies may have against Lessor or Lessee, as the case may be, so long as the insurance is not invalidated thereby. 8.7 INDEMNITY: Except for Lessor's gross negligence or willful misconduct, Lessee shall indemnify, protect, defend and hold harmless the Premises, Lessor and its agents, Lessor's master or ground lessor, partners and Lenders, from and against any and all claims, loss of rents and/or damages, liens, judgments, penalties, attorneys' and consultants' fees, expenses and/or liabilities arising out of, involving, or in connection with, the use and/or occupancy of the Premises by Lessee. If any action or proceeding is brought against Lessor by reason of any of the foregoing matters, Lessee shall upon notice defend the same at Lessee's expense by counsel reasonably satisfactory to Lessor and Lessor shall cooperate with Lessee in such defense. Lessor need not have first paid any such claim in order to be defended or indemnified. 8.8 EXEMPTION OF LESSOR FROM LIABILITY. Lessor shall not be liable for injury or damage to the person or goods, wares, merchandise or other property of Lessee, Lessee's employees, contractors, invitees, customers, or any other person in or about the Premises, whether such damage or injury is caused by or results from fire, steam, electricity, gas, water or rain, or from the breakage, leakage, obstruction or other defects of pipes, fire sprinklers, wires, appliances, plumbing, HVAC or lighting fixtures, or from any other cause, whether the said injury or damage results from conditions arising upon the Premises or upon other portions of the Building, or from other sources or places. Lessor shall not be liable for any damages arising from any act or neglect of any other tenant of Lessor nor from the failure of Lessor to enforce the provisions of any other lease in the Project. Notwithstanding Lessor's negligence or breach of this Lease, Lessor shall under no circumstances be liable for injury to Lessee's business or for any loss of income or profit therefrom. 9. DAMAGE OR DESTRUCTION. 9.1 DEFINITIONS. (a) "PREMISES PARTIAL DAMAGE" shall mean damage or destruction to the improvements on the Premises, other than Lessee Owned Alterations and Utility Installations, which can reasonably be repaired in 3 months or less from the date of the damage or destruction, and the cost thereof does not exceed a sum equal to 6 month's Base Rent. Lessor shall notify Lessee in writing within 30 days from the date of the damage or destruction as to whether or not the damage is Partial or Total. (b) "PREMISES TOTAL DESTRUCTION" shall mean damage or destruction to the improvements on the Premises, other than Lessee Owned Alterations and Utility Installations and Trade Fixtures, which cannot reasonably be repaired in 3 months or less from the date of the damage or destruction and/or the cost thereof exceeds a sum equal to 6 month's Base Rent. Lessor shall notify Lessee in writing within 30 days from the date of the damage or destruction as to whether or not the damage is Partial or Total, (c) "INSURED LOSS" shall mean damage or destruction to improvements on the Premises, other than Lessee Owned Alterations and Utility Installations and Trade Fixtures, which was caused by an event required to be covered by the insurance described in Paragraph 8.3(a), irrespective of any deductible amounts or coverage limits involved. (d) "REPLACEMENT COST" shall mean the cost to repair or rebuild the improvements owned by Lessor at the time of the occurrence to their condition existing immediately prior thereto, including demolition, debris removal and upgrading required by the operation of Applicable Requirements, and without deduction for depreciation. (e) "HAZARDOUS SUBSTANCE CONDITION" shall mean the occurrence or discovery of a condition involving the presence of, or a contamination by, a Hazardous Substance as defined in Paragraph 6.2(a), in, on, or under the Premises which requires repair, remediation, or restoration. 9.2 PARTIAL DAMAGE - Insured Loss. If a Premises Partial Damage that is an Insured Loss occurs, then Lessor shall, at Lessor's expense, repair such damage (but not Lessee's Trade Fixtures or Lessee Owned Alterations and Utility Installations) as soon as reasonably possible and this Lease shall continue in full force and effect; provided, however, that Lessee shall, at Lessor's election, make the repair of any damage or destruction the total cost to repair of which is $5,000 or less, and, in such event, Lessor shall make any applicable insurance proceeds available to Lessee on a reasonable basis for that purpose. Notwithstanding the foregoing, if the required insurance was not in force or the insurance proceeds are not sufficient to effect such repair, the Insuring Party shall promptly contribute the shortage in proceeds as and when required to complete said repairs. In the event, however, such shortage was due to the fact that, by reason of the unique nature of the improvements, full replacement cost insurance coverage was not commercially reasonable and available, Lessor shall have no obligation to pay for the shortage in insurance proceeds or to fully restore the unique aspects of the Premises unless Lessee provides Lessor with the funds to cover same, or adequate assurance thereof, within 10 days following receipt of written notice of such shortage and request therefor. If Lessor receives said funds or adequate assurance thereof within said 10 day period, the party responsible for making the repairs shall complete them as soon as"i"easonably possible and this Lease shall remain in full force and effect. If such funds or assurance are not received, Lessor may nevertheless elect by written notice to Lessee within 10 days thereafter to: (i) make such restoration and repair as is commercially reasonable with Lessor paying any shortage in proceeds, in which case this Lease shall remain in full force and effect, or (ii) have this Lease terminate 30 days thereafter. Lessee shall not be entitled to reimbursement of any funds contributed by Lessee to repair any such damage or destruction. Premises Partial Damage due to flood or earthquake shall be subject to Paragraph 9.3, notwithstanding that there may be some insurance coverage, but the net proceeds of any such insurance shall be made available for the repairs if made by either Party. 9.3 PARTIAL DAMAGE - Uninsured Loss. If a Premises Partial Damage that is not an Insured Loss occurs, unless caused by a negligent or willful act of Lessee (in which event Lessee shall make the repairs at Lessee's expense), Lessor may either: (i) repair such damage as soon as reasonably possible at Lessor's expense, in which event this Lease shall continue in full force and effect, or (ii) terminate this Lease by giving written notice to Lessee within 30 days after receipt by Lessor of knowledge of the occurrence of such damage. Such termination shall be effective 60 days following the date of such notice. In the event Lessor elects to terminate this Lease, Lessee shall have the right within 10 days after receipt of the termination notice to give written notice to Lessor of Lessee's commitment to pay for the repair of such damage without reimbursement from Lessor. Lessee shall provide Lessor with said funds or satisfactory assurance thereof within 30 days after making such commitment. In such event this Lease shall continue in full force and effect, and Lessor shall proceed to make such repairs as soon as reasonably possible after the required funds are available. If Lessee does not make the required commitment, this Lease shall terminate as of the date specified in the termination notice. 9.4 TOTAL DESTRUCTION. Notwithstanding any other provision hereof, if a Premises Total Destruction occurs, this Lease shall terminate 60 days following such Destruction. If the damage or destruction was caused by the gross negligence or willful misconduct of Lessee, Lessor shall have the right to recover Lessor's damages from Lessee, except as provided in Paragraph 8.6. 9.5 DAMAGE NEAR END OF TERM. If at any time during the last 6 months of this Lease there is damage for which the cost to repair exceeds one month's Base Rent, whether or not an Insured Loss, Lessor may terminate this Lease effective 60 days following the date of occurrence of such damage by giving a written termination notice to Lessee within 30 days after the date of occurrence of such damage. Notwithstanding the foregoing, if Lessee at that time has an exercisable option to extend this Lease or to purchase the Premises, then Lessee may preserve this Lease by, (a) exercising such option and (b) providing Lessor with any shortage in insurance proceeds (or adequate assurance thereof) needed to make the repairs on or before the earlier of (i) the date which is 10 days after Lessee's receipt of Lessor's written notice purporting to terminate this Lease, or (ii) the day prior to the date upon which such option expires. If Lessee duly exercises such option during such period and provides Lessor with funds (or adequate assurance thereof) to cover any shortage in insurance proceeds, Lessor shall, at Lessor's commercially reasonable expense, repair such damage as soon as reasonably possible and this Lease shall continue in full force and effect If Lessee fails to exercise such option and provide such funds or assurance during such period, then this Lease shall terminate on the date specified in the termination notice and Lessee's option shall be extinguished. 9.6 ABATEMENT OF RENT; LESSEE'S REMEDIES. (a) ABATEMENT. In the event of Premises Partial Damage or Premises Total Destruction or a Hazardous Substance Condition for which Lessee is not responsible under this Lease, the Rent payable by Lessee for the period required for the repair, remediation or restoration of such damage shall be abated in proportion to the degree to which Lessee's use of the Premises is impaired, but not to exceed the proceeds received from the Rental Value insurance. All other obligations of Lessee hereunder shall be performed by Lessee, and Lessor shall have no liability for any such damage, destruction, remediation, repair or restoration except as provided herein. (b) REMEDIES. If Lessor shall be obligated to repair or restore the Premises and does not commence, in a substantial and meaningful way, such repair or restoration within 90 days after such obligation shall accrue, Lessee may, at any time prior to the commencement of such repair or restoration, give written notice to Lessor and to any Lenders of which Lessee has actual notice, of Lessee's election to terminate this Lease on a date not less than 60 days following the giving of such notice. If Lessee gives such notice and such repair or restoration is not commenced within 30 days thereafter, this Lease shall terminate as of the date specified in said notice. If the repair or restoration is commenced within such 30 days, this Lease shall continue in full force and effect. "Commence" shall mean either the unconditional authorization of the preparation of the required plans, or the beginning of the actual work on the Premises, whichever first occurs. 9.7 TERMINATION; ADVANCE PAYMENTS. Upon termination of this Lease pursuant to Paragraph 6.2(g) or Paragraph 9, an equitable adjustment shall be made concerning advance Base Rent and any other advance payments made by Lessee to Lessor. Lessor shall, in addition, return to Lessee so much of Lessee's Security Deposit as has not been, or is not then required to be, used by Lessor. 9.8 WAIVE STATUTES. Lessor and Lessee agree that the terms of this Lease shall govern the effect of any damage to or destruction of the Premises with respect to the termination of this Lease and hereby waive the provisions of any present or future statute to the extent inconsistent herewith. 10. REAL PROPERTY TAXES. 10.1 DEFINITIONS. As used herein, the term "REAL PROPERTY TAXES" shall include any form of assessment; real estate, general, special, ordinary or extraordinary, or rental levy or tax (other than inheritance, personal income or estate taxes); improvement bond; and/or license fee imposed upon or levied against any legal or equitable interest of Lessor in the Project, Lessor's right to other income therefrom, and/or Lessor's business of leasing, by any authority having the direct or indirect power to tax and where the funds are generated with reference to the Project address and where the proceeds so generated are to be applied by the city, county or other local taxing authority of a jurisdiction within which the Project is located. "REAL PROPERTY TAXES" SHALL also include any tax, fee, levy, assessment or charge, or any increase therein, imposed by reason of events occurring during the term of this Lease, including but not limited to, a change in the ownership of the Project or any portion thereof or a change in the improvements thereon. 10.2 PAYMENT OF TAXES. Except as otherwise provided in Paragraph 10.3, Lessor shall pay the Real Property Taxes applicable to the Project, and said payments shall be included in the calculation of Operating Expenses in accordance with the provisions of Paragraph 4.2. 10.3 ADDITIONAL IMPROVEMENTS. Operating Expenses shall not include Real Property Taxes specified in the tax assessor's records and work sheets as being caused by additional improvements placed upon the Project by other lessees or by Lessor for the exclusive enjoyment of such other lessees. Notwithstanding Paragraph 10.2 hereof, Lessee shall, however, pay to Lessor at the time Operating Expenses are payable under Paragraph 4.2, the entirety of any increase in Real Property Taxes if assessed solely by reason of Alterations, Trade Fixtures or Utility Installations placed upon the Premises by Lessee or at Lessee's request. 10.4 JOINT ASSESSMENT. If the Building is not separately assessed, Real Property Taxes allocated to the Building shall be an equitable proportion of the Real Property Taxes for all of the land and improvements included within the tax parcel assessed, such proportion to be determined by Lessor from the respective valuations assigned in the assessor's work sheets or such other information as may be reasonably available. Lessor's reasonable determination thereof, in good faith, shall be conclusive. 10.5 PERSONAL PROPERTY TAXES. Lessee shall pay prior to delinquency all taxes assessed against and levied upon Lessee Owned Alterations and Utility Installations, Trade Fixtures, furnishings, equipment and all personal property of Lessee contained in the Premises. When possible, Lessee shall cause its Lessee Owned Alterations and Utility Installations, Trade Fixtures, furnishings, equipment and all other personal property to be assessed and billed separately from the real property of Lessor. If any of Lessee's said property shall be assessed with Lessor's real property, Lessee shall pay Lessor the taxes attributable to Lessee's property within 10 days after receipt of a written statement setting forth the taxes applicable to Lessee's property. 11. UTILITIES AND SERVICES. 11.1 SERVICES PROVIDED BY LESSOR. Lessor shall provide heating, ventilation, air conditioning, reasonable amounts of electricity for the common area only. ------------------------------------------------------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 11.2 SERVICES EXCLUSIVE TO LESSEE. Lessee shall pay for all water, sewer, gas, heat, light, power, telephone, trash and other utilities and services specially or exclusively supplied and/or metered exclusively to the Premises or to Lessee, together with any taxes thereon. If a service is deleted by Paragraph 1. 13 and such service is not separately metered to the Premises, Lessee shall pay at Lessor's option, either Lessee's Share or a reasonable proportion to be determined by Lessor of all charges for such jointly metered service. 11.3 HOURS OF SERVICE. Said services and utilities shall be provided during times set forth in Paragraph 1.12. Utilities and services required at other times shall he subject to advance request and reimbursement by Lessee to Lessor of the cost thereof. 11.4 EXCESS USAGE BY LESSEE. Lessee shall not make connection to the utilities except by or through existing outlets and shall not install or use machinery or equipment in or about the Premises that uses excess water, lighting or power, or suffer or permit any act that causes extra burden upon the utilities or services, including but not limited to security and trash services, over standard office usage for the Project. Lessor shall require Lessee to reimburse Lessor for any excess expenses or costs that may arise out of a breach of this subparagraph by Lessee. Lessor may, in its sole discretion, install at Lessee's expense supplemental equipment and/or separate metering applicable to Lessee's excess usage or loading. 11.5 INTERRUPTIONS. There shall be no abatement of rent and Lessor shall not be liable in any respect whatsoever for the inadequacy, stoppage, interruption or discontinuance of any utility or service due to riot, strike, labor dispute, breakdown, accident, repair or other cause beyond Lessor's reasonable control or in cooperation with governmental request or directions. 12. ASSIGNMENT AND SUBLETTING. 12.1 LESSOR'S CONSENT REQUIRED. (a) Lessee shall not voluntarily or by operation of law assign, transfer, mortgage or encumber (collectively, "assign or assignment") or sublet all or any part of Lessee's interest in this Lease or in the Premises without Lessor's prior written consent. (b) Unless Lessee is a corporation and its stock is publicly traded on a national stock exchange, a change in the control of Lessee shall constitute an assignment requiring consent. The transfer, on a cumulative basis, of 25% or more of the voting control of Lessee shall constitute a change in control for this purpose. (c) The involvement of Lessee or its assets in any transaction, or series of transactions (by way of merger, sale, acquisition, financing, transfer, leveraged buyout or otherwise), whether or not a formal assignment or hypothecation of this Lease or Lessee's assets occurs, which results or will result in a reduction of the Net Worth of Lessee by an amount greater than 25% of such Net Worth as it was represented at the time of the execution of this Lease or at the time of the most recent assignment to which Lessor has consented, or as it exists immediately prior to said transaction or transactions constituting such reduction, whichever was or is greater, shall be considered an assignment of this Lease to which Lessor may withhold its consent. "NET WORTH OF LESSEE" shall mean the net worth of Lessee (excluding any guarantors) established under generally accepted accounting principles. (d) An assignment or subletting without consent shall, at Lessor's option, be a Default curable after notice per Paragraph 13.1(c), or a noncurable Breach without the necessity of any notice and grace period. If Lessor elects to treat such unapproved assignment or subletting as a noncurable Breach, Lessor may either: (i) terminate this Lease, or (ii) upon 30 days written notice, increase the monthly Base Rent to 110% of the Base Rent then in effect. Further, in the event of such Breach and rental adjustment, (i) the purchase price of any option to purchase the Premises held by Lessee shall be subject to similar adjustment to 110% of the price previously in effect, and (ii) all fixed and non-fixed rental adjustments scheduled during the remainder of the term shall be increased to 110% of the scheduled adjusted rent. (e) Lessee's remedy for any breach of Paragraph 12.1 by Lessor shall be limited to compensatory damages and/or injunctive relief. 12.2 TERMS AND CONDITIONS APPLICABLE TO ASSIGNMENT AND SUBLETTING. (a) Regardless of Lessor's consent, no assignment or subletting shall: (i) he effective without the express written assumption by such assignee or sublessee of the obligations of Lessee under this Lease, (ii) release Lessee of any obligations hereunder, or (iii) alter the primary liability of Lessee for the payment of Rent or for the performance of any other obligations to be performed by Lessee. (b) Lessor may accept Rent or performance of Lessee's obligations from any person other than Lessee pending approval or disapproval of an assignment. Neither a delay in the approval or disapproval of such assignment nor the acceptance of Rent or performance shall constitute a waiver or estoppel of Lessor's right to exercise its remedies for Lessee's Default or Breach. (C) Lessor's consent to any assignment or subletting shall not constitute a consent to any subsequent assignment or subletting. (d) In the event of any Default or Breach by Lessee, Lessor may proceed directly against Lessee, any Guarantors or anyone else responsible for the performance of Lessee's obligations under this Lease, including any assignee or sublessee, without first exhausting Lessor's remedies against any other person or entity responsible therefore to Lessor, or any security held by Lessor. (e) Each request for consent to an assignment or subletting shall be in writing, accompanied by information relevant to Lessor's determination as to the financial and operational responsibility and appropriateness of the proposed assignee or sublessee, including but not limited to the intended use and/or required modification of the Premises, if any. Lessee agrees to provide Lessor with such other or additional information and/or documentation as may be reasonably requested. (See also Paragraph 36) (f) Any assignee of, or sublessee under, this Lease shall, by reason of accepting such assignment or entering into such sublease, be deemed to have assumed and agreed to conform and comply with each and every term, covenant, condition and obligation herein to be observed or performed by Lessee during the term of said assignment or sublease, other than such obligations as are contrary to or inconsistent with provisions of an assignment or sublease to which Lessor has specifically consented to in writing. (g) Lessor's consent to any assignment or subletting shall not transfer to the assignee or sublessee any Option granted to the original Lessee by this Lease unless such transfer is specifically consented to by Lessor in writing. (See Paragraph 39.2) 12.3 ADDITIONAL TERMS AND CONDITIONS APPLICABLE TO SUBLETTING. The following terms and conditions shall apply to any subletting by Lessee of all or any part of the Premises and shall be deemed included in all subleases under this Lease whether or not expressly incorporated therein: (a) Lessee hereby assigns and transfers to Lessor all of Lessee's interest in all Rent payable on any sublease, and Lessor may collect such Rent and apply same toward Lessee's obligations under this Lease; provided, however, that until a Breach shall occur in the performance of Lessee's obligations, Lessee may collect said Rent. Lessor shall not, by reason of the foregoing or any assignment of such sublease, nor by reason of the collection of Rent, be deemed liable to the sublessee for any failure of Lessee to perform and comply with any of Lessee's obligations to such sublessee. Lessee hereby irrevocably authorizes and directs any such sublessee, upon receipt of a written notice from Lessor stating that a Breach exists in the performance of Lessee's obligations under this Lease, to pay to Lessor all Rent due and to become due under the sublease. Sublessee shall rely upon any such notice from Lessor and shall pay all Rents to Lessor without any obligation or right to inquire as to whether such Breach exists, notwithstanding any claim from Lessee to the contrary. (b) In the event of a Breach by Lessee, Lessor may, at its option, require sublessee to attorn to Lessor, in which event Lessor shall undertake the obligations of the sublessor under such sublease from the time of the exercise of said option to the expiration of such sublease; provided, however, Lessor shall not be liable for any prepaid rents or security deposit paid by such sublessee to such sublessor or for any prior Defaults or Breaches of such sublessor. - (c) Any matter requiring the consent of the sublessor under a sublease shall also require the consent of Lessor. (d) No sublessee shall further assign or sublet all or any part of the Premises without Lessor's prior written consent. (e) Lessor shall deliver a copy of any notice of Default or Breach by Lessee to the sublessee, who shall have the right to cure the Default of Lessee within the grace period, if any, specified in such notice. The sublessee shall have a right of reimbursement and offset from and against Lessee for any such Defaults cured by the sublessee. 13. DEFAULT; BREACH; REMEDIES. 13.1 DEFAULT; BREACH. A "Default" is defined as a failure by the Lessee to comply with or perform any of the terms, covenants, conditions or Rules and Regulations under this Lease. A "Breach" is defined as the occurrence of one or more of the following Defaults, and the failure of Lessee to cure such Default within any applicable grace period: (a) The abandonment of the Premises; or the vacating of the Premises without providing a commercially reasonable level of security, or where the coverage of the property insurance described in Paragraph 8.3 is jeopardized as a result thereof, or without providing reasonable assurances to minimize potential vandalism. (b) The failure of Lessee to make any payment of Rent or any Security Deposit required to be made by Lessee hereunder, whether to Lessor or to a third party, when due, to provide reasonable evidence of insurance or surety bond, or to fulfill any obligation under this Lease which endangers or threatens life or property, where such failure continues for a period of 3 business days following written notice to Lessee. (c) The failure by Lessee to provide (i) reasonable written evidence of compliance with Applicable Requirements, (ii) the service contracts, (iii) the rescission of an unauthorized assignment or subletting, (iv) an Estoppel Certificate, (v) a requested subordination, (vi) evidence concerning any guaranty and/or Guarantor, (vii) any document requested under Paragraph 41 (easements), or (viii) any other documentation or information which Lessor may reasonably require of Lessee under the terms of this Lease, where any such failure continues for a period of 10 days following written notice to Lessee. (d) A Default by Lessee as to the terms, covenants, conditions or provisions of this Lease, or of the rules adopted under Paragraph 2.9 hereof, other than those described in subparagraphs 13.1(a), (b) or (c), above, where such Default continues for a period of 30 days after written notice; provided, however, that if the nature of Lessee's Default is such that more than 30 days are reasonably required for its cure, then it shall not be deemed to be a Breach if Lessee commences such cure within said 30 day period arid thereafter diligently prosecutes such cure to completion. (e) The occurrence of any of the following events: (i) the making of any general arrangement or assignment for the benefit of creditors; (ii) becoming a "DEBTOR" as defined in 11 U.S.C. Sec. 101 or any successor statute thereto (unless, in the case of a petition filed against Lessee, the same is dismissed within 60 days); (iii) the appointment of a trustee or receiver to take possession of substantially all of Lessee's assets located at the Premises or of Lessee's interest in this Lease, where possession is not restored to Lessee within 30 days; or (iv) the attachment, execution or other judicial seizure of substantially all of Lessee's assets located at the Premises or of Lessee's interest in this Lease, where such seizure is not discharged within 30 days; provided, however, in the event that any provision of this subparagraph (e) is contrary to any applicable law, such provision shall be of no force or effect, and not affect the validity ofthe remaining provisions. (f) The discovery that any financial statement of Lessee or of any Guarantor given to Lessor was materially false. (g) If the performance of Lessee's obligations under this Lease is guaranteed: (i) the death of a Guarantor, (ii) the termination of a Guarantor's liability with respect to this Lease other than in accordance with the terms of such guaranty, (iii) a Guarantor's becoming insolvent or the subject of a bankruptcy filing, (iv) a Guarantor's refusal to honor the guaranty, or (v) a Guarantor's breach of its guaranty obligation on an anticipatory basis, and Lessee's failure, within 60 days following written notice of any such event, to provide written alternative assurance or security, which, when coupled with the then existing resources of Lessee, equals or exceeds the combined financial resources of Lessee and the Guarantors that existed at the time of execution of this Lease. 13.2 REMEDIES. If Lessee fails to perform any of its affirmative duties or obligations, within 10 days after written notice (or in case of an emergency, without notice), Lessor may, at its option, perform such duty or obligation on Lessee's behalf, including but not limited to the obtaining of reasonably required bonds, insurance policies, or governmental licenses, permits or approvals. The costs and expenses of any such performance by Lessor shall be due and payable by Lessee upon receipt of invoice therefor. If any check given to Lessor by Lessee shall not be honored by the bank upon which it is drawn, Lessor, at its option, may require all future payments to be made by Lessee to be by cashier's check. In the event of a Breach, Lessor may, with or without further notice or demand, and without limiting Lessor in the exercise of any right or remedy which Lessor may have by reason of such Breach: (a) Terminate Lessee's right to possession of the Premises by any lawful means, in which case this Lease shall terminate and Lessee shall immediately surrender possession to Lessor. In such event Lessor shall be entitled to recover from Lessee: (i) the unpaid Rent which had been earned at the time of termination; (ii) the worth at the time of award of the amount by which the unpaid rent which would have been earned after termination until the time of award exceeds the amount of such rental loss that the Lessee proves could have been reasonably avoided; (iii) the worth at the time of award of the amount by which the unpaid rent for the balance of the term after the time of award exceeds the amount of such rental loss that the Lessee proves could be reasonably avoided; and (iv) any other amount necessary to compensate Lessor for all the detriment proximately caused by the Lessee's failure to perform its obligations under this Lease or which in the ordinary course of things would be likely to result therefrom, including but not limited to the cost of recovering possession of the Premises, expenses of reletting, including necessary renovation and alteration of the Premises, reasonable attorneys' fees, and that portion of any leasing commission paid by Lessor in connection with this Lease applicable to the unexpired term of this Lease. 'The worth at the time of award of the amount referred to in provision (iii) of the immediately preceding sentence shall be computed by discounting such amount at the discount rate of the Federal Reserve Bank of the District within which the Premises are located at the time of award plus one percent. Efforts by Lessor to mitigate damages caused by Lessee's Breach .of this Lease shall not waive Lessor's right to recover damages under Paragraph 12. If termination of this Lease is obtained through the provisional remedy of unlawful detainer, Lessor shall have the right to recover in such proceeding any unpaid Rent and damages as are recoverable therein, or Lessor may reserve the right to recover all or any part thereof in a separate suit. If a notice and grace period required under Paragraph 13.1 was not previously given, a notice to pay rent or quit, or to perform or quit given to Lessee under the unlawful defamer statute shall also constitute the notice required Paragraph 13.1. In such case, the applicable grace period required by Paragraph 13.1 and the unlawful detainer statute shall run concurrently, and thefailure of Lessee to cure' the Default within the greater of the two such grace periods shall constitute both an unlawful detainer and a Breach of this Lease entitling Lessor to the remedies provided for in this Lease and/or by said statute. (b) Continue the Lease and Lessee's right to possession and recover the Rent as it becomes due, in which event Lessee may sublet or assign, subject only to reasonable limitations. Acts of maintenance, efforts to relet, and/or the appointment of a receiver to protect the Lessor's interests, shall not constitute a termination of the Lessee's right to possession. (c) Pursue any other remedy now or hereafter available under the laws or judicial decisions of the state wherein the Premises are located. The expiration or termination of this Lease and/or the termination of Lessee's right to possession shall not relieve Lessee from liability under any indemnity provisions of this Lease as to matters occurring or accruing during the term hereof or by reason of Lessee's occupancy of the Premises. 13.3 INDUCEMENT RECAPTURE. Any agreement for free or abated rent or other charges, or for the giving or paying by Lessor to or for Lessee of any cash or other bonus, inducement or consideration for Lessee's entering into this Lease, all of which concessions are hereinafter referred to as "Inducement Provisions", shall be deemed conditioned upon Lessee's full and faithful performance of all of the terms, covenants and conditions of this Lease. Upon Breach of this Lease by Lessee, any such Inducement Provision shall automatically be deemed deleted from this Lease and of no further force or effect, and any rent, other charge, bonus, inducement or consideration theretofore abated, given or paid by Lessor under such an Inducement Provision shall be immediately due and payable by Lessee to Lessor, notwithstanding any subsequent cure of said Breach by Lessee. The acceptance by Lessor of rent or the cure of the Breach which initiated the operation of this paragraph shall not be deemed a waiver by Lessor of the provisions of this paragraph unless specifically so stated in writing by Lessor at the time of such acceptance. 13.4 LATE CHARGES Lessee hereby acknowledges that late payment by Lessee of Rent will cause Lessor to incur costs not contemplated by this Lease, the exact amount of which will be extremely difficult to ascertain. Such costs include, but are not limited to, processing and accounting charges, and late charges which may be imposed upon Lessor by any Lender. Accordingly, if any Rent shall not be received by Lessor within 5 days after such amount shall be due, then, without any requirement for notice to Lessee, Lessee shall pay to Lessor a one-time late charge equal to 10% of each such overdue amount or $100, whichever is greater. The parties hereby agree that such late charge represents a fair and reasonable estimate of the costs Lessor will incur by reason of such late payment. Acceptance of such late charge by Lessor shall in no event constitute a waiver of Lessee's Default or Breach with respect to such overdue amount, nor prevent the exercise of any of the other rights and remedies granted hereunder. In the event that a late charge is payable hereunder, whether or not collected, for 3 consecutive installments of Base Rent, then notwithstanding any provision of this Lease to the contrary, Base Rent shall, at Lessor's option, become due and payable quarterly in advance. 13.5 INTEREST. Any monetary payment due Lessor hereunder, other than late charges, not received by Lessor, when due as to scheduled payments (such as Base Rent) or within 30 days following the date on which it was due for nonscheduled payment, shall bear interest from the date when due, as to scheduled payments, or the 31st day after it was due as to nonscheduled payments. The interest ("Interest") charged shall be computed at the rate of 10% per annum but shall not exceed the maximum rate allowed by law. Interest is payable in addition to the potential late charge provided for in Paragraph 13.4. 13.6 BREACH BY LESSOR. (a) Notice of Breach. Lessor shall not be deemed in breach of this Lease unless Lessor fails within a reasonable time to perform an obligation required to be performed by Lessor. For purposes of this Paragraph, a reasonable time shall in no event be less than 30 days after receipt by Lessor, and any Lender whose name and address shall have been furnished Lessee in writing for such purpose, of written notice specifying wherein such obligation of Lessor has not been performed; provided, however, that if the nature of Lessor's obligation is such that more than 30 days are reasonably required for its performance, then Lessor shall not be in breach if performance is commenced within such 30 day period and thereafter diligently pursued to completion. (b) Performance by Lessee on Behalf of Lessor. in the event that neither Lessor nor Lender cures said breach within 30 days after receipt of said notice, or if having commenced said cure they do not diligently pursue it to completion, then Lessee may elect to cure said breach at Lessee's expense and offset from Rent the actual and reasonable cost to perform such cure, provided however, that such offset shall not exceed an amount equal to the greater of one month's Base Rent or the Security Deposit, reserving Lessee's right to seek reimbursement from Lessor. Lessee shall document the cost of said cure and supply said documentation to Lessor. 14. CONDEMNATION, If the Premises or any portion thereof are taken under the power of eminent domain or sold under the threat of the exercise of said power (collectively "CONDEMNATION"), this Lease shall terminate as to the part taken as of the date the condemning authority takes title or possession, whichever first occurs. If more than 10% of the rentable floor area of the Premises, or more than 25% of Lessee's Reserved Parking Spaces, if any, are taken by Condemnation, Lessee may, at Lessee's option, to be exercised in writing within 10 days after Lessor shall have given Lessee written notice of such taking (or in the absence of such notice, within 10 days after the condemning authority shall have taken possession) terminate this Lease as of the date the condemning authority takes such possession. If Lessee does not terminate this Lease in accordance with the foregoing, this Lease shall remain in full force and effect as to the portion of the Premises remaining, except that the Base Rent shall be reduced in proportion to the reduction in utility of the Premises caused by such Condemnation. Condemnation awards and/or payments shall be the property of Lessor, whether such award shall be made as compensation for diminution in value of the leasehold, the value of the part taken, or for severance damages; provided, however, that Lessee shall be entitled to any compensation for Lessee's relocation expenses, loss of business goodwill and/or Trade Fixtures, without regard to whether or not this Lease is terminated pursuant to the provisions of this Paragraph. All Alterations and Utility Installations made to the Premises by Lessee, for purposes of Condemnation only, shall be considered the property of the Lessee and Lessee shall be entitled to any and all compensation which is payable therefor. In the event that this Lease is not terminated by reason of the Condemnation, Lessor shall repair any damage to the Premises caused by such Condemnation. 15. BROKERAGE FEES. 15.1 ADDITIONAL COMMISSION. In addition to the payments owed pursuant to Paragraph 1.10 above, and unless Lessor and the Brokers otherwise agree in writing, Lessor agrees that: (a) if Lessee exercises any Option, (b) if Lessee acquires from Lessor any rights to the Premises or other premises owned by Lessor and located within the Project, (c) if Lessee remains in possession of the Premises, with the consent of Lessor, after the expiration of this Lease, or (d) if Base Rent is increased, whether by agreement or operation of an escalation clause herein, then, Lessor shall pay Brokers a fee in accordance with the schedule of the Brokers in effect at the time of the execution of this Lease. 15.2 ASSUMPTION OF OBLIGATIONS. Any buyer or transferee of Lessor's interest in this Lease shall be deemed to have assumed Lessor's obligation hereunder. Brokers shall be third party beneficiaries of the provisions of Paragraphs 110, 15, 22 and 31. If Lessor fails to pay to Brokers any amounts due as and for brokerage fees pertaining to this Lease when due, then such amounts shall accrue Interest. In addition, if Lessor fails to pay any amounts to Lessee's Broker when due, Lessee's Broker may send written notice to Lessor and Lessee of such failure and if Lessor fails to pay such amounts within 10 days after said notice, Lessee shall pay said monies to its Broker and offset such amounts against Rent. In addition, Lessee's Broker shall be deemed to be a third party beneficiary of any commission agreement entered into by and/or between Lessor and Lessor's Broker for the limited purpose of collecting any brokerage fee owed. 15.3 REPRESENTATIONS AND INDEMNITIES OF BROKER RELATIONSHIPS. Lessee and Lessor each represent and warrant to the other that it has had no dealings with any person, firm, broker or finder (other than the Brokers, if any) in connection with this Lease, and that no one other than said named Brokers is entitled to any commission or finder's fee in connection herewith. Lessee and Lessor do each hereby agree to indemnify, protect, defend and hold the other harmless from and against liability for compensation or charges which may be claimed by any such unnamed broker, finder or other similar party by reason of any dealings or actions of the indemnifying Party, including any costs, expenses, attorneys' fees reasonably incurred with respect thereto. 16. ESTOPPEL CERTIFICATES. (a) Each Party (as "RESPONDING PARTY") shall within 10 days after written notice from the other Party (the "REQUESTING PARTY") execute, acknowledge and deliver to the Requesting Party a statement in writing in form similar to the then most current "ESTOPPEL CERTIFICATE" form published by the American Industrial Real Estate Association, plus such additional information, confirmation and/or statements as may be reasonably requested by the Requesting Party. (b) If the Responding Party shall fail to execute or deliver the Estoppel Certificate within such 10 day period, the Requesting Party may execute an Estoppel Certificate stating that: (i) the Lease is in full force and effect without modification except as may be represented by the Requesting Party, (ii) there are no uncured defaults in the Requesting Party's performance, and (iii) if Lessor is the Requesting Party, not more than one month's rent has been paid In advance. Prospective purchasers and encumbrancers may rely upon the Requesting Party's Estoppel Certificate, and the Responding Party shall be estopped from denying the truth of the facts contained in said Certificate. (c) If Lessor desires to finance, refinance, or sell the Premises, or any part thereof, Lessee and all Guarantors shall deliver to any potential lender or purchaser designated by Lessor such financial statements as may be reasonably required by such lender or purchaser, including but not limited to Lessee's financial statements for the past 3 years. All such financial statements shall be received by Lessor and such lender or purchaser in confidence and shall be used only for the purposes herein set forth. 17. DEFINITION OF LESSOR. The term "LESSOR" as used herein shall mean the owner or owners at the time in question of the fee title to the Premises, or, if this is a sublease, of the Lessee's interest in the prior lease. In the event of a transfer of Lessor's title or interest in the Premises or this Lease, Lessor shall deliver to the transferee or assignee (in cash or by credit) any unused Security Deposit held by Lessor. Except as provided in Paragraph 15, upon such transfer or assignment and delivery of the Security Deposit, as aforesaid, the prior Lessor shall be relieved of all liability with respect to the obligations and/or covenants under this Lease thereafter to be performed by the Lessor. Subject to the foregoing, the obligations and/or covenants in this Lease to be performed by the Lessor shall be binding only upon the Lessor as hereinabove defined. 18. SEVERABILITY. The invalidity of any provision of this Lease, as determined by a court of competent jurisdiction, shall in no way affect the validity ofany other provision hereof. 19. DAYS. Unless otherwise specifically indicated to the contrary, the word "days" as used in this Lease shall mean and refer to calendar days 20. LIMITATION ON LIABILITY The obligations of Lessor under this Lease shall not constitute personal obligations of Lessor or its partners, members, directors, officers or shareholders, and Lessee shall look to the Project, and to no other assets of Lessor, for the satisfaction of any liability of Lessor with respect to this Lease, and shall not seek recourse against Lessor's partners, members, directors, officers or shareholders, or any of their personal assets for such satisfaction. 21. TIME OF ESSENCE. Time is of the essence with respect to the performance of all obligations to be performed or observed by the Parties under this Lease. 22. NO PRIOR OR OTHER AGREEMENTS; BROKER DISCLAIMER This Lease contains all agreements between the Parties with respect to any matter mentioned herein, and no other prior or contemporaneous agreement or understanding shall be effective. Lessor and Lessee each represents and warrants to the Brokers that it has made, and is relying solely upon. its own investigation as to the nature, quality, character and financial responsibility of the other Party to this Lease and as to the use, nature, quality and character of the Premises. Brokers have no responsibility with respect thereto or with respect to any default or breach hereof by either Party. The liability (including court costs and attorneys' fees) of any Broker with respect to negotiation, execution, delivery or performance by either Lessor or Lessee under this Lease or any amendment or modification hereto shall be limited to an amount up to the fee received by such Broker pursuant to this Lease; provided, however, that the foregoing limitation on each Broker's liability shall not be applicable to any gross negligence or willful misconduct of such Broker. 23. NOTICES. 23.1 NOTICE REQUIREMENTS. All notices required or permitted by this Lease or applicable law shall be in writing and may be delivered in person (by hand or by courier) or may be sent by regular, certified or registered mail or U.S. Postal Service Express Mail, with postage prepaid, or by facsimile transmission, and shall be deemed sufficiently given if served in a manner specified in this Paragraph 23. The addresses noted adjacent to a Party's signature on this Lease shall be that Party's address for delivery or mailing of notices. Either Party may by written notice to the other specify a different address for notice, except that upon Lessee's taking possession of the Premises, the Premises shall constitute Lessee's address for notice. A copy of all notices to Lessor shall be concurrently transmitted to such party or parties at such addresses as Lessor may from time to time hereafter designate in writing. 23.2 DATE OF NOTICE. Any notice sent by registered or certified mail, return receipt requested, shall be deemed given on the date of delivery shown on the receipt card, or if no delivery date is shown, the postmark thereon. If sent by regular mail the notice shall be deemed given 48 hours after the same is addressed as required herein and mailed with postage prepaid. Notices delivered by United States Express Mail or overnight courier that guarantee next day delivery shall be deemed given 24 hours after delivery of the same to the Postal Service or courier. Notices transmitted by facsimile transmission or similar means shall be deemed delivered upon telephone confirmation of receipt (confirmation report from fax machine is sufficient), provided a copy is also delivered via delivery or mail. If notice is received on a Saturday, Sunday or legal holiday, it shall be deemed received on the next business day. 24. WAIVERS. No waiver by Lessor of the Default or Breach of any term, covenant or condition hereof by Lessee, shall be deemed a waiver of any other term, covenant or condition hereof, or of any subsequent Default or Breach by Lessee of the same or of any other term, covenant or condition hereof. Lessor's consent to, or approval of, any act shall not be deemed to render unnecessary the obtaining of Lessor's consent to, or approval of, any subsequent or similar act by Lessee, or be construed as the basis of an estoppel to enforce the provision or provisions of this Lease requiring such consent. The acceptance of Rent by Lessor shall not be a waiver of any Default or Breach by Lessee. Any payment by Lessee may be accepted by Lessor on account of moneys or damages due Lessor, notwithstanding any qualifying statements or conditions made by Lessee in connection therewith, which such statements and/or conditions shall be of no force or effect whatsoever unless specifically agreed to in writing by Lessor at or before the time of deposit of such payment. 25. DISCLOSURES REGARDING THE NATURE OF A REAL ESTATE AGENCY RELATIONSHIP. (a) When entering into a discussion with a real estate agent regarding a real estate transaction, a Lessor or Lessee should from the outset understand what type of agency relationship or representation it has with the agent or agents in the transaction. Lessor and Lessee acknowledge being advised by the Brokers in this transaction, as follows: (i) Lessor's Agent. A Lessor's agent under a listing agreement --------------- with the Lessor acts as the agent for the Lessor only. A Lessor's agent or subagent has the following affirmative obligations: To the Lessor: A fiduciary ------------- duty of utmost care, integrity, honesty, and loyalty in dealings with the Lessor. To the Lessee and the Lessor: a. Diligent exercise of reasonable skills ---------------------------- and care in performance of the agent's duties. b. A duty of honest and fair dealing and good faith. c. A duty to disclose all facts known to the agent materially affecting the value or desirability of the property that are not known to, or within the diligent attention and observation of, the Parties. An agent is not obligated to reveal to either Party any confidential information obtained from the other Party which does not involve the affirmative duties set forth above. (ii) Lessee's Agent. An agent can agree to act as agent for the -------------- Lessee only. In these situations, the agent is not the Lessor's agent, even if by agreement the agent may receive compensation for services rendered, either in full or in part from the Lessor. An agent acting only for a Lessee has the following affirmative obligations. To the Lessee: A fiduciary duty of utmost ------------- care, integrity, honesty, and loyalty in dealings with the Lessee. To the Lessee ------------- and the Lessor: a. Diligent exercise of reasonable skills and care in - -------------- performance of the agent's duties. b. A duty of honest and fair dealing and good faith. c. A duty to disclose all facts known to the agent materially affecting the value or desirability of the property that are not known to, or within the diligent attention and observation of, the Parties. An agent is not obligated to reveal to either Party any confidential information obtained from the other Party which does not involve the affirmative duties set forth above. (iii) Agent Representing Both Lessor and Lessee. A real estate ------------------------------------------- agent, either acting directly or through one or more associate licenses, can legally be the agent of both the Lessor and the Lessee in a transaction, but only with the knowledge and consent of both the Lessor and the Lessee. In a dual agency situation, the agent has the following affirmative obligations to both the Lessor and the Lessee: a. A fiduciary duty of utmost care, integrity, honesty and loyalty in the dealings with either Lesser or the Lessee. b. Other duties to the Lessor and the Lessee as stated above in subparagraphs (i) or (ii). In representing both Lessor and Lessee, the agent may not without the express permission of the respective Party, disclose to the other Party that the Lessor will accept rent in an amount less than that indicated in the listing or that the Lessee is willing to pay a higher rent than that offered. The above duties of the agent in a real estate transaction do not relieve a Lessor or Lessee from the responsibility to protect their own interests. Lessor and Lessee should carefully read all agreements to assure that they adequately express their understanding of the transaction. A real estate agent is a person qualified to advise about real estate. If legal or tax advise is desired, consult a competent professional. (b) Brokers have no responsibility with respect to any default or breach hereof by either Party. The liability (including court costs and attorneys' fees), of any Broker with respect to any breach of duty, error or omission relating to this Lease shall not exceed the fee received by such Broker pursuant to this Lease; provided, however, that the foregoing limitation on each Broker's liability shall not be applicable to any gross negligence or willful misconduct of such Broker. (c) Buyer and Seller agree to identify to Brokers as "Confidential" any communication or information given Brokers that is considered by such Party to be confidential. 26. NO RIGHT TO HOLDOVER. Lessee has no right to retain possession of the Premises or any part thereof beyond the expiration or termination of this Lease. In the event that Lessee holds over, then the Base Rent shall be increased to 115% 4.50% of the Base Rent applicable immediately preceding the expiration or termination. Nothing contained herein shall be construed as consent by Lessor to any holding over by Lessee. 27. CUMULATIVE REMEDIES. No remedy or election hereunder shall be deemed exclusive but shall, wherever possible, be cumulative with alt other remedies at law or in equity. 28. COVENANTS AND CONDITIONS; Construction of Agreement. All provisions of this Lease to be observed or performed by Lessee are both covenants and conditions. In construing this Lease, all headings and titles are for the convenience of the Parties only and shall not be considered a part of this Lease. Whenever required by the context, the singular shall include the plural and vice versa. This Lease shall not be construed as if prepared by one of the Parties, but rather according to its fair meaning as a whole, as if both Parties had prepared it. 29. BINDING EFFECT; Choice of Law. This Lease shall be binding upon the Parties, their personal representatives, successors and assigns and be governed by the laws of the State in which the Premises are located. Any litigation between the Parties hereto concerning this Lease shall be initiated in the county in which the Premises are located. 30. SUBORDINATION; ATTORNMENT; NON-DISTURBANCE. 30.1 SUBORDINATION. This Lease and any Option granted hereby shall be subject and subordinate to any ground lease, mortgage, deed of trust, or other hypothecation or security device (collectively, "SECURITY DEVICE"), now or hereafter placed upon the Premises, to any and all advances made on the security thereof, and to all renewals, modifications, and extensions thereof. Lessee agrees that the holders of any such Security Devices (in this Lease together referred to as "Lender") shall have no liability or obligation to perform any of the obligations of Lessor under this Lease. Any Lender may elect to have this Lease and/or any Option granted hereby superior to the lien of its Security Device by giving written notice thereof to Lessee, whereupon this Lease and such Options shall be deemed prior to such Security Device, notwithstanding the relative dates of the documentation or recordation thereof. 30.2 ATTORNMENT. In the event that Lessor transfers title to the Premises, or the Premises are acquired by another upon the foreclosure or termination of a Security Device to which this Lease is subordinated (I) Lessee shall, subject to the nondisturbance provisions of Paragraph 30.3, attorn to such new owner, and upon request, enter into a new lease, containing all of the terms and provisions of this Lease, with such new owner for the remainder of the term hereof, or, at the election of such new owner, this Lease shall automatically become a new Lease between Lessee and such new owner, upon all of the terms and conditions hereof, for the remainder of the term hereof, and (ii) Lessor shall thereafter be relieved of any further obligations hereunder and such new owner shall assume all of Lessor's obligations hereunder, except that such new owner shall not: (a) be liable for any act or omission of any prior lessor or with respect to events occurring prior to acquisition of ownership; (b) be subject to any offsets or defenses which Lessee might have against any prior lessor, (c) be bound by prepayment of more than one month's rent, or (d) be liable for the return of any security deposit paid to any prior lessor. 30.3 NON-DISTURBANCE. With respect to Security Devices entered into by Lessor after the execution of this Lease, Lessee's subordination of this Lease shall be subject to receiving a commercially reasonable non-disturbance agreement (a "NON-DISTURBANCE AGREEMENT") from the Lender which Non-Disturbance Agreement provides that Lessee's possession of the Premises, and this Lease, including any options to extend the term hereof, will not be disturbed so long as Lessee is not in Breach hereof and attorns to the record owner of the Premises. Further, within 60 days after the execution of this Lease, Lessor shall use its commercially reasonable efforts to obtain a Non-Disturbance Agreement from the holder of any pre-existing Security Device which is secured by the Premises. In the event that Lessor is unable to provide the Non-Disturbance Agreement within said 60 days, then Lessee may, at Lessee's option, directly contact Lender and attempt to negotiate for the execution and delivery of a Non-Disturbance Agreement. 30.4 SELF-EXECUTING. The agreements contained in this Paragraph 30 shall be effective without the execution of any further documents; provided, however, that, upon written request from Lessor or a Lender in connection with a sale, financing or refinancing of the Premises, Lessee and Lessor shall execute such further writings as may be reasonably required to separately document any subordination, attornment and/or Non-Disturbance Agreement provided for herein. 31. ATTORNEYS' FEES. If any Party or Broker brings an action or proceeding involving the Premises whether founded in tort, contract or equity, or to declare rights hereunder, the Prevailing Party (as hereafter defined) in any such proceeding, action, or appeal thereon, shall be entitled to reasonable attorneys' fees. Such fees may be awarded in the same suit or recovered in a separate suit, whether or not such action or proceeding is pursued to decision or judgment. The term, "PREVAILING PARTY" shall include, without limitation, a Party or Broker who substantially obtains or defeats the relief sought, as the case may be, whether by compromise, settlement, judgment, or the abandonment by the other Party or Broker of its claim or defense. The attorneys' fees award shall not be computed in accordance with any court fee schedule, but shall be such as to fully reimburse all attorneys' fees reasonably incurred. In addition, Lessor shall be entitled to attorneys' fees, costs and expenses incurred in the preparation and service of notices of Default and consultations in connection therewith, whether or not a legal action is subsequently commenced in connection with such Default or resulting Breach ($200 is a reasonable minimum per occurrence for such services and consultation). 32. LESSOR'S ACCESS; SHOWING PREMISES; REPAIRS. Lessor and Lessor's agents shall have the right to enter the Premises at any time, in the case of an emergency, and otherwise at reasonable times for the purpose of showing the same to prospective purchasers, lenders, or tenants, and making such alterations, repairs, improvements or additions to the Premises as Lessor may deem necessary or desirable and the erecting, using and maintaining of utilities, services, pipes and conduits through the Premises and/or other premises as long as there is no material adverse effect to Lessee's use of the Premises. All such activities shall be without abatement of rent or liability to Lessee. Lessor may at any time place on the Premises any ordinary "FOR SALE" signs and Lessor may during the last 6 months of the term hereof place on the Premises any ordinary "FOR LEASE" signs. In addition, Lessor shall have the right to retain keys to the Premises and to unlock all doors in or upon the Premises other than to files, vaults and safes, and in the case of emergency to enter the Premises by any reasonably appropriate means, and any such entry shall not be deemed a forcible or unlawful entry or detainer of the Premises or an eviction. Lessee waives any charges for damages or injuries or interference with Lessee's property or business in connection therewith. 33. AUCTIONS. Lessee shall not conduct, nor permit to be conducted, any auction upon the Premises without Lessor's prior written consent. Lessor shall not be obligated to exercise any standard of reasonableness in determining whether to permit an auction. 34. SIGNS. Lesse tl-not-~pla6e any-sign upon the Project without Leesor's prior written consent.? See Addendum. 35. TERMINATION; MERGER. Unless specifically stated otherwise in writing by Lessor, the voluntary or other surrender of this Lease by Lessee, the mutual termination or cancellation hereof, or a termination hereof by Lessor for Breach by Lessee, shall automatically terminate any sublease or lesser estate in the Premises; provided, however, that Lessor may elect to continue any one or all existing sub-tenancies. Lessor's failure within 10 days following any such event to elect to the contrary by written notice to the holder of any such lesser interest, shall constitute Lessor's election to have such event constitute the termination of such interest. 36. CONSENTS. Except as otherwise provided herein, wherever in this Lease the consent of a Party is required to an act by or for the other Party, such consent shall not be unreasonably withheld or delayed. Lessor's actual reasonable costs and expenses (including but not limited to architects', attorneys', engineers' and other consultants' fees) incurred in the consideration of, or response to, a request by Lessee for any Lessor consent, including but not limited to consents to an assignment, a subletting or the presence or use of a Hazardous Substance, shall be paid by Lessee upon receipt of an invoice and supporting documentation therefor. Lessor's consent to any act, assignment or subletting shall not constitute an acknowledgment that no Default or Breach by Lessee of this Lease exists, nor shall such consent be deemed a waiver of any then existing Default or Breach, except as may be otherwise specifically stated in writing by Lessor at the time of such consent. The failure to specify herein any particular condition to Lessor's consent shall not preclude the imposition by Lessor at the time of consent of such further or other conditions as are then reasonable with reference to the particular matter for which consent is being given. In the event that either Party disagrees with any determination made by the other hereunder and reasonably requests the reasons for such determination, the determining party shall furnish its reasons in writing and in reasonable detail within 10 business days following such request. 37. GUARANTOR. 37.1 EXECUTION. The Guarantors, if any, shall each execute a guaranty in the form most recently published by the American Industrial Real Estate Association. 37.2 DEFAULT. It shall constitute a Default of the Lessee 1 any Guarantor fails or refuses, upon request to provide: (a) evidence of the execution of the guaranty, including the authority of the party signing on Guarantor's behalf to obligate Guarantor, and in the case of a corporate Guarantor, a certified copy of a resolution of its board of directors authorizing the making of such guaranty, (b) current financial statements, (c) an Estoppel Certificate, or (d) written confirmation that the guaranty is still in effect. 38. QUIET POSSESSION. Subject to payment by Lessee of the Rent and performance of all of the covenants, conditions and provisions on Lessee's part to be observed and performed under this Lease, Lessee shall have quiet possession and quiet enjoyment of the Premises during the term hereof. 39. OPTIONS. If Lessee is granted an Option, as defined below, then the following provisions shall apply. 39.1 DEFINITION. "OPTION" shall mean: (a) the right to extend the term of or renew this Lease or to extend or renew any lease that Lessee has on other property of Lessor; (b) the right of first refusal or first offer to lease either the Premises or other property of Lessor; (c) the right to purchase or the right of first refusal to purchase the Premises or other property of Lessor. 39.2 OPTIONS PERSONAL TO ORIGINAL LESSEE Any Option granted to Lessee in this Lease is personal to the original Lessee, and cannot be assigned or exercised by anyone other than said original Lessee and only while the original Lessee is in full possession of the Premises and, if requested by Lessor, with Lessee certifying that Lessee has no intention of thereafter assigning or subletting. 39.3 MULTIPLE OPTIONS. In the event that Lessee has any multiple Options to extend or renew this Lease, a later Option cannot be exercised unless the prior Options have been validly exercised. 39.4 EFFECT OF DEFAULT ON OPTIONS. (a) Lessee shall have no right to exercise an Option: (i) during the period commencing with the giving of any notice of Default and continuing until said Default is cured, (ii) during the period of time any Rent is unpaid (without regard to whether notice thereof is given Lessee), (iii) during the time Lessee is in Breach of this Lease, or (iv) in the event that Lessee has been given 3 or more notices of separate Default, whether or not the Defaults are cured, during the 12 month period immediately preceding the exercise of the Option. (b) The period of time within which an Option may be exercised shall not be extended or enlarged by reason of Lessee's inability to exercise an Option because of the provisions of Paragraph 39.4(a). (c) An Option shall terminate and be of no further force or effect, notwithstanding Lessee's due and timely exercise of the Option, if, after such exercise and prior to the commencement of the extended term or completion of the purchase, (i) Lessee fails to pay Rent for a period of 30 days after such Rent becomes due (without any necessity of Lessor to give notice thereof), or (ii) if Lessee commits a Breach of this Lease. 40. SECURITY MEASURES. Lessee hereby acknowledges that the Rent payable to Lessor hereunder does not include the cost of guard service or other security measures, and that Lessor shall have no obligation whatsoever to provide same. Lessee assumes all responsibility for the protection of the Premises, Lessee, its agents and invitees and their property from the acts of third parties. In the event, however, that Lessor should elect to provide security services, then the cost thereof shall be an Operating Expense. 41. RESERVATIONS. (a) Lessor reserves the right: (i) to grant, without the consent or joinder of Lessee, such easements, rights and dedications that Lessor deems necessary, (ii) to cause the recordation of parcel maps and restrictions, (iii) to create and/or install new utility raceways, so long as such easements, rights, dedications, maps, restrictions, and utility raceways do not unreasonably interfere with the use of the Premises by Lessee. Lessor may also: change the name, address or title of the Building or Project upon at least 90 days prior written notice; provide and install, at Lessee's expense, Building standard graphics on the door of the Premises and such portions of the Common Areas as Lessor shall reasonably deem appropriate; grant to any lessee the exclusive right to conduct any business as long as such exclusive right does not conflict with any rights expressly given herein; and to place such signs, notices or displays as Lessor reasonably deems necessary or advisable upon the roof, exterior of the Building or the Project or on pole signs in the Common Areas. Lessee agrees to sign any documents reasonably requested by Lessor to effectuate such rights. The obstruction of Lessee's view, air, or light by any structure erected in the vicinity of the Building, whether by Lessor or third parties, shall in no way affect this Lease or impose any liability upon Lessor. (b) Lessor also reserves the right to move Lessee to other space of comparable size in the Building or Project. Lessor must provide at least 45 days prior written notice of such move, and the new space must contain improvements of comparable quality to those contained within the Premises. Lessor shall pay the reasonable out of pocket costs that Lessee incurs with regard to such relocation, including the expenses of moving and necessary revision costs. In no event, however, shall Lessor be required to pay an amount in excess of two months Base Rent. Lessee may not be relocated more than once during the term of this Lease. (c) Lessee shall not: (i) use a representation (photographic or otherwise) of the Building or Project or their name(s) in connection with Lessee's business; or (ii) suffer or permit anyone, except in emergency, to go upon the roof of the Building. 42. PERFORMANCE UNDER PROTEST. If at any time a dispute shall arise as to any amount or sum of money to be paid by one Party to the other under the provisions hereof, the Party against whom the obligation to pay the money is asserted shall have the right to make payment "under protest" and such payment shall not be regarded as a voluntary payment and there shall survive the right on the part of said Party to institute suit for recovery of such sum. If it shall be adjudged that there was no legal obligation on the part of said Party to pay such sum or any part thereof, said Party shall be entitled to recover such sum or so much thereof as it was not legally required to pay. 43. AUTHORITY. (a) If either Party hereto is a corporation, trust, limited liability company, partnership, or similar entity, each individual executing this Lease on behalf of such entity represents and warrants that he or she is duly authorized to execute and deliver this Lease on its behalf. Each party shall, within 30 days after request, deliver to the other party satisfactory evidence of such authority. (b) If this Lease is executed by more than one person or entity as "Lessee", each such person or entity shall be jointly and severally liable hereunder. It is agreed that any one of the named Lessees shall be empowered to execute any amendment to this Lease, or other document ancillary thereto and bind all of the named Lessees, and Lessor may rely on the same as if all of the named Lessees had executed such document. 44. CONFLICT. Any conflict between the printed provisions of this Lease and the typewritten or handwritten provisions shall be controlled by the typewritten or handwritten provisions. 45. OFFER. Preparation of this Lease by either party or their agent and submission of same to the other Party shall not be deemed an offer to lease to the other Party. This Lease is not intended to be binding until executed and delivered by all Parties hereto. 46. AMENDMENTS This Lease may be modified only in writing, signed by the Parties in interest at the time of the modification. As long as they do not materially change Lessee's obligations hereunder, Lessee agrees to make such reasonable nonmonetary modifications to this Lease as may be reasonably required by a Lender in connection with the obtaining of normal financing or refinancing of the Premises. 47. MULTIPLE PARTIES. If more than one person or entity is named herein as either Lessor or Lessee, such multiple Parties shall have joint and several responsibility to comply with the terms of this Lease. 48. WAIVER OF JURY TRIAL. THE PARTIES HEREBY WAIVE THEIR RESPECTIVE RIGHTS TO TRIAL BY JURY IN ANY ACTION OR PROCEEDINGINVOLVING THE PROPERTY OR ARISING OUT OF THIS AGREEMENT. 49. MEDIATION AND ARBITRATION OF DISPUTES. An Addendum requiring the Mediation and/or the Arbitration of all disputes between the Parties and/or Brokers arising out of this Lease [_] is [X] is not attached to this Lease. 50. AMERICANS WITH DISABILITIES ACT. In the event that as a result of Lessee's use, or intended use, of the Premises the Americans with Disabilities Act or any similar law requires modifications or the construction or installation of improvements in or to the Premises, or second floor Common Areas the Parties agree that such modifications, construction or improvements shall be made at: [_] Lessor's expense [X] Lessee's expense. LESSOR AND LESSEE HAVE CAREFULLY READ AND REVIEWED THIS LEASE AND EACH TERM AND PROVISION CONTAINED HEREIN, AND BYTHE EXECUTION OF THIS LEASE SHOW THEIR INFORMED AND VOLUNTARY CONSENT THERETO. THE PARTIES HEREBY AGREE THAT, AT THE TIME THIS LEASE IS EXECUTED, THE TERMS OF THIS LEASE ARE COMMERCIALLY REASONABLE AND EFFECTUATE THE INTENT AND PURPOSE OF LESSOR AND LESSEE WITH RESPECT TO THE PREMISES. ATTENTION: NO REPRESENTATION OR RECOMMENDATION IS MADE BY THE AMERICAN INDUSTRIAL REAL ESTATE ASSOCIATION OR BY ANYBROKER AS TO THE LEGAL SUFFICIENCY, LEGAL EFFECT, OR TAX CONSEQUENCES OF THIS LEASE OR THE TRANSACTION TO WHICH ITRELATES. THE PARTIES ARE URGED TO: 1. SEEK ADVICE OF COUNSEL AS TO THE LEGAL AND TAX CONSEQUENCES OF THIS LEASE. 2. RETAIN APPROPRIATE CONSULTANTS TO REVIEW AND INVESTIGATE THE CONDITION OF THE PREMISES. SAID INVESTIGATION SHOULD INCLUDE BUT NOT BE LIMITED TO: THE POSSIBLE PRESENCE OF HAZARDOUS SUBSTANCES, THE ZONING AND SIZE OF THEPREMISES, THE STRUCTURAL INTEGRITY, THE CONDITION OF THE ROOF AND OPERATING SYSTEMS, COMPLIANCE WITH THE AMERICANSWITH DISAHILITIES ACT AND THE SUITABILITY OF THE PREMISES FOR LESSEE'S INTENDED USE. WARNING: IF THE PREMISES ARE LOCATED IN A STATE OTHER THAN CALIFORNIA, CERTAIN PROVISIONS OF THE LEASE MAY NEED TO BE REVISED TO COMPLY WITH TFIE LAWS OF THE STATE IN WHICH THE PREMISES ARE LOCATED. The parties hereto have executed this Lease at the place and on the dates specified above their respective signatures. THESE FORMS ARE OFTEN MODIFIED TO MEET CHANGING REQUIREMENTS OF LAW AND NEEDS OF THE INDUSTRY. ALWAYS WRITE OR CALL TO MAKE SURE YOU ARE UTILIZING THE MOST CURRENT FORM: AMERICAN INDUSTRIAL REAL ESTATE ASSOCIATION, 700 SOUTH FLOWER STREET, SUITE 600, LOS ANGELES, CA 90017. (C)COPYRIGHT 1999-BY AMERICAN INDUSTRIAL REAL ESTATE ASSOCIATION. ALL RIGHTS RESERVED. NO PART OF THESE WORKS MAY BE REPRODUCED IN ANY FORM WITHOUT PERMISSION IN WRITING. RENT ADJUSTMENT(S) ------------------ STANDARD LEASE ADDENDUM ----------------------- DATED May 21, 2003 --------------------------------------------------------- BY AND BETWEEN (LESSOR) 1989 Sheehan Family Trust dated October ---------------------------------------- 24, 1989 ---------------------------------------- (LESSEE) Electronic Clearing House, Inc., a ---------------------------------------- Nevada Corporation ---------------------------------------- ADDRESS OFPREMISES: 730Paseo Camarillo, Camarillo, CA 93010 ---------------------------------------- Paragraph 51 ---- A. RENT ADJUSTMENTS: The monthly rent for each month of the adjustment period(s) specified below shall be increased using the method(s) indicated below: (Check Method(s) to be Used and Fill in Appropriately) [_] I. COST OF LIVING ADJUSTMENT(S) (COLA) a. On(Fill in COLA Dates): ------------------------------------------ - -------------------------------------------------------------------------------- the Base Rent shall be adjusted by the change, if any, from the Base Month specified below, in the Consumer Price Index of the Bureau of Labor Statistics of the U.S. Department of Labor for (select one): [_] CPI W (Urban Wage Earners and Clerical Workers) or [_] CPI U (All Urban Consumers), for (Fill in Urban Area): , All Items (1982-1984 = 100), herein referred to as "CPI". b. The monthly rent payable in accordance with paragraph A.I.a. Addendum shall be calculated as follows: the Base Rent set forth in paragraph 1.5 of the attached Lease, shall be multiplied by a fraction the numerator of which shall be the CPI of the calendar month 2 months prior to the month(s) specified in paragraph Ala. above during which the adjustment is to take effect, and the denominator of which shall be the CPI of the calendar month which is 2 months prior to (select one): [_] the first month of the term of this Lease as set forth in paragraph 1.3 ("Base Month") or [_] (Fill in Other "Base Month"): The sum so calculated shall constitute the new monthly rent hereunder, but in no event, shall any such new monthly rent be less than the rent payable for the month Immediately preceding the rent adjustment. c. In the event the compilation and/or publication of the CPI shall be transferred to any other governmental department or bureau or agency or shall be discontinued, then the index most nearly the same as the CPI shall be used to make such calculation. In the event that the Parties cannot agree on such alternative index, then the matter shall be submitted for decision to the American Arbitration Association in accordance with the then rules of said Association and the decision of the arbitrators shall be binding upon the parties. The cost of said Arbitration shall be paid equally by the Parties. [_] II. MARKET RENTAL VALUE ADJUSTMENT(S) (MRV) a. On (Fill in MRV Adjustment Date(s): ------------------------------ - -------------------------------------------------------------------------------- the Base Rent shall be adjusted to the "Market Rental Value" of the property as follows: 1) Four months prior to each Market Rental Value Adjustment Date described above, the Parties shall attempt to agree upon what the new MRV will be on the adjustment date. If agreement cannot be reached within thirty days, then: (a) Lessor and Lessee shall immediately appoint a mutually acceptable appraiser or broker to establish the new MRV within the next 30 days. Any associated costs will be split equally between the Parties, or (b) Both Lessor and Lessee shall each immediately make a reasonable determination of the MRV and submit such determination, in writing, to arbitration in accordance with the following provisions: (I) Within 15 days thereafter, Lessor and Lessee shall each select an appraiser or broker ("CONSULTANT" - check one) of their choice to act as an arbitrator. The two arbitrators so appointed shall immediately select a third mutually acceptable Consultant to act as a third arbitrator. (ii) The 3 arbitrators shall within 30 days of the appointment of the third arbitrator reach a decision as to what the actual MRV for the Premises is, and whether Lessor's or Lessee's submitted MRV is the closest thereto. The decision of a majority of the arbitrators shall be binding on the Parties. The submitted MRV which is determined to be the closest to the actual MRV shall thereafter be used by the Parties. (iii) If either of the Parties fails to appoint an arbitrator within the specified 15 days, the arbitrator timely appointed by one of them shall reach a decision on his or her own, and said decision shall be binding on the Parties. (iv) The entire cost of such arbitration shall be paid by the party whose submitted MRV is not selected, ie. the one that is NOT the closest to the actual MRV. 2) Notwithstanding the foregoing, the new MRV shall not be less than the rent payable for the month immediately preceding the rent adjustment. b. Upon the establishment of each New Market Rental Value: 1) the new MRV will become the new "Base Rent" for the purpose of calculating any further Adjustments, and 2) the first month of each Market Rental Value term shall become the new 'Base Month' for the purpose of calculating any further Adjustments. [_] III. FIXED RENTAL ADJUSTMENT(S) (FRA) The Base Rent shall be increased to the following amounts on the dates set forth belo
On (Fill in FRA Adjustment Date(s)): The New Base Rent shall be: October 1, 2005 $ 23,034.50 ------------------------------------ ---------------------------- October 1, 2007 $ 24,036.00 ------------------------------------ ---------------------------- $ ------------------------------------ ---------------------------- $ ------------------------------------ ----------------------------
B. NOTICE: Unless specified otherwise herein, notice of any such adjustments, other than Fixed Rental Adjustments, shall be made as specified in paragraph 23 of the Lease. C. BROKERS FEE: The Brokers shall be paid a Brokerage Fee for each adjustment specified above in accordance with paragraph 15 of the Lease. Sandrosky-2OO3-rentadj-730 Paseo Camarillo NOTE: THESE FORMS ARE OFTEN MODIFIED TO MEET CHANGING REQUIREMENTS OF LAW AND NEEDS OF THE INDUSTRY. ALWAYS WRITE OR CALL TO MAKE SURE YOU ARE UTILIZING THE MOST CURRENT FORM: AMERICAN INDUSTRIAL REAL ESTATE ASSOCIATION, 700 S. FLOWER STREET, SUITE 600, LOS ANGELES, CALIF. 90017 OPTION( S) TO EXTEND STANDARD LEASE ADDENDUM DATED May 21, 2003 --------------------------------------------------------- BY AND BETWEEN (LESSOR) 1989 Sheehan Family Trust dated October ---------------------------------------- 24, 1989 ---------------------------------------- (LESSEE) Electronic Clearing House, Inc., a ---------------------------------------- Nevada Corporation ---------------------------------------- ADDRESS OFPREMISES: 730Paseo Camarillo, Camarillo, CA 93010 ---------------------------------------- Paragraph 52 - ------------ A. OPTION(S) TO EXTEND: Lessor hereby grants to Lessee the option to extend the term of this Lease for one (1) additional sixty (60) month period(s) commencing when the prior - ----------- --------- term expires upon each and all of the following terms and conditions: (i) In order to exercise an option to extend, Lessee must give written notice of such election to Lessor and Lessor must receive the same at least 6 but not more than 9 months prior to the date that the ----- ------ option period would commence, time being of the essence. If proper notification of the exercise of an option is not given and/or received, such option shall automatically expire. Options (if there are more than one) may only be exercised consecutively. (ii) The provisions of paragraph 39, including those relating to Lessee's Default set forth in paragraph 39.4 of this Lease, are conditions of this Option. (iii) Except for the provisions of this Lease granting an option or options to extend the term, all of the terms and conditions of this Lease except where specifically modified by this option shall apply. (iv) This Option is personal to the original Lessee, and cannot be assigned or exercised by anyone other than said original Lessee and only while the original Lessee is in full possession of the Premises and without the intention of thereafter assigning or subletting. (v) The monthly rent for each month of the option period shall be calculated as follows, using the method(s) indicated below: (check method(s) to be Used and Fill in Appropriately) [_] I. COST OF LIVING ADJUSTMENT(S) (COLA) a. On (Fill in COLA Dates): ---------------------------------------------- - -------------------------------------------------------------------------------- the Base Rent shall be adjusted by the change. if any, from the Base Month specified below, in the Consumer Price Index of the Bureau of Labor Statistics of the U.S. Department of Labor for (select one): [ ] CPI W (Urban Wage Earners and Clerical Workers) or [ ] CPI U (All Urban Consumers), for (Fill in Urban Area): - -------------------------------------------------------------------------------- All Items (1982-1984 = 100), herein referred to as "CPI". b. The monthly rent payable in accordance with paragraph A.I.a. of this Addendum shall be calculated as follows: the Base Rent set forth in paragraph 1.5 of the attached Lease, shall be multiplied by a fraction the numerator of which shall be the CPI of the calendar month 2 months prior to the month(s) specified in paragraph A.l.a. above during which the adjustment is to take effect, and the denominator of which shall be the CPI of the calendar month which is 2 months prior to (select one): [ ] the first month of the term of this Lease as set forth in paragraph 1.3 ("Base Month") or [ ] (Fill in Other "Base Month"): . - -------------------------------------------------------------------------------- The sum so calculated shall constitute the new monthly rent hereunder, but in no event, shall any such new monthly rent be less than the rent payable for the month immediately preceding the rent adjustment. c. In the event the compilation and/or publication of the CPI shall be transferred to any other governmental department or bureau or agency or shall be discontinued, then the index most nearly the same as the CPI shall be used to make such calculation. In the event that the Parties cannot agree on such alternative index, then the matter shall be submitted for decision to the American Arbitration Association in accordance with the then rules of said Association and the decision of the arbitrators shall be binding upon the parties. The cost of said Arbitration shall be paid equally by the Parties. [_] II. MARKET RENTAL VALUE ADJUSTMENT(S) (MRV) a. On (Fill in MRV Adjustment Date(s)) ----------------------------------- - -------------------------------------------------------------------------------- the Base Rent shall be adjusted to the "Market Rental Value" of the property as follows: 1) Four months prior to each Market Rental Value Adjustment Date described above, the Parties shall attempt to agree upon what the new MRV will be on the adjustment date. If agreement cannot be reached, within thirty days, then: (a) Lessor and Lessee shall immediately appoint a mutually acceptable appraiser or broker to establish the new MRV within the next 30 days. Any associated costs will be split equally between the Parties, or (b) Both Lessor and Lessee shall each immediately make a reasonable determination of the MRV and submit such determination, in writing, to arbitration in accordance with the following provisions: (i) Within 15 days thereafter, Lessor and Lessee shall each select an D appraiser or 0 broker ("Consultant" check one) of their choice to act as an arbitrator. The two arbitrators so appointed shall immediately select a third mutually acceptable Consultant to act as a third arbitrator. (ii) The 3 arbitrators shall within 30 days of the appointment of the third arbitrator reach a decision as to what the actual MRV for the Premises is, and whether Lessor's or Lessee's submitted MRV is the closest thereto. The decision of a majority of the arbitrators shall be binding on the Parties. The submitted MRV which is determined to be the closest to the actual MRV shall thereafter be used by the Parties. (iii) If either of the Parties fails to appoint an arbitrator within the specified 15 days, the arbitrator timely appointed by one of them shall reach a decision on his or her own, and said decision shall be -------------------------------------- binding on the Parties. closest to the actual MRV. (iv) The entire cost of such arbitration shall be paid by the party whose submitted MRV is not selected, ie. the one that is NOT the closest to the actual MRV. 2) Notwithstanding the foregoing, the new MRV shall not be less than the rent payable for the month immediately preceding the rent adjustment. b. Upon the establishment of each New Market Rental Value: 1) the new MRV will become the new "Base Rent" for the purpose of calculating any further Adjustments, and 2) the first month of each Market Rental Value term shall become the new "Base Month" for the purpose of calculating any further Adjustments. [_] III. FIXED RENTAL ADJUSTMENT(S) (FRA) The Base Rent shall be increased to the following amounts on the dates set forth below:
On (Fill in FRA Adjustment Date(s)): The New Base Rent shall be: October 1, 2008 $ 25,037.50 ------------------------------------ ---------------------------- October1, 2010 $ 26,039.00 ------------------------------------ ---------------------------- October 1, 2012 $ 27,040.50 ------------------------------------ ---------------------------- $ ------------------------------------ ----------------------------
B. NOTICE: Unless specified otherwise herein, notice of any rental adjustments, other than Fixed Rental Adjustments, shall be made as specified in paragraph 23 of the Lease. AMERICAN INDUSTRIAL REAL ESTATE ASSOCIATION ------------------------------------------- OPTION TO PURCHASE ------------------ Standard Lease Addendum ----------------------- DATED May 21, 2003 --------------------------------------------------------- BY AND BETWEEN (LESSOR) 1989 Sheehan Family Trust dated October ---------------------------------------- 24, 1989 ---------------------------------------- (LESSEE) Electronic Clearing House, Inc., a ---------------------------------------- Nevada Corporation ---------------------------------------- ADDRESS OFPREMISES: 730Paseo Camarillo, Camarillo, CA 93010 ---------------------------------------- Paragraph 53 ---- (a) Lessor hereby grants to Lessee an option to purchase the Premises upon the terms and conditions herein set forth. (b) In order to exercise this option to purchase, Lessee must give written notice of the exercise of the option to Lessor during the period from October 1, ---------- 2005 to October 31, 2005 (the "Option Period"), time being of the - -------- -------------------- essence. If such notice is not so given, this option shall automatically expire. At the same time the option is exercised, Lessee must deliver to Lessor a cashier's check in the amount of $25,000.00 payable to Chicago Title Insurance ---------- ------------------------- Co. TO be part of the purchase price. - --- (c) The provisions of paragraph 39, including those relating to Lessee's Default set forth in paragraph 39.4 of this LEASE ARE CONDITIONS OF this Option. (d) II Lessee elects to exercise this option to purchase as provided above, the transfer of title to Lessee shall occur on the close of escrow on and until that time the terms of this Lease shall remain in full force and effect. (e) If Lessee elects to exercise this option to purchase, the purchase price to be paid by Lessee shall be $The Fair Market Value an determined by -------------------------------------------- agreement between Less and Lessee or failing agreement by the AIR - -------------------------------------------------------------------------------- "Three Arbitrator Approach". In no event will the purchase price be less than $4,&OO,000.0O plus the cost of Capital Improvements and Tenant lmprovements expended on the building by Lessor from the date of Lease execution to lessee's exercise of the Option to Purchase, but in no civil; shall the Capital Improvements arid Tenant improvements in total exceed one million dollars ($1,000,000.00). (f) Within 10 days after this option to purchase is exercised, Lessor and Lessee shall give instructions to consummate the sale to Chicago Title Insurance ----------------------- Co. , located at 5675 Ralston Street - ---------------------------- --------------------------------------- Ventura,CA, who shall act as escrow holder, on the normal and usual escrow forms - ----------- then used by such escrow holder, as follows: (i) Escrow shall close 90 or days after mutual execution of the ---- Purchase and SALE Agreement. (ii) Lessor shall deposit the check referred to in paragraph (b) into escrow upon opening thereof, with the balance of the purchase price to be deposited into escrow no hater then 2:00 P.M. on the last business day prior to the expected closing date; (iii) The parties agree to execute any additional instructions as are normal and usual; (iv) The balance of the terms and conditions of sale shall be as set forth in the American Industrial Real Estate Association "STANDARD OFFER, AGREEMENT AND ESCROW INSTRUCTIONS FOR THE PURCHASE OF REAL ESTATE", a copy of which is attached hereto: May 21, 2003 for reference purposes ---------------------------------------------- and paragraphs 4.2; 5; 6; 9.1 a,b,c,d,e,h,i,j, and k; and 20, which do not apply. (g) Either Lessor or Lessee shall, upon request of the other, execute, acknowledge and deliver to the other a short form memorandum of this Lease for recording purposes. The Party requesting recordation shall be responsible for payment of any fees applicable thereto. (h) In the event that this option to purchase is not exercised by Lessee in a timely fashion, the Lessee shall, upon request of Lessor, execute, acknowledge and deliver to Lessor a quit claim deed releasing Lessee's interest in such option. Lessor shall be responsible for the preparation of such deed and the payment of any fees applicable to the recording thereof. (i) In order to establish the value of the property prior to the dates for exercise of the Option to Purchase, the value must 170 agreed upon or the appraisal must be conducted prior to the window of October 1, 2005 to October 31, 2005. In order to establish the value prior to such time period, the parties agree to the following procedure: (i) On or prior to August 1, 2005 the parties shall either agree on the price at which the Option may be exercised or implement the AIR "Three Arbitrator Approach". (ii). The time period for the exercise of the option shall not commence to run until there has been an agreement regarding value or the determination of value. (iii).If the value is agreed upon or determined prior to October 1, 2005, the time period for exercise shall be as in 53(b). (iv). Despite the efforts of the parties, if the value is not agreed upon or determined prior to October 1,2005, the option period specified in paragraph E~3(17) shall be extended so that ~u.ycr has the option of exercise to purchase for a full thirty (30) day period commencing from the date of agreement or determination, WARNING: 1. LESSEE SHOULD NOT EXERCISE THIS OPTION UNTIL LESSEE HAS COMPLETED SUCH INVESTIGATION AS MAY BE APPROPRIATE, OBTAINED ANY NECESSARY FINANCING, AND IS OTHERWISE IN A POSITION TO COMPLETE SUCH PURCHASE. 2. IF THE PROPERTY IS LOCATED IN A STATE OTHER THAN CALIFORNIA, CERTAIN PROVISIONS OF THE STANDARD OFFER, AGREEMENT AND EXCROW INSTRUCTIONS FOR THE PURCHASE OF REAL ESTATE MAY NEED TO BE REVISED TO COMPLY WITH THE LAWS OF THE STATE IN WHICH THE PROPERTY IS LOCATED.H:/SAndrosky-2OO3-optpur-73O Paseo CamarilIo RIGHT OF FIRST REFUSAL TO PURCHASE ---------------------------------- STANDARD LEASE ADDENDUM ----------------------- DATED May 21, 2003 --------------------------------------------------------- BY AND BETWEEN (LESSOR) 1989 Sheehan Family Trust dated October ---------------------------------------- 24, 1989 ---------------------------------------- (LESSEE) Electronic Clearing House, Inc., a ---------------------------------------- Nevada Corporation ---------------------------------------- ADDRESS OFPREMISES: 730Paseo Camarillo, Camarillo, CA 93010 ---------------------------------------- Paragraph 54. - ------------- (a) Lessor shall not, at any time prior to the expiration of the term of this Lease, or any extension thereof, sell the Premises, or any interest therein, without first giving written notice thereof to Lessee, which notice is hereinafter referred to as "Notice of Sale". (b) The Notice of Sale shall include the exact and complete terms of the proposed sale and shall have attached thereto a copy of the bona fide offer and counteroffer, if any, duly executed by both Lessor and the prospective purchaser. (c) For a period of 12 10 business calendar-days after receipt by Lessee of the Notice of Sale, Lessee shall have the right to give written notice to Lessor of Lessee's exercise of Lessee's right to purchase the Premises, the interest therein proposed to be sold, or the property of which the Premises are a part, on the same terms, price and conditions as set forth in the Notice of Sale. In the event that Lessor does not receive written notice of Lessee's exercise of the right herein granted within said 12 10 business day period, there shall be a conclusive presumption that Lessee has elected NOT to exercise Lessee's right hereunder, and Lessor may complete the sale to the prospective purchaser, on the same terms set forth in the Notice of Sale. (d) In the event that Lessee declines to exercise its right of first refusal after receipt of the Notice of Sale, and, thereafter, Lessor and the prospective purchaser modify by more than 5%, (I) the sales price, or (ii) the amount of down payment, or if there is a material change in any seller financing offered, or in the event that the sale is not consummated within 180 days of the date of the Notice of Sale, then Lessee's right of first refusal shall reapply to said transaction. (e) In the event that Lessee declines to exercise its right of first refusal after receipt of the Notice of Sale, and, thereafter, the proposed transfer or sale is not consummated, the Lessee's right of first refusal shall apply to any subsequent transaction. If, however, said transfer or sale is, in fact, completed, then said right shall be extinguished and shall not apply to any subsequent transactions. (f) Notwithstanding the above, this right of first refusal is intended to apply only to voluntary transfers involving third party transferees. This right of first refusal shall not, therefore, apply: where the Premises are taken by eminent domain or sold under threat of condemnation, to inter-family or inter-ownership transfers, to transfers by Lessor to a trust created by Lessor, or, if Lessor is a trust, to transfers to a trust beneficiary. (g) NOTE: This right of first refusal cannot be exercised: (i) during the period commencing with the giving of any notice of Default and continuing until said Default is cured, (ii) during the period of lime any Rent is unpaid (without regard to whether notice thereof is given Lessee), (iii) during the time Lessee is in Breach of this Lease, or (iv) in the event that Lessee has been given 3 or more notices of Default, whether or not the Defaults are cured, during the 12 month period immediately preceding the exercise of the right of first refusal. ADDENDUM TO THAT STANDARD MULTI-TENANT OFFICE LEASE GROSS DATED MAY 21, 2003, BY AND BETWEEN 1989 SHEEHAN FAMILY TRUST DATE1) OCTOBER 24, 1989, AS LESSOR, AND ELECTRONIC CLEARING HOUSE, INC, A NEVADA CORPORATION, AS LESSEE, FOR THAT PROPERTY COMMONLY KNOWN AS 730 PASEO CAMARILLO, CAMARILLO, CALIFORNIA. 55. SIGNS: Lessee shall have the right to install building lop signage subject to approval by the Lessor and City of Camarillo of the signage, its size and location on the building. All costs of the signage, its fabrication, installation, maintenance, and removal shall be the responsibility of Lessee. 56. ROOFTOP RIGHTS: Lessee, at Lessee's sole cost, shall have the right to install its telecommunications equipment or additional UVAC equipment on the roof of the building subject to approval of the equipment, its size, location, and its interconnectivity, by Lessor and, if necessary, the City of Camarillo. 57. RIGHT OF FIRST REFUSAL - Lease: Lessor hereby grants to Lessee an on-going Right of First Refusal to Lease space on the first floor of the building. In the event Lessor receives an acceptable bonafide third party offer to Lease all or part of the first floor space, Lessor shall Business first notify Lessee of said offer. Lessee shall have ten (l0) business days to provide Lessor with written exercise of its Right of First Refusal to Lease the space which Lease will be at Lessee's then prevailing base rent, with the space in its "as-is" condition, and with an overall remaining Lease term no less than three (3) years. Upon such written exercise, Lessor will prepare an Addendum to this Lease execution by the parties. 58. OPTION TO TERMINATE: Lessee shall have a one-time option to terminate the Lease effective as of the end of the thirty-sixth (36T11) month of the Lease term by providing Lessor with at least four (4) months prior written notice and, within thirty (30) days of delivery of such notice, delivering to Lessor a termination fee equal to the sum of: I) The unamortized balance of tenant improvement allowance, furniture/equipment fees-plus; 2) A termination fee equal to four (4) months of the then prevailing base rent (approx. $92,138.00). 59. FURNITURE/EQUIPMENT FEE: In addition to the base rent payable per Sections 1.5 and 51 of the Lease, Lessee shall be responsible to pay monthly with the base rent during the initial Lease term a furniture/equipment fee of $3,000 per month. At the end of the five (5) year Lease term, this furniture and equipment including the UPS system shall become the property of Lessee upon the payment to Lessor of One Dollar ($1 .00). Upon acquisition of such property, the furniture/equipment fee shall terminate, and Lessee shall remit the remaining balance to Lessor. 60. STANDBY DIESEL GENERATOR: A standby diesel generator is interconnected with the building and Premises and is available for use by Lessee and other tenants in the building. Lessee shall be responsible to maintain and test the generator on a regular basis. The cost of replacement parts and diesel fuel shall be shared equally by Lessee and Lessor or by Lessee and other tenants utilizing the standby diesel generator. Landlord acknowledged standby diesel generator is not permitted. Notwithstanding above Landlord at Landlords sole cost and expense shall deliver to Lessee, prior to Rent Commencement (October 1, 2003), the standby diesel generator fully compliant with all Federal, State local laws and regulations. 61. Sections 2.3(1)), 4.2(c) (viii) and 4.2(g) are hereby amended to eliminate from the definition of Operating I ~expenses the cost. of any Capital Expenditure and, therefore, eliminate from the obligations of Lessee the responsibility for amortization of such expenditures. By this modification, Lessor and Lessee agree that Lessee shall not be responsible for any Capital Expenditure including but not limited to the roof, foundations, exterior walls or a Common Area capital improvement together with renovations, divisions and improvements to the first floor of the Project. The parties acknowledge that Lessor intends to refurbish, divide and improve the first-floor of the Project and, by this Addendum, the parties specifically eliminate from the Lease all obligations of Lessee therefore. 62. Section 2.6 is hereby modified to provide that, during the term of this Lease and any extension thereof, Lessee shall have the right to utilize such parking spaces specified in Section 1.2(b) without any rent or charge. 63. Except as provided in the Lease, the Lessee accepts the Premises in "as-is" condition except that Lessor will clean the carpets, repaint the walls, and replace any damage ceiling tiles and light fixtures. 64. Notwithstanding the provisions of Section 1 .12, concerning the Business Flours for the Building, Lessee shall be entitled to access to the Premises and parking areas on all dates and at all times. Lessor acknowledges that Lessee's business operation is twenty-four (24) hours per day, seven (7) days per week. 65. Notwithstanding the provisions of Section 12, Lessor's consent to such an assignment or sublease shall not be unreasonably withheld, delayed or conditioned. Lessee shall retain 50% of any excess consideration received. A reorganization, merger, sale, partnership change, assignment, transfer or hypothecation or other ownership interest in Lessee shall not be deemed an assignment or sublease under this section. Neither the use by, nor [lie subletting to, any subsidiary, any subsidiary or any subsidiary or affiliate of Lessee of all or a portion of the Premises shall be deemed an assignment or sublease under the Lease and Lessee shall not be required to secure consent from the Lessor. 67. Notwithstanding the provisions of Section 6.2 hazardous Substances, Lessor hereby discloses to Lessee that the building's original rooting materials may have contained asbestos and that these materials were covered up by a rubber membrane when the roof was re-done by GTE in 1998. Lessor subsequently had a new roof installed over the rubber membrane. Lessee is advised that any work on the roof should not be attempted by an unqualified person, and not without coordination with Lessor. RULES AND REGULATIONS FOR STANDARD OFFICE LEASE --------------------- Dated: May 21, 2003 --------------------------------- By and Between 1989 Sheehan Family Trust dated October 24, 1989 (Lessor) and ------------------------------------------------------------------------- Electronic Clearing House, Inc., a Nevada Corporation (Lessee) - -------------------------------------------------------------- GENERAL RULES ------------- 1. Lessee shall not suffer or permit the obstruction of any Common Areas, including driveways, walkways and stairways. 2. Lessor reserves the right to refuse access to any persons Lessor in good faith judges to be a threat to the safety and reputation of the Project and its occupants. 3. Lessee shall not make or permit any noise or odors that annoy or interfere with other lessees or persons having business within the Project. 4. Lessee shall not keep animals or birds within the Project, and shall not bring bicycles, motorcycles or other vehicles into areas not designated as authorized for same. 5. Lessee s~1iall not make, suffer or permit litter except in appropriate receptacles for that purpose. 6. Lessee shall not alter any lock or install new or additional locks or bolts. 7. Lessee shall be responsible for the inappropriate use of any toilet rooms, plumbing or other utilities. No foreign substances of any kind are to be inserted therein. 8. Lessee shall not deface the walls, partitions or other surfaces of the Premises or Project. 9. Lessee shall not suffer or permit anything in or around the Premises or Building that causes excessive vibration or floor loading in any part of the Project. 10. Furniture, significant freight and equipment shall be moved into or out of the building only with the Lessor's knowledge and consent, and subject to such reasonable limitations, techniques and timing, as may be designated by Lessor. Lessee shall be responsible for any damage to the Office Building Project arising from any such activity. 11. Lessee shall not employ any service or contractor for services or work to be performed in the Building, except as approved by Lessor. 12. Lessor reserves the right to close and lock the Building on Saturdays, Sundays and Building Holidays, and on other days between the hours of 7:00P.M. and 7:00AM. of the following day. If Lessee uses the Premises during - ---- ---- such periods, Lessee shall be responsible for securely locking any doors it may have opened for entry. 13. Lessee shall return all keys at the termination of its tenancy and shall be responsible for the cost of replacing any keys that are lost. 14. No window coverings, shades or awnings shall be installed or used by Lessee. Lessee's sole cost and expense. 16. Lessee shall not suffer or permit smoking or carrying of lighted cigars or cigarettes in areas reasonably designated by Lessor or by applicable governmental agencies as non-smoking areas. 17. Lessee shall not use any method of heating or air conditioning other than as provided by Lessor. 18. Lessee shall not install, maintain or operate any vending machines upon the Premises without Lessor's written consent. 19. The Premises shall not be used for lodging or manufacturing, cooking or food preparation. 20. Lessee shall comply with all safety, fire protection and evacuation regulations established by Lessor or any applicable governmental agency. 21. Lessor reserves the right to waive any one of these rules or regulations, and/or as to any particular Lessee, and any such waiver shall not constitute a waiver of any other rule or regulation or any subsequent application thereof to such Lessee. 22. Lessee assumes all risks from theft or vandalism and agrees to keep its Premises locked as may be required. 23. Lessor reserves the right to make such other reasonable rules and regulations as it may from time to time deem necessary for the appropriate operation and safety of the Project and its occupants. Lessee agrees to abide by these and such rules and regulations. PARKING RULES 1. Parking areas shall be used only for parking by vehicles no longer than full size, passenger automobiles herein called "Permitted Size Vehicles." Vehicles other than Permitted Size Vehicles are herein referred to as "Oversized Vehicles." 2. Lessee shall not permit or allow any vehicles that belong to or are controlled by Lessee or Lessee's employees, suppliers, shippers, customers, or invitees to be loaded, unloaded, or parked in areas other than those designated by Lessor for such activities. 3. Parking stickers or identification devices shall be the property of Lessor and be returned to Lessor by the holder thereof upon termination of the holder's parking privileges. Lessee will pay such replacement charge as is reasonably established by Lessor for the loss of such devices. 4. Lessor reserves the right to refuse the sale of monthly identification devices to any person or entity that willfully refuses to comply with the applicable rules, regulations, laws and/or agreements. 5. Lessor reserves the right to relocate all or a part of parking spaces from floor to floor, within one floor, and/or to reasonably adjacent offsite location(s), and to reasonably allocate them between compact and standard size spaces, as long as the same complies with applicable laws, ordinances and regulations. 6. Users of the parking area will obey all posted signs and park only in the areas designated for vehicle parking. 7. Unless otherwise instructed, every person using the parking area is required to park and lock his own vehicle. Lessor will not be responsible for any damage to vehicles, injury to persons or loss of property, all of which risks are assumed by the party using the parking area. 8. Validation, If established, will be permissible only by such method or methods as Lessor and/or its licensee may establish at rates generally applicable to visitor parking. 9. The maintenance, washing, waxing or cleaning of vehicles in the parking structure or Common Areas is prohibited. 10. Lessee shall be responsible for seeing that all of its employees, agents and invitees comply with the applicable parking rules, regulations, laws and agreements. 11. Lessor reserves the right to modify these rules and/or adopt such other reasonable and non-discriminatory rules and regulations as it may deem necessary for the proper operation of the parking area. 12. Such parking use as is herein provided is intended merely as a license only and no bailment is intended or shall be created hereby. FIRST AMENDMENT TO LEASE This First Amendment to Lease ("First Amendment") is entered into as of July 10, 2003 by and between the 1989 Sheehan Family Trust dated October 24, 1989 ("Lessor") and Electronic Clearing House, Inc., a Nevada Corporation ("Lessee"), and amends that certain Standard Multi- Tenant Lease - Gross dated May 21, 2003 for the Premises commonly known as 730 Paseo Camarillo, Suite 200, Camarillo, California ("Premises"), as more particularly described therein. Lessee wishes to lease additional space and the parties wish to amend the Lease to specify the New Premises and new terms and conditions. Accordingly, the parties agree to amend the Lease as follows: 1. NEW PREMISES: Suite 101 consisting of approximately 1,536 usable square feet shall be added to the Premises for a total New Premises of approximately 21,566 square feet. 2. EFFECTIVE DATE: October 1, 2003. 3. EARLY POSSESSION OF SUITE 101: Upon fill execution of this First Amendment. 4. NEW MONTHLY BASE RENT: $23,722.60. 5. ADDITIONAL BASE RENT AND SECURITY DEPOSIT TO BE PAID UPON EXECUTION: (a) Base Rent: $1,689.60 for the period October, 2003 for a total Base Rent paid of - -- $23,722.60. (b) Security Deposit: $1,689.60 for a total Security Deposit paid of $23,722.60. 6. PARKING: 142 unreserved spaces. 7. LESSEE'S SHARE OF OPERATING EXPENSE INCREASE: Fifty-three and 87/100 percent (53.87%). 8. TENANT IMPROVEMENTS: Lessee shall accept Suite 101 in its "as-is" condition except Lessor, at its cost, and within thirty (30) days of fill execution of this First Amendment, shall complete the following improvements: - Add a single entry door with lockset from the lobby area into Suite 101. - Paint the suite. - Add signage in the lobby area in a configuration and location agreeable to Lessee and Lessor: "ECHO Shipping and Receiving Headquarters on 2t~~I floor". - At Lessor's option, add a door from Suite 101 into the telephone area containing the UPS system. 9. UTILITIES AND SERVICES: Lessee shall pay, at Lessor's option, either Lessee's share or a reasonable proportion to be determined by Lessor of all charges for jointly metered utilities and for services to Suite 101. 10. FORCE AND EFFECT: To the extent that any terms or provisions of this Amendment are inconsistent with any terms or provisions of the Lease, the terms and provisions of this Amendment shall prevail and control for all purposes. EX-31.1 4 doc3.txt EXHIBIT 31.1 EXHIBIT 31.1 CERTIFICATION OF CEO PURSUANT TO SECURITIES EXCHANGE ACT RULES 13A-14(A) AND 15D-14(A) AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Joel M. Barry, certify that: 1. I have reviewed this annual report on Form 10-K of Electronic Clearing House, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: December 26, 2003 /s/ Joel M. Barry ----------------------- Joel M. Barry Chief Executive Officer EX-31.2 5 doc4.txt EXHIBIT 31.2 EXHIBIT 31.2 CERTIFICATION OF CFO PURSUANT TO SECURITIES EXCHANGE ACT RULES 13A-14(A) AND 15D-14(A) AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Alice L. Cheung, certify that: 1. I have reviewed this annual report on Form 10-K of Electronic Clearing House, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: December 26, 2003 /s/ Alice L. Cheung ----------------------- Alice L. Cheung Chief Financial Officer EX-32.1 6 doc5.txt EXHIBIT 32.1 EXHIBIT 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Electronic Clearing House, Inc. (the "Company") on Form 10-K for the year ended September 30, 2003, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Joel M. Barry, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of my knowledge: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Joel M. Barry Joel M. Barry Chief Executive Officer December 26, 2003 EX-32.2 7 doc6.txt EXHIBIT 32.2 EXHIBIT 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Electronic Clearing House, Inc. (the "Company") on Form 10-K for the year ended September 30, 2003, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Alice L. Cheung, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of my knowledge: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Alice L. Cheung Alice L. Cheung Chief Financial Officer December 26, 2003 -----END PRIVACY-ENHANCED MESSAGE-----