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, 2002
/ / 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)
- --------------------------------------------------------------------------------
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 $14,187,474 based on the last sale price of the Registrant's
common stock on April 11, 2003, ($0.62 per share) as reported by the Nasdaq
Stock Market.
The Registrant had 28,640,497 shares of common stock outstanding as of March 31,
2003.
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
company, which became effective on January 4, 1999.
At a special stockholders meeting held on June 22, 2001, our stockholders
approved the distribution of all of our assets and liabilities to Equitex
2000, Inc., which was then our wholly-owned, Delaware-chartered subsidiary
(formed in 2001), 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. Equitex 2000 also assumed
all of 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.
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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 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 as receiver. The
FDIC subsequently closed all the credit card accounts relating to Key's contract
with Net First National Bank. The FDIC's action resulted in the termination of
all future credit card servicing revenues to Key from the Net First portfolio
after March 4, 2002. As of December 31, 2002, Key and Nova have ceased current
business operations but continue to receive residual revenue from the Merrick
Bank and Key Bank and Trust portfolios.
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.
In August 2002 we formed a new majority owned subsidiary, Denaris Corporation,
to pursue opportunities in stored value card operations. In return for assigning
our rights to certain notes receivable as well as the opportunity to acquire
certain technological and other information from our subsidiary Key, Denaris
agreed to pay Equitex $250,000 in cash in the form of a promissory note as well
as 5,000,000 shares of Denaris common stock. As of December 31, 2002, Denaris
had 6,500,000 shares of common stock outstanding; therefore, we owned 77% of the
outstanding common stock.
Our common stock is currently traded on the Nasdaq SmallCap Market. In July
2002, we received notice from the Nasdaq Stock Market that for the last 30
consecutive trading days our common stock's minimum bid price had fallen below
the $1.00 per share price required for continued inclusion. We had until January
14, 2003 to regain compliance with the minimum bid price requirement. Although
we did not meet the minimum bid price requirement by January 14, 2003, we
received notice from the Nasdaq Stock Market that we met the initial inclusion
criteria for The Nasdaq SmallCap Market and will, therefore, be provided an
additional 180 calendar days, or until July 14, 2003 to regain compliance with
the minimum bid price requirement. Initial inclusion criteria required us to
have (i) stockholders' equity of $5 million, (ii) market value of listed
securities of $50 million, or (iii) net income from continuing operations of
$750,000 in the most recently completed fiscal year or in two of the last three
completed fiscal years. At September 30, 2002, the period on which the Nasdaq
notice was based, our balance sheet reflected stockholders' equity of
$10,707,796. As of December 31, 2002, our stockholders' equity was $9,507,511.
If at any time before July 14, 2003, the bid price of our common stock closes at
$1.00 per share or more for a minimum of 10 consecutive trading days, the Nasdaq
Stock Market will provide written notification that we comply with Marketplace
Rule 4310(c)(4). If compliance with the Marketplace Rule cannot be demonstrated
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by July 14, 2003, the Nasdaq Stock Market will provide written notification that
our securities will be delisted. At that time we may appeal the Nasdaq Stock
Market's determination to a Listing Qualifications Panel.
In November 2002, we received notice from Nasdaq that our issuance of 300,000
warrants to purchase common stock at $.50 per share to James P. Welbourn, one of
our directors, in March 2002, violated Nasdaq Marketplace Rule 4310(i)(1)(A).
Mr. Welbourn exercised the warrants in March and April 2002 and paid us $150,000
for the exercise price. We provided Nasdaq with all requested material regarding
the warrants and the circumstances upon which they were issued. Nasdaq
requested, and we provided, a plan to achieve and sustain compliance which
included the rescission of the warrants issued in addition to our acquisition of
the common stock that was issued in connection with Mr. Welbourn's exercise of
the warrants. Accordingly, Mr. Welbourn returned 300,000 shares of our common
stock to us and we have reimbursed Mr. Welbourn $150,000 for the exercise price
he paid through the issuance of a note payable. Additionally, we have
implemented policies and procedures that require future issuances of any
equity-based compensation, including options and warrants, to any executive
officer, director, consultant or other person as compensation for services
rendered to us, be reviewed by outside counsel for compliance with Marketplace
Rules. Nasdaq has accepted our definitive plan to achieve and sustain compliance
with respect to this issue.
On December 27, 2002, we held our Annual Meeting of Stockholders. At that
meeting, a proposal was approved to cause a one share for six shares reverse
stock split of our common stock. As of our filing of this Annual Report on Form
10-K, our board of directors has not enacted the reverse split which has been
put on hold until further notice.
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, 2002.
(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 three
wholly-owned subsidiaries, Chex Services, Inc., a Minnesota corporation, Key
Financial Systems, Inc., a Florida corporation and Nova Financial Systems, Inc.,
a Florida corporation, and Denaris Corporation, a Delaware Corporation and our
majority-owned subsidiary. The business operations of each subsidiary is
outlined more fully below.
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.
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As of March 31, 2003, Chex had contracts to provide its cash access products and
services in fifty (50) locations throughout the United States. At each of these
locations Chex can provide any one or a combination of: check cashing;
credit/debit card cash advance systems; and ATM terminals. Chex either staffs
the locations with its personnel or provides its products and services to the
locations based upon the contract with the location.
Chex's services are provided pursuant to the terms of a financial services
agreement entered into with the respective 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 the transaction volumes of each
product and the average dollar amount per transaction. 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.
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 is 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.
For the year ended December 31, 2002, Chex processed approximately 481,000
credit/debit card transactions with $174 million in advances and earned fees of
$5,490,224 on these transactions.
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
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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. Chex also contacts 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.
In the past, Chex has used its own in-house collections department to pursue
collection of returned checks. In September 2002, Chex incorporated this
department as Collection Solutions, Inc. creating a separate wholly-owned
stand-alone collections subsidiary licensed as a collection agency in seven
states. In addition to providing collection services for Chex, Collection
Solutions intends to offer its services to current Chex customers as well as
other companies both within and outside of the gaming industry. For the year
ended December 31, 2002, Chex Services collected fees of $465,820 on returned
checks and had other income of $210,164.
For the year ended December 31, 2002, Chex cashed approximately $321 million in
customer checks and earned fees of approximately $9,960,000 on these
transactions.
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. For the year ended December 31, 2002, Chex processed over 3.3
million ATM transactions with over $332 million in advances and earned fees or
commissions of $3,453,572.
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STORED VALUE CARD. In August 2002, Chex executed an agreement with West Suburban
Bank to issue stored value cards. Under the terms of the agreement, Chex
services will primarily function as an independent marketing agent. The
"FastFunds" Stored Value Card program allows customers to load money onto the
FastFunds card that can be used at ATM's worldwide and at any location that
accepts pin based Point of Sale debit transactions. FastFunds current customer
base can load jackpot winnings on to the card, up to a maximum of $7,500 per
day, which is less costly and more secure for the establishment and safer for
the customers. Customers can also load money on to the card rather than leave
the gaming establishment with a significant amount of cash winnings. Using two
cards and transferring money from one card to the other also allows the card to
be used for money remittance in a method that can be less expensive and more
convenient than traditional money remittance systems.
PREPAID PAYROLL CARD. Chex has been approved by Visa U.S.A. to market a prepaid
payroll card program through West Suburban Bank to current and prospective
clients. This program allows employees to have their payroll loaded on to the
"PowerCash" payroll card which they can then use at ATM's to make cash
withdrawals or make purchases at any location that accepts debit and credit
cards. The PowerCash payroll card is targeted at employees who do not have
checking accounts or do not like direct deposit and can be used as a virtual
checking account including bill payment capabilities.
In March 2003, we began marketing the PowerCash prepaid payroll card to
employees of casinos in which we operate. By law, employers are required to
offer to their employees at least one alternative to direct deposit for their
pay. To comply with this law, traditionally, employers have offered manual
checks, which are costly. Our PowerCash prepaid payroll card will allow
employers to comply with the law with more ease and less cost. If requested by
the employee, we "load" the amount of the employees pay, as reported by the
employer, onto a card, which the employee may then utilize to draw down the
balance like a debit card. Our PowerCash prepaid payroll cards are accepted by
most merchants throughout the world. We receive a transaction fee each time the
employee utilizes the card as well as half of the monthly maintenance fee.
Because we believe this product can be utilized in a broad context, we intend to
market this product outside of the gaming industry.
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 casino's current contracts with another cash access service
provider expire. At December 31, 2002, Chex had 50 contracts with casinos and
other gaming establishments to provide varying levels of cash access services as
compared to 44 at December 31, 2001. As of December 31, 2002, Chex Services is
the number one provider of full-service booth operations utilizing cash access
services to the Native American gaming industry.
In furtherance of Chex's objective to increase its market share, its marketing
plan is designed to increase 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 its 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, which 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, its operations 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.
Tribal governments exercise a form of governmental immunity that is comparable
to the immunity of states, local governments and the federal government. Like
the federal government, tribal governments retain limited immunity in order to
protect government funds and discretionary governmental functions from lawsuits
and may limit the size of damages or claims. Tribes provide for insurance and
limited waivers of their sovereign immunity, taking responsibility for the
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actions of tribal employees. Tribal sovereign immunity may limit our ability to
pursue certain legal remedies should Chex believe it has a claim against a
tribal authority.
DENARIS CORPORATION
Denaris Corporation was formed on August 16, 2002 to develop and market a
prepaid reloadable stored value card program. As of December 31, 2002, Denaris
had not commenced active business operations. Stored value cards offer a
convenient alternative to customers, particularly immigrants, who choose not to
utilize traditional bank accounts due to language barriers and apprehension.
Initially, Denaris intends to focus on the development of marketing programs
targeting various immigrant populations that utilize international fund
remittance services to transfer funds. Additionally, we, through Denaris, intend
to market a proprietary stored value card program, with our initial focus on the
international funds remittance business between the United States and Jamaica.
Reloadable stored value cards can be obtained by anyone without a credit check
or intrusive personal information and allow a customer to place funds on the
card in varying amounts at any time that can be accessed at most ATM's, through
point-of-sale transactions wherever debit cards are accepted or at partner
customer service outlets. They also provide a fast, easy and cost effective
means of transferring funds to anyone, anywhere in the world.
Stored value cards offer a convenient alternative to customers who may not have
convenient access to traditional banking institutions or who choose not to
utilize traditional banking institutions due to language barriers, fear or
mistrust of the banking system. Stored value card customers may be immigrants,
college students, international travelers, armed forces personnel or other
individuals or entities that need a safe way to store, transfer or utilize cash
outside of a traditional bank account.
Once money is loaded onto a card, customers have immediate access to their funds
wherever the card is accepted. If a customer wishes to transfer funds to family
or friends either nationally or internationally, they may purchase a second card
that is sent to the recipient, which may be used to access the transferred funds
for a minimal fee. Often these transfer fees are significantly lower than those
charged by traditional money transfer services.
PAYMASTER JAMAICA AGREEMENT. In August 2002, we signed an agreement (described
below) with Paymaster Jamaica Ltd. headquartered in Kingston, Jamaica. Paymaster
Jamaica commenced operations in October 1997, offering improved revenue
collection and customer care facilities to businesses, institutions and
consumers on the island of Jamaica. It offers its client companies a viable,
cost effective alternative to retaining their own commercial offices. Paymaster
Jamaica's clients include every local utility company, five remittance
companies, select internet service providers and cable networks, among others.
Paymaster Jamaica presently has over 700,000 consumer clients accessing services
at approximately 100 service outlets processing over 400,000 transactions per
month with average collections of Ja$1 billion (US$20 million). In addition to
its bill payment services, Paymaster Jamaica offers cash remittance services
affording its customers the convenience to send and receive all types of
remittances nationally or internationally via cash or debit cards.
Paymaster Jamaica recently executed a contract with the Jamaican Postal Service
providing exclusive "transactions system rights" for twenty years throughout the
640 branch network, including the country's prime commercial areas. This
agreement gives Paymaster Jamaica an exclusive right to provide its services at
all post office locations throughout the island.
Paymaster Jamaica has also secured the contract for Jamaica's first Electronics
Benefits Transfer Program. Under this program, the Jamaican government would
disburse pension and benefit payments to pensioners and welfare recipients
through the Paymaster Jamaica network.
In 2002, we advanced $500,000 capital advance to Paymaster Jamaica in exchange
for a 6% promissory note. Under the terms of the Paymaster Jamaica note,
Paymaster Jamaica may convert the amounts due under the capital advance into
equity of a newly formed subsidiary, Paymaster Worldwide, which would then be
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jointly owned by Denaris and Paymaster Jamaica. Paymaster Worldwide is to
franchise the Paymaster Jamaica business model to other markets initially in
other Caribbean countries with the possibility of eventually going worldwide.
Denaris is to provide the computer systems, network design, and technical
support to support all of Paymaster Jamaica's current business activities on a
per transaction fee basis. Denaris' system will be capable of handling
additional products and services that are similar in nature to Paymaster
Jamaica's existing products as well as remittance and stored value products.
Additional products to be supported by Denaris' system will include the
government's Electronics Benefits Transfer Program, direct deposit of payroll to
stored value cardholder accounts, and prepaid long distance and prepaid cellular
products.
STORED VALUE CARDS. As part of its agreement with Paymaster Jamaica, Denaris is
to provide a stored value card for use by Paymaster Jamaica customers. Denaris
is to offer, free of charge, a base stored value card with a preprinted unique
account number and an assigned Personal Identification Number (PIN) number
required for customers to access their funds. Upgraded cards offering additional
features and benefits will be offered on a fee basis. Denaris will own the
stored value cards and account, and any associated balances that remain on the
account. Denaris is to share fee based privilege, loading, and withdrawal
revenue on stored value cards and related transactions with Paymaster Jamaica
based on a separate revenue sharing agreement.
Monies placed on the stored value accounts are to be deposited in a Denaris
account, in good funds, prior to or simultaneous to the value being placed on
the stored value card at a Paymaster Jamaica location. Deposits may include
cash, government pension or benefits payments, or local and international
remittances transferred to customer accounts. Authorization policies and
procedures have been established to minimize fraudulent deposits or withdrawals.
Denaris will bear fraud risk as long as established authorization policies &
procedures are met. Paymaster Jamaica, and/or its subagents, will bear fraud
risk for failure to follow procedures. Paymaster Jamaica will establish vault
cash procedures that ensure that sufficient cash is available to pay out demands
on the stored value accounts.
A significant feature of the stored value card is the ability to transfer funds
from card to card either locally, or internationally. Utilizing this feature,
customers may transfer balances from one card to another, either locally, or
internationally, with the funds being available to the transferee immediately.
Transfers are made between two separate cards via a PIN based system. In
addition, cardholders may use their card to pay bills with Paymaster Jamaica
bill-pay clients, which include every local utility company, five remittance
companies, select internet service providers and cable networks, among others.
Denaris intends to offer value-added services in conjunction with its stored
value cards. Products including pre-paid cellular and long distance services are
being developed as an easy and cost-effective means for cardholders to
consolidate these popular services in one convenient account.
COMPETITION. Currently many large financial institutions and funds transfer
services are offering stored value cards, which compete directly with Denaris'
products. In addition, Denaris competes with major funds transfer services which
include Western Union.
GOVERNMENT REGULATION. Denaris operations are regulated by individual state
money transmitter licensing requirements and we may be required to obtain and
maintain licenses to do business in certain states. Denaris also may be subject
to certain federal and international anti-money laundering laws.
KEY AND NOVA FINANCIAL SERVICES
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
-8-
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.
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 Federal Deposit Insurance
Corporation 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. In May 2002, Key filed a claim with the FDIC for all funds
due from Net First National Bank to Key under the credit card program agreement
through the date federal banking regulators closed Net First. The total amount
of the claim was $4,311,027. As of December 31, 2002, Key and Nova had ceased
business operations, however, the companies continue to receive residual
payments on approximately 4,000 cards still active in the Merrick Bank and Key
Bank and Trust portfolios.
EMPLOYEES
Equitex currently employs four full-time employees. Chex employs twelve
full-time employees at its corporate office, twelve employees in home offices,
and 140 full-time and 44 part-time employees at its casino locations. Denaris
employs one full-time employee. Key and Nova have no employees.
(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
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.
Until August 2002, we also leased an executive office in Palm Beach Gardens,
Florida consisting of approximately 980 square feet. The lease payment was
$2,287 per month.
Nova and Key leased approximately 21,870 square feet of office space in
Clearwater, Florida. The lease payment was $32,843 per month and was to increase
to $34,485 per month in June 2003 and $36,209 per month in June 2004. This lease
was set to expire on September 30, 2004. In March 2003, we executed an agreement
with the landlord to terminate this lease effective December 31, 2002. The lease
will be terminated upon payment by us of $150,000 as follows: a $20,000 lease
deposit was retained by the landlord; $30,000 was paid upon execution of the
termination agreement in March 2003; and five equal payments of $20,000 are to
be paid monthly beginning in April 2003.
Chex leases approximately 4,195 square feet for its executive office in
Minnetonka, Minnesota, which is adequate for its current needs. The lease
payment is currently $5,768 per month increasing to $5,942 per month in April
2003, and $6,030 per month in April 2005. 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. The
-9-
liquidating agent has not commenced an arbitration proceeding. Presently, we are
unable 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 27, 2002, we held our Annual Meeting of Stockholders where our
stockholders re-elected each of five incumbent directors. Mr. Scott Lucas
declined to run for re-election. The votes were cast as follows:
For Withhold Authority
---------- ------------------
Henry Fong 13,180,685 404,225
Russell L. Casement 13,180,928 403,982
Aaron Grunfeld 13,181,218 403,692
Joseph W. Hovorka 13,181,218 403,692
James P. Welbourn 13,259,279 325,631
Additionally, the following two proposals were presented and voted upon at the
meeting and the votes were cast as follows:
To amend Paragraph Four of the Certificate of Incorporation to cause a one share
for six share reverse split of the common stock.
For Against Abstain
---------- ------- -------
Shares voted 13,172,770 378,643 33,497
To ratify the appointment of Gelfond Hochstadt Pangburn, P.C. as the independent
auditors of the Registrant for the year ending December 31, 2002.
For Against Abstain
---------- ------- -------
Shares voted 13,294,177 269,225 21,508
-10-
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
------------- ---- ---
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
2002
----
March 31, 2002 $3.95 $1.33
June 30, 2002 1.35 0.48
September 30, 2002 0.53 0.43
December 31, 2002 0.48 0.30
(b) Holders.
The number of record holders of our common stock as of March 31, 2003 was 1,996
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. 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, 2002, we issued a total of 872,960
unregistered shares of our $0.02 par value common stock and 1,380 unregistered
shares of our preferred 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
-11-
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:
On October 9, 2002, we issued 715 shares of our $0.01 par value Series J 6%
Convertible Preferred Stock to four accredited investors, including our
subsidiary Chex Services which purchased 350 shares, for gross proceeds of
$715,000, the stated value of $1,000 per share.
On November 26, 2002, we issued 665 shares of our $0.01 par value Series J 6%
Convertible Preferred Stock to eight accredited investors, including our
subsidiary Chex Services which purchased 300 shares, for gross proceeds of
$665,000, the stated value of $1,000 per share.
On December 31, 2002, we issued 456,627 shares of our $0.02 par value common
stock to an accredited investor for the conversion of debt valued at $187,217 or
$0.41 per share.
On December 31, 2002, we issued 416,341shares of our $0.02 par value common
stock to a legal consultant for services valued at $170,700 or $0.41 per share.
ITEM 6. SELECTED FINANCIAL DATA.
The following tables contains 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 of our liabilities.
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 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 and 1998, are those of Key and Nova on a combined basis.
2002 2001 2000 1999 1998*
- ----------------------------------------------------------------------------------------------------------
Revenues $23,936,249 $16,528,139 $14,456,354 $21,030,343 $4,945,622
Net income (loss) (4,319,000) (1,031,369) 3,556,720 5,589,938 451,626
Net income (loss) applicable to
common stockholders (4,439,580) (4,196,369) 3,556,720 5,589,938 451,626
Basic & diluted net loss per
common share (0.19) (0.32) 0.40 0.63 0.08
Total assets 27,431,748 35,349,155 7,163,464 7,580,093 2,391,339
Total long-term liabilities 240,629 232,200 - - -
Convertible preferred stock 4,015,000 4,285,000 - - -
Cash dividends - 2,000,000 4,225,000 4,063,888 798,112
- ----------------------------------------------------------------------------------------------------------
* Nova's date of inception was October 10, 1998.
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, 2002, 2001 and
2000. The financial statements presented for the year ended December 31, 2002
are those of Equitex along with its subsidiaries Chex Services, Key Financial
Systems and Nova Financial Systems as well as Denaris Corporation since its
inception in August 2002. The financial results presented for the year ended
-12-
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 for the
month of December 2001. The financial results presented for the year ended
December 31, 2000 are those of Key Financial Systems and Nova Financial Systems.
(a) Liquidity and Capital Resources.
For the year ending December 31, 2003, 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 ("Net
First") and subsequent closure of operations will eliminate cash flows at Key,
our other operating subsidiary, Chex, has experienced an increase in cash flows
in 2002 from the increase in cash access locations and from the introduction of
new products during the year. We anticipate that Chex will continue to grow in
2003. These products are complementary to its existing products and services.
Future products may include: cashless gaming smart cards, debit cards and
customized funds transfer systems for multi-jurisdictional gaming operators.
Additionally, included in notes payable related parties and other are
approximately $11.6 million of 12% notes payable by Chex, due through December
2003. Chex is attempting to restructure some of these notes, as they become due
and are renewed, thereby reducing interest costs and further increasing cash
flow in the future.
Cash flow activity for the year ended December 31, 2002, includes the activity
of Chex, Key, Nova, and Equitex for the entire year and Denaris from August
2002. The 2001 activity includes the activity of Key and Nova through August 5,
2001 as well as the activity of the Company, Key and Nova from August 6, 2001
through December 31, 2001 and Chex from December 1, 2001 through December 31,
2001. For the year ended December 31, 2002, net cash provided by operating
activities was $2,568,112 compared to $182,768 for the year ended December 31,
2001, an increase of $2,385,344. The most significant portion of this change was
the change in adjustments to the net loss which increased to $6,887,112 in 2002
from $1,214,137 in 2001. In 2002 accounts receivable decreased by $1,167,710
compared to an increase of $2,433,347 in 2001, representing a change of
$3,602,057. Other changes in the adjustments to the operating results included
increases in depreciation and amortization of $1,058,851 and the impairment and
write off of receivables of $1,604,302. The change of $5,672,975 in the
adjustments was partially offset by the increase in net loss of $3,287,631 in
2002.
Cash used in investing activities for the year ended December 31, 2002 was
$1,994,023 compared to $8,704,315 cash provided by investing activities for the
year ended December 31, 2001. The 2001 activity included the acquisition of Chex
which resulted in the acquisition of $9,994,124 of cash. Issuances of related
party and other notes receivable increased by $746,255 in the 2002 period
compared to 2001.
Cash provided by financing activities for the year ended December 31, 2002 was
$527,198 compared to cash used in financing activities of $1,130,269 for the
year ended December 31, 2001. This change is primarily due to the net proceeds
received in 2002 from the common stock and preferred stock issuances as well as
the exercise of warrants of $1,541,078 compared to $244,332 in 2001 from the
exercise of warrants. Other 2002 activity included the redemption of Series I
preferred stock for cash of $846,343, the repayment of notes payable, related
party and other of $2,438,176, and the issuance of notes payable related party
of $2,381,839.
During the year ended December 31, 2001, (prior to the acquisition of Key and
Nova by the Company) Key and Nova received capital contributions of $1,000,000
and paid dividends to Key and Nova shareholders of $2,000,000.
For the year ended December 31, 2002, net cash increased $1,101,287 compared to
an increase of $7,756,814 for the year ended December 31, 2001, and ending cash
at December 31, 2002, was $8,931,713 compared to $7,830,426 at December 31,
2001.
Other sources available to us that we may utilize include the sale of equity
securities through private placements of common and/or preferred stock as well
as the exercise of stock options and/or warrants, all of which may cause
dilution to our stockholders. We may also be able to borrow funds from related
and/or third parties.
-13-
Contractual obligations for future payments under existing debt and lease
commitments at December 31, 2002, were as follows:
Contractual Less than 1-3 3-5 More than
Obligation Total one year years years 5 years
- --------------------------------------------------------------------------------
Long-term debt $14,240,326 13,999,697 $240,629
Operating lease
obligations 232,299 70,791 161,508
- --------------------------------------------------------------------------------
Total $14,472,625 $14,070,488 $402,137
================================================================================
(b) Results of operations.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Preparation of the consolidated financial statements in accordance with
accounting principles generally accepted 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 sheets and the reported amounts of revenues 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 litigation;
o income taxes, deferred taxes; and
o goodwill and other intangible assets
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
Statement of Financial Accounting Standard ("SFAS") No. 123, ACCOUNTING FOR
STOCK BASED COMPENSATION, defines fair value-based method of accounting for
stock-based employee compensation plans and transaction in which an entity
issued 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 account
for employee stock-based compensation plans using the intrinsic-value method
-14-
prescribed in Accounting Principles Board Opinion No. 25 (APB No. 25),
ACCOUNTING FORM STOCK ISSUED TO EMPLOYEES, and related interpretations.
Accordingly, employee compensation cost for stock is measured as the excess, if
any, of the estimated fair value of our stock at the date of the grant over the
amount an employee must pay to acquire the stock.
ACCOUNTING FOR GOODWILL AND OTHER INTANGIBLE ASSETS
We have significant intangible assets on our balance sheet that include goodwill
and other intangibles related to acquisitions. The valuation and classification
of these assets and the assignment of useful amortization lives involves
significant judgments and the use of estimates. The testing of these intangibles
under established account guidelines for impairment also requires significant
use of judgment and assumptions. Our assets are tested and reviewed for
impairment on an ongoing basis under the established accounting guidelines.
Changes in business conditions could potentially require future adjustments to
asset valuations.
Since the adoption of SFAS 142 on January 1, 2002, we no longer amortize
goodwill but instead test annually for impairment. If the carrying value of
goodwill exceeds its fair value, an impairment loss must be recognized. A
present value technique is often the best available technique with which to
estimate the fair value of a group of assets. The use of a present value
technique requires the use of estimates of future cash flows. These cash flow
estimates incorporate assumptions that marketplace participants would use in
their estimates of fair value as well as our own assumptions. These cash flow
estimates are based on reasonable and supportable assumptions and consider all
available evidence. However, there is inherent uncertainty in estimates of
future cash flow. As such, different assumptions were used in our calculations
and the likelihood of possible outcomes was considered.
We evaluate long-lived assets whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable. In
performing the review of recoverability, we estimate future cash flows expected
to result from the use of the asset and its eventual disposition. The estimates
of future cash flows, based on reasonable and supportable assumptions and
projections, require management's subjective judgments. The time periods for
estimating future cash flows is often lengthy, which increases the sensitivity
to assumptions made. Depending on the assumptions and estimates used, the
estimated future cash flows projected in the evaluation of long-lived assets can
vary within a wide range of outcomes. We consider the likelihood of possible
outcomes in determining the best estimate of future cash flows.
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.
In May 2002, Key filed a claim with the FDIC for all funds due from Net First to
Key under the credit card program agreement through the date federal banking
regulators closed Net First. The total amount of the claim was $4,311,027. In
October 2002, the FDIC notified Key that it had determined to disallow all but
$111,734 of the total claim. The notification states that as the FDIC liquidates
the assets of the receivership, Key may periodically receive payments on the
allowed portion of this claim through dividends. The Company and its legal
counsel do not agree with this disallowance. In November 2002, the Company filed
a lawsuit in the United States District Court for the Southern District of
Florida seeking to recover the full amount of its claim. The FDIC has answered
the complaint, asserting a counterclaim for $1,000,000 which the FDIC asserts is
for refunds to be made to customers who did not receive credit cards as a result
of the FDIC's actions.
-15-
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 $9,100,000 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 $1,263,000 in 2002, 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.
RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2002 VS. DECEMBER 31, 2001
REVENUES
Consolidated revenues for the year ended December 31, 2002, were $23,936,249
compared to revenues of $16,528,139 for the year ended December 31, 2001.
REVENUE BY SEGMENT
SEGMENT 2002 2001 2000
- ------- ---- ---- ----
Cash disbursement services $19,580,399 $ 1,373,158 $14,456,354
Credit card services 4,355,850 15,140,210 -
Corporate activities - 14,771 -
---------------------------------------
$23,936,249 $16,528,139 $14,456,354
=======================================
CASH DISBURSEMENT SERVICES SEGMENT
Chex recognizes revenue at the time certain financial services are performed.
The effective date of our acquisition of Chex was December 1, 2001, and
therefore the revenues of Chex are included for the year ended December 31,
2002, but only for one month in the year ended December 31 2001. Chex processed
approximately $829 million in cash transactions for the year ended December 31,
2002, and revenues are derived principally from check cashing fees, credit and
debit card advance fees, automated teller machine ("ATM") surcharge and
transaction fees.
Chex cashes personal checks at its cash access locations for fees of between 3
and 10 percent based on its casino contracts. Chex also cashes "other" checks,
comprised of tax and insurance refunds, casino employee payroll checks and
casino jackpot winnings at a reduced rate. For the year ended December 31, 2002,
-16-
Chex cashed over $167 million of personal checks and $154 million of "other
checks". Fees earned on personal and "other" checks were $8,782,513 and
$1,178,106, respectively, for the year ended December 31, 2002. Chex earned fees
of $2,048,986 on personal checks and $237,600 on "other" checks for the year
ended December 31, 2002.
For the year ended December 31, 2002, Chex processed approximately 481,000
credit/debit card transactions with approximately $174 million in advances and
earned fees of $5,490,224. For the year ended December 31, 2002, Chex processed
over 3.3 million ATM transactions, earning commissions or fees of $3,453,572 on
approximately $332 million of transactions. For the year ended December 31,
2002, Chex collected fees of $465,820 on returned checks and had other income of
$210,164.
The financial results of the Registrant include the results of operations of
Chex only from the date of acquisition, December 1, 2001. However, for the year
ended December 31, 2002, total revenues for Chex increased by $4,816,730 or
32.6% from the year ended December 31, 2001. This increase was primarily due to
the increase in the number of casino locations in which Chex operated during
2002 as compared to 2001.
CREDIT CARD SERVICES SEGMENT
CREDIT CARD INCOME
On March 1, 2002, the Office of the Comptroller of the Currency closed Net First
National Bank ("Net First") 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 all future credit card servicing revenues to Key from the Net
First portfolio after March 4, 2002. For the year ended 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.
Through February 28, 2002, the Net First portfolio provided $2,121,220 of credit
card servicing fees. For the year ended December 31, 2001, credit card servicing
fees resulting from the Net First portfolio were $7,982,799.
In June 2002, Key began test telemarketing a stored value card product on behalf
of an unaffiliated company. The initial results were consistent with the success
rate Key experienced with the Net First program and accordingly, Key increased
its sales staff in July and August. However, in September 2002 it became
apparent that refunds and initial cancellations significantly lagged the initial
sales. Key attempted to improve the performance, but ultimately was unable to
obtain an acceptable success rate. Due to these circumstances Key ceased selling
the program in mid-September and terminated the sales staff. There will continue
to be minimized revenues from the prior existing credit card portfolios.
Prior to March 1, 2002, credit card servicing fees were the major component of
credit card income, which was Key and Nova's principal source of earnings before
the closure of Net First. Credit card fees were assessed on credit card accounts
owned by each company's client banks. These include monthly membership fees,
late charges, over limit fees, and return check fees. The fees were 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, 2002, were $2,899,633. For
the year ended December 31, 2001, credit card servicing fees were $10,580,448.
Key has made contact with other financial institutions that had shown initial
interest in a Key credit card program to provide future credit card servicing
revenues and help replace the Net First program. To date none of these contacts
have resulted in any agreements and there is no assurance that a new financial
institution will be identified or a new secured credit card program instituted.
Marketing accelerated in May 2001, increasing from 23,646 new accounts added
during January through April 2001 to 188,656 added during May 2001 through March
-17-
1, 2002. This increase in marketing placed a larger expense burden on Key that
normally would be borne by income generated in subsequent periods. Usually a few
months lapse before new accounts become profitable, with later per card profits
recovering earlier losses on such new cards.
In March of 2001, Key performed a detailed analysis comparing the number of
active accounts on file for three months and longer between two different cards
issuance methodologies. They found a significantly smaller percentage of active
accounts on file in relationship to applications for a method implemented in
June 2000 versus the method previously used. Though the average credit card
income per account was higher using the new method, which required customers to
return a signed activation certificate, the number of net remaining accounts was
significantly less, thereby reducing the amount of residual income Key would
earn over the life of the account relationships. As a result of this analysis,
effective April 2001, Key returned to the previous card issuance method, which
does not require applicants to return a signed activation certificate.
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. For the year ended
December 31, 2002, Key and Nova had a total provision of $121,307 compared to
$415,932 for the same period in 2001. This decrease is attributed to the FDIC's
closure of the Net First credit card accounts. The allowance for losses at
December 31, 2002, was $3,465 or 2.1% of credit card receivables, net of
unearned income, compared to $208,070 or 10.9% of credit card receivables, net
of unearned income, at December 31, 2001. This decrease is also attributed to
the FDIC's closure of the Net First credit card accounts. Management believes
that the reserve for possible losses was adequate to provide for potential
losses at December 31, 2002 and 2001.
APPLICATION FEES, NET OF DIRECT MARKETING COSTS
Application fees have been reduced significantly in 2002 compared to 2001 due to
the closure of Net First and the termination of all marketing programs related
to the Net First credit card. Application fees were $354,826 for the year ended
December 31, 2002, compared to $4,213,466 for the year ended December 31, 2001.
The total application processing fees in 2001 were attributable to the Net First
marketing efforts. New account volume for the year ended December 31, 2002, was
31,477 compared to 180,825 for the same period in 2001. Key does not anticipate
any future fees.
During the first quarter in 2001 the Company was still using the activation
certificate described above. The lower unit income in 2002 is due to the higher
concentration of telemarketing sales in 2002 and the impact of refunds related
to December and January sales against the lower new application volume in
February and the returns posting after the shutdown by the FDIC with no new
sales volume.
OTHER INCOME, NET
Other income for Key and Nova for the year ended December 31, 2002, was
$1,101,391 compared to $361,067 for the year ended December 31, 2001. This
income is primarily comprised of other marketing and lead income of $649,331 and
$452,060, respectively.
OPERATING EXPENSES
Total operating expenses for the year ended December 31, 2002, were $26,952,541
compared to $17,377,015 for the year ended December 31, 2001. The 2002 period
includes expenses for the Company, Chex, Key, Nova, and Denaris from August
2002. The 2001 period includes expenses of Key and Nova combined basis through
August 5, 2001 and on a consolidated basis with those of the Company for the
period from August 6, 2001 through December 31, 2001, and Chex from December 1,
2001.
-18-
OPERATING EXPENSES BY SEGMENT
SEGMENT 2002 2001 2000
- ------- ---- ---- ----
Cash disbursement services $17,827,542 $ 1,605,015 -
Credit card services 7,104,835 13,246,163 $10,899,634
Corporate activities 2,020,164 2,525,937 -
-----------------------------------------
$26,952,541 $17,377,115 $10,899,634
=========================================
CASH DISBURSEMENT SERVICES SEGMENT
Chex operating expenses were $17,827,542 for the year ended December 31, 2002,
compared to $1,605,015 for the year ended December 31, 2001. Chex expenses were
comprised as follows:
2002 2001
---- ----
Fees to casinos $ 6,189,730 $ 437,411
Salaries and related costs 6,461,279 380,335
Returned checks, net of collections 634,531 19,132
General operating expenses 3,390,499 646,566
Depreciation and amortization 1,151,553 121,571
-----------------------------
$17,827,542 $1,605,015
=============================
Chex was acquired in December 2001 and accordingly only one month of expenses is
included in the year ending December 31, 2001 compared to the full year of
expenses being included in the year ended December 31, 2002. Fees to casinos are
the result of the amounts due under the financial serving agreements that Chex
has entered into with each of the individual locations.
CREDIT CARD SERVICES SEGMENT
The closing of Net First and the shut down of their portfolio has had a
significant impact in reducing 2002 operating expenses. The majority of the
operating expenses were 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 has experienced significant reduction in
these costs in 2002. Included in operating expenses for the year ended December
31, 2002, is the impairment of the FDIC receivable for $2,151,207. Based on the
Company receiving a notice from the FDIC regarding the disallowance of our
claim, the Company decided to reserve 100% of the receivable. The Company has
filed a lawsuit seeking collection. Without the impairment of the FDIC
receivable, operating expenses for Key and Nova for the year ended December 31,
2002, decreased to $4,970,507 from $13,246,163 for the same period in 2001.
Third party servicing fees, affected by the volume decreases, decreased by
$1,646,304 for the year ended December 31, 2002 compared to $6,136,638 for the
year ended December 31, 2001. Other expenses including occupancy costs decreased
by $744,948 for the year ended December 31, 2002 compared to December 31, 2001.
CORPORATE ACTIVITY
Included in the year ended December 31, 2002, are operating expenses for Equitex
and Denaris totaling $1,750,420 and $269,744 respectively. For the year ended
December 31, 2002, these expenses are comprised of salaries, wages and employee
benefits of $391,261 selling, general and administrative expenses of $1,209,600,
stock-based compensation expense of $419,303. Stock-based compensation expense
represents non-cash expenses related to issuances of common stock and warrants
to third party consultants for services. Included in the selling, general and
administrative expenses are charges related to a late registration filing
regarding the Series I convertible preferred shares of $263,600. Other costs
include professional fees of $368,326 and other general operating costs of
$577,674.
-19-
OTHER INCOME AND EXPENSES
For the year ended December 31, 2002 other expenses were $1,247,708 compared to
$239,893 for the year ended December 31, 2001. The primary reason for the
increase is the increase in Chex's interest expense being included for the
entire year in 2002 of $1,529,438 compared to only one month in the 2001 period
(acquisition occurred in December 2001) of $102,733. This increase in interest
expense was partially offset by interest income of $124,400 and proceeds from a
settlement of a lawsuit of $240,000 in the 2002 period.
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
- ------- ---- ----
Credit card services $15,140,210 $14,456,354
Cash disbursement services (one month) 1,373,158 -
Corporate activities 14,771 -
------------------------------
$16,528,139 $14,456,354
==============================
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.
-20-
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
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.
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 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.
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. 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
-21-
commissions on ATM advances of $366,626 and $235,344 respectively. Included in
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
- ------- ---- ----
Credit card services $13,246,163 $10,899,634
Cash disbursements services (one month) 1,605,015 -
Corporate activities 2,525,937 -
------------------------------
$17,377,115 $10,899,634
==============================
Total operating expenses for the year ended December 31, 2001 were $17,377,115,
an increase of 59.4% 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 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.
CASH DISBURSEMENT SERVICES SEGMENT
Chex operating expenses since the date of its acquisition (December 1, 2001) are
$1,605,015. 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 and other general operating expenses of $443,138).
CORPORATE ACTIVITY SEGMENT
Included in the year ended December 31, 2001 are operating expenses for Equitex
of approximately $2,525,937 for the period from August 6, 2001 through December
31, 2001. These expenses are comprised of selling, general and administrative
expenses of $393,703 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.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In December 2002, FASB issued SFAS No. 148, ACCOUNTING FOR STOCK-BASED
COMPENSATION TRANSITION AND DISCLOSURE. This statement amends SFAS No. 123
-22-
ACCOUNTING FOR STOCK-BASED COMPENSATION and establishes two alternative methods
of transition from the intrinsic value method to the fair value method of
accounting for stock-based employee compensation. In addition, SFAS No. 148
requires prominent disclosure about the effects on reported net income and
requires disclosure for these effects in interim financial information. The
provisions for the alternative transition methods are effective for fiscal years
ending after December 15, 2002 and the amended disclosure requirements are
effective for interim periods beginning after December 15, 2002. The Company
plans to continue accounting for stock-based compensation under APB 25.
Therefore, this pronouncement is not expected to impact the Company's financial
position or results of operations.
In June 2002, FASB issued SFAS No. 146, ACCOUNTING FOR COSTS ASSOCIATED WITH
EXIT OR DISPOSAL ACTIVITIES. SFAS No. 146 addresses financial accounting and
reporting for costs associated with exit or disposal activities. This statement
supersedes Emerging Issues Task Force Issue No. 94-3, LIABILITY RECOGNITION FOR
CERTAIN EMPLOYEE TERMINATION BENEFITS AND OTHER COSTS TO EXIT AN ACTIVITY. The
Company does not expect that the adoption of SFAS No. 146 will have a
significant immediate impact on the financial condition or results of operations
of the Company.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the potential loss arising from adverse changes in market rates
and prices, such as interest rates and a decline in the stock market. The
Company does not enter into derivatives or other financial instruments for
trading or speculative purposes. The Company has limited exposure to market
risks related to changes in interest rates. The Company does not currently
invest in equity instruments of public or private companies for business or
strategic purposes.
The principal risks of loss arising from adverse changes in market rates and
prices to which the Company and its subsidiaries are exposed relate to interest
rates on debt. The Company has both fixed and variable rate debt. Chex has
$13,644,132 of debt outstanding as of December 31, 2002, of which $12,208,776
has been borrowed at fixed rates ranging from 8% to 12%. A 1% increase in
interest rates would result in an approximate $150,000 increase in the Company's
net loss for the year. This fixed rate debt is subject to renewal annually and
is payable upon demand with 90 days written notice by the debt holder. Chex also
has $1,455,356 of variable rate debt at December 31, 2002, owed to a bank. The
lender presently charges interest at .50% to .75% over the prime rate.
As most of the Company's average outstanding indebtedness is renewed annually
and carries a fixed rate of interest, a change in interest rates is not expected
to have a material impact on the consolidated financial position, results of
operations or cash flows of the Company during the year ending December 31,
2003.
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 accountants
were Gelfond Hochstadt Pangburn, P.C. while Key and Nova's independent certified
public accountants were 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
independent certified public accountants for the year ended December 31, 2001.
As a result, on January 24, 2002, Key and Nova notified McGladrey & Pullen, LLP
that it would no longer serve as the independent certified public accountants of
-23-
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 with 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 67 President, Treasurer, Since Inception
Principal Executive
Financial and Accounting
Officer and Director of Equitex
Thomas B. Olson 37 Secretary Since 1988
Russell L. Casement 59 Director Since 1989
Aaron A. Grunfeld 56 Director Since 1991
Joseph W. Hovorka 73 Director Since 2001*
James P. Welbourn 54 President of Chex Services and Since 2001*
Director of Equitex
* Mr. Welbourn resigned from our board of directors in February 2003 and Mr.
Hovorka resigned from our board of directors in March 2003.
Our directors 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 was elected or appointed to such office or
position.
We have appointed an Audit Committee currently consisting of Dr. Casement as
chairman and Mr. Grunfeld and a Compensation Committee currently consisting of
Mr. Grunfeld as chairman and Dr. Casement.
-24-
(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. Mr. Fong has been president and a director of Equitex 2000, Inc.
since its inception in 2001. Mr. Fong has been President and a Director of
Torpedo Sports USA, Inc. since March 2002. Torpedo Sports USA, Inc. is a
publicly traded manufacturer and distributor of recreational equipment. From
December 2000 to January 2002, Mr. Fong was a director of Popmail.com, Inc., a
publicly traded Internet marketing company. 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 and has been a
director of Chex Services since May 2002. Since March 2002, Mr. Olson has been
the secretary of Torpedo Sports USA, Inc., a publicly traded manufacturer and
distributor of recreational equipment. Mr. Olson has been Secretary of Equitex
2000, Inc. since its inception in 2001. Since August 2002, Mr. Olson has been
the secretary of El Capitan Precious Metals, Inc., a publicly traded company
with ownership interest in a mining property. 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. Dr. Casement
has been a director of Equitex 2000, Inc. since its inception in 2001. 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
had been a director of Equitex 2000, Inc. since its inception in 2001. Mr.
Grunfeld has been engaged in the practice of law since 1971 and has been of
counsel to the firm of Resch Polster Alpert & Berger, LLP, Los Angeles,
California since November 1995. From April 1990 to November 1995, Mr. Grunfeld
was a member of the firm of Spensley Horn Jubas & Lubitz, Los Angeles,
California. 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 was a director of Equitex from June 2001 to March 2003. 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,
-25-
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.
JAMES P. WELBOURN
Mr. Welbourn was a director of Equitex from December 2001 to February 2003 and
has been the chief executive officer, president and director of Equitex's wholly
owned subsidiary Chex Services, Inc., since June of 1992. 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, 2002,
received an annual salary of $183,013. Beginning July 1, 2001, the only
compensation Mr. Fong receives from Equitex is his annual salary. 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 with the balance paid by Equitex 2000.
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
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.
-26-
Fong, in consultation with the Compensation Committee, agreed to end the bonus
plan beginning July 1, 2001 through December 31, 2002. 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 $105,414 per year for such period as may be necessary to fully fund
the policy, and was considered other future compensation to Mr. Fong in previous
years.
(b) Summary compensation table.
The following table sets forth information regarding compensation paid to our
officers during the years ended December 31, 2002, 2001 and 2000:
SUMMARY COMPENSATION TABLE
Long-Term
Compensation
Annual Compensation Awards
-------------------------------- ---------
Name & Other Annual All Other
Principal Salary Bonus Compensation Options Compensation
Position Year ($) ($) ($) & SARs(#) ($)
- -------- ---- --- --- --- --------- ---
Henry Fong 2002 183,013 -0- -0- -0- -0-
President,
Treasurer 2001 76,255 -0- -0- -0- -0-
Principal (1)
Executive
Officer and 2000 183,013 161,668 -0- 476,000 165,000(2)
Accounting
Officer
- ----------
(1) Includes salary paid and accrued during the period from August 6, 2001 to
December 31, 2001 following our merger with Key and Nova.
(2) Includes payments and tax liability on the life insurance policy as
explained more fully in "Item 10 (a) General" above.
(c) Option/SAR grants table.
None.
-27-
(d) Aggregated Option/SAR exercises and fiscal year-end Option/SAR value table.
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION/SAR VALUES
(a) (b) (c) (d) (e)
Number of
Securities Value of
Underlying Unexercised
Unexercised In-the-Money
Options/SARs Options/SARs
Shares at FY-End (#) at FY-End (#)
Acquired on Value Exercisable/ Exercisable/
Name Exercise (#) Realized ($) 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, 2002, Messrs. Grunfeld and
Hovorka each received a total of $15,500 while Dr. Casement received $15,000.
Mr. Hovorka resigned from our board in March 2003. Members of the Board of
Directors also receive reimbursement for expenses incurred in attending board
meetings.
(2) Other Arrangements
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
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
under a previous plan, 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.
-28-
(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, 2002 consisted of Mr.
Grunfeld as chairman and Dr. Casement both of whom 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 thereafter beginning July 1, 2001 the President received an annual salary of
$183,013 and no bonus.
No changes were made by the Compensation Committee to the President's
compensation plan in 2002, however, the Compensation Committee is reviewing
executive compensation for possible adjustment in 2003.
Compensation Committee
- ----------------------
Russell L. Casement
Aaron A. Grunfeld
(i) Performance graph.
12/31/97 12/31/98 12/31/99 12/31/00 12/31/01 12/31/02
NASDAQ US 100.00 140.99 261.48 157.77 125.16 86.53
NASDAQ FINANCIAL 100.00 97.15 96.50 104.23 114.52 117.85
EQUITEX 100.00 845.63 984.01 592.00 445.26 50.43
-29-
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, 2003, 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, 2003.
Shares of
Common Percentage
Shares of Shares of Common Stock of Common
Name and Address of Common Stock Stock Underlying Underlying Stock Owned
Beneficial Owner Owned (1) Options (1) Warrants (1) Total (7)
- ---------------------------------------------------------------------------------------------------------
Henry Fong 606,375 (3) 945,700 (2) 49,239 1,601,314 3.4%
7315 East Peakview Ave.
Englewood, CO 80111
Russell L. Casement 146,795 365,900 (4) 759 513,454 1.8%
1355 S. Colorado Blvd.,
Suite 320
Denver, CO 80222
Aaron A. Grunfeld 32,700 379,500 (5) 0 412,200 1.4%
10390 Santa Monica Blvd.,
Fourth Floor
Los Angeles, CA 90025
Thomas Olson 0 66,300 0 66,300 0.2%
7315 East Peakview Avenue
Englewood, CO 80111
Daniel Bishop (6) 4,185,554 0 280,000 4,465,554 15.4%
7315 East Peakview Avenue
Englewood, CO 80111
All officers and directors 785,870 1,757,400 49,998 2,593,268 8.5%
as a group (four 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) Ownership information obtained from Form 13-D filing dated September 23,
2002.
(7) As of March 31, 2003, 28,690,497 shares of our common stock were
outstanding.
-30-
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. During 2002, Mr. Fong and these same companies loaned us an additional
$116,050 in varying amounts from time-to-time. The entire principal balance of
these loans were repaid prior to December 31, 2002. These loans were due on
demand and carried interest rates of 8% and 10% depending on the loan.
In November 2001, Scott Lucas, a director of Equitex and President of Key loaned
$100,000 to us. This note was due in November 2002, bears interest at 9% per
annum and remains unpaid. The total principal and 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.
ITEM 14. CONTROLS AND PROCEDURES.
A review and evaluation was performed by the Company's management, including the
Company's Chief Executive Officer (the "CEO"), of the effectiveness of the
design and operation of the Company's disclosure controls and procedures as of a
date within 90 days prior to the filing of this annual report. Based on that
review and evaluation, the CEO has concluded that the Company's current
disclosure controls and procedures, as designed and implemented, were effective.
There have been no significant changes in the Company's internal controls or in
other factors that could significantly affect the Company's internal controls
subsequent to the date of their evaluation. There were no significant material
weaknesses identified in the course of such review and evaluation and,
therefore, no corrective measures were taken by the Company.
-31-
PART IV
ITEM 17. 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, 2002 and 2001 F-2 - F-3
- --------------------------------------------------------------------------------
Consolidated/combined statements of operations - years ended
December 31, 2002, 2001 and 2000 F-4
- --------------------------------------------------------------------------------
Consolidated/combined statements of changes in stockholders'
equity - years ended December 31, 2002, 2001 and 2000 F-5 - F-10
- --------------------------------------------------------------------------------
Consolidated/combined statements of cash flows - years ended
December 31, 2002, 2001 and 2000 F-11 - F-13
- --------------------------------------------------------------------------------
Notes to consolidated/combined financial statements F-14 - F-49
- --------------------------------------------------------------------------------
Key Financial Systems, Inc. - As of December 31, 2000 and for
the year ended December 31, 2000, including Independent Auditors'
Report of McGladrey & Pullen, LLP
- --------------------------------------------------------------------------------
Nova Financial Systems, Inc. - As of December 31, 2000 and for
the year ended December 31, 2000, 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)
- --------------------------------------------------------------------------------
3.9 Certificate of Amendment to the Certificate of Designations of
Registrant's Series H Convertible Preferred Stock. (9)
- --------------------------------------------------------------------------------
3.10 Certificate of Designations of Registrant's Series I Convertible
Preferred Stock. (10)
- --------------------------------------------------------------------------------
3.11 Certificate of Designations of Registrant's Series J Convertible
Preferred Stock (16)
- --------------------------------------------------------------------------------
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)
- --------------------------------------------------------------------------------
-32-
- --------------------------------------------------------------------------------
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.
- --------------------------------------------------------------------------------
23.1 Consent of Independent Certified Public Accountants, Gelfond Hochstadt
Pangburn, P.C. FILED HEREWITH
- --------------------------------------------------------------------------------
23.2 Independent Auditors Consent, McGladrey & Pullen. FILED HEREWITH.
- --------------------------------------------------------------------------------
23.3 Independent Auditors Consent, McGladrey & Pullen. FILED HEREWITH.
- --------------------------------------------------------------------------------
99.1 Certification of Section 906 of the Sarbanes-Oxley Act of 2002.
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
Registration Statement 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
Registration Statement 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.
-33-
(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.
(16) Incorporated by reference from Exhibit 3(i).10 of the Registrant's
Registration Statement on Form S-3, No. 333-101731 effective January 9, 2003.
(b) Reports on Form 8-K.
Not applicable.
(c) Exhibits required by Item 601 of Regulation S-K
See Item 17(a)(3) above.
(d) Financial statement schedules required by Regulation S-X
Not applicable.
-34-
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, 2003 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, 2003 /S/ HENRY FONG
------------------------------------
Henry Fong, President,
Treasurer and Director
(Principal Executive, Financial,
and Accounting Officer)
Date: April 15, 2003 /S/ RUSSELL L. CASEMENT
------------------------------------
Russell L. Casement, Director
Date: April 15, 2003 /S/ AARON A. GRUNFELD
------------------------------------
Aaron A. Grunfeld, Director
-35-
CERTIFICATION PURSUANT TO RULE 13A-14 OR 15D-14 OF THE SECURITIES
EXCHANGE ACT OF 1934, AS ADOPTED PURSUANT TO SECTION 302 OF
THE SARBANES-OXLEY ACT OF 2002
I, Henry Fong, certify that:
1. I have reviewed this annual report on Form 10-K of Equitex, Inc. and
subsidiaries (the "Registrant");
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the Registrant as of, and for, the periods presented in this annual report;
4. I am responsible for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the
Registrant and have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the Registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
b) evaluated the effectiveness of the Registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report my conclusions about the effectiveness
of the disclosure controls and procedures based on my evaluation as of the
Evaluation Date;
5. I have disclosed, based on my most recent evaluation, to the Registrant's
auditors and the audit committee of Registrant's board of directors (or
persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
Registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the Registrant's internal
controls; and
6. I have indicated in this annual report whether there were significant
changes in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of my most recent
evaluation, including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: April 15, 2003
/s/ Henry Fong
----------------------------------------
Henry Fong
President, Treasurer and
Chief Executive Officer
-36-
EQUITEX, INC. AND SUBSIDIARIES
CONSOLIDATED/COMBINED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
EQUITEX, INC. AND SUBSIDIARIES
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
INDEX TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS
Page
----
Independent auditors' report F-1
Consolidated/combined financial statements:
Consolidated balance sheets F-2 - F-3
Consolidated/combined statements of operations F-4
Consolidated/combined statements of changes in
stockholders' equity F-5 - F-10
Consolidated/combined statements of cash flows F-11 - F-13
Notes to consolidated/combined financial statements F-14 - F-49
INDEPENDENT AUDITORS' REPORT
Board of Directors
Equitex, Inc.
We have audited the accompanying consolidated balance sheets of Equitex, Inc.
and subsidiaries (the "Company") as of December 31, 2002 and 2001, and the
related consolidated/combined statements of operations, changes in stockholders'
equity and cash flows for each of the years in the two-year period ended
December 31, 2002. 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 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, 2002 and 2001, and the results of their
operations and their cash flows for each of the years in the two-year period
ended December 31, 2002, 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 statements of operations, changes in stockholders' equity, and cash
flows for the year ended December 31, 2000, represent the combined 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 statements of operations, changes
in stockholders' equity, and cash flows for the year ended December 31, 2000,
including the accounting for the August 6, 2001 reverse acquisition. In our
opinion, such combined financial statements have been properly combined on the
basis described in Note 1 to the consolidated/combined financial statements.
As discussed in Notes 2 and 3 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, and adopted the provisions of Statement of
Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets,
effective January 1, 2002.
/s/ GELFOND HOCHSTADT PANGBURN, P.C.
Denver, Colorado
April 3, 2003
F-1
EQUITEX, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2002 AND 2001
ASSETS
2002 2001
----------- -----------
Current assets:
Cash and cash equivalents $ 8,931,713 $ 7,830,426
Accounts receivable, net (Note 2) 2,918,135 4,141,469
Credit card receivables, net (Note 4) 155,997 1,493,481
Other receivables (Note 5) 433,293 6,435,060
Current portion of notes receivable, related parties (Note 6) 245,322 563,460
Interest receivable, related parties (Note 6) 95,547 39,923
Prepaid expenses and other 354,433 557,040
----------- -----------
Total current assets 13,134,440 21,060,859
----------- -----------
Notes receivable, related parties, net (Note 6) 1,480,030 1,146,375
Note receivable, other (Note 6) 500,000
Property, equipment and leaseholds (Notes 7 and 9) 1,202,885 1,180,258
Deferred tax asset (Note 10) 1,380,000 1,380,000
Intangible and other assets (Note 8) 4,098,393 4,945,663
Goodwill (Notes 2 and 3) 5,636,000 5,636,000
----------- -----------
14,297,308 14,288,296
----------- -----------
$27,431,748 $35,349,155
=========== ===========
(Continued) F-2
EQUITEX, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (CONTINUED)
DECEMBER 31, 2002 AND 2001
LIABILITIES AND STOCKHOLDERS' EQUITY
2002 2001
------------ ------------
Current liabilities:
Accounts payable $ 1,278,267 $ 1,819,555
Accrued expenses and other liabilities, including related
party accruals of $375,109 (2002) and $83,000 (2001) 1,379,878 827,065
Accrued liabilities on casino contracts (Note 12) 622,361 517,805
Current portion of long-term debt (Note 9) 251,727 527,754
Line of credit, notes, and loans payable (Note 9) 13,493,776 13,587,926
Notes payable, related parties (Note 9) 254,194 211,625
Due to credit card holders (Note 12) 403,405 5,056,668
------------ ------------
Total current liabilities 17,683,608 22,548,398
------------ ------------
Long-term debt, net of current portion, related party (Note 9) 232,200
Long-term debt, net of current portion (Note 9) 240,629
------------ ------------
Total liabilities 17,924,237 22,780,598
------------ ------------
Commitments and contingencies (Notes 9, 12 and 13)
Stockholders' equity (Note 13):
Preferred stock; 2,000,000 shares authorized:
Series D, 6%; stated value $1,000 per share; 575 (2002) and 725 (2001)
shares issued and outstanding; liquidation preference $796,500 575,000 725,000
Series G, 6%; stated value $1,000 per share; 370 (2002) and 900 (2001)
shares issued and outstanding; liquidation preference $534,000 370,000 900,000
Series I, 6%; stated value $1,000 per share; 1,690 (2002) and 2,660 (2001)
shares issued and outstanding; liquidation preference $2,342,500 1,690,000 2,660,000
Series J, 6%; stated value $1,000 per share; 1,380 shares issued,
730 shares outstanding; liquidation preference $778,500 1,380,000
Less preferred treasury stock; Series J, at cost; 650 shares (650,000)
Common stock, $0.02 par value; 50,000,000 shares authorized;
26,527,282 (2002) and 21,244,797 (2001) shares issued; 26,111,425
(2002) and 21,211,447 (2001) shares outstanding 530,546 424,896
Common stock and warrants to be issued 750,485
Additional paid-in capital 12,719,855 9,754,252
Accumulated deficit (6,851,039) (2,532,039)
Less common treasury stock at cost; 415,857 (2002) and 33,350 (2001)
shares (256,851) (114,037)
------------ ------------
Total stockholders' equity 9,507,511 12,568,557
------------ ------------
$ 27,431,748 $ 35,349,155
============ ============
See notes to consolidated/combined financial statements. F-3
EQUITEX, INC. AND SUBSIDIARIES
CONSOLIDATED/COMBINED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
(Note 1)
2002 2001 2000
------------ ------------ ------------
Fee revenue $ 19,580,399 $ 1,373,158
Credit card income, net of provision for losses (Note 4) 2,899,633 10,580,448 $ 11,538,298
Application fees, net of direct marketing costs, including related
party costs of $3,010,055 through August 6, 2001, and
$897,521 (2000), respectively (Note 11) 354,826 4,213,466 2,735,438
Other 1,101,391 361,067 182,618
------------ ------------ ------------
Total revenues 23,936,249 16,528,139 14,456,354
------------ ------------ ------------
Third party servicing fees 1,646,304 6,136,638 5,677,641
Fees paid to casinos 6,189,730 437,411
Salaries, wages and employee benefits 9,045,683 7,470,814 3,019,876
Other operating expenses 7,919,617 3,332,252 2,202,117
Impairment of FDIC receivable (Note 12) 2,151,207
------------ ------------ ------------
26,952,541 17,377,115 10,899,634
------------ ------------ ------------
Income (loss) from operations (3,016,292) (848,976) 3,556,720
------------ ------------ ------------
Other income (expense):
Interest income, including related party interest of $14,634 124,400
Interest expense, including related party interest of
$19,285 (2002) and $137,160 (2001) (1,687,608) (239,893)
Other 315,500
------------ ------------ ------------
(1,247,708) (239,893)
------------ ------------ ------------
Income (loss) before income taxes (4,264,000) (1,088,869) 3,556,720
Income tax expense (benefit) 55,000 (57,500)
------------ ------------ ------------
Net income (loss) (4,319,000) (1,031,369) 3,556,720
Beneficial conversion features and warrant accretion (Note 13) (2,080) (2,924,000)
Additional warrants issued to preferred stockholders (Note 13) (53,000) (152,000)
Redemption of convertible preferred stock in excess
of beneficial conversion features (Note 13) 266,000 92,000
Deemed preferred stock dividends (Note 13) (331,500) (181,000)
------------ ------------ ------------
Net income (loss) applicable to common stockholders $ (4,439,580) $ (4,196,369) $ 3,556,720
============ ============ ============
Basic and diluted net income (loss) per common share $ (0.19) $ (0.32) $ 0.40
============ ============ ============
Weighted average number of common shares outstanding 22,833,159 13,032,655 8,903,730
============ ============ ============
See notes to consolidated/combined financial statements. F-4
EQUITEX, INC. AND SUBSIDIARIES
CONSOLIDATED/COMBINED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
(Note 1)
Convertible
preferred stock Preferred Common stock Common
--------------------- treasury --------------------------- treasury
Shares Amount stock Shares Amount stock
------ ------------ ----------- ------------- ----------- ----------
Balances, January 1, 2000 (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
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
------ ------------ ----------- ------------- ----------- ----------
(Continued) F-5
EQUITEX, INC. AND SUBSIDIARIES
CONSOLIDATED/COMBINED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
(Note 1)
Retained
Common stock Deferred Additional earnings Total
and warrants compensation paid-in (accumulated stockholders'
to be issued cost capital deficit) equity
------------ ------------ ------------- ------------ ------------
Balances, January 1, 2000 (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)
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
------------ ------------ ------------- ------------ ------------
(Continued) F-6
EQUITEX, INC. AND SUBSIDIARIES
CONSOLIDATED/COMBINED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
(Note 1)
Convertible
preferred stock Preferred Common stock Common
--------------------- treasury --------------------------- treasury
Shares Amount stock Shares Amount stock
------ ------------ ----------- ------------- ----------- ----------
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)
Exercise of warrants for common stock 304,856 6,098
Issuance of common stock under private placement
agreements (net of offering costs) 1,212,386 24,247
Purchase of the Company's common stock by subsidiary (80,000)
Conversion of promissory note and accrued interest
to common stock by subsidiary 130,862 2,617 (62,814)
Coversion of promissory note and accounts payable
to common stock 123,829 2,475
------ ------------ ----------- ------------- ----------- ----------
(Continued) F-7
EQUITEX, INC. AND SUBSIDIARIES
CONSOLIDATED/COMBINED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
(Note 1)
Retained
Common stock Deferred Additional earnings Total
and warrants compensation paid-in (accumulated stockholders'
to be issued cost capital deficit) equity
------------ ------------ ------------- ------------ ------------
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
Exercise of warrants for common stock (485) 250,949 256,562
Issuance of common stock under private placement
agreements (net of offering costs) 681,949 706,196
Purchase of the Company's common stock by subsidiary (80,000)
Conversion of promissory note and accrued interest
to common stock by subsidiary 60,197 -
Coversion of promissory note, accrued interest and
accounts payableto common stock 105,436 107,911
------------ ------------ ------------- ------------ ------------
(Continued) F-8
EQUITEX, INC. AND SUBSIDIARIES
CONSOLIDATED/COMBINED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
(Note 1)
Convertible
preferred stock Preferred Common stock Common
--------------------- treasury --------------------------- treasury
Shares Amount stock Shares Amount stock
------ ------------ ----------- ------------- ----------- ----------
Redemption of Series I preferred stock for cash (710) (710,000)
Conversion of Series G preferred stock to common
stock (530) (530,000) 1,224,221 24,486
Conversion of Series I preferred stock to common
stock (260) (260,000) 616,035 12,321
Issuance of common stock and warrants under deferred
compensation agreement 15,000 300
Amortization of deferred compensation cost
Cancellation of agreement to issue common stock
and warrants for services
Conversion of Series D preferred stock to common
stock (150) (150,000) 782,328 15,646
Issuance of common stock and warrants to consultants
for services 416,341 8,327
Issuance of Seies J preferred stock, including 650
shares purchased by subsidiary (net of offering
costs) 1,380 1,380,000 $ (650,000)
Conversion of accrued liabilities to common stock 148,792 2,976
Issuance of common stock for services 307,835 6,157
Issuance of additional warrants to preferred
stockholders (53,000)
Amortization of additional warrants issued to
preferred stockholders 53,000
Beneficial conversion feature and warrants attached
to convertible promissory notes
Net loss
------ ------------ ----------- ------------- ----------- ----------
Balances, December 31, 2002 4,015 $ 4,015,000 $ (650,000) 26,527,282 $ 530,546 $(256,851)
====== ============ =========== ============= =========== ==========
(Continued) F-9
EQUITEX, INC. AND SUBSIDIARIES
CONSOLIDATED/COMBINED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
(Note 1)
Retained
Common stock Deferred Additional earnings Total
and warrants compensation paid-in (accumulated stockholders'
to be issued cost capital deficit) equity
------------ ------------ ------------- ------------ ------------
Redemption of Series I preferred stock for cash (136,343) (846,343)
Conversion of Series G preferred stock to common
stock 505,514 -
Conversion of Series I preferred stock to common
stock 247,679 -
Issuance of common stock and warrants under deferred
compensation agreement (134,000) 133,700 -
Amortization of deferred compensation cost 134,000 134,000
Cancellation of agreement to issue common stock
and warrants for services (750,000) 687,500 (62,500)
Conversion of Series D preferred stock to common
stock 134,354 -
Issuance of common stock and warrants to consultants
for services 213,263 221,590
Issuance of Series J preferred stock, including
650 shares purchased by subsidiary (net of offering
costs) (151,680) 578,320
Conversion of accrued liabilities to common stock 58,029 61,005
Issuance of common stock for services 120,056 126,213
Issuance of additional warrants to preferred
stockholders 53,000 -
Amortization of additional warrants issued to preferred
stockholders (53,000) -
Beneficial conversion feature and warrants attached
to convertible promissory notes 55,000 55,000
Net loss (4,319,000) (4,319,000)
------------ ------------ ------------- ------------ ------------
Balances, December 31, 2002 $ - $ - $ 12,719,855 $(6,851,039) $ 9,507,511
============ ============ ============= ============ ============
See notes to consolidated/combined financial statements. F-10
EQUITEX, INC. AND SUBSIDIARIES
CONSOLIDATED/COMBINED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
(Note 1)
2002 2001 2000
----------- ----------- -----------
Cash flows provided by operating activities:
Net (loss) income $(4,319,000) $(1,031,369) $ 3,556,720
----------- ----------- -----------
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Provision for losses 194,175 741,080 56,520
Impairment of FDIC receivable 2,151,207
Depreciation and amortization 1,274,085 215,234 93,167
Beneficial conversion features and warrants attached to
convertible promissory notes 55,000 128,000
Amortization of discount on convertible promissory notes 52,800 4,200
Stock-based compensation expense 419,303 2,132,234
Deferred income taxes 60,000 606,500
Changes in assets and liabilities, net of business acquisition:
Decrease (increase) in accounts receivable 1,167,710 (2,433,347)
(Increase) decrease in other receivables (259,804) (1,156,975) 176,873
Decrease (increase) in due from shareholders 300,000 606,500 (606,500)
Decrease (increase) in other assets 202,607 10,366 (14,412)
Increase in due to credit card holders 582,296 667,225 65,297
Increase in accounts payable and accrued liabilities 747,733 239,620 186,355
----------- ----------- -----------
Total adjustments 6,887,112 1,214,137 563,800
----------- ----------- -----------
Net cash provided by operating activities 2,568,112 182,768 4,120,520
----------- ----------- -----------
Cash flows from investing activities:
Cash acquired in business acquisition 9,994,124
Net (increase) decrease in credit card receivables (471,754) (1,003,266) 176,262
Purchases of furniture, fixtures and equipment (433,884) (157,769) (55,834)
Issuance of note receivable (500,000)
Issuance of related party notes receivable (747,842) (501,599)
Repayment of related party notes receivable 159,457 372,825
----------- ----------- -----------
Net cash (used in) provided by investing activities (1,994,023) 8,704,315 120,428
----------- ----------- -----------
Cash flows from financing activities:
Common stock of Key and Nova issued for cash 1,000,000
Dividends paid to Key and Nova shareholders (2,000,000) (4,225,000)
Redemption of Series I preferred stock for cash (846,343) (418,805)
Proceeds from the exercise of warrants 256,562 244,332
Proceeds from common stock private placements (net of offering costs) 706,196
Proceeds from Series J preferred stock offering (net of offering costs) 578,320
Purchase of Equitex shares for treasury by subsidiary (80,000)
Increase in deferred costs (29,200)
Issuance of notes payable, related parties and other 2,381,839 571,950
Repayment of notes payable, related parties and other (2,438,176) (765,708)
Net (repayments) borrowings on line of credit (2,000) 237,962
----------- ----------- -----------
Net cash provided by (used in) financing activities 527,198 (1,130,269) (4,225,000)
----------- ----------- -----------
(Continued) F-11
EQUITEX, INC. AND SUBSIDIARIES
CONSOLIDATED/COMBINED STATEMENTS OF CASH FLOWS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
2002 2001 2000
---------- ---------- ----------
Increase in cash and cash equivalents 1,101,287 7,756,814 15,948
Cash and cash equivalents, beginning of year 7,830,426 73,612 57,664
---------- ---------- ----------
Cash and cash equivalents, end of year $8,931,713 $7,830,426 $ 73,612
========== ========== ==========
Supplemental disclosure of cash flow information:
Cash paid for interest $1,634,000 $ 8,828
========== ==========
Cash paid for income taxes $ 10,000
==========
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
==========
Cancellation of agreement to issue common stock
for services $ 415,000
==========
Amortization of discount on preferred stock $2,924,000
==========
Conversion of preferred stock to common stock $ 940,000 $1,410,000
========== ==========
Warrants attached to convertible promissory notes $ 52,800
==========
Amortization of value additional warrants issued to
preferred stockholders $ 53,000 $ 152,000
========== ==========
Cancellation of agreement to issue common stock and
warrants for services $ 750,000
==========
Note receivable offset against note payable $ 200,000
==========
Conversion of promissory note, accrued interest and
accounts payable to common stock $ 107,911
==========
Conversion of promissory note and accrued interest to
common stock by subsidiary $ 62,814
==========
Capital lease obligations $ 57,000
==========
Equipment exchanged for a reduction in related party note
payable $ 70,642
==========
Conversion of accrued liabilities to common stock $ 61,005
==========
(Continued) F-12
EQUITEX, INC. AND SUBSIDIARIES
CONSOLIDATED/COMBINED STATEMENTS OF CASH FLOWS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
2002 2001 2000
------------ ------------ ------------
Reclassification of receivables from Net First and
liabilities to Net First card holders:
Credit card receivables, net $ 1,687,931
Other receivables 6,261,571
Accounts payable (562,736)
Due to credit card holders (5,235,559)
------------
Impairment of FDIC receivable $ 2,151,207
============
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 (Note 8) (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-13
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
1. ORGANIZATION, BASIS OF PRESENTATION, RECENT EVENTS AND MANAGEMENT'S 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 was recorded as a reverse acquisition based on
factors demonstrating that Key and Nova constituted 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 included 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 was 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) was carried forward after the acquisition.
PRINCIPLES OF CONSOLIDATION/COMBINATION:
The Company and its subsidiaries operate in three operating segments, which
consist of the credit card services segment, the cash disbursement
services segment and the stored value card segment. For purposes of
financial statement reporting, the stored value card segment is not
considered a reportable segment through December 31, 2002, as defined in
Statement of Financial Accounting Standards ("SFAS") No. 131, DISCLOSURES
ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION. The Company's
significant subsidiaries include the following:
F-14
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
1. ORGANIZATION, BASIS OF PRESENTATION, RECENT EVENTS AND MANAGEMENT'S PLANS
(CONTINUED):
PRINCIPLES OF CONSOLIDATION/COMBINATION (CONTINUED):
KEY and NOVA, 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, 2002.
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, Connecticut, Florida, Illinois,
Michigan, Minnesota, Nebraska, New Mexico, New York, North Dakota and
Wisconsin; wholly-owned by the Company at December 31, 2002.
DENARIS CORPORATION ("Denaris"), which represents the stored value
card segment; a Delaware corporation formed in August 2002 to develop
and market a prepaid re-loadable stored value card program, which is
designed to offer customers, particularly immigrants, a convenient
alternative to traditional bank accounts; 77%-owned by the Company at
December 31, 2002; Denaris generated no revenues through December 31,
2002.
The accompanying consolidated financial statements as of and for the year
ended December 31, 2002, include the accounts of Equitex and its
significant subsidiaries, Chex, Key, and Nova, and beginning August 16,
2002, Denaris. During the year ended December 31, 2002, the net loss
incurred by the Company's majority-owned subsidiary Denaris, exceeded the
minority interest in the common equity (deficiency) of the subsidiary.
The excess of 2002 losses applicable to the minority interest have been
charged to the Company, and no minority interest is reflected in the
Company's December 31, 2002 consolidated financial statements. The
consolidated balance sheet as of December 31, 2001, includes the accounts
of Equitex, Chex, Key and Nova. The consolidated/combined financial
statements for the year ended December 31, 2001 include the combined
accounts of Key and Nova through August 5, 2001 (the date of the
Company's acquisition of Key and Nova) and the consolidated accounts of
Equitex, Key and Nova from August 6, 2001, and Chex from December 1,
2001. The combined statements of operations, stockholders' equity, and
cash flows for the year ended December 31, 2000, have been derived from
the audited financial statements of Key and Nova for the year ended
December 31, 2000. All significant intercompany accounts and transactions
have been eliminated in consolidation/combination.
F-15
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
1. ORGANIZATION, BASIS OF PRESENTATION, RECENT EVENTS AND MANAGEMENT'S PLANS
(CONTINUED):
PRINCIPLES OF CONSOLIDATION/COMBINATION (CONTINUED):
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:
2001 2000
----------- ----------
Net income (loss), as reported $(1,031,000) $3,557,000
Net income (loss), pro forma $(1,616,000) $2,157,000
Net income (loss) applicable to common
stockholders, as reported $(4,196,000) $3,557,000
Net income (loss) applicable to common
stockholders, pro forma $(5,094,000) $ 902,000
Basic and diluted net income (loss) per
common share, as reported $ (0.32) $ 0.40
Basic and diluted net income (loss) per
common share, pro forma $ (0.39) $ 0.10
RECENT EVENTS AND MANAGEMENT'S PLANS:
NASDAQ STOCK MARKET LISTING:
In July 2002, the Company received notice from the Nasdaq Stock Market
("Nasdaq") that the minimum bid price of the Company's common stock had
fallen below the $1.00 per share price required for continued inclusion.
The Company had until January 14, 2003 to regain compliance with the
minimum bid price requirement, which the Company did not meet. On January
14, 2003, the Company received notice from Nasdaq that it met the initial
inclusion criteria for the Nasdaq Small Cap Market listing and therefore
Nasdaq provided the Company an additional 180 calendar days, or until
July 14, 2003, to regain compliance with the minimum bid price
requirement. If at any time before July 14, 2003, the bid price of the
Company's common stock closes at $1.00 per share or more for a minimum of
10 consecutive trading days, Nasdaq will provide written notification of
compliance. If compliance cannot be demonstrated by July 14, 2003, the
Company's securities will be delisted. At that time, the Company may
appeal Nasdaq's determination to a Listing Qualifications Panel.
F-16
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
1. ORGANIZATION, BASIS OF PRESENTATION, RECENT EVENTS AND MANAGEMENT'S PLANS
(CONTINUED):
RECENT EVENTS AND MANAGEMENT'S PLANS (CONTINUED):
AGREEMENT WITH PAYMASTER JAMAICA:
In August 2002, the Company entered into a binding agreement with Paymaster
(Jamaica) Limited ("Paymaster Jamaica") to form a jointly-owned and
operated company to replicate Paymaster Jamaica's financial services
business model throughout the Caribbean, North America and ultimately,
worldwide. This newly formed company is to be named Paymaster Worldwide,
Inc. ("PWI"). Under the terms of the agreement, the Company advanced
$500,000 to Paymaster Jamaica in exchange for a 6% promissory note that
may be converted into stock of PWI (Note 6). As of December 31, 2002, PWI
has not yet been formed.
Paymaster Jamaica, headquartered in Kingston, Jamaica, commenced operations
in 1997, and offers revenue collection and customer care to businesses,
institutions and consumers on the island of Jamaica. It offers its
customers an alternative to retaining their own commercial offices. In
addition, through its bill payment services, Paymaster Jamaica is
developing cash remittance services affording its customers the
convenience to send and receive various types of remittances nationally
or internationally via cash or debit cards.
NET FIRST NATIONAL BANK CLOSURE AND KEY AND NOVA OPERATIONS:
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. In November
2002, the Company filed a lawsuit seeking to recover the full amount of a
claim with the FDIC for all funds due from Net First to Key through the
date federal banking regulators closed Net First (Note 12).
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 had discussions with financial
institutions to initiate a new credit card program; however, the Company
has not been able to establish such a relationship. As of December 31,
2002, Key and Nova operations consist solely of processing residual
payments on remaining active accounts.
MANAGEMENT'S PLANS:
The Company haS developed plans and strategies to address the recent events
discussed above, and to address its capital and liquidity needs for the
next 12-month period. Management believes that cash flows from Chex will
continue to provide the Company's primary source of operating capital;
however, management believes that the Company may also be able to issue
additional debt or equity instruments in order to raise additional
capital if necessary. The Company also evaluates, on an ongoing basis,
potential business acquisition/restructuring opportunities that become
available from time to time, which management considers in relation to
its corporate plans and strategies.
F-17
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
2. SIGNIFICANT ACCOUNTING POLICIES:
CASH AND CASH EQUIVALENTS AND PRESENTATION OF CASH FLOWS:
The Company maintains cash in bank accounts which exceed federally insured
limits. At December 31, 2002 and 2001, the Company had deposits in excess
of federally insured amounts aggregating $2,563,787 and $3,508,158,
respectively, 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 recorded an allowance against these accounts
receivable of $66,000 at December 31, 2001. No allowance was considered
necessary at December 31, 2002.
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 information available to
make its evaluation, this estimate is susceptible to change.
F-18
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
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 values are not necessarily indicative of the
amounts that the Company could realize in a current market exchange.
The fair values of cash and cash equivalents, current non-related party
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 value of long-term debt payable to banks
approximate fair value based on market rates currently available to the
Company. The fair values of notes payable to related parties are not
practicable to estimate, based upon the related party nature of the
underlying transactions.
F-19
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
PROPERTY, EQUIPMENT AND LEASEHOLDS:
Property, equipment and leaseholds are stated at cost, and depreciation is
provided by use of accelerated and straight-line methods 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:
Office equipment, furniture and vehicles 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 December 2001 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 and intangible assets with indefinite lives are not
amortized pursuant to recently issued accounting standards. Identifiable
intangible assets with finite lives are being amortized on a
straight-line basis over three to seven years (Note 8).
In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS. Effective January 1, 2002,
SFAS No. 142 no longer allows the amortization of goodwill and intangible
assets with indefinite useful lives. SFAS No. 142 requires that these
assets be reviewed for impairment at least annually, or whenever there is
an indication of impairment. Intangible assets with finite lives continue
to be amortized over their estimated useful lives and are reviewed for
impairment in accordance with SFAS No. 144, ACCOUNTING FOR THE IMPAIRMENT
OR DISPOSAL OF LONG-LIVED ASSETS, discussed below.
SFAS No. 142 requires companies to allocate goodwill to identifiable
reporting units, which are then tested for impairment using a two-step
process. The first step requires comparing the fair value of each
reporting unit with its carrying amount, including goodwill. If the fair
value exceeds the carrying amount, goodwill of the reporting unit is
considered not impaired, and the second step of the impairment test is
not necessary. If the fair value of the reporting unit does not exceed
the carrying amount, the second step of the goodwill impairment test must
be performed to measure the amount of impairment loss, if any. This step
requires the allocation of the fair value of the reporting unit to the
reporting unit's assets and liabilities (including any unrecognized
intangible assets) as if the reporting unit had been acquired in a
business combination and the fair value of the reporting unit was the
price paid to acquire the reporting unit. The excess of the fair value of
the reporting unit over its re-evaluated net assets would be the new
basis for the reporting unit's goodwill, and any necessary goodwill write
down to this new value would be recognized as an impairment expense.
F-20
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
GOODWILL, INTANGIBLE ASSETS AND AMORTIZATION (CONTINUED):
The Company adopted SFAS No. 142 on January 1, 2002, and completed the
first step of the transitional goodwill impairment test as required. The
Company allocated all goodwill to Chex. The fair value of the reporting
unit exceeded the carrying value of the reporting unit and accordingly,
as of that date, there was no goodwill impairment. The Company also
performed a goodwill impairment test in the fourth quarter of 2002 and
determined that there was no goodwill impairment as of that test date. A
goodwill impairment test will be performed annually in the fourth quarter
or upon significant changes in the Company's business environment.
IMPAIRMENT OF LONG-LIVED ASSETS:
In August 2001, the FASB issued SFAS No. 144, ACCOUNTING FOR THE IMPAIRMENT
OR DISPOSAL OF LONG-LIVED ASSETS, which addresses financial accounting
and reporting for the impairment or disposal of long-lived assets. While
SFAS No. 144 supersedes SFAS No. 121, ACCOUNTING FOR THE IMPAIRMENT OF
LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF, it retains
many of the fundamental provisions of that statement. The Company adopted
SFAS No. 144 on January 1, 2002 with no material impact to its financial
statements.
ADVERTISING:
Advertising costs, which are primarily incurred by Chex, are expensed as
incurred. Advertising costs were approximately $296,000 in 2002, and were
not material in 2001 or 2000.
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 sheets and
the reported amounts of revenues and expenses during the reporting
periods. Actual results could differ from those estimates.
F-21
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
NET INCOME (LOSS) PER SHARE:
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 years
ended December 31, 2002 and 2001, as the impact of the potential common
shares, which total 15,668,290 and 12,184,343, respectively, 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 year ended December 31, 2000, therefore diluted
income per share is equivalent to basic income per share.
COMPREHENSIVE INCOME:
SFAS No. 130, REPORTING COMPREHENSIVE INCOME, establishes requirements for
disclosure of comprehensive income. During the years presented, 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-22
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
RECENTLY ISSUED ACCOUNTING STANDARDS:
In December 2002, the FASB issued SFAS No. 148, ACCOUNTING FOR STOCK-BASED
COMPENSATION TRANSITION AND DISCLOSURE. This statement amends SFAS No.
123, ACCOUNTING FOR STOCK-BASED COMPENSATION, and establishes two
alternative methods of transition from the intrinsic value method to the
fair value method of accounting for stock-based employee compensation. In
addition, SFAS No. 148 requires prominent disclosure about the effects on
reported net income and requires disclosure for these effects in interim
financial information. The provisions for the alternative transition
methods are effective for fiscal years ending after December 15, 2002,
and the amended disclosure requirements are effective for interim periods
beginning after December 15, 2002. The Company plans to continue
accounting for stock-based compensation under APB 25. Therefore, this
pronouncement is not expected to impact the Company's financial position
or results of operations.
In June 2002, the FASB issued SFAS No. 146, ACCOUNTING FOR COSTS ASSOCIATED
WITH EXIT OR DISPOSAL ACTIVITIES. SFAS No. 146 addresses financial
accounting and reporting for costs associated with exit or disposal
activities initiated after December 31, 2002, with earlier application
encouraged. This statement supersedes Emerging Issues Task Force Issue
No. 94-3, LIABILITY RECOGNITION FOR CERTAIN EMPLOYEE TERMINATION BENEFITS
AND OTHER COSTS TO EXIT AN ACTIVITY. The Company adopted SFAS No. 146 in
the fourth quarter of 2002, and applied its provisions in connection with
certain exit activities related to Key (Note 12). The adoption of this
pronouncement had no material impact on the Company's financial position
or results of operations.
RECLASSIFICATIONS:
Certain amounts reported in the 2001 and 2000 financial statements have
been reclassified to conform to the 2002 presentation.
3. ACQUISITION OF CHEX:
In June 2001, the FASB issued SFAS No. 141, Business Combinations. 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. The Company applied the provisions of SFAS No. 141 in connection
with its December 1, 2001 acquisition of Chex.
Effective December 1, 2001, the Company acquired all of 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. An
allocation of the purchase price was made to major categories of assets
and liabilities, of which $5,636,000 was allocated to goodwill and
$5,000,000 was allocated to identifiable intangible assets (Note 8). In
conjunction with the acquisition, 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 (Note 13).
F-23
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
4. CREDIT CARD RECEIVABLES:
The composition of credit card receivables at December 31, 2002 and 2001,
is as follows:
2002 2001
------------ ------------
Credit card receivables $ 1,328,858 $ 57,289,378
Refundable reservation fees (1,169,396) (55,587,827)
------------- -------------
159,462 1,701,551
Less allowance for losses 3,465 208,070
------------ ------------
$ 155,997 $ 1,493,481
============ ============
Changes in the allowance for losses for the years ended December 31, 2002,
2001, and 2000, are as follows:
2002 2001 2000
------------ ------------ -----------
Balances, beginning of year $ 208,070 $ 254,086 $ 529,498
Provision for recoveries 121,307 416,080 56,520
Amounts charged-off (325,912) (462,096) (331,932)
------------ ------------ -----------
Balances, end of year $ 3,465 $ 208,070 $ 254,086
============ ============ ===========
5. OTHER RECEIVABLES:
The composition of other receivables at December 31, 2002 and 2001, is as
follows:
2002 2001
------------ ------------
Due from Net First $ 5,490,915
Due from Key Bank & Trust $ 15,803 233,907
Due from Merrick Bank 417,490 689,946
Other 20,292
------------ ------------
$ 433,293 $ 6,435,060
============ ============
The amounts due from Key Bank & Trust are held in trust accounts at
December 31, 2002 and 2001.
F-24
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
6. NOTES RECEIVABLE:
RELATED PARTIES:
Notes receivable, related parties at December 31, 2002 and 2001, consist of
the following:
2002 2001
----------- -----------
Notes receivable from a shareholder/deceased
Chex officer's estate; interest at 6%;
principal and unpaid interest due in November
2004; collateralized by unregistered shares of
the Company's common stock; a valuation
allowance of $1,211,100 has been recorded
against this receivable at December 31, 2002
($1,150,000 at December 31, 2001) $ 1,484,691 $ 1,469,691
Notes receivable from an officer of Chex;
interest at rates ranging from 5.75% to 6%;
due on demand; collateralized by unregistered
shares of the Company's common stock; the
Company also has a $150,000 note payable to
this officer (Note 9) [A] 585,936 735,936
Note receivable from an individual; interest at
12%; unsecured; note matured in December 2002
and has been extended on a month to month
basis [A] 288,000 500,000
Notes receivable from Equitex 2000; interest at
10%; unsecured, and due on demand [A] 522,724 47,300
Notes receivable from various Chex employees and
a shareholder; non-interest bearing,
unsecured, and due on demand [A] 55,101 106,908
----------- -----------
2,936,452 2,859,835
Less current maturities (245,322) (563,460)
----------- -----------
Notes receivable - related parties, net of
current portion 2,691,130 2,296,375
Less allowance for uncollectible notes receivable (1,211,100) (1,150,000)
----------- -----------
Notes receivable - related parties, long-term $ 1,480,030 $ 1,146,375
=========== ===========
[A] Demand notes receivable aggregating to $1,206,439 at December 31, 2002,
have been classified as long-term assets, as it is management's intention
not to demand payment in 2003.
F-25
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
6. NOTES RECEIVABLE (CONTINUED):
OTHER:
As of December 31, 2002, the Company has a $500,000 note receivable from
Paymaster Jamaica. This note bears interest at 10% and matures in July
2008. Under the terms of the note, the first interest payment is due
August 15, 2003, with quarterly payments of interest and principal due
thereafter. The note is collateralized by a pledge of Paymaster Jamaica
common shares by the president of Paymaster Jamaica.
7. PROPERTY, EQUIPMENT AND LEASEHOLDS:
The major classes of property, equipment and leaseholds, and total
accumulated depreciation at December 31, 2002 and 2001, are as follows:
2002 2001
----------- -----------
Office equipment, furniture and vehicles $ 1,504,491 $ 1,404,445
Leasehold improvements 52,765 125,854
Computer software 144,822 16,433
----------- -----------
1,702,078 1,546,732
Less accumulated depreciation (499,193) (366,474)
----------- -----------
$ 1,202,885 $ 1,180,258
=========== ===========
The amounts above include equipment under capital leases with a gross
carrying value of approximately $157,000 and accumulated depreciation of
approximately $14,000 at December 31, 2002.
8. GOODWILL, INTANGIBLE AND OTHER ASSETS:
At December 31, 2002 and 2001, goodwill was $5,636,000, none of which is
deductible for tax purposes, based on the structuring of the Chex
acquisition or tax purposes. Intangible and other assets are as follows:
December 31, 2002 December 31, 2001
---------------------------------- ----------------------------------
Gross Net Gross Net
carrying Accumulated carrying carrying Accumulated carrying
amount amortization amount amount amortization amount
---------- ---------- ---------- ---------- ---------- ----------
Casino contracts $4,300,000 $ 749,440 $3,550,560 $3,500,000 $ 41,660 $3,458,340
Non-compete agreements 350,000 99,300 250,700 500,000 8,330 491,670
Technology and software 500,000 13,885 486,115
Customer lists 250,000 102,600 147,400 300,000 8,330 291,670
Trade names 100,000 100,000 200,000 2,380 197,620
---------- ---------- ---------- ---------- ---------- ----------
Total intangible assets 5,000,000 951,340 4,048,660 5,000,000 74,585 4,925,415
Other assets 49,733 49,733 20,248 20,248
---------- ---------- ---------- ---------- ---------- ----------
$5,049,733 $ 951,340 $4,098,393 $5,020,248 $ 74,585 $4,945,663
========== ========== ========== ========== ========== ==========
The carrying amounts of intangible assets at December 31, 2001, represent the
Company's preliminary allocation of the Chex purchase price. In the fourth
quarter of 2002, based upon the results of an independent valuation, the
Company finalized the Chex purchase price allocation and re-allocated the
gross carrying amounts among intangible asset classes.
F-26
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
8. GOODWILL, INTANGIBLE AND OTHER ASSETS (CONTINUED):
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.
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. Trade names consist of the Chex Services and Fast Funds names,
which are believed to be readily identified and known in the marketplace
by Chex customers. Trade names are considered to have an indefinite life
and are therefore not amortized. Other assets primarily represent
long-term deposits.
Aggregate amortization expense for the years ended December 31, 2002 and
2001, was $876,755 and $74,585, respectively. Estimated amortization
expense for each of the five succeeding fiscal years is as follows:
Year Amount
---- -----------
2003 $ 741,000
2004 735,000
2005 664,000
2006 659,000
2007 600,000
9. NOTES PAYABLE AND LONG-TERM DEBT:
NOTES PAYABLE, RELATED PARTIES:
Notes payable and long-term debt at December 31, 2002 and 2001, consist of
the following:
2002 2001
----------- -----------
Notes payable to a former officer of the Company
and Key; interest at 10%; the notes are
unsecured and due on demand $ 79,194 $ 150,000
Note payable to the Company's president;
interest at 10%; 25,000 33,925
Note payable to an officer of the Company and
Chex; interest at 8%; the note is unsecured
and due on demand 150,000
Convertible promissory notes, related parties
through November 2002 (see below);
the notes were due in February 2003, currently
in default [A] 232,200
F-27
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
9. NOTES PAYABLE AND LONG-TERM DEBT (CONTINUED):
NOTES PAYABLE, RELATED PARTIES (CONTINUED):
2002 2001
----------- -----------
Notes payable to affiliate through common
ownership and control by the Company's
president; interest at 10%; the notes were
paid in 2002 27,700
----------- -----------
254,194 443,825
Less current maturities (254,194) (211,625)
----------- -----------
$ - $ 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 was due 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 was amortized to interest expense using the
effective interest method over the term of the promissory notes.
Through December 31, 2002 and 2001, the Company recognized $57,000
and $4,200 of interest expense relating to the warrants,
respectively. 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.
LONG-TERM DEBT:
2002 2001
----------- -----------
Note payable to a bank; at prime plus .25%
(4.50% and 5% at December 31, 2002 and 2001);
interest payable monthly and principal payable
quarterly; the note matures in June 2004; the
note is collateralized by substantially all
assets of Chex and is guaranteed by an officer
of Chex; subject to various restrictive
covenants $ 350,000 $ 450,000
Note payable to a bank; interest at 7.5%;
interest and principal payable monthly; the
note was paid in October 2002 77,754
F-28
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
9. NOTES PAYABLE AND LONG-TERM DEBT (CONTINUED):
LONG-TERM DEBT (CONTINUED):
2002 2001
----------- -----------
Obligations under capital leases, imputed
interest rates ranging from 6.5% to 7%; due at
various dates through October 2005;
collateralized by equipment 142,356
----------- -----------
492,356 527,754
Less current maturities (251,727) (527,754)
----------- -----------
$ 240,629 $ -
=========== ===========
Aggregate annual maturities of long-term debt are as follows:
Years ending
December 31,
------------
2003 $ 251,727
2004 201,727
2005 38,902
-----------
$ 492,356
===========
LINE OF CREDIT, NOTES AND LOANS PAYABLE:
2002 2001
----------- -----------
Chex line of credit, maximum availability of $1
million through November 2003; subject to
various restrictive covenants, interest is
payable monthly at prime rate plus .5% (4.75%
and 5.25% at December 31, 2002), borrowings
are collateralized by substantially all assets
of Chex and are guaranteed by a shareholder of
the Company $ 1,000,000 $ 1,002,000
Notes payable to individuals; interest
rates ranging from 10% to 12%; interest and
principal payable quarterly; the notes are
unsecured and mature on various dates through
December 2003; the notes are subject to
repayment with ninety days notice at the
option of the holder 11,658,776 11,385,926
Notes payable, other; interest at 9%; the notes
are unsecured and due on demand 550,000 1,200,000
Convertible promissory notes; the notes were
due in November 2002, currently in default 285,000
----------- -----------
$13,493,776 $13,587,926
=========== ===========
F-29
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
9. NOTES PAYABLE AND LONG-TERM DEBT (CONTINUED):
LINE OF CREDIT, NOTES AND LOANS PAYABLE (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. 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 was
amortized to interest expense in 2002. The warrants expire in January
2005 (Note 13). The promissory notes were converted into common stock of
the Company in May 2002 at 80% of the average of the closing bid price of
the Company's common stock as defined in the promissory note agreement
(Note 13). The intrinsic value of the beneficial conversion feature was
determined to be approximately $40,000 and was charged to interest
expense in January 2002.
The weighted-average interest rates on short-term borrowings was 11.4%,
11.2% and 10% in 2002, 2001 and 2000, respectively.
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, 2002 and 2001
is as follows:
2002 2001
------------ ------------
Current:
Federal $ (100,500)
State $ 55,000 (17,000)
------------ ------------
55,000 (117,500)
Deferred 60,000
------------ ------------
$ 55,000 $ (57,500)
============ ============
F-30
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
10. INCOME TAXES (CONTINUED):
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, 2002 and 2001, is as follows:
2002 2001
----------- -----------
Statutory federal income tax rate (34)% (34)%
Federal and state taxes not incurred by
Key and Nova as S Corporations from January 1,
through August 5, 2001 (49)%
State taxes, net of federal income tax benefit (4)% (4)%
Effect of change in valuation allowance 39% 82%
----------- -----------
1% (5)%
=========== ===========
The following is a summary of the Company's deferred tax assets and
liabilities:
2002 2001
----------- -----------
Deferred tax assets:
Allowance for loan losses$ 594,000 $ 513,000
Intangible and other assets 14,000 12,000
Accruals 170,000
Net operating loss carryforwards 3,099,000 2,850,000
----------- -----------
Total deferred tax assets 3,877,000 3,375,000
Valuation allowance (2,437,000) (1,405,000)
----------- -----------
1,440,000 1,970,000
Deferred tax liabilities, credit card receivables (60,000) (590,000)
----------- -----------
Net deferred tax asset $ 1,380,000 $ 1,380,000
=========== ===========
Net operating loss carryforwards of approximately $9,100,000 are available
to offset future taxable income, if any, and expire between 2015 and
2022. 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. 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-31
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
11. RELATED PARTY TRANSACTIONS:
Key and Nova had 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 provided credit card marketing services for Key and
Nova. Paragon earned commissions for card applications that were not
subsequently refunded. Key and Nova incurred $3,010,055 and $897,521 of
commissions under the Paragon agreement during the years ended December
31, 2001 and 2000, 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 $101,000 of operating income and
$420,000 of operating losses under this agreement for the years ended
December 31, 2002 and 2001, respectively. The Company terminated this
agreement with Paragon on March 1, 2002.
12. COMMITMENTS, CONTINGENCIES AND CREDIT RISK:
Litigation:
In May 2002, Key filed a claim with the FDIC for all funds due from Net
First to Key under the Credit Card Program Agreement through the date
federal banking regulators closed Net First. The total amount of the
claim was $4,311,027. In October 2002, the FDIC notified Key that it had
determined to disallow all but $111,734 of the total claim. The
notification states that as the FDIC liquidates the assets of the
receivership, Key may periodically receive payments on the allowed
portion of this claim through dividends. The Company and its legal
counsel do not agree with this disallowance. In November 2002, the
Company filed a lawsuit in the United States District Court for the
Southern District of Florida seeking to recover the full amount of its
claim. The FDIC has answered the complaint, asserting a counterclaim
for $1,000,000 which the FDIC asserts is for refunds to be made to
customers who did not receive credit cards as a result of the FDIC's
actions.
While the Company believes that it will ultimately be successful in
collecting on its claim, there is no assurance that collection will
eventually occur. Accordingly, the Company has reserved 100% of the net
remaining balance due of $2,151,207 from the FDIC, as receiver for Net
First, in addition to amounts previously reserved.
F-32
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
12. COMMITMENTS, CONTINGENCIES AND CREDIT RISK (CONTINUED):
LITIGATION (CONTINUED):
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.
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 $ 403,405 and $5,056,668 as of December
31, 2002 and December 31, 2001, respectively.
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.
F-33
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
12. COMMITMENTS, CONTINGENCIES AND CREDIT RISK (CONTINUED):
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, 2002, are as follows:
Years ending
December 31, Amount
------------------ ------------------
2003 $ 70,791
2004 71,315
2005 72,102
2006 18,091
------------------
$ 232,299
==================
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.
In December 31, 2002, the Company total rent expense under operating leases
was approximately $693,000, $389,000 and $299,000 for the years ended
December 31, 2002, 2001, and 2000, respectively.
In February 2003, the Company entered into an agreement to terminate the
operating lease agreement for Key for the unexpired portion of the term
of the lease. In consideration for this settlement, the Company agreed to
pay a lease termination fee of $150,000 in 2003. The amount has been
accrued and is included in operations for the year ended December 31,
2002.
CONSULTING AGREEMENTS:
In September 2000, the Company entered into an athlete endorsement, license
and consulting agreement (the "Agreement") with a professional athlete
(the "Athlete"). The Athlete was unable to perform the endorsement
services pursuant to the original term of the Agreement, which expired in
September 2001. The parties verbally agreed to extend the contract
through September 2002. The Company asserts that in November 2001, the
Athlete violated the "Reputational Standards" clause of the Agreement.
Accordingly, the Company terminated the Agreement, and all compensation
called for by the Agreement is being withheld. As a result, the Company
has eliminated the common stock and warrants that were to be issued under
the Agreement and reduced stock-based compensation by $62,500 in the
2002.
F-34
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
12. COMMITMENTS, CONTINGENCIES AND CREDIT RISK (CONTINUED):
CONSULTING AGREEMENTS (CONTINUED):
In April 2002, the Company entered into a consulting agreement with an
individual to assist the Company in obtaining a state or national bank
charter. Pursuant to the agreement, the Company issued the consultant
warrants to purchase 100,000 shares of common stock at $0.75 per share
(the market value of the Company's common stock was $0.99 per share at
the date of the agreement). The warrants were valued at approximately
$62,000 based upon the Black-Scholes option pricing model at the date of
commitment. The Company has recognized $62,000 of expense through
December 31, 2002, as the performance criteria under the agreement have
been fully satisfied.
In January 2002, the Company entered into a consulting agreement for
financial services in exchange for 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 (Note 13). At the date of
commitment, total compensation expense was estimated to be approximately
$72,000, which was recognized as operating expense during the year ended
December 31, 2002, as the performance criteria have been fully satisfied.
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 and which
is included in the Company's operations for the year ended December 31,
2001 as the performance criteria have been fully satisfied. The Company
issued the common stock and the warrants underlying this agreement in
November 2001 (Note 13).
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 was 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).
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 approximately $236,000 at December 31, 2002, in the event that
their employment is terminated.
F-35
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
12. COMMITMENTS, CONTINGENCIES AND CREDIT RISK (CONTINUED):
CHEX EMPLOYMENT AGREEMENTS:
Chex 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,
2002, a liability of $33,000 has been accrued.
Chex has entered into three-year employment agreements with eight 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 to approximately $1,343,000 at December 31, 2002.
The amounts are to be paid in monthly installments over the duration of
the original contract terms.
In 2002, Chex terminated one of its employees under an employment
agreement. In July 2002, the Company and the former employee entered into
a settlement agreement and mutual release, in which the Company paid the
former employee $65,000, which was charged to operating expense in 2002.
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.
As of December 31, 2002 and 2001, the Company has recorded $189,717 and
$342,012, respectively, of prepaid amounts on casino contracts and has
recorded $622,361 and $517,805, respectively, of accrued liabilities on
casino contracts.
Pursuant to the contracts, the Native American owned casinos have not
waived their sovereign immunity.
F-36
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
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 shares of common stock were issued upon
the conversion of newly issued series H preferred stock, discussed below.
F-37
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
13. STOCKHOLDERS' EQUITY (CONTINUED):
ISSUANCES OF COMMON STOCK PRIOR TO THE AUGUST 6, 2001 MERGER (CONTINUED):
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.
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.
F-38
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
13. STOCKHOLDERS' EQUITY (CONTINUED):
ISSUANCE OF SERIES H AND SERIES I PREFERRED STOCK IN CONNECTION WITH MERGER
(CONTINUED):
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.
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 approximately $230,000
(approximately $136 per share) at December 31, 2002. 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. Because a
registration statement had not been declared effective by the stipulated
date, the Company incurred approximately $263,600 in penalties for the
year ended December 31, 2002, which is payable in cash, and is included
in the Company's operations for the year ended December 31, 2002. On May
3, 2002, the Company filed a Form S-3/A with the SEC to register the
shares underlying the Series I Preferred Stock. The registration
statement was declared effective by the SEC on May 30, 2002, and
accordingly, the Company has not incurred additional penalties since that
date.
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.
F-39
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
13. STOCKHOLDERS' EQUITY (CONTINUED):
ISSUANCE OF SERIES H AND SERIES I PREFERRED STOCK IN CONNECTION WITH MERGER
(CONTINUED):
SERIES I CONVERTIBLE PREFERRED STOCK (CONTINUED):
In November 2001, the Company redeemed 330 shares of Series I Preferred
Stock, plus cumulative unpaid dividends of $6,305, for $418,805. 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.
During the year ended December 31, 2002, the Company redeemed 710 shares of
Series I Preferred Stock, plus cumulative unpaid dividends of $30,343,
for $846,343. 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 $266,000 for the year
ended December 31, 2002.
During the year ended December 31, 2002, 260 shares of Series I Preferred
Stock, plus cumulative unpaid dividends of $13,080, were converted into
616,035 shares of common stock, at conversion prices of $0.28 to $2.33
per share.
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.
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 Preferred Stock is entitled to a 6%
cumulative annual dividend, payable quarterly. Dividends are payable in
cash or, at the Company's option, in shares of the Company's common
stock. Cumulative unpaid dividends are approximately $49,000
(approximately $85 per share) at December 31, 2002. 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.
During the year ended December 31, 2002, 150 shares of Series D Preferred
Stock plus cumulative unpaid dividends of $38,041 were converted into
782,328 shares of common stock, at conversion prices of $0.21 to $0.28
per share.
F-40
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
13. STOCKHOLDERS' EQUITY (CONTINUED):
SERIES D AND SERIES G PREFERRED STOCK (CONTINUED):
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 approximately $53,000
(approximately $143 per share) at December 31, 2002. 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.
During the year ended December 31, 2002, 530 shares of Series G Preferred
Stock, plus cumulative unpaid dividends of $54,595, were converted into
1,224,221 shares of common stock at an average conversion price of $0.28
to $2.33 per share.
SERIES J REDEEMABLE CONVERTIBLE PREFERRED STOCK:
During the fourth quarter of 2002, the Company issued 1,380 shares of 6%,
Series J Preferred Stock, (the "Series J Preferred Stock") along with
warrants to purchase 138,000 shares of common stock, of which 650 shares
were sold to Chex and are being presented as preferred treasury stock
(total proceeds of $730,000 less issue costs of $151,680). The warrants
were valued at $20,000 utilizing the Black-Scholes option pricing model,
and therefore $20,000 of the total proceeds was allocated to the warrants
resulting in an imputed dividend rate of 6.3%. The warrants are being
accreted to net loss applicable to common shareholders over the expected
life of the warrants, which is two years. In connection with this
placement, the Company issued to the underwriter, warrants to purchase
345,000 shares of common stock.
F-41
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
13. STOCKHOLDERS' EQUITY (CONTINUED):
SERIES J REDEEMABLE CONVERTIBLE PREFERRED STOCK (CONTINUED):
The Series J 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 65% of the average closing bid
price of the Company's common stock as specified in the agreement, but in
no event shall the conversion price be less than $0.40 per share.
The holder of each share of the Series J Preferred Stock is entitled to
cumulative dividends at 6% per annum plus a 4% dividend default rate,
payable quarterly. Dividends are payable in cash or, at the Company's
option, in shares of the Company's common stock. Cumulative unpaid
dividends are approximately $12,000 (approximately $16 per share) at
December 31, 2002. The Series J Preferred Stock contains a liquidation
preference equal to an amount equal to 105% of the stated par value plus
the aggregate of all cumulative unpaid dividends on each share of Series
J Preferred Stock until the most recent dividend payment date or date or
liquidation, dissolution or winding up of the Company. All outstanding
shares of Series J Preferred Stock automatically convert into common
stock on the third anniversary of the issuance. The Series J Preferred
Stock is redeemable at the Company's option at any time through the third
anniversary, at a redemption price equal to $1,250 per share plus any
cumulative unpaid dividends.
In January 2003, all of the outstanding shares of Series J Preferred Stock
and unpaid dividends of $18,542 were converted into 3,496,354 shares of
common stock at $0.40 per share.
ISSUANCE 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 for
$244,332, 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.
During the year ended December 31, 2002, the Company sold 1,212,386 shares
of common stock for $706,196 under various private placement agreements.
Under the terms of the agreements, 78,636 shares were sold at $2.75 per
share, representing a 25% discount from the market price at that time.
The remainder of the shares were sold at the then current market prices
which were between $0.50 and $1.20 per share.
During the year ended December 31, 2002, the Company issued 604,856 shares
of common stock upon the conversion of 304,856 warrants to purchase
common stock for $256,562 at an average conversion price of $0.67 per
share.
F-42
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
13. STOCKHOLDERS' EQUITY (CONTINUED):
ISSUANCE OF COMMON STOCK SUBSEQUENT TO AUGUST 6, 2001 (CONTINUED):
In March 2002, the Company issued 15,000 shares of common stock to a
consultant for services rendered under a deferred compensation agreement.
These shares were valued at $57,000, the market value of the common stock
at the date of commitment.
In May 2002, convertible promissory notes and accounts payable of $100,000
and $5,000, respectively, plus accrued interest of $2,911 were converted
into 119,662 and 4,167 shares of common stock, respectively.
In November 2002, the Company received notice from Nasdaq notifying the
Company that the issuance of 300,000 warrants to purchase common stock at
$.50 per share in March 2002 to a director of the company violated Nasdaq
Marketplace Rule 4310(i)(1)(A) (the "Rule"). This director exercised the
warrants in March and April 2002 for $150,000. The Company provided
Nasdaq with requested material regarding the warrants and the
circumstances upon which they were issued, as well as a plan to achieve
and sustain compliance. The plan included the rescission of the warrants
and the Company's acquisition of the common stock that was issued in
connection with the exercise of the warrants. Accordingly, the director
returned 300,000 shares of common stock to the Company, and the Company
agreed to reimburse the director $150,000 for the exercise price.
Additionally, the Company informed Nasdaq that it implemented polices and
procedures regarding future issuances of equity-based compensation to
address compliance with marketplace rules. Nasdaq accepted the plan to
achieve and sustain compliance with respect to this issue.
In December 2002, the Company issued 416,341 shares of common stock to a
consultant for services valued at $170,700 ($0.41 per share), the market
value of the common stock at the date of issuance. In addition, the
Company issued 148,792 shares in exchange for accrued liabilities of
$61,005, and 307,835 shares for services valued at $126,213. The shares
were valued at $0.41 per share, the market price of the common stock at
the date of issuance.
TREASURY STOCK TRANSACTIONS:
COMMON STOCK:
In April 2002, Chex purchased 105,645 shares of the Company's common stock
from a related party under a Stock Purchase Agreement for $80,000 ($0.76
per share). The cost of the shares received has been classified as
treasury stock.
In August 2002, Chex acquired 130,862 shares of the Company's common stock
valued at $62,814 ($0.48 per share, the market price of the Company's
common stock on the purchase date). The cost of the shares received has
been classified as treasury stock.
PREFERRED STOCK:
In October and December 2002, Chex purchased 650 shares of the Company's
Series J Preferred Stock for $650,000. This transaction has been
presented as preferred treasury stock.
F-43
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
13. STOCKHOLDERS' EQUITY (CONTINUED):
STOCK OPTIONS AND WARRANTS:
STOCK OPTIONS:
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, which were all issued in 1999.
In April 2000, the Company's Board of Directors amended the 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 to purchase 511,000 shares and 21,000 shares to the Company's
officers and employees, respectively. In addition, non-statutory stock
options to purchase 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, 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 to purchase 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.
No stock options were granted in 2002. In 2001, and 2000, stock options
were granted 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
=========
(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, 2002,
recharacterization of the options as variable awards did not
materially affect compensation expense.
F-44
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
13. STOCKHOLDERS' EQUITY (CONTINUED):
STOCK OPTIONS AND WARRANTS (CONTINUED):
STOCK OPTIONS (CONTINUED):
A summary of the status of 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, 2000 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 6.14 1,786,400 6.00
Forfeited - - - - - -
Granted - - - - - -
Exercised - - - - - -
-------- ---------- ---------- -------- ---------- --------
December 31, 2002 86,400 $ 3.19 1,700,000 $ 6.14 1,786,400 $ 6.00
======== ========== ========== ======== ========== ========
Options exercisable at December 31, 2002, 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
forma income (loss) applicable to common stockholders and net income
(loss) per common share would have been as follows:
2001 2000
------------- -----------
Net income (loss) applicable to common
stockholders, as reported $ (4,196,369) $ 3,556,720
Net income (loss) applicable to common
stockholders, pro forma $ (4,238,000) $ 1,555,000
Net income (loss) per share, as reported $ (.32) $ .40
Net income (loss) per share, pro forma $ (.33) $ .17
F-45
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
13. STOCKHOLDERS' EQUITY (CONTINUED):
STOCK OPTIONS AND WARRANTS (CONTINUED):
STOCK OPTIONS (CONTINUED):
The fair value of options granted was estimated on the date of grant using
the Black-Scholes option pricing model. The following weighted average
assumptions were utilized:
2001 2000
------------- ------------
Expected dividend yield 0 0
Expected stock price volatility 53% 56%
Risk-free interest rate 4.2% 5.1%
Expected life of options 2 years 3 years
WARRANTS:
In December 2002, the Company issued 100,000 warrants to purchase shares of
common stock to an outside consultant. The warrants were exercisable
immediately at $0.41 per share (the market price of the common stock at
the date of issuance). The warrants were valued at $10,900, based upon
the Black-Scholes option pricing model. In addition, the Company
converted $39,900 of accounts payable due to a consultant into 150,000
warrants to purchase shares of common stock in December 2002.
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 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 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.
F-46
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
13. STOCKHOLDERS' EQUITY (CONTINUED):
STOCK OPTIONS AND WARRANTS (CONTINUED):
WARRANTS (CONTINUED):
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.
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 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 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.
The fair value of each warrant and option granted to non-employees during
2002 was estimated on the date of grant using the Black-Scholes
option-pricing model. The following weighted average assumptions were
utilized:
2002 2001 2000
--------- --------- --------
Expected dividend yield 0 0 0
Expected stock price volatility 84% 54% 63%
Risk-free interest rate 2.0% 3.8% 6.0%
Expected life of warrants 1.3 years 1.3 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-47
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
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, 2002, segment results were as follows:
Cash
Credit card disbursement Corporate
services services activities Total
------------ ----------- ----------- ------------
(Key and Nova) (Chex)
Revenues $ 4,355,850 $19,580,399 $ - $23,936,249
Depreciation and amortization 122,248 1,151,553 284 1,274,085
Stock based compensation - - 419,303 419,303
Impairment of FDIC receivable 2,151,207 - - 2,151,207
Interest expense 16,879 1,529,438 141,291 1,687,608
Income tax expense - - 55,000 55,000
Net income (loss) (2,525,864) 757,271 (2,550,407) (4,319,000)
Intangible assets - 4,048,660 - 4,048,660
Goodwill - 5,636,000 - 5,636,000
Total assets 660,466 24,281,983 2,489,299 27,431,748
Capital expenditures 2,939 428,375 2,570 433,884
As of and for the year ended December 31, 2001, 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 - 5,636,000 - 5,636,000
Total assets 8,541,368 26,742,249 65,538 35,349,155
Capital expenditures 125,422 32,347 - 157,769
For the year ended December 31, 2000, the Company operated in only the
credit card services segment.
F-48
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
15. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED):
Selected unaudited quarterly financial data for the years ended 2002 and
2001, 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 for the periods indicated.
2002 quarters
---------------------------------------------------------------------
First Second Third Fourth
quarter quarter quarter (a) quarter
--------------- --------------- -------------- ---------------
Revenues $ 7,770,374 $ 5,766,861 $ 5,637,651 $ 4,761,363
Net loss (758,228) (32,457) (2,370,328) (1,157,987)
Preferred stock beneficial conversion
features, deemed dividends and other
transactions (53,000) (85,000) (82,000) 99,420
Net loss applicable to common
shareholders (811,228) (117,457) (2,452,328) (1,058,567)
Basic and diluted loss per common
share (d) (0.04) (0.01) (0.10) (0.04)
2001 quarters
---------------------------------------------------------------------
First Second Third Fourth
quarter quarter quarter (b) quarter (b) (c)
--------------- --------------- -------------- ------------------
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 (d) 0.07 0.06 (0.15) (0.30)
(a) In August 2002, the Company received $240,000 from the settlement of a
lawsuit. This amount was reclassified from revenue to other income to
conform to the 2002 statement of operations presentation.
(b) 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 was 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) were carried
forward after the acquisition.
(c) 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.
(d)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.
F-49
KEY FINANCIAL SYSTEMS, INC.
FINANCIAL REPORT
DECEMBER 31, 2000
Contents
- --------------------------------------------------------------------------------
INDEPENDENT AUDITOR'S REPORT
- --------------------------------------------------------------------------------
FINANCIAL STATEMENTS
Statements of income
Statements of stockholders' equity
Statements of cash flows
Notes to financial statements
- --------------------------------------------------------------------------------
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors
Key Financial Systems, Inc.
Clearwater, Florida
We have audited the accompanying statements of income, stockholders' equity, and
cash flows of Key Financial Systems, Inc. for the year ended December 31, 2000.
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 financial statements referred to above present fairly, in
all material respects, the results of operations and cash flows of Key Financial
Systems, Inc. for the year ended December 31, 2000, in conformity with
accounting principles generally accepted in the United States of America.
/s/ McGladrey & Pullen, LLP
Fort Lauderdale, Florida
March 30, 2001
KEY FINANCIAL SYSTEMS, INC.
STATEMENT OF INCOME
Year Ended December 31, 2000
-------------------------------------------------------------------------------
Credit card income:
Card servicing fees $ 6,892,015
Other 231,799
-----------------
7,123,814
Provision for losses (Note 2) 139,782
-----------------
NET CREDIT CARD INCOME
AFTER PROVISION FOR LOSSES 6,984,032
-----------------
Other income:
Application fees, net of direct marketing costs of $10,366,826 (Note 3) 2,735,438
Servicing fee income (Note 3) 672,420
Other 182,618
-----------------
3,590,476
-----------------
Operating expenses (Note 3):
Salaries and wages 2,686,033
Employee benefits 333,843
Third party servicing fees 3,007,077
Occupancy and equipment (Note 4) 426,930
Other operating expenses (Note 5) 1,139,842
-----------------
7,593,725
-----------------
NET INCOME $ 2,980,783
=================
See Notes to Financial Statements.
KEY FINANCIAL SYSTEMS, INC.
STATEMENT OF STOCKHOLDERS' EQUITY
Year Ended December 31, 2000
Additional
Common Paid In Retained
Stock Capital Earnings Total
-----------------------------------------------------------------------------------------------------
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.
KEY FINANCIAL SYSTEMS, INC.
STATEMENT OF CASH FLOWS
Year Ended December 31, 2000
- --------------------------------------------------------------------------------
Cash Flows From Operating Activities
Net income $ 2,980,783
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for losses 139,782
Depreciation and amortization 93,167
Increase in other receivables (913,561)
Decrease in due from affiliates 604,326
Increase in other assets (14,412)
Increase in due to cardholders 700,549
Increase in accounts payable, accrued expenses and other liabilities 307,961
-----------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 3,898,595
-----------------
Cash Flows From Investing Activities
Net (increase) decrease in credit card receivables (242,796)
Purchase of property and equipment (55,834)
-----------------
NET CASH (USED IN) INVESTING ACTIVITIES (298,630)
-----------------
Cash Flows Used In Financing Activities
Dividends paid (3,559,000)
-----------------
NET INCREASE IN CASH
40,965
Cash:
Beginning 30,908
-----------------
Ending $ 71,873
=================
See Notes to Financial Statements.
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
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: 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.
TRANSACTIONS WITH AFFILIATES: The Company provided credit card marketing,
customer service and collection services for Nova Financial Systems, Inc.
("Nova"), a company affiliated though common ownership, in exchange for a fee.
Effective July 1, 2000, the Company no longer provides such services for Nova.
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.
KEY FINANCIAL SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 2. PROVISION FOR CREDIT CARD LOSSES
Changes in the allowance for losses for year ended December 31, 2000 are as
follows:
Balance, beginning $ 60,466
Provision for losses 139,782
Recoveries of amounts charged-off -
Amounts charged-off (70,520)
------------------
Balance, ending $ 129,728
==================
Note 3. 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 associated with Nova's
activities during 2000. These amounts are included in other operating income.
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 in commissions during 2000.
Note 4. COMMITMENTS, CONTINGENCIES AND CREDIT RISK
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.
KEY FINANCIAL SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 4. COMMITMENTS, CONTINGENCIES AND CREDIT RISK (CONTINUED)
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.
Note 5. OTHER OPERATING EXPENSES
Other operating expense for the year ended December 31, 2000 included the
following:
Telecommunications $ 402,038
Professional fees 341,444
Printing and supplies 15,007
Bank charges 101,183
Other 280,170
----------------
$ 1,139,842
================
Note 6. 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 7. 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.
NOVA FINANCIAL SYSTEMS, INC.
FINANCIAL REPORT
DECEMBER 31, 2000
CONTENTS
- --------------------------------------------------------------------------------
INDEPENDENT AUDITOR'S REPORT
- --------------------------------------------------------------------------------
FINANCIAL STATEMENTS
Statements of operations
Statements of stockholders' equity
Statements of cash flows
Notes to financial statements
- --------------------------------------------------------------------------------
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors
Nova Financial Systems, Inc.
Clearwater, Florida
We have audited the accompanying statements of operations, stockholders' equity,
and cash flows of Nova Financial Systems, Inc. for the year ended December 31,
2000. 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 financial statements referred to above present fairly, in
all material respects, the results of operations and cash flows of Nova
Financial Systems, Inc. for the year ended December 31, 2000, in conformity with
accounting principles generally accepted in the United States of America.
/s/ McGladrey & Pullen, LLP
Fort Lauderdale, Florida
March 30, 2001
NOVA FINANCIAL SYSTEMS, INC.
STATEMENT OF OPERATIONS
Year Ended December 31, 2000
- --------------------------------------------------------------------------------
Credit card income:
Servicing fees $ 4,322,258
Other 148,746
------------------
4,471,004
Provision for (recovery of) losses (Note 2) (83,262)
------------------
NET CREDIT CARD INCOME AFTER
PROVISION FOR LOSSES 4,554,266
------------------
Operating expenses:
Third party servicing fees (Note 3) 3,342,984
Other operating expenses (Note 6) 635,345
------------------
3,978,329
------------------
INCOME BEFORE INCOME TAXES 575,937
Provision for income taxes (Note 5) -
------------------
NET INCOME $ 575,937
==================
See Notes to Financial Statements.
NOVA FINANCIAL SYSTEMS, INC.
STATEMENT OF STOCKHOLDERS' EQUITY
Year Ended December 31, 2000
Additional
Common Paid In Retained
Stock Capital Earnings Total
- --------------------------------------------------------------------------------------------------------
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.
NOVA FINANCIAL SYSTEMS, INC.
STATEMENTS OF CASH FLOWS
Year Ended December 31, 2000
- --------------------------------------------------------------------------------
Cash Flows From Operating Activities
Net income $ 575,937
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for (recovery of) losses (83,262)
Deferred income taxes 606,500
Decrease in other receivables 1,090,434
Increase in due from stockholders (606,500)
Decrease in accounts payable and accrued expenses (121,606)
Decrease in due to cardholders (635,252)
Decrease in due to affiliates (604,327)
----------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 221,924
----------------
Cash Flows Provided By Investing Activities
Net decrease in credit card receivables 419,058
----------------
Cash Flows Used In Financing Activities
Payment of dividends (666,000)
----------------
NET DECREASE IN CASH (25,018)
Cash:
Beginning 26,756
----------------
Ending $ 1,738
================
See Notes to Financial Statements.
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
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: 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.
TRANSACTIONS WITH AFFILIATES: Key Financial Systems, Inc. ("Key"), a company
affiliated through common ownership, provided credit card marketing, customer
service and collection services in connection with Nova's card activity.
Effective July 1, 2000, the Company no longer receives such services from Key.
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.
NOVA FINANCIAL SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Note 2. Provision for Credit Card Losses
Changes in the allowance for losses for the year ended December 31, 2000, are as
follows:
Balance, beginning $ 469,032
Provision for (recovery of) losses (83,262)
Recoveries of amounts charged-off -
Amounts charged-off (261,412)
-------------------
Balance, ending $ 124,358
===================
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 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 receiving services from Key. The Company
recognized processing fee and servicing expense of $672,420 associated with
Key's activities during 2000.
NOTE 4. COMMITMENTS, CONTINGENCIES AND CREDIT RISK
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.
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 year ended December
31, 2000 consists of the following:
Currently payable or paid:
Federal $ -
State -
Deferred income taxes 606,500
Reimbursement (606,500)
------------------
$ -
==================
NOTE 6. OTHER OPERATING EXPENSES
Other operating expenses for the year ended December 31, 2000, included the
following:
Cardholder expense, other $ 146,438
Professional fees 391,391
Printing and supplies -
Other 97,516
------------------
$ 635,345
==================
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.
NOVA FINANCIAL SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
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.