U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
/X/ ANNUAL REPORT UNDER SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934 (FEE REQUIRED) For
the fiscal year ended: DECEMBER 31, 2001
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE
REQUIRED) For transition period from to .
Commission File Number: 0-12374
EQUITEX, INC.
(Name of small business issuer in its charter)
DELAWARE 84-0905189
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
7315 EAST PEAKVIEW AVENUE, ENGLEWOOD, COLORADO 80111
(Address of principal executive offices)(Zip Code)
Issuer's telephone number: (303) 796-8940
Securities registered under Section 12 (b) of the Exchange Act:
NONE
Securities registered under Section 12 (g) of the Exchange Act:
COMMON STOCK, $.02 PAR VALUE
(Title of Class)
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Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Exchange during the past 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 in this form, and will not be contained, to
the best of the 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: /X/
The aggregate market value of the voting stock held by non-affiliates of the
Registrant was $24,089,825 based on the last sale price of the Registrant's
common stock on April 5, 2002, ($1.27 per share) as reported by the Nasdaq Stock
Market.
The Registrant had 21,478,197 shares of common stock outstanding as of April 5,
2002.
Documents incorporated by reference: None
EQUITEX, INC.
FORM 10-K
THIS REPORT MAY CONTAIN CERTAIN "FORWARD-LOOKING" STATEMENTS AS SUCH TERM IS
DEFINED IN THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 OR BY THE
SECURITIES AND EXCHANGE COMMISSION IN ITS RULES, REGULATIONS AND RELEASES, WHICH
REPRESENT THE REGISTRANT'S EXPECTATIONS OR BELIEFS, INCLUDING BUT NOT LIMITED
TO, STATEMENTS CONCERNING THE REGISTRANT'S OPERATIONS, ECONOMIC PERFORMANCE,
FINANCIAL CONDITION, GROWTH AND ACQUISITION STRATEGIES, INVESTMENTS, AND FUTURE
OPERATIONAL PLANS. FOR THIS PURPOSE, ANY STATEMENTS CONTAINED HEREIN THAT ARE
NOT STATEMENTS OF HISTORICAL FACT MAY BE DEEMED TO BE FORWARD-LOOKING
STATEMENTS. WITHOUT LIMITING THE GENERALITY OF THE FOREGOING, WORDS SUCH AS
"MAY", "WILL", "EXPECT", "BELIEVE", "ANTICIPATE", "INTENT", "COULD", "ESTIMATE",
"MIGHT", OR "CONTINUE" OR THE NEGATIVE OR OTHER VARIATIONS THEREOF OR COMPARABLE
TERMINOLOGY ARE INTENDED TO IDENTIFY FORWARD-LOOKING STATEMENTS. THESE
STATEMENTS BY THEIR NATURE INVOLVE SUBSTANTIAL RISKS AND UNCERTAINTIES, CERTAIN
OF WHICH ARE BEYOND THE REGISTRANT'S CONTROL, AND ACTUAL RESULTS MAY DIFFER
MATERIALLY DEPENDING ON A VARIETY OF IMPORTANT FACTORS, INCLUDING UNCERTAINTY
RELATED TO ACQUISITIONS, GOVERNMENTAL REGULATION, MANAGING AND MAINTAINING
GROWTH, THE OPERATIONS OF THE COMPANY AND ITS SUBSIDIARIES, VOLATILITY OF STOCK
PRICE AND ANY OTHER FACTORS DISCUSSED IN THIS AND OTHER REGISTRANT FILINGS WITH
THE SECURITIES AND EXCHANGE COMMISSION.
PART I
ITEM 1. DESCRIPTION OF BUSINESS.
(a) General development of business.
Equitex, Inc. was organized under the laws of the State of Delaware in 1983, and
we elected to become a business development company and be subject to the
applicable provisions of the Investment Company Act of 1940 in 1984. Until
January 4, 1999, Equitex was a business development company which is a form of
closed-end, non-diversified investment company under the Investment Company Act
of 1940. A business development company generally must maintain 70% of its
assets in new, financially troubled or otherwise qualified companies, known as
investee companies, and offers significant managerial assistance to such
companies. Business development companies are not subject to the full extent of
regulation under the Investment Company Act of 1940. We primarily were engaged
in the business of investing in and providing managerial assistance to
developing companies that, in our opinion, would have a significant potential
for growth. On April 3, 1998, our stockholders authorized us to change the
nature of our business and withdraw our election as a business development which
became effective on January 4, 1999.
At a special stockholders meeting held on June 22, 2001, our stockholders
approved the distribution by us of all of our assets and liabilities to Equitex
2000, Inc., which was then a wholly-owned and Delaware-chartered subsidiary of
us, and the distribution by us of all of the outstanding shares of Equitex 2000
common stock to our stockholders on the basis of one share of common stock of
Equitex 2000 for each share of our common stock.
On August 6, 2001, we distributed all of our assets (which primarily consisted
of investments in subsidiaries) to Equitex 2000, Inc. a subsidiary formed by us
in 2001. Equitex 2000 also assumed all or our liabilities. Simultaneous with the
distribution of assets and liabilities to Equitex 2000, we transferred our
rights, title and interest in the issued and outstanding shares of Equitex 2000
to an escrow account, outside of our control. The shares of Equitex 2000 are to
be distributed from escrow to our stockholders upon the effective registration
of Equitex 2000. Shares of Equitex 2000 are to be distributed based on each
stockholder's proportional ownership interest in Equitex as of July 20, 2001.
Also on August 6, 2001, immediately following the distribution to Equitex 2000,
we acquired all of the outstanding common stock of Key Financial Systems, Inc.
and Nova Financial Systems, Inc., both Florida companies previously under common
control with nearly an identical ownership structure. We acquired Key and Nova
in exchange for (i) 9,084,773 shares of our common stock, (ii) cash of $5
million, (iii) warrants to acquire an aggregate of 990,134 shares of common
stock exercisable at $0.02 per share, and (iv) warrants to acquire an aggregate
of 3,933,350 shares of our common stock exercisable at $5.65 per share. In order
to raise the cash
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consideration of $5 million, we issued two new series of convertible preferred
stock, including 2,359 shares of Series H 8% convertible preferred stock in
exchange for net proceeds of $2,059,000, and 4,000 shares of Series I 6%
convertible preferred stock in exchange for net proceeds of $3,500,000.
Key Financial Systems was established in Clearwater, Florida in June 1997 to
design, market and service credit card products aimed at the sub-prime credit
market. In late 1998, the sister company, Nova Financial Systems was formed to
provide the same services as Key Financial Systems for Key Financial Systems'
second bank client, Merrick Bank. Nova Financial Systems marketed the Pay As You
Go credit card program with Merrick Bank until September of 1999.
Until March 1, 2002, Key marketed the Pay As You Go credit card program with Net
First National Bank of Boca Raton, Florida. At the close of business on March 1,
2002, the Office of the Comptroller of the Currency closed Net First National
Bank and appointed the Federal Deposit Insurance Corporation (the "FDIC") as
receiver.
As a result of the closing of Net First National Bank, Key is not currently
marketing or servicing the Pay As You Go credit card program. The FDIC
repudiated Key's contract with Net First National Bank effective March 4, 2002
and has closed all the credit card accounts relating to Key's contract with Net
First National Bank. The FDIC's action results in the termination of all future
credit card servicing revenues to Key from the Net First portfolio after March
4, 2002. The Net First portfolio accounted for approximately 139,000 of Nova and
Key's 149,000 active accounts at March 1, 2002. In addition, the FDIC is
presently holding certain funds owed to Key under its contract with Net First.
Key is pursuing all amounts due from Net First with the FDIC.
Upon the closure of Net First, marketing of the Pay As You Go credit card was
immediately suspended. Key took immediate steps to eliminate operating costs
associated with the marketing and servicing of the Pay As You Go program at Net
First. They retained their core personnel allowing them to maintain the
infrastructure necessary to quickly re-establish marketing and servicing
capabilities upon establishing a relationship with a new financial institution.
Key also reallocated certain resources to other contract projects which should
provide ongoing cash flow. Key is presently seeking a new financial institution
to establish a new credit card program. On March 15, 2002, we announced the
signing of a letter of intent to develop a credit card program for an existing
financial institution. Completion of this transaction is subject to further due
diligence by both parties, negotiation and execution of a definitive agreement,
necessary state and/or federal regulatory approvals, board of director approval
and any necessary stockholder approvals. There is no assurance this transaction
will be completed.
Effective December 1, 2001, we acquired all the outstanding common stock of Chex
Services, Inc. in exchange for 1,992,001 shares of our common stock valued at
$10,119,000 ($5.08 per share), in a transaction accounted for as a purchase. In
conjunction with the agreement, we entered into an employment incentive
agreement with the president of Chex in which we granted him a warrant to
purchase up to 730,000 shares of our common stock at an exercise price of $3.85
per share, which was the quoted market price of the common stock at the date the
warrant was granted. The warrant is exercisable for a four-year period beginning
December 1, 2001. Chex provides comprehensive cash access services to 50 casinos
and other gaming establishments.
As a holding company, from time to time we evaluate opportunities for strategic
investments or acquisitions that would complement our current services and
products, enhance our technical capabilities or otherwise offer growth
opportunities. As a result, acquisition discussions and, in some cases,
negotiations may take place and future investments or acquisitions involving
cash, debt or equity securities or a combination thereof may result
(b) Financial information about segments.
We operate in two industry segments, credit card services and cash disbursement
services. Information relating to our operating segments can be found in Note 14
to our consolidated/combined financial statements for the year ended December
31, 2001.
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(c) Narrative description of business.
EQUITEX
Beginning August 6, 2001, as a result of our transfer of assets and liabilities
to Equitex 2000, we are now a holding company that operates through our
wholly-owned subsidiaries, Key Financial Systems, Inc., a Florida corporation,
Nova Financial Systems, Inc., a Florida corporation and Chex Services, Inc., a
Minnesota corporation. Key and Nova are financial companies that specialize in
selling credit card programs designed for high credit risk clients. Key and Nova
are also full service organizations, that provide credit card portfolio
management services, including automated application processing, customer
service, mediation, collection services, risk management, accounting and
management information systems. Chex Services is a financial company that
provides comprehensive cash access services to casinos and other gaming
establishments.
KEY FINANCIAL SYSTEMS AND NOVA FINANCIAL SYSTEMS
Key Financial Systems was established in Clearwater, Florida in June 1997 to
design, market and service credit card products aimed at the sub-prime credit
market. In late 1998, a sister company, Nova Financial Systems, was formed to
provide the same services as Key Financial Systems for Key Financial Systems'
second bank client. Key marketed the Pay As You Go credit card program for Key
Bank & Trust until April of 1999 and marketed the Pay As You Go credit card
program with Net First National Bank until March 1, 2002. Nova marketed the Pay
As You Go program for Merrick Bank until September of 1999. Key has 100 percent
loan participation interest in the Pay As You Go portfolios. The net loan
balances on each portfolio is recorded by Key and all credit card income
associated with each portfolio flows to Key under the program. Key is
responsible for all losses and servicing costs including processing costs
incurred on the portfolio with third party service providers and the bank
client. As of March 1, 2002, Nova and Key have processed over 1,600,000 credit
card applications and currently have 9,800 active credit card accounts.
At the close of business on March 1, 2002, the Office of the Comptroller of the
Currency closed Net First National Bank, the sole issuing bank for the Pay As
You Go credit card program, and appointed the FDIC as receiver. Subsequent to
the closure, the FDIC informed the Pay As You Go credit card cardholders that
their accounts were being closed and any monies due refunded. As a result, Key
immediately suspended marketing the Pay As You Go credit card and took immediate
steps to eliminate operating costs associated with the marketing and servicing
of the Pay As You Go program. Key is now seeking a new financial institution
partner to market credit card products. They retained their core personnel
allowing them to maintain the infrastructure necessary to quickly re-establish
marketing and servicing capabilities upon establishing a relationship with a new
financial institution. In addition, Key reallocated certain resources to other
contract projects to provide some ongoing cash flow. On March 15, 2002 we
announced the signing of a letter of intent to develop a credit card program for
an existing financial institution. Completion of this transaction is subject to
further due diligence by both parties, negotiation and execution of a definitive
agreement, necessary state or federal regulatory approvals, board of director
approval and any necessary stockholder approvals. Until such time as Key is able
to commence a new credit card program with one or more financial institutions,
for which there is no guarantee, it will experience significantly lower revenues
and cash flows and consequently, a negative effect on earnings that presently
cannot be predicted.
Nova and Key are able to provide credit card portfolio management services
including:
APPLICATION PROCESSING. Nova and Key provide automated application processing
services with a proprietary software system including application entry by data
file or paper, underwriting and data edits, processing fee payment processing by
check including electronic checks (ACH), and return item processing. Nova and
Key generate files for uploading new credit card account records to Equifax and
FDR, the largest third party processor of credit card transactions.
CUSTOMER SERVICE. Nova and Key handle inbound customer service calls and written
correspondence from customers concerning their application or credit card
account. They have access to Equifax and FDR for card servicing and use their
in-house application processing system for access to application information.
They also provide customers the ability to make payments over the telephone.
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MEDIATION. Nova and Key have designated specialists to provide mediation between
their bank clients and their customers. They have established formal procedures
for managing customer complaints and have a formal reporting process to their
client banks.
COLLECTIONS. Nova and Key provide collection services for their portfolios. They
use proprietary dialing software and collections management techniques to
effectively collect sub-prime credit card accounts.
RISK MANAGEMENT. Nova and Key monitor suspect authorization activity and
unusually large or suspicious payment activity. They provide all account control
functions to minimize loss exposure from payment and sales activity.
ACCOUNTING. Nova and Key have the ability to process exception payments and all
payment returns. They control and process fee adjustments pursuant to the client
bank's policy. They perform the daily settlement accounting for the credit card
portfolio. They have developed a proprietary commission accounting system to
track compensation due their marketing vendors.
MANAGEMENT INFORMATION SYSTEMS. Nova and Key use cutting-edge technologies in
hardware and software and have their own internal software development
capabilities. Their technology resources include:
o Proprietary application processing system;
o Proprietary ACD (Automated Call Distribution) telephone system;
o Proprietary dialing systems using Dialogic hardware;
o Customized reporting from any application system;
o FoxPro, Sequel Server and Microsoft Access Databases; and
o NT Network with interfaces to FDR and Equifax.
Support equipment includes:
o 8 servers;
o 250 personal computers; and
o DS3 (576 incoming and outbound telephone lines).
PRODUCT. Prior to the closure of Net First, Key offered an innovative product to
customers with poor or little credit histories. There are no credit checks or
credit turndowns. Key designed a "Pay As You Go" credit card that was issued
with a $500 credit limit, with zero availability at issuance. The customers were
required to make payments to have available credit on their account. This was
accomplished by charging the customer's account at issuance, with a fully
refundable "Reservation Fee" of $500. The fee was refunded as a credit to the
customer's account at closure, either at the customer's request or if the
account is charged-off. There was an $8 monthly membership fee and the balance
was not subject to any interest charge. The account required a minimum payment
of 3%, or $15 for each billing statement.
As Key searches for, and negotiates with, a new financial institution or
institutions to market and/or service a new credit card product or products, it
may be required to change certain features of that new product which may differ
from the Pay As You Go card. Key Financial Services intends to work with the
financial institution partner to establish the key features of any new credit
card program. In addition, any new credit card program may require review and/or
approval from certain federal or state regulatory agencies.
NOVA AND KEY TARGET MARKET. The opinions on the size of the sub-prime market
vary depending on the particular label described, however, a 1996 survey from
Faulkner and Gray, estimated the size of this market in the U.S. at 30 million
and growing. More recent surveys by MasterCard International indicate the number
to be at least twice as large. There are two basic segments in this market:
1. EMERGING/THIN FILES - includes ethnic/immigrants groups, youth, elderly
on fixed income, divorced, widows/widowers; and
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2. RECOVERING/CREDIT IMPAIRED - includes credit abusers with a history of
credit problems including bankruptcies and those who have experienced a
catastrophic one-time life event that destroyed their credit, such as
death to a spouse, illness or divorce.
According to MasterCard International, this large underdeveloped segment
includes 25-30% of U.S. households. This market has continuous segment growth
and a 50% higher profit potential than the industry average (i.e. interest
rates, processing fees, annual/membership fees, ancillary fees, etc.).
COMPETITION. Today, sub-prime credit cards continue to be marketed successfully
to consumers throughout the U.S. with poor or limited credit histories.
Generally, four types of credit cards are offered to sub-prime consumers in the
marketplace:
1. Fully secured;
2. Partially secured;
3. High fee unsecured; and
4. Low limit unsecured.
The fully secured credit card is collateralized by a savings account equal to
the credit limit. This type of credit card is difficult to sell and therefore
not marketed as aggressively today. The fully secured card has low risk but has
a high acquisition cost since a deposit has to be collected up front, which
creates a challenging marketing hurdle. Most of the major issuers of traditional
unsecured cards offer fully secured credit cards through their branch systems
and as an alternative to the unsuccessful applicants for a regular card.
The partially secured credit card requires a collateral savings account but is
issued with some unsecured credit - usually $50 - $300. The major issuers of
these types of cards are Capital One, Providian, First National Bank of Marin,
First Consumers National Bank, Sterling Bank, and most others in the sub-prime
segment. The product is offered through all major distribution channels,
including direct mail, telemarketing, television and the Internet. While the
credit exposure per account is limited, issuers use credit based underwriting
and decline applicants for card issuance.
The high fee unsecured credit card generally has less credit exposure than
partially secured credit cards. A high non-refundable fee is charged on the card
in order to limit the amount of available credit. Most of these card programs do
not collect an up front processing fee. The high fee card programs are usually
offered by banks that specialize in arranging relationships with marketing
companies that sell the product and purchase the receivable from the issuing
banks.
Many issuers, based on credit scoring models that have been developed in recent
years, are now offering a low limit unsecured product. They are targeting the
"improving" segment of the sub-prime customer base. Most have annual fees and
many charge an application processing fee. Providian, Capital One, First
Consumers National Bank, First Premier Bank, NA and many others are aggressively
marketing this product. These programs have a significant number of declined
applications, as a large segment of the sub-prime market will not qualify.
The Pay As You Go credit card was designed with the purpose of having a low risk
profile for Nova and Key while being more competitive than most other sub-prime
credit cards in the market. All the other programs charge a high interest rate
with an annual fee. In most cases, Key's membership fee was less costly than the
interest and annual fee charged on other programs. Nova and Key had no credit
turn downs, which significantly improved response rates and the financial
effectiveness of their marketing efforts. There will always be a significant
number of consumers that will not qualify for the other sub-prime products or do
not want to invest in a collateral savings account.
MARKETING. Nova and Key developed strategic relationships with companies that
have significant marketing abilities in the major distribution channels,
including inbound/outbound telesales, direct mail, television, and the Internet.
Nova and Key manage and control all marketing programs related to the products
offered by them. In addition, Nova and Key have access to proprietary methods of
managing lists to identify the best potential customers from lists available in
the market.
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Historically, Nova and Key's most active distribution channel has been the
Internet. Key has marketed through alliances with a number of popular Internet
web sites including: Creditland.com, uproar.com, Mail.com, Spinway.com,
GetSmart.com, NetCreations.com, Lendingtree.com, winvite.com and USA.net.
Internet customers were directed to the Net First website, which is no longer
operating, by a combination of banner links displayed on thousands of web sites,
including those listed above, and approved e-mail programs. The Pay As You Go
card had been ranked at various times during 2000 and 2001 within the top ten
most popular credit card sites on the Internet by top9.com.
GOVERNMENT REGULATION. While state or federal banking authorities do not
directly regulate Key and Nova, the financial institutions with which either
company executes marketing or servicing contracts are subject to regulations by
either or both. The Office of the Comptroller of the Currency is the primary
regulator of federally chartered banks and has established operating guidelines
for those banks. State chartered banks are regulated by individual state banking
regulators which establish operating guidelines for state chartered banks. Many
financial institutions are also insured by the Bank Insurance Fund which is
administered by the FDIC and are therefore are subject to regulation by the FDIC
as a secondary regulator. Any or all of these regulators can require activities
to be performed by a financial institution for which Key or Nova markets or
services credit card programs, either informally or by order, which could
materially affect either company's ability to market or service its products. In
addition, review and approval may be required by certain of these regulators
prior to Key or Nova establishing a new credit card program with a financial
institution.
On November 15, 2000, Key temporarily suspended marketing, including the
Internet site, for Net First National Bank. This suspension was at the request
of Net First National Bank to conform to the requirements of a Consent Order
between Net First National Bank and Office of the Comptroller of the Currency.
Net First National Bank was required to obtain legal opinions that Key's credit
card marketing and the Pay As You Go program conformed to all applicable federal
and state laws. The necessary opinions were prepared and forwarded to the Office
of the Comptroller of the Currency. On December 15, 2000, Net First National
Bank notified Key to resume marketing the Pay As You Go credit card on its
behalf and was marketed until March 1, 2002.
CHEX SERVICES
Chex Services, Inc. was organized as a Minnesota corporation in July 1992. Chex
was formed to provide comprehensive cash access services to casinos, and other
gaming establishments, while also marketing their products ala carte to other
establishments in the casino, entertainment, and hospitality industries. Chex's
total funds transfer system allows casino patrons to access cash through check
cashing, credit/debit card cash advances, automated teller machines and wire
transfers. Chex's check and credit card advance systems allow it to compile
detailed demographic data about patrons that utilize these services. The
collected patron demographic data is then provided to the casino operators and
can be used in their marketing efforts.
As of March 26, 2002, Chex has contracts to provide its comprehensive cash
access service portfolio to twenty eight (28) locations. In addition, it
provides ala carte products and services to twenty two (22) other locations. At
each of these other locations Chex places credit/debit card cash advance systems
and/or ATM terminals at the facility. In locations where Chex provides their
comprehensive services, they actually operate their own independent teller
facility separate from the casino's cashier cage. This teller facility is
staffed by Chex's employees to process transactions and disburse cash to the
location's customers when they transact requests for check cashing, credit/debit
card advances, wire transfers and other services, such as, the issuance of money
orders.
Chex's services are provided pursuant to the terms of a financial services
agreement entered into with the gaming establishment. The agreement specifies
which cash access services will be provided by Chex, the transaction fees to be
charged by Chex to patrons for each type of cash access transaction and the
amount of compensation to be paid by Chex to the casino. Pursuant to all of
these agreements with the locations serviced, Chex maintains the exclusive
rights (with rare exception) to provide its services for the term of the
contract.
At each of the locations where Chex provides its cash access services, it must
have sufficient cash available to process both check cashing and credit card
advance transactions. Additionally, at each location where it operates ATMs,
Chex must have sufficient cash available to replenish the ATM machines. The
amount of cash required is dependent upon transaction volume which Chex
calculates on a location by location basis to ensure sufficient reserves. To
meet its cash needs, Chex arranges to have the cash it maintains on deposit
delivered from a local bank as needed. Chex will usually utilize the same
financial institution for depositing customer checks.0
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Chex is presently exploring and anticipates introducing during 2002 one or more
new products that would be complementary to their existing products and services
which may include: cashless gaming smart cards, debit cards and/or credit cards
and customized funds transfer systems for multi-jurisdictional gaming operators.
CREDIT/DEBIT CARD CASH ADVANCE SERVICES. Chex's credit/debit card cash advance
services allow patrons to use their VISA, MasterCard, Discover, and American
Express cards to obtain cash. The remote cash access terminals and other
equipment used to provide credit card advance services are provided by a vendor
pursuant to cash advance service agreements between Chex and the vendor. Each of
the agreements provides that the vendor will supply, install and maintain, at
the vendor's expense, the equipment and supplies necessary to operate the cash
advance system.
Under the terms of the vendor agreements, the vendor charges each patron
completing a credit card advance transaction a service fee based on the cash
advance amount and pays a portion of such service fee to Chex. The service fee
and the credit card cash advance amount are charged against the credit card
account of the location patron effecting the transaction and deposited by the
appropriate credit card company into the vendor's account. The vendor reimburses
Chex for the advance amount, by check, and pays the commission due to Chex in
the month following the month the transaction was completed. At all of the
locations at which Chex provides credit card advance services, it pays the
operator a commission for each completed credit card cash advance transaction.
Patrons may initiate a credit card cash advance transaction at a remote credit
card cash advance terminal at Chex's teller facility. The remote credit card
cash advance terminals consist of a credit card reader with an integrated keypad
and a digital display. The patron initiates the credit card cash advance
transaction by swiping the credit card's magnetic strip through the card reader
and then entering the amount of cash requested. The remote terminal
automatically accesses the credit card company's authorization center for
approval of the transaction. If the transaction is approved, a cash advance
draft is automatically generated at the teller facility and the patron is
directed to go to the teller facility to obtain the cash advance. At the teller
facility, the employee verifies the patron's identity and performs certain other
security measures gathering certain demographic information, including the
patron's address and telephone number. The patron then endorses the back of the
cash advance draft, initials the front of the draft acknowledging the service
fee charge and receives the cash requested with a transaction receipt. The
vendor, pursuant to the terms of the agreements with Chex, guarantees payment to
Chex for all transactions that are processed in accordance with the procedures
specified in the agreements.
CHECK CASHING SERVICES. Chex's check cashing services allow location patrons to
access cash by writing a check to Chex Services at its teller facility staffed
by employees of the company. Chex's employees conduct the authorization and
verification process for check cashing transactions in accordance with detailed
procedures developed by Chex to help minimize bad debt from returned checks.
Chex's customers are granted check cashing limits based upon their check cashing
history which is captured and maintained by Chex. The customer's ability to pay
is critical in establishing their check cashing limits.
Chex charges the customer a fee for cashing checks. The fee for personal checks
ranges from 3% to 10% of the amount of the cashed check. At the locations where
they provide check-cashing services, Chex pays the location operator a
commission based upon the monthly amount of checks cashed. Chex also cashes
other financial instruments at varying customer fees, such as, money orders,
government checks, payroll checks, insurance checks, etc.
Chex's check cashing services benefit location operators by providing
demographic information on the location's patrons, relieving the location of any
risk and collection costs associated with returned checks and by allowing the
location to focus on the aspects of the business that they do best.
Chex mitigates its potential for returned items by establishing check-cashing
limits based on the customer's history at Chex locations. In addition, Chex
utilizes national negative databases to determine if a customer has written
non-negotiable checks in the past. They also contact the customer's bank to
verify funds availability in the customer's checking account and take the
fingerprints and photo of customers to both deter potential bad checks and to
assist their efforts in collections when necessary.
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ATM SYSTEMS. Under the terms of the agreements with the processor, also known as
the vendor, Chex receives a surcharge fee for each cash withdrawal and the
vendor credits Chex's bank settlement account for each transaction, less any
processing fees. The surcharge, which is a charge in addition to the cash
advance, is made against the bank account of the patron effecting the
transaction and is deposited in the vendor's account. The vendor reimburses Chex
for the cash advance amount generally within two days of the transaction and
pays the surcharge commission due Chex for each withdrawal either immediately or
in the month following the month the transactions were completed. This variance
in the timing of the surcharge payments is based upon the ATM processing
agreements between Chex and its vendors. The Company generally passes on an
agreed upon percentage of the surcharge commissions to the locations where the
ATMs are placed.
MARKETING AND SALES OF SERVICES. Chex's objective is to increase the number of
locations at which it provides cash access services in the gaming industry. It
intends to pursue obtaining additional contracts with new casinos, existing
casinos not currently contracting with a cash access provider and other existing
casinos when such casinos current contracts with another cash access service
provider expire. At December 31, 2001, Chex had 44 contracts with casinos and
other gaming establishments as compared to 30 at December 31, 2000. As of
December 31, 2001, Chex Services is the number one provider of cash access
services to the Native American gaming industry. As of March 30, 2002, Chex has
contracts with 50 casinos and other gaming establishments to provide varying
levels of cash access services.
In furtherance of the Chex's objective to increase its market share, its
marketing plan is designed to increase the Chex's profile in the casino
industry. The marketing plan includes increasing direct personal contact with
casino management personnel responsible for decision making regarding cash
access services, including the implementation of customer service workshops that
are designed for the company's and the casino's employees. Chex has developed a
network of associates in the casino industry who are able to refer casino
management to the company. It also advertises in trade publications, attends
industry trade shows and distributes sales material to casino operators through
direct mail. Chex has a marketing Director for this purpose.
COMPETITION. Chex competes with a number of companies in their market niche. The
other companies that offer full service booth check cashing operations are Game
Financial Corp. (owned by Travelers Express), Global Cash Access, Cash Systems,
Inc. and Americash. Chex Services also competes with a number of companies that
offer ala carte credit card cash advance systems and ATMs to the gaming and
hospitality industries which include Global Cash Access, Game Financial Corp.,
Cash Systems, Inc., Cash & Win (through an alliance with Comerica Bank and NDC),
Americash, and Borrego Springs Bank.
GOVERNMENT REGULATION. Chex is licensed at many of the locations where it
operates by the local Tribal Authority and/or various state licensing
organizations. All of the Tribes operate under various compacts negotiated with
the states where they are domiciled. The Bureau of Indian Affairs who reports to
the U.S. Department of Commerce oversees the regulatory aspects of these
compacts. If a Tribe was found in violation of the regulations of the state
compact, they could be closed down. An event of this type would have a negative
impact on Chex. Also, if the government or individual states were to ban ATM
convenience fees, that too would have a negative affect on Chex's operations.
EMPLOYEES.
Equitex currently employs three full-time employees. In addition, Nova and Key
employ seven full-time employees down from approximately 300 at December 31,
2001, as a result of employee lay-offs due to the Net First closure, and Chex
employs twelve full-time employees at its corporate office, twelve employees in
home offices, and one hundred forty full-time and forty-four part-time employees
at its casino locations.
(d) Financial information about geographic areas.
Not applicable.
ITEM 2. PROPERTIES.
Our principal executive office is located in Englewood, Colorado. We lease this
space, consisting of approximately 1,800 square feet, on a month-to-month basis
for $2,500 per month, from a corporation in which our president is the sole
-8-
stockholder. We believe these terms to be no less favorable than those that
could be obtained from a non-affiliated party for similar facilities in the same
area.
We also lease an executive office in Palm Beach Gardens, Florida consisting of
approximately 980 square feet. The lease payment is currently $2,205 per month
and increases by $82 per month in April of each year until the lease expires in
February 2004.
Nova and Key lease approximately 21,870 square feet of office space in
Clearwater, Florida. The lease payment is currently $31,278 per month increasing
to $32,843 per month in June 2002, $34,485 per month in June 2003 and $36,209
per month in June 2004. This lease expires on September 30, 2004.
Chex leases approximately 4,195 square feet for its executive office in
Minnetonka, Minnesota. The lease payment is currently $5,768 per month
increasing to $5,942 per month in month 25, April 2003, and $6,030 per month in
months 49 through 60 of the five year lease. This lease expires on March 31,
2006.
ITEM 3. LEGAL PROCEEDINGS.
In August 2000, William G. Hays, Jr., liquidating agent for RDM Sports Group,
Inc. and related debtors, filed an adversary proceeding against us, Smith
Gambrell and Russell, LLP, David J. Harris, P.C. and David J. Harris, in the
United States Bankruptcy Court for the Northern District of Georgia, Newnan
Division, Adversary Proceeding No. 00-1065. The liquidating agent alleges that
we breached our October 29, 1987, consulting agreement with RDM, breached
fiduciary duties allegedly owed to RDM, and that we are liable for civil
conspiracy and acting in concert with directors of RDM. The liquidating agent is
seeking unspecified compensatory and punitive damages, along with attorney's
fees, costs and interest. On April 2, 2001, the court granted our motion to
enforce the arbitration clause contained in the consulting agreement. Because
this matter is in the preliminary stages and no arbitration date has been set,
it is too early to predict the outcome of this matter. In connection with the
distribution of our assets and liabilities to Equitex 2000 on August 6, 2001,
Equitex 2000 has agreed to indemnify us and assume defense in this matter, as
well as certain other legal actions existing at August 6, 2001. Although we
believe this lawsuit is without merit, there is no assurance of a favorable
outcome. The costs to defend this matter may be material, and an unfavorable
outcome may have a material adverse effect on us should Equitex 2000 not be in a
position to fulfill its indemnification to us for any losses that may be
incurred.
We are involved in various other claims and legal actions arising in the
ordinary course of business. In the opinion of management, the ultimate
disposition of these matters will not have a material adverse impact either
individually or in the aggregate on our consolidated results of operations,
financial position or cash flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
On December 20, 2001, we held our Annual Meeting of Stockholders. The
stockholders re-elected each of our incumbent four directors and elected two new
directors to serve until the next Annual Meeting of Stockholders. The votes were
cast as follows:
For Withhold Authority
--------- ------------------
Henry Fong 10,845,426 46,068
Russell L. Casement 10,846,020 45,474
Aaron Grunfeld 10,846,150 45,344
Joseph W. Hovorka 10,846,150 45,344
Scott A. Lucas 10,845,950 45,364
James P. Welbourn 10,845,950 45,364
-9-
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
(a) Market Information.
Our common stock trades on the Nasdaq SmallCap Stock Market under the symbol
EQTX. The table below states the quarterly high and low last sale prices for the
common stock as reported by The Nasdaq Stock Market, and represents actual high
and low last sale prices.
Last Sale
---------
Quarter ended High Low
------------- ---- ---
2000
----
March 31, 2000 $11.13 $6.63
June 30, 2000 9.38 5.38
September 30, 2000 8.00 5.63
December 31, 2000 6.25 4.13
2001
----
March 31, 2001 $6.94 $4.00
June 30, 2001 7.13 5.03
September 30, 2001 5.75 3.50
December 31, 2001 5.00 3.30
(b) Holders.
The number of record holders of our common stock as of April 5, 2002 was 2,240
according to our transfer agent. This figure excludes an indeterminate number of
shareholders whose shares are held in "street" or "nominee" name.
(c) Dividends.
Prior to the reverse acquisition date of August 6, 2001, Key and Nova, as S
Corporations, paid dividends to shareholders for tax purposes. No dividends were
paid by Key and Nova subsequent to August 6, 2001. Equitex has never declared or
paid cash dividends on our common stock, nor do we anticipate paying any cash
dividends in the foreseeable future. We currently intend to retain any future
earnings to fund operations and for the continued development of our business.
While a business development company, we made an in-kind distribution of one of
our larger investment positions to stockholders. Any further in-kind
distribution will be made only when, in the judgment of our Board of Directors,
it is in the best interest of our stockholders to do so. It is possible that we
may make an in-kind distribution of securities, which have appreciated or
depreciated from the time of purchase depending upon the particular
distribution. We have not established a policy as to the frequency or size of
distributions and indeed there can be no assurance that any future distributions
will be made. To date, only one such distribution has been approved by the Board
of Directors and was distributed in April 1988.
(d) Recent sales of unregistered securities.
During the quarter ended December 31, 2001, we issued a total of 2,629,872
unregistered shares of our $0.02 par value common stock in various transactions
as described below. For each of the following transactions, we relied upon the
exemptions from registration provided by Sections 4(6) or 4(2) of the Securities
Act and Rule 506 promulgated thereunder based upon (i) representations from each
investor that it is an accredited or sophisticated investor with experience in
investing in securities such that it could evaluate the merits and risks related
to our securities; (ii) that no general solicitation of the securities was made
by us; (iii) each investor represented to us that it was acquiring the
securities for its own account and not with a view towards further distribution;
(iv) the securities issued were "restricted securities" as that term is defined
under Rule 144 promulgated under the Securities Act; (v) we placed appropriate
restrictive legends on the certificates representing the securities regarding
the restricted nature of these securities; and (vi) prior to completion of the
transaction, each investor was informed in writing of the restricted nature of
the securities, provided with all information regarding Equitex as required
under Rule 502 of Regulation D and were given the opportunity to ask questions
of and receive additional information from us regarding our financial condition
and operations. The shares were issued as follows:
-10-
On October 3, 2001, we issued 38,944 shares of our $0.02 par value common stock
to an accredited investor upon conversion of 100 shares of Series I Preferred
Stock valued at $100,000. This represents a conversion price of $2.57 per share.
On October 4, 2001, we issued 25,409 shares of our $0.02 par value common stock
to an accredited investor upon conversion of 70 shares of Series I Preferred
Stock valued at $70,000. This represents a conversion price of $2.75 per share.
On November 21, 2001, we issued 4,852 shares of our $0.02 par value common stock
to an accredited investor upon conversion of 4,852 warrants to purchase common
stock at an exercise price of $0.02 per share for total proceeds to the Company
of $97.00.
On November 30, 2001, we issued 180,331 shares of our $0.02 par value common
stock to an accredited investor upon conversion of 440 shares of Series I
Preferred Stock valued at $440,000. This represents a conversion price of $2.44
per share.
On November 30, 2001, we issued 3,335 shares of our $0.02 par value common stock
to a consultant for services valued at $17,309 or $5.19 per share.
On December 3, 2001, we issued 350,000 shares of our $0.02 par value common
stock to a consultant for services valued at $1,400,000 or $5.19 per share.
On November 30, 2001, we issued 1,992,001 shares of our $0.02 par value common
stock to the stockholders of Chex in consideration for the acquisition of all of
the outstanding securities of Chex The value of these securities was $10,119,000
or $5.08 per share, which represents the closing price of our common stock as
reported by the Nasdaq Stock Market on the date the companies executed the
definitive agreement for the acquisition.
On December 17, 2001, we issued 35,000 shares of our $0.02 par value common
stock to consultants for services valued at $140,000 or $4.00 per share.
ITEM 6. SELECTED FINANCIAL DATA.
The following tables contain selected financial data of Equitex for the previous
five years. On August 6, 2001, we completed the distribution of all of our
assets to Equitex 2000, and Equitex 2000 assumed all liabilities of us.
Immediately following this transaction, we completed the acquisitions of Key and
Nova, which were recorded as reverse acquisitions. The selected financial data
presented for the year ended December 31, 2001 are those of the Key and Nova
presented on a consolidated basis with those of Equitex for the period from
August 6, 2001 through December 31, 2001 as well as those of Chex for the month
of December 2001. The selected financial data presented for the years ended
December 31, 2000, 1999, 1998 and 1997, are those of Key and Nova on a combined
basis.
- -------------------------------- ------------ ------------ ------------ ----------- ----------
2001 2000 1999 1998* 1997*
- -------------------------------- ------------ ------------ ------------ ----------- ----------
Revenues $16,528,139 $14,456,354 $21,030,343 $4,945,622 -
- -------------------------------- ------------ ------------ ------------ ----------- ----------
Net income (loss) (1,031,369) 3,556,720 5,589,938 451,626 (11,954)
- -------------------------------- ------------ ------------ ------------ ----------- ----------
Net income (loss) applicable to
common stockholders (4,196,369) 3,556,720 5,589,938 451,626 (11,954)
- -------------------------------- ------------ ------------ ------------ ----------- ----------
Basic & diluted net loss per
common share (0.32) 0.40 0.63 0.08 NIL
- -------------------------------- ------------ ------------ ------------ ----------- ----------
Total assets 35,349,155 7,163,464 7,580,093 2,391,339 38,746
- -------------------------------- ------------ ------------ ------------ ----------- ----------
Total long-term liabilities 232,200 - - - -
- -------------------------------- ------------ ------------ ------------ ----------- ----------
Convertible preferred stock 4,285,000 - - - -
- -------------------------------- ------------ ------------ ------------ ----------- ----------
Cash dividends 2,000,000 4,225,000 4,063,888 798,112 -
- -------------------------------- ------------ ------------ ------------ ----------- ----------
* Key's date of inception was June 12, 1997 and Nova's date of inception was
October 10, 1998.
-11-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion and analysis of our financial condition and results of
operations should be read in conjunction with the consolidated financial
statements and notes thereto for the years ended December 31, 2001, 2000 and
1999. The financial results presented for the year ended December 31, 2001 are
those of the Key Financial Systems and Nova Financial Systems on a consolidated
basis with those of Equitex for the period from August 6, 2001 through December
31, 2001 as well as those of Chex Services, Inc. for the month of December 2001.
The financial results presented for the years ended December 31, 2000 and 1999
are those of Key Financial Systems and Nova Financial Systems.
(a) Liquidity and Capital Resources.
For the year 2002, we presently anticipate our liquidity and capital resource
needs will be satisfied from cash flows generated from our operating activities.
Although the closure of Net First National Bank will reduce cash flows at Key,
they have taken immediate actions to rapidly reduce personnel, marketing and
other operating costs. Key and Nova will continue other marketing programs and
management anticipates implementation of new sales and marketing programs.
Our other operating subsidiary, Chex, anticipates an increase in cash flows in
2002 both from the increase in cash access locations and from the introduction
of new products during the year. These products would be complementary to their
existing products and services and may include: cashless gaming smart cards,
debit cards and customized funds transfer systems for multi-jurisdictional
gaming operators. Additionally, Chex is attempting to restructure some
of its 12% investor notes, thereby reducing interest costs and increase cash
flow.
Other sources available to us that we may utilize include the sale of equity
securities through private placements of common or preferred stock as well as
the exercise of stock options or warrants all of which may cause dilution to our
stockholders. We could also borrow funds from related and/or third parties.
On August 6, 2001, we completed the distribution of all of our assets to Equitex
2000, and Equitex 2000 assumed all of our liabilities. Immediately following the
distribution to Equitex 2000, we acquired all of the outstanding common stock of
Key Financial Systems, Inc. and Nova Financial Systems, Inc., both Florida
companies previously under common control with nearly an identical ownership
structure. We acquired Key and Nova in exchange for (i) 9,084,773 shares of our
common stock, (ii) cash of $5 million, (iii) warrants to acquire an aggregate of
990,134 shares of our common stock exercisable at $0.02 per share, and (iv)
warrants to acquire an aggregate of 3,933,350 shares of our common stock
exercisable at $5.65 per share. In order to raise the cash consideration of $5
million, we issued two new series of convertible preferred stock, including
2,359 shares of Series H 8% convertible preferred stock in exchange for net
proceeds of $2,059,000, and 4,000 shares of Series I 6% convertible preferred
stock in exchange for net proceeds of $3,500,000 as described in Note 13 to the
consolidated financial statements included in this report.
Effective December 1, 2001, we acquired all the outstanding common stock of Chex
Services, Inc. in exchange for 1,992,001 shares of our common stock valued at
$10,119,000 ($5.08 per share), in a transaction accounted for as a purchase. In
conjunction with the agreement, we entered into an employment incentive
agreement with the president of Chex in which we granted him a warrant to
purchase up to 730,000 shares of our common stock at an exercise price of $3.85
per share, which was the quoted market price of the common stock at the date the
warrant was granted. The warrant is exercisable for a four-year period beginning
December 1, 2001.
At December 31, 2001, we had a cash position on a consolidated basis of
$7,830,426. Net cash provided by operating activities for the year ended
December 31, 2001 was $182,768 versus $4,120,520 during the same period of 2000
for Key and Nova. The most significant portion of this change was the decrease
in net income from $3,556,720 in 2000 to a loss of $1,031,369 in 2001 as
described more fully in Results of Operations below. Total adjustments to
reconcile net income to net cash increased by $650,337 to $1,214,137 at December
31, 2001.
Increases in provision for recovery of losses, depreciation and amortization,
uncollectible related party receivable and stock based compensation were
partially offset by increases in accounts and other receivables, and by
increases in amounts due to credit card holders and account payable and accrued
liabilities.
-12-
Net cash provided by investing activities was $8,704,315 for the year ended
December 31, 2001 compared to $120,426 for the year ended December 31, 2000.
Cash acquired in business acquisition (Chex Services) increased by $9,994,124,
which was offset by increases in credit card receivables and by net increases in
related party notes receivable.
Net cash used in financing activities was $1,130,269 for the year ended December
31, 2001 as compared to $4,225,000 in 2000 for Key and Nova. Common stock of Key
and Nova issued for cash of $1,000,000 in 2001, a decrease in dividends paid to
Key and Nova stockholders from $4,225,000 in 2000 to $2,000,000 in 2001, net
changes in notes payable related parties of $246,950 and payment in cash of
$418,805 for redemption of Series I Preferred Stock accounted for the majority
of the decrease.
(b) Results of operations.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Preparation of the consolidated financial statements in accordance with
generally accepted accounting principles in the United States requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the balance sheet and the reported amounts of revenue and expenses
during the reporting periods. Actual results could differ from those estimates.
We believe that the following are some of the more critical accounting policies
that currently affect our financial condition and results of operations:
o allowances for refundable fees and losses;
o returned checks;
o stock based compensation;
o estimation of certain revenues, assets and liabilities;
o accounting for business combinations;
o litigation; and
o income taxes, deferred taxes.
ALLOWANCES FOR REFUNDABLE FEES AND LOSSES
The allowance for losses is established through a provision for losses charged
to expense. Receivables are charged against the allowance for losses when
management believes that collectibility of principal is unlikely. The allowance
is an amount that management believes will be adequate to absorb estimated
losses on existing accounts, based on evaluation of the collectibility of the
accounts and prior loss experience. This evaluation also takes into
consideration such factors as changes in the volume of the credit card
receivable portfolio, overall portfolio quality, and current economic conditions
that may affect the borrower's ability to pay. While management uses the best
information available to make its evaluation, this estimate is susceptible to
significant change in the near term.
RETURNED CHECKS
We charge operations for potential losses on returned checks in the period such
checks are returned, since ultimate collection of these items is uncertain.
Recoveries on returned checks are credited in the period when the recovery is
received.
STOCK BASED COMPENSATION
We have chosen a policy to account for stock-based compensation plans and
transactions in which we issue stock in exchange for goods and services, as an
expense.
ESTIMATES OF CERTAIN REVENUES, ASSETS AND LIABILITIES
Credit card fees are accrued monthly on active credit card accounts and included
in credit card receivables. Accrual of income is discounted on credit card
accounts that have been closed or charged-off.
-13-
Fee revenue is recognized from financial services at the time the service is
provided.
Credit card receivables are stated at cost and include refundable and earned
fees, which represents the balance reported to customers. At March 31, 2002,
approximately $2.3 million (unaudited) were due from Net First. We are pursuing
collection of these receivables from Net First with the FDIC, and management
believes that the collection of this balance is probable.
Certain of Chex's contracts with gaming establishments contain provisions that
could be subject to interpretation by the contractual parties. At December 31,
2001, Chex is operating at certain gaming establishments with unsigned
contracts, verbal agreements or verbal amendments to the existing written
contracts. As of December 31, 2001, we have estimated and recorded obligations
under these contracts using management's understanding and interpretation of the
underlying agreements.
ACCOUNTING FOR BUSINESS COMBINATIONS
We applied the provisions of SFAS No. 141 in connection with our acquisition of
Chex in December 2001 as described in Note 3 to the consolidated financial
statements included in this report. The Financial Accounting Standards Board
("FASB") issued Statement of Financial Accounting Standards SFAS No. 141,
BUSINESS COMBINATIONS, and SFAS No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS.
SFAS No. 141 requires that the purchase method of accounting be used for all
business combinations for which the date of acquisition is after June 30, 2001.
SFAS No. 141 also establishes specific criteria for the recognition of
intangible assets.
LITIGATION
We are currently involved in certain legal proceedings, as described in Note 12
to the consolidated financial statements included in this report. Since the
matter is in the preliminary stage it is too early to predict the outcome of
this matter. In connection with the distribution of our assets and liabilities
to Equitex 2000 on August 6, 2001, Equitex 2000 has agreed to indemnify us and
assume defense in this matter, as well as certain other legal actions existing
at August 6, 2001. Although we believe this lawsuit is without merit, there is
no assurance of a favorable outcome. The costs to defend this matter may be
material, and an unfavorable outcome may have a material adverse effect on us
should Equitex 2000 not be in a position to fulfill its indemnification to us
for any losses that may be incurred.
We are involved in various other claims and legal actions arising in the
ordinary course of business. In the opinion of management, the ultimate
disposition of these matters will not have a material adverse impact either
individually or in the aggregate on our consolidated results of operations,
financial position or cash flows.
INCOME TAXES, DEFERRED TAXES
Income taxes are provided for the tax effects of transactions reported in the
financial statements, and a deferred income tax liability or asset is recognized
for temporary differences between our financial statements and tax returns.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to reverse. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in the statement of
operations in the period that includes the enactment date.
Effective August 6, 2001, in conjunction with the acquisition of Key and Nova,
and in conjunction with Key and Nova's termination of S Corporation status, we
recorded a net deferred tax asset of approximately $1,440,000, which was
recorded as an increase to deferred tax assets and an increase in additional
paid-in capital. The net deferred tax asset primarily represents net operating
loss carryforwards of Equitex, which may be utilized to offset our future
taxable income, as discussed below.
Net operating loss carryforwards of approximately $7,300,000 are available to
offset future taxable income, if any, and expire between 2015 and 2021. The net
operating loss carryforwards may be subject to certain limitations due to
business acquisitions and other transactions.
A valuation allowance has been provided to reduce the deferred tax assets, based
on management's estimate of the assets' realizibility. We increased the
valuation allowance by $1,342,000 in the fourth quarter of 2001, based on these
estimates. Realization of the net deferred tax asset is dependent on generating
sufficient taxable income prior to expiration of the loss carryforwards.
-14-
Although realization is not assured, management believes it is more likely than
not that the net deferred tax asset will be realized. The amount of the deferred
tax asset considered realizable, however, could be reduced in the near term if
estimates of future taxable income during the carry forward period are reduced.
RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2001 VS. DECEMBER 31, 2000
REVENUES
Consolidated Revenues for the year ended December 31, 2001 were $16,528,139
compared to $14,456,354 for the year ended December 31, 2000 for us and our
subsidiaries.
REVENUES BY SEGMENT
Segment 2001 2000 1999
- ------- -------------- -------------- -------------
Credit card services $ 15,140,210 $ 14,456,354 $ 21,030,343
Cash disbursement services
(one month) 1,373,158 - -
Corporate activities 14,771 - -
-------------- -------------- -------------
$ 16,528,139 $ 14,456,354 $ 21,030,343
============== ============== =============
CREDIT CARD SERVICES SEGMENT
CREDIT CARD INCOME
Credit card servicing fees the major component of credit card income, Key and
Nova's principal source of earnings, are credit card fees assessed on credit
card accounts owned by each company's client banks. These include monthly
membership fees, late charges, overlimit fees, and return check fees. The fees
are paid to Key and Nova under a 100% loan participation agreement with the
client bank. Credit card servicing fees for the year ended December 31, 2001
decreased 5.8% to $10,566,999 from the 2000 period. Although the year-to-date
average number of active accounts during 2001 was 111,099 versus 99,147 in 2000,
a 12% increase, the 2001 average includes a larger percentage of new accounts.
New accounts have lower revenue per card than accounts that are more seasoned.
The new account volume in 2001 was 180,825 compared to 60,621 for 2000, a 198%
increase.
At the inception of the program, all applicants that paid the processing fee
were issued a credit card account. In June 2000, Key implemented a new account
activation procedure that required applicants to return a signed activation
certificate. This procedure greatly reduced the number of credit cards issued to
individuals that historically never activated their accounts.
In March of 2001, Key performed a detailed analysis comparing the number of
active accounts on file for three months and longer between the two different
card issuance methodologies. They found a significantly smaller percentage of
active accounts on file in relationship to applications for the new method
versus the original card issuance policy. Though the average credit card income
per account was higher during 2000 when the activation certificates were
required, the number of net remaining accounts was significantly less, which
reduces the amount of residual income Key will earn over the life of the account
relationships. Therefore, effective April 2001, new applicants that have paid
the processing fee are issued credit cards without the need to return a signed
activation certificate. The majority of the accounts that represent the increase
in new accounts in 2001 versus 2000 were booked after the change in the card
issuance policy.
Marketing accelerated in May 2001, increasing from 23,646 new accounts added
during January through April 2001 to 157,179 added during May through December.
This increase in marketing placed a larger expense burden on Key that normally
would be borne by income generated in subsequent periods. A few months lapse
before new accounts become profitable, with later per card profits recovering
earlier losses on such new cards.
On March 1, 2002, the Office of the Comptroller of the Currency closed Net First
National Bank and appointed the FDIC as receiver. Key immediately ceased all
marketing and processing of new credit card accounts at the close of business on
March 1, 2002. In addition, the FDIC repudiated Key's contract with Net First
effective March 4, 2002 and has closed all the credit card accounts subject to
Key's contract with Net First. The FDIC's action results in the termination of
-15-
all future credit card servicing revenues to Key from the Net First Portfolio
after March 4, 2002. For the year ending December 31, 2001 the Net First
portfolio provided 71.3% of the total credit card servicing revenues for Key.
The Net First portfolio was projected to represent an even greater percentage of
2002 revenues due to the continuing attrition of the Key Bank & Trust and
Merrick Bank portfolios that were originated in 1998 and 1999 and the expected
growth in the Net First portfolio.
We have signed a letter of intent with a financial institution to create a new
credit card program and Key has made contact with other financial institutions
interested in the Key credit card program. If successful, the new programs would
provide future credit card servicing revenues to help replace the Net First
program. Completion of this transaction is subject to further due diligence by
both parties, negotiation and execution of a definitive agreement, necessary
state or federal regulatory approvals, board of director approval and any
necessary stockholder approvals. There is no assurance this transaction will be
completed.
The provision for losses is the charge to operating earnings that management
feels is necessary to maintain the reserve for possible losses at an adequate
level. The provision is determined based on growth of the portfolio, the net
amount of losses incurred, and management's estimation of losses based on an
evaluation of the portfolio risks and economic conditions. In the 2001 period,
Key and Nova had a total provision of $416,080 compared to $56,520 for the same
period in 2000. This resulted from a reduced 2000 provision, and not from a
decrease in credit quality. The allowance for losses at December 31, 2001 was
$208,070 or 12.3% of credit card receivables, net of unearned income, compared
to $254,086 or 21.9% of credit card receivables, net of unearned income, at
December 31, 2000. Management believes that the reserve for possible losses was
adequate to provide for potential losses at December 31, 2001 and 2000.
The 2000 reduction in provision came from the maturation of Key's credit card
portfolio. Key ceased marketing of new accounts from April 1999 to January 2000,
at the request of the initial client bank. New card volume during this time was
transferred to the client bank of Key's affiliate company, Nova. Marketing
resumed in February 2000.
The termination of the Net First portfolio, as previously disclosed, will result
in a significant reduction in the provision for loss expense in 2002. The total
provision for loss expense in 2001 is attributable to the Net First portfolio.
APPLICATION FEES, NET OF DIRECT MARKETING COSTS
As a result of increased marketing efforts, application fees for the year ended
December 31, 2001 increased 54% to $4,213,466 compared to the same period in
2000. Paid applications were 180,825 in 2001 compared to 143,372 for the same
period in 2000. Key generally collects $99 per new account application and
expended approximately $75 per paid application in direct marketing costs in
2001.
With the termination of all marketing for the Net First portfolio effective
March 1, 2002, Key anticipates a significant reduction in 2002 application
processing income. For 2001, application processing fees totaling $4,213,466
were attributable to the Net First marketing efforts.
OTHER INCOME, NET
Other income for Key and Nova for the year ended December 31, 2001 was $346,296
representing an 89.6% increase over the December 31, 2000 period. This income is
mostly comprised of other marketing and lead income. Total income was $772,057,
which was partially offset by expenses of $425,761 incurred under the Paragon
Agreement as described in Note 12 to the consolidated financial statements
included in this report.
Other marketing income was predominantly associated with the Net First
portfolio. As previously noted, Key plans to replace some of the lost Net First
revenues with other marketing efforts on behalf of new bank clients.
Additionally, Equitex had other income of $14,771 representing interest income
and realized gain on investment.
CASH DISBURSEMENT SERVICES SEGMENT
Chex recognizes revenue at the time certain financial services are performed.
Since the effective date of the acquisition on December 1, 2001, Chex received
check cashing fees of $726,025 for cashing over $22 million of checks. In
addition, Chex received commissions from credit card advances and surcharge
commissions on ATM advances of $366,626 and $235,344 respectively. Included in
-16-
fee revenue is foreign currency exchange transactions of $5,000, fees collected
related to previously written insufficient checks of $33,239 and other income of
$6,924.
OPERATING EXPENSES
Segment 2001 2000 1999
- ------- ------------- ------------- -------------
Credit card services $13,246,163 $10,899,634 $15,322,905
Cash disbursements services
(one month) 1,707,748 - -
Corporate activities 2,663,097 - -
------------- ------------- -------------
$17,617,008 $10,899,634 $15,322,905
============= ============= =============
Total operating expenses for the year ended December 31, 2001 were $17,617,008,
an increase of 61.6% over the December 31, 2000 period. The 2001 period includes
expenses for the full year of Key and Nova and of Equitex from August 6, 2001
through December 31, 2001, and for Chex Services for the month of December. The
financial statements presented for year ended December 31, 2000 are those of Key
and Nova only.
CREDIT CARD SERVICES SEGMENT
Operating expenses for Key and Nova for the year ended December 31, 2001
increased $2,346,529 to $13,246,163 from $10,899,634 for the same period in
2000. This operating expense corresponds to increases in salaries, wages, and
associated costs of $1,794,337 due to increases in call center staffing. The
year-to-date average account base of 111,079 was slightly higher to the average
account base of 99,147 for the year-to-date period in 2000. However, the average
life of the average account was significantly less in the 2001 period.
Additionally, in 2001, there were 15,105 average monthly new accounts compared
to 5,052 average monthly new accounts in 2000. This resulted in a higher
percentage of newer accounts, the most costly period of the account's life.
Third party servicing fees, also affected by the volume increases, increased by
$458,997 to $6,136,638 for the year ended December 31, 2001 compared to December
31, 2000. Other expenses including occupancy costs increased by $93,195 for the
year ended December 31, 2001 compared to December 31, 2000. The closing of Net
First and closure of the Net First portfolio will have a significant impact in
reducing 2002 operating expenses. The majority of the operating expenses are
directly related to Key's credit card marketing efforts and portfolio servicing
responsibilities under the contract with Net First. Effective March 11, 2002,
Key has eliminated all direct costs associated with the Net First Program. In
2001, outside servicing fees of $3,901,764 or 29.5% of total operating costs
were incurred on behalf of the Net First portfolio and have ceased effective
March 4, 2002. Approximately 85% of personnel and other operating expenses were
incurred for the Net First marketing and portfolio servicing functions;
therefore Key anticipates significant reduction in these costs in 2002.
CASH DISBURSEMENT SERVICES SEGMENT
Chex operating expenses since the date of its acquisition (December 1, 2001) are
$1,707,748. Chex expenses were comprised of fees to casinos of $437,411 (see
Note 12), salaries and associated costs of $380,335, a provision for the
uncollectible note receivable from shareholder of $325,000 (see Note 6),
returned checks of $267,958 offset by collections of previously written-off
checks of $248,826, other general operating expenses of $443,138 and interest
expense of $102,733 (see Note 9).
CORPORATE ACTIVITY SEGMENT
Included in the year ended December 31, 2001 are operating expenses for Equitex
of approximately $2,663,097 for the period from August 6, 2001 through December
31, 2001. These expenses are comprised of selling, general and administrative
expenses of $530,863 and stock based compensation expense of $2,132,234. Stock
based compensation expense represents non-cash expense related to issuance of
common stock for services.
-17-
RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2000 VS. DECEMBER 31, 1999
CREDIT CARD SERVICES SEGMENT
CREDIT CARD INCOME
Credit card servicing fees the major component of credit card income, Key and
Nova's principal source of earnings, are credit card fees assessed on credit
card accounts owned by each company's client banks. These include monthly
membership fees, late charges, overlimit fees, and return check fees. The fees
are paid to Key and Nova under a 100% loan participation agreement with the
client bank. Credit card servicing fees decreased 40.7% to $11,214,273 from 1999
as a result of the decrease in active credit card accounts. The average number
of active accounts during the year 2000 was 99,147 versus 178,699 in 1999, a
44.5% decrease.
In June 2000, Key implemented a new account activation procedure that greatly
reduced the number of credit cards issued to individuals that historically
failed to activate their accounts. This resulted in much lower closure,
delinquency and charge-off rates on new accounts issued. An additional benefit
of the new procedure was significantly reduced new account and portfolio
servicing costs. The historically high level of "non-activated" accounts
resulted in significant expenditures for new account setup, data processing,
customer service and collections associated with accounts from which Key
Financial Systems received no credit card revenue.
On November 15, 2000 Key temporarily suspended marketing for Net First National
Bank. This suspension was at the request of Net First to conform to the
requirements of a Consent Order between Net First and the Office of the
Comptroller of the Currency. Net First was required to obtain legal opinions
that Key's credit card marketing and the Pay As You Go program conformed to all
applicable federal and state laws. The necessary opinions were prepared and
forwarded to the Office of the Comptroller of the Currency. On December 15,
2000, Net First notified Key to resume marketing the Pay As You Go credit card
program.
The provision for losses is the charge to operating earnings that management
feels is necessary to maintain the reserve for possible losses at an adequate
level. The provision is determined based on growth of the portfolio, the net
amount of losses incurred, and management's estimation of losses based on an
evaluation of the portfolio risks and economic conditions. The provision for the
year 2000 was significantly less than the provision for 1999. Some of the
reduction in principal losses in 2000 was offset by an increase in the fee
reversals per account at charge-off. The reserve balance at December 31, 2000 is
52% lower than the balance at December 31, 1999 due to the reduction in credit
card receivables. At December 31, 2000 and 1999, the allowance for losses was
$254,086 or 21.9% of credit card receivables, net of unearned income, compared
to $529,498 or 31.4% of credit card receivables, net of unearned income.
Management believes that the reserve for losses is management's best estimate of
probable losses inherent in the portfolio at December 31, 2000 and 1999.
APPLICATION FEES, NET OF DIRECT MARKETING COSTS
For the year ended December 31, 2000, application fees, net, were $2,735,438
compared to $2,877,535 in 1999. There were 143,372 paid applications in 2000
compared to 230,718 paid applications in 1999. Although there were more paid
applications in 1999, the 1999 direct marketing costs were mostly associated
with telemarketing costs while the 2000 costs were mostly derived from Internet
marketing sources. Telemarketing expenses are higher than Internet related
expenses.
OPERATING EXPENSES
Operating expenses for the year 2000 decreased to $10,899,634, a 28.9% decrease
from the year 1999. The decrease is due to lower third party servicing fees and
a decrease in personnel related expenses due to lower staffing levels. The
decrease in operating expenses is directly related to the decrease in active
credit cards.
OTHER ISSUES
In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No.
141, ACCOUNTING FOR BUSINESS COMBINATIONS, and SFAS No. 142, GOODWILL AND
INTANGIBLE ASSETS. SFAS No. 141 requires that the purchase method of accounting
be used for all business combinations for which the date of acquisition is after
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June 30, 2001. SFAS No. 141 also establishes specific criteria for the
recognition of intangible assets. We applied the provisions of SFAS No. 141 in
connection with our acquisition of Chex in December 2001.
SFAS No. 142, effective for fiscal years beginning after December 15, 2001,
establishes accounting and reporting standards for goodwill and other intangible
assets. Under SFAS No. 142, goodwill and intangible assets deemed to have
indefinite lives will no longer be amortized, but will be subject to annual
impairment tests in accordance with the standard. Other intangible assets will
continue to be amortized over their estimated useful lives. We will adopt SFAS
No 142, in the first quarter of 2002 and will perform the first of the required
impairment tests of goodwill under SFAS No. 142. Our current policy for
measuring goodwill impairment is based upon an analysis of undiscounted cash
flows, which did not result in an indicated impairment as of December 31, 2001.
Under SFAS No. 142, goodwill must be assigned to reporting units and measured
for impairment based upon the fair value of the reporting units. We have not yet
determined what the effect of these new impairment tests will be on our
consolidated financial position or results of operations.
In August 2001, FASB issued SFAS No. 144, ACCOUNTING FOR THE IMPAIRMENT OR
DISPOSAL OF LONG-LIVED ASSETS. SFAS No. 144, which is effective for fiscal years
beginning after December 15, 2001 and which supersedes SFAS No. 121, ACCOUNTING
FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED
OF, addresses accounting and financial reporting for the impairment or disposal
of long-lived assets. The adoption of this statement is not expected to have a
material impact on our consolidated financial position or results of operations.
In 2001, we adopted SFAS No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND
HEDGING ACTIVITIES. This statement, as amended, establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities. This
statement had no impact on our consolidated financial statements.
In December 1999, the staff of the Securities and Exchange Commission issued
Staff Accounting Bulletin ("SAB") No. 101, REVENUE RECOGNITION IN FINANCIAL
STATEMENTS. SAB No. 101, as amended by SAB No. 101A and SAB No. 101B, is
effective no later than the fourth fiscal quarter of fiscal years beginning
after December 15, 1999. SAB No. 101 and related amendments provide the staff's
views in applying generally accepted accounting principles to selected revenue
recognition issues. Adoption of SAB No. 101 did not have an impact our
consolidated financial statements.
SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, defines a fair-value
based method of accounting for stock-based employee compensation plans and
transactions in which an entity issues its equity instruments to acquire goods
or services from non-employees, and encourages but does not require companies to
record compensation cost for stock-based employee compensation plans at fair
value. We have chosen to continue to account for stock-based compensation using
the intrinsic value method prescribed in Accounting Principles Board Opinion No.
25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and guidance provided in SFAS
Interpretation No. 44,
ACCOUNTING FOR CERTAIN TRANSACTIONS INVOLVING STOCK COMPENSATION. Accordingly,
compensation cost for stock options is measured as the excess, if any, of the
quoted market price of our stock at the date of the grant over the amount an
employee must pay to acquire the stock.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The financial statements are listed under Item 14.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Effective August 6, 2001, we completed the acquisitions of Key and Nova in a
reverse acquisition. As a result, for accounting purposes, Key and Nova are
treated as the continuing reporting entity for purposes of financial reporting.
Prior to the acquisitions, Equitex's independent certified public accountant was
Gelfond Hochstadt Pangburn, P.C. while Key and Nova's independent certified
public accountant was McGladrey & Pullen, LLP.
On January 22, 2002, our board of directors, following a recommendation by our
Audit Committee, appointed Gelfond Hochstadt Pangburn, P.C. to serve as our
-19-
independent certified public accountant for the year ended December 31, 2001. As
a result, on January 24, 2002, Key and Nova notified McGladrey & Pullen, LLP
that it will no longer serve as the independent certified public accountant of
the companies. There have been no adverse opinions, disclaimers of opinion or
qualifications or modifications as to uncertainty, audit scope or accounting
principles regarding the reports of McGladrey & Pullen, LLP on the Key or Nova
financial statements for each of the fiscal years ended December 31, 2000 and
1999, or any subsequent interim period. During the two most recent fiscal years
and through January 24, 2002, there were no disagreements with McGladrey &
Pullen, LLP on any matter of accounting principles or practices, financial
statement disclosure, or auditing scope or procedures, which disagreements, if
not resolved to the satisfaction of McGladrey & Pullen, LLP, would have caused
it to make a reference to the subject matter of the disagreements in connection
with its report.
There were no reportable events, in each case, during either of Equitex's or Key
and Nova's two most recent fiscal years or any subsequent interim period.
During our two most recent fiscal years or subsequent interim periods we have
not consulted Gelfond Hochstadt Pangburn, P.C. regarding the application of
accounting principles to a specified transaction, either completed or proposed
of Key and Nova, or the type of audit opinion that might be rendered on Key and
Nova's financial statements, or any matter that was the subject of a
disagreement or a reportable event.
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT.
(a)(b)(c) Identification of directors, executive officers and certain
significant persons.
Length of
Name Age Offices held Service
- ---- --- ------------ ---------
Henry Fong 66 President, Treasurer, Since Inception
Principal Executive
Financial and Accounting
Officer and Director of
Equitex
Thomas B. Olson 36 Secretary Since 1988
Russell L. Casement 58 Director Since 1989
Aaron A. Grunfeld 55 Director Since 1991
Joseph W. Hovorka 72 Director Since 2001
Scott A. Lucas 50 President of Key Financial Since 2001
Services and Director of Equitex
James P. Welbourn 53 President of Chex Services and Since 2001
Director of Equitex
Our directors are elected to hold office until the next annual meeting of the
stockholders and until their respective successors have been elected and
qualified. Officers are elected by our Board of Directors and hold office until
their successors are duly elected and qualified.
No arrangement exists between any of the above officers and directors pursuant
to which any one of those persons were elected to such office or position.
We have appointed an Audit Committee currently consisting of Dr. Casement as
chairman, Mr. Grunfeld and Mr. Hovorka and a Compensation Committee currently
consisting of Mr. Grunfeld as chairman and Dr. Casement.
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(d) Family relationships.
Not applicable.
(e) Business experience.
HENRY FONG
Mr. Fong has been the president, treasurer and a director of Equitex
since its inception. Since 1999 Mr. Fong has been a director of iGenisys, Inc.,
a business project management software company which is presently working to
complete its initial public offering. From December 2000 to January 2002, Mr.
Fong was a director of Popmail.com, Inc., a publicly traded Internet marketing
company. From 1987 to June 1997, Mr. Fong was chairman of the board and chief
executive officer of RDM Sports Group, Inc. (f/k/a Roadmaster Industries, Inc.)
a publicly held investee of us and was its president and treasurer from 1987 to
1996. Subsequent to Mr. Fong's departure from RDM, it filed Chapter 11
bankruptcy petitions for RDM and all of its subsidiaries with the U.S.
Bankruptcy Court for the Northern District of Georgia on August 29, 1997. From
July 1996 to October 1997, Mr. Fong was a director of Stellent, Inc. (f/k/a
IntraNet Solutions, Inc.), a publicly-held investee company which provides
internet/intranet solutions to Fortune 1000 companies and was the chairman of
the board and treasurer of its predecessor company, MacGregor Sports and
Fitness, Inc. from February 1991 until the two companies merged in July 1996.
From January 1993 to January 20, 1999, Mr. Fong was chairman of the board
and chief executive officer of California Pro Sports, Inc., a publicly traded
manufacturer and distributor of in-line skates, hockey equipment and related
accessories. From 1959 to 1982 Mr. Fong served in various accounting, finance
and budgeting positions with the Department of the Air Force. During the period
from 1972 to 1981 he was assigned to senior supervisory positions at the
Department of the Air Force headquarters in the Pentagon. In 1978, he was
selected to participate in the Federal Executive Development Program and in
1981, he was appointed to the Senior Executive Service. In 1970 and 1971, he
attended the Woodrow Wilson School, Princeton University and was a Princeton
Fellow in Public Affairs. Mr. Fong received the Air Force Meritorious Civilian
Service Award in 1982. Mr. Fong has passed the uniform certified public
accountant exam. In March 1994, Mr. Fong was one of twelve CEOs selected as
Silver Award winners in FINANCIAL WORLD magazine's corporate American "Dream
Team."
THOMAS B. OLSON
Mr. Olson has been secretary of Equitex since January 1988. From
February 1990 to February 2000, Mr. Olson was a director, and from May 1994 to
February 2000 secretary, of Immune Response, Inc. a publicly held investee of
Equitex which merged with Opticon Medical, Inc., in February 2000. Mr. Olson has
attended Arizona State University and the University of Colorado at Denver.
RUSSELL L. CASEMENT
Dr. Casement has been a director of Equitex since February
1989. Since 1969, Dr. Casement has been the president of his own private dental
practice, Russell Casement, D.D.S., P.C., in Denver, Colorado. Dr. Casement
earned a Doctor of Dental Science degree from Northwestern University in 1967.
Dr. Casement is a member of the American Dental Association, the Colorado Dental
Association and the Metro Denver Dental Association.
AARON A. GRUNFELD
Mr. Grunfeld has been a director of Equitex since November
1991. Mr. Grunfeld has been engaged in the practice of law for the past 28 years
and has been of counsel to the firm of Resch Polster Alpert & Berger, LLP, Los
Angeles, California since November 1995. Mr. Grunfeld received an A.B. in
Political Science from UCLA in 1968 and a J.D. from Columbia University in 1971.
He is a member of the California Bar Association.
JOSEPH W. HOVORKA
Mr. Hovorka became a director of Equitex on June 21, 2001.
From September 1987 to February 2000, Mr. Hovorka was a director, and from
February 1990 to February 2000 was president, chief executive officer, chief
financial officer, and treasurer of Immune Response, Inc., a publicly held
company which merged with Opticon Medical, Inc. in February 2000. From 1989 to
1993, Mr. Hovorka served as president, chief operating officer, and treasurer
and was a director of Williams Controls, Inc., a publicly held manufacturer of
pneumatic, electronic and hydraulic controls for trucks, buses, mining,
construction and refuse collection vehicles. Mr. Hovorka also served as
president and was a director of Enercorp, Inc., a publicly held investment
company from July 1986 until June 1993. From September 1990 until June 1993 Mr.
Hovorka served as president and was a director of Ajay Sports, Inc., a publicly
traded manufacturer of golf bags and accessories. Mr. Hovorka had been engaged
in commercial and business banking for over thirty years.
-21-
SCOTT A. LUCAS
Mr. Lucas has been a director of Key Financial Systems, Inc. and
Nova Financial Systems, Inc. since their inception. Since September of 1998 he
has served as president of Key Financial Systems, Inc. He has served in the same
capacities for Nova Financial Systems, Inc. since its inception. From 1993
through 1997 Mr. Lucas held various executive management positions with First
National Bank of Marin and its affiliates. In all, Mr. Lucas has more than 26
years experience in the financial services industry, where he has held positions
as president, chief operations officer, chief financial officer, vice president
and other management positions in banking and insurance. Mr. Lucas received a
B.S. in Business Administration from the University of California, Berkeley in
1973.
JAMES P. WELBOURN
Mr. Welbourn has been the chief executive officer, president
and director of Chex Services, Inc., since June of 1992. On December 21, 2001,
Equitex completed the acquisition of Chex Services, Inc. Chex Services, Inc., is
a privately held company that provides cash access products and services to the
entertainment and hospitality industries. From 1971 through 1985, Mr. Welbourn
held various positions at AT&T, where he last served as District Manager for New
Product Introductions. From 1985 through 1992 Mr. Welbourn served as president
of Gamest, Inc., a specialty retailing company. Prior to joining Chex Services,
Mr. Welbourn provided financial consulting services to emerging companies in
various industries from 1989 through 1992. Mr. Welbourn has consistently been
awarded the distinction of "Honored Professional" in the NATIONAL REGISTER'S
WHO'S WHO IN EXECUTIVES AND PROFESSIONALS from 1996 through 2002. Mr. Welbourn
received a B.A. in Speech Education from Marquette University in 1971 and an
M.B.A. in Organizational Development from George Williams College in 1985.
(f) Involvement in certain legal proceedings.
Not applicable.
(g) Promoters and control persons.
Not applicable.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 ("Section 16") requires our
officers, directors and persons who own more than ten percent of our voting
securities to file reports of their ownership and changes in such ownership with
the Securities and Exchange Commission (the "Commission"). Commission
regulations also require that such persons provide us with copies of all Section
16 reports they file. Based solely upon its review of such reports received by
us, or written representations from certain persons that they were not required
to file any reports under Section 16, we believe that, during 2001, our officers
and directors have complied with all Section 16 filing requirements.
ITEM 11. EXECUTIVE COMPENSATION.
(a) General.
Henry Fong, our President and the only officer of Equitex whose total
compensation exceeded $100,000 for the fiscal year ended December 31, 2000,
received an annual salary of $183,013. Beginning July 1, 2001, the only
compensation Mr. Fong receives from Equitex is his annual salary, which
presently remains $183,013 for the year ended December 31, 2002. Of the
compensation expense to Mr. Fong during 2001, $76,255 was expensed during the
period from August 6, 2001 to December 31, 2001 following our merger with Key
and Nova, $61,004 of which was accrued and remains unpaid.
In January 1998, the Compensation Committee of our Board of Directors retained
an independent consultant to review the President's compensation. As a result of
that review, a new compensation arrangement was instituted based on
recommendations made by the independent consultant. In addition to Mr. Fong's
annual salary, beginning January 1, 1998 and ended June 30, 2001, Mr. Fong
received an annual bonus equaling 1% of our total assets combined with 5% of the
increase in the market value of our common stock, excluding shares owned by him,
calculated quarterly from January 1 to December 31 of any fiscal year. If there
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was a negative computation in any given quarter, no bonus was accrued and that
negative amount was carried forward to offset the subsequent quarter's bonus
during the fiscal year. Negative amounts were not accumulated nor carried into
subsequent fiscal years. During the year ended December 31, 2001, this bonus
totaled $223,294. Following our acquisition of Nova and Key in August 2001, Mr.
Fong, in consultation with the Compensation Committee, agreed to end the bonus
plan beginning July 1, 2001. In addition, all accrued bonuses due under the plan
became the responsibility of Equitex 2000 following the spin-off in August 2001.
We have no retirement or pension plan for our President, Mr. Fong. In April
1992, we obtained a life insurance policy with retirement benefits for Mr. Fong,
which pays his beneficiary $2,600,000 in the event of Mr. Fong's death or
provides for retirement benefits for Mr. Fong upon his retirement, provided he
is at least 65, utilizing the cash value of the policy at that time. This
benefit was provided to Mr. Fong in consideration of his nineteen years of
service to us and in anticipation of his serving until retirement. All
liabilities under this plan were transferred to Equitex 2000 in the spin-off
transaction that took place effective August 6, 2001. The annual premium on this
policy was $105,414 per year for such period as may be necessary to fully fund
the policy, and was considered other future compensation to Mr. Fong in previous
years.
(b) Summary compensation table.
The following table sets forth information regarding compensation paid to our
officers during the years ended December 31, 2001, 2000 and 1999:
SUMMARY COMPENSATION TABLE
Long-Term
Compensation
Annual Compensation Awards
--------------------------- -----------
Name & Other Annual All Other
Principal Salary Bonus Compensation Options Compensation
Position Year ($) ($) ($) & SARs(#) ($)
- --------------------------------------------------------------------------------
Henry Fong 2001 76,255 -0- -0- -0- -0-
President, (1)
Treasurer
Principal 2000 183,013 161,668 -0- 476,000 165,000(2)
Executive
Officer and 1999 183,013 883,164 -0- 469,700 165,000(2)
Accounting
Officer
- --------------------------------------------------------------------------------
Scott A. Lucas, 2001 130,000 -0- -0- -0- -0-
President-Key
2000 130,000 -0- -0- -0- -0-
1999 120,000 -0- -0- -0- -0-
- --------------------------------------------------------------------------------
Robert Darst 2001 130,000 -0- -0- -0- -0-
Director of
Marketing - 2000 130,000 -0- -0- -0- -0-
Key
1999 120,000 -0- -0- -0- -0-
- ----------
(1) Includes salary paid and accrued during the period from August 6, 2001 to
December 31, 2001 following our merger with Key and Nova.
(2) Includes payments and tax liability on the life insurance policy as
explained more fully in "Item 10 (a) General" above.
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(c) Option/SAR grants table.
None.
(d) Aggregated Option/SAR exercises and fiscal year-end Option/SAR value table.
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION/SAR VALUES
(a) (b) (c) (d) (e)
Number of
Securities Value of
Underlying Unexercised
Unexercised In-the-Money
Options/SARs Options/SARs
Shares at FY-End (#) at FY-End (#)
Acquired on Value Exercisable/ Exercisable/
Name Exercise (#) Realized ($) Unexercisable Unexercisable
- ---- ------------ ------------ ------------- -------------
Henry Fong -0- -0- 945,700/-0- $-0-/-0-
(e) Long Term Incentive Plans -- awards in last fiscal year.
Not applicable.
(f) Defined benefit or actuarial plan disclosure.
Not applicable.
(g) Compensation of directors.
(1)Standard Arrangements
Each independent member of our Board of Directors, Messrs. Russell L. Casement,
Aaron A. Grunfeld and Joseph W. Hovorka, receive $10,000 per year payable
monthly and $500 for each Board of Director's meeting attended either in person
or by telephone. For the year ended December 31, 2001, Messrs. Casement and
Grunfeld each received a total of $16,000 while Mr. Hovorka received $14,500.
Members of the Board of Directors also receive reimbursement for expenses
incurred in attending board meetings.
(2) Other Arrangements
We adopted the 1993 Stock Option Plan for Non-Employee Directors reserving an
aggregate of 250,000 shares of common stock for issuance pursuant to the
exercise of stock options that may be granted to our non-employee directors. On
July 5, 1995, an order was issued by the Securities and Exchange Commission
authorizing the 1993 Stock Option Plan for Non-Employee Directors and the
options granted thereunder. The 1993 Stock Option Plan for Non-Employee
Directors was for a ten-year term commencing July 5, 1995. Each non-employee
director automatically, as of the July 5, 1995, was granted an option to
purchase 50,000 shares of common stock at $3.00 per share. This plan was
terminated effective with the creation of the 1999 Stock Option Plan described
below.
On June 2, 1998, our Board of Directors authorized the granting of 75,000
options to purchase our common stock to each of our two independent directors at
$3.19 per share for a period of five years. The grant of these options was
contingent upon our successful withdrawal as a business development company. On
January 4, 1999 we filed for withdrawal as a business development company.
On January 5, 1999, our Board of Directors adopted a new stock option plan, the
1999 Stock Option Plan. On January 5, 1999, our two independent directors each
received options to purchase 158,700 shares of our common stock at an exercise
-24-
price of $6.75 per share expiring on January 5, 2004. These options were granted
in lieu of the 75,000 options at $3.19 per share authorized on June 2, 1998,
which were canceled. In addition, each director received 86,800 options to
purchase 86,800 shares of our common stock at an exercise price of $6.75 per
share under the 1999 Plan.
On April 17, 2000, our Board of Directors granted 84,000 options to purchase our
common stock to each of our two independent directors at that time. These
options, granted under the 1999 Stock Option Plan, are exercisable at $5.50 per
share and expire on April 17, 2005.
(h) Employment contracts and termination of employment and change-in-control
arrangements.
We have no compensation plan or arrangement with respect to any executive
officer which plan or arrangement results or will result from the resignation,
retirement or any other termination of such individual's employment with us. We
have no plan or arrangement with respect to any such persons, which will result
from a change in control of Equitex or a change in the individual's
responsibilities following a change in control.
(i) Report on repricing of Options/SARs.
Not applicable.
(j) Additional information with respect to Compensation Committee Interlocks and
Insider Participation in compensation decisions.
Our Compensation Committee for the year ended December 31, 2001 consisted of Mr.
Grunfeld as chairman and Dr. Casement both of who continue to serve in that
capacity. No member of the Compensation Committee was an officer or employee of
us or any of our subsidiaries during the year. No executive officer has served
on the board of directors of any other entity with either member of the
Compensation Committee.
(k) Board compensation committee report on executive compensation.
In January 1998, the Compensation Committee of our Board of Directors retained
an independent consultant to review the President's compensation. The
compensation committee directed the consultant to review both the salary and
bonus structure. The independent consultant analyzed the compensation structure
and compared it to the compensation structures of companies similar to us. The
consultant recommended no change in the President's salary but did recommended
an annual bonus plan equaling 1% of our total assets combined with 5% of the
increase in the market value of our common stock not held by the President. The
bonus was calculated and paid quarterly from January 1 to December 31 of any
fiscal year based on a formula provided by the consultant. The Compensation
Committee felt this compensation arrangement, tied primarily to the market
performance of our common stock while including incentives for increases in
assets, was the most equitable method for compensating the President. This
provided a quantitative measure on which to reward the President's performance,
by directly emphasizing market performance, which correlates directly with the
expectations and goals of us and our stockholders.
This plan was in place until June 30, 2001. At that time, the President
approached the Compensation Committee and voluntarily proposed an end to the
bonus portion of his compensation in connection with the acquisition of Key
Financial Systems and Nova Financial Systems. The Compensation Committee agreed
and therefore for the period from July 1, 2001 until the Compensation Committee
reviews the compensation arrangements in 2002, the President will receive an
annual salary of $183,013 and no bonus.
Compensation Committee
- ----------------------
Russell L. Casement
Aaron A. Grunfeld
-25-
(i) Performance graph.
12/29/96 12/31/97 12/31/98 12/31/99 12/31/00 12/31/01
-------- -------- -------- -------- -------- --------
Nasdaq US 100.00 122.48 172.68 320.83 192.98 153.12
Nasdaq Financial 100.00 152.93 148.57 147.58 159.40 175.37
Equitex 100.00 44.84 379.21 441.26 265.47 199.67
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
(a) (b) Security Ownership of Certain Beneficial Owners and Security Ownership
of Management.
The following table contains information at March 31, 2002, as to the beneficial
ownership of shares of our common stock by each person who, to our knowledge at
that date, was the beneficial owner of five percent or more of the outstanding
shares of the class, each person who is a director or executive officer of us
and all persons as a group who are executive officers and directors, and as to
the percentage of outstanding shares so held by them at March 31, 2002.
Shares of Shares of
Common Common Percentage
Shares of Stock Stock of Common
Name and Address of Common Stock Underlying Underlying Stock Owned
Beneficial Owner Owned (1) Options (1) Warrants (1) Total (6)
- ------------------- ------------ ----------- ------------ --------- -----------
Henry Fong 608,525 (3) 945,700 (2) 49,239 1,603,464 7.1%
7315 East Peakview Ave.
Englewood, CO 80111
Russell L. Casement 121,795 365,900 (4) 759 488,454 2.2%
1355 S. Colorado Blvd.,
Suite 320
Denver, CO 80222
Aaron A. Grunfeld 32,700 379,500 (5) 0 412,200 1.9%
10390 Santa Monica Blvd.,
Fourth Floor
Los Angeles, CA 90025
Joseph W. Hovorka 4,477 11,000 477 15,954 --%
1930 S. Kearney Way
Denver, CO 80224
-26-
Thomas Olson 0 66,300 0 66,300 0.3%
7315 East Peakview Avenue
Englewood, CO 80111
James P. Welbourn 659,467 0 573,206 1,232,673 5.6%
11100 Wayzata Blvd.
Suite 111
Minnetonka, MN 55305
Scott A. Lucas 1,082,867 0 599,001 1,681,868 7.6%
934 Skye Lane
Palm Harbor, Florida 34683
Charles R. Darst 902,097 0 485,026 1,387,123 6.3%
734 Weadon Drive
Clearwater, FL 34625
Dia Erickson 896,897 0 488,026 1,384,923 6.3%
2196 Feather Sound Dr.
Clearwater, FL 33762
All officers and directors 2,509,831 1,768,400 1,222,682 5,500,913 22.5%
as a group (seven persons)
- ---------------
(1) The beneficial owners exercise sole voting and investment power.
(2) Shares underlying options granted under the 1999 Stock Option Plan.
(3) Includes shares owned by a corporation in which Mr. Fong is an officer and
director and a partnership in which Mr. Fong is a partner.
(4) Includes 36,400 shares underlying options granted under our 1993 Stock
Option Plan for Non-Employee Directors and 329,500 shares underlying
options granted under the 1999 Stock Option Plan.
(5) Includes 50,000 shares underlying options granted under our 1993 Stock
Option Plan for Non-Employee Directors and 329,500 shares underlying
options granted under our 1999 Stock Option Plan.
(6) As of February 28, 2001, 18,449,188 shares of our common stock were
outstanding.
We are unaware of any arrangements that may, at a subsequent date, result in a
change in control of our company.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
(a) Transactions with Management and Others.
We currently lease approximately 1,800 square feet of office space in Greenwood
Executive Park, 6400 South Quebec, Englewood, Colorado from a partnership in
which our President is the sole partner, on terms comparable to the existing
market for similar facilities.
During 2001, our President, and two companies in which he is the sole officer
and director, loaned us a total of $88,150 of which $26,525 was repaid prior to
year end. The remaining principal balance of $61,625 is due on demand and bears
interest at 10% per annum.
In November 2001, Scott Lucas, a director of Equitex and President of Key loaned
$100,000 to us. This note is due in November 2002, bears interest at 9% per
annum payable quarterly and may be converted to common stock at any time at 80%
of the average closing price of the common stock as reported by the Nasdaq Stock
Market for the 10 days immediately preceding conversion. The total principal and
-27-
interest balance on this note remains outstanding as of the filing of this
report. In connection with this note, Mr. Lucas also received 10,000 warrants to
purchase 10,000 shares of our common stock at $4.00 per share and 10,000
warrants to purchase 10,000 shares of our common stock at $5.00 per share both
exercisable until November 2004.
(b) Certain business relationships.
Not applicable.
(c) Indebtedness of management.
Not applicable.
(d) Transactions with promoters.
Not applicable.
-28-
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) The following documents are filed as a part of this report immediately
following the signature page.
Page
----
1. Financial Statements and Supplementary Data
Independent auditors' report - Gelfond Hochstadt Pangburn, P.C. F-1
- --------------------------------------------------------------------------------
Consolidated/combined financial statements:
- --------------------------------------------------------------------------------
Consolidated balance sheets - December 31, 2001 F-2 - F-3
- --------------------------------------------------------------------------------
Combined balance sheet - December 31, 2000 F-4
- --------------------------------------------------------------------------------
Consolidated/combined statements of operations - years ended
December 31, 2001, 2000 and 1999 F-5
- --------------------------------------------------------------------------------
Consolidated/combined statements of changes in stockholders'
equity - years ended December 31, 2001, 2000 and 1999 F-6 - F-9
- --------------------------------------------------------------------------------
Consolidated/combined statements of cash flows - years ended
December 31, 2001, 2000 and 1999 F-10 - F-11
- --------------------------------------------------------------------------------
Notes to consolidated/combined financial statements F-12 - F-42
- --------------------------------------------------------------------------------
Key Financial Systems, Inc. - As of December 31, 2000 and for the
years ended December 31, 2000 and 1999, including Independent
Auditors' Report of McGladrey & Pullen, LLP
- --------------------------------------------------------------------------------
Nova Financial Systems, Inc. - As of December 31, 2000 and for the
years ended December 31, 2000 and 1999, including Independent
Auditors' Report of McGladrey & Pullen, LLP
- --------------------------------------------------------------------------------
2. Financial Statements Schedules.
None
3. Exhibits.
3.1 Articles of Incorporation (1)
- --------------------------------------------------------------------------------
3.2 Bylaws (1)
- --------------------------------------------------------------------------------
3.3 Certificate of Designations of Registrant's Series D Convertible
Preferred Stock. (4)
- --------------------------------------------------------------------------------
3.4 Certificate of Designations of Registrant's Series E Convertible
Preferred Stock. (4)
- --------------------------------------------------------------------------------
3.5 Certificate of Designations of Registrant's Series F Convertible
Preferred Stock. (7)
- --------------------------------------------------------------------------------
3.6 Certificate of Amendment to Certificate of Designation of Registrant's
Series F Convertible Preferred Stock. (7)
- --------------------------------------------------------------------------------
3.7 Certificate of Designations of Registrant's Series G Convertible
Preferred Stock. (7)
- --------------------------------------------------------------------------------
3.8 Certificate of Designations of Registrant's Series H Convertible
Preferred Stock. (8)
- --------------------------------------------------------------------------------
Certificate of Amendment to the Certificate of Designations of
Registrant's Series H Convertible Preferred Stock. (9)
- --------------------------------------------------------------------------------
3.9 Certificate of Designations of Registrant's Series I Convertible
Preferred Stock. (10)
- --------------------------------------------------------------------------------
10.1 1993 Stock Option Plan (2)
- --------------------------------------------------------------------------------
10.2 1993 Stock Option Plan for Non-Employee Directors (2)
- --------------------------------------------------------------------------------
10.3 Custody Agreement between Colorado National Bank and the Registrant (2)
-29-
- --------------------------------------------------------------------------------
10.4 1999 Stock Option Plan. (3).
- --------------------------------------------------------------------------------
10.5 Rescission Agreement among Vincent Muratore, the Registrant, and
nMortgage, Inc. (5)
- --------------------------------------------------------------------------------
10.6 Agreement and Plan of Merger by and among the Registrant, GR.com, Inc.,
Howard J. Zuckerman, David Brecher, Meridian Capital Group, LLC, and The
Meridian Residential Group, Inc. (6)
- --------------------------------------------------------------------------------
10.7 Distribution Agreement., between Equitex, Inc. and Equitex 2000, Inc.
dated August 6, 2001 (11)
- --------------------------------------------------------------------------------
10.8 Agreement and Plan of Reorganization among Equitex, Inc., Key Financial
Systems, Inc. and Key Merger Corporation dated June 27, 2000 (12)
- --------------------------------------------------------------------------------
10.9 Agreement and Plan of Reorganization among Equitex, Inc., Nova Financial
Systems, Inc. and Nova Acquisition Corporation dated June 27, 2000 (13)
- --------------------------------------------------------------------------------
10.10 Stock Purchase Agreement by and between Equitex, Inc. and the Selling
Stockholders of Chex Services, Inc. (14)
- --------------------------------------------------------------------------------
10.11 Amendment No. 1 to the Stock Purchase Agreement by and between Equitex,
Inc. and the Selling Stockholders of Chex Services, Inc. (15)
- --------------------------------------------------------------------------------
21 List of Subsidiaries. Filed Herewith.
- --------------------------------------------------------------------------------
(1) Incorporated by reference from the like numbered exhibits filed with the
Registrant's Registration Statement on Form S-18, No. 2-82104-D effective April
11, 1983.
(2) Incorporated by reference from the like numbered exhibits filed with the
Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.
(3) Incorporated by reference from the like numbered exhibits filed with the
Registrant's Annual Report on Form 10-KSB for the year ended December 31, 1998.
(4) Incorporated by reference from Exhibit 4 of the Registrant's Report on Form
8-K, No. 0-12374 filed with the Securities and Exchange Commission on September
8, 1999.
(5) Incorporated by reference from Exhibit 10.1 of the Registrant's Report on
Form 8-K, No. 0-12374 filed with the Securities and Exchange Commission on
August 30, 2000.
(6) Incorporated by reference from Exhibit 2.1 of the Registrant's Report on
Form 8-K, No. 0-12374 filed with the Securities and Exchange Commission on
October 12, 2000.
(7) Incorporated by reference from the like numbered exhibits filed with the
Registrant's Annual Report on Form 10-K for the year ended December 31, 2000.
(8) Incorporated by reference from Exhibit 3(i).5 of the Registrant's Report on
Form S-3, No. 333-64408 filed with the Securities and Exchange Commission on
July 2, 2001.
(9) Incorporated by reference from Exhibit 3(i).6 of the Registrant's Report on
Form S-3/A, No. 333-64408 filed with the Securities and Exchange Commission on
July 23, 2001.
(10) Incorporated by reference from Exhibit 2.1 of the Registrant's Report on
Form 8-K, No. 0-12374 filed with the Securities and Exchange Commission on
August 21, 2001.
(11) Incorporated by reference from Exhibit 4.5 of the Registrant's Report on
Form 8-K, No. 0-12374 filed with the Securities and Exchange Commission on
August 21, 2001.
(12) Incorporated by reference from Exhibit 2.2 of the Registrant's Report on
Form 8-K, No. 0-12374 filed with the Securities and Exchange Commission on
August 21, 2001.
-30-
(13) Incorporated by reference from Exhibit 2.3 of the Registrant's Report on
Form 8-K, No. 0-12374 filed with the Securities and Exchange Commission on
August 21, 2001.
(14) Incorporated by reference from Exhibit 2.1 of the Registrant's Report on
Form 8-K, No. 0-12374 filed with the Securities and Exchange Commission on
January 7, 2002.
(15) Incorporated by reference from Exhibit 2.2 of the Registrant's Report on
Form 8-K, No. 0-12374 filed with the Securities and Exchange Commission on
January 7, 2002.
(b) Reports on Form 8-K.
On October 22, 2001, the Registrant filed a report on Form 8-K relating to Items
2 and 7.
(c) Exhibits required by Item 601 of Regulation S-K
See Item 14(a)(3) above.
(d) Financial statement schedules required by Regulation S-X
Not applicable.
-31-
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.
Date: April 15, 2002 EQUITEX, INC.
(Registrant)
By /S/ HENRY FONG
-----------------------
Henry Fong, President
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Date: April 15, 2002 /S/ HENRY FONG
-----------------------
Henry Fong, President,
Treasurer and Director
(Principal Executive, Financial,
and Accounting Officer)
Date: April 15, 2002 /S/ RUSSELL L. CASEMENT
-----------------------
Russell L. Casement, Director
Date: April 15, 2002 /S/ AARON A. GRUNFELD
-----------------------
Aaron A. Grunfeld, Director
Date: April 15, 2002 /S/ JOSEPH W. HOVORKA
-----------------------
Joseph W. Hovorka, Director
Date: April 15, 2002 /S/ SCOTT A. LUCAS
-----------------------
Scott A. Lucas, Director
Date: April 15, 2002 /S/ JAMES P. WELBOURN
-----------------------
James P. Welbourn, Director
-32-
EQUITEX, INC. AND SUBSIDIARIES
CONSOLIDATED/COMBINED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
EQUITEX, INC. AND SUBSIDIARIES
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
INDEX TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS
Page
----
Independent auditors' report - Gelfond Hochstadt Pangburn, P.C. F-1
Consolidated/combined financial statements:
Consolidated balance sheet - December 31, 2001 F-2 - F-3
Combined balance sheet - December 31, 2000 F-4
Consolidated/combined statements of operations F-5
Consolidated/combined statements of changes in stockholders'
equity F-6 - F-9
Consolidated/combined statements of cash flows F-10 - F-11
Notes to consolidated/combined financial statements F-12 - F-44
INDEPENDENT AUDITORS' REPORT
----------------------------
Board of Directors
Equitex, Inc.
We have audited the accompanying consolidated balance sheet of Equitex, Inc. and
subsidiaries (the "Company") as of December 31, 2001, and the related
consolidated/combined statements of operations, changes in stockholders' equity
and cash flows for the year 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 audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. 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 audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated/combined financial statements referred to above
present fairly, in all material respects, the financial position of Equitex,
Inc. and subsidiaries as of December 31, 2001, and the results of their
operations and their cash flows for the year then ended in conformity with
accounting principles generally accepted in the United States of America.
As discussed in Note 1 to the consolidated/combined financial statements, on
August 6, 2001, the Company acquired Key Financial Systems, Inc. and Nova
Financial Systems, Inc. in a transaction recorded as a reverse acquisition. The
combined balance sheet as of December 31, 2000, and the combined statements of
operations, changes in stockholders' equity, and cash flows for each of the
years in the two-year period ended December 31, 2000, represent the combination
of the financial statements of Key Financial Systems, Inc. and Nova Financial
Systems, Inc., which were audited and reported on separately by other auditors.
We have audited the combination of the accompanying combined balance sheet as of
December 31, 2000, and the related combined statements of operations, changes in
stockholders' equity, and cash flows for each of the years in the two-year
period ended December 31, 2000, including the accounting for the August 6, 2001
reverse acquisition. In our opinion, such combined statements have been properly
combined on the basis described in Note 1 to the consolidated/combined financial
statements.
As discussed in Note 1 to the consolidated/combined financial statements, on
March 1, 2002, federal banking regulators closed Net First National Bank, which
was the sole issuing bank for a credit card program of Key Financial Systems,
Inc., a wholly-owned subsidiary of the Company.
As discussed in Note 2 to the consolidated/combined financial statements, the
Company adopted the provisions of Statement of Financial Accounting Standards
No. 141, Business Combinations, in connection with its acquisition of Chex
Services, Inc. in December 2001.
/s/ GELFOND HOCHSTADT PANGBURN, P.C.
Denver, Colorado
April 10, 2002, except for Note 9,
as to which the date is April 12, 2002
F-1
EQUITEX, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2001
ASSETS
Unaudited
pro forma Historical
----------- -----------
(NOTE 1)
Current assets:
Cash and cash equivalents $ 7,830,426 $ 7,830,426
Accounts receivable, net (Note 2) 4,181,392 4,181,392
Credit card receivables, net (Note 4) 73,116 1,493,481
Other receivables (Note 5) 944,145 6,435,060
Current portion of notes receivable, related parties (Note 6) 563,460 563,460
Prepaid expenses and other 577,288 577,288
----------- -----------
Total current assets 14,169,827 21,081,107
----------- -----------
Receivable from FDIC, as receiver for Net First National
Bank (Notes 1, 4 and 5) 2,789,109
Notes receivable, related parties, net (Note 6) 1,146,375 1,146,375
Property, equipment and leaseholds (Notes 7 and 9) 1,180,258 1,180,258
Deferred tax asset (Note 10) 1,380,000 1,380,000
Intangible assets (Note 8) 4,925,415 4,925,415
Goodwill (Notes 2 and 3) 5,636,000 5,636,000
----------- -----------
17,057,157 14,268,048
----------- -----------
$31,226,984 $35,349,155
=========== ===========
(Continued)
F-2
EQUITEX, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (CONTINUED)
DECEMBER 31, 2001
LIABILITIES AND STOCKHOLDERS' EQUITY
Unaudited
pro forma Historical
------------ ------------
(NOTE 1)
Current liabilities:
Accounts payable $ 1,819,555 $ 1,819,555
Accrued expenses and other liabilities, including
related party accruals of $83,000 827,065 827,065
Accrued liability on casino contracts (Note 12) 517,805 517,805
Notes payable, related parties (Note 9) 5,225,241 5,225,241
Line of credit, notes and loans payable (Note 9) 8,574,310 8,574,310
Current portion of long-term debt (Note 9) 527,754 527,754
Due to credit card holders (Note 12) 934,497 5,056,668
------------ ------------
Total current liabilities 18,426,227 22,548,398
------------ ------------
Long-term debt, related parties, net of current portion (Note 9): 232,200 232,200
------------ ------------
Total liabilities 18,658,427 22,780,598
------------ ------------
Commitments and contingencies (Notes 9, 12, 13, and 16)
Stockholders' equity (Note 13):
Preferred stock; 2,000,000 shares authorized:
Series D, 6%; stated value $1,000 per share; 725 shares issued
and outstanding; liquidation preference $960,500 725,000 725,000
Series G, 6%; stated value $1,000 per share; 900 shares issued
and outstanding; liquidation preference $1,207,000 900,000 900,000
Series I, 6%; stated value $1,000 per share; 2,660 shares issued
and outstanding; liquidation preference $3,418,000 2,660,000 2,660,000
Common stock, $0.02 par value; 50,000,000 shares authorized;
21,244,797 shares issued; 21,211,447 shares outstanding 424,896 424,896
Common stock and warrants to be issued 750,485 750,485
Additional paid-in capital 9,754,252 9,754,252
Accumulated deficit (2,532,039) (2,532,039)
Less treasury stock at cost (33,350 common shares) (114,037) (114,037)
------------ ------------
Total stockholders' equity 12,568,557 12,568,557
------------ ------------
$ 31,226,984 $ 35,349,155
============ ============
See notes to consolidated/condensed financial statements.
F-3
EQUITEX, INC. AND SUBSIDIARIES
COMBINED BALANCE SHEET
DECEMBER 31, 2000
(Note 1)
ASSETS
Cash $ 73,612
Credit card receivables, net (Note 4) 906,295
Other receivables (Note 5) 5,278,085
Leaseholds and equipment, net (Note 7) 266,643
Due from shareholders (Note 9) 606,500
Other assets 32,329
----------
$7,163,464
==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Notes and advances payable, related parties (Note 9) $ 325,000
Accounts payable 680,635
Accrued expenses and other liabilities 870,221
Due to cardholders (Note 12) 4,389,443
----------
Total liabilities 6,265,299
----------
Commitments and contingencies (Notes 9, 12 and 13)
Stockholders' equity (Note 13):
Common stock, $0.02 par value; 50,000,000 shares
authorized; 8,937,080 shares issued and outstanding 178,741
Additional paid-in capital 220,094
Retained earnings 499,330
----------
Total stockholders' equity 898,165
----------
$7,163,464
==========
See notes to consolidated/condensed financial statements.
F-4
EQUITEX, INC. AND SUBSIDIARIES
CONSOLIDATED/COMBINED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
(Note 1)
2001 2000 1999
------------ ------------ ------------
Credit card income, net of provision for losses (Note 4) $ 10,580,448 $ 11,538,298 $ 18,093,001
Application fees, net of direct marketing costs, including related
party costs of $3,010,055 through August 6, 2001, and $897,521
and $12,293,634 in 2000 and 1999, respectively (Note 11) 4,213,466 2,735,438 2,877,535
Fee revenue 1,373,158
Other 361,067 182,618 59,807
------------ ------------ ------------
Total revenues 16,528,139 14,456,354 21,030,343
------------ ------------ ------------
Application processing fees 2,112,092
Third party servicing fees 6,136,638 5,677,641 7,079,668
Fees paid to casinos 437,411
Salaries, wages and employee benefits 5,338,580 3,019,876 4,464,264
Stock-based compensation 2,132,234
Other operating expenses 3,007,252 2,202,117 1,666,881
Interest expense:
Related parties 137,160
Other 102,733
Provision for uncollectible note receivable, shareholder 325,000
------------ ------------ ------------
17,617,008 10,899,634 15,322,905
------------ ------------ ------------
Income (loss) before income taxes (1,088,869) 3,556,720 5,707,438
Income tax expense (benefit) (57,500) 117,500
------------ ------------ ------------
Net income (loss) (1,031,369) 3,556,720 5,589,938
Beneficial conversion features (Note 13) (2,924,000)
Additional warrants issued to preferred stockholders (Note 13) (152,000)
Redemption of convertible preferred stock in excess
of beneficial conversion features (Note 13) 92,000
Deemed preferred stock dividends (Note 13) (181,000)
------------ ------------ ------------
Net income (loss) applicable to common stockholders $ (4,196,369) $ 3,556,720 $ 5,589,938
============ ============ ============
Basic and diluted net income (loss) per common share $ (0.32) $ 0.40 $ 0.63
============ ============ ============
Weighted average number of common shares outstanding 13,032,655 8,903,730 8,903,730
============ ============ ============
See notes to consolidated/condensed financial statements.
F-5
EQUITEX, INC. AND SUBSIDIARIES
CONSOLIDATED/COMBINED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
(Note 1)
Convertible
preferred stock Common stock
------------------------ ----------------------- Treasury
Shares Amount Shares Amount stock
---------- ---------- --------- ---------- ----------
Balances, January 1, 1999 (Note 1) 8,937,080 $ 178,741
Capital contribution by Key and Nova
shareholders to Key and Nova
Net income of Key and Nova
Dividends paid to Key and Nova shareholders
by Key and Nova
---------- ---------- --------- ---------- ----------
Balances, December 31, 1999 (Note 1) 8,937,080 178,741
Net income of Key and Nova
Dividends paid to Key and Nova shareholders
by Key and Nova
---------- ---------- --------- ---------- ----------
Balances, December 31, 2000 (Note 1) 8,937,080 178,741
Common stock of Key and Nova
issued for cash 181,043 3,621
Dividends paid to Key and Nova shareholders
by Key and Nova
---------- ---------- --------- ---------- ----------
Balances as of August 6, 2001, prior to the
Company's acquisition of Key and Nova
(represents Company's outstanding shares of
9,084,773, plus 33,350 shares of treasury stock) 9,118,123 182,362
Issuance of common stock in connection with the
acquisition of Key and Nova - preferred stock
of Equitex outstanding includes 725 shares of
Series D, 1,300 shares of Series G, and 4,000
shares of Series I preferred stock; also
outstanding: options, warrants, and common
stock and warrants to be issued 6,025 $6,025,000 9,084,773 181,696 (114,037)
Allocation of Series H and I preferred stock
beneficial conversion features (2,924,000)
Amortization of Series H and I preferred stock
beneficial conversion features 2,924,000
---------- ---------- --------- ---------- ----------
(Continued)
F-6
EQUITEX, INC. AND SUBSIDIARIES
CONSOLIDATED/COMBINED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (CONTINUED)
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
(Note 1)
Common Retained
stock and Deferred Additional earnings Total
warrants compensation paid-in (accumulated stockholders'
be issued cost capital deficit) equity
---------- ---------- ---------- ---------- ----------
Balances, January 1, 1999 (Note 1) $ 120,094 $ (358,440) $ (59,605)
Capital contribution by Key and Nova
shareholders to Key and Nova 100,000 100,000
Net income of Key and Nova 5,589,938 5,589,938
Dividends paid to Key and Nova shareholders
by Key and Nova (4,063,888) (4,063,888)
---------- ---------- ---------- ---------- ----------
Balances, December 31, 1999 (Note 1) 220,094 1,167,610 1,566,445
Net income of Key and Nova 3,556,720 3,556,720
Dividends paid to Key and Nova shareholders
by Key and Nova (4,225,000) (4,225,000)
---------- ---------- ---------- ---------- ----------
Balances, December 31, 2000 (Note 1) 220,094 499,330 898,165
Common stock of Key and Nova
issued for cash 996,379 1,000,000
Dividends paid to Key and Nova shareholders
by Key and Nova (2,000,000) (2,000,000)
---------- ---------- ---------- ---------- ----------
Balances as of August 6, 2001, prior to the
Company's acquisition of Key and Nova
(represents Company's outstanding shares of
9,084,773, plus 33,350 shares of treasury stock) 1,216,473 (1,500,670) (101,835)
Issuance of common stock in connection with the
acquisition of Key and Nova - preferred stock
of Equitex outstanding includes 725 shares of
Series D, 1,300 shares of Series G, and 4,000
shares of Series I preferred stock; also
outstanding: options, warrants, and common
stock and warrants to be issued $1,528,000 $ (589,834) (5,590,825) 1,440,000
Allocation of Series H and I preferred stock
beneficial conversion features 2,924,000
Amortization of Series H and I preferred stock
beneficial conversion features (2,924,000)
---------- ---------- ---------- ---------- ----------
(Continued)
F-7
EQUITEX, INC. AND SUBSIDIARIES
CONSOLIDATED/COMBINED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (CONTINUED)
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
(Note 1)
Convertible
preferred stock Common stock
------------------------ ----------------------- Treasury
Shares Amount Shares Amount stock
---------- ---------- ---------- ---------- ----------
Conversion of Series I preferred stock
to common stock (1,010) (1,010,000) 359,958 7,199
Exercises of warrants for common stock 69,852 1,397
Redemption of Series I preferred stock
for cash (330) (330,000)
Conversion of Series G preferred stock to
common stock (400) (400,000) 165,090 3,302
Agreements to issue common stock
and warrants for services
Common stock and warrants issued for
services 455,000 9,100
Cancellation of agreement to issue
common stock for services
Amortization of deferred compensation
cost
Common stock issued for the acquisition
of Chex Financial Services, Inc. (Note 3) 1,992,001 39,840
Beneficial conversion feature and warrants
attached to convertible debentures
Issuance of additional warrants to preferred
stockholders (152,000)
Amortization of additional warrants issued to
preferred stockholders 152,000
Repricing of warrants
Net loss
---------- ---------- ---------- ---------- ----------
Balances, December 31, 2001 4,285 $4,285,000 21,244,797 $ 424,896 $ (114,037)
========== ========== ========== ========== ==========
(Continued)
F-8
EQUITEX, INC. AND SUBSIDIARIES
CONSOLIDATED/COMBINED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (CONTINUED)
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
(Note 1)
Common Retained
stock and Deferred Additional earnings Total
warrants compensation paid-in (accumulated stockholders'
be issued cost capital deficit) equity
---------- ---------- ---------- ----------- -----------
Conversion of Series I preferred stock
to common stock 1,002,801
Exercises of warrants for common stock 485 242,450 244,332
Redemption of Series I preferred stock
for cash (88,805) (418,805)
Conversion of Series G preferred stock to
common stock 396,698
Agreements to issue common stock
and warrants for services 1,873,000 (1,733,000) 140,000
Common stock and warrants issued for
services (2,236,000) 2,245,300 18,400
Cancellation of agreement to issue
common stock for services (415,000) 415,000
Amortization of deferred compensation
cost 1,907,834 1,907,834
Common stock issued for the acquisition
of Chex Financial Services, Inc. (Note 3) 10,079,160 10,119,000
Beneficial conversion feature and warrants
attached to convertible debentures 185,000 185,000
Issuance of additional warrants to preferred
stockholders 152,000
Amortization of additional warrants issued to
preferred stockholders (152,000)
Repricing of warrants 66,000 66,000
Net loss (1,031,369) (1,031,369)
---------- ---------- ---------- ----------- -----------
Balances, December 31, 2001 $ 750,485 $ -- $9,754,252 $(2,532,039) $12,568,557
========== ========== ========== =========== ===========
See notes to consolidated/combined financial statements.
F-9
EQUITEX, INC. AND SUBSIDIARIES
CONSOLIDATED/COMBINED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
(Note 1)
2001 2000 1999
----------- ----------- -----------
Cash flows provided by operating activities:
Net income (loss) $(1,031,369) $ 3,556,720 $ 5,589,938
----------- ----------- -----------
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Provision for losses 416,080 56,520 1,187,988
Depreciation and amortization 215,234 93,167 117,349
Provision for uncollectible related party note receivable 325,000
Beneficial conversion features on convertible promissory notes 128,000
Amortization of discount on convertible promissory notes 4,200
Stock-based compensation expense 2,132,234
Deferred income taxes 60,000 606,500 (606,500)
Changes in assets and liabilities, net of business acquisition:
Increase in accounts receivable (2,433,347)
(Increase) decrease in other receivables (1,156,975) 176,873 (5,082,226)
Decrease (increase) in due from shareholders 606,500 (606,500)
Decrease (increase) in other assets 10,366 (14,412) 21,960
Decrease in due from affiliates 22,761
Increase in due to credit card holders 667,225 65,297 2,915,453
Increase in accounts payable and accrued liabilities 239,620 186,355 642,251
----------- ----------- -----------
Total adjustments 1,214,137 563,800 (780,964)
----------- ----------- -----------
Net cash provided by operating activities 182,768 4,120,520 4,808,974
----------- ----------- -----------
Cash flows from investing activities:
Cash acquired in business acquisition 9,994,124
Net (increase) decrease in credit card receivables (1,003,266) 176,262 (1,204,770)
Collection of advances to stockholders 288,888
Purchases of furniture, fixtures and equipment (157,769) (55,834) (208,370)
Issuance of related party notes receivable (501,599)
Repayment of related party notes receivable 372,825
----------- ----------- -----------
Net cash provided by (used in) investing activities 8,704,315 120,428 (1,124,252)
----------- ----------- -----------
Cash flows from financing activities:
Capital contributions to Key and Nova 100,000
Common stock of Key and Nova issued for cash 1,000,000
Redemption of Series I preferred stock for cash (418,805)
Proceeds from the exercise of warrants 244,332
Dividends paid to Key and Nova shareholders (2,000,000) (4,225,000) (4,063,888)
Issuance of notes payable, related parties 571,950
Repayment of notes payable, related parties (325,000)
Repayment of notes payable, other (440,708)
Net borrowings on line of credit 237,962
----------- ----------- -----------
Net cash used in financing activities (1,130,269) (4,225,000) (3,963,888)
----------- ----------- -----------
(Continued)
F-10
EQUITEX, INC. AND SUBSIDIARIES
CONSOLIDATED/COMBINED STATEMENTS OF CASH FLOWS (CONTINUED)
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
2001 2000 1999
------------ ------------ ------------
Change in cash and cash equivalents 7,756,814 15,948 (279,166)
Cash and cash equivalents, beginning of year 73,612 57,664 336,830
------------ ------------ ------------
Cash and cash equivalents, end of year $ 7,830,426 $ 73,612 $ 57,664
============ ============ ============
Supplemental disclosure of cash flow information:
Cash paid for interest $ 8,828
============
Supplemental disclosure of non-cash investing and financing activities:
Issuance of common stock by Equitex to acquire Key
and Nova, resulting in recognition of a deferred tax asset $ 1,440,000
============
Conversion of preferred stock to common stock $ 1,410,000
============
Amortization of discount on preferred stock $ 2,924,000
============
Warrants attached to convertible promissory notes $ 57,000
============
Cancellation of agreement to issue common stock
for services $ 415,000
============
Amortization of additional warrants issued to preferred
stockholders $ 152,000
============
Purchase of Chex Services, Inc. (Note 3):
Fair value of tangible assets acquired:
Accounts receivable $ (1,748,045)
Notes receivable, related parties (1,906,061)
Property and equipment (896,495)
Prepaid expenses and other (555,325)
Intangible assets (Note 8) (5,000,000)
Goodwill (5,636,000)
Liabilities assumed:
Accounts payable and accrued expenses 1,373,949
Notes payable, related parties 4,938,291
Notes payable, other 8,540,772
Line of credit 764,038
Fair value of common stock exchanged 10,119,000
------------
Cash acquired $ 9,994,124
============
See notes to consolidated/combined financial statements.
F-11
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
1. ORGANIZATION, BASIS OF PRESENTATION, RECENT EVENTS AND MANAGEMENT PLANS:
Equitex, Inc. ("Equitex", or the "Company"), a Delaware corporation, was
incorporated in January 1983, and prior to August 6, 2001, Equitex,
through its former subsidiaries, operated in two segments, the financial
services segment and the sporting goods/product related segment. On
August 6, 2001, the Company distributed all of its assets (which
primarily consisted of its investments in subsidiaries) to Equitex 2000,
Inc. ("Equitex 2000"), a subsidiary formed by the Company in 2001.
Equitex 2000 also assumed all liabilities of the Company. Simultaneous
with the distribution of assets and liabilities to Equitex 2000, the
Company transferred its rights, title and interest in the issued and
outstanding shares of Equitex 2000 to an escrow account, outside of the
control of the Company. The shares of Equitex 2000 are to be distributed
from escrow to the stockholders of the Company upon the effective
registration of Equitex 2000. Shares of Equitex 2000 are to be
distributed based on each stockholder's proportional ownership interest
in the Company as of July 20, 2001.
Also on August 6, 2001, immediately following the transactions described
above, the Company acquired all of the outstanding common stock of Key
Financial Systems, Inc. ("Key") and Nova Financial Systems, Inc.
("Nova"), both Florida companies previously under common control with
nearly an identical ownership structure. The Company acquired Key and
Nova in exchange for (i) 9,084,773 shares of the Company's common stock,
(ii) cash of $5 million, (iii) warrants to acquire an aggregate of
990,134 shares of common stock exercisable at $0.02 per share, and (iv)
warrants to acquire an aggregate of 3,933,350 shares of the Company's
common stock exercisable at $5.65 per share. In order to raise the cash
consideration of $5 million, the Company issued two new series of
convertible preferred stock, including 2,359 shares of Series H, 8%
convertible preferred stock in exchange for net proceeds of $2,059,000,
and 4,000 shares of Series I, 6% convertible preferred stock in exchange
for net proceeds of $3,500,000 (Note 13).
The Key/Nova transaction has been recorded as a reverse acquisition based
on factors demonstrating that Key and Nova constitute the accounting
acquirer. The shareholders of Key and Nova received 50% of the
post-acquisition outstanding common stock and rights to purchase common
stock of the Company, which resulted in the Key/Nova shareholders
receiving significant voting blocks of the Company's common stock. In
addition, post-acquisition management personnel and board members of the
Company now include certain individuals previously holding positions with
Key and Nova. The purchase price applied to the reverse acquisition was
based on the net book value of the underlying assets of the Company prior
to the transaction plus $5,000,000. The historical stockholders' equity
of Key and Nova prior to the merger has been retroactively restated (a
recapitalization) for the equivalent number of shares received in the
merger after giving effect to any differences in the par value of the
Equitex, Key, and Nova common stock, with an offset to additional paid-in
capital. The restated combined retained earnings of the accounting
acquirer (Key and Nova) has been carried forward after the acquisition.
F-12
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
1. ORGANIZATION, BASIS OF PRESENTATION, RECENT EVENTS AND MANAGEMENT PLANS
(CONTINUED):
PRINCIPLES OF CONSOLIDATION/COMBINATION:
Beginning in December 2001, with the acquisition of Chex Services Inc.
("Chex"), the Company and its subsidiaries operate in two segments, which
consist of the credit card services segment and the cash disbursement
services segment. The Company's significant subsidiaries include the
following:
KEY FINANCIAL SYSTEMS, INC. AND NOVA FINANCIAL SYSTEMS, INC. ,
which represent the Company's credit card services segment; both
Florida corporations formed in June 1997 and September 1998,
respectively; both companies design, market and service credit
card products aimed at the sub-prime market; both companies are
wholly-owned by the Company at December 31, 2001.
CHEX SERVICES, INC. ("Chex"), which represents the cash
disbursement services segment; a Minnesota corporation formed in
July 1992; acquired by the Company effective December 1, 2001
(Note 3), to provide financial services, primarily check cashing,
automated teller machine and credit card advances to customers at
gaming establishments located in California, Michigan, Minnesota,
Nebraska, New Mexico, New York, North Dakota and Wisconsin;
wholly-owned by the Company at December 31, 2001.
The accompanying financial statements present the consolidated financial
position of the Company, Key, Nova and Chex as of December 31, 2001, and
the results of operations and cash flows of the Company (Key and Nova)
for the year then ended, and Chex from the date of acquisition. The
financial statements presented for periods prior to August 6, 2001,
consist of the combined balance sheets of Key and Nova at December 31,
2000, and the combined statements of operations and cash flows of Key and
Nova through August 5, 2001. Subsequent to August 5, 2001, the
accompanying financial statements present the financial position, results
of operations and cash flows of the Company on a consolidated basis. The
combined balance sheet as of December 31, 2000, and the combined
statements of operations, stockholders' equity, and cash flows for the
years ended December 31, 2000 and 1999, have been derived from the
audited financial statements of Key and Nova as of and for the years
ended December 31, 2000 and 1999. All significant intercompany accounts
and transactions have been eliminated in consolidation/combination.
Key maintained S Corporation status for federal income tax purposes through
August 5, 2001, and Nova did so from January 1, 2000 through August 5,
2001. As an S corporation, the shareholders reported their respective
share of net income on their income tax returns, and no income taxes are
reflected in the financial statements for those periods. Effective August
6, 2001, in connection with the Company's acquisition of Key and Nova,
both Key and Nova terminated their S Corporation status and became C
corporations (Note 10). Additionally, prior to and subsequent to the Key
and Nova transaction, Equitex had certain preferred stock instruments
outstanding that impact the earnings available to common stockholders
(Note 13). The following unaudited pro forma information reflects the
historical Key and Nova net income and per share amounts adjusted for the
impact of the current C corporation status and equity structure of the
Company:
F-13
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
1. ORGANIZATION, BASIS OF PRESENTATION, RECENT EVENTS AND MANAGEMENT PLANS
(CONTINUED):
PRINCIPLES OF CONSOLIDATION/COMBINATION (CONTINUED):
2001 2000 1999
----------- ---------- ----------
Net income (loss), as reported $(1,031,000) $3,557,000 $5,590,000
Net income (loss), pro forma $(1,616,000) $2,157,000 $3,463,000
Net income (loss) applicable to common
stockholders, as reported $(4,196,000) $3,557,000 $5,590,000
Net income (loss) applicable to common
stockholders, pro forma $(5,094,000) $ 902,000 $ 194,000
Basic and diluted net income (loss) per
common share, as reported $ (0.32) $ 0.40 $ 0.63
Basic and diluted net income (loss) per
common share, pro forma $ (0.39) $ 0.10 $ 0.02
As a result of the Company's August 2001 acquisition of Key and Nova, the
Company presented an unclassified balance sheet as of September 30, 2001.
In connection with the Company's subsequent acquisition of Chex effective
December 1, 2001, the Company determined that a classified balance sheet
provides a better presentation of the Company's financial position at
December 31, 2001.
RECENT EVENTS AND MANAGEMENT'S PLANS:
NET FIRST NATIONAL BANK CLOSURE:
Through March 1, 2002, Key's credit card products were marketed for Net
First National Bank ("Net First") under an agreement that provided the
Company with a 100% participation interest in the receivables and related
rights associated with credit cards issued, and required the payment of
monthly servicing fees to Net First. The Company provided collection and
customer services related to the credit cards issued. On March 1, 2002,
federal banking regulators closed Net First, which was the sole issuing
bank for Key's PAY AS YOU GO credit card program.
On March 4, 2002, the Federal Deposit Insurance Corporation ("FDIC")
notified the Company that it had been appointed receiver of all funds due
from Net First to Key. As receiver, the FDIC elected to disaffirm, to the
full extent, all contracts Key was a party to with Net First. On March
10, 2002, the Company was made aware that the FDIC was notifying Net
First credit card holders that their accounts were to be closed, and
accordingly, Key would not be able to transfer the existing PAY AS YOU GO
Credit card portfolio to a successor financial institution.
F-14
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
1. ORGANIZATION, BASIS OF PRESENTATION, RECENT EVENTS AND MANAGEMENT PLANS
(CONTINUED):
RECENT EVENTS AND MANAGEMENT'S PLANS (CONTINUED):
MANAGEMENT'S PLANS:
The Company immediately implemented steps to eliminate Key's operating
costs associated with marketing and servicing the Net First program.
These steps included employee lay-offs of all but essential management
and employee personnel necessary to re-establish its marketing and
servicing capabilities upon the establishment of a new relationship with
another financial institution. The Company is currently in discussions
with financial institutions to initiate a new credit card program;
however, through April 10, 2002, the Company has not established such a
relationship, and cannot provide any assurance that it will be able to
negotiate an agreement, or be able to generate a new credit card program
similar to the Net First program. On March 14, 2002, the Company did sign
a letter of intent to utilize its resources to develop a credit card
program for an existing financial institution, however, completion of
this transaction is subject to further due diligence, negotiation of a
definitive agreement, and necessary state and/or federal regulation and
other approvals. The Company is also actively pursuing collection of the
credit card receivables from Net First with the FDIC (approximately
$2,300,000 at March 31, 2002, unaudited).
In December 2001, the Company completed its acquisition of Chex (Note 3),
which management believes will generate additional cash flows to support
operations. The Company is also negotiating the terms of a planned
acquisition of Money Centers of America, Inc. ("MCOA", Note 16).
The Company's management believes that its cost reduction efforts at Key,
as well as Chex operations, will provide the Company with cash flows
necessary to support operations for the next twelve months, regardless of
whether Key can implement a new credit card program with a new financial
institution. Management believes that the successful completion of the
acquisition of MCOA will further support the Company's operations and
cash flows for the next year.
PRO FORMA INFORMATION:
Due to the significance of the Net First closing and the effect on the
Company's financial position and results of operations, the accompanying
consolidated/combined financial statements include an unaudited pro forma
consolidated balance sheet as of December 31, 2001. The accompanying
unaudited pro forma consolidated balance sheet gives effect to the Net
First closure as if it had occurred on December 31, 2001, and reflects
the following transactions:
a. Credit card receivables of $1,420,365 due from Net First credit card
holders at December 31, 2001 have been reclassified from current assets
to the long-term receivable from the FDIC, in the unaudited pro forma
consolidated balance sheet (Note 4).
b. Other current receivables due from Net First credit card holders
exceeds the balance due to Net First credit card holders by $1,368,744.
This amount is included in the long-term receivable from the FDIC, in
the unaudited pro forma consolidated balance sheet.
F-15
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
2. SIGNIFICANT ACCOUNTING POLICIES:
CASH AND CASH EQUIVALENTS AND PRESENTATION OF CASH FLOWS:
The Company maintains cash in bank deposit accounts, which exceed federally
insured limits. At December 31, 2001, the Company had deposits in excess
of federally insured amounts aggregating $3,508,158 at various financial
institutions. The Company believes it has its cash deposits at high
quality financial institutions. In addition, the Company maintains a
significant amount of cash at each of the casinos. Management believes
that the Company has controls in place to safeguard these on-hand
amounts, and that no significant credit risk exists with respect to cash.
For purposes of the statements of cash flows, the Company considers all
highly-liquid investments with an original maturity date of three months
or less to be cash equivalents. Cash flows from credit card receivables
are reported net.
RECEIVABLES AND REVENUE RECOGNITION:
ACCOUNTS RECEIVABLE:
Accounts receivable arise primarily from credit card and ATM advances
provided at casino locations. Concentrations of credit risk related to
credit card and ATM advances are limited to the credit card and ATM
processors who remit the cash advanced back to the Company along with the
Company's allocable share of fees earned. The Company believes these
processors are financially stable and no significant credit risk exists
with respect to accounts receivable arising from ATM and credit card
advances. The Company has recorded an allowance against these accounts
receivable of $66,000 at December 31, 2001. Accounts receivable also
include approximately $736,000 due from MCOA.
CREDIT CARD RECEIVABLES:
Credit card receivables are stated at cost and include refundable and
earned fees, which represents the balance reported to customers. Credit
card receivables are reduced by allowances for refundable fees and
losses.
Fees are accrued monthly on active credit card accounts and included in
credit card receivables, net of estimated uncollectible amounts. Accrual
of income is discontinued on credit card accounts that have been closed
or charged off. Accrued fees on credit card loans are charged off with
the card balance, generally when the account becomes 90 days past due.
The allowance for losses is established through a provision for losses
charged to expense. Receivables are charged against the allowance for
losses when management believes that collectibility of principal is
unlikely. The allowance is an amount that management believes will be
adequate to absorb estimated losses on existing accounts, based on
evaluation of the collectibility of the accounts and prior loss
experience. This evaluation also takes into consideration such factors as
changes in the volume of the credit card receivable portfolio, overall
portfolio quality, and current economic conditions that may affect the
borrower's ability to pay. While management uses the best information
available to make its evaluation, this estimate is susceptible to
significant change in the near term.
F-16
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
RECEIVABLES AND REVENUE RECOGNITION (CONTINUED):
OTHER RECEIVABLES AND DUE TO CARDHOLDERS:
The Company charges a fully refundable reservation fee equal to each
cardholder's borrowing limit upon issuance of a credit card. Other
receivables include the balance of the reservation fees due from third
party financial institutions. These amounts are held in trust under
agreements with third party financial institutions to secure payment of
the reservation fees due to cardholders.
RETURNED CHECKS:
The Company charges operations for potential losses on returned checks in
the period such checks are returned, since ultimate collection of these
items is uncertain. Recoveries on returned checks are credited in the
period when the recovery is received.
FAIR VALUE OF FINANCIAL INSTRUMENTS:
The estimated fair values of financial instruments has been determined by
the Company using available market information and appropriate
methodologies; however, considerable judgment is required in interpreting
information necessary to develop these estimates. Accordingly, the
Company's estimates of fair value are not necessarily indicative of the
amounts that the Company could realize in a current market exchange.
The fair value of cash and cash equivalents, credit card receivables,
accounts payable and accrued expenses approximate their carrying amounts
because of the short maturities of these instruments.
The fair values of notes and advances receivable from non-related parties
approximates their carrying values because of the short maturities of
these instruments. The fair values of notes and advances receivable from
related parties are not practicable to estimate, based upon the related
party nature of the underlying transactions.
The fair values of notes and loans payable to non-related parties
approximates their carrying values because of the short maturities of
these instruments. The fair values of long-term debt payable to banks
approximate fair value based on market rates currently available to the
Company. The fair values of convertible debentures and notes payable to
related parties are not practicable to estimate, based upon the related
party nature of the underlying transactions.
F-17
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
PROPERTY, EQUIPMENT AND LEASEHOLDS:
Property, equipment and leaseholds are stated at cost, and depreciation is
provided by use of the straight-line method over the estimated useful
lives of the assets. The cost of leasehold improvements is depreciated
over the estimated useful lives of the assets or the length of the
respective leases, whichever period is shorter. The estimated useful
lives of property, equipment and leaseholds are as follows:
Vehicles 5 years
Office equipment and furniture 3 to 7 years
Computer hardware and software 3 to 5 years
Leasehold improvements 7 years
GOODWILL, INTANGIBLE ASSETS AND AMORTIZATION:
Goodwill and intangible assets were recorded in connection with the
Company's acquisition of Chex (Note 3). Goodwill represents the excess of
the purchase price over the estimated fair values of the net tangible and
identifiable intangible assets acquired. As discussed below, goodwill is
not amortized pursuant to recently issued accounting standards.
Identifiable intangible assets are being amortized on a straight-line
basis over three to seven years (Note 8).
ADVERTISING:
Advertising costs, which are primarily incurred by Chex, are expenses as
incurred. Advertising costs were not material in 2001, 2000, or 1999.
INCOME TAXES:
Income taxes are provided for the tax effects of transactions reported in
the financial statements and a deferred income tax liability or asset is
recognized for temporary differences between the Company's financial
statements and tax returns. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in
the years in which those temporary differences are expected to reverse.
The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in the statement of operations in the period that
includes the enactment date.
ESTIMATES:
Preparation of the consolidated/combined financial statements in accordance
with accounting principles generally accepted in the United States of
America 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 balance sheet and
the reported amounts of revenues and expenses during the reporting
periods. Actual results could differ from those estimates.
Certain of Chex's contracts with gaming establishments contain provisions
that could be subject to interpretation by the contractual parties. At
December 31, 2001, Chex is operating at certain gaming establishments
with unsigned contracts, verbal agreements or verbal amendments to the
existing written contracts. As of December 31, 2001, the Company has
estimated and recorded obligations under these contracts using
management's understanding and interpretation of the underlying
agreements. It is reasonably possible that significant changes will occur
in the near term, which could affect these estimates.
F-18
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
NET INCOME (LOSS) PER SHARE:
Statement of Financial Accounting Standards ("SFAS") No. 128, EARNINGS PER
SHARE, requires dual presentation of basic and diluted earnings or loss
per share ("EPS") with a reconciliation of the numerator and denominator
of the basic EPS computation to the numerator and denominator of the
diluted EPS computation. Basic EPS excludes dilution. Diluted EPS
reflects the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into common
stock or resulted in the issuance of common stock that then shared in the
earnings of the entity.
Income and loss per share of common stock is computed based on the weighted
average number of common shares outstanding during the period. The
historical income per share of Key and Nova prior to the merger have been
presented to reflect the new capital structure. Stock options, warrants,
common stock to be issued, and common stock underlying convertible
preferred stock are not considered in the calculations for the year ended
December 31, 2001, as the impact of the potential common shares, which
total 12,184,343, would be to decrease loss per share. Therefore, diluted
loss per share is equivalent to basic loss per share. Key and Nova did
not have any equity instruments outstanding for the years ended December
31, 2000 and 1999, therefore diluted income per share is equivalent to
basic income per share.
RECENTLY ISSUED ACCOUNTING STANDARDS:
In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 141, BUSINESS COMBINATIONS, and SFAS No. 142, GOODWILL AND OTHER
INTANGIBLE ASSETS. SFAS No. 141 requires that the purchase method of
accounting be used for all business combinations for which the date of
acquisition is after June 30, 2001. SFAS No. 141 also establishes
specific criteria for the recognition of intangible assets. The Company
applied the provisions of SFAS No. 141 in connection with its acquisition
of Chex in December 2001 (Note 3) and has not amortized the acquired
goodwill.
SFAS No. 142, effective for fiscal years beginning after December 15, 2001,
establishes accounting and reporting standards for goodwill and other
intangible assets. Under SFAS No. 142, goodwill and intangible assets
deemed to have indefinite lives will no longer be amortized, but will be
subject to annual impairment tests in accordance with the standard. Other
intangible assets will continue to be amortized over their estimated
useful lives. All of the Company's goodwill and identifiable intangibles
were acquired in a transaction after June 30, 2001. In accordance with
SFAS No. 142, the Company has continued to review these assets for
impairment under current accounting standards. The Company's current
policy for measuring goodwill impairment is based upon an analysis of
undiscounted cash flows, which did not result in an indicated impairment
as of December 31, 2001. The Company will adopt SFAS No. 142 in its
entirety January 1, 2002. In accordance with SFAS 141, the Company will
assign goodwill to reporting units and will complete the first step of
the transitional goodwill impairment test by June 30, 2002. The Company
has not yet determined what the effect of these new impairment tests will
be on its consolidated financial position or results of operations.
F-19
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
RECENTLY ISSUED ACCOUNTING STANDARDS (CONTINUED):
In August 2001, the FASB issued SFAS No. 144, ACCOUNTING FOR THE IMPAIRMENT
OR DISPOSAL OF LONG-LIVED ASSETS. SFAS No. 144, which is effective for
fiscal years beginning after December 15, 2001 and which supersedes SFAS
No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR
LONG-LIVED ASSETS TO BE DISPOSED OF, addresses accounting and financial
reporting for the impairment or disposal of long-lived assets. The
adoption of this statement is not expected to have a material impact on
the consolidated financial position or results of operations of the
Company.
In 2001, the Company adopted SFAS No. 133, ACCOUNTING FOR DERIVATIVE
INSTRUMENTS AND HEDGING ACTIVITIES. This statement, as amended,
establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities. This statement had no impact on
the Company's consolidated financial statements.
In December 1999, the staff of the Securities and Exchange Commission
issued Staff Accounting Bulletin ("SAB") No. 101, REVENUE RECOGNITION IN
FINANCIAL STATEMENTS. SAB No. 101, as amended by SAB No. 101A and SAB No.
101B, is effective no later than the fourth fiscal quarter of fiscal
years beginning after December 15, 1999. SAB No. 101 and related
amendments provide the Staff's views in applying generally accepted
accounting principles to selected revenue recognition issues. Adoption of
SAB No. 101 did not have an impact the Company's consolidated/combined
financial statements.
COMPREHENSIVE INCOME:
SFAS No. 130, REPORTING COMPREHENSIVE INCOME, establishes requirements for
disclosure of comprehensive income. During the years ended December 31,
2001, 2000 and 1999, the Company did not have any components of
comprehensive income to report.
STOCK-BASED COMPENSATION:
SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, defines a fair-value
based method of accounting for stock-based employee compensation plans
and transactions in which an entity issues its equity instruments to
acquire goods or services from non-employees, and encourages but does not
require companies to record compensation cost for stock-based employee
compensation plans at fair value. The Company has chosen to continue to
account for stock-based compensation using the intrinsic value method
prescribed in Accounting Principles Board Opinion No. 25, ACCOUNTING FOR
STOCK ISSUED TO EMPLOYEES, and guidance provided in SFAS Interpretation
("FIN") No. 44, ACCOUNTING FOR CERTAIN TRANSACTIONS INVOLVING STOCK
COMPENSATION. Accordingly, compensation cost for stock options is
measured as the excess, if any, of the quoted market price of the
Company's stock at the date of the grant over the amount an employee must
pay to acquire the stock.
F-20
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
3. ACQUISITION OF CHEX:
On August 31, 2001, the Company signed a definitive agreement to acquire
Chex, the effectiveness of which was subject to the completion of certain
final closing documents and other customary pre-closing conditions. On
November 30, 2001, the Company closed the acquisition of Chex into escrow
pending the execution of certain remaining documents required for
closing, which subsequently occurred on December 21, 2001, at which time
the Company signed an amended Stock Purchase Agreement (the "Agreement").
Pursuant to the Agreement, effective December 1, 2001, the Company acquired
all the outstanding common stock of Chex in exchange for 1,992,001 shares
of the Company's common stock valued at $10,119,000 ($5.08 per share), in
a transaction accounted for as a purchase. The purchase method of
accounting conforms to the accounting policies followed by the
consolidated entities. A preliminary allocation of the purchase price has
been made to major categories of assets and liabilities in the
accompanying consolidated financial statements, of which $5,636,000 was
allocated to goodwill, none of which is deductible for tax purposes. The
actual allocation of the purchase price and the resulting effect on
income (loss) from operations may differ from the amounts included in the
accompanying consolidated financial statements.
In conjunction with the Agreement, the Company entered into an employment
incentive agreement with the president of Chex in which the Company
granted the president of Chex a warrant to purchase up to 730,000 shares
of the Company's common stock at an exercise price of $3.85 per share,
which was the quoted market price of the Company's common stock at the
date the warrant was granted. The warrant is exercisable for a four-year
period beginning December 1, 2001.
The following unaudited pro forma financial information for the years ended
December 31, 2001 and 2000, give effect to the above acquisition as if it
had occurred at the beginning of each respective period. The unaudited
pro forma results of operations for 2001 and 2000 include amortization of
identifiable intangible assets, but do not include any amortization of
goodwill, pursuant to recently issued accounting standards.
Years ended December 31,
2001 2000
------------ ------------
Revenue $ 29,919,000 $ 23,452,000
Net income (loss) $ (2,972,000) $ 1,737,000
Net income (loss) applicable to common
shareholders $ (6,210,000) $ 1,737,000
Basic net income (loss) per common share $ (.42) $ .04
Diluted net income (loss) per common share $ (.42) $ .01
Shares used in per share calculation 14,858,656 10,895,731
F-21
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
4. CREDIT CARD RECEIVABLES:
The composition of credit card receivables at december 31, 2001 and 2000,
is as follows:
2001 2000
-------------- --------------
Credit card receivables $ 57,289,378 $ 31,994,865
Refundable reservation fees (55,587,827) (30,834,484)
-------------- --------------
1,701,551 1,160,381
Less allowance for losses 208,070 254,086
-------------- --------------
$ 1,493,481 $ 906,295
============== ==============
At March 31, 2002, credit card receivables of approximately $2,300,000
(unaudited) are due from Net First. The Company is pursuing collection of
these receivables from Net First with the FDIC, and management believes
that collection of this balance is probable.
Changes in the allowance for losses for the years ended December 31, 2001,
2000, and 1999, are as follows:
2001 2000 1999
----------- ----------- -----------
Balances, beginning of year $ 254,086 $ 529,498 $ 218,064
Provision for recoveries 416,080 56,520 1,187,988
Amounts charged-off (462,096) (331,932) (876,554)
----------- ----------- -----------
Balances, end of year $ 208,070 $ 254,086 $ 529,498
=========== =========== ===========
5. OTHER RECEIVABLES:
The composition of other receivables at December 31, 2001 and 2000, is as
follows:
2001 2000
-------------- --------------
Due from Net First $ 5,490,915 $ 2,150,410
Due from Key Bank & Trust 233,907 1,532,254
Due from Merrick Bank 689,946 1,490,231
Other 20,292 105,190
-------------- --------------
$ 6,435,060 $ 5,278,085
============== ==============
The amounts due from Net First and Key Bank & Trust are held in trust
accounts by each respective bank at December 31, 2001 and 2000. In
connection with the closure of Net First on March 4, 2002, the
receivables due from Net First are to be used to pay credit card holders.
F-22
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
6. NOTES RECEIVABLE:
RELATED PARTIES:
Notes receivable, related parties at December 31, 2001 and 2000, consist of
the following:
2001 2000
----------- -----------
Notes receivable from a shareholder/deceased
Chex officer's estate; interest at 6%;
principal and unpaid interest due in
November 2004; collateralized by 332,000
unregistered shares of the Company's common
stock; at December 31, 2001, management has
recorded a $1,150,000 valuation allowance
against this note of which a $325,000
provision was recorded in December 2001 to
increase the allowance from $825,000 at the
date of acquisition to $ 1,150,000 $ 1,469,691
Notes receivable from shareholder/former Chex
officer; interest at rates ranging from
5.75% to 6%; annual payments of interest
only beginning November 2002; due on
demand; collateralized by both registered
and unregistered shares of the Company's
common stock; the notes are classified as
long-term on the Company's balance sheet as
it is not management's intention to demand
payment in 2002 735,936
Notes receivable from shareholders; interest
at 12%; unsecured; notes matured in
December 2001; notes have been extended on
a month to month basis 500,000
Notes receivable from various Chex employees;
non-interest bearing, unsecured, and due on
demand 61,908
Note receivable from shareholder;
non-interest bearing, unsecured, and due on
demand or in weekly deductions from payroll;
the note is classified as long-term
on the Company's balance sheet as it is not
management's intention to demand payment in
2002 45,000
Notes receivable from Equitex 2000; interest
at 10%; unsecured and due on demand 47,300
Due from previous Key/Nova shareholders;
non-interest bearing; repaid in 2001 $606,500
----------- -----------
2,859,835 606,500
Less current maturities (563,460) (606,500)
----------- -----------
Notes receivable - related parties, net of
current portion 2,296,375 -
Less allowance for uncollectible notes
receivable (1,150,000) -
----------- -----------
Notes receivable - related parties, long-term $ 1,146,375 $ -
=========== ===========
F-23
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
6. NOTES RECEIVABLE (CONTINUED):
RELATED PARTIES: (CONTINUED)
Certain of the Company's notes receivable from related parties are
collateralized by common stock of the Company, including registered and
unregistered shares. Both the registered and unregistered shares are
exposed to an overall market volatililty risk. The unregistered shares
are exposed to an additional risk for lack of marketability. Due to the
level of risk associated with this common stock, it is reasonably
possible that changes in the values of the common stock will occur in
the near term and that such changes could materially affect the Company's
ability to collect the notes receivable from related parties.
OTHER:
As of December 31, 2001, Chex has a $100,000 note receivable from an
individual with interest accruing at 12%. The note is unsecured and
matured in January 2000, however, management has verbally extended the
loan on a month-to-month basis. Due to uncertainty as to the ultimate
collectibility of this note, a valuation allowance of $100,000 against
this receivable existed at the date of the Company's acquisition of Chex
and through December 31, 2001.
7. PROPERTY, EQUIPMENT AND LEASEHOLDS:
The major classes of property, equipment and leaseholds, and total
accumulated depreciation at December 31, 2001 and 2000 are as follows:
2001 2000
----------- -----------
Vehicles, office equipment and furniture $ 1,404,445 $ 360,011
Leasehold improvements 125,854 116,202
Computer software 16,433 15,944
----------- -----------
1,546,732 492,157
Less accumulated depreciation (366,474) (225,514)
----------- -----------
$ 1,180,258 $ 266,643
=========== ===========
8. INTANGIBLE ASSETS:
Intangible assets consist of the following at December 31, 2001:
Amount
-----------
Casino contracts $ 3,500,000
Non-compete agreements 500,000
Technology and software 500,000
Customer lists 300,000
Tradenames 200,000
5,000,000
-----------
Less accumulated amortization (74,585)
-----------
$ 4,925,415
===========
Casino contracts represent Chex's renewable agreements with Native American
owned gaming establishments to operate in those establishments for initial
terms of between one and five years. Casino contracts have historically been
renewed by gaming establishments, and are amortized using the straight-line
method over seven years. The non-compete agreements with members of Chex
management are amortized using the straight-line method over the five-year
terms of the related agreements.
F-24
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
8. INTANGIBLE ASSETS (CONTINUED):
Technology and software relate to unique systems installed at each casino
operation and are amortized using the straight-line method over three
years. Customer lists relate to core customers that rely on the use of
Chex's facilities and are amortized using the straight-line method over
three years.
Tradenames consist of the CHEX SERVICES and FAST FUNDS names, which are
believed to be readily identified and known in the marketplace by Chex
customers. Tradenames are amortized using the straight-line method over
seven years.
9. NOTES PAYABLE AND LONG-TERM DEBT:
Notes payable and long-term debt at December 31, 2001 and 2000, consist of
the following:
NOTES PAYABLE, RELATED PARTIES:
2001 2000
----------- -----------
Notes payable to the Company's president;
interest at 10%; the notes are unsecured
and due on demand $ 33,925
Notes payable to affiliate through common
ownership and control by the Company's
president; interest at 10%; the notes are
unsecured and due on demand 27,700
Notes payable to affiliates through common
ownership and control by officers of Key;
interest at 10%; the notes are unsecured
and due on demand 150,000 $ 325,000
Notes payable to Chex officers/shareholders;
interest at 12%; interest and principal
payable quarterly; the notes are unsecured
and mature on various dates through
December 2002; the notes are subject to
repayment with ninety days notice at the
option of the holder 5,013,616
----------- -----------
$ 5,225,241 $ 325,000
=========== ===========
F-25
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
9. NOTES PAYABLE AND LONG-TERM DEBT (CONTINUED):
LINE OF CREDIT, NOTES AND LOANS PAYABLE:
2001
-----------
Chex line of credit, subject to various
restrictive covenants, of which Chex is not
in compliance at December 31, 2001 [A] $ 1,002,000
Notes payable to numerous individual
investors; interest at 12%; interest and
principal payable quarterly; the notes are
unsecured and mature on various dates
through December 2002; the notes are
subject to repayment with ninety days notice
at the option of the holder 6,372,310
Notes payable to MCOA (Note 16); interest at
9%; the notes are unsecured and due on
demand 1,200,000
-----------
$ 8,574,310
===========
[A] At December 31, 2001, Chex has a line of credit with a bank under a
Term Loan and Credit Agreement (the "Term Loan Agreement") available
through December 31, 2002, with a maximum credit limit of $1,000,000.
The Company exceeded maximum borrowings by $2,000 at December 31,
2001, with the bank's authorization. Interest is payable monthly at a
variable rate (5.25% at December 31, 2001). Borrowings are
collateralized by substantially all of Chex's assets and are
guaranteed by a shareholder of the Company.
This Term Loan Agreement requires Chex to maintain certain
restrictive financial covenants. At December 31, 2001, Chex was not
in compliance with two of these covenants. In April 2002, the bank
agreed to refrain from pursuing its rights and remedies with regard
to the covenant violations and agreed to continue the availability of
advances under the Term Loan Agreement through June 12, 2002,
conditional upon a pledge by Chex of $300,000 to partially secure the
indebtedness.
The weighted-average interest rate on short-term borrowings was 11.2% and
10% in 2001 and 2000, respectively.
F-26
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
9. NOTES PAYABLE AND LONG-TERM DEBT (CONTINUED):
LONG-TERM DEBT:
2001
-----------
Convertible promissory notes, related parties
[A] $ 232,200
Note payable to a bank; variable interest
rate (5% at December 31, 2001), interest
payable monthly and principal payable
quarterly; the note matures in June 2004;
the note is collateralized by substantially
all of Chex's assets and is guaranteed by
an officer of Chex; subject to various
restrictive covenants of which Chex is not
in compliance at December 31, 2001[B] 450,000
Note payable to a bank; variable interest
rate (7.5% at December 31, 2001); interest
and principal payable monthly; the note
matures in October 2002; the note is
collateralized by substantially all of
Chex's assets and is guaranteed by an
officer of Chex 77,754
-----------
759,954
Less current maturities (527,754)
-----------
$ 232,200
===========
[A] In November 2001, the Company issued $285,000 of 9% convertible
promissory notes along with warrants to purchase 57,000 shares of the
Company's common stock to related parties for $285,000. Interest is
payable in quarterly installments beginning February 28, 2002.
Principal and all remaining interest is due in full at maturity in
February 2003. The portion of the proceeds applicable to the warrants
was determined to be approximately $57,000 utilizing the
Black-Scholes pricing model, and therefore $57,000 of the total
proceeds was allocated to the warrants, resulting in an imputed
dividend rate of 12.5%. The value assigned to the warrants is being
amortized to interest expense using the effective interest method
over the term of the promissory notes. Through December 31, 2001, the
Company has recognized $4,200 of interest expense relating to the
warrants. The warrants expire in November 2004 (Note 13). The
convertible promissory notes include a beneficial conversion feature
in which the promissory notes are convertible at 80% of the average
of the closing bid price of the Company's common stock during the ten
trading days immediately preceding the date on which the holder
elects to convert the promissory notes. The intrinsic value of the
beneficial conversion feature was determined to be approximately
$128,000 and was charged to interest expense in November 2001, as the
notes are convertible at any time after the date of issuance at the
option of the holder.
F-27
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
9. NOTES PAYABLE AND LONG-TERM DEBT (CONTINUED):
LONG-TERM DEBT (CONTINUED):
In January 2002, the Company issued $100,000 of 9% convertible
promissory notes along with warrants to purchase 20,000 shares of the
Company's common stock to unrelated parties for $100,000. Interest is
payable in quarterly installments beginning February 28, 2002.
Principal and all remaining interest is due in full at maturity in
February 2003. The portion of the proceeds applicable to the warrants
was determined to be approximately $15,000 utilizing the
Black-Scholes pricing model, and therefore $15,000 of the total
proceeds was allocated to the warrants, resulting in an imputed
dividend rate of 10.6%. The value assigned to the warrants will be
amortized to interest expense using the effective interest method
over the term of the promissory notes. The warrants expire in January
2005 (Note 13). The convertible promissory notes include a beneficial
conversion feature in which the promissory notes are convertible at
80% of the average of the closing bid price of the Company's common
stock during the ten trading days immediately preceding the date on
which the holder elects to convert the promissory notes. The
intrinsic value of the beneficial conversion feature was determined
to be approximately $40,000 and will be charged to interest expense
in January 2002.
[B] This note is subject the Term Loan Agreement along with a line of
credit discussed above. At December 31, 2001, Chex was not in
compliance with certain restrictive financial covenants. In April
2002, the bank agreed to refrain from pursuing its rights and
remedies with regard to the covenant violations and continue the
availability of advances under the Term Loan Agreement through June
12, 2002, conditional upon a pledge by Chex of $300,000 to partially
secure the indebtedness. The note balance has been classified as a
current liability at December 31, 2001.
Aggregate annual maturities of long-term debt are as follows:
Years ending Related
December 31, parties Other Total
------------ ----------- ----------- -----------
2002 $ 527,754 $ 527,754
2003 $ 232,200 232,200
----------- ----------- -----------
$ 232,200 $ 527,754 $ 759,954
=========== =========== ===========
F-28
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
10. INCOME TAXES:
Effective August 6, 2001, in conjunction with the acquisition of Key and
Nova by Equitex, and in conjunction with Key and Nova's termination of S
Corporation status, the Company recorded a net deferred tax asset of
approximately $1,440,000, which was recorded as an increase to deferred
tax assets and an increase in additional paid-in capital. The net
deferred tax asset primarily represents net operating loss carryforwards
of Equitex, which may be utilized to offset future taxable income of the
Company, as discussed below.
Income tax expense (benefit) for the years ended December 31, 2001 and 1999
is as follows:
2001 1999
----------- -----------
Current:
Federal $ (100,500) $ 618,000
State (17,000) 106,000
----------- -----------
(117,500) 724,000
Deferred 60,000 (606,500)
----------- -----------
$ (57,500) $ 117,500
=========== ===========
The reconciliation between the expected tax benefit computed at the federal
statutory income tax rate of 34% and the effective tax rate for the years
ended December 31, 2001 and 1999, is as follows:
2001 1999
------ ------
Statutory federal income tax rate (34) % 34 %
Federal and state tax not incurred by
Key and Nova as S Corporations from
January 1, through August 5, 2001, and Key
in 1999 (49) (33)
State taxes, net of federal income tax benefit ( 4)
Effect of change in valuation allowance 82 1
------ ------
( 5) % 2 %
====== ======
The following is a summary of the Company's deferred tax assets and
liabilities at December 31, 2001:
Deferred tax assets:
Allowance for loan losses $ 513,000
Property and equipment 12,000
Net operating loss carryforwards 2,850,000
-----------
Total deferred tax assets 3,375,000
Valuation allowance (1,405,000)
-----------
1,970,000
Deferred tax liabilities, credit card receivables (590,000)
-----------
Net deferred tax asset $ 1,380,000
===========
Net operating loss carryforwards of approximately $7,300,000 are available
to offset future taxable income, if any, and expire between 2015 and
2021. The net operating loss carryforwards may be subject to certain
limitations due to business acquisitions and other transactions.
A valuation allowance has been provided to reduce the deferred tax assets,
based on management's estimate of the assets' realizibility. The Company
increased the valuation allowance by $1,405,000 in the fourth quarter of
2001, based on these estimates. Realization of the net deferred tax asset
is dependent on generating sufficient taxable income prior to expiration
of the loss carryforwards. Although realization is not assured,
management believes it is more likely than not that the net deferred tax
asset will be realized. The amount of the deferred tax asset considered
realizable, however, could be reduced in the near term if estimates of
future taxable income during the carry forward period are reduced.
F-29
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
11. RELATED PARTY TRANSACTIONS:
Key and Nova has an agreement with Paragon Water Member Services
("Paragon"), a company that was affiliated with Key and Nova through
common ownership prior to the acquisition of Key and Nova on August 6,
2001, whereby Paragon provides credit card marketing services for Key and
Nova. Paragon earns commissions for card applications that are not
subsequently refunded. Key and Nova incurred $3,010,055, $897,521 and
$12,293,634 of commissions under the Paragon agreement during the years
ended December 31, 2001, 2000 and 1999, respectively.
Effective March 20, 2001, Key entered into an agreement with Paragon to
manage Paragon's telemarketing operations. Under the agreement, Key
assumed certain operating expenses and was entitled to a management fee
based on 75% of net operating profits of Paragon's telemarketing
operations, if any. The Company was responsible for any operating losses,
with the right of offset against future operating profits, if any. The
Company recognized approximately $420,000 in operating losses for the
year ended December 31, 2001 under this agreement. The Company terminated
this agreement with Paragon on March 1, 2002.
12. COMMITMENTS, CONTINGENCIES AND CREDIT RISK:
LITIGATION:
In August 2000, William G. Hays, Jr., liquidating agent for RDM Sports
Group, Inc. and related debtors, filed an adversary proceeding against
Equitex, Smith Gambrell and Russell, LLP, David J. Harris, P.C. and David
J. Harris, in the United States Bankruptcy Court for the Northern
District of Georgia, Newnan Division, Adversary Proceeding No. 00-1065.
The liquidating agent alleges that the Company breached its October 29,
1987, consulting agreement with RDM, breached fiduciary duties allegedly
owed to RDM, and that Equitex is liable for civil conspiracy and acting
in concert with directors of RDM. The liquidating agent is seeking
unspecified compensatory and punitive damages, along with attorney's
fees, costs and interest. On April 2, 2001, the court granted Equitex's
motion to enforce the arbitration clause contained in the consulting
agreement. Because this matter is in the preliminary stages and no
arbitration date has been set, it is too early to predict the outcome of
this matter. In connection with the Company's distribution of its assets
and liabilities to Equitex 2000 on August 6, 2001, Equitex 2000 has
agreed to indemnify the Company and assume defense in this matter, as
well as certain other legal actions existing at August 6, 2001. Although
the Company believes this lawsuit is without merit, there is no assurance
of a favorable outcome. The costs to defend this matter may be material,
and an unfavorable outcome may have a material adverse effect on the
Company should Equitex 2000 not be in a position to fulfill its
indemnification to the Company for any losses that may be incurred.
The Company is involved in various other claims and legal actions arising
in the ordinary course of business. In the opinion of management, the
ultimate disposition of these matters will not have a material adverse
impact either individually or in the aggregate on consolidated results of
operations, financial position or cash flows of the Company.
F-30
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
12. COMMITMENTS, CONTINGENCIES AND CREDIT RISK (CONTINUED):
CONTINGENCIES:
A credit limit has been established for each credit card holder account
acquired by Key and Nova. By agreement, the credit limit can be
terminated at any time for any reason. Because the initial reservation
fee charged to all account holders is fully refundable, the total of
accounts with credit limits in excess of cardholder balances is reflected
as a liability in the amount of $5,056,668 and $4,389,443 as of December
31, 2001 and December 31, 2000, respectively, in the accompanying balance
sheets.
Credit cards are issued throughout the United States to customers that are
considered high credit risks. The Company evaluates each customer's
credit worthiness on a case-by-case basis. Because of the reservation fee
charged upon issuance of credit cards, charges by customers for purchases
or cash advances are generally limited to the amount of payments
collected from each customer less fees charged.
The Company's credit card receivables were initiated under membership terms
with VISA and MasterCard. Modification of these terms by VISA and
MasterCard could adversely affect operating results. At March 31, 2002,
credit card receivables of approximately $2,300,000 (unaudited) are due
from Net First. The Company is pursuing collection of these receivables
from Net First with the FDIC, and management believes that the collection
of this balance is probable.
LEASE COMMITMENTS:
The Company rents space under various non-cancelable operating leases that
provide for monthly lease payments through April 2006. Pursuant to
certain leases, the Company is required to pay its pro-rata share of
taxes and operating expenses. Certain leases also contain various renewal
options.
Future minimum rental payments due under these non-cancelable leases as of
December 31, 2001, are as follows:
Years ending
December 31, Amount
------------ ---------------
2002 $ 569,000
2003 592,000
2004 490,000
2005 156,000
2006 36,000
---------------
$ 1,843,000
===============
In addition, the Company leases office space in Colorado on a month to
month basis for $2,500 per month from a corporation in which the
Company's president is the sole shareholder.
Total rent expense under operating leases was approximately $389,000,
$299,000 and $229,000 for the years ended December 31, 2001, 2000, and
1999, respectively.
F-31
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
12. COMMITMENTS, CONTINGENCIES AND CREDIT RISK (CONTINUED):
CONSULTING AGREEMENTS:
In September 2000, the Company entered into a one-year consulting agreement
for promotional services, in which, upon the satisfaction of various
performance criteria, the Company is to issue 75,000 shares of common
stock and warrants to purchase an additional 75,000 shares of common
stock at an exercise price equal to 80% of the average closing bid price
of the Company's common stock ten days prior to issuance. At the date of
commitment, total compensation cost was calculated to be approximately
$750,000. The Company recognized $687,500 of expense prior to the August
6, 2001 merger, and $62,500 of expense subsequent to the August 6, 2001
merger, which is included in the Company's operations for the year ended
December 31, 2001. The Company has not as yet issued the common stock and
warrants underlying this agreement.
In April 2001, the Company entered into a consulting agreement for investor
relations and development services, in which, upon the satisfaction of
various performance criteria, the Company is to issue 150,000 shares of
common stock. At the date of commitment, total compensation cost was
estimated to be approximately $778,000, which was to be recognized as the
performance criteria were satisfied. In October 2001, the Company
exercised its right to cancel this contract and agreed to issue only
70,000 shares of common stock upon cancellation of the contract.
Therefore, compensation cost was recalculated to be approximately
$363,000 at the date of the original commitment. The Company recognized
$250,666 of expense prior to the August 6, 2001 merger, and $112,334 of
expense subsequent to the August 6, 2001 merger, which is included in the
Company's operations for the year ended December 31, 2001. The Company
issued the common stock underlying this agreement in December 2001 (Note
13).
In September 2001, the Company entered into a consulting agreement for
investor communications and public relations in exchange for 350,000
shares of common stock and warrants to purchase an additional 350,000
shares of common stock at exercise prices ranging from $4 to $10 per
share. At the date of the commitment, total compensation cost was
estimated to be approximately $1,733,000, which was recognized as the
performance criteria were satisfied. The Company recognized $1,733,000 of
expense under this contract during the fourth quarter of 2001 as the
performance criteria were completed, and which is included in the
Company's operations for the year ended December 31, 2001. The Company
issued the common stock and the warrants underlying this agreement in
November 2001 (Note 13).
In January 2002, the Company entered into a consulting agreement for
financial services to issue 15,000 shares of common stock and warrants to
purchase an additional 15,000 shares of common stock at an exercise price
equal to 120% of the closing bid price of the Company's common stock at
the date of the agreement. At the date of commitment, total compensation
expense was estimated to be approximately $72,000, which is to be
recognized subsequent to December 31, 2001, as the performance criteria
are satisfied. The Company issued the common stock and warrants
underlying this agreement in January 2002 (Note 13).
CHEX SALARY CONTINUATION PLAN:
Chex has a salary continuation plan for two of its employees. Pursuant to
the plan, these two individuals are guaranteed two years of salary, which
totals $230,000 at December 31, 2001, in the event that their employment
is terminated.
F-32
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
12. COMMITMENTS, CONTINGENCIES AND CREDIT RISK (CONTINUED):
CHEX EMPLOYMENT AGREEMENTS:
The Company is obligated under an employment contract to pay a deceased
officer's beneficiary a $72,000 death benefit, payable in twenty-four
monthly installments of $3,000 beginning in December 2001. As of December
31, 2001, $69,000 is reflected as an accrued liability on the
accompanying consolidated balance sheet.
Chex has entered into three-year employment agreements with five of its
employees, which expire at various dates between July 2003 and April
2004. Pursuant to each agreement, if terminated for other than an
egregious act, the employees are to continue to receive annual
compensation, including a guaranteed minimum bonus under one of the
contracts, aggregating $651,000 at December 31, 2001. The amounts are to
be paid in monthly installments over the duration of the original
contract terms.
Subsequent to December 31, 2001, the Company terminated one of its
employees under an employment agreement. Management does not believe that
the employee is entitled to severance as a result of the circumstances
surrounding the termination. Management has received notification from
the employee's attorney indicating the employee's intention to seek
enforcement of the severance position of his contract. Management intends
to vigorously enforce its position, and no amount has been accrued for
this contingent liability at December 31, 2001, as management does not
believe payment is probable.
CHEX CASINO CONTRACTS:
Chex operates at a number of Native American owned gaming establishments
under contracts requiring the Company to pay a rental fee to operate at
the respective gaming locations. Occasionally, these agreements require
the Company to prepay a negotiated amount of such anticipated fees.
Typically, the fees are earned by the gaming establishment over the life
of the contract based on one of the following scenarios:
o A minimum amount as defined in the contract.
o A dollar amount, as defined by the contract, per transaction volume
processed by Chex.
o A percentage of Chex's profits at the respective location.
o The greater of the monthly amount, dollar amount per transaction
volume or percent of Chex's profits payable at the end of the
contract term.
Certain of the casino contracts contain provisions that could be subject to
interpretation by the contractual parties. In addition, Chex is operating
at some gaming establishments with unsigned contracts, verbal agreements
or verbal amendments to the existing written contracts. As of December
31, 2001, the Company has estimated and recorded obligations under these
contracts using management's understanding and interpretation of the
underlying agreements. As of December 31, 2001, the parties to these
contracts have brought no challenges or claims to the Company's
attention. Any contingent liability stemming from any such future issues
cannot be estimated at this time.
As of December 31, 2001, the Company had $342,012 of prepaid amounts on
casino contracts and had $517,805 of accrued liability on casino
contracts, which are included on the accompanying consolidated balance
sheet.
Pursuant to the contracts, the Native American owned casinos have not
waived their sovereign immunity.
F-33
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
13. STOCKHOLDERS' EQUITY:
ISSUANCES OF COMMON STOCK PRIOR TO THE AUGUST 6, 2001 MERGER:
At December 31, 2000, the Company had 7,140,293 shares of common stock
issued and 68,675 shares held in treasury (7,071,618 outstanding) and a
total of 461,450 shares of Series D, E and F preferred stock issued and
outstanding (the "Series D, E, and F Preferred Stock"). In addition, at
December 31, 2000, the Company had 1,300 shares of Series G preferred
stock outstanding (the "Series G Preferred Stock"), which was not
included in stockholders' equity at December 31, 2000. From January 1,
2001 through August 6, 2001 (the date of the acquisition of Key and Nova)
the Company recorded the following equity transactions, which resulted in
an increase in the number of shares of common stock issued to 9,118,123
shares and 33,350 shares held in treasury (9,084,773 shares outstanding),
and a decrease in the total number of shares of Series D, E and F
preferred stock issued and outstanding to 2,025 shares:
In May 2001, the Company satisfied certain criteria, which removed the
mandatory redemption requirements from the Series G Preferred Stock
terms, and therefore 1,300 shares of Series G Preferred Stock were
reclassified from the mezzanine section of the consolidated balance
sheet to stockholders' equity. In May and June 2001, 475 shares of
Series D Preferred Stock, plus cumulative unpaid dividends of $65,401
were converted into 127,364 shares of common stock at an average
conversion price of $4.24 per share.
In June 2001, the remaining 250 shares of Series E Preferred Stock,
along with 50 shares of Series E Preferred Stock to be issued, were
automatically converted into 300,000 shares of common stock at a
conversion price of $1,000 per share, in accordance with the
designation agreement. The Company also issued 20,000 shares of common
stock to a third party for legal services provided to the Company.
These shares were valued at $120,000 ($6.00 per share). In addition,
the Company issued 100,000 shares of common stock to third parties for
consulting and legal services provided to the Company. These shares
were valued at $519,000 ($5.19 per share).
In July 2001, the remaining 460,000 shares of Series F Preferred Stock
were converted into 525,716 shares of common stock at a conversion
price of $7.00 per share. The Company also issued 112,500 shares of
common stock to third-party consultants upon the exercise of warrants
at $4.00 per share. In addition, 471,800 shaes of common stock were
issued upon the conversion of newly-issued Series H Preferred Stock,
discussed below.
In August 2001, the Company issued 78,339 shares of common stock along
with warrants to purchase 78,339 shares of common stock to Equitex 2000
as compensation for expenses it incurred in connection with the
acquisition of Key and Nova. The exercise price of the warrants is
$5.76 per share (the market price of the common stock at the date of
grant was $5.24 per share). The warrants are exercisable through August
2006. The common stock and warrants were valued at approximately
$410,000, which is included in the Company's operating expenses for the
year ended December 31, 2001. In addition, the Company issued 78,645
shares of common stock along with warrants to purchase 78,645 shares of
common stock to Equitex 2000 in satisfaction of $495,510 in related
party payables and accrued interest. The exercise price of the warrants
is $5.76 per share (the market price of the common stock at the date of
grant was $5.24 per share). The warrants are exercisable through August
2006.
F-34
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
13. STOCKHOLDERS' EQUITY (CONTINUED):
ISSUANCES OF COMMON STOCK PRIOR TO THE AUGUST 6, 2001 MERGER (CONTINUED):
In August 2001, the Company also converted $859,062 of notes and other
payables to related parties into 163,466 shares of common stock at a
price equal to the closing price of the Company's common stock at the
date of issuance ($5.24 per share) along with warrants to purchase
163,466 shares of common stock at $5.76 per share (the market price of
the common stock at the date of grant was $5.24 per share). The
warrants are exercisable through August 2006.
ISSUANCE OF SERIES H AND SERIES I PREFERRED STOCK IN CONNECTION WITH
MERGER:
SERIES H CONVERTIBLE PREFERRED STOCK:
In July 2001, the Company issued 2,359 shares of 8%, Series H convertible
preferred stock (the "Series H Preferred Stock") for $1,000 per share,
which is the stated value per share (total proceeds of $2,359,000 less
issue costs of approximately $300,000). In July 2001, each share of
Series H Preferred Stock automatically converted into 200 shares of the
Company's common stock (471,800 shares) and warrants to purchase 200
shares of common stock. The warrants were valued at $455,000 using the
Black-Scholes option pricing model, and therefore $355,000 of the total
proceeds were allocated to the warrants, resulting in an imputed dividend
rate of 9.4%. Each warrant is exercisable until July 2004 at an exercise
price of $5.78 per share.
Because the Series H Preferred Stock contained an immediate beneficial
conversion feature, net loss applicable to common stockholders was
increased by $507,000 for the year ended December 31, 2001, the amount of
the discount resulting from the beneficial conversion feature.
SERIES I CONVERTIBLE PREFERRED STOCK:
In August 2001, prior to the merger, the Company issued 4,000 shares of 6%,
Series I convertible preferred stock (the "Series I Preferred Stock")
along with warrants to purchase 400,000 shares of common stock for $1,000
per share, which is the stated value per share (total proceeds of
$4,000,000 less issue costs of approximately $500,000). The warrants were
valued at $264,000 using the Black-Scholes option pricing model, and
therefore $264,000 of the total proceeds were allocated to the warrants,
resulting in an imputed dividend rate of 6.4%.
The Series I Preferred Stock is convertible, together with any accrued but
unpaid dividends, at any time into shares of the Company's common stock
at a conversion price per share equal to the lesser of $5.98 or 65% of
the average closing price of the Company's common stock as specified in
the agreement.
Because the Series I Preferred Stock contained an immediate beneficial
conversion feature, net loss applicable to common stockholders was
increased by $2,417,000 for year ended December 31, 2001, the amount of
the discount resulting from the beneficial conversion feature.
F-35
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
13. STOCKHOLDERS' EQUITY (CONTINUED):
ISSUANCE OF SERIES H AND SERIES I PREFERRED STOCK IN CONNECTION WITH MERGER
(CONTINUED):
SERIES I CONVERTIBLE PREFERRED STOCK (CONTINUED):
The holder of each share of Series I Preferred Stock is entitled to
cumulative dividends at 6% per annum plus a 4% dividend default rate,
payable quarterly commencing September 30, 2001. Dividends are payable in
cash, or at the Company's option, in shares of the Company's common
stock. Cumulative unpaid dividends are $93,000 (approximately $35 per
share) at December 31, 2001. The Series I Preferred Stock contains a
liquidation preference equal to the sum of the stated value of each share
plus an amount equal to 125% of the stated value plus the aggregate of
all cumulative unpaid dividends on each share of Series I Preferred Stock
until the most recent dividend payment date or date of liquidation,
dissolution or winding up of the Company. All outstanding shares of the
Series I Preferred Stock automatically convert into common stock on July
20, 2004. The Series I Preferred Stock is redeemable at the Company's
option at any time through July 20, 2004 at a redemption price equal to
$1,250 per share plus any cumulative unpaid dividends.
The Series I Preferred Stock is subject to a registration rights agreement,
which provides that the Company will use its best efforts to register the
common stock underlying the Series I Preferred Stock and the common stock
underlying the warrants within a specified time period. If a registration
statement covering of these shares is not declared effective within 180
days from the issuance of the Series I Preferred Stock, the Company is
subject to penalties equal to 2% of the purchase price of the stock. If a
registration statement is not declared effective within 210 days from the
issuance of the Series I Preferred Stock, the Company is subject to
penalties equal to 4% of the purchase price of the stock increasing 1%
per month until the registration statement is declared effective by the
SEC. Because a registration statement has not been declared effective by
the stipulated date, the Company has incurred approximately $132,000 in
penalties subsequent to December 31, 2001, which is payable in cash.
In August, October and November 2001, 1,010 shares of Series I Preferred
Stock, plus cumulative unpaid dividends of $3,020, were converted into
359,958 shares of common stock, at an average conversion price of $2.81
per share.
In November 2001, the Company redeemed 330 shares of Series I Preferred
Stock for $412,500. The redemption price was less than the amount
originally allocated to the beneficial conversion feature, and as a
result, loss applicable to common stockholders was reduced by $92,000 for
the year ended December 31, 2001.
In January 2002, 100 shares of Series I Preferred Stock, plus cumulative
unpaid dividends of $2,533, were converted into 44,006 shares of common
stock at an average conversion price of $2.33.
SERIES D AND SERIES G PREFERRED STOCK:
SERIES D CONVERTIBLE PREFERRED STOCK:
In August 1999, the Company issued 1,200 shares of 6%, Series D convertible
preferred stock (the "Series D Preferred Stock") for $1,200,000, which is
the stated value per share. In May and June 2001, 475 shares of Series D
Preferred Stock were converted into common stock.
F-36
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
13. STOCKHOLDERS' EQUITY (CONTINUED):
SERIES D AND SERIES G PREFERRED STOCK (CONTINUED):
The Series D Preferred Stock is convertible, together with any cumulative
unpaid dividends, at any time into shares of the Company's common stock
at a conversion price per share of common stock equal to 65% of the
average closing bid price of the Company's common stock as specified in
the agreement.
The holder of each share of Series D convertible preferred stock (the
"Series D Preferred Stock") is entitled to a 6% cumulative annual
dividend, payable quarterly commencing June 30, 1999. Dividends are
payable in cash or, at the Company's option, in shares of the Company's
common stock. Cumulative unpaid dividends are $18,000 (approximately $25
per share) at December 31, 2001. The Series D Preferred Stock contains a
liquidation preference equal to the sum of the stated value of each share
plus an amount equal to 130% of the stated value plus the aggregate of
all cumulative unpaid dividends on each share of Series D Preferred Stock
until the most recent dividend payment date or date of liquidation,
dissolution or winding up of the Company.
SERIES G CONVERTIBLE PREFERRED STOCK:
In September 2000, the Company issued 1,300 shares of 6%, Series G
convertible preferred stock (the "Series G Preferred Stock") along with
warrants to purchase 130,000 shares of common stock for $1,000 per share,
which is the stated value per share (total proceeds of $1,300,000 less
issue costs of $60,000). The warrants were valued at $242,000 utilizing
the Black-Scholes option-pricing model, and therefore $242,000 of the
total proceeds was allocated to the warrants, resulting in an imputed
dividend rate of 7.4%.
The Series G Preferred Stock is convertible, together with any cumulative
unpaid dividends, at any time into shares of the Company's common stock
at a conversion price per share equal to the lesser of $6.50 or 65% of
the average closing bid price of the Company's common stock as specified
in the agreement.
The holder of each share of the Series G Preferred Stock is entitled to
cumulative dividends at 6% per annum plus a 4% dividend default rate,
payable quarterly commencing September 30, 2000. Dividends are payable in
cash or, at the Company's option, in shares of the Company's common
stock. Cumulative unpaid dividends are $37,000 (approximately $41 per
share) at December 31, 2001. The Series G Preferred Stock contains a
liquidation preference equal to the sum of the stated value of each share
plus an amount equal to 130% of the stated par value plus the aggregate
of all cumulative unpaid dividends on each share of Series G Preferred
Stock until the most recent dividend payment date or date of liquidation,
dissolution or winding up of the Company. All outstanding shares of
Series G Preferred Stock automatically convert into common stock on
August 31, 2003. The Series G Preferred Stock is redeemable at the
Company's option at any time through August 31, 2003, at a redemption
price equal to $1,350 per share plus any cumulative unpaid dividends.
In November 2001, 400 shares of Series G Preferred Stock, plus cumulative
unpaid dividends of $28,767, were converted into 165,090 shares of common
stock at an average conversion price of $2.60 per share. In January 2002,
200 shares of Series G Preferred Stock, plus cumulative unpaid dividends
of $16,267, were converted into 93,776 shares of common stock at an
average conversion price of $2.31.
F-37
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
13. STOCKHOLDERS' EQUITY (CONTINUED):
ISSUANCES OF COMMON STOCK SUBSEQUENT TO AUGUST 6, 2001:
In September 2001, the Company agreed to issue 35,000 shares of its common
stock valued at $140,000 in exchange for acquisition costs incurred by
third parties in connection with the Company's acquisition of Chex, and
in October and November 2001, the Company issued 69,852 shares of common
stock upon the conversion of 69,852 warrants to purchase common stock at
an average exercise price of $3.47 per share.
In November and December 2001, the Company issued 455,000 shares of common
stock to consultants for services rendered under deferred compensation
agreements. These shares were valued at $1,903,300, the market value of
the common stock at the dates of commitment. In addition, in December
2001, the Board of Directors authorized the Company to issue up to
500,000 shares of its common stock through a private placement offering.
The shares are to be sold at a 25% discount from market. No shares were
sold or issued under this offering during 2001. The Company sold and
issued 78,635 shares of common stock for cash under the agreement in
January 2002, at an average price of $2.75 per share.
In January and February 2002, the Company issued 50,333 shares of common
stock upon the conversion of warrants at an average conversion price of
$3.00 per share. In addition, the Company issued 15,000 shares of common
stock to a consultant for services provided to the Company under a
deferred compensation agreement entered into in January 2002. These
shares were valued at $72,000, the market value of the common stock at
the date of commitment.
STOCK OPTIONS AND WARRANTS:
In 1993, the Company adopted two stock option plans: the 1993 Stock Option
Plan and the 1993 Stock Option Plan for Non-Employee Directors. In
January 1999, the Company's Board of Directors adopted an incentive stock
option plan (the "1999 Option Plan") covering up to 1,000,000 shares of
the Company's common stock. During 1999, the Company granted incentive
stock options under the 1999 Option Plan for 29,000 shares and 8,000
shares to the Company's officers and employees, respectively. In
addition, non-statutory stock options for 472,000 and 491,000 shares were
granted to under the 1999 Option Plan to officers and directors,
respectively. All options were granted at a price of $6.75 per share
which represented the market value of the Company's common stock at the
grant date.
In April 2000, the Company's Board of Directors increased 1999 Option Plan
to cover up to 1,700,000 shares of the Company's common stock. During
2000, the Company granted incentive stock options under the 1999 Option
Plan for 511,000 shares and 21,000 shares to the Company's officers and
employees, respectively. In addition, non-statutory stock options for
168,000 shares were granted under the 1999 Option Plan to directors. All
options were granted at a price of $5.50 per share which represented the
market value of the Company's common stock at the grant date.
In June 2001, stock options to purchase 21,000 shares of common stock were
voluntarily forfeited in accordance with the 1999 Option Plan when an
employee left the Company. In addition, the Company granted incentive
stock options under the 1999 Option Plan for 10,000 shares and 11,000
shares, respectfully, to an employee and a director of the Company. These
stock options were granted with an exercise price equal to market value
at the date of issuance ($6.00 per share) and are exercisable through
June 2006.
F-38
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
13. STOCKHOLDERS' EQUITY (CONTINUED):
STOCK OPTIONS AND WARRANTS (CONTINUED):
In 2001, 2000 and 1999, the Board of Directors granted stock options to
officers, directors and employees of the Company as follows:
Number Option
Option type Grantee of shares price
----------- ------- ----------- -------
2001 Incentive Employee 10,000 $ 6.00
Incentive Director 11,000 $ 6.00
-----------
21,000
===========
2000 Incentive Officers 476,000 $ 5.50
Incentive Officers 35,000 $ 4.00 (a)
Incentive Employees 21,000 $ 5.50
Non-qualified Directors 168,000 $ 5.50
-----------
700,000
===========
1999 Incentive Officer 29,000 $ 6.75
Incentive Employees 8,000 $ 4.00 (a)
Non-qualified Officers 440,700 $ 6.75
Non-qualified Officers 31,300 $ 4.00 (a)
Non-qualified Directors 491,000 $ 6.75
-----------
1,000,000
===========
(a) In March 2001, the Company reduced the exercise price of certain
existing stock options previously issued to employees to purchase up
to 74,300 shares of the Company's common stock. As a result of the
reduction in exercise price, these stock options are now accounted
for as variable awards from the date of modification through the date
the award is exercised, forfeited, or expires unexercised in
accordance with FIN No. 44. Through December 31, 2001,
recharacterization of the options as variable awards did not result
in additional compensation expense.
F-39
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
13. STOCKHOLDERS' EQUITY (CONTINUED):
STOCK OPTIONS AND WARRANTS (CONTINUED):
A summary of the status of the Company's stock options outstanding and
exercisable and weighted average exercise prices is as follows:
1993 Plans 1999 Plan Total
------------------- -------------------- --------------------
Weighted Weighted Weighted
average average average
exercise exercise exercise
Shares price Shares price Shares price
-------- -------- --------- -------- --------- --------
January 1, 1999 752,000 $ 3.13 752,000 $ 3.13
Forfeited - - - -
Granted - - 1,000,000 $ 6.75 1,000,000 6.75
Exercised (665,600) 3.10 - - (665,600) 3.10
-------- -------- --------- -------- --------- --------
December 31, 1999 86,400 3.19 1,000,000 6.75 1,086,400 6.46
Forfeited - - - - - -
Granted - - 700,000 5.50 700,000 5.50
Exercised - - - - - -
-------- -------- --------- -------- --------- --------
December 31, 2000 86,400 3.19 1,700,000 6.24 1,786,400 6.08
Forfeited - - (21,000) 5.50 (21,000) 5.50
Granted - - 21,000 6.00 21,000 6.00
Exercised - - - - - -
-------- -------- --------- -------- --------- --------
December 31, 2001 86,400 $ 3.19 1,700,000 $ 6.24 1,786,400 $ 6.08
======== ======== ========= ======== ========= ========
Options exercisable at December 31, 2001, expire from January 2004 through
June 2006. Had compensation cost for the Company's stock-based
compensation plans been determined based on the fair value on the grant
dates consistent with the provisions of SFAS No. 123, the Company's pro
form income (loss) and net income (loss) per common share would have been
as follows:
2001 2000 1999
----------- ---------- ----------
Net income (loss) applicable to common
stockholders, as reported $(4,196,369) $3,556,720 $5,589,938
Net income (loss) applicable to common
stockholders, pro forma $(4,238,000) $1,555,000 $2,159,000
Net income (loss) per share, as reported $ (.32) $ .40 $ .63
Net income (loss) per share, pro forma $ (.33) $ .17 $ .24
F-40
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
13. STOCKHOLDERS' EQUITY (CONTINUED):
STOCK OPTIONS AND WARRANTS (CONTINUED):
The fair value of options granted during 2001 was estimated on the date of
grant using the Black-Scholes option pricing model. The following
weighted average assumptions were utilized:
2001 2000 1999
------- ------- -------
Expected dividend yield 0 0 0
Expected stock price volatility 53% 56% 71%
Risk-free interest rate 4.2% 5.1% 6.0%
Expected life of options 2 years 3 years 3 years
In July 2001, in connection with the issuance of the Series H Preferred
Stock, the Company issued warrants to purchase 239,500 shares of common
stock at an exercise price of $5.00 per share (the market price at the
date of grant was $5.45) to an investment banker as offering costs. The
warrants were valued at $252,000 using the Black-Scholes option pricing
model.
In September 2001, the Company issued warrants to purchase 350,000 shares
of common stock at prices ranging from $4 to $10 per share (the market
price at the date of measurement was $4.00) to a consultant for services
rendered under a deferred compensation agreement. The warrants were
valued at $333,000 on the date of commitment based upon the Black-Scholes
option pricing model.
In November 2001, the Company issued five-year warrants to purchase an
additional 113,750 shares of the Company's common stock at prices ranging
from $3.50 to $5.00 per share (the market price at the date of grant was
$4.09) to a holder of the Company's convertible preferred stock. These
warrants were valued at $152,000 based upon the Black-Scholes option
pricing model. The fair value of these additional warrants increased net
loss applicable to common stockholders by $152,000 as the warrants were
immediately exercisable upon issuance. In addition, the Company issued
warrants to purchase 57,000 shares of common stock at prices ranging from
$4 to $5 per share (the market price at the date of grant was $4.00) to
related parties as additional consideration for convertible promissory
notes.
In November and December 2001, the Company reduced the exercise price of
certain existing warrants to purchase up to 165,333 shares of the
Company's common stock. As a result of the reduction in exercise price,
the Company recognized an additional $66,000 of stock based compensation
expense related to these repriced warrants, which is included in the
Company's operating expenses for the year ended December 31, 2001.
F-41
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
13. STOCKHOLDERS' EQUITY (CONTINUED):
STOCK OPTIONS AND WARRANTS (CONTINUED):
In December 2001, the Company issued three-year warrants to purchase 17,000
shares of the Company's common stock at $3.55 per share (the market price
of the common stock at the date of grant) to a consultant for services
provided to the Company. These warrants were valued at $18,400 based upon
the Black-Scholes option pricing model, which is included in the
Company's operating expenses for the year ended December 31, 2001. In
January 2002, the Company issued three-year warrants to purchase an
additional 53,333 shares of the Company's common stock at prices ranging
from $3.50 to $5.00 per share (the market price of the common stock at
the date of grant was $3.55) to a holder of the Company's convertible
preferred stock. These warrants were valued at $53,000 based upon the
Black-Scholes option pricing model. In addition, the Company issued
warrants to purchase 20,000 shares of common stock at prices ranging from
$4 to $5 per share (the market price at the date of grant was $3.95) to
unrelated parties as additional consideration for convertible promissory
notes.
In 2000, the Company issued 135,000 warrants and options to purchase shares
of common stock to outside consultants. The warrants and options were
exercisable immediately at a weighted average exercise price of $5.96 per
share. The Company valued these warrants and options, which expire
through April 2004, at $272,000 utilizing the Black-Scholes option
pricing model.
In 1999, the Company issued 397,500 warrants and options to purchase shares
of common stock to third parties in connection with the Company's private
placements of common and preferred stock. The warrants and options were
exercisable immediately at a weighted average exercise price of $7.99 per
share. During 1999, 337,500 of these warrants were exercised. The
remaining 60,000 warrants outstanding at December 31, 2001 expire in
February 2002. Also in 1999, additional warrants to purchase 50,000
shares of the Company's common stock at $3.75 per share were granted to
an unrelated entity for services valued at $150,000. The warrants expire
in April 2002.
The fair value of each warrant and option granted to non-employees during
2001 was estimated on the date of grant using the Black-Scholes
option-pricing model. The following weighted average assumptions were
utilized:
2001 2000 1999
--------- ------- -------
Expected dividend yield 0 0 0
Expected stock price volatility 54% 56% 63%
Risk-free interest rate 3.8% 5.1% 6.0%
Expected life of warrants 1.3 years 2 years 2 years
14. OPERATING SEGMENTS:
Operating segments are defined as components of an enterprise for which
separate financial information is available that is evaluated regularly
by the chief operating decision makers in deciding how to allocate
resources and in assessing performance.
F-42
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
14. OPERATING SEGMENTS (CONTINUED):
Beginning in December 2001, with the acquisition of Chex, the Company has
two reportable segments, for which the accounting policies of the
segments are the same as those described in the summary of significant
accounting policies. The Company evaluates performance based on operating
earnings of the respective business units. As of and for the year ended
December 31, 2001, the segment results were as follows:
Cash
Credit card disbursement Corporate
services services activities Total
------------ ------------ ------------ -----------
(Key and Nova) (Chex)
Revenues $ 15,140,210 $ 1,373,158 $ 14,771 $ 16,528,139
Depreciation and amortization 115,302 99,932 -- 215,234
Stock based compensation -- -- 2,132,234 2,132,234
Interest expense -- 102,733 137,160 239,893
Income tax expense (benefit) (117,500) -- 60,000 (57,500)
Net income (loss) 2,011,547 (334,591) (2,708,325) (1,031,369)
Intangible assets -- 4,925,415 -- 4,925,415
Goodwill -- 5,636,285 -- 5,636,285
Total assets 8,541,368 26,742,249 65,538 35,349,155
Capital expenditures 125,422 32,347 -- 157,769
15. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED):
Selected unaudited quarterly financial data for the years ended 2001 and
2000 is summarized below. Prior to the August 6, 2001 merger, the amounts
below were derived from the unaudited combined statements of operations
of Key and Nova as of and for the periods indicated.
2001 quarters
------------------------------------------------------------
First Second Third Fourth
quarter quarter quarter (a) quarter (a) (b)
------------ ------------ ------------ ------------
Revenues $ 3,291,956 $ 3,793,443 $ 4,112,193 $ 5,330,547
Net income (loss) 617,930 559,247 270,907 (2,479,453)
Preferred stock beneficial conversion
features, deemed dividends and other
transactions - - (2,426,756) (738,244)
Net income (loss) applicable to
common shareholders 617,930 559,247 (2,255,849) (3,117,697)
Basic and diluted income (loss) per
common share (c) 0.07 0.06 (0.15) (0.30)
F-43
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
15. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) (CONTINUED):
(a) On August 6, 2001, the Company acquired all of the outstanding common
stock of Key and Nova. The transaction was recorded as a reverse
acquisition. The historical stockholders' equity of Key and Nova
prior to the merger has been retroactively restated (a
recapitalization) for the equivalent number of shares received in the
merger after giving effect to any differences in the par value of the
Equitex, Key, and Nova common stock, with an offset to additional
paid-in capital. The restated retained earnings of the accounting
acquirer (Key and Nova) have been carried forward after the
acquisition.
(b) Effective December 1, 2001, the Company acquired all the outstanding
common stock of Chex. The transaction was accounted for as a
purchase. The results of operations for Chex have been included in
the consolidated results from the date of acquisition.
(c) The sum of earnings per share for the four quarters may differ from
the annual earnings per share due to the required method of computing
weighted average number of shares in the respective periods.
2000 quarters
------------------------------------------------------------
First Second Third Fourth
quarter quarter quarter (a) quarter (a) (b)
------------ ------------ ------------ ------------
Revenues $ 4,039,307 $ 3,431,977 $ 4,034,822 $ 2,950,248
Net income, and net income applicable
common shareholders 1,312,527 974,753 1,135,263 134,177
Basic and diluted income per
common share 0.15 0.11 0.13 0.01
16. PROPOSED TRANSACTION WITH MCOA:
In September 2001, the Company signed a letter of intent to acquire MCOA,
the effectiveness of which is subject to completion and acceptance of
customary due diligence, negotiation and execution of a definitive
agreement and other customary conditions. MCOA is a financial services
company that provides cash access, technology, and marketing services to
the gaming and retail markets. MCOA funds-transfer systems allow casino
patrons to access cash through check cashing, credit/debit card advances,
automated teller machines and wire transfers. MCOA also owns a
proprietary "Cash Access System", which processes check, credit, and
debit card transactions, thereby reducing the need for third party
vendors.
F-44
KEY FINANCIAL SYSTEMS, INC.
FINANCIAL REPORT
DECEMBER 31, 2000
CONTENTS
- -----------------------------------------------------------------------------
INDEPENDENT AUDITOR'S REPORT 1
- -----------------------------------------------------------------------------
FINANCIAL STATEMENTS
Balance sheet 2
Statements of income 3
Statements of stockholders' equity 4
Statements of cash flows 5
Notes to financial statements 6 - 10
- -----------------------------------------------------------------------------
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors
Key Financial Systems, Inc.
Clearwater, Florida
We have audited the accompanying balance sheet of Key Financial Systems, Inc. as
of December 31, 2000, and the related statements of income, stockholders'
equity, and cash flows for the years ended December 31, 2000 and 1999. 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 auditing standards generally accepted
in the United States of America. 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 Key Financial Systems, Inc. as
of December 31, 2000, and the results of its operations and its cash flows for
the years ended December 31, 2000 and 1999, in conformity with accounting
principles generally accepted in the United States of America.
/s/ McGladrey & Pullen, LLP
Fort Lauderdale, Florida
March 30, 2001
1
KEY FINANCIAL SYSTEMS, INC.
BALANCE SHEET
DECEMBER 31, 2000
ASSETS
-----------------------------------------------------------------------------
Cash $ 71,873
Credit card receivables, net (Note 2) 622,943
Other receivables (Note 3) 3,787,854
Due from affiliates (Note 5) 81,138
Leaseholds and equipment, net (Note 4) 266,643
Other assets 32,329
----------------
$ 4,862,780
================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Due to cardholders (Note 6) $ 3,102,926
Accounts payable (Note 5) 595,550
Accrued expenses and other liabilities (Note 5) 402,452
----------------
4,100,928
----------------
Commitments and contingencies (Note 6)
Stockholders' equity:
Common stock, par value $1 per share, authorized
7,500 shares; issued and outstanding 2,000 shares 2,000
Additional paid-in capital 371,835
Retained earnings 388,017
----------------
761,852
----------------
$ 4,862,780
================
See Notes to Financial Statements.
2
KEY FINANCIAL SYSTEMS, INC.
STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 2000 AND 1999
2000 1999
--------------------------------------------------------------------------------------------------
Credit card income:
Card servicing fees $ 6,892,015 $11,628,340
Other 231,799 246,767
----------------- ---------------
7,123,814 11,875,107
Provision for losses (Note 2) 139,782 511,645
----------------- ---------------
NET CREDIT CARD INCOME
AFTER PROVISION FOR LOSSES 6,984,032 11,363,462
----------------- ---------------
Other income:
Application fees, net of direct marketing costs; 2000
$10,366,826, 1999 $7,153,144 (Note 5) 2,735,438 935,015
Servicing fee income (Note 5) 672,420 3,832,736
Other 182,618 59,807
----------------- ---------------
3,590,476 4,827,558
----------------- ---------------
Operating expenses (Note 5):
Salaries and wages 2,686,033 3,997,724
Employee benefits 333,843 466,540
Third party servicing fees (Note 8) 3,007,077 4,978,279
Occupancy and equipment (Note 6) 426,930 351,647
Other operating expenses (Note 7) 1,139,842 1,011,976
----------------- ---------------
7,593,725 10,806,166
----------------- ---------------
NET INCOME $ 2,980,783 $ 5,384,854
================= ===============
See Notes to Financial Statements.
3
KEY FINANCIAL SYSTEMS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2000 AND 1999
Additional Retained
Common Paid In Earnings
Stock Capital (Deficit) Total
-------------------------------------------------------------------------------------------------------------------
Balance, January 1, 1999 $ 2,000 $ 271,835 $ (354,732) $ (80,897)
Net income - - 5,384,854 5,384,854
Capital contributed - 100,000 - 100,000
Dividends paid - - (4,063,888) (4,063,888)
--------------- --------------- ---------------- -----------------
Balance, December 31, 1999 2,000 371,835 966,234 1,340,069
Net income - - 2,980,783 2,980,783
Dividends paid - - (3,559,000) (3,559,000)
--------------- --------------- ---------------- -----------------
Balance, December 31, 2000 $ 2,000 $ 371,835 $ 388,017 $ 761,852
=============== =============== ================ =================
See Notes to Financial Statements.
4
KEY FINANCIAL SYSTEMS, INC.
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2000 AND 1999
2000 1999
- ---------------------------------------------------------------------------------------------------------
Cash Flows From Operating Activities
Net income $ 2,980,783 $ 5,384,854
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Provision for losses 139,782 511,645
Depreciation and amortization 93,167 117,349
Increase in other receivables (913,561) (2,501,580)
(Increase) decrease in due from affiliates 604,326 (685,464)
(Increase) decrease in other assets (14,412) 21,960
Increase in due to cardholders 700,549 993,684
Increase (decrease) in accounts payable, accrued
expenses and other liabilities 307,961 (334,823)
----------------- -----------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 3,898,595 3,507,625
----------------- -----------------
Cash Flows From Investing Activities
Net (increase) decrease in credit card receivables (242,796) 89,823
Collection of advances to stockholders - 288,888
Purchase of property and equipment (55,834) (208,370)
----------------- -----------------
NET CASH PROVIDED BY (USED IN) INVESTING
ACTIVITIES (298,630) 170,341
----------------- -----------------
Cash Flows From Financing Activities
Capital contributions - 100,000
Dividends paid (3,559,000) (4,063,888)
----------------- -----------------
NET CASH USED IN FINANCING ACTIVITIES (3,559,000) (3,963,888)
----------------- -----------------
NET INCREASE (DECREASE) IN CASH
40,965 (285,922)
Cash:
Beginning 30,908 316,830
----------------- -----------------
Ending $ 71,873 $ 30,908
================= =================
See Notes to Financial Statements.
5
KEY FINANCIAL SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
NATURE OF BUSINESS: Key Financial Systems, Inc. (the "Company") designs and
markets credit card products aimed at the sub-prime market. The credit card
products are marketed for unaffiliated banks under agreements that provide the
Company with a 100% participation interest in the receivables and related rights
associated with credit cards issued and requires the payment of monthly
servicing fees to the banks. The Company provides collection and customer
service related to the credit cards issued.
BASIS OF FINANCIAL STATEMENT PRESENTATION AND ACCOUNTING ESTIMATES: The
accounting and reporting policies of the Company conform to generally accepted
accounting principles and general practices within the financial services
industry. In preparing the accompanying financial statements, management is
required to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities as of
the date of the balance sheet and the reported amounts of revenue and expenses
for the period. Actual results could differ from those estimates.
PRESENTATION OF CASH FLOWS: Cash flows from credit card receivables are reported
net.
CREDIT CARD RECEIVABLES: Credit card receivables are stated at cost plus
refundable and earned fees (the balance reported to customers), reduced by
allowances for refundable fees and losses.
Fees are accrued monthly on active credit card accounts and included in credit
card receivables, net of estimated uncollectible amounts. Accrual of income is
discontinued on credit card accounts that have been closed or charged off.
Accrued fees on credit card loans are charged off with the card balance,
generally when the account becomes 90 days past due.
The allowance for losses is established through a provision for losses charged
to expense. Receivables are charged against the allowance for losses when
management believes that collectibility of principal is unlikely. The allowance
is an amount that management believes will be adequate to absorb estimated
losses on existing accounts, based on evaluation of the collectibility of the
accounts and prior loss experience. This evaluation also takes into
consideration such factors as changes in the volume of the credit card
receivable portfolio, overall portfolio quality, and current economic conditions
that may affect the borrowers' ability to pay. While management uses the best
information available to make its evaluation, this estimate is susceptible to
significant change in the near term.
DUE FROM AFFILIATES: The amount due from affiliate in the accompanying balance
sheets represents amounts paid by the Company for Nova Financial Systems, Inc.
("Nova"), a company affiliated through common ownership, and the balance of
unpaid servicing fees receivable in connection with Nova's card activity. The
Company provided credit card marketing, customer service and collection services
for Nova in exchange for a fee. Effective July 1, 2000, the Company no longer
provides such services for Nova.
6
KEY FINANCIAL SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
OTHER RECEIVABLES AND DUE TO CARDHOLDERS: The Company charges a fully refundable
reservation fee equal to each cardholder's borrowing limit upon issuance of a
credit card. The amount due to cardholders represents the balance of reservation
fees that would have to be refunded to cardholders should they close their
accounts at the balance sheet date. Funds held in trust at Key Bank & Trust to
secure payment of this liability are reflected in other receivables in the
accompanying balance sheet.
LEASEHOLDS AND EQUIPMENT: Leaseholds and equipment are stated at cost less
accumulated depreciation. Depreciation is computed principally by the double
declining-balance method over the assets' estimated useful lives.
INCOME TAXES: The Company, with the consent of its stockholders, elected to be
taxed under the provisions of Subchapter S of the Internal Revenue Code
effective January 1, 1998, which provides that in lieu of corporate income tax
the stockholders separately account for their pro rata shares of the Company's
items of income, deductions, losses and credits. As a result of this election,
no income taxes have been recognized in the accompanying financial statements.
As of December 31, 2000, the Company's reported net assets exceed their tax
bases by approximately $330,000. Accordingly, if the election was terminated on
that date, a deferred tax liability of approximately $122,000 would be
recognized by a charge to income tax expense. Funds received in excess of
projected required cash requirements for the next month are generally
distributed to the stockholders.
NOTE 2. CREDIT CARD RECEIVABLES
The composition of credit card receivables at December 31, 2000 is as follows:
Credit card receivables $ 24,993,671
Refundable reservation fees (24,241,000)
-------------------
752,671
Less allowance for losses 129,728
-------------------
$ 622,943
===================
Changes in the allowance for losses for years ended December 31, 2000 and 1999
are as follows:
2000 1999
------------------ ------------------
Balance, beginning $ 60,466 $ 217,872
Provision for losses 139,782 511,645
Recoveries of amounts charged-off - 4,231
Amounts charged-off (70,520) (673,282)
------------------ ------------------
Balance, ending $ 129,728 $ 60,466
================== ==================
7
KEY FINANCIAL SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 3. OTHER RECEIVABLES
The composition of other receivables at December 31, 2000 is as follows:
Due from Key Bank & Trust $ 1,532,254
Due from Net 1st National Bank 2,150,410
Other 105,190
--------------------
$ 3,787,854
====================
The amounts due from Key Bank and Trust and Net First National Bank are held in
trust accounts by the respective bank.
NOTE 4. LEASEHOLDS AND EQUIPMENT
The major classes of leaseholds and equipment and total accumulated depreciation
at December 31, 2000, is as follows:
Leasehold improvements $ 116,202
Furniture and equipment 360,011
Software 15,944
-------------------
492,157
Less accumulated depreciation 225,514
-------------------
$ 266,643
===================
NOTE 5. TRANSACTIONS WITH RELATED PARTIES
The Company had an informal agreement with Nova under which the Company provided
marketing and preprocessing of credit card applications, customer service and
collection services for Nova. Expenses were charged to Nova for application
processing and customer service based on a set fee per application processed and
for collections based on a set fee per delinquent account on file. The Company
believes the method and per unit price charged were consistent with the methods
and rates of similar third party credit card processors. As of July 1, 2000, the
Company is no longer providing these services to Nova. The Company recognized
processing fee and servicing income of $672,420 and $3,832,736 associated with
Nova's activities during 2000 and 1999, respectively. These amounts are included
in other operating income. As of December 31, 2000, Nova owed the Company
$81,138 in connection with services performed and amounts paid for Nova by the
Company.
8
KEY FINANCIAL SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 5. TRANSACTIONS WITH RELATED PARTIES (CONTINUED)
Accrued expenses and other liabilities include $325,000 of short-term borrowings
from shareholders at December 31, 2000. This amount was borrowed in December to
provide working capital and repaid in January of 2001.
The Company has entered into an agreement with Paragon Water Member Services
("Paragon"), a company affiliated through common ownership, whereby Paragon
provides credit card marketing services for the Company and for Nova. Paragon
earns commissions for card applications that are not subsequently refunded. The
Company paid Paragon $897,521 and $5,662,026 in commissions during 2000 and
1999. No amount was due to Paragon at December 31, 2000.
NOTE 6. COMMITMENTS, CONTINGENCIES AND CREDIT RISK
A credit limit has been established for each cardholder account acquired by the
Company. By agreement, the credit limit can be terminated at any time for any
reason. Because the initial reservation fee charged to all account holders is
fully refundable, the total of accounts with credit limits in excess of
cardholder balances is reflected as a liability in the amount of $3,102,926 as
of December 31, 2000, in the accompanying balance sheets.
LEASE COMMITMENTS: The Company rents office space under an operating lease with
initial terms through September 30, 2004. The office lease has a five-year
renewal option. The future minimum rental payments due under the lease is as
follows:
Year Ending
December 31, Amount
- -----------------------------------------------------------------------------
2001 $ 292,130
2002 306,737
2003 322,074
2004 250,502
-------------------
$ 1,171,443
===================
Total rent expense under operating leases was approximately $299,000 and
$229,000 for the years ended December 31, 2000 and 1999, respectively.
CONTINGENCIES: In the normal course of business, the Company is involved in
various legal proceedings. In the opinion of management, any liability resulting
from such proceedings would not have a material adverse effect on the Company's
financial statements.
Credit cards are issued throughout the United States to customers that are
considered high credit risks. The Company evaluates each customer's credit
worthiness on a case-by-case basis. Because of the reservation fee charged upon
issuance of credit cards, charges for purchases or cash advances are generally
limited to the amount of payments collected from each customer less fees
charged.
The Company's credit card receivables were initiated under membership terms with
VISA and MasterCard. Modification of these terms by VISA or MasterCard could
adversely affect operating results.
9
KEY FINANCIAL SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 7. OTHER OPERATING EXPENSES
Other operating expense for the years ended December 31, 2000 and 1999 included
the following:
2000 1999
---------------- ----------------
Telecommunications $ 402,038 $ 648,111
Professional fees 341,444 166,005
Printing and supplies 15,007 41,461
Bank charges 101,183 3,461
Other 280,170 152,938
---------------- ----------------
$ 1,139,842 $ 1,011,976
================ ================
NOTE 8. SETTLEMENT WITH BANK
In April 1999, the Company reached a settlement with Key Bank & Trust that
resulted in a) a significant increase in the amount of collected funds held in
trust by the Bank pending payment to the Company, b) the cessation of marketing
credit cards for the Bank, c) a reduction in the monthly fees charged by the
Bank to the Company, and d) mutual releases from any and all claims against each
other through the date of the release. In connection with the settlement, the
Bank paid the Company $1,016,928, which has been recognized as a reduction in
third party servicing fees for the year ended December 31, 1999 in the
accompanying statements of operations.
NOTE 9. PLAN OF REORGANIZATION
The Company has entered into an Agreement and Plan of Reorganization with
Equitex, Inc. under which the Company's stockholders would exchange all of the
issued and outstanding shares of the Company for a) 25% of the outstanding
common shares of Equitex, after giving effect to the consummation of this merger
and a similar planned merger of Nova, b) warrants for the purchase of common
stock of Equitex equal to 50% of any warrants, options, preferred stock or other
securities outstanding at the closing date and exchangeable for or convertible
into Equitex common shares, and c) $2,500,000.
NOTE 10. SUBSEQUENT EVENT
On March 5, 2001, the Company agreed to issue 40.82 shares of common stock,
representing 2% of the outstanding common stock of the Company on a fully
diluted basis, to three individual investors for $900,000. Mr Henry Fong,
President and Chairman of Equitex, Inc. purchased 20.41 of the shares and owns
1% of the Company.
10
NOVA FINANCIAL SYSTEMS, INC.
FINANCIAL REPORT
DECEMBER 31, 2000
CONTENTS
- -----------------------------------------------------------------------------
INDEPENDENT AUDITOR'S REPORT 1
- -----------------------------------------------------------------------------
FINANCIAL STATEMENTS
Balance sheet 2
Statements of operations 3
Statements of stockholders' equity 4
Statements of cash flows 5
Notes to financial statements 6 - 10
- -----------------------------------------------------------------------------
Independent Auditor's Report
To the Board of Directors
Nova Financial Systems, Inc.
Clearwater, Florida
We have audited the accompanying balance sheet of Nova Financial Systems, Inc.
as of December 31, 2000, and the related statements of operations, stockholders'
equity, and cash flows for the years ended December 31, 2000 and 1999. 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 auditing standards generally accepted
in the United States of America. 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 Nova Financial Systems, Inc. as
of December 31, 2000, and the results of its operations and its cash flows for
the years ended December 31, 2000 and 1999, in conformity with accounting
principles generally accepted in the United States of America.
/s/ McGladrey & Pullen, LLP
Fort Lauderdale, Florida
March 30, 2001
1
NOVA FINANCIAL SYSTEMS, INC.
BALANCE SHEET
DECEMBER 31, 2000
ASSETS
- -------------------------------------------------------------------------------
Cash $ 1,738
Credit card receivables, net (Note 2) 283,353
Due from Merrick Bank 1,490,231
Due from shareholders 606,500
-----------------
$ 2,381,822
=================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Accounts payable $ 85,085
Due to cardholders (Note 4) 1,286,517
Due to affiliate (Note 3) 81,138
Accrued expenses and other liabilities 792,769
-----------------
2,245,509
-----------------
Commitments and contingencies (Note 4)
Stockholders' equity:
Common stock, par value $1 per share, authorized
7,500 shares; issued and outstanding 1,000 shares 1,000
Additional paid-in capital 24,000
Retained earnings 111,313
-----------------
136,313
-----------------
$ 2,381,822
=================
See Notes to Financial Statements.
2
NOVA FINANCIAL SYSTEMS, INC.
STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2000 AND 1999
2000 1999
- ------------------------------------------------------------------------------------------------
Credit card income:
Servicing fees $ 4,322,258 $ 7,278,767
Other 148,746 127,115
----------------- -----------------
4,471,004 7,405,882
Provision for (recovery of) losses (Note 2) (83,262) 676,343
----------------- -----------------
NET CREDIT CARD INCOME AFTER
PROVISION FOR LOSSES 4,554,266 6,729,539
----------------- -----------------
Other income:
Application fees, net of direct marketing costs
2000 none, 1999 $11,307,984 (Note 3) - 1,942,520
----------------- -----------------
Operating expenses:
Application processing fees (Note 3) - 2,112,092
Third party servicing fees (Note 3) 3,342,984 5,934,125
Other operating expenses (Note 6) 635,345 303,258
----------------- -----------------
3,978,329 8,349,475
----------------- -----------------
INCOME (LOSS) BEFORE INCOME TAXES 575,937 322,584
Provision for income taxes (Note 5) - 117,500
----------------- -----------------
NET INCOME (LOSS) $ 575,937 $ 205,084
================= =================
See Notes to Financial Statements.
3
NOVA FINANCIAL SYSTEMS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2000 AND 1999
Additional Retained
Common Paid In Earnings
Stock Capital (Deficit) Total
- -------------------------------------------------------------------------------------------------------------------
Balance, January 1, 1999 $ 1,000 $ 24,000 $ (3,708) $ 21,292
Net income - - 205,084 205,084
-------------- --------------- -------------- ---------------
Balance, December 31, 1999 1,000 24,000 201,376 226,376
Net income - - 575,937 575,937
Dividends - - (666,000) (666,000)
-------------- --------------- -------------- ---------------
Balance, December 31, 2000 $ 1,000 $ 24,000 $ 111,313 $ 136,313
============== =============== ============== ===============
See Notes to Financial Statements.
4
NOVA FINANCIAL SYSTEMS, INC.
STATEMENTS OF CASH FLOWS
Years Ended December 31, 2000 and 1999
2000 1999
- ------------------------------------------------------------------------------------------------
Cash Flows From Operating Activities
Net income $ 575,937 $ 205,084
Adjustments to reconcile net income
(loss) to net cash provided by (used
in) operating activities:
Provision for (recovery of) losses (83,262) 676,343
Deferred income taxes 606,500 (606,500)
Decrease (increase) in other receivables 1,090,434 (2,580,646)
Increase in due from stockholders (606,500) -
Decrease in due from affiliates - 22,761
(Decrease) increase in accounts payable and accrued
expenses (121,606) 977,074
(Decrease) increase in due to cardholders (635,252) 1,921,769
(Decrease) increase in due to affiliates (604,327) 685,464
---------------- -----------------
NET CASH PROVIDED BY (USED IN)
OPERATING ACTIVITIES 221,924 1,301,349
---------------- -----------------
Cash Flows Provided By (Used In) Investing activities
Net (increase) decrease in credit card receivables 419,058 (1,294,593)
---------------- -----------------
Cash Flows From Financing Activities
Payment of dividends (666,000) -
---------------- -----------------
NET CASH PROVIDED BY (USED IN) FINANCING
ACTIVITIES (666,000) -
---------------- -----------------
NET INCREASE (DECREASE) IN CAsh (25,018) 6,756
Cash:
Beginning 26,756 20,000
---------------- -----------------
Ending $ 1,738 $ 26,756
================ =================
See Notes to Financial Statements.
5
NOVA FINANCIAL SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
NATURE OF BUSINESS: Nova Financial Systems, Inc. (the "Company") designs and
markets credit card products aimed at the sub-prime market. The credit card
products are marketed for an unaffiliated bank under an agreement that provides
the Company with a 100% participation interest in the credit cards issued and
requires the payment of monthly servicing fees to the bank.
BASIS OF FINANCIAL STATEMENT PRESENTATION AND ACCOUNTING ESTIMATES: The
accounting and reporting policies of the Company conform to generally accepted
accounting principles and general practices within the financial services
industry. In preparing the accompanying financial statements, management is
required to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities as of
the date of the balance sheet and the reported amounts of revenue and expenses
for the period. Actual results could differ from those estimates.
PRESENTATION OF CASH FLOWS: Cash flows from credit card receivables are reported
net.
CREDIT CARD RECEIVABLES: Credit card receivables are stated at cost plus
refundable and earned fees (the balance reported to customers), reduced by
allowances for refundable fees and losses.
Fees are accrued monthly on active credit card accounts and included in credit
card receivables, net of estimated uncollectible amounts. Accrual of income is
discontinued on credit card accounts that have been closed or charged off.
Accrued fees on credit card loans are charged off with the card balance,
generally when the account becomes 90 days past due.
The allowance for losses is established through a provision for losses charged
to expense. Credit card receivables are charged against the allowance for losses
when management believes that collectibility of the principal is unlikely. The
allowance is an amount that management believes will be adequate to absorb
estimated losses on existing receivables, based on evaluation of the
collectibility of the accounts and prior loss experience. This evaluation also
takes into consideration such factors as changes in the volume of the loan
portfolio, overall portfolio quality and current economic conditions that may
affect the borrowers' ability to pay. While management uses the best information
available to make its evaluation, this estimate is susceptible to significant
change in the near term.
DUE TO AFFILIATES: The amount due to affiliate in the accompanying balance
sheets represents amounts paid on behalf of the Company by Key Financial
Systems, Inc. ("Key"), a company affiliated through common ownership, and the
balance of unpaid servicing fees payable in connection with Nova's card
activity. Effective July 1, 2000, the Company no longer receives such services
from Key.
6
NOVA FINANCIAL SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
DUE FROM MERRICK BANK AND DUE TO CARDHOLDERS: The Company charges a fully
refundable reservation fee equal to each cardholder's borrowing limit upon
issuance of a credit card. The amount due to cardholders represents the balance
of reservation fees that would have to be refunded to cardholders should they
close their accounts at the balance sheet date. Funds held in trust to secure
payment of this liability are reflected in due from Merrick Bank in the
accompanying balance sheet.
INCOME TAXES: The Company, with the consent of its stockholders, elected to be
taxed under the provisions of Subchapter S of the Internal Revenue Code
effective January 1, 2000, which provides that in lieu of corporate income tax
the stockholders separately account for their pro rata shares of the Company's
items of income, deductions, losses and credits. As of December 31, 2000, the
Company's reported net assets exceed their tax bases by approximately $155,000.
Accordingly, if the election was terminated on that date, a deferred tax
liability of approximately $58,000 would be recognized by a charge to income tax
expense. Funds received in excess of projected required cash requirements for
the next month are generally distributed to the stockholders.
NOTE 2. CREDIT CARD RECEIVABLES
The composition of credit card receivables at December 31, 2000 is as follows:
Credit card receivables $ 7,001,194
Refundable reservation fees (6,593,483)
-------------------
407,711
Less allowance for losses 124,358
-------------------
$ 283,353
===================
Changes in the allowance for losses for the year ended December 31, 2000 and
1999, are as follows:
2000 1999
------------------- --------------------
Balance, beginning $ 469,032 $ 192
Provision for (recovery of) losses (83,262) 676,343
Recoveries of amounts charged-off - -
Amounts charged-off (261,412) (207,503)
------------------- --------------------
Balance, ending $ 124,358 $ 469,032
=================== ====================
7
NOVA FINANCIAL SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 3. TRANSACTIONS WITH RELATED PARTIES
The Company had an informal agreement with Key under which Key provided
marketing and preprocessing of credit card applications, customer service and
collection services for Nova. Expenses were charged to the Company for
application processing and customer service based on set fee per application
processed and for collections based on a set fee per delinquent account on file.
The Company believes the method and per unit price charged were consistent with
the methods and rates of similar third party credit card processors. As of July
1, 2000, the Company is no longer receiving services from Key. The Company
recognized processing fee and servicing expense of $672,420 and $3,832,736
associated with Key's activities during 2000 and 1999, respectively. As of
December 31, 2000, the Company owed Key $81,138 in connection with services
performed and amounts paid for Nova by Key.
The Company has entered into an agreement with Paragon Water Services, Inc.
(Paragon), a company affiliated through common ownership, whereby Paragon
provides credit card marketing services for the Company. Paragon earns
commissions for card applications that are not subsequently refunded. The
Company paid Paragon approximately $6,631,608 in commissions during 1999, and
none in 2000.
NOTE 4. COMMITMENTS, CONTINGENCIES AND CREDIT RIsk
A credit limit has been established for each cardholder account acquired by the
Company. By agreement, the credit limit can be terminated at any time for any
reason. Because the initial reservation fee charged to all account holders is
fully refundable, the total of accounts with credit limits in excess of
cardholder balances is reflected as a liability in the amount of $1,286,517 as
of December 31, 2000, in the accompanying balance sheet.
CONTINGENCIES: In the normal course of business, the Company is involved in
various legal proceedings. In the opinion of management, any liability resulting
from such proceedings would not have a material adverse effect on the Company's
financial statements.
Credit card loans are issued throughout the United States to customers that are
considered high credit risks. The Company evaluates each customer's credit
worthiness on a case-by-case basis. Because of the reservation fee charged upon
issuance of credit cards, charges for purchases or cash advances are generally
limited to the amount of payments collected from each customer less fees
charged.
The Company issues its credit cards under membership terms with VISA.
Modification of these terms by VISA could adversely affect operating results.
8
NOVA FINANCIAL SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 5. INCOME TAXES
All active card accounts are charged monthly membership fees, late charges,
overlimit fees and other charges according to the card agreements. The Company
has not recognized certain of these monthly charges as income for financial
reporting purposes because the charges are not believed to be collectible.
The Company elected S Corporation status effective January 1, 2000. Upon
converting to S Corporation status, the Company eliminated deferred tax assets
in the amount of $606,500 as a charge against income from operations. This
charge against income was offset by the recognition of a receivable from
shareholders in the amount of $606,500 due to a commitment from the shareholders
to reimburse the Company for income taxes paid by the Company related to losses
recognized by the Company for financial reporting purposes in 1999, but passed
through to the shareholders in years subsequent to 1999 for income tax purposes.
The provision for income taxes charged to operations for the years ended
December 31, 2000 and 1999 consist of the following:
2000 1999
----------------- ------------------
Currently payable or paid:
Federal $ - $ 618,000
State - 106,000
Deferred income taxes 606,500 (606,500)
Reimbursement (606,500) -
----------------- ------------------
$ - $ 117,500
================= ==================
The income tax provision differs from the amount of income tax determined by
applying the U. S. federal income tax rate to pretax income for the years ended
December 31, 2000 and 1999, due to the following:
2000 1999
----------------- ------------------
Computed "expected" tax expense (benefit) $ - $ 109,679
Increase resulting from state income
taxes, net of federal tax benefit - 11,710
Effect of lower tax brackets and other - (3,889)
----------------- ------------------
$ - $ 117,500
================= ==================
9
NOVA FINANCIAL SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 6. OTHER OPERATING EXPENSES
Other operating expenses for the years ended December 31, 2000 and 1999,
included the following:
2000 1999
----------------- -----------------
Cardholder expense, other $ 146,438 $ 96,206
Professional fees 391,391 20,128
Printing and supplies - 21,742
Other 97,516 165,182
----------------- -----------------
$ 635,345 $ 303,258
================= =================
NOTE 7. PLAN OF REORGANIZATION
The Company has entered into an Agreement and Plan of Reorganization with
Equitex, Inc. (Equitex) under which the Company's stockholders would exchange
all of the issued and outstanding shares of the Company for a) 25% of the
outstanding common shares of Equitex, after giving effect to the consummation of
this merger and a similar planned merger of Key, b) warrants for the purchase of
common stock of Equitex equal to 50% of any warrants, options, preferred stock
or other securities outstanding at the closing date and exchangeable for or
convertible into Equitex common shares, and c) $2,500,000.
NOTE 8. SUBSEQUENT EVENT
On March 5, 2001, the Company agreed to issue 20.41 shares of common stock,
representing 2% of the outstanding common stock of the Company on a fully
diluted basis, to three individual investors for $100,000. Mr Henry Fong,
President and Chairman of Equitex, Inc. purchased 10.20 of the shares and owns
1% of the Company.
10