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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-KSB
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 0-22081
--------------------------------------
ELECTRONIC PROCESSING, INC.
(NAME OF SMALL BUSINESS ISSUER IN ITS CHARTER)
Missouri 48-1056429
(State or Other Jurisdiction of (IRS Employer Identification Number)
Incorporation or Organization)
501 Kansas Avenue, Kansas City, Kansas 66105-1300
(Address of Principal Executive Office)
913-321-6392
(Issuer's Telephone Number)
Securities Registered Under Section 12(b) of the Exchange Act:
None
Securities Registered Under Section 12(g) of the Exchange Act:
Common Stock, Without Par Value
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months and (2) has been
subject to such filing requirements for the past 90 days. Yes No X
--- ---
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [X]
Revenues for the fiscal year ended December 31, 1996 are $6,319,192
The aggregate market value of the Common Stock held by non-affiliates (based
upon the last reported price on the bid-ask average on the OTC bulletin board)
on March 17, 1997 was approximately
$6,244, 590. As of March 17, 1997 there were 3,400,000 shares of Common Stock
outstanding.
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DOCUMENTS INCORPORATED BY REFERENCE
NONE
PART I
ITEM 1. DESCRIPTION OF BUSINESS
Electronic Processing, Inc. ("EPI" or the "Company") serves a national
client base with specialty products that facilitate financial and administrative
aspects of bankruptcy management, including legal noticing, claims management,
funds distribution and government reporting. The Company develops, markets,
licenses and supports internally developed and proprietary software products
primarily to trustees under Chapter 7 and Chapter 13 of the Bankruptcy Code of
1978, as amended (the "Bankruptcy Code"), as well as to other users of the
federal bankruptcy system, including trustees in Chapter 11 and Chapter 12. EPI
assimilates software development, network operations, value-added services and
comprehensive post-installation support into an integrated environment that
offers clients a high level of coordinated support.
Between 1993 and 1996, the Company concentrated on developing software
and systems compatible with current technologies and recruited a management
team experienced in bankruptcy management and software development. During
this time the Company concentrated on developing and upgrading its Chapter 7
and Chapter 13 products to be compatible with current software operating
environments. In 1996, the Company introduced its TCMS Chapter 7
Windows95/Windows NT 4 based system. In late 1996, the Company completed
testing of CASEPOWER, a new PC-based Windows95/Windows NT 4 Chapter 13
product, designed to replace the Company's MIDRANGE Chapter 13 product, which
was based on IBM mini-computer AS/400 technology.
INDUSTRY OVERVIEW
Title 11 of the U.S. Code establishes federal law governing bankruptcies.
The participants in a bankruptcy proceeding include the debtor, the creditors,
and a trustee, as well as the presiding judge. The trustee acts as an
intermediary between the debtor and the creditors and is responsible for
administering the bankruptcy case. The end user clients of the Company's
products are TRUSTEES, not individual debtors or creditors.
The United States Trustee's office, a division of the Justice Department,
oversees bankruptcy trustees and establishes administrative rules concerning
trustees' activities. Local bankruptcy judges also direct trustees' activities
and have a high level of authority in a bankruptcy case. The trustees'
activities are guided by the Bankruptcy Code, the Federal Rules of Bankruptcy
Procedure, the trustee handbooks developed by the United States Trustee, and
local rules established by the courts.
There are five chapters of the Bankruptcy Code that define various
configurations of bankruptcy cases:
Chapter 7 - Liquidation
Chapter 9 - Reorganization of Municipality
Chapter 11 - Reorganization of Corporation
Chapter 12 - Reorganization of Family Farm
Chapter 13 - Reorganization of Individual Debt
The Company believes that Chapter 7 and Chapter 13 are the most attractive
sectors in the bankruptcy
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industry to which it can provide service and has developed a strategic plan
accordingly. There are significantly fewer filings in Chapter 9 and Chapter 12
than in Chapters 7 and 13, and the industry analysts note that Chapter 11
filings have decreased as distressed organizations increasingly make private
arrangements with their creditors for payment of debt.
Chapter 7 and Chapter 13 bankruptcies serve different purposes and require
different services and information. Chapter 7 of the Bankruptcy Code provides
for liquidation of the assets of the debtor (which can be an individual,
partnership or corporation) and for the disbursement of the resulting cash
proceeds to the creditors. Chapter 13 provides for adjustments of debt whereby
the debtor makes regular payments to the trustee, who in turn disburses the
collected funds to the creditors. Assets are not liquidated in Chapter 13.
Bankruptcy trustees in Chapters 7 and 13 are appointed by the United States
Trustee. A United States Trustee is appointed in most federal court districts
and generally has responsibility for overseeing the integrity of the bankruptcy
system. Bankruptcy trustees in Chapter 7 and Chapter 13 cases are charged with
managing the administrative aspects of liquidation or reorganization
bankruptcies. The trustee's primary responsibilities include collecting funds
from the debtor (Chapter 13) or liquidating the debtor's assets (Chapter 7),
distributing the collected funds to creditors pursuant to the orders of the
bankruptcy court, and preparing regular status reports, including financial
updates, for the United States Trustee and for the bankruptcy court. Trustees
typically are attorneys or certified public accountants and manage many
different bankruptcy cases simultaneously. A trustee client uses an EPI product
to manage an entire caseload; the Company does not contract with trustees to
manage specific individual cases. The Company estimates that Chapter 13 trustees
typically manage over one thousand cases simultaneously and that Chapter 7
trustees can manage over one hundred cases simultaneously. It is possible for a
given individual trustee to have caseloads in both Chapter 7 and Chapter 13
bankruptcies, but normally a trustee will specialize in one or the other.
CHAPTER 7 BANKRUPTCY TRUSTEES
For Chapter 7 liquidation bankruptcy, each region of the country has a
rotating "panel" of trustees. Because Chapter 7 comprises the overwhelming
majority of bankruptcies, multiple trustees are required in most parts of the
country to accommodate the caseload. As assets are liquidated and the first
funds are received in each asset case, the trustee opens bank accounts for the
case. In Chapter 7, each case must have its own bank accounts so that interest
earned can be segregated. Because asset liquidation and litigation regarding the
case may be a lengthy process, the trustee will deposit cash proceeds into an
interest-bearing account for the benefit of the creditors who will eventually
receive distributions. Typically, the trustee makes a single distribution at the
conclusion of the case. The administration of a Chapter 7 case can take several
years.
CHAPTER 13 BANKRUPTCY TRUSTEES
There are fewer filings in Chapter 13 (individual debt reorganization) than
in Chapter 7 (liquidation), so most areas of the country have a single standing
Chapter 13 trustee who administers all Chapter 13 filings rather than the
"panel" configuration associated with Chapter 7. In certain areas of the
country, the trustee is responsible for sending various notices to the debtor,
debtor's attorney, clerk of the court, United States Trustee and each creditor
indicating that the case has been filed. Because the debtor's assets are NOT
liquidated under Chapter 13, the trustee analyzes the debtor's income and
expenses and directs the debtor to make regular cash payments to the trustee
according to the court-approved plan of reorganization. Each month, the trustee
disburses the monies received from the debtor to eligible creditors according to
the plan. The trustee must provide regular status reports to the United States
Trustee. Every six months, the trustee must also prepare a detailed ledger of
financial activity in each bankruptcy case and mail it to each debtor and
debtor's attorney. Chapter 13 reorganizations usually last between thirty-six
and sixty months. Upon conclusion of the case, the trustee must submit a final
report to the bankruptcy court outlining the financial history of the case.
MARKET CONDITIONS
The Company estimates that there are approximately $2 billion in cash
proceeds being administered in
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Chapter 7 by approximately 1,200 trustees. The Company estimates there are
approximately 550,000 cases pending in Chapter 13 managed by approximately 180
standing Chapter 13 trustees.
MARKET CONDITIONS IN CHAPTER 7
The Company believes that there are favorable market conditions for its
Chapter 7 product and services. Since the introduction of TCMS for Windows95 in
January 1996, the Company has successfully entered new key strategic markets,
including California and New York, two of the largest national bankruptcy
markets. The Company has also successfully entered other key metropolitan areas
and believes that these initial accounts will facilitate significant additional
sales. In November 1996, the Company began releasing a new enhanced version of
the software, TCMS version 2.0, that incorporates substantial new features that
the Company believes are unique in the marketplace. These features include an
internal auditor, e-mail enabled import/export, account receivable management, a
rapid posting module and a rapid case set-up module.
MARKET CONDITIONS IN CHAPTER 13
In October 1994, Congress passed the Bankruptcy Reform Act of 1994 (the
"Reform Act"). Among the changes enacted was an increase in the debt ceiling, or
"cap," that establishes an individual's eligibility to file Chapter 13
bankruptcy. The Reform Act raised the debt cap from $350,000 to $1,000,000. If
the cap is exceeded, the individual must file a Chapter 7 liquidation bankruptcy
or a small Chapter 11. The Company believes the increase in the Chapter 13 debt
cap expands the pool of eligible debtors in Chapter 13 and potentially increases
the number of Chapter 13 filings.
PRODUCTS
The Company's existing products include TCMS (Trustee Case Management
System) for Chapter 7, and MIDRANGE for Chapter 13. The Company plans to begin
selling a new Chapter 13 product, CASEPOWER, in early 1997. The TCMS product can
also track Chapter 11 cases, and the MIDRANGE/CASEPOWER products can also track
Chapter 12 cases. The Company produces its software applications internally with
a full time staff of professional software developers.
CHAPTER 7 PRODUCTS
The Company's Chapter 7 product assists trustees to manage liquidation
bankruptcies, whereby the trustee liquidates the debtor's assets and disburses
the resulting funds to creditors.
CURRENT CHAPTER 7 PRODUCT: TCMS
TCMS (Trustee Case Management System) is a Windows95/Windows NT 4 based
package of proprietary software, computer equipment and support services offered
to Chapter 7 trustees through a national marketing arrangement with NationsBank.
TCMS provides easy-to-use modules for asset management, financial record keeping
and claims administration. An electronic banking link developed by the Company
gives users an automated mechanism for entering banking transactions, and an
electronic court interface allows users to download claim information into the
trustee's database automatically.
A typical TCMS system is provided to the end-user trustee client without
direct charge and includes the following products and services: (i) a license to
use the proprietary TCMS software and subsequent upgrades; (ii) computer
hardware, laser printer, modem, tape backup and operating software, which are
returned to EPI if the trustee's bankruptcy deposits leave the bank designated
by EPI; (iii) database conversion from previous computer system;
(iv) configuration and installation of hardware by EPI personnel; (v) on-site
software training; (vi) customization of reports conforming to local bankruptcy
court regulations; (vii) toll-free customer service; and (viii) remote
diagnostics. The Company's revenues are based upon the total funds kept on
deposit. See "Pricing -
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Chapter 7 Pricing."
SOFTWARE FEATURES
The TCMS software streamlines administrative tasks associated with
Chapter 7 liquidation bankruptcies. Most trustees use the system on a daily
basis for record keeping and to meet reporting requirements.
ASSET MANAGEMENT. As assets are identified, the trustee enters them
into TCMS through a convenient spreadsheet-like interface. The system
automatically tracks the remaining values of assets as they are
liquidated and provides a summary overview of properties within each
case.
BANKING. An online banking module developed by the Company allows the
trustee to open and close bank accounts electronically as well as to
enter funds transfers. Simple to sophisticated financial transactions
can be recorded on an online computer screen that resembles a personal
check register. The system prepares MICR encoded laser checks and
deposit slips on demand.
CLAIMS ADMINISTRATION. TCMS categorizes each claim by class and
desired priority level for distribution. Distribution checks are
calculated and printed automatically, and all financial ledgers are
updated. An extensive library of financial reports provides detailed
information for each case. A proprietary feature allows information to
be downloaded from the court into the trustee's database.
CALENDARING AND DOCKETING. Key events in asset cases are posted
automatically to a central trustee's calendar that can be printed
regularly. The software automatically schedules tasks required to
close cases in a timely fashion.
CUSTOMIZED DISTRICT REPORTS. EPI utilizes OLE (object linking and
embedding) and ActiveX technology and the Microsoft Word for Windows95
word processing program to custom tailor final reports and final
accounts for each district where TCMS is marketed. Preparing these
documents has traditionally been one of the most time consuming tasks
in Chapter 7 case administration. With TCMS, trustees can quickly
generate a fully formatted, polished report with all figures
calculated and filled in.
180 DAY REPORTS. The United States Trustee requires the trustee to
submit detailed status reports for each case every six months in a
very specific reporting format. TCMS prints these reports in
compliance with the most recent regulations.
CHAPTER 13 PRODUCTS
The Company's Chapter 13 products assist trustees to manage individual
reorganization bankruptcies, whereby the debtor makes payments to the trustee,
who in turn disburses the funds to creditors:
CURRENT CHAPTER 13 PRODUCT: MIDRANGE
MIDRANGE is based on IBM mini-computer AS/400 technology and uses the
Company's proprietary software to assist Chapter 13 trustees managing databases
containing from approximately 500 to over 10,000 active bankruptcies
simultaneously. Because Chapter 13 bankruptcy cases typically undergo thirty-six
to sixty consecutive monthly distributions, Chapter 13 is considerably more
transaction intensive and paperwork intensive than Chapter 7, where a single
distribution is normally made at the end of the case. Chapter 13 trustee clients
out-source various activities to EPI to facilitate the preparation of large
output jobs.
Processing and report printing functions are divided between the
client-site AS/400 installation and EPI's data center in Kansas City. The
MIDRANGE is installed in a multi-user configuration that allows each member of
the trustee's office staff to access the database and enter transactions
throughout the business day. The trustee's live database resides in his or her
office. The size of a Chapter 13 trustee's office staff varies proportionally
with the
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caseload managed. Therefore, MIDRANGE installations vary in size from three
workstations to over twenty workstations.
The trustee's office staff enters financial information into the MIDRANGE,
including cash receipts, financial adjustments and payment instructions for each
claim. EPI's proprietary program logic interprets a wide variety of
court-directed payment scenarios and consolidates them into easy-to-understand
codes that are entered by users. Daily reports and customized inquiries can be
requested and printed inside the trustee's office.
At the end of each month, the trustee forwards a copy of the database to
EPI in Kansas City. EPI prints distribution checks for each eligible creditor
and prepares detailed laser output for every case in the database as a billable
service. Checks and reports are shipped overnight back to the trustee for
inspection, approval and mailout.
In certain parts of the country, the Chapter 13 trustee is responsible for
noticing parties-in-interest of key developments in each bankruptcy case,
including the setting of the mandatory first meeting of creditors. The Company's
MIDRANGE software automates this meeting notice for the trustees. Other events
that may be noticed through the MIDRANGE include motions to dismiss the case,
reset notices, correcting notices and motions to allow claims. The MIDRANGE
software provides an optional noticing module that receives relevant input from
the office staff. Alternatively, trustees may purchase data entry services from
EPI and forward original documents to Kansas City for keying. Each evening,
EPI's data center receives a modem transmission of daily noticing activity from
the client-site AS/400. EPI prints and reviews the notices, inserts them into
envelopes and mails them the next day. Trustees are billed directly for noticing
services based upon the number of documents generated.
Some bankruptcy courts require additional information, such as a photocopy
of the plan of reorganization, to be included with the notice. EPI offers such
document reproduction and assembly services to trustees at an additional charge.
SOFTWARE FEATURES
The MIDRANGE software helps trustees manage administrative aspects of
Chapter 13 bankruptcy. The trustee and office staff typically use the system
each day to monitor activity in their caseload.
NOTICING. When new cases are entered on the MIDRANGE system, the EPI
data center in Kansas City can extract relevant information and
prepare mandatory first meeting of creditors notices for each case.
Subsequent forms, such as reset notices, correcting notices, motions
to allow claims, motions to allow additional claims and motions to
dismiss, can also be selected and prepared through the system.
CASE MANAGEMENT. The MIDRANGE stores and monitors key dates, names,
addresses and text notes for every case in the system. A variety of
retrieval mechanisms enable users to view case information from
various perspectives.
FINANCIAL HISTORY. The office staff enters cash receipts and
financial adjustments in the system as part of the daily bank deposit.
The MIDRANGE updates the balances in each case and summarizes the
day's financial transactions. Each month, the MIDRANGE prepares a
single-page summary of the receipts and disbursements in every case.
MONTHLY DISTRIBUTION. The MIDRANGE's advanced distribution logic
interprets payment orders from the bankruptcy court. Several different
payment methodologies (e.g., pro rata, fixed monthly payment, per
capita, etc.) may be spread over 99 separate distribution priority
levels. Individual checks or voucher checks can be printed for each
creditor. Claims having objections filed on them can continue to
accrue distributions without releasing funds until the objection has
been settled.
INQUIRY. Chapter 13 offices receive a multitude of outside inquiries
each day from creditors' and debtors' attorneys. The Midrange provides
instantaneous inquiry access to the financial status of
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each debtor and claim in the system. An optional creditor dial-in
system gives outside parties inquiry access only to the system through
a modem connection.
NEW CHAPTER 13 PRODUCT: CASEPOWER
The Company has developed a new PC-based Windows95/Windows NT 4 Chapter 13
product, CASEPOWER, that is intended to replace the existing MIDRANGE
mini-computer-based product. The Company tested this product in a trustee's
office from early 1996 and concluded such testing in the fourth quarter of 1996.
CASEPOWER is scheduled for general release in early 1997. CASEPOWER is
constructed on client-server architecture, whereby intelligent desktop devices
receive and transmit data and applications to and from file servers. The
database uses the Oracle7 database engine. The front end interface runs under
Microsoft Windows95 and therefore takes advantage of a graphical user interface
(GUI), which the Company believes has yet to be introduced in the mass
Chapter 13 market.
CASEPOWER incorporates several advanced technologies that the Company
believes enhance its marketability. These include document imaging, bar coding,
audio and video instruction, speech recognition and outside creditor inquiry
dial-in.
With the CASEPOWER product, EPI has further simplified creditor
distribution logic for the trustee and added important functions, including an
interactive on-screen ledger that consolidates an entire bankruptcy case into a
single window and a comprehensive docketing module that manages court
appearances and key status changes in each bankruptcy case.
CHAPTER 7 MARKETING ARRANGEMENT
On November 22, 1993, the Company established an exclusive national
marketing arrangement with NationsBank of Texas, N.A. ("NationsBank"), a
subsidiary of NationsBank Corporation, for its Chapter 7 products. In this
marketing arrangement, EPI and NationsBank promote products and services to
trustees in all states. Because Chapter 7 trustees are discouraged from
incurring direct costs for computer services, it is essential for EPI to align
with a bank or series of banks to earn revenues in Chapter 7. NationsBank
Corporation, headquartered in Charlotte, North Carolina, is the fourth largest
national banking company. The Company works in partnership with NationsBank
Federal Government Banking Division based in Atlanta to market TCMS and
NationsBank banking services as a package. Chapter 7 bankruptcy deposits are
housed in Dallas, where NationsBank has established a customer service team to
support trustees using EPI's products.
The agreement with NationsBank does not have an expiration date. The
termination clause stipulates that either party must provide the other 90 days'
notice if it wishes to end the agreement. The Company believes its
representatives have developed positive, close working relationships with their
counterparts at NationsBank, and the Company believes that it will maintain this
relationship. However, were the relationship with NationsBank to end, there is
no assurance that the Company would be able to establish a new banking
relationship or series of relationships with comparable terms.
EPI holds the primary responsibility for developing all facets of the TCMS
system and for driving the national sales and marketing effort. NationsBank
personnel provide additional assistance in the marketing effort and are
responsible for administering the banking services provided to the trustee
clients.
Through this arrangement, EPI has a continual revenue stream from its
Chapter 7 operations. The structure of the marketing alliance assists
NationsBank to build its deposit base in this market.
The Company continues to support a limited number of trustee relationships
through other banks that predate the exclusive agreement with NationsBank.
PRICING
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CHAPTER 7 PRICING
Unlike Chapter 13, the application of Chapter 7 bankruptcy regulations has
the practical effect of discouraging trustees from incurring direct
administrative costs for computer expenses. All nationally marketed Chapter 7
systems are provided to trustees without direct billing to the trustee because
of traditional market conventions. Clients typically choose systems based upon
the capability of the software and the quality of technical support services.
EPI has aligned with NationsBank to provide computer services to Chapter 7
trustees without direct charges to the Chapter 7 trustee under an arrangement
whereby (1) EPI licenses its proprietary software to the trustee and furnishes
hardware, conversion services, training and customer support, all at no cost to
the trustee, (2) the trustee agrees to deposit with NationsBank the cash
proceeds from all asset liquidations; and (3) NationsBank pays the Company a fee
each month based upon the total deposits in the Chapter 7 bankruptcy portfolio.
CHAPTER 13 PRICING
The Company typically receives an initial licensing fee and conversion
charge from the Chapter 13 trustee. It also receives monthly fees from each
Chapter 13 trustee client based on the total number of cases in that trustee's
database and the number of noticing documents generated. Variables affecting
pricing for EPI Chapter 13 clients include the number of cases in the database,
the type of equipment installed, the volume of noticing to be out sourced to
EPI, and the level of support service selected by the trustee. EPI prepares
individualized price quotes for each client.
SALES AND DISTRIBUTION
The Company's products and services are marketed directly to trustees
through on-site sales calls by the Company's internal sales department and, in
the case of Chapter 7, by supporting representatives of NationsBank. Trustees
make their own decisions for software and service providers. The Company
believes that the most important factors in attracting business are the quality
of the software products and the quality of the post-installation support.
The Company's national sales manager is in the Kansas City headquarters and
manages the internal sales force and acts as liaison with the NationsBank
representatives. The Company estimates that a typical sales cycle, from
identification of the client to the receipt of a trustee's agreement, lasts from
two to four months.
The Company's Chapter 7 and Chapter 13 service agreements with trustees
typically include provisions for (i) descriptions of the products and services
included in the agreement, (ii) a limited warranty and indemnification clauses,
(iii) the trustee's agreement to deposit funds with NationsBank (applicable in
Chapter 7 only), and (iv) termination information.
The Executive Office of the United States Trustee in Washington, D.C.,
regularly issues a directory of all current bankruptcy trustees. The Company
obtains this directory as it is issued and uses it as its prospect list.
The Company's sales representatives attend approximately eight bankruptcy
trade shows annually. The Company conducts direct mail campaigns and advertises
in trade journals to heighten its exposure and to stimulate sales.
COMPETITION
The Company works in an industry with a limited number of Chapter 7 and
Chapter 13 trustees. The Company estimates that there are approximately 550,000
pending Chapter 13 cases being managed by approximately 180 Chapter 13 trustees,
and that there is approximately $2 billion on deposit by approximately 1,200
Chapter 7 trustees. There are several companies in the market all competing for
sales from this finite group of customers, and some of the Company's competitors
have substantially greater financial and marketing resources than does the
Company. For its Chapter 7 product, the Company competes with the Chase
Manhattan Bank and Union Bank of California, as well as other regional
competitors in selected markets. For its Chapter 13 product, the Company
competes with DCI Corporation of Memphis, Tennessee, a private company, and
other competitors. Although the
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Company believes that the requisite detailed knowledge of the bankruptcy system
makes it difficult for new competitors to successfully enter the market, and
there are presently a limited number of firms that offer services that directly
compete with the Company's, there can be no assurance that other firms with
resources significantly greater than the Company's will not enter the Company's
industry. The Company's future financial performance will depend on its ability
to maintain existing customer accounts and to attract business from customer
accounts which are currently using a competitor's software product.
PROPRIETARY RIGHTS
Historically, the Company has not protected its intellectual property
rights through patents or formal copyright registration. It has relied on trade
secret, copyright, and trademark law and non-disclosure agreements to establish
and protect its proprietary rights in its products. The Company believes,
however, that its financial performance will depend more upon the innovation,
technological expertise and marketing abilities of its associates than upon such
protection.
There is no assurance that the Company will be able to protect its trade
secrets or that others will not independently develop substantially equivalent
proprietary information and techniques or otherwise gain access to the Company's
trade secrets. There is no assurance that intellectual property laws will
protect the Company's intellectual property rights. In addition, litigation may
be necessary to enforce the Company's intellectual property rights, to protect
the Company's trade secrets, to determine the validity and scope of the
proprietary rights of others or to defend against claims of infringements. Such
litigation could result in substantial costs and diversion of management and
other resources and could have a material adverse effect on the Company's
business, financial condition and results of operation.
EMPLOYEES
The Company employs approximately 60 full-time employees, distributed as
follows: (i) 6 in senior management; (ii) 14 in information services; (iii) 23
in client services/sales; (iv) 14 in support services; and (v) 3 in accounting.
No Company employees are covered by collective bargaining agreements. The
Company believes its relationships with its employees are good.
ITEM 2. PROPERTIES
The Company's corporate offices are located in a 30,000-square-foot facility
leased in Kansas City, Kansas. In connection with corporate growth and the
development of new products, this facility has been recently renovated with
additional office space. The Company believes that this facility will be
adequate for use for at least the next full year. The leased facility is
partially owned by a related party. See Item 12 "Certain Relationships and
Related Transactions."
ITEM 3. LEGAL PROCEEDINGS
The Company presently is not a party to any litigation, although it occasionally
becomes involved in litigation arising in the normal course of business.
ITEM 4. SUBMISSION OF MATTERS
No matters were submitted in the fourth quarter to a vote of security holders.
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PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS.
MARKET INFORMATION
The Company's Common Stock is traded on the Nasdaq SmallCap Market-TM- under the
symbol "EPIQ." Trading in the Common Stock commenced on February 4, 1997, the
date on which the Company closed the initial public offering of its Common
Stock. Accordingly, there was no trading in the Common Stock during 1995 or
1996.
HOLDER
As of March 17, 1997, there were approximately 500 holders of record of the
Common Stock.
DIVIDENDS
The Company elected to be treated as an S Corporation for federal and certain
state income tax purposes commencing July 15, 1988. Unlike a C Corporation, an
S Corporation is generally not subject to income tax at the corporate level.
Instead, the S Corporation's income generally passes through to the
stockholders and is taxed on their personal income tax returns. The Company
terminated its status as an S Corporation and became a C Corporation as of
February 4, 1997 (the "Termination Date"). After the Termination Date, the
Company will no longer be treated as an S Corporation and will, accordingly, be
fully taxable under federal and state income tax laws. The Company paid a final
S Corporation distribution to present stockholders following termination of the
Company's S Corporation status. It was previously agreed that this final S
Corporation distribution would not exceed $250,000 and would represent the
Company previously undistributed earnings only since January 1, 1996 through
the Termination Date. The amount of this final S Corporation distribution was
$250,000 and it was paid on March 6, 1997.
The Company made S Corporation distributions to its stockholders in 1995 and
1996 in the aggregate amounts of $195,968 and $102,165, respectively.
The Company does not expect to declare or pay any other cash dividends in the
foreseeable future. The Company currently intends to retain any earnings for use
in the operation and expansion of its business. The payment of future dividends
is within the discretion of the Board of Directors and will depend upon the
Company's future earnings, if any, its capital requirements, financial condition
and other relevant factors.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
Operating revenues for 1996 were $6,319,192 compared to $5,233,959 for 1995, an
increase of 20.7%. Chapter 7 sales increased $571,909 or 82.0% between years.
The increase in revenues was primarily due to the introduction of TCMS for
Windows95 in early 1996, which resulted in new Chapter 7 trustee clients for the
Company. Chapter 13 revenue in 1996 compared to 1995 increased $409,548 or
10.3%. The additional revenue experienced in 1996 was due to an increase in
caseloads managed by Chapter 13 trustee clients. Also, the number of new
bankruptcy filings in 1996 was greater than in 1995 resulting in increased legal
noticing revenue which constituted 33.9% of the total Chapter 13 revenue for
1996.
Processing costs increased to $2,498,109 during fiscal 1996 from $2,098,401 in
1995 or a 19.0% increase. The increase in 1996 resulted principally from an
increase in customer service expense,
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resulting from hiring additional trainers, hardware installers and other
customer service functions to support the growth of Chapter 7 sales.
Depreciation and amortization increased to $810,939 during fiscal 1996 from
$687,314 in 1995 or a 18.0% increase. This increase related primarily to the
purchase of computer equipment for the installations of the Company's new
Chapter 7 product. Total cost of goods sold and direct costs increased to
$3,309,048 during fiscal 1996 from $2,785,715 in 1995 or a 18.8% increase.
Gross profit increased 23.0% or $561,900 to $3,010,144 in 1996 compared to
$2,448,244 for 1995. Gross profit as a percentage of operating revenues
increased to 47.6% for the 1996 period from 46.8% for the 1995 period due
primarily to TCMS, which has higher gross margins, comprising a greater
percentage of operating revenues in 1996. The Company anticipates the Chapter 7
revenue will continue to grow in 1997 as the number of installations of TCMS for
Windows95 continues to increase.
Operating expenses as a percentage of operating revenues were 38.0% for the
twelve months ended December 31, 1996 compared to 38.9% for 1995. Sales and
marketing expenses were $714,067 in 1996 compared to $488,509 in 1995. The
Company increased its marketing activities in 1996 related to the introduction
of a Windows95 version of TCMS, including costs associated with trade shows and
promotional materials.
Income from operations increased 48.0% to $610,759 in 1996 , compared to
$412,555 for 1995 , principally due to increased sales and higher gross profit
margins.
For the twelve months ended December 31, 1996, the Company reported net income
of $333,953 compared to net income of $150,870 for the twelve months ended
December 31, 1995, a 121.4% increase.
Capital Resources and Liquidity
The Company completed an initial public offering of its common stock on February
4, 1997, when it sold 1,600,000 shares of common stock at $3.50 per share to
raise $4,938,000 in net proceeds (prior to deferred stock issuance costs).
Management believes that the net proceeds from the offering, together with funds
generated from operations, will be sufficient of finance the Company's
anticipated working capital and property and equipment expenditures for the
foreseeable future.
During the twelve months ended December 31, 1996, net cash provided by
operating activities was $1,161,432 representing principally net income of
$333,953 plus depreciation and amortization of $900,833 and an increase of
$293,895 in accounts payable and accrued expense offset primarily by an
increase in accounts receivable of $322,868. The outstanding accounts
receivable balance has increased primarily due to the growth in revenue
financed in part by accounts payable.
The Company has a $500,000 operating line of credit from a financial
institution, of which $500,000 was outstanding December 31, 1996 and a term loan
with an outstanding balance of $511,151 as of December 31, 1996. The Company may
borrow up to 80% of eligible accounts receivable against this line which is
collateralized by accounts receivable and free and clear computer equipment.
The Company originated a $250,000 loan in June of 1996 to provide additional
short term working capital. The Company paid off the term loan and the short
term working capital loan with a portion of the proceeds of the initial public
offering and paid the line of credit down to zero. The line of credit expires
in October, 1997, although the Company anticipates no difficulties in obtaining
a renewal or extension of the line of credit.
The Company invested in property and equipment totaling $1,294,603 for the
twelve months ending December 31, 1996, which related principally to the
installation of computer equipment for the Company's new Chapter 7 product. The
equipment was financed through various capital leases and a bank equipment term
loan. As of December 31, 1996, the balances outstanding on capital leases and
the bank equipment term loan were $1,245,560 and $235,307, respectively. The
bank equipment loan was paid off with a
<PAGE>
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portion of the proceeds of the initial public offering and the capital leases
were reduced by $400,000. The Company anticipates future equipment purchases to
be at or above the 1996 level of spending, and that the Company will continue to
be able to finance the computer equipment through capital lease financings.
The Company incurred expenditures for software development costs totaling
$511,471 in 1996. Software development costs are capitalized and are amortized
on a straight line basis over a maximum five year period. The Company
anticipates future software development to be at or above the 1996 level of
spending, which the Company expects to finance from cash flow from operations
and, if necessary, a portion of the proceeds of the stock offering.
ITEM 7. FINANCIAL STATEMENTS
Following are the report of Baird, Kurtz & Dobson, Kansas City, Missouri,
independent auditors for the Company, and the financial statements of the
Company as of and for the 12 month periods ended December 31, 1995 and 1996.
INDEPENDENT ACCOUNTANTS' REPORT
Board of Directors
Electronic Processing, Inc.
Kansas City, Kansas
We have audited the accompanying balance sheets of ELECTRONIC PROCESSING, INC.
as of December 31, 1995 and 1996, and the related statements of income, changes
in stockholders' equity and cash flows for each of the years then ended. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the 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. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of ELECTRONIC PROCESSING, INC. as
of December 31, 1995 and 1996, and the results of its operations and its cash
flows for each of the years then ended in conformity with generally accepted
accounting principles.
Baird, Kurtz & Dobson
Kansas City, Missouri
February 14, 1997
<PAGE>
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ELECTRONIC PROCESSING, INC.
BALANCE SHEETS
DECEMBER 31, 1995 AND 1996
ASSETS
<TABLE>
<CAPTION>
1996
----
1995 ACTUAL PRO FORMA
--------- --------- ---------
<S> <C> <C> <C>
CURRENT ASSETS
Cash and cash equivalents $ 26,938 $ 4,882 $2,442,882
Accounts receivable, trade, less allowance for
doubtful accounts of $5,000 475,362 798,230 798,230
Prepaid expenses and other 135,194 153,907 153,907
Deferred income taxes 7,300
--------- --------- ---------
Total Current Assets 637,494 957,019 3,402,319
--------- --------- ---------
PROPERTY AND EQUIPMENT, At cost
Furniture and fixtures 354,413 390,599 390,599
Computer equipment 2,322,751 3,312,303 3,312,303
Office equipment 337,676 297,971 297,971
Leasehold improvements 253,669 247,494 247,494
Transportation equipment 14,969 14,969 14,969
--------- --------- ---------
3,283,478 4,263,336 4,263,336
Less accumulated depreciation 1,800,120 2,087,483 2,087,483
--------- --------- ---------
1,483,358 2,175,853 2,175,853
--------- --------- ---------
SOFTWARE DEVELOPMENT COSTS, Net of
amortization 1,044,421 1,256,159 1,256,159
--------- --------- ---------
INTANGIBLE ASSETS, Net of amortization
Excess of cost over fair value of net assets acquired 65,512 63,499 63,499
--------- --------- ---------
OTHER ASSETS
Deferred stock issuance costs 127,589 271,563
Other 18,386 42,145 42,145
--------- --------- ---------
145,975 313,708 42,145
--------- --------- ---------
$3,376,760 $4,766,238 $6,939,975
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS
<PAGE>
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LIABILITIES AND STOCKHOLDERS' EQUITY
<PAGE>
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Page 16
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<TABLE>
<CAPTION>
1996
----
1995 ACTUAL PRO FORMA
--------- --------- ---------
<S> <C> <C> <C>
CURRENT LIABILITIES
Note payable - line of credit $ 325,000 $ 500,000
Current maturities of long-term debt 505,214 1,008,889 $ 282,779
Accounts payable 263,197 534,519 534,519
Accrued expenses 67,567 90,140 90,140
Dividends declared 250,000
--------- --------- ---------
Total Current Liabilities 1,160,978 2,133,548 1,157,438
--------- --------- ---------
LONG-TERM DEBT 1,016,540 1,242,660 368,770
--------- --------- ---------
DEFERRED INCOME TAXES 284,300
---------
SUBORDINATED DEBT 400,000 400,000
--------- ---------
REDEEMABLE STOCK PURCHASE WARRANT 41,000
---------
STOCKHOLDERS' EQUITY
Common stock, $.01 par value; authorized 5,000,000
shares; issued and outstanding 1,800,000 shares 18,000 18,000 34,000
Additional paid-in capital 282,000 282,000 5,095,467
Retained earnings 458,242 690,030
--------- --------- ---------
758,242 990,030 5,129,467
--------- --------- ---------
$3,376,760 $4,766,238 $6,939,975
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
<PAGE>
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ELECTRONIC PROCESSING, INC.
STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 1995 AND 1996
<PAGE>
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Page 18
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1995 1996
---------- ----------
OPERATING REVENUES $5,233,959 $6,319,192
---------- ----------
COST OF GOODS SOLD AND DIRECT COSTS
Processing costs 2,098,401 2,498,109
Depreciation and amortization 687,314 810,939
---------- ----------
2,785,715 3,309,048
---------- ----------
GROSS PROFIT 2,448,244 3,010,144
OPERATING EXPENSES
General and administrative 1,947,795 2,309,491
Depreciation and amortization 87,894 89,894
---------- ----------
2,035,689 2,399,385
---------- ----------
INCOME FROM OPERATIONS 412,555 610,759
---------- ----------
OTHER INCOME (EXPENSE)
Interest income 1,686 48
Interest expense (262,391) (280,158)
Other (980) 3,304
---------- ----------
(261,685) (276,806)
---------- ----------
NET INCOME $ 150,870 $ 333,953
---------- ----------
---------- ----------
UNAUDITED PRO FORMA DATA
Income before income taxes $ 150,870 $ 333,953
Provision for income taxes 68,000 144,000
---------- ----------
PRO FORMA NET INCOME $ 82,870 $ 189,953
---------- ----------
---------- ----------
PRO FORMA PER SHARE INFORMATION
Net income $.05 $.11
---------- ----------
---------- ----------
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING 1,800,000 1,800,000
---------- ----------
---------- ----------
SEE NOTES TO FINANCIAL STATEMENTS
<PAGE>
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ELECTRONIC PROCESSING, INC.
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1995 AND 1996
<TABLE>
<CAPTION>
Additional
Common Paid-In Retained
Total Stock Capital Earnings
-------- ----------
<S> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1994 $ 809,340 $18,000 $282,000 $ 509,340
Net income 150,870 150,870
Increase in value of redeemable warrant (6,000) (6,000)
-------- -------
Dividends paid on common stock,
$.65 per share (195,968) (195,968)
-------- -------- ------- --------
BALANCE, DECEMBER 31, 1995 758,242 18,000 282,000 458,242
Net income 333,953 333,953
Dividends (102,165) (102,165)
-------- -------- ------- --------
BALANCE, DECEMBER 31, 1996 $ 990,030 $18,000 $282,000 $ 690,030
-------- -------- ------- --------
-------- ------- --------
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS
<PAGE>
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ELECTRONIC PROCESSING, INC.
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1995 AND 1996
<PAGE>
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Page 21
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<TABLE>
<CAPTION>
1995 1996
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 150,870 $ 333,953
Items not requiring (providing) cash:
Depreciation 426,960 599,087
Amortization of software development costs 337,515 299,733
Amortization of intangible assets 10,734 2,013
(Gain) loss on disposal of equipment 980 (1,909)
Changes in:
Accounts receivable 32,722 (322,868)
Prepaid expenses and other assets 21,200 (42,472)
Accounts payable and accrued expenses 50,178 293,895
----------- -----------
Net cash provided by operating activities 1,031,159 1,161,432
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sale of property and equipment 4,930
Purchase of property and equipment (72,729) (133,256)
Expenditures for software development costs (364,479) (511,471)
----------- -----------
Net cash used in investing activities (437,208) (639,797)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Net borrowings under line-of-credit agreement 175,000 175,000
Proceeds from long-term debt 11,694 250,000
Principal payments under capital lease obligation (300,866) (450,989)
Principal payments on long-term debt (191,810) (230,563)
Dividends paid (195,968) (102,165)
Deferred stock issuance costs (127,589) (143,974)
Payment to retire stock warrant (41,000)
----------- -----------
Net cash used in financing activities (629,539) (543,691)
----------- -----------
DECREASE IN CASH AND CASH
EQUIVALENTS (35,588) (22,056)
CASH AND CASH EQUIVALENTS,
BEGINNING OF YEAR 62,526 26,938
----------- -----------
CASH AND CASH EQUIVALENTS,
END OF YEAR $ 26,938 $ 4,882
----------- -----------
----------- -----------
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS
<PAGE>
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Electronic Processing, Inc.
Notes to Financial Statements
Years ended 1995 and 1996
NOTE 1: NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS
The Company is engaged primarily in the development and marketing of advanced
proprietary software for electronic management of bankruptcy cases. An
extensive array of support services complements the software. The Company
extends unsecured credit to customers throughout the United States.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
PROPERTY AND EQUIPMENT
Property and equipment are depreciated on a straight-line basis over the
estimated useful life of each asset as follows:
Furniture and fixtures 10 years
Computer equipment 5 years
Office equipment 5-10 years
Transportation equipment 3-5 years
Leasehold improvements are depreciated over the shorter of the lease term or
the estimated useful lives (5-10 years) of the improvements.
SOFTWARE DEVELOPMENT COSTS
Certain internal software development costs incurred in the creation of
computer software products are capitalized once technological feasibility has
been established. Prior to the completion of a detail program design,
development costs are expensed. Capitalized costs are amortized based on
current and future revenue for each product with an annual minimum equal to the
straight-line amortization (5 years) over the remaining estimated economic life
of the product.
INTANGIBLE ASSETS
The excess of cost over fair value of net assets acquired is being amortized
over 40 years. Organizational costs are being amortized over seven years. All
amortization is provided by the straight-line method.
<PAGE>
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NOTE 1: NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REVENUE RECOGNITION
Revenues for Chapter 13 processing and noticing are recorded monthly at the
completion of the services based on the trustees' month-end caseloads. For
Chapter 7 bankruptcy services, monthly fees are received from a national
financial institution after the product is installed and deposits are
transferred based on the level of trustees' deposits with that institution. All
ancillary fees are recognized as the services have been provided.
INCOME TAX STATUS
The Company, with the consent of its stockholders, has elected under the
Internal Revenue Code to be an S corporation. In lieu of corporation income
taxes, the stockholders are taxed on their proportionate shares of the Company's
taxable income. Therefore, these statements do not include any provision for
corporation income taxes. Management intends to distribute sufficient funds to
the stockholders to pay personal taxes related to flow-through taxable income.
WARRANTS SUBJECT TO REDEMPTION AGREEMENT
Warrants to purchase common stock include a right to require the Company to
purchase such stock, if acquired, at a price based on an agreed-upon formula.
The warrant liability amount is being accrued over the period to the first
exercise date, based on the formula price determined as of the balance sheet
date. Increases in warrant liability are charged to retained earnings in a
manner similar to recognition of dividend liabilities on redeemable preferred
stock. During 1996, the liability amount was fixed at $41,000 by agreement with
the majority shareholder and was paid in December 1996.
CASH EQUIVALENTS
The Company considers all liquid investments with original maturities of three
months or less (primarily money market accounts) to be cash equivalents.
NEW PRONOUNCEMENT
The Financial Accounting Standards Board issued Statement No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of" in March 1995. The new Statement requires that assets to be held and used
be reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of the asset in question may not be recoverable. The
Company has determined that no such impairment exists at December 31, 1996.
NOTE 2: SOFTWARE DEVELOPMENT COSTS
The following is a summary of software development costs capitalized:
Years Ended December 31,
---------------------------
1995 1996
------------ ------------
Amounts capitalized, net of retirements $ 3,991,547 $ 2,811,189
<PAGE>
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Page 24
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Accumulated amortization,
beginning of year (2,609,611) (2,947,126)
Amortization expense (337,515) (299,733)
Retirements 1,691,829
------------ ------------
Accumulated amortization, end of year (2,947,126) (1,555,030)
------------ ------------
Net software development costs $ 1,044,421 $ 1,256,159
------------ ------------
------------ ------------
Included in the above are development costs relating to products not yet
released. Such costs totaled $503,827 and $713,849 at December 31, 1995 and
1996, respectively.
NOTE 3: NOTES PAYABLE AND LONG-TERM DEBT
Note payable at December 31, 1995 and 1996 represents advances against a
$500,000 working capital line of credit. Interest is 2% in excess of the bank's
base lending rate (10.25% at December 31, 1996) per annum and is adjusted and
payable on a quarterly basis. Principal is due on October 1, 1997. The note is
collateralized by substantially all assets and is personally guaranteed by the
majority stockholder.
Long-term debt includes the following at December 31, 1995 and 1996:
1995 1996
----------- -----------
Note payable, bank (A) $ 674,376 $ 511,151
Note payable, bank (B) 184,581 235,307
Note payable, bank (C) 250,000
Capital lease obligations 650,789 1,245,560
Other 12,008 9,531
----------- -----------
1,521,754 2,251,549
Less current maturities 505,214 1,008,889
----------- -----------
$1,016,540 $1,242,660
----------- -----------
----------- -----------
(A) Principal and interest (2% in excess of bank's base lending rate -
10.25% at December 31, 1996) payable in monthly installments of $18,792
with final payment due in June 1999; collateralized by substantially all
assets and personally guaranteed by the majority stockholder.
(B) Revolving equipment line of credit of $250,000, with interest (2% in
excess of bank's base lending rate - 10.25% at December 31, 1996) payable
monthly, in addition to monthly principal reductions equal to one
thirty-sixth of the outstanding principal balance, with the unpaid balance
being due October 1997; collateralized by substantially all assets and
personally guaranteed by the majority stockholder.
<PAGE>
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(C) Note and accrued interest (1% in excess of highest prime rate in WALL
STREET JOURNAL, calculated daily - 9.25% at December 31, 1996); due in
October 1997; personally guaranteed by majority stockholder.
The following maturities schedule reflects the payment terms noted above:
1997 $1,008,889
1998 859,756
1999 373,592
2000 9,312
----------
$2,251,549
----------
----------
In February 1997, a portion of the proceeds of the public offering (SEE NOTE
9) were utilized to retire approximately $2,000,000 of the obligations noted
above.
NOTE 4: LEASES
OPERATING
The Company has a noncancellable operating lease for office space which
expires in February 2001. The majority stockholder of the Company is a partner
in the partnership that leases office space to the Company. The lease requires
the Company to pay all executory costs (property taxes, maintenance and
insurance).
For the years ended December 31, 1995 and 1996, an agreement was reached with
the partnership whereby the Company was reimbursed for the property taxes which
amounted to approximately $30,000 for both 1995 and 1996.
Future minimum lease payments at December 31, 1996 are as follows:
1997 $145,500
1998 149,250
1999 154,000
2000 157,800
2001 189,600
--------
$796,150
--------
--------
Rental expense under this lease was $142,125 and $145,500 for the years ended
December 31, 1995 and 1996, respectively.
CAPITAL
Capital leases shown in long-term debt (SEE NOTE 3) include leases for the use
of computer
<PAGE>
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equipment for no more than five years expiring in 2000.
Property and equipment include the following property under capital leases:
YEAR ENDED DECEMBER 31,
----------------------
1995 1996
---------- ----------
Computer equipment $1,163,513 $1,822,113
Less accumulated depreciation 355,542 412,717
---------- ----------
$ 807,971 $1,409,396
---------- ----------
---------- ----------
Future minimum lease payments as of December 31, 1996 are as follows:
1997 $609,676
1998 538,722
1999 251,399
2000 9,540
----------
Future minimum lease payments 1,409,337
Less amount representing interest 163,777
----------
Present value of future minimum
lease payments
1,245,560
Less current maturities 507,107
----------
Noncurrent portion $ 738,453
----------
----------
NOTE 5: SUBORDINATED DEBT AND STOCK PURCHASE WARRANT
The Company has the following subordinated debt outstanding with the majority
stockholder at both December 31, 1995 and 1996:
10% interest payable monthly, principal
balance due July 1998 $400,000
--------
Interest expense under this agreement was $40,000 for both the years ended
December 31, 1995 and 1996.
The holder of the subordinated note also held a stock purchase warrant
(originally issued in 1988) to acquire 969,228 shares of the Company's common
stock at $.41 per share (giving retroactive effect to the 6 to 1 stock split
discussed in Note 9) at any time prior to July 14, 1998.
<PAGE>
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Commencing July 15, 1996, the holder of common stock obtained by exercising
the stock purchase warrant could have required the Company to purchase for cash
all or any part of the stock held. Likewise, the Company had the right to
purchase for cash all or part of the stock held that was obtained by exercising
the stock purchase warrant. The price in either such event was the greater of,
using either the preceding fiscal year-end financial statements or an average of
the two preceding fiscal year financial statements, (1) net book value per share
or (2) a valuation per share computed from a seven times pre-tax income
multiple. As of December 31, 1995, the Company calculated and recorded a value
of such warrants in the amount of $41,000. In December 1996, the Company
reached an agreement with the principal stockholder and retired the warrant for
the same amount.
In February 1997, a portion of the proceeds of the public offering (SEE NOTE
9) were utilized to retire the $400,000 subordinated debt obligation noted
above.
NOTE 6: RELATED PARTY TRANSACTIONS
Included in accounts payable at December 31, 1996 is $45,000 due to the
majority stockholder. Additionally, fees totaling $24,658 were paid to the
stockholder during 1995 for guarantees on Company debt.
NOTE 7: PROFIT SHARING PLAN
The Company has adopted a 401(k) plan covering substantially all employees.
Company matching contributions to the Plan are discretionary. Such
contributions amounted to $11,847 and $18,113 for the years ended December 31,
1995 and 1996, respectively.
NOTE 8: SIGNIFICANT ESTIMATES AND CONCENTRATIONS
Generally accepted accounting principles require disclosure of certain
significant estimates and current vulnerabilities due to certain concentrations.
Those matters include the following:
- The Company capitalizes and amortizes costs incurred in the
development of software products. These costs are being realized over
the estimated life of the resulting software product, principally five
years. Ultimate recoverability is dependent upon estimated future
revenues over the life of the product being realized.
- The majority of the Company's revenues are generated from processing
and noticing services for Chapter 13 bankruptcy cases. For Chapter 7
bankruptcy services, the Company has a significant marketing agreement
with a national financial institution which provides for the generation
of monthly revenues based on the level of trustees' deposits with that
institution.
NOTE 9: SUBSEQUENT EVENTS
In February 1997, the Company completed a public offering of 1,600,000 shares
of common stock and received net proceeds (prior to deferred stock issuance
costs) of $4,938,000. In conjunction with the offering, during 1996, the
Company increased the number of authorized common shares to 5,000,000 and
declared a 6 to 1 stock split which became effective, through a stock dividend,
on November 4, 1996. In lieu of historical earnings per share, pro forma per
share amounts reflecting the effects of the stock dividend retroactively have
been provided as described below. Additionally, the number of shares in the
<PAGE>
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accompanying balance sheets was retroactively increased to reflect this stock
split.
In connection with the issuance of common stock to the public, the Company
changed its income tax status to a C corporation. Pro forma earnings
information has been provided to reflect the effects of corporate income taxes
on historical earnings, including the effects of permanent and temporary
differences in reporting income and expenses for tax and financial reporting
purposes, as if the Company had been subject to income taxes for all the periods
presented. Pro forma adjustments reflect the provision for corporate income
taxes.
At the time of becoming a C corporation, the Company accrued an income tax
provision to record the effects of temporary differences between assets and
liabilities presented on the financial reporting basis and the income tax basis.
At December 31, 1996, the deferred tax effects of such differences were as
follows:
Deferred tax assets:
Allowance for doubtful accounts $ 1,900
Accrued compensated absences 4,200
Other 1,200
------------
7,300
Deferred tax liabilities:
Property and equipment basis difference (284,300)
------------
Net deferred tax asset (liability) $(277,000)
------------
------------
The pro forma provision for income taxes included these components:
YEARS ENDED DECEMBER 31,
------------------------
1995 1996
--------- --------
Taxes currently payable $ 95,000 $179,000
Deferred income taxes (27,000) (35,000)
--------- --------
$ 68,000 $144,000
--------- --------
--------- --------
A reconciliation of pro forma income tax provision at the statutory rate to
pro forma income tax expense at the Company's effective rate is shown below:
<PAGE>
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YEARS ENDED DECEMBER 31,
------------------------
1995 1996
--------- --------
Computed at statutory rate (34%) $51,300 $113,500
Increase in taxes resulting from:
Nondeductible expenses 8,500 12,800
State income taxes, net of federal tax
effect and other 8,200 17,700
--------- --------
Pro forma tax provision $68,000 $144,000
--------- --------
--------- --------
The Company has reserved 270,000 shares of common stock for issuance of stock
options to employees, officers and directors of the Company. Upon completion of
the offering, the Company issued options for 119,500 of these shares with the
exercise price being equal to the initial public offering price. The Company
will account for such options in accordance with APB Opinion No. 25, "Accounting
for Stock Issued to Employees," and will provide pro forma disclosures, if
material, as required by Financial Accounting Standards No. 123 "Accounting for
Stock-Based Compensation."
For supplementary purposes, pro forma earnings per share would have been $.10
and $.14 for the years ended December 31, 1995 and 1996, respectively. Such
calculations give effect (net of income taxes) to the repayment of approximately
$2,500,000 of the Company's outstanding indebtedness and resulting reduction of
interest expense as if a portion of the proceeds from this initial public
offering had been used to repay the debt, and the number of shares of common
stock (whose proceeds are to be used to retire the debt) were outstanding.
NOTE 10: PRO FORMA (UNAUDITED)
In connection with the public offering, the Company declared a final S
corporation distribution to present stockholders. This final distribution
represents the Company's previously undistributed earnings from January 1, 1996,
through February 7, 1997 (termination date). The amount of this final
distribution was $250,000 and was distributed during 1997. The remaining
retained earnings were reclassified to additional paid-in capital.
Pro forma adjustments made to the 1996 balance sheet include the effects of
the final distribution of $250,000, the recording of the net deferred tax
liability, the receipt of the net proceeds, $4,938,000, and subsequent repayment
of $2,500,000 of the Company's outstanding indebtedness.
NOTE 11: ADDITIONAL CASH FLOWS INFORMATION
YEARS ENDED DECEMBER 31,
------------------------
1995 1996
--------- --------
NONCASH INVESTING AND FINANCING ACTIVITIES
Capital lease obligation and notes payable
incurred for equipment $549,004 $1,161,347
<PAGE>
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ADDITIONAL CASH INFORMATION
Interest paid 262,391 280,158
<PAGE>
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ITEM 8.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE.
NONE.
<PAGE>
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PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
DIRECTORS AND EXECUTIVE OFFICERS
The executive officers and directors of the Company, their ages as of March
17, 1997, and their positions with the Company are set forth below.
NAME AGE POSITION
Tom W. Olofson* 55 Chairman, President and Chief
Executive Officer
Christopher E. Olofson 27 Executive Vice President, Chief
Operating Officer, and Director
Albert T. Annillo 46 Senior Vice President
Reed A. Eichner 39 Vice President - Operations
Nanci R. Trutna 43 Vice President - Finance
Sally D. MacDonald 50 Vice President - Human Resources
Robert C. Levy * 50 Secretary and Director
W. Bryan Satterlee * 62 Director
* Member of Audit Committee
TOM W. OLOFSON led a private investor group that acquired the Company in
July 1988, and has served as Chief Executive Officer and Chairman of the Board
since that time. During his business career, Mr. Olofson has held various
management positions with Xerox Corporation and was a Senior Vice President and
member, Office of the President of Marion Laboratories (now Hoechst Marion
Roussel, Inc.). Mr. Olofson is a director of Saztec International, Inc., a
provider of information management services, and also serves as a director of
various private companies in which he is an investor. He earned a BBA from the
University of Pittsburgh in 1963, and is currently a member of the Board of
Visitors of the Katz Graduate School of Business at the University of
Pittsburgh. He is the father of Christopher E. Olofson.
CHRISTOPHER E. OLOFSON joined EPI as a Vice President in June 1993, and was
a part-time employee of the Company from 1988 to 1993. In January 1994, he was
named Senior Vice President - Operations, and became Executive Vice President
and a member of the Board of Directors effective January 1, 1995. Effective
July 1, 1996, Mr. Olofson also assumed the duties of Chief Operating Officer. He
earned an AB degree from Princeton University in 1992, SUMMA CUM LAUDE. He was
named a Fulbright Scholar; as which he completed a one-year program of study at
the Stanford University Center in Taipei, Taiwan in 1993. He is the son of Tom
W. Olofson.
ALBERT T. ANNILLO has been Senior Vice President since January 1995.
Mr. Annillo joined the Company in October 1992 as a corporate Vice President. He
was Assistant Director, Executive Office for United States Trustees, Department
of Justice, Washington, D.C. for six years before his association with the
Company. He earned an MBA and an MED from William Patterson College in 1975 and
1979, respectively.
REED A. EICHNER joined the Company as Vice President - Sales and Marketing
in September 1995. He became Vice President - Operations on September 1, 1996.
From May 1991 through August 1995 he served as President and owner of
Connexions, Inc., a company which provided system integration and document
conversion services. He was General Manager of Innovision Systems, Inc. from
September 1989 to May 1991. Mr. Eichner earned a BA from the University of North
Carolina in 1982.
NANCI R. TRUTNA assumed her present position as Vice President - Finance in
June 1993. She was with
<PAGE>
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Merchants Bank, Kansas City, Missouri from 1981 to June 1993 where she became a
Senior Vice President. Ms. Trutna is a Certified Public Accountant and earned a
BSBA in 1975 from the University of North Dakota.
SALLY D. MACDONALD joined the Company as Vice President - Human Resources
in January 1996. She served as Regional Human Resources Manager for Network
General, Inc. from 1992 to 1994, as Manager, Employment with North Supply
Company from 1989 to 1991, and as Manager, Employment and Employee Relations
with Informix Software, Inc. from 1986 to 1989. Ms. MacDonald earned a BS in
Business Administration from the University of San Francisco in 1984.
ROBERT C. LEVY is a director, stockholder and executive committee member of
the law firm of Seigfreid, Bingham, Levy, Selzer & Gee in Kansas City, Missouri.
He has been the Corporate Secretary and a Director of the Company since
July 1988. He earned a BS from Northwestern University in 1968, and a J.D. from
the University of California at Berkeley in 1971. Mr. Levy formerly was Chairman
of the Board of Directors of Blue Cross and Blue Shield of Kansas City and
presently serves as a member of that Board of Directors.
W. BRYAN SATTERLEE was elected to the Company's Board of Directors on
February 7, 1997. Mr. Satterlee has been a partner since 1989 in NorthEast
Ventures, a consulting firm based in Hartford, Connecticut which specializes in
business development services for and evaluations of technology-based venture
companies. He has extensive general management and marketing experience in
technology-based firms. Mr. Satterlee's background includes ten years of
management experience with IBM, as well as having been a founder of a computer
leasing/software business, telecommunications company and a venture investment
services business. He earned a BS in 1956 from Lafayette College.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
In 1996, the Company was not a reporting company under the Securities
Exchange Act of 1934, as amended (the "Exchange Act"). As such none of its
directors, officers or 10% or greater beneficial owners were subject to the
reporting requirements of Section 16(a) of the Exchange Act in 1996.
ITEM 10. EXECUTIVE COMPENSATION
EXECUTIVE COMPENSATION
The following table sets forth the cash and other compensation paid in 1996
to the Company's Chief Executive Officers. No other executive officers of the
Company earned in excess of $100,000 in 1996.
<TABLE>
<CAPTION>
SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS OTHER ANNUAL ALL OTHER
---- ------ ----- COMPENSATION (1) COMPENSATION
---------------- (2)(3)
<S> <C> <C> <C> <C> <C>
Tom W. Olofson, Chairman/CEO 1996 $50,000 $24,000 $36,827 $11,434
Christopher E. Olofson, EVP/COO 1996 $108,101 $3,349 $1,620
</TABLE>
(1) Includes $33,782 for payment of annual life insurance premiums on policies
owned by Tom W. Olofson which designate Jeanne H. Olofson, his wife, as
the beneficiary and $3,045 for personal use of company automobile. Includes
$3,349 for Christopher E. Olofson for personal use of company automobile.
<PAGE>
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- - --------------------------------------------------------------------------------
(2) Company benefits which include $9,075 for group insurance and $2,359 for
Company matching contributions to 401(k) plan for Tom W. Olofson.
Includes $1,620 for company matching contributions to 401K plan for
Christopher E. Olofson.
(3) Does not include interest of $40,000 on a subordinated note in 1996 on
amounts borrowed by the Company from Tom W. Olofson. See "Certain
Transactions."
In 1996, the Company made no grants of stock options or stock appreciation
rights, and the Company does not have a long-term incentive compensation plan.
Additionally, there were no exercises of stock options by the Chief Executive
Officer or the Chief Operating Officer in 1996.
COMPENSATION OF DIRECTORS
The Company pays its non-employee directors a fee of $750 per quarter and
$750 per meeting attended.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
The following table sets forth certain information regarding the beneficial
ownership of shares of Common Stock as of the March 17, 1997 for (i) each
director of the Company; (ii) each person known to the Company to be the
beneficial owner of more than 5% of the outstanding shares; and (iii) all
directors and executive officers as a group. Except pursuant to applicable
community property laws or as otherwise indicated, each stockholder has sole
voting and investment power with respect to the shares beneficially owned.
NAME AND ADDRESS OF BENEFICIAL OWNER (1) NUMBER OF PERCENTAGE
SHARES OWNED
Tom W. Olofson(2) 1,620,000 47.6%
Christopher E. Olofson 109,500 3.2%
Robert C. Levy 30,000 1.0%
W. Bryan Satterlee 0 -
All directors and executive officers
as a group (4 persons) 1,759,500 51.8%
(1) The address of all of the named individuals is c/o Electronic Processing,
Inc., 501 Kansas Avenue, Kansas City, Kansas 66105.
(2) Excludes 35,500 shares owned by Mr. Olofson, adult son, Scott W. Olofson,
as to which shares Mr. Olofson disclaims beneficial ownership.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In July 1988, an unaffiliated venture capital firm purchased a $400,000
subordinated note and a stock purchase warrant from the Company. In
October 1991, the Company's Board of Directors deemed it in the best interest of
the Company to purchase the subordinated note and stock purchase warrant from
the venture capital firm. Because the Company could not then complete this
transaction without incurring additional debt, Tom W. Olofson, Chairman and
Chief Executive Officer, purchased the subordinated note and stock purchase
warrant. The note provided for interest at the rate of 10% with a maturity date
of July 1998. Interest paid to Tom W. Olofson under this agreement was $40,000
per year for 1996, 1995 and 1994. The stock purchase warrant provided for the
acquisition of 969,228 shares of the Company's Common Stock at $.4125 per share
at any time prior to July 14, 1998 (giving retroactive effect to the six-for-one
stock split). The Company has calculated and recorded a value of such stock
<PAGE>
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- - --------------------------------------------------------------------------------
purchase warrant in the amount of $41,000, with the value being calculated using
the difference between net book value and exercise price per share. In an
October 11, 1996 agreement between the Company and Mr. Olofson, it was agreed
that the Company would pay $41,000 to Mr. Olofson on or before December 31,
1996, at which time the stock purchase warrant would be retired. The Company
repaid the $400,000 outstanding face value of the subordinated note to
Mr. Olofson from the proceeds of its Common stock offering in February, 1997.
The Company has a noncancellable operating lease for its corporate
headquarters which expires in February 2001. Tom W. Olofson holds a 50%
interest, as a general partner, in T & J Investment Company, a Kansas general
partnership ("T & J Investment Company") that leases this facility to the
Company. The lease requires the Company to pay all executory costs (property
taxes, maintenance and insurance). Rental expense was $145,500 for the year
ended December 31, 1996. Rental expense under a predecessor lease between the
Company and T & J Investment Company was $142,125 and $137,625 for the years
ended December 31, 1995 and 1994, respectively.
Tom W. Olofson personally guaranteed substantially all of the Company's
outstanding debt prior to the Common Stock Offering. Fees totaling $24,658 were
paid to Mr. Olofson during 1995, for guaranteeing the Company's debt. Upon
application of the proceeds of the Common Stock Offering to retire certain
corporate debt, Mr. Olofson's guarantee obligations with respect to such debt
was extinguished.
ITEM 13 EXHIBITS AND REPORTS ON FORM 8-K
EXHIBITS
The following exhibits are filed with this Form 10-KSB or are incorporated
herein by reference:
EXHIBIT NUMBER DESCRIPTION
3.1 Articles of Incorporation, dated July 13, 1988; incorporated by
reference to Exhibit 3.1 to the Registration Statement on
form SB-2 dated Feb 4, 1997 (Registration No. 333-16805) (The
"Registration Statement").
3.1a Amendment of Articles of Incorporation , dated August 10, 1988;
incorporated by reference to Exhibit 3.1a to the Registration
Statement.
3.1b Amendment of Articles of Incorporation, dated October 31, 1995;
incorporated by reference to Exhibit 3.1b to the Registration
Statement.
3.1c Amendment of Articles of Incorporation, dated April 1, 1996;
incorporated by reference to Exhibit 3.1c to the Registration
Statement.
3.2 Bylaws; incorporated by reference to Exhibit 3.2 to the
Registration Statement .
<PAGE>
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4.1 Form of Underwriters Warrant; incorporated by reference to
Exhibit 4.1 to the Registration Statement.
4.3 1995 Stock Option Plan; incorporated by reference to Exhibit
4.3 to the Registration Statement.
10.1 Agreement for Computerized Trustee Case Management System
between the Company and NationsBank of Texas, N.A., dated
November 22, 1993; incorporated by reference to Exhibit 10. 1
to the Registration Statement.
10.2 Lease between T&J Investment Company and the Company, dated
February 20, 1996; incorporated by reference to Exhibit 10.2 to
the Registration Statement.
10.3 Subordinated Note to Tom Olofson; incorporated by reference to
Exhibit 10.3 to the Registration Statement.
10.4 Loan Agreement between Industrial State Bank and the Company,
dated June 17, 1996; incorporated by reference to Exhibit 10.4
to the Registration Statement.
10.4a Modification to Loan Agreement between Industrial State Bank
and the Company, dated October 31, 1996; incorporated by
reference to Exhibit 10.4a to the Registration Statement.
10.5 Loan Agreement between Industrial State Bank and the Company,
dated June 8, 1994; incorporated by reference to Exhibit 10.5
to the Registration Statement.
10.5a Modification to Loan Agreement between Industrial State Bank
and the Company, dated June 17, 1996; incorporated by reference
to Exhibit 10.5a to the Registration Statement.
<PAGE>
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10.6 Loan Agreement between Industrial State Bank and the Company,
dated June 8, 1994; incorporated by reference to Exhibit 10.6
to the Registration Statement.
10.6a Modification to Loan Agreement between Industrial State Bank
and the Company, dated June 17, 1996; incorporated by reference
to Exhibit 10.6a to the Registration Statement.
10.7 Loan Agreement between Citizens National Bank and the Company,
dated June 18, 1996; incorporated by reference to Exhibit 10.7
to the Registration Statement.
10.8 Form of Service Agreement between EPI and Trustee; incorporated
by reference to Exhibit 10.8 to the Registration Statement.
27.1 Financial Data Schedule
REPORTS ON FORM 8-K
NONE
<PAGE>
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Page 38
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SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed by the undersigned, thereunto duly authorized.
Dated: March 24, 1997
ELECTRONIC PROCESSING, INC.
By: /s/ Tom W. Olofson
------------------
Tom W. Olofson
Chairman/CEO
In accordance with the Exchange Act this report has been signed below by the
following persons on behalf of the registrant and in the capacities indicated on
March 24, 1997.
Signature Capacity
- - --------- --------
/s/ Tom W. Olofson Chairman of the Board
- - ------------------ Chief Executive Officer
Tom W. Olofson (Principal Executive Officer)
Director
/s/ Christopher E. Olofson Executive Vice President
- - -------------------------- Chief Operating Officer
Christopher E. Olofson Director
/s/ Nanci R. Trutna Vice President of Finance
- - ------------------ (Principal Financial Officer and
Nanci R. Trutna Accounting Officer)
/s/ Robert C. Levy Director
- - ------------------
Robert C. Levy
/s/ W. Bryan Satterlee Director
- - ----------------------
Bryan Satterlee
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM ELECTRONIC
PROCESSING, INC. CONSOLIDATED STATEMENT OF INCOME FOR THE YEARS ENDED DECEMBER
31, 1996 AND CONSOLIDATED BALANCE SHEET AS AT DECEMBER 31, 1996, AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 4,882
<SECURITIES> 0
<RECEIVABLES> 803,230
<ALLOWANCES> 5,000
<INVENTORY> 0
<CURRENT-ASSETS> 957,019
<PP&E> 4,263,336
<DEPRECIATION> 2,087,483
<TOTAL-ASSETS> 4,766,238
<CURRENT-LIABILITIES> 2,133,548
<BONDS> 0
0
0
<COMMON> 18,000
<OTHER-SE> 972,030<F1>
<TOTAL-LIABILITY-AND-EQUITY> 4,766,238
<SALES> 6,319,192
<TOTAL-REVENUES> 6,322,544<F2>
<CGS> 3,309,048
<TOTAL-COSTS> 3,309,048
<OTHER-EXPENSES> 2,399,385
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 280,158
<INCOME-PRETAX> 333,953
<INCOME-TAX> 0
<INCOME-CONTINUING> 333,953
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 333,953
<EPS-PRIMARY> .11<F3>
<EPS-DILUTED> .11<F3>
<FN>
<F1> Reflects retained earnings and addition paid in capital.
<F2> Reflects operating revenues and other income.
<F3> Calculated on a pro-forma basis.
</FN>
</TABLE>
