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, 2003
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE
REQUIRED) For transition period from to .
Commission File Number: 0-12374
EQUITEX, INC.
(Name of small business issuer in its charter)
DELAWARE 84-0905189
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
7315 EAST PEAKVIEW AVENUE, ENGLEWOOD, COLORADO 80111
(Address of principal executive offices)(Zip Code)
Issuer's telephone number: (303) 796-8940
Securities registered under Section 12 (b) of the Exchange Act:
NONE
Securities registered under Section 12 (g) of the Exchange Act:
COMMON STOCK, $.02 PAR VALUE
(Title of Class)
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Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Exchange during the past 12 months
(or for such shorter period that the Registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
Days: Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained in this form, and will not be contained, to
the best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K: /X/
The aggregate market value of the voting stock held by non-affiliates of the
Registrant was $24,893,275 based on the last sale price of the Registrant's
common stock on March 31, 2004, ($0.99 per share) as reported by the Nasdaq
Stock Market.
The Registrant had 33,894,728 shares of common stock outstanding as of March 31,
2004.
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.
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.
Chex Services provides comprehensive cash access services to 44 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 Financial
Systems, 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, 2003, Denaris had 6,500,000 shares of common stock outstanding;
therefore, we owned 77% of the outstanding common stock.
On July 23, 2003, we executed an Agreement and Plan of Merger with Cash Systems,
Inc. pursuant to which our wholly-owned subsidiary, Chex Services, would have
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been acquired by Cash Systems, Inc. for stock of Cash Systems. On December 4,
2003, Cash Systems notified us that they were terminating the Agreement and Plan
of Merger, which action we deemed as a wrongful termination. On December 14,
2003, we notified Cash Systems that we were terminating the Agreement and Plan
of Merger. Both parties filed legal actions with each seeking payment of a
$500,000 termination fee as well as reimbursement for costs incurred related to
the proposed transaction.
On January 2, 2004, we received a termination notice from Native American Cash
Systems Florida, Inc. ("NACSF, Inc.") for our contract providing cash access
services at five of the Seminole Tribe of Florida Tribal casino properties
located throughout Florida. Citing claimed breaches of the five-year contract
signed in December 2001, the termination notice required Chex Services to
immediately vacate the properties as of midnight eastern time on January 4,
2004. As a result of the loss of this contract that provided approximately
$4,000,000 of Chex Services' unaudited revenue for the year ended December 31,
2003, Chex Services immediately implemented cost savings measures throughout the
organization. Subsequent to the termination of this contract, NACSF, Inc.
contracted Cash Systems to provide cash access services to the Seminole Tribe
casino properties. In January 2004, we amended our legal action against Cash
Systems to include NACSF, Inc., Native American Cash Systems, Inc. ("NACS,
Inc."), and its President, Lisa G. Maulson, seeking damages for wrongful
termination of the contract for cash access services to the Seminole Tribe
casinos in addition to the original claims.
On April 9, 2004, we executed a Settlement Agreement with Cash Systems pursuant
to which we agreed to pay Cash Systems $125,000 for their expenses related to
the terminated Agreement and Plan of Merger. As part of that settlement, Cash
Systems agreed to pay Chex Services approximately $476,000 for commissions owed
to Chex Services by Cash Systems for services provided at the Seminole Tribe
casino and one other casino. In addition, Cash Systems agreed to reimburse Chex
Services for cash that was loaded into ATM's at the Seminole Tribe casinos by
Chex Services at the time of the termination in an amount to be agreed upon by
the parties and estimated by Chex Services to be in excess of $100,000. Each
side agreed to mutually release each other from further liability related to the
Agreement and Plan of Merger and Seminole Tribe termination, however, we
retained our rights relative to the legal action against NASCF, Inc., NACS, Inc.
and Lisa G. Maulson for the wrongful termination of the Seminole Tribe casino
contracts.
On November 3, 2003, we executed a Stock Purchase Agreement with iGames
Entertainment, Inc. and Money Centers of America pursuant to which our
wholly-owned subsidiary, Chex Services, would have been acquired by iGames
Entertainment for stock of iGames Entertainment and other consideration. On
March 12, 2004, we notified iGames Entertainment that we were terminating the
Stock Purchase Agreement due to various material adverse affects on the business
of iGames Entertainment and declaring a default under a Term Loan Note made by
iGames Entertainment in favor of Chex Services dated January 6, 2004.
On March 16, 2004, Chex Services commenced a lawsuit in Hennepin County,
Minnesota demanding repayment of $2,000,000, plus a $1,000,000 termination fee,
accrued interest and other fees, due from iGames Entertainment under the Term
Loan Note. On or about March 15, 2004, iGames Entertainment commenced a lawsuit
in Philadelphia against the Company and Chex Services for alleged breach of
contract relative to the stock purchase agreement which lawsuit was later
withdrawn. On March 23, 2004, we commenced a lawsuit in Delaware state court
(New Castle county) relative to the termination of the Stock Purchase Agreement.
On March 24, 2004, iGames Entertainment commenced a lawsuit in United States
District Court for the District of Delaware relative to both the termination of
the stock purchase agreement and iGames Entertainment's obligations under the
promissory note which is the subject of Chex Services' lawsuit in Hennepin
County, Minnesota. We are confident that our claims in litigation will be upheld
and believe that the various claims made by iGames Entertainment lack merit. We
intend to vigorously prosecute our claims and defend against iGames
Entertainment's claims. Further information relating to the various lawsuits can
be found under Part I, Item 3. Legal Proceedings later in this document.
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
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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, 2003.
(c) Narrative description of business.
EQUITEX
We are a holding company that operates primarily through our wholly-owned
subsidiary, Chex Services, a Minnesota corporation as well as our majority owned
subsidiary, Denaris Corporation, a Delaware corporation. We also have run-off
operations from our wholly owned subsidiary Nova Financial Systems, Inc., a
Florida corporation. Our wholly-owned subsidiary, Key Financial Systems, Inc., a
Florida corporation, ceased run-off operations in the fourth quarter of 2003 and
is presented as a discontinued operation. 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
Services 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 Services' 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 Services' check and credit card advance
systems allow it to compile detailed demographic data about patrons that utilize
these services. The collected patron demographic data is then provided to the
casino operators and can be used in their marketing efforts.
As of March 31, 2004, Chex Services had contracts to provide its cash access
products and services in forty four (44) locations throughout the United States.
At each of these locations Chex Services can provide any one or a combination
of: check cashing; credit/debit card cash advance systems; and ATM terminals.
Chex Services either staffs the locations with its personnel or provides its
products and services to the locations based upon the contract with the
location.
Chex Services' 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 Services, the
transaction fees to be charged by Chex Services to patrons for each type of cash
access transaction, and the amount of compensation to be paid by Chex Services
to the location Pursuant to all of these agreements with the locations serviced,
Chex Services maintains the exclusive rights (with rare exception) to provide
its services for the term of the contract.
At each of the locations where Chex Services 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 Services 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 Services arranges to have the cash it maintains on deposit delivered
from a local bank as needed. If Chex Services is providing it's products to it's
customers and not the employees, then the customer is responsible for providing
the cash to manage its operations. Chex Services has a Treasury Managemant
account with Wells Fargo bank that is set up to sweep all the local banking
accounts each day in order to control, expedite, and realize economies of scale
in their money movement.
CREDIT/DEBIT CARD CASH ADVANCE SERVICES. Chex Services' credit/debit card cash
advance services allow patrons to use their VISA, MasterCard, Discover, and
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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 Services 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. Chex Services has recently completed
development of their own proprietary Credit Card Cash Advance System and will be
retrofitting all of its locations to the new technology through the second
quarter of 2004. In addition, the Chex Services sales organization will be
marketing this product to the gaming industry.
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 Services. 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 Services for the advance amount, by check, and pays the
commission due to Chex Services in the month following the month the transaction
was completed. At all of the locations at which Chex Services provides credit
card advance services, it pays the operator a commission for each completed
credit card cash advance transaction. Chex Services' new technology will allow
them to have the funds electronically transferred into their account, thus
maximizing their cash position and expediting the float of funds.
Patrons may initiate a credit card cash advance transaction at a remote credit
card cash advance terminal at Chex Services' 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 Services, guarantees
payment to Chex Services for all transactions that are processed in accordance
with the procedures specified in the agreements.
For the year ended December 31, 2003, Chex Services processed approximately
434,100 credit/debit card transactions totaling $150 million in advances and
earned fees of $5,200,000 on these transactions.
CHECK CASHING SERVICES. Chex Services' check cashing services allow location
patrons to access cash by writing a check to Chex Services at its teller
facility staffed by employees of the company. Chex Services' employees conduct
the authorization and verification process for check cashing transactions in
accordance with detailed procedures developed by Chex Services to help minimize
bad debt from returned checks. Chex Services' new product, ChexGuard, developed
with Wells Fargo bank and VISA POS, electronically deposits the checks, and
utilizes the VISA banking rail to verify that the account is open and that the
funds written for the check amount are currently in the account. The funds are
deposited into Chex Services' account the following day, thus significantly
speeding up deposits into their account versus the manual deposit method and
decreasing overall bank charges. In addition, risk is mitigated with this new
technology. Chex Services has implemented ChexGuard in all of its locations and
is now marketing the product to potential customers in the retail,
entertainment, and gaming industries.
Chex Services' customers are granted check cashing limits based upon their check
cashing history, which is captured and maintained by Chex Services. The
customer's ability to pay is critical in establishing their check cashing
limits.
Chex Services 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 Services pays the
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location operator a commission based upon the monthly amount of checks cashed.
Chex Services also cashes other financial instruments at varying customer fees,
such as, money orders, government checks, payroll checks, insurance checks, etc.
Chex Services' 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 Services mitigates its potential for returned items by establishing
check-cashing limits based on the customer's history at Chex Services locations.
In addition, Chex Services utilizes their recently developed ChexGuard product
to determine if a customer has a valid open account and whether the funds for
the amount of the check written are currently in the account. Chex Services also
takes an imprint of the customers finger and photo of customers to both deter
potential bad checks and to assist their efforts in collections when necessary.
Chex Services utilizes its own in-house collections department to pursue
collection of returned checks. In September 2002, Chex Services incorporated
this department as Collection Solutions, Inc. creating a separate wholly-owned
stand-alone collections subsidiary intending to offer its services to customers
other than Chex Services. As of December 31, 2003, Chex Services shut down the
operations of Collection Solutions but continues to operate its in-house
collections department. For the year ended December 31, 2003, Chex Services
collected fees of $510,000 on returned checks and had other income of $633,000.
For the year ended December 31, 2003, Chex Services cashed approximately $307
million in customer checks and earned fees of approximately $9,100,000 on these
transactions.
ATM SYSTEMS. Under the terms of the agreements with the processor, also known as
the vendor, Chex Services receives a surcharge fee for each cash withdrawal and
the vendor credits Chex Services' 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
Services for the cash advance amount generally within two days of the
transaction and pays the surcharge commission due Chex Services 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 Services 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, 2003, Chex Services processed 3.7 million ATM transactions
with $354 million in advances and earned fees or commissions of $3,200,000.
STORED VALUE CARD. In August 2002, Chex Services executed an agreement with West
Suburban Bank to issue stored value cards. Under the terms of the agreement,
Chex Services 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 personal identification number (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 Services 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 prefer to use direct deposit and can be used as a
virtual checking account including bill payment capabilities.
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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 Services' 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, 2003, Chex Services had 44 contracts
with casinos and other gaming establishments to provide varying levels of cash
access services.
In furtherance of Chex Services' objective to increase its market share, its
marketing plan is designed to increase Chex Services' 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 Services 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.
SIGNIFICANT CUSTOMERS. For the year ended December 31, 2003, four of Chex
Services largest customers represented approximately 57% of its casino contract
revenues including approximately 22.5% from the Seminole Tribe casinos, which
contract was terminated in January 2004 as more fully described in Part I, Item
1(a) above. While Chex Services strives to maintain good working relationships
with its contracted casinos and presently believes those relationships to be
satisfactory, the loss of any of the remaining three casinos could adversely
affect our results of operations in future periods.
COMPETITION. Chex Services 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 Certigy,Inc.), 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. Chex Services will
also be competing in the gaming and retail markets with Telecheck, Checkwrite,
SCAN and a number of other vendors for the check conversion, authorization, and
guarantee business with its ChexGuard product. Currently Global Cash Access
controls a majority of the Credit Card Cash Advance business in the industry.
The full booth Cash access Financial Service Centers located in Gaming
facilities are fairly equally split between, Chex Services, Cash Systems, and
GameCash.
GOVERNMENT REGULATION. Chex Services 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 Services. Also, if the government or individual states
were to ban ATM convenience fees, that too would have a negative affect on Chex
Services' 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
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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
actions of tribal employees. Tribal sovereign immunity may limit our ability to
pursue certain legal remedies should Chex Services believe it has a claim
against a tribal authority.
DENARIS
Denaris Corporation was formed on August 16, 2002 to develop and market a
prepaid reloadable stored value card program. 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.
In 2002, Paymaster Jamaica 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
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equity of a newly formed subsidiary, Paymaster Worldwide, which would then be
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. During 2003, Denaris began designing this system
which has been tested and is operational in certain of Paymaster's locations.
Ultimately, 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 and
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 FINANCIAL SYSTEMS AND NOVA FINANCIAL SYSTEMS
Key Financial Systems, Inc. and Nova Financial Systems, Inc., which represent
our credit card services segment and were our wholly-owned subsidiaries at
December 31, 2003, are Florida corporations formed in June 1997 and September
1998, respectively. Both companies were formed to design, market and service
-8-
credit card products aimed at the sub-prime market consisting mainly of
consumers who may not qualify for traditional credit card products. Nova
processes payments on a remaining portfolio which provides the company with
"run-off" operations. Key Financial Systems ceased "run-off" operations in the
fourth quarter of 2003 with the closing of its remaining portolio. As a result,
Key Financial Systems operations for the years ended December 31, 2003, 2002 and
2001 have been presented as discontinued operations in our financial statements
as described more fully in Note 4 to the financial statements accompanying this
report.
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 ("FDIC") as receiver. Subsequent to the closure, the FDIC informed
the Pay As You Go credit card cardholders that their accounts were being closed
and any monies due refunded. As a result, Key Financial Systems immediately
suspended marketing the Pay As You Go credit card. In May 2002, Key Financial
Systems filed a claim with the FDIC for all funds due from Net First National
Bank to Key Financial Systems 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 Financial Systems and Nova
had ceased business operations, however, Nova continues to receive residual
payments on approximately 2,000 cards still active in the Merrick Bank portfolio
at December 31, 2003, down from approximately 4,000 at December 31, 2002. The
Merrick Bank portfolio should continue to see a decline in active accounts in
2004. Effective October 2003, Key Financial Systems and KBank ceased operating
the KBank portfolio as only three cards remained active. Key Financial Systems
and KBank terminated the Credit Card Program Agreement on March 31, 2004.
EMPLOYEES
Equitex currently employs four full-time employees. Chex Services employs 19
full-time employees at its corporate office, 10 employees in home offices, and
139 full-time and 23 part-time employees at its casino locations. Denaris, Key
Financial Systems and Nova currently have no employees other than their officers
and directors.
(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.
Effective April 1, 2004, Equitex also leases four executive office suites from
an unaffiliated third party in West Palm Beach, Florida for $3,710 per month.
This lease expires on March 31, 2005.
Nova and Key Financial Systems 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 was terminated upon payment by us of $150,000 during the year
ended December 31, 2003, which included a $20,000 deposit placed with the
landlord upon signing the lease.
Chex Services 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 $5,942 per month increasing to $6,030 per month in April
2005. This lease expires on March 31, 2006.
-9-
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
liquidating agent has not commenced an arbitration proceeding. 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. In November
2003, Equitex reached a settlement agreement with the liquidating agent pursuant
to which Equitex is to pay the sum of $400,000 no later than May 21, 2004, in
exchange for the dismissal of the adversary proceeding and the execution of a
mutual release of claims by both parties. Should Equitex 2000 be unable to
fulfill its obligations under the indemnification and settlement, we will be
required to perform under the settlement agreement and pay the $400,000 as
agreed.
On December 23, 2003, Jack Wen, an individual, filed a lawsuit against us and
our President, Henry Fong, in the United States District Court, District of
Colorado, Civil Action No. 03-M-2597. The plaintiff alleges securities fraud and
breach of contract claiming that we and Mr. Fong failed to honor a "put"
agreement to purchase for $500,000, 50,000 shares of First Telebanc Corporation
stock assigned to the plaintiff by a foreign purchaser who is not a party to the
suit. The complaint further alleges that we participated in an effort to "pump"
the price of our stock in 1999. The complaint seeks payment of $500,000 plus
costs and interest. On March 16, 2004, we filed a motion to dismiss the
complaint on several grounds including failure of the complaint to comply with
applicable law, failure to file the claims within the appropriate statute of
limitations period and lack of standing by the plaintiff under securities laws,
among others. While the outcome of this lawsuit cannot presently be predicted,
we intend to vigorously defend ourselves against this frivolous lawsuit that we
believe lacks any merit under law.
On March 16, 2004, our subsidiary Chex Services, Inc. commenced a lawsuit in
Hennepin County, Minnesota demanding repayment of the $2,000,000 principal
balance, accrued interest and other fees, plus payment of $1,000,000 as
additional interest (as expressly provided under the note) due from iGames
Entertainment, Inc. under a term loan note and Stock Purchase Agreement given by
iGames Entertainment in favor of Chex Services.
On or about March 15, 2004, iGames Entertainment commenced a lawsuit in
Philadelphia against the Company and Chex Services, for alleged breach of
contract relative to the Stock Purchase Agreement by and among us, Chex Services
and iGames, which lawsuit was later voluntarily withdrawn by iGames.
On March 23, 2004, we commenced a lawsuit in Delaware state court (New Castle
county) relative to the termination of the iGames Entertainment Stock Purchase
Agreement seeking payment of the $1,000,000 termination fee expressly provided
under the iGames Entertainment Stock Purchase Agreement as well as related
costs.
On March 24, 2004, iGames Entertainment commenced a lawsuit in United States
District Court for the District of Delaware relative to both the termination of
the iGames Entertainment Stock Purchase Agreement and iGames Entertainment's
obligations under the term loan note. iGames Entertainment is alleging that the
Company breached express and implied terms of both the iGames Entertainment
Stock Purchase Agreement and the term loan note, and that the Company tortiously
interfered with iGames' business relationship with one of its lenders. iGames
Entertainment is seeking payment of the $1,000,000 termination fee under the
iGames Entertainment Stock Purchase Agreement, as well as consequential and
punitive damages due to the Company's alleged actions and related attorneys
fees. We are confident that our claims in litigation will be upheld and believe
that the various claims made by iGames Entertainment lack merit. While the
ultimate outcome of these lawsuits cannot presently be predicted, we intend to
vigorously prosecute our claims and defend against iGames Entertainment's
claims.
-10-
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 29, 2003, we held our Annual Meeting of Stockholders where our
stockholders re-elected each of three incumbent directors. The votes were cast
as follows:
For Against Abstain
---------- ------- -------
Henry Fong 23,940,281 411,311 14,544
Russell L. Casement 13,180,928 120,175 14,544
Aaron Grunfeld 13,181,218 120,335 14,544
Additionally, the following two proposals were presented and voted upon at the
meeting and the votes were cast as follows:
To ratify the appointment of Gelfond Hochstadt Pangburn, P.C. as the independent
auditors of the Registrant for the year ending December 31, 2003.
For Against Abstain
---------- ------- -------
Shares voted 24,343,545 12,434 10,177
-11-
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
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
2003
March 31, 2003 $0.90 $0.41
June 30, 2003 1.20 0.59
September 30, 2003 1.15 0.92
December 31, 2003 1.60 0.87
(b) Holders.
The number of record holders of our common stock as of March 31, 2004 was 2,192
according to our transfer agent. This figure excludes an indeterminate number of
shareholders whose shares are held in "street" or "nominee" name.
(c) Dividends.
Equitex has not declared nor paid cash dividends on our common stock during the
previous two fiscal years, 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, 2003, we issued a total of 607,110
unregistered shares of our $0.02 par value common stock. For each of the
following transactions, we relied upon the exemptions from registration provided
by Sections 4(6) or 4(2) of the Securities Act and Rule 506 promulgated
thereunder based upon (i) representations from each investor that it is an
accredited or sophisticated investor with experience in investing in securities
such that it could evaluate the merits and risks related to our securities; (ii)
that no general solicitation of the securities was made by us; (iii) each
investor represented to us that it was acquiring the securities for its own
account and not with a view towards further distribution; (iv) the securities
issued were "restricted securities" as that term is defined under Rule 144
promulgated under the Securities Act; (v) we placed appropriate restrictive
legends on the certificates representing the securities regarding the restricted
nature of these securities; and (vi) prior to completion of the transaction,
each investor was informed in writing of the restricted nature of the
-12-
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 1, 2003, we issued 400,000 shares of our $0.02 par value common stock
to two accredited investors upon the exercise of warrants for total proceeds of
$276,000 or $0.69 per share.
On October 1, 2003, we issued 12,777 shares of our $0.02 par value common stock
to an accredited investor upon the exercise of warrants for total proceeds of
$6,900 or $0.54 per share.
On December 29, 2002, we issued 107,110 shares of our $0.02 par value common
stock to our legal counsel as contingent consideration for payment of legal
services valued at $160,665 or $1.50 per share and performed in connection with
our general corporate activities and not in relation to any offering of
securities.
On December 29, 2003, we issued 87,223 shares of our $0.02 par value common
stock to an accredited investor upon the exercise of warrants for total proceeds
of $47,100 or $0.54 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
Financial Systems and Nova Financial Systems, which were recorded as reverse
acquisitions. The selected financial data presented for the year ended December
31, 2001 are those of Key Financial Systems and Nova financial Systems 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 Services 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 Financial Systems and Nova
Financial Systems on a combined basis. In the fourth quarter of 2003, Key
Financial Systems ceased "run-off" operations and therefore Key Financial
Systems operations for all periods is presented on a one-line presentation and
are included in "Income (loss) from discontinued operations".
In light of the foregoing, the historical data presented below is not indicative
of future results. You should read this information in conjunction with the
audited consolidated/combined financial statements of the Company, including the
notes to those statements (Item 8), and "Management's Discussion and Analysis of
Financial Conditions and Results of Operations (Item 7) that follows.
- ----------------------------------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
- ----------------------------------------------------------------------------------------------------------------
Revenues $18,520,248 $20,461,976 $3,144,479 $4,554,266 $8,672,059
Income (loss) from continuing
operations (4,501,384) (1,390,60) (1,915,781) 575,937 205,084
Income (loss) from discontinued
operations, net of income taxes (75,841) (2,928,400) 884,412 2,980,783 5,384,884
Net income (loss) (4,5377,225) (4,319,000) (1,031,369) 3,556,720 5,589,938
Net income (loss) applicable to
common stockholders (5,165,075) (4,439,580) (4,196,369) 3,556,720 5,589,938
Basic & diluted net income (loss)
per common share
Continuing operations (0.18) (0.06) (0.39) 0.07 0.02
Discontinued operations * (0.13) 0.07 0.33 0.61
Total assets 26,257,750 27,431,748 35,349,155 7,163,464 7,580,093
Total long-term liabilities 37,243 240,629 232,200 - -
Convertible preferred stock 2,378,000 4,015,000 4,285,000 - -
Cash dividends - - 2,000,000 4,225,000 4,063,888
- ----------------------------------------------------------------------------------------------------------------
* Amount is less than (0.01) per share
-13-
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 combined
financial statements and notes thereto for the years ended December 31, 2003,
2002 and 2001. The financial statements presented for the year ended December
31, 2003 and 2002 are those of Equitex along with its subsidiaries Chex
Services, Key Financial Systems, Nova Financial Systems and beginning August 16,
2002, Denaris Corporation. The financial statements presented for the year ended
December 31, 2001 include the combined accounts of Key Financial Systems and
Nova Financial Systems through August 5, 2001 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. In the fourth quarter
of 2003, Key Financial Systems ceased "run-off" operations and Key Financial
Systems operations for all periods presented into a one-line presentation and
are included in "Income (loss) from discontinued operations".
In light of the foregoing, the historical data presented below is not indicative
of future results. You should read this information in conjunction with the
audited consolidated/combined financial statements of the Company, including the
notes to those statements (Item 8), and the following "Management's Discussion
and Analysis of Financial Conditions and Results of Operations.
(a) Liquidity and Capital Resources.
For the year ending December 31, 2004, we presently anticipate our liquidity and
capital resource needs will be satisfied from cash flows generated from our
operating activities within our Chex Services subsidiary.
Cash flow activity for the year ended December 31, 2003, includes the activity
of Chex Services, Key Financial Systems, Nova Financial Systems, and Equitex for
the entire year and Denaris from August 2002. The 2001 activity includes the
activity of Key Financial Systems and Nova Financial Systems through August 5,
2001 as well as the activity of the Company, Key Financial Systems and Nova
Financial Systems from August 6, 2001 through December 31, 2001 and Chex
Services from December 1, 2001 through December 31, 2001. For the year ended
December 31, 2002, net cash used in operating activities was $1,012,402 compared
to cash provided by operating activities from continuing operations of
$2,255,164 for the year ended December 31, 2002. The most significant portion of
this change was the change in adjustments to the net loss which were $3,564,823
in 2003 compared to $6,574,164 in 2002. In 2003, accounts receivable increased
by $194,599 compared to a decrease of $1,167,710 in 2002, representing a change
of $1,362,309.
Cash used in investing activities from continuing operations for the year ended
December 31, 2003 was $1986,159 compared to $1,131,003 for the year ended
December 31, 2002.
Cash provided by financing activities for the year ended December 31, 2003 was
$1,354,339 compared to $527,198 for the year ended December 31, 2002. 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.
-14-
For the year ended December 31, 2003, net cash decreased $866,344 compared to
an increase of $1,236,574 for the year ended December 31, 2002, and ending cash
at December 31, 2003, was $8,059,780 compared to $8,926,124 at December 31,
2002.
On March 9, 2004, we closed on a $5,000,000 convertible promissory note (the
"Note") from Pandora Select Partners, LP and Whitebox Hedged High Yield Ltd.
(the "Lenders"). The Note carries an interest rate of 7% per annum with a 45
month term. Months one through three require interest only payments and
beginning in month four, the principal and interest payments will amortize over
a 42 month period. The Note shall be senior to all other debt of both us and
Chex Services. The proceeds will be loaned by us to Chex Services in terms
identical to the Note. The Note is collateralized by all of the assets of Chex
Services, our stock ownership in Chex Services and the note between us and Chex
Services.
The Note is convertible into our common stock at $1.35 per share up to an amount
equal to 4.99% of our outstanding common stock. We have the right to make any
monthly payment of principal and interest in our registered common stock. The
common stock will be issued based on 85% of the average bid price for the 20
trading days prior to the payment due date. The maximum number of shares that
can be delivered as payment will equal 10% of the average monthly trading volume
for the month prior to the payment due date. We may also issue common shares
each month in an amount not to exceed 10% of the prior month's total share
volume up to a value of $100,000 as payment to be applied to the outstanding
principal balance.
The Note contains certain anti-dilution provisions requiring us to pay Lenders
as collateral the pro-rata number of shares Lenders would receive in any
spin-off or dividend from the Registrant as if the remaining principal balance
under the Note was fully converted at $1.35 per share. The dividend shares shall
be segregated may be liquidated at the discretion of Lenders. At the end of each
quarter, 85% of the proceeds will be applied to the principal balance so long as
we are current in our monthly principal and interest payments.
The Lenders received a fee of $150,000, legal fees of $15,000, and warrants to
acquire up to 800,000 shares of our common stock at an exercise price of $1.50
for a period of five years and include a cashless exercise provision.
We paid a transaction fee to Blake Advisors, who introduced us to the Lenders,
of $150,000. In addition, Blake Advisors received 300,000 options or warrants
exercisable at $1.00 per share for a period of two years.
We must file a registration statement covering all underlying shares of our
common stock for conversion of the Note, warrants and shares used to make
monthly payments. If the registration statement is not declared effective within
180 days of closing, we must issue additional stock or warrants in amounts to be
negotiated. If after twelve months from the closing date the registration
statement is not effective, Lenders shall have the right to call the loan.
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.
-15-
Contractual obligations for future payments under existing debt and lease
commitments at December 31, 2002, were as follows:
CONTRACTUAL LESS THAN MORE THAN
OBLIGATION TOTAL ONE YEAR 1-3 YEARS 3-5 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.
In September 2003, Chex Services cashed checks totaling $606,316 from one
customer that were returned for insufficient funds. In March 2004, Chex Services
received a non-interest bearing, promissory note (see Note 6 to the
consolidated/combined financial statements included in this report). Based on an
imputed interest rate of 12%, a discount of $256,316 was charged to operating
expense in 2003. We believe the remaining balance of $350,000 is collectible
based upon collateral pledged in connection with the note.
-16-
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
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.
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 the matter relating to the RDM Sports Group, inc., as well as certain
other legal actions existing at August 6, 2001. In November 2003, Equitex
reached a settlement agreement with the liquidating agent pursuant to which
Equitex is to pay the sum of $400,000 no later than May 21, 2004, in exchange
for the dismissal of the adversary proceeding and the execution of a mutual
release of claims by both parties. Should Equitex 2000 be unable to fulfill its
obligations under the indemnification and settlement, we will be required to
perform under the settlement agreement and pay the $400,000 as agreed.
-17-
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.
On March 4, 2002, the Federal Deposit Insurance Corporation notified us that it
had been appointed receiver of all funds due from Net First to Key Financial
Systems. As receiver, the FDIC elected to disaffirm, to the full extent, all
contracts Key Financial Systems 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
Financial Systems 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 Financial Systems through the
date federal banking regulations closed Net First.
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 Financial
Systems and Nova Financial Systems, and in conjunction with Key Financial
Systems and Nova Financial Systems'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 $12,100,000 are available to
offset future taxable income, if any, and expire between 2016 and 2023. 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 $1,290,000 in 2003, 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 CONTINUING OPERATIONS
Financial statements for the years ended December 31, 2002 and 2001 have been
restated to report the Registrant's Key Financial Systems Financial Systems
subsidiary as discontinued operations (see Note 4 to the Company's
consolidated/combined financial statements).
RESULTS OF CONTINUING OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2003
VS. DECEMBER 31, 2002
REVENUES
Consolidated revenues for the year ended December 31, 2003 were $18,520,248
compared to revenues of $20,461,976 for the year ended December 31, 2002.
-18-
REVENUE BY SEGMENT
Segment 2003 2002
- ------- ---- ----
Cash disbursement services $18,104,995 $19,580,399
Credit card services 415,253 881,577
----------- -----------
$18,520,248 $20,461,976
=========== ===========
CASH DISBURSEMENT SERVICES SEGMENT
Chex Services recognizes revenue at the time certain financial services are
performed. Revenues are derived from check cashing fees, credit and debit card
advance fees, and automated teller machine ("ATM") surcharge and transaction
fees. Chex revenues were comprised of:
2003 2002
------------ ------------- ------------ ------------ ------------- ------------
Number of Dollars Earned Number of Dollars Earned
Transactions Handled Revenues Transactions Handled Revenues
------------ ------------- ------------ ------------ ------------- ------------
Personal checks 796,594 $157,086,984 $ 8,027,449 1,334,375 $167,831,673 $ 8,782,513
"Other" checks 373,869 147,762,190 1,061,680 154,146,088 1,178,106
Credit cards 368,922 125,955,019 4,819,287 418,947 149,367,510 5,210,635
Debit cards 65,141 23,785,520 451,503 62,316 25,092,053 279,589
ATM transactions 3,620,947 353,699,208 3,178,163 3,385,536 332,525,867 3,453,572
NSF Collection
Fees - - 510,375 - - 465,820
Other - - 56,540 - - 210,164
------------ ------------- ------------ ------------ ------------- ------------
5,225,473 $808,288,921 $18,104,995 5,201,174 $828,963,191 $19,580,399
============ ============= ============ ============ ============= ============
Chex Services cashes personal checks at its cash access locations for fees of
between 3 and 10 percent based on its casino contracts. Chex Services also
cashes "other" checks, comprised of tax and insurance refunds, casino employee
payroll checks and casino jackpot winnings at a reduced rate.
Chex Services' credit/debit card cash advance services allow patrons to use
their VISA, MasterCard, Discover and American Express cards to obtain cash.
Third party vendors, at their expense, supply, install and maintain the
equipment to operate the cash advance system. Under vendor agreements, the
vendor charges each customer a services fee based upon the cash advance amount
and pays a portion of such service fee to Chex Services.
Chex Services receives a surcharge fee for each cash withdrawal from the ATM
machines in locations where Chex Services provides such services. The surcharge,
which is a charge in addition to the cash advance, is made against the bank
account of the customer and is deposited in the vendor's account. The vendor
reimburses Chex Services for the cash amount and pays the surcharge commission
due.
Chex Services utilizes its own in-house collections department to pursue
collection of returned checks, and generally charges an insufficient funds fee
when it ultimately collects the check.
In the ordinary course of business, Chex Services receives new financial
services agreements or renews existing ones as their original terms expire. Chex
Services may also not renew contracts from certain expiring agreements. In
January of 2004, Chex Services was advised that 5 existing casino locations were
terminating the agreements for Chex Services to provide its services. These
locations accounted for $4,089,557 and $3,486,707 in revenues for the years
ended December 31, 2003 and 2002, respectively. Accordingly, Chex Services
anticipates a decline in 2004 revenues due to the loss of these contracts and
the absence of significant new contracts to replace the revenues lost. Chex
Services has implemented cost savings expense reductions to minimize the effect
of the loss of these contracts.
-19-
OPERATING EXPENSES
Total operating expenses for the year ended December 31, 2003 were $21,753,962
compared to $20,326,745 for the year ended December 31, 2002.
Segment 2003 2002
- ------- ---- ----
Cash disbursement services $17,024,745 $17,327,542
Credit card services 332,404 479,039
Corporate activities 4,396,813 2,520,164
----------- -----------
$21,753,962 $20,326,745
=========== ===========
CASH DISBURSEMENT SERVICES SEGMENT
Chex Services' operating expenses were $17,024,745 for the year ended December
31, 2003 compared to $17,327,542 for the year ended December 31, 2002. Chex
Services expenses were comprised as follows:
2003 2002
---- ----
Fees to casinos $ 6,300,400 $ 6,189,730
Salaries and related costs 5,932,633 5,961,279
Returned checks, net of collections 751,815 634,531
General operating expenses 2,946,131 3,390,449
Depreciation and amortization 1,093,766 1,151,553
----------- -----------
$17,024,745 $17,327,542
=========== ===========
Chex Services pays a fee to casinos as compensation pursuant to the terms of
each financial services agreement that the company has entered into with the
respective establishment. At locations where Chex Services provides check
cashing services, Chex Services pays the location operator a commission based
upon the monthly amount of checks cashed. Chex Services passes on an agreed upon
percentage of the surcharge commissions to the locations where ATM's are
utilized. At all of the locations at which Chex Services provides credit/debit
card advance services, it pays the operator a commission for each completed
transaction.
Chex Services employs personnel at the locations where it provides check cashing
services as well as corporate staff to support its operations. For the year
ended December 31, 2003, corporate salaries and related costs were $1,818,968
while location salaries and related costs were $4,113,665. For the year ended
December 31, 2002, corporate salaries and related costs were 1,410,226 and
location salaries and related costs were $4,551,055. Due to the terminated
locations, Chex Services has reduces staff nees going forward. The company has
reduces staff and in some instances reduced salaries for retained employees
beginning in February 2004. It is anticipated that these reductions on an annual
basis should reduce salary costs by approximately $400,000.
Chex Services generally records a returned check expense for potential losses in
the period such checks are returned. In September 2003, checks totaling $606,316
from one customer were cashed by Chex Services and were returned for
insufficient funds. In March 2004, the company received a non-interest bearing
promissory note from this customer. Based on an imputed interest rate of 12%, a
discount of $256,316 was applied to this note which was charged to returned
check expense during the fourth quarter of 2003. Chex Services believes the
remaining balance of $350,000 is collectible, based on collateral pledged in
connection with the note.
The terminated locations accounted for $1,901,432 and $1,457,338 of fees to
casinos for the years ended December 31, 2003 and 2002, respectively. Additional
direct costs associated with the terminated contract location were $1,205,410
and $1,125,067 for the years ended December 31, 2003 and 2002, respectively.
-20-
CREDIT CARD SERVICES SEGMENT
Nova Financial Systems' operating expenses were $332,404 and $479,039 for the
years ended December 31, 2003 and 2002, respectively. The 2003 expenses were
comprised of third party servicing fees of $242,431 and other operating expenses
of $89,973, compared to the 2002 expenses of $403,496 for third party servicing
fees and $75,546 for other operating expenses. The decrease in the third party
servicing fees for the 2003 period compared to the 2002 period is a direct
result of the reduced credit card revenue in the respective periods.
CORPORATE ACTIVITY
Corporate activity expenses include those of Equitex and Denaris for 2003 and
Equitex in 2003 with Denaris beginning August 6, 2002. Total corporate activity
expenses for 2003 were $4,396,813 compared to $2,520,164 for 2002, and were
comprised as follows:
2003 2002
---- ----
Employee costs $ 1,976,774 $ 891,261
Other 1,655,039 1,209,600
Stock based compensation 355,000 419,303
Impairment of notes receivable 410,000 -
----------- -----------
$ 4,396,813 $ 2,520,164
=========== ===========
Employee costs for the year ended December 31, 2003 includes approximately
$1,400,000 of expense under a bonus agreement with our president.
Other expenses for the year ended December 31, 2003 include the write-off of
$352,368 of expenses related to previously incurred professional fees and
associated costs with preparing Chex for an initial public offering. Other
expenses include professional fees of $434,422, consulting services of $369,376
and general operating costs of $498,873.
Other operating expenses for the year ended December 31, 2002 include
professional fees of $368,326, charges related to a late registration filing
regarding the Series I Convertible Preferred Stock of $263,600 and general
operating costs of $577,674.
Stock based compensation represents non-cash expenses related to issuances of
common stock and warrants to third party consultants for services.
Impairment of notes receivable for the year ended December 31, 2003 include an
allowance of $250,000 on a note receivable from Paymaster Jamaica and an
allowance of $160,000 on notes receivable from Equitex 2000 (see Note 6 to the
condensed/combined audited financial statements attached to this report).
OTHER INCOME AND EXPENSES
For the year ended December 31, 2003, other expenses were $1,229,670 compared to
$1,470,831 for the year ended December 31, 2002.
DISCONTINUED OPERATIONS
The net loss from discontinued operations were $75,841 for the year ended
December 31, 2003 compared to $2,928,398 for the year ended December 31, 2002.
-21-
2003 2002
---- ----
Revenues $36,644 $ 3,474,273
Operating expenses (106,038) (4,474,586)
Impairment of FDIC receivable - (2,151,207)
Interest expense (6,447) (16,878)
Other income - 240,000
----------- -----------
Net loss $ (75,841) $(2,928,398)
=========== ===========
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 $20,461,976
compared to revenues of $3,144,479 for the year ended December 31, 2001.
REVENUE BY SEGMENT
Segment 2002 2001
- ------- ---- ----
Cash disbursement services $19,580,399 $ 1,373,158
Credit card services 881,577 1,756,550
Corporate activities - 14,771
----------- -----------
$20,461,976 $ 3,144,479
=========== ===========
CASH DISBURSEMENT SERVICES SEGMENT
The effective date of our acquisition of Chex Services was December 1, 2001, and
therefore the revenues of Chex Services are included for the year ended December
31, 2002, but only for one month in the year ended December 31 2001. Chex
Services 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.
For the year ended December 31, 2002, Chex Services 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 Services earned fees of $2,048,986 on personal checks
and $237,600 on "other" checks for the year ended December 31, 2001.
For the year ended December 31, 2002, Chex Services 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 Services 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 Services collected fees of $465,820 on
returned checks and had other income of $210,164. Chex Services earned fees of
$1,208,815 on over 104,000 credit/debit card transactions with over $36 million
in advances for the year ended December 31, 2001. Chex Services processed over
870,000 ATM transactions earning commissions of $864,345 on approximately $77
million of transactions and earned frees on returned checks and had other income
of $78,912.
The financial results of the Registrant include the results of operations of
Chex Services only from the date of acquisition, December 1, 2001. However, for
the year ended December 31, 2002, total revenues for Chex Services 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
Services operated during 2002 as compared to 2001.
-22-
CREDIT CARD SERVICES SEGMENT
Credit card income for the year ended December 31, 2002 was $759,576 compared to
$1,756,350 for the year ended December 31, 2001.
OPERATING EXPENSES
Total operating expenses for the year ended December 31, 2002, were $20,326,745
compared to $5,392,867 for the year ended December 31, 2001. The 2002 period
includes expenses for the Company, Chex Services, Nova, and Denaris from August
2002. The 2001 period includes expenses of Nova Financial Systems and on a
consolidated basis with those of the Company for the period from August 6, 2001
through December 31, 2001, and Chex Services from December 1, 2001.
OPERATING EXPENSES BY SEGMENT
Segment 2002 2001
- ------- ---- ----
Cash disbursement services $17,327,542 $ 1,605,015
Credit card services 479,039 1,261,915
Corporate activities 2,520,164 2,525,937
----------- -----------
$20,326,745 $ 5,392,867
=========== ===========
CASH DISBURSEMENT SERVICES SEGMENT
Chex Services operating expenses were $17,327,542 for the year ended December
31, 2002, compared to $1,605,015 for the year ended December 31, 2001. Chex
Services expenses were comprised as follows:
2002 2001
---- ----
Fees to casinos $ 6,189,730 $ 437,411
Salaries and related costs 5,961,279 380,335
Returned checks, net of collections 634,531 19,132
General operating expenses 3,390,449 646,566
Depreciation and amortization 1,151,553 121,571
----------- -----------
$17,327,542 $ 1,605,015
=========== ===========
Chex Services 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 Services has entered into with each of the individual locations.
CREDIT CARD SERVICES SEGMENT
Included in Nova Financial Systems' operating expenses for the year ended
December 31, 2002 were $403,496 for third party servicing fees and $75,546 for
other operating expenses. Included in the operating expenses for the year ended
December 31, 2001 were third party services fees of $1,080,098 and general
operating costs of $181,817.
CORPORATE ACTIVITY
Included in the year ended December 31, 2002, are operating expenses for Equitex
and Denaris totaling $2,250,420 and $269,744 respectively. For the year ended
December 31, 2002, these expenses are comprised of salaries, wages and employee
benefits of $891,261 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.
-23-
OTHER INCOME AND EXPENSES
For the year ended December 31, 2002 other expenses were $1,470,831 compared to
$239,893 for the year ended December 31, 2001. The primary reason for the
increase is the increase in Chex Services' 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.
DISCONTINUED OPERATIONS
The net loss for discontinued operations was $2,928,398 for the year ended
December 31, 2002 compared to net income of $884,412 for the year ended December
31, 2001.
2002 2001
---- ----
Revenues $ 3,474,273 $13,383,660
Operating expenses (4,474,586) (11,984,248)
Impairment of FDIC receivable (2,151,207) -
Interest expense (16,878) -
Other income 240,000 -
Income tax expense - (515,000)
----------- -----------
Net (loss) income $(2,928,398) $ 884,412
=========== ===========
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In May 2003, the FASB issued SFAS No. 150, ACCOUNTING FOR CERTAIN FINANCIAL
INSTRUMENTS WITH CHARACTERISTICS OF BOTH LIABILITIES AND EQUITY. SFAS No.150
establishes new standards on how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. The
provisions of SFAS No. 150 are generally effective for all financial instruments
entered into or modified after May 31, 2003, except for those provisions
relating to mandatorily redeemable non-controlling interests, which have been
deferred. The adoption of SFAS No. 150 did not have a material impact on the
financial position or results operation of the Company. If the deferred
provisions of SFAS No. 150 are finalized in their current form, management does
not expect adoption to have a material effect on the financial position or
results of operation of the Company.
In January 2003, the FASB issued SFAS Interpretation No. 46, CONSOLIDATION OF
VARIABLE INTEREST ENTITIES ("FIN 46"), which changes the criteria by which one
company includes another entity in its consolidated financial statements. FIN 46
requires a variable interest entity ("VIE") to be consolidated by a company if
that company is subject to a majority of the entity's residual returns or both.
In December 2003, the FASB approved a partial deferral of FIN 46 along with
various other amendments. The effective date for this interpretation has been
extended until the first fiscal period ending after December 15, 2004. However,
prior to the required application of this interpretation, a public entity that
is not a small business issuer shall apply this interpretation to those entities
that are considered to be special purpose entities no later than as of the end
of the first reporting period after December 15, 2003. As the Company does not
currently have an interest in a VIE or special purpose entity, management does
not expect that the adoption of FIN 46 will have an effect on the financial
condition or results of operations of the Company.
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 or loss
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
-24-
effective for interim periods beginning after December 15, 2002. The Company
adopted the disclosure only provisions of SFAS No. 148 and plans to continue
accounting for stock-based compensation under APB 25.
In November 2002, the FASB issued SFAS Interpretation No. 45 ("FIN 45"),
GUARANTOR'S ACCOUNTING AND DISCLOSURE REQUIREMENTS FOR GUARANTEES, INCLUDING
INDIRECT GUARANTEES AND INDEBTEDNESS OF OTHERS. FIN 45 elaborates on the
disclosures to be made by the guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it has issued. It
also requires that a guarantor recognize, at the inception of a guarantee, a
liability for the fair value of the obligation undertaken in issuing the
guarantee. The initial recognition and measurement provisions of this
interpretation are applicable on a prospective basis to guarantees issued or
modified after December 31, 2002, while the provisions of the disclosure
requirements are effective for financial statements of interim or annual reports
ending after December 15, 2002. The adoption of FIN 45 did not have a effect on
the financial condition or results of operations of the Company, as the Company
has not issued any guarantees.
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 disposal activities related to Key
Financial Systems. The adoption of this pronouncement had no material impact on
the Company's financial position or results of operations.
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 Services
has $10,931,147 of debt outstanding as of December 31, 2003, of which
$10,692,177 has been borrowed at fixed rates ranging from 8% to 12%. This fixed
rate debt is subject to renewal annually and is payable upon demand with 90 days
written notice by the debt holder. Chex Services also has $238,970 of variable
rate debt at December 31, 2003, 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,
2004.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The financial statements are listed under Item 15.
-25-
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE.
Effective August 6, 2001, we completed the acquisitions of Key Financial Systems
and Nova Financial Systems in a reverse acquisition. As a result, for accounting
purposes, Key Financial Systems and Nova Financial Systems 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 Financial Systems and Nova Financial Systems'
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 Financial Systems and Nova Financial
Systems notified McGladrey & Pullen, LLP that it would no longer serve as the
independent certified public accountants of the companies. There have been no
adverse opinions, disclaimers of opinion or qualifications or modifications as
to uncertainty, audit scope or accounting principles regarding the reports of
McGladrey & Pullen, LLP on the Key Financial Systems or Nova Financial Systems
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
Financial Systems and Nova Financial Systems' 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 Financial Systems and Nova Financial Systems, or the type of audit
opinion that might be rendered on Key Financial Systems and Nova Financial
Systems' financial statements, or any matter that was the subject of a
disagreement or a reportable event.
ITEM 9A. 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.
-26-
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 68 President, Treasurer, Since Inception
Principal Executive
Financial and Accounting
Officer and Director of Equitex
Thomas B. Olson 38 Secretary Since 1988
Russell L. Casement 60 Director Since 1989
Aaron A. Grunfeld 57 Director Since 1991
Michael S. Casazza 54 Director Since 2004*
* Mr. Casazza was appointed to the board on February 5, 2004.
Our directors hold office until the next annual meeting of the stockholders and
until their respective successors have been elected and qualified. Officers are
appointed 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.
(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."
-27-
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
has 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.
MICHAEL S. CASAZZA
Mr. Casazza became a director of Equitex in February 2004. From 1998 to the
present, Mr. Casazza has been chairman of the board and president of A&M
Trucking, Inc., a privately-held trucking company based in Denver, Colorado.
From 1993 to 1997, and from 1990 to 1996, Mr. Casazza was president and chief
executive officer of California Pro Sports, Inc. and MacGregor Sports and
Fitness, respectively, both publicly-held manufacturers of sporting goods
equipment. Prior to 1990, Mr. Casazza also held senior executive level positions
with Dunlop Sports Corporation and Wilson Sporting Goods. Mr. Casazza received
his Bachelors degree in Business Administration from St. Bonaventure University
in 1972.
(f) Involvement in certain legal proceedings.
Not applicable.
(g) Promoters and control persons.
Not applicable.
(h) Audit committee financial expert.
Our board of directors had determined that Mr. Michael S. Casazza, an
independent member of our board of directors and member of our audit committee,
meets the requirements as our audit committee financial expert.
(i) Identification of the audit committee.
We have appointed an Audit Committee currently consisting of Dr. Casement
as chairman, Mr. Grunfeld and Mr. Casazza.
-28-
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.
CODE OF ETHICS
We have adopted a Code of Ethics for our senior financial management, which
includes our president and secretary as principal executive or accounting
officers, that has been filed as an exhibit to this report.
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, 2003,
received an annual salary of $210,000. Beginning July 1, 2001 and for the year
ended December 31, 2002, the only compensation Mr. Fong received from Equitex
was 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 Financial Systems and Nova Financial Systems 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. Following our acquisition of Nova Financial Systems and
Key Financial Systems in August 2001, Mr. Fong, in consultation with the
Compensation Committee, agreed to end the bonus plan beginning July 1, 2001
through December 31, 2002. All accrued bonuses due under the plan became the
responsibility of Equitex 2000 following the spin-off in August 2001. In June
2003, the Compensation Committee reviewed Mr. Fong's compensation arrangement
and reinstituted the bonus plan effective June 1, 2003, for a bonus to be
calculated quarterly based on 5% of the increase in the market value of our
common stock as described above.
We have no retirement or pension plan for our President, Mr. Fong.
(b) Summary compensation table.
The following table sets forth information regarding compensation paid to our
officers during the years ended December 31, 2003, 2002 and 2001:
-29-
SUMMARY COMPENSATION TABLE
Long-Term
Annual Compensation Compensation
---------------------------------- Awards
Name & Other Annual ------------ All Other
Principal Salary Bonus Compensation Options Compensation
Position Year ($) ($) ($) & SARs(#) ($)
- ---------- ---- ------ --------- ------------ ------------ ------------
Henry Fong 2003 210,000 1,489,566 -0- 328,000 -0-
President,
Treasurer 2002 183,013 -0- -0- -0- -0-
Principal
Executive 2001 76,255 -0- -0- -0- -0-
Officer and (1)
Accounting
Officer
- ----------
(1) Includes salary paid and accrued during the period from August 6, 2001 to
December 31, 2001 following our merger with Key Financial Systems and Nova
Financial Systems.
(c) Option/SAR grants table.
OPTION/SAR GRANTS IN LAST FISCAL YEAR
GRANT DATE
INDIVIDUAL GRANTS VALUE
(a) (b) (c) (d) (e) (f)
Number of
Securities Percent of total
Underlying options/ SARs Exercise Grant
Options/ granted to of Base Date
SARs employees in Price Expiration Present
Name Granted (#) Fiscal Year ($/Sh) Date Value($)
- ---- ----------- ---------------- -------- ---------- ----------
Henry Fong 328,000 22% $1.03 6/20/2008 337,840(1)
(1) Represents the value of the stock options based upon the closing stock price
of the Registrant's common stock ($1.03) on the date of grant.
(d) Aggregated Option/SAR exercises and fiscal year-end Option/SAR value table.
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR
AND FY-END OPTION/SAR VALUES
Number of
Securities Value of
Underlying Unexercised
Unexercised In-the-Money
Options/SARs Options/SARs
Shares at FY-End (#) at FY-End (#)
Acquired on Value Exercisable/ Exercisable/
Name Exercise (#) Realized ($) Unexercisable Unexercisable
- ---- ------------ ------------ ------------- -------------
Henry Fong -0- -0- 945,700/-0- $-0-/-0-
-30-
(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 Michael S. Casazza, 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, 2003, Messrs. Casement and
Grunfeld each received a total of $14,500 while Mr. Hovorka received $1,667
prior to his resignation in March 2003. Mr. Casazza became a director in
February 2004 and therefore did not receive any compensation in 2003. Members of
the Board of Directors also receive reimbursement for expenses incurred in
attending board meetings.
(2) Other Arrangements
On December 30, 2002, our Board of Directors adopted a new stock option plan,
the 2003 Stock Option Plan. On June 20, 2003, our two independent directors at
the time, Mr. Russell L. Casement and Mr. Aaron A. Grunfeld, each received
options to purchase 100,000 shares of our common stock at an exercise price of
$1.03 per share expiring on June 20, 2008.
(h) Employment contracts and termination of employment and change-in-control
arrangements.
We have no compensation plan or arrangement with respect to any executive
officer which plan or arrangement results or will result from the resignation,
retirement or any other termination of such individual's employment with us. We
have no plan or arrangement with respect to any such persons, which will result
from a change in control of Equitex or a change in the individual's
responsibilities following a change in control.
(i) Report on repricing of Options/SARs.
Not applicable.
(j) Additional information with respect to Compensation Committee Interlocks and
Insider Participation in compensation decisions.
Our Compensation Committee for the year ended December 31, 2003 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 recommend an
-31-
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, our 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, our President received an annual salary
of $183,013 and no bonus through the year ended December 31, 2002.
During 2003, the Compensation Committee reviewed our president's salary, which
had not been adjusted since 1991. The Compensation Committee determined his
salary should be increased to reflect the approximate annual increase in the
consumer price index for the previous five years. This amounted to an increase
of approximately 15% to $210,000. In reviewing Mr. Fong's compensation, the
Compensation Committee also determined it was in the best interest of the
Company to give him additional incentive to maximize the Company's performance.
The Compensation Committee determined the bonus plan based solely on the
increase in market value of our common stock recommended by the independent
consultant in 1998 still presented a viable way to reward our president's
performance by tying his bonus to the goals of our stockholders.
Therefore, effective June 1, 2003, the Compensation Committee reinstated the
previous bonus plan for our president absent payment for 1% of the total assets.
Compensation Committee
- ----------------------
Russell L. Casement
Aaron A. Grunfeld
(i) Performance graph.
12/31/1998 12/31/1999 12/31/2000 12/31/2001 12/31/2002 12/31/2003
- ----------------------------------------------------------------------------------------
Nasdaq US 100.00 185.43 111.83 88.76 61.37 91.75
Nasdaq Financial 100.00 99.34 107.40 117.96 121.48 164.30
Equitex 100.00 116.36 70.01 52.65 5.96 23.27
-32-
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, 2004, 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, 2004.
Shares of Shares of
Shares of Shares of Common Stock Common Percentage
Common Common Stock Underlying Stock of Common
Name and Address of Stock Owned Underlying Preferred Underlying Stock Owned
Beneficial Owner (1) Options (1) Stock (1) Warrants (1) Total (8)
- ------------------- ------------ ------------ ------------ ------------ ----- -----------
Henry Fong 688,277(2) 804,000(3) 0 39,337 1,531,614 4.4%
7315 E. Peakview Ave.
Englewood, CO 80111
Russell L. Casement 146,795 220,400(4) 0 795 367,990 1.1%
1355 S. Colorado Blvd Suite
320
Denver, CO 80222
Aaron A. Grunfeld 32,700 234,000(5) 0 0 266,700 0.8%
10390 Santa Monica Blvd,
Fourth Floor
Los Angeles, CA 90025
Michael S. Casazza 5,167 0 0 10,000 15,167 0.0%
906 Thornblade Blvd
Greer, SC 29650
Thomas Olson 0 135,000(6) 0 0 135,000 0.4%
7315 E. Peakview Ave
Englewood, CO 80111
Daniel Bishop (7) 7,877,067 0 1,250,000 280,000 9,407,067 25.8%
7315 E Peakview Ave
Englewood, CO 80111
All officers and directors as 872,939 1,393,400 0 50,132 2,316,471 6.4%
a group (five persons)
- ---------------
(1) The beneficial owners exercise sole voting and investment power. (2)
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. (3) Includes
476,000 shares underlying options granted under our 1999 Stock
Option Plan and 328,000 shares underlying options granted under our 2003
Stock Option Plan.
(4) Includes 36,400 shares underlying options granted under our 1993 Stock
Option Plan for Non-Employee Directors and 84,000 shares underlying options
granted under the 1999 Stock Option Plan and 100,000 shares underlying
options granted under our 2003 Stock Option Plan.
(5) Includes 50,000 shares underlying options granted under our 1993 Stock
Option Plan for Non-Employee Directors and 84,000 shares underlying options
granted under our 1999 Stock Option Plan and 100,000 shares underlying
options granted under our 2003 Stock Option Plan.
(6) Includes 35,000 shares underlying options granted under our 1999 Stock
Option Plan and 100,000 shares underlying options granted under our 2003
Stock Option Plan.
(7) Ownership information obtained from Form 4 filing dated October 31, 2003.
(8) As of March 31, 2004, 33,894,728 shares of our common stock were
outstanding.
-33-
(c) Changes in control.
We are unaware of any arrangements that may, at a subsequent date, result in a
change in control of our company.
(d) Securities authorized for issuance under equity compensation plans.
We have the following securities authorized for issuance under our equity
compensation plans as of December 31, 2003, including options outstanding or
available for future issuance under our 1993 Stock Option Plan for Non-Employee
Directors, 1999 Stock Option Plan and our 2003 Stock Option Plan.
Equity Compensation Plan Information
- ---------------------------------------------------------------------------------------
Number of securities
remaining available
for future issuance
Number of securities Weighted-average under equity
to be issued upon exercise price of compensation plans
exercise of outstanding (excluding securities
outstanding options, options, warrants reflected in column
Plan category warrants and rights and rights (a))
- ---------------------------------------------------------------------------------------
(a) (b) (c)
- ---------------------------------------------------------------------------------------
Equity compensation 1,962,400 $2.56 2,000,000
plans not approved by
security holders
---------------------------------------------------------------
Total 1,962,400 $2.56 2,000,000
===============================================================
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 2002, our President, and a company in which he is the sole officer and
director, loaned us a total of $25,000, which remained unpaid at December 31,
2002. During 2003, Mr. Fong and these same companies loaned us an additional
$64,459 in varying amounts from time-to-time. Of this amount, $89,038 was repaid
during 2003, therefore $421 remained unpaid as of December 31, 2003. These loans
were due on demand and carried an interest rate of 8%.
(b) Certain business relationships.
Not applicable.
(c) Indebtedness of management.
Not applicable.
(d) Transactions with promoters.
Not applicable.
-34-
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
Gelfond Hochstadt Pangburn, P.C. served as our auditors for the years ended
December 31, 2003 and 2002.
AUDIT FEES
Fees billed by Gelfond Hochstadt Pangburn, P.C. for audit and review services
rendered for each of the years ended December 31, 2003 and 2002 were $209,000
and $149,000, respectively, which includes out-of-pocket costs incurred in
connection with these services.
AUDIT-RELATED FEES
Fees billed by Gelfond Hochstadt Pangburn, P.C. for audit-related fees in each
of the years ended December 31, 2003 and 2002 were $19,000 and $15,000,
respectively. Gelfond Hochstadt Pangburn, P.C. performed ?due-diligence services
which comprised these fees.
TAX FEES
Fees billed by Gelfond Hochstadt Pangburn, P.C. for tax fees rendered in each of
the years ended December 31, 2003 and 2002 were $21,000 and $17,000,
respectively. These fees were for services including tax return preparation.
ALL OTHER FEES
Gelfond Hochstadt Pangburn, P.C. did not bill for any other fees with respect to
the years ended December 31, 2003 and 2002.
Pursuant to our Audit Committee Charter, before the accountant is engaged by us
to render audit or non-audit services, the engagement is approved by our audit
committee.
-35-
PART IV
ITEM 15. 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, 2003 and 2002 F-2 - F-3
- --------------------------------------------------------------------------------
Consolidated/combined statements of operations - years ended
December 31, 2003, 2002 and 2001 F-4
- --------------------------------------------------------------------------------
Consolidated/combined statements of changes in stockholders'
equity - years ended December 31, 2003, 2002 and 2001 F-5 - F-12
- --------------------------------------------------------------------------------
Consolidated/combined statements of cash flows - years ended
December 31, 2003, 2002 and 2001 F-13 - F-15
- --------------------------------------------------------------------------------
Notes to consolidated/combined financial statements F-16 - F-55
- --------------------------------------------------------------------------------
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 G Convertible Preferred
Stock. (5)
- --------------------------------------------------------------------------------
3.5 Certificate of Designations of Registrant's Series I Convertible Preferred
Stock. (6)
- --------------------------------------------------------------------------------
3.6 Certificate of Designations of Registrant's Series J Convertible Preferred
Stock (12)
- --------------------------------------------------------------------------------
10.1 1993 Stock Option Plan for Non-Employee Directors (2)
- --------------------------------------------------------------------------------
10.2 1999 Stock Option Plan. (3)
- --------------------------------------------------------------------------------
10.3 2003 Stock Option Plan. FILED HEREWITH.
- --------------------------------------------------------------------------------
10.4 Distribution Agreement., between Equitex, Inc. and Equitex 2000, Inc.
dated August 6, 2001 (7)
- --------------------------------------------------------------------------------
10.5 Agreement and Plan of Reorganization among Equitex, Inc., Key Financial
Systems, Inc. and Key Merger Corporation dated June 27, 2000 (8)
- --------------------------------------------------------------------------------
10.6 Agreement and Plan of Reorganization among Equitex, Inc., Nova Financial
Systems, Inc. and Nova Acquisition Corporation dated June 27, 2000 (9)
- --------------------------------------------------------------------------------
10.7 Stock Purchase Agreement by and between Equitex, Inc. and the Selling
Stockholders of Chex Services, Inc. (10)
- --------------------------------------------------------------------------------
10.8 Amendment No. 1 to the Stock Purchase Agreement by and between Equitex,
Inc. and the Selling Stockholders of Chex Services, Inc. (11)
- --------------------------------------------------------------------------------
-36-
- --------------------------------------------------------------------------------
10.9 Purchase Agreement by and among Equitex, Inc., Pandora Select Partners,
L.P. and Whitebox Hedged High Yield Partners, L.P. FILED HEREWITH.
- --------------------------------------------------------------------------------
10.10 Convertible Secured Promissory Note payable by Equitex, Inc. to Pandora
Select Partners, L.P. FILED HEREWITH.
- --------------------------------------------------------------------------------
10.11 Convertible Secured Promissory Note payable by Equitex, Inc. to Whitebox
Hedged High Yield Partners, L.P. FILED HEREWITH.
- --------------------------------------------------------------------------------
10.12 Secured Promissory Note payable by Chex Services, Inc. to Equitex, Inc.
FILED HEREWITH.
- --------------------------------------------------------------------------------
10.13 Security Agreement by and between Equitex, Inc., Pandora Select Partners,
L.P. and Whitebox Hedged High Yield Partners, L.P. FILED HEREWITH.
- --------------------------------------------------------------------------------
10.14 Guaranty Agreement by and between Equitex, Inc., Pandora Select Partners,
L.P. and Whitebox Hedged High Yield Partners, L.P. FILED HEREWITH.
- --------------------------------------------------------------------------------
10.15 Security Agreement by and between Chex Services, Inc., Pandora Select
Partners, L.P. and Whitebox Hedged High Yield Partners, L.P.
FILED HEREWITH.
- --------------------------------------------------------------------------------
10.16 Security Agreement by and between Equitex, Inc. and Chex Services, Inc.
FILED HEREWITH.
- --------------------------------------------------------------------------------
10.17 Registration Rights Agreement by and among Equitex, Inc., Pandora Select
Partners, L.P. and Whitebox Hedged High Yield Partners, L.P.
FILED HEREWITH.
- --------------------------------------------------------------------------------
21 List of Subsidiaries. FILED HEREWITH.
- --------------------------------------------------------------------------------
23 Consent of Independent Certified Public Accountants, Gelfond Hochstadt
Pangburn, P.C. FILED HEREWITH
- --------------------------------------------------------------------------------
31 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
FILED HEREWITH.
- --------------------------------------------------------------------------------
32 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
FILED HEREWITH.
- --------------------------------------------------------------------------------
99.1 Code of Ethics for Senior Financial Management. 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 the like numbered exhibits filed with the
Registrant's Annual Report on Form 10-K for the year ended December 31,
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
August 21, 2001.
(7) 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.
(8) 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.
(9) 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.
-37-
(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
January 7, 2002.
(11) 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.
(12) 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 15(a)(3) above.
(d) Financial statement schedules required by Regulation S-X
Not applicable.
-38-
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 14, 2004 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 14, 2004 /S/ HENRY FONG
-------------------------------------
Henry Fong, President,
Treasurer and Director
(Principal Executive, Financial,
and Accounting Officer)
Date: April 14, 2004 /S/ RUSSELL L. CASEMENT
-------------------------------------
Russell L. Casement, Director
Date: April 14, 2004 /S/ AARON A. GRUNFELD
-------------------------------------
Aaron A. Grunfeld, Director
Date: April 14, 2004 /S/ MICHAEL S. CASAZZA
-------------------------------------
Michael S. Casazza, Director
-39-
EQUITEX, INC. AND SUBSIDIARIES
CONSOLIDATED/COMBINED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
EQUITEX, INC. AND SUBSIDIARIES
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
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-12
Consolidated/combined statements of cash flows F-13 - F-15
Notes to consolidated/combined financial statements F-16 - F-55
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, 2003 and 2002, and the
related consolidated/combined statements of operations, changes in stockholders'
equity and cash flows for each of the years in the three-year period ended
December 31, 2003. 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, 2003 and 2002, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 2003, in conformity with accounting principles generally
accepted in the United States of America.
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 13, 2004
F-1
EQUITEX, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2003 AND 2002
ASSETS
2003 2002
------------ ------------
Current assets:
Cash and cash equivalents $ 8,059,780 $ 8,926,124
Receivables, net (Note 5) 3,509,120 3,484,387
Current portion of notes and interest receivable, including related
parties of $239,206 (2003) and $245,322 (2002) (Note 6) 707,155 340,869
Prepaid expenses and other 314,372 350,830
Assets of discontinued operations (Note 4) 1,055 32,230
------------- -------------
Total current assets 12,591,482 13,134,440
------------- -------------
Assets of discontinued operations (Note 4) 61,170
Notes and interest receivable, net, including related parties of
$1,462,375 (2003) and $1,480,030 (2002) (Note 6) 2,107,062 1,980,030
Property, equipment and leaseholds (Notes 7 and 9) 1,184,813 1,141,715
Deferred tax asset (Note 10) 1,380,000 1,380,000
Intangible and other assets (Note 8) 3,358,393 4,098,393
Goodwill (Notes 3 and 8) 5,636,000 5,636,000
------------- -------------
13,666,268 14,297,308
------------- -------------
$ 26,257,750 $ 27,431,748
============= =============
(Continued)
F-2
EQUITEX, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (CONTINUED)
DECEMBER 31, 2003 AND 2002
LIABILITIES AND STOCKHOLDERS' EQUITY
2003 2002
------------- -------------
Current liabilities:
Bank overdraft (Note 9) $ 2,497,766
Accounts payable 651,106 $ 671,487
Accrued expenses and other liabilities, including related party
accruals of $1,293,360 (2003) and $375,109 (2002) (Note 11) 2,722,986 1,219,328
Accrued liabilities on casino contracts (Note 12) 587,099 622,361
Notes payable, related parties (Note 9) 155,421 175,000
Current portion of long-term debt (Note 9) 201,727 251,727
Line of credit, notes, and loans payable (Note 9) 11,277,177 13,493,776
Due to credit card holders (Note 12) 275,499 389,535
Liabilities of discontinued operations (Note 4) 621,768 860,394
------------- -------------
Total current liabilities 18,990,549 17,683,608
------------- -------------
Long-term debt, net of current portion (Note 9) 37,243 240,629
------------- -------------
Total liabilities 19,027,792 17,924,237
------------- -------------
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; 408 shares (2003) and 575
shares (2002) issued and outstanding; liquidation preference $594,000 408,000 575,000
Series G, 6%; stated value $1,000 per share; 370 shares issued and
outstanding; liquidation preference $571,000 370,000 370,000
Series I, 6%; stated value $1,000 per share; 1,600 shares (2003) and 1,690
shares (2002) issued and outstanding; liquidation preference $2,283,000 1,600,000 1,690,000
Series J, 6%; stated value $1,000 per share; 1,380 shares issued, 730
shares outstanding 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; 34,530,040
shares (2003) and 26,527,282 shares (2002) issued; 33,167,972 shares
(2003) and 26,111,425 shares (2002) outstanding 690,601 530,546
Stock subscription note receivable (800,000)
Additional paid-in capital 17,115,338 12,719,855
Accumulated deficit (11,428,264) (6,851,039)
Less common treasury stock at cost; 1,362,068 shares (2003) and 415,857
shares (2002) (725,717) (256,851)
------------- -------------
Total stockholders' equity 7,229,958 9,507,511
------------- -------------
$ 26,257,750 $ 27,431,748
============= =============
See notes to consolidated/combined financial statements.
F-3
EQUITEX, INC. AND SUBSIDIARIES
CONSOLIDATED/COMBINED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
(Note 1)
2003 2002 2001
------------- ------------- -------------
Fee revenue $ 18,104,995 $ 19,580,399 $ 1,373,158
Credit card income, net of provision for losses (Note 4) 415,253 759,576 1,752,559
Other 122,001 18,762
------------- ------------- -------------
Total revenues 18,520,248 20,461,976 3,144,479
------------- ------------- -------------
Third party servicing fees 242,431 403,496 1,080,098
Fees paid to casinos 6,300,400 6,189,730 437,411
Salaries, wages and employee benefits 7,909,407 7,271,845 2,656,601
Other operating expenses 7,301,724 6,461,674 1,218,757
------------- ------------- -------------
21,753,962 20,326,745 5,392,867
------------- ------------- -------------
Income (loss) from operations (3,233,714) 135,231 (2,248,388)
------------- ------------- -------------
Other income (expense):
Interest income, including related party interest of $71,755 (2003)
and $14,634 (2002) 122,454 124,400
Interest expense, including related party interest of $12,941 (2003),
$19,285 (2002) and $137,160 (2001) (1,352,124) (1,595,231) (239,893)
------------- ------------- ------------
(1,229,670) (1,470,831) (239,893)
------------- ------------- -------------
Loss from continuing operations before income taxes (4,463,384) (1,335,600) (2,488,281)
Income tax expense (benefit) 38,000 55,000 (572,500)
------------- ------------- -------------
Loss from continuing operations (4,501,384) (1,390,600) (1,915,781)
Income (loss) from discontinued operations, net of income taxes (Note 4) (75,841) (2,928,400) 884,412
------------- ------------- -------------
Net loss (4,577,225) (4,319,000) (1,031,369)
------------- ------------- -------------
Beneficial conversion features and warrant accretion (Note 13) (13,280) (2,080) (2,924,000)
Additional warrants issued to preferred stockholders (Note 13) (53,000) (152,000)
Repricing of warrants to preferred stockholders (Note 13) (375,000)
Redemption of convertible preferred stock in excess
of beneficial conversion features (Note 13) 38,430 266,000 92,000
Deemed preferred stock dividends (Note 13) (229,000) (331,500) (181,000)
------------- ------------- -------------
Net loss applicable to common stockholders $ (5,156,075) $ (4,439,580) $ (4,196,369)
============= ============= =============
Basic and diluted loss (income) per common share:
Loss from continuing operations $ (0.18) $ (0.06) $ (0.39)
Income (loss) from discontinued operations * (0.13) 0.07
------------- ------------- -------------
Basic and dilutedloss per share $ (0.18) $ (0.19) $ (0.32)
============= ============= =============
Weighted average number of common shares outstanding, basic 29,357,058 22,833,159 13,032,655
============= ============ =============
*Amount is less than $(0.01) per share.
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, 2003, 2002, AND 2001
(Note 1)
Convertible preferred stock Common stock
--------------------------- Preferred ------------------------ Additional
treasury paid-in
Shares Amount stock Shares Amount capital
------------ ------------ ---------- ----------- ----------- ------------
Balances, January 1, 2001 (Note 1) 8,937,080 $ 178,741 $ 220,094
Common stock of Key and Nova
issued for cash 181,043 3,621 996,379
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 1,216,473
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 (5,590,825)
Allocation of Series H and I preferred stock
beneficial conversion features (2,924,000) 2,924,000
Amortization of Series H and I preferred stock
beneficial conversion features 2,924,000 (2,924,000)
Conversion of Series I preferred stock
to common stock (1,010) (1,010,000) 359,958 7,199 1,002,801
Exercises of warrants for common stock 69,852 1,397 242,450
Redemption of Series I preferred stock
for cash (330) (330,000) (88,805)
Conversion of Series G preferred stock to
common stock (400) (400,000) 165,090 3,302 396,698
------------ ------------ ---------- ----------- ----------- ------------
(Continued)
F-5
EQUITEX, INC. AND SUBSIDIARIES
CONSOLIDATED/COMBINED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
(Note 1)
Retained
Common Common stock Deferred earnings Total
treasury and warrants compensation (accumulated stockholders'
stock to be issued cost deficit) equity
----------- ------------- ------------- ------------- -------------
Balances, January 1, 2001 (Note 1) $ 499,330 $ 898,165
Common stock of Key and Nova
issued for cash 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) (1,500,670) (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 $(114,037) $ 1,528,000 $ (589,834) 1,440,000
Allocation of Series H and I preferred stock
beneficial conversion features
Amortization of Series H and I preferred stock
beneficial conversion features
Conversion of Series I preferred stock
to common stock
Exercises of warrants for common stock 485 244,332
Redemption of Series I preferred stock
for cash (418,805)
Conversion of Series G preferred stock to
common stock
----------- ------------- ------------- ------------- -------------
(Continued)
F-6
EQUITEX, INC. AND SUBSIDIARIES
CONSOLIDATED/COMBINED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
(Note 1)
Convertible preferred stock Common stock
--------------------------- Preferred ------------------------ Additional
treasury paid-in
Shares Amount stock Shares Amount capital
------------ ------------ ---------- ----------- ----------- ------------
Agreements to issue common stock
and warrants for services
Common stock and warrants issued for
services 455,000 9,100 2,245,300
Cancellation of agreement to issue
common stock for services (Note 12)
Amortization of deferred compensation
cost
Common stock issued for the acquisition
of Chex Financial Services, Inc. (Note 3) 1,992,001 39,840 10,079,160
Beneficial conversion feature and warrants
attached to convertible debentures 185,000
Issuance of additional warrants to preferred
stockholders (152,000) 152,000
Amortization of additional warrants issued to
preferred stockholders 152,000 (152,000)
Repricing of warrants 66,000
Net loss
------------ ------------ ---------- ----------- ----------- ------------
Balances, December 31, 2001 4,285 4,285,000 21,244,797 424,896 9,754,252
Exercise of warrants for common stock 304,856 6,098 250,949
Issuance of common stock under private placement
agreements (net of offering costs) 1,212,386 24,247 681,949
Purchase of shares of the Company's common
stock by subsidiary
Conversion of promissory note and accrued interest
to common stock by subsidiary 130,862 2,617 60,197
Conversion of promissory note and accounts payable
to common stock 123,829 2,475 105,436
------------ ------------ ---------- ----------- ----------- ------------
(Continued)
F-7
EQUITEX, INC. AND SUBSIDIARIES
CONSOLIDATED/COMBINED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
(Note 1)
Retained
Common Common stock Deferred earnings Total
treasury and warrants compensation (accumulated stockholders'
stock to be issued cost 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) 18,400
Cancellation of agreement to issue
common stock for services (Note 12) (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) 10,119,000
Beneficial conversion feature and warrants
attached to convertible debentures 185,000
Issuance of additional warrants to preferred
stockholders
Amortization of additional warrants issued to
preferred stockholders
Repricing of warrants 66,000
Net loss (1,031,369) (1,031,369)
----------- ------------- ------------- ------------- -------------
Balances, December 31, 2001 (114,037) 750,485 (2,532,039) 12,568,557
Exercise of warrants for common stock (485) 256,562
Issuance of common stock under private placement
agreements (net of offering costs) 706,196
Purchase of shares of the Company's common
stock by subsidiary (80,000) (80,000)
Conversion of promissory note and accrued
interest to common stock by subsidiary (62,814) -
Conversion of promissory note, accrued interest
and accounts payable to common stock 107,911
----------- ------------- ------------- ------------- -------------
(Continued)
F-8
EQUITEX, INC. AND SUBSIDIARIES
CONSOLIDATED/COMBINED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
(Note 1)
Convertible preferred stock Common stock
--------------------------- Preferred ------------------------ Additional
treasury paid-in
Shares Amount stock Shares Amount capital
------------ ------------ ---------- ----------- ----------- ------------
Redemption of Series I preferred stock for cash (710) (710,000) (136,343)
Conversion of Series G preferred stock to common
stock (530) (530,000) 1,224,221 24,486 505,514
Conversion of Series I preferred stock to common
stock (260) (260,000) 616,035 12,321 247,679
Issuance of common stock and warrants under
deferred compensation agreement 15,000 300 133,700
Amortization of deferred compensation cost
Cancellation of agreement to issue common stock
and warrants for services (Note 12) 687,500
Conversion of Series D preferred stock to common
stock (150) (150,000) 782,328 15,646 134,354
Issuance of common stock and warrants to
consultants for services 416,341 8,327 213,263
Issuance of Series J preferred stock, including
650 shares purchased by subsidiary
(net of offering costs) 1,380 1,380,000 $(650,000) (151,680)
Conversion of accrued liabilities to common stock 148,792 2,976 58,029
Issuance of common stock for services 367,835 6,157 120,056
Issuance of additional warrants to preferred
stockholders (53,000) 53,000
Amortization of additional warrants issues to
preferred stockholders 53,000 (53,000)
Beneficial conversion feature and warrants
attached to convertible promissory notes 55,000
Net loss
------------ ------------ ---------- ----------- ----------- ------------
Balances, December 31, 2002 4,015 4,015,000 (650,000) 26,587,282 530,546 12,719,855
(Continued)
F-9
EQUITEX, INC. AND SUBSIDIARIES
CONSOLIDATED/COMBINED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
(Note 1)
Retained
Common Common stock Deferred earnings Total
treasury and warrants compensation (accumulated stockholders'
stock to be issued cost deficit) equity
----------- ------------- ------------- ------------- -------------
Redemption of Series I preferred stock for cash (846,343)
Conversion of Series G preferred stock to common
stock -
Conversion of Series I preferred stock to common
stock -
Issuance of common stock and warrants under
deferred compensation agreement (134,000) -
Amortization of deferred compensation cost 134,000 134,000
Cancellation of agreement to issue common stock
and warrants for services (Note 12) (750,000) (62,500)
Conversion of Series D preferred stock to common
stock -
Issuance of common stock and warrants to
consultants for services 221,590
Issuance of Series J preferred stock, including
650 shares purchased by subsidiary
(net of offering costs) 578,320
Conversion of accrued liabilities to common stock 61,005
Issuance of common stock for services 126,213
Issuance of additional warrants to preferred
stockholders -
Amortization of additional warrants issues to
preferred stockholders -
Beneficial conversion feature and warrants
attached to convertible promissory notes 55,000
Net loss (4,319,000) (4,319,000)
----------- ------------- ------------- ------------- -------------
Balances, December 31, 2002 (256,851) - - (6,851,039) 9,507,511
(Continued)
F-10
EQUITEX, INC. AND SUBSIDIARIES
CONSOLIDATED/COMBINED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
(Note 1)
Convertible preferred stock Common stock
--------------------------- Preferred ------------------------ Additional
treasury paid-in
Shares Amount stock Shares Amount capital
------------ ------------ ---------- ----------- ----------- ------------
Exercises of options and warrants for common
stock (net of offering costs) 3,543,224 70,864 1,662,303
Warrants issued for services 254,000
Purchase of shares of common stock by subsidiary,
including $207,000 from a related party 78,578
Redemption of Series I preferred stock for cash (90) (90,000) (32,776)
Conversion of Series D preferred stock to common
stock (167) (167,000) 467,253 9,345 157,655
Conversion of Series J preferred stock to common
stock (1,380) (1,380,000) 650,000 3,496,354 69,927 1,310,073
Conversion of accounts payable and notes payable
to common stock 388,817 7,777 290,758
Common stock issued as contingent consideration
for accounts payable 107,110 2,142 (2,142)
Sale of treasury stock for cash and note
receivable 576,034
Repricing of warrants 101,000
Net loss
------------ ------------ ---------- ----------- ----------- ------------
Balances December 31, 2003 2,378 $ 2,378,000 $ - 34,590,040 $ 690,601 $17,115,338
============ ============ ========== =========== =========== ============
(Continued)
F-11
EQUITEX, INC. AND SUBSIDIARIES
CONSOLIDATED/COMBINED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
(Note 1)
Retained
Common Common stock Deferred Stock earnings Total
treasury and warrants compensation subscription (accumulated stockholders'
stock to be issued cost receivable deficit) equity
----------- ------------- ------------- ----------- ------------- ------------
Exercises of options and warrants for common
stock (net of offering costs (105,050) 1,628,117
Warrants issued for services 254,000
Purchase of shares of common stock by
subsidiary, including $207,000 from a
related party (289,784) (211,206)
Redemption of Series I preferred stock
for cash (122,776)
Conversion of Series D preferred stock to
common stock
Conversion of Series J preferred stock to
common stock (650,000)
Conversion of accounts payable and notes
payable to common stock 298,535
Common stock issued as contingent
consideration for accounts payable
Sale of treasury stock for cash and note
receivable 575,968 (800,000) 352,002
Repricing of warrants 101,000
Net loss (4,577,225) (4,577,225)
----------- ------------- ------------- ----------- ------------- ------------
Balances December 31, 2003 $ (725,717) $ - $ - $ (800,000) $(11,428,264) $ 7,229,958
=========== ============= ============= =========== ============= ============
See notes to consolidated/combined financial statements.
F-12
EQUITEX, INC. AND SUBSIDIARIES
CONSOLIDATED/COMBINED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
(Note 1)
2003 2002 2001
----------- ----------- -----------
Cash flows provided by operating activities from continuing operations:
Net loss $(4,577,225) $(4,319,000) $(1,031,369)
----------- ----------- -----------
Adjustments to reconcile net loss to net cash (used in)
provided by operating activities of continuing operations:
Loss (gain) from discontinued operations 75,841 2,928,400 (884,412)
Provision for losses 250,282 194,175 601,298
Discount on note receivable 256,316
Depreciation and amortization 1,119,446 1,055,865 99,621
Beneficial conversion features on convertible promissory notes 55,000 128,000
Amortization of discount on convertible promissory notes 52,800 4,200
Stock-based compensation expense 355,000 419,303 2,132,234
Deferred income taxes (455,000)
Changes in assets and liabilities, net of business acquisition:
(Increase) decrease in accounts receivable (194,599) 1,167,710 (2,433,347)
Decrease (increase) in other receivables 174,651 (6,050,835) 833,279
Decrease in due from shareholders 300,000 606,500
(Increase) decrease in other assets (4,628) 202,606 10,365
(Decrease) increase in due to credit card holders (114,036) 4,855,694 (517,117)
Increase in accounts payable and accrued liabilities 1,646,550 1,393,446 (254,617)
----------- ----------- -----------
Total adjustments 3,564,823 6,574,164 (128,996)
----------- ----------- -----------
Net cash (used in) provided by operating activities from continuing operations (1,012,402) 2,255,164 (1,160,365)
----------- ----------- -----------
Cash flows from investing activities:
Cash acquired in business acquisition 9,994,124
Net increase in credit card receivables (2,865) 388,327 (188,066)
Purchases of furniture, fixtures and equipment (422,544) (430,945) (32,348)
Issuance of notes receivable, other (606,316) (500,000)
Issuance of related party notes receivable (513,100) (747,842) (501,599)
Repayment of related party notes receivable 558,666 159,457 372,825
----------- ----------- -----------
Net cash (used in) provided by investing activities from continuing operations (986,159) (1,131,003) 9,644,936
----------- ----------- -----------
Cash flows from financing activities:
Increase in bank overdraft 2,497,766
Sale of treasury stock 352,002
Common stock of Key and Nova issued for cash 100,000
Dividends paid to Key and Nova shareholders (350,000)
Redemption of Series I preferred stock for cash (122,776) (846,343) (418,805)
Proceeds from the exercise of warrants 1,628,117 256,562 244,332
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 (211,206) (80,000)
Increase in deferred costs (29,200)
Issuance of notes payable, related parties and other 1,980,000 2,381,839 571,950
Repayment of notes payable, related parties and other (3,769,564) (2,438,176) (765,708)
Net (repayments) borrowings on line of credit (1,000,000) (2,000) 237,962
----------- ----------- -----------
Net cash provided by (used in) financing activities from continuing operations 1,354,339 527,198 (380,269)
----------- ----------- -----------
Net cash used in discontinued operations (222,122) (414,785) (416,491)
----------- ----------- -----------
(Continued)
F-13
EQUITEX, INC. AND SUBSIDIARIES
CONSOLIDATED/COMBINED STATEMENTS OF CASH FLOWS (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
2003 2002 2001
----------- ----------- -----------
(Decrease) increase in cash and cash equivalents (866,344) 1,236,574 7,687,811
Cash and cash equivalents, beginning of year 8,926,124 7,689,550 1,739
----------- ----------- -----------
Cash and cash equivalents, end of year $ 8,059,780 $ 8,926,124 $ 7,689,550
=========== =========== ===========
Supplemental disclosure of cash flow information:
Cash paid for interest $ 1,386,173 $ 1,634,000 $ 8,828
=========== =========== ===========
Cash paid for income taxes $ 196,000 $ 10,000
=========== ===========
Supplemental disclosure of non-cash investing and financing activities:
Conversion of preferred stock to common stock $ 1,547,000 $ 940,000 $ 1,410,000
=========== =========== ===========
Conversion of promissory note, accrued interest and accounts
payable to common stock by subsidiary $ 62,814
===========
Equipment exchanged for a reduction in related party
note payable included in discontinued operations $ 12,640 $ 70,642
=========== ===========
Issuance of common stock by Equitex to acquire Key
and Nova, resulting in recognition of a deferred tax asset $ 1,440,000
===========
Repricing of warrants to preferred stockholders $ 375,000
===========
Cancellation of agreement to issue common stock
for services $ 415,000
===========
Amortization of discount on preferred stock $ 13,280 $ 2,080 $ 2,924,000
=========== =========== ===========
Issuance of additional warrants 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 $ 400,000 $ 200,000
=========== ===========
Conversion of promissory note, accrued interest and
accounts payable to common stock $ 298,535 $ 107,911
=========== ===========
Capital lease obligations $ 57,000
===========
Conversion of accrued liabilities to common stock $ 61,005
===========
Warrants attached to convertible promissory notes $ 52,800
===========
Common stock issued as contingent consideration for accounts
payable $ 2,142
===========
Sale of treasury stock for note receivable $ 800,000
===========
(Continued)
F-14
EQUITEX, INC. AND SUBSIDIARIES
CONSOLIDATED/COMBINED STATEMENTS OF CASH FLOWS (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
2003 2002 2001
------------ ------------ ------------
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-15
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTSD)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
1. ORGANIZATION, BASIS OF PRESENTATION, RECENT EVENTS AND MANAGEMENT'S PLANS:
ORGANIZATION AND BASIS OF PRESENTATIon:
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 with the Securities and Exchange Commission. 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.
F-16
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
PRINCIPLES OF CONSOLIDATION/COMBINATION:
The Company and its subsidiaries operate in three operating segments, which
consist of the cash disbursement services segment, the credit card
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, 2003, 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:
CHEX SERVICES, INC. ("Chex") and its wholly-owned subsidiary,
Collection Solutions, Inc. ("Collection") represent the cash
disbursement services segment; Chex is a Minnesota corporation formed
in July 1992, and Collection is a Minnesota corporation, formed in
October 2002; the Company acquired Chex 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
(through January 2004), Illinois, Michigan, Minnesota, Nebraska, New
Mexico, New York, North Dakota and Wisconsin; wholly-owned by the
Company at December 31, 2003.
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 were formed to design, market and
service credit card products aimed at the sub-prime market; both
companies are wholly-owned by the Company at December 31, 2003. Nova
processes payments on a remaining portfolio which provides the
Company with "run-off" operations. Key ceased "run-off" operations in
the fourth quarter of 2003, and Key operations for the years ended
December 31, 2003, 2002 and 2001 have been presented as discontinued
operations (Note 4).
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, 2003; Denaris generated no revenues through December 31,
2003.
The accompanying consolidated financial statements as of December 31, 2003
and 2002, and for each of the two years then ended 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, exceed the minority interest in the common equity (deficiency) of
the subsidiary. The excess of the losses in 2003 and 2002 applicable to
the minority interest have been charged to the Company, and therefore no
minority interest is reflected in the Company's December 31, 2003 and 2002
consolidated balance sheets. The consolidated/combined financial
statements for the year ended December 31, 2001 include the combined
accounts of Key and Nova through August 5, 2001 (prior to 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.
All significant intercompany accounts and transactions have been
eliminated in consolidation/combination.
F-17
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
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 for the
year ended December 31, 2001:
Net loss, as reported $ (1,031,000)
Net loss, pro forma $ (1,616,000)
Net loss applicable to common stockholders, as reported $ (4,196,000)
Net loss applicable to common stockholders, pro forma $ (5,094,000)
Basic and diluted net loss per common share, as reported $ (0.32)
Basic and diluted net loss per common share, pro forma $ (0.39)
RECENT EVENTS AND MANAGEMENT'S PLANS:
CHEX RECENT EVENTS:
In July 2003, the Company executed an Agreement and Plan of Merger (the
"APM") with Cash Systems, Inc. ("Cash Systems"), a publicly-traded
Delaware Corporation. Pursuant to the APM, Chex was to have been acquired
by Cash Systems in exchange for 9,000,000 shares of Cash Systems' common
stock. In December 2003, Cash Systems notified the Company that they were
terminating the APM, which was deemed by the Company as a wrongful
termination. In December 2003, the Company notified Cash Systems that it
was terminating the APM. Both the Company and Cash Systems have filed
legal actions against each other. In April 2004, the Company and Cash
Systems reached a settlement agreement (Note 12).
In November 2003, the Company executed a Stock Purchase Agreement (the
"SPA") with iGames Entertainment, Inc. ("iGames"), a publicly-traded
Nevada Corporation. Pursuant to the SPA, Chex was to have been acquired by
iGames in exchange for 62.5% of iGames' common stock and other
consideration. In March 2004, the Company notified iGames that it was
terminating the SPA due to various material unrelated adverse events that
have impacted the business of iGames. In addition, the Company declared a
default under a term loan made by Chex to iGames in January 2004 (Note
12).
In January 2004, Chex received a termination notice from Native American
Cash Systems Florida, Inc. ("NACSF"), terminating Chex's December 2001
contract to provide cash access services at five Seminole Tribe casino
properties located throughout Florida. The loss of this contract, which
provided approximately $4,000,000 of Chex's revenue for the year ended
December 31, 2003, resulted in Chex immediately implementing cost savings
measures.
F-18
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
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 was to be named Paymaster Worldwide,
Inc. ("PWI"). Under the terms of the agreement, the Company advanced
$500,000 to Paymaster Jamaica that could be converted into stock of PWI if
the Company was formed by August 15, 2003. Because the Company was not
formed by this date, the $500,000 advance became a promissory note under
the terms of the agreement. The note is due in full on August 15, 2008.
The note bears interest at 6%, is due in bi-annual payments of interest
only, and is collateralized by shares of Paymaster Jamaica stock
sufficient to represent on a fully diluted basis, a 20% ownership interest
in Paymaster Jamaica of the Company, which have been pledged by the
President of Paymaster Jamaica (Note 9). As of December 31, 2003, PWI had
not yet been formed. The Company has determined that a valuation allowance
of $250,000 should be recorded against this receivable at December 31,
2003.
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.
MANAGEMENT'S PLANS:
The Company has developed plans and strategies to address its capital and
liquidity needs for the next twelve-month period based on the events
discussed above. Management believes that cash flows from Chex will
continue to provide the Company's primary source of operating capital. In
March 2004, the Company closed on a $5,000,000 convertible promissory
note, which provided the Company with additional working capital. (Note 9)
Management believes that the Company may 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.
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, 2003 and 2002, the Company had deposits in excess
of federally insured amounts aggregating $846,630 and $2,563,787,
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.
F-19
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
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. No allowance on these receivables was considered necessary at
December 31, 2003 and 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 are 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 when considered delinquent, generally when the account
becomes 90 days past due.
The allowance for losses is established through a provision for losses
charged to expense. Receivables are charged against the allowance for
losses when management believes that collectibility of principal is
unlikely. The allowance is an amount that management believes will be
adequate to absorb estimated losses on existing accounts, based on
evaluation of the collectibility of the accounts and prior loss
experience. This evaluation also takes into consideration such factors as
changes in the volume of the credit card receivable portfolio, overall
portfolio quality, and current economic conditions that may affect the
borrower's ability to pay. While management uses the best information
available to make its evaluation, this estimate is susceptible to change.
RECEIVABLE AND DUE TO CARDHOLDERS:
The Company establishes an allowance for losses on notes receivable through
a provision for losses charged to expense. The allowance is an amount
management believes will be adequate to cover estimated losses, based on
an evaluation of hte collectibility of the notes receivable
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 a third
party financial institution. These amounts are held in a trust under an
agreement with a third party financial institution to secure payment of
the reservation fees due to cardholders.
F-20
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
RETURNED CHECKS:
The Company charges operations for potential losses on returned checks in
the period in which the amoutns are deemed uncollectible, generally when
such checks are returned. since Generally recoveries on returned checks
are credited in the period when the recovery is received.
In September 2003, checks totaling $606,316 from one customer were cashed by
the Company and were returned as insufficient funds. In March 2004, the
Company received a non-interest bearing promissory note from this
customer. Based on an imputed interest rate of 12%, a discount of $256,316
was applied to this note which was charged to operating expense during the
fourth quarter of 2003. The Company believes the remaining balance of
$350,000 is collectible, based on collateral pledged in connection with
the note (Note 6).
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, and accounts payable approximate their carrying amounts
because of the short maturities of these instruments.
The fair values of notes and advances receivable from non-related parties
approximate their carrying values because of the short maturities of these
instruments, except for a $606,316 non-interest bearing note receivable
from a Chex customer (Note 6), as to which the fair value is estimated to
be approximately $350,000. The fair values of notes and advances
receivable from related parties are not practicable to estimate, based
upon the related party nature of the underlying transactions.
The fair values of notes and loans payable to non-related parties
approximates their carrying values because of the short maturities of
these instruments. The fair values of long-term debt payable to banks
approximate fair value based on market rates currently available to the
Company. The fair values of convertible debentures and notes payable to
related parties are not practicable to estimate, based upon the related
party nature of the underlying transactions.
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
F-21
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
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.
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.
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
goodwill impairment tests in the fourth quarters of 2003 and 2002 and
determined that there was no goodwill impairment as of the test date. A
goodwill impairment test is 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.
F-22
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
ADVERTISING:
Advertising costs, which are primarily incurred by Chex, are expensed as
incurred. Advertising costs were approximately $392,000 and $296,000 in
2003 and 2002, respectively, and were not material in 2001.
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.
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 or 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, 2003 and 2002, as the impact of the potential common shares,
which total 14,017,025, 15,668,270 and 12,184,343, respectively, would be
to decrease loss 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.
F-23
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
STOCK-BASED COMPENSATION:
The Company applies Accounting Principles Board Opinion No. 25 ACCOUNTING
FOR STOCK ISSUED TO EMPLOYEES and related interpretations in accounting
for its stock option plans. Accordingly, no compensation expense has been
recognized for options granted at fair market value. Had compensation cost
for the Company's stock option plans been determined based on the fair
values at the grant dates for awards under the plans consistent with the
fair-value based method of accounting prescribed by SFAS No. 123
ACCOUNTING FOR STOCK-BASED COMPENSATION, the Company's results would have
been changed to the pro forma amounts indicated below (in thousands):
2003 2002 2001
----------- ----------- -----------
Net loss $(4,577,225) $(4,319,000) $(1,031,369)
Add: Total stock-based employee compensation
expense included in reported net loss, net of
related tax effects 19,000 - -
Deduct: Total stock-based employee
compensation expense determined under fair
value based method for all awards, net of
related tax effects (503,000) - (41,631)
----------- ----------- -----------
Pro forma net loss $(5,061,225) $(4,319,000) $(1,073,000)
=========== =========== ===========
Net loss per share:
Basic and diluted - as reported $ (0.18) $ (0.19) $ (0.32)
=========== =========== ===========
Basic and diluted - pro forma $ (0.17) $ (0.19) $ (0.33)
=========== =========== ===========
The fair value of options granted was estimated on the date of grant using
the Black-Scholes option pricing model. No options were issued during
2002. The following weighted average assumptions were utilized:
2003 2001
---------- ----------
Expected dividend yield 0 0
Expected stock price volatility 76% 53%
Risk-free interest rate 1.2% 4.2%
Expected life of options 2.5 years 2 years
F-24
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
RECENTLY ISSUED ACCOUNTING STANDARDS:
In May 2003, the FASB issued SFAS No. 150, ACCOUNTING FOR CERTAIN FINANCIAL
INSTRUMENTS WITH CHARACTERISTICS OF BOTH LIABILITIES AND EQUITY. SFAS
No.150 establishes new standards on how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. The provisions of SFAS No. 150 are generally effective for all
financial instruments entered into or modified after May 31, 2003, except
for those provisions relating to mandatorily redeemable non-controlling
interests, which have been deferred. The adoption of SFAS No. 150 did not
have a material impact on the financial position or results operation of
the Company. If the deferred provisions of SFAS No. 150 are finalized in
their current form, management does not expect adoption to have a material
effect on the financial position or results of operation of the Company.
In January 2003, the FASB issued SFAS Interpretation No. 46, CONSOLIDATION
OF VARIABLE INTEREST ENTITIES ("FIN 46"), which changes the criteria by
which one company includes another entity in its consolidated financial
statements. FIN 46 requires a variable interest entity ("VIE") to be
consolidated by a company if that company is subject to a majority of the
entity's residual returns or both. In December 2003, the FASB approved a
partial deferral of FIN 46 along with various other amendments. The
effective date for this interpretation has been extended until the first
fiscal period ending after December 15, 2004. However, prior to the
required application of this interpretation, a public entity that is not a
small business issuer shall apply this interpretation to those entities
that are considered to be special purpose entities no later than as of the
end of the first reporting period after December 15, 2003. As the Company
does not currently have an interest in a VIE or special purpose entity,
management does not expect that the adoption of FIN 46 will have an effect
on the financial condition or results of operations of the Company.
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 or loss 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 adopted the
disclosure only provisions of SFAS No. 148 and plans to continue
accounting for stock-based compensation under APB 25.
In November 2002, the FASB issued SFAS Interpretation No. 45 ("FIN 45"),
GUARANTOR'S ACCOUNTING AND DISCLOSURE REQUIREMENTS FOR GUARANTEES,
INCLUDING INDIRECT GUARANTEES AND INDEBTEDNESS OF OTHERS. FIN 45
elaborates on the disclosures to be made by the guarantor in its interim
and annual financial statements about its obligations under certain
guarantees that it has issued. It also requires that a guarantor
recognize, at the inception of a guarantee, a liability for the fair value
of the obligation undertaken in issuing the guarantee. The initial
recognition and measurement provisions of this interpretation are
applicable on a prospective basis to guarantees issued or modified after
December 31, 2002, while the provisions of the disclosure requirements are
effective for financial statements of interim or annual reports ending
after December 15, 2002. The adoption of FIN 45 did not have a effect on
the financial condition or results of operations of the Company, as the
Company has not issued any guarantees.
F-25
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
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 disposal 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 2002 and 2001 consolidated/combined
financial statements have been reclassified to conform to the 2003
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.
4. DISCONTINUED 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.
F-26
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
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
was not able to establish such a relationship. During the fourth quarter
of 2003, "run-off" operations which consisted of processing residual
payments on remaining active accounts in its portfolio ceased.
The carrying amounts of assets and liabilities of Key at December 31, 2003
and 2002 are as follows:
2003 2002
----------- ----------
Cash $ 1,055 $ 5,589
Receivables, net 23,037
Prepaid expenses and other 3,604
----------- ----------
Total current assets 1,055 32,230
Property, equipment and leaseholds 61,170
----------- ----------
Total assets $ 1,055 $ 93,400
=========== ==========
Accounts payable $ 524,829 $ 606,780
Accrued expenses 25,000 160,550
Notes payable, related party 71,939 79,194
Due to credit card holders 13,870
----------- ----------
Total liabilities (all current) $ 621,768 $ 860,394
=========== ==========
Key revenues for the years ended December 31, 2003, 2002 and 2001 reported in
discontinued operations were $36,644, $3,474,273 and $12,383,660. Income
(losses) incurred by Key in 2003, 2002 and 2001 were ($75,841), ($2,928,398) and
$884,412 (net of $515,000 of income tax expense). In 2002, Key losses included
$2,151,207, related to the closure of Net First (Note 12).
F-27
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
5. RECEIVABLES:
Receivables at December 31, 2003 and 2002, consist of the following:
2003 2002
----------- -----------
Credit card and ATM processors $ 2,278,232 $ 2,460,601
Due from Paymaster Jamaica 608,000
Amount held in trust 258,642 433,293
Credit card receivables, net of allowance,
for losses of $1,545 (2003) and $3,465 (2002) 153,547 148,762
Other receivables 210,699 441,731
----------- -----------
$ 3,509,120 $ 3,484,387
=========== ===========
Amounts due from credit card and ATM processors arise primarily from credit
card and ATM advances by Chex to casino patrons. Credit card receivables
are reduced by allowances for refundable fees and losses. Amounts due from
Paymaster Jamaica are due for services performed by Denaris, which have
been recorded as deferred revenue at December 31, 2003. The amount held in
a trust under an agreement is to secure payment of reservation fees due
customers. The amount is held by a third party financial institution.
Credit card receivables include refundable and earned fees, which
represent the balance reported to customers.
Changes in the allowance for credit card losses for the years ended December
31, 2003, 2002 and 2001, are as follows:
2003 2002 2001
--------- ---------- ---------
Balances, beginning of year $ 3,465 $ 208,070 $ 254,086
Provision for recoveries 4,879 121,307 416,080
Amounts charged-off (6,799) (325,912) (462,096)
---------- ----------- ----------
Balances, end of year $ 1,545 $ 3,465 $ 208,070
========= ========== =========
6. NOTES AND INTEREST RECEIVABLE:
Notes receivable at December 31, 2003 and 2002, consist of the following:
2003 2002
----------- -----------
Notes receivable from the estate of a deceased
shareholder 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 $1,053,300
has been recorded against this receivable at
December 31, 2003 ($1,211,100 at December
31, 2002) $ 1,484,691 $ 1,484,691
F-28
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
2003 2002
----------- -----------
Note receivable from a customer of Chex;
non-interest bearing; principal balance of
$606,316, net of $256,316 discount at
December 31, 2003, based on imputed interest
rate of 12%; discount charged to operating
expense in 2003; monthly payments of $4,500
beginning May 2004 through December 2010, at
which time the balance is due in full;
collateralized by mortgages on three parcels
of real property in Florida 350,000
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] 485,936 585,936
Note receivable from Paymaster Jamaica;
interest at 10%, collateralized by a pledge
of Paymaster Jamaica common shares by
Paymaster Jamaica's president; note matures
in August 15, 2008; payments of interest
only due semi-annually beginning August 15,
2003 through maturity; a valuation allowance
of $250,000 has been recorded against this
receivable at December 31, 2003; first
interest payment waived by the Company 500,000 500,000
Notes receivable from Equitex 2000; interest
at 10%; unsecured; due on demand; a
valuation allowance of $160,000 has been
recorded against this receivable at December
31, 2003 [A] 1,266,556 522,724
Notes receivable from various Chex employees
and a shareholder; non-interest bearing;
unsecured; due on demand [A] 53,700 55,101
Note receivable from individual; interest at
12%; unsecured; note matured in December
2002 and was repaid in July 2003 288,000
----------- -----------
4,140,883 3,436,452
Interest receivabl 136,633 95,547
Less current maturities (707,155) (340,869)
----------- -----------
Notes receivable, net of current portion 3,570,361 3,191,130
Less allowances for uncollectible notes receivable (1,463,299) (1,211,100)
----------- -----------
Notes and interest receivable, long-term $ 2,107,062 $ 1,980,030
=========== ===========
F-29
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
[A] Demand notes receivable, less valuation allowances aggregating to
$1,797,492 at December 31, 2003, have been classified as long-term
assets, as it is management's intention not to demand payment in 2004.
Demand notes receivable aggregating to $1,206,439 were classified as
long-term assets at December 31, 2002.
7. PROPERTY, EQUIPMENT AND LEASEHOLDS:
The major classes of property, equipment and leaseholds, and total
accumulated depreciation at December 31, 2003 and 2002, are as follows:
2003 2002
------------ -----------
Office equipment, furniture and vehicles $ 1,771,948 $ 1,362,679
Leasehold improvements 52,765 52,765
Computer software 141,664 128,389
------------ -----------
1,966,377 1,543,833
Less accumulated depreciation (781,564) (402,118)
------------ -----------
$ 1,184,813 $ 1,141,715
============ ===========
The amounts above include equipment under capital leases with a gross
carrying value of approximately $157,000 at December 31, 2003 and 2002,
respectively, and accumulated depreciation of approximately $47,000 and
$14,000 at December 31, 2003 and 2002, respectively.
8. GOODWILL, INTANGIBLE AND OTHER ASSETS:
At December 31, 2003 and 2002, goodwill was $5,636,000, none of which is
deductible for tax purposes, based on the structuring of the Chex
acquisition. Intangible and other assets are as follows:
December 31, 2003 December 31, 2002
------------------------------------- --------------------------------------
Gross Net Gross Net
carrying Accumulated carrying carrying Accumulated carrying
amount amortization amount amount amortization amount
----------- ----------- ----------- ----------- ------------ -----------
Casino contracts $ 4,300,000 $ 1,349,440 $ 2,950,560 $ 4,300,000 $ 749,440 $ 3,550,560
Non-compete agreements 350,000 163,300 186,700 350,000 99,300 250,700
Technology and software
Customer lists 250,000 178,600 71,400 250,000 102,600 147,400
Trade names 100,000 100,000 100,000 100,000
----------- ----------- ----------- ----------- ------------ -----------
Total intangible assets 5,000,000 1,691,340 3,308,660 5,000,000 951,340 4,048,660
Other assets 49,733 49,733 49,733 49,733
----------- ----------- ----------- ----------- ------------ -----------
$ 5,049,733 $ 1,691,340 $ 3,358,393 $ 5,049,733 $ 951,340 $ 4,098,393
=========== =========== =========== =========== ============ ===========
F-30
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
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, 2003, 2002
and 2001, was $740,000, $876,755 and $745,585, respectively. Estimated
amortization expense for each of the five succeeding fiscal years is as
follows:
Year ending
December 31, Amount
------------ -----------
2004 $ 735,000
2005 664,000
2006 659,000
2007 600,000
2008 551,000
9. NOTES PAYABLE AND LONG-TERM DEBT:
Notes payable and long-term debt at December 31, 2003 and 2002, consist of
the following:
NOTES PAYABLE, RELATED PARTIES:
2003 2002
----------- -----------
Note payable to an officer of Chex; interest
at 8%; unsecured; due on demand $ 150,000 $ 150,000
Note payable to the Company's president;
interest at 10%; unsecured; due on demand;
repaid during the first quarter of 2003 25,000
Notes payable to affiliate through common
ownership and control by the Company's
president; interest at 10%; unsecured; due
on demand 5,421
----------- -----------
155,421 175,000
Less current maturities (155,421) (175,000)
----------- -----------
$ - $ -
=========== ===========
F-31
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
LONG-TERM DEBT:
2003 2002
----------- -----------
Note payable to a bank; interest at prime plus
.25% (4.25% and 4.5% at December 31, 2003
and 2002, respectively); interest payable
monthly and principal payable quarterly; the
note matures in June 2004; collateralized by
substantially all assets of Chex; guaranteed
by an officer of Chex; subject to various
restrictive covenants $ 150,000 $ 350,000
Obligations under capital leases; imputed
interest rates ranging from 6.5% to 7%; due
at various dates through October 2005;
collateralized by equipment 88,970 142,356
----------- -----------
238,970 492,356
Less current maturities (201,727) (251,727)
----------- -----------
$ 37,243 $ 240,629
=========== ===========
Aggregate annual maturities of long-term debt are as follows:
Years ending
December 31,
------------
2004 $ 201,727
2005 37,243
-----------
$ 238,970
===========
In March 2004, the Company closed on $5,000,000 of convertible promissory
notes (the "Notes") with two financial institutions (the "Lenders"). The
Notes carry a stated interest rate of 7% per annum and have a 45-month
term. Payments are due monthly beginning in April 2004. Interest only
payments are due through June 2004. Beginning in July 2004, principal and
interest payments will amortize over the remaining 42-month period. The
Notes are senior to all other debt of the Company and are collateralized
by all assets of Chex and the Company's stock ownership in Chex.
The Notes are convertible into common stock at $1.35 per share up to an
amount equal to 4.99% of the Company's outstanding common stock. The
Company has the right to make any monthly payment of principal and
interest in shares of its common stock. The common stock is to be issued
based on 85% of the average bid price for 20 trading days prior to the
payment due date. The maximum number of shares that can be delivered as
payment is to be equal to 10% of the average monthly trading volume for
the month prior to the payment due date. The Company may also issue common
shares each month in an amount not to exceed 10% of the prior month's
total share volume as payment, to be applied to the outstanding principal
balance up to a value of $100,000.
F-32
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
The Notes contain certain anti-dilution provisions requiring the Company to
pay the Lenders as collateral, the pro-rata number of shares the Lenders
would receive in any spin-off or dividend from the Company as if the
remaining principal balance under the Note was fully converted at $1.35
per share. The dividend shares are to be segregated and may be liquidated
at the discretion of Lenders. At the end of each quarter, 85% of the
proceeds are to be applied to the principal balance as long as the Company
is current in monthly principal and interest payments.
The Lenders also received 800,000 warrants to acquire up to 800,000 shares
of the Company's common stock at an exercise price of $1.50. The warrants
are exercisable for a period of five years, and include a cashless
exercise provision. In addition, 300,000 warrants exercisable at $1.00
per share for a period of two years were issued to an advisory firm in
connection with the transaction.
The Company is required to register common shares underlying conversion of
the Notes, warrants and shares used to make monthly payments. If the
registration statement is not declared effective within 180 days of
closing, the Company is required to issue additional common stock or
warrants in amounts to be negotiated. If after twelve months from the
closing date, the registration statement is not effective, the Lenders
have the right to call the Notes.
LINE OF CREDIT, NOTES AND LOANS PAYABLE:
2003 2002
----------- -----------
Chex line of credit; maximum availability of
$1 million through November 2003; subject to
various restrictive covenants; interest
payable monthly at prime rate plus .5% (4.5%
and 4.75% at December 31, 2003 and 2002,
respectively); borrowings were
collateralized by substantially all assets
of Chex and were guaranteed by a officer of
Chex [A] $ 1,000,000
Notes payable to individual investors;
interest rates ranging from 10% to 12%;
interest and principal payable quarterly;
the notes are unsecured and mature on
various dates through December 2004; the
notes are subject to repayment with ninety
days notice at the option of the holder [B] $10,692,177 11,658,776
Convertible promissory notes; originally due
November 2002; notes of $100,000 were
converted into common stock in November
2003; notes of $185,000 are currently in
default [C] 185,000 285,000
Note payable under litigation settlement
agreement (Note 12); due in May 2004;
non-interest bearing; however, if not repaid
within seven business days of the maturity
date, interest accrues at 18% per annum from
December 1, 2003 400,000
F-33
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
2003 2002
----------- -----------
Notes payable, other; interest at 9%; the
notes were repaid at various dates
throughout 2003 550,000
----------- -----------
$11,277,177 $13,493,776
=========== ===========
[A] At December 31, 2003, Chex has a bank overdraft of $2,497,766
outstanding with the bank. Interest on the overdraft was charged at 4.5%.
In March 2004, Chex paid the amount due on the overdraft with funds
received by the Company in a $5 million debt refinancing.
[B] Subsequent to December 31, 2003, the Company repaid $645,000 of these
notes payable.
[C] 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. 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
interest 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 notes. Through December 31, 2002 and 2001, the Company recognized
$57,000 and $4,200, respectively, of interest expense related to the
warrants. The warrants expire November 2004 (Note 13).
The convertible promissory notes include a beneficial conversion feature
in which the 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
notes. The intrinsic value of the beneficial conversion feature was
determined to be approximately $128,000 and was charge 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.
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. 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 interest 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 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 10.3%,
11.4% and 11.2% in 2003, 2002 and 2001, respectively.
F-34
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
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, 2003, 2002 and
2001 is as follows:
2003 2002 2001
---------- ----------- -----------
Continuing operations:
Current:
Federal $ (100,500)
State $ 38,000 $ 55,000 (17,000)
---------- ----------- ------------
38,000 55,000 (117,500)
Deferred (455,000)
---------- ----------- ------------
38,000 55,000 (572,500)
Deferred:
Discontinued operations 515,000
---------- ----------- -----------
$ 38,000 $ 55,000 $ (57,500)
========== =========== ===========
The reconciliation between the expected tax benefit computed at the federal
statutory income tax rate of 34% and the effective tax rate applied to the
pre-tax loss from continuing operations for the years ended December 31,
2003, 2002 and 2001, is as follows:
2003 2002 2001
------ ------ ------
Statutory federal income tax rate (34)% (34)% (34)%
Federal and state taxes not incurred by
an S Corporation from January 1,
through August 5, 2001 (46)%
State taxes, net of federal income tax benefit (4)% (4)% (4)%
Effect of change in valuation allowance 39% 42% 61%
------ ------ ------
1% 4% (23)%
====== ====== ======
F-35
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
The following is a summary of the Company's deferred tax assets and
liabilities:
2003 2002
----------- -----------
Deferred tax assets:
Allowance for loan losses$ $ 680,000 $ 594,000
Intangible and other assets 18,000 14,000
Accruals 357,000 170,000
Net operating loss carryforwards 4,113,000 3,099,000
----------- -----------
Total deferred tax assets 5,168,000 3,877,000
Valuation allowance (3,727,000) (2,437,000)
----------- -----------
1,441,000 1,440,000
Deferred tax liabilities, credit card receivables (61,000) (60,000)
----------- -----------
Net deferred tax asset $ 1,380,000 $ 1,380,000
=========== ===========
Net operating loss carryforwards of approximately $12,100,000 are available
to offset future taxable income, if any, and expire between 2016 and 2023.
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.
11. RELATED PARTY TRANSACTIONS:
BONUS TO OFFICER:
In June 2003, the Company's Board of Directors approved a bonus arrangement
with the Company's president. The bonus arrangement, effective June 2,
2003, provides for an annual bonus calculated quarterly based on 5% of the
increase in the market value of the Company's common stock, accrued
quarterly, beginning with the closing price as reported by Nasdaq on
December 31 of each year, and ending with the closing price on December 31
of the following year. Payments under the bonus arrangement are to be made
at the discretion of the Company's management from time to time, as cash
flow permits. Total compensation expense recorded under this arrangement
from June 2, 2003 through December 31, 2003, was approximately $1,490,000,
of which approximately $209,000 was paid in 2003 and approximately
$1,281,000 is included in accrued liabilities at December 31, 2003.
F-36
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
PARAGON AGREEMENTS:
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 of commissions
under the Paragon agreement during the year ended December 31, 2001.
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 income and $420,000 of
operating losses under this agreement, which are presented as discontinued
operations, 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 April 2004, the Company executed a settlement agreement with Cash Systems
pursuant to which is to pay Cash Systems $125,000 for expenses related to
the terminated APM. As part of the settlement agreement, Cash Systems is
to pay Chex approximately $476,000 for commissions owed to Chex by Cash
Systems and approximately $120,000 related to cash that was in ATM's at
the Seminole Tribe casinos at the time of the APM termination. Both the
Company and Cash Systems agreed to mutually release each other from
further liability related to the APM and the Seminole Tribe termination,
however, the Company has retained the right to legal action against NASCF,
NACS and its President, for the wrongful termination of the Seminole Tribe
casino contracts.
In March 2004, Chex commenced a lawsuit in Hennepin County, Minnesota
demanding repayment of $2,000,000, plus a $1,000,000 termination fee,
accrued interest and other fees, due from iGames under a term note made in
January 2004. In addition, in March 2004, the Company commenced a lawsuit
in Delaware state court (New Castle county) relative to the termination of
the SPA. In March 2004, iGames commenced a lawsuit in United States
District Court for the District of Delaware relative to both the
termination of the SPA and iGames' obligations under the term note, which
is the subject of Chex's lawsuit in Hennepin County, Minnesota. The
Company is confident that its claims in litigation will be upheld and
management believe that the claims made by iGames lack merit. The Company
intends to vigorously prosecute its claims and defend against iGames'
claims.
In December 2003, an individual filed a lawsuit against the Company and the
Company's president alleging securities fraud and breach of contract,
claiming that the Company and its president failed to honor an agreement
to purchase, for $500,000, certain shares of a former (prior to August 6,
2001) subsidiary of the Company. The complaint further alleges that the
Company participated in an effort to "pump" the price of its stock in
1999. The complaint seeks payment of $500,000 plus costs and interest. In
March 2004, the Company filed a motion to dismiss the complaint on
several grounds, including failure of the complaint to comply with
applicable law, failure to file the claims within the appropriate statute
of limitations period and lack of standing by the plaintiff under
securities laws, among others. While the outcome of this matter cannot
presently be predicted, the Company intends to vigorously defend against
this claim.
F-37
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
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 does 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 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 closing of Net First.
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 in 2002, the Company 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.
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 alleged 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 was 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. In November
2003, Equitex reached a settlement agreement with the liquidating agent
pursuant to which Equitex is to pay the sum of $400,000 by May 21, 2004,
in exchange for the dismissal of the adversary proceeding and the
execution of a mutual release of claims by both parties. 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 a result, the Company has recorded a
liability of $400,000 and a corresponding receivable of $400,000 due from
Equitex 2000 as of December 31, 2003.
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 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 $275,499 and $389,535 as of December 31, 2003 and December 31,
2002, respectively.
F-38
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
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.
LEASE COMMITMENTS:
The Company rents space under various non-cancelable operating leases that
provide for monthly lease payments through March 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, 2003, are as follows:
Years ending
December 31, Amount
------------ ------------
2004 $ 114,000
2005 83,000
2006 18,000
------------
$ 215,000
============
In addition, the Company leases office space in Colorado on a month to month
basis for $2,500 per month from a corporation in which the Company's
president is the sole shareholder.
Total rent expense under operating leases was approximately $272,000,
$693,000 and $389,000 for the years ended December 31, 2003, 2002 and
2001, 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 paid a lease
termination fee of $150,000 in 2003. This amount was accrued at December
31, 2002 and is included in loss from discontinued opeartions in 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
reversed the common stock and warrants that were to be issued under the
Agreement and reduced stock-based compensation by $62,500 during the year
ended December 31, 2002.
F-39
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
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).
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 were fully satisfied. The Company issued
the common stock and the warrants underlying this agreement in November
2001 (Note 13).
In January 2002, the Company entered into a consulting agreement for
financial services 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. 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 were fully satisfied. The Company
issued the common stock and warrants underlying this agreement in March
2002 (Note 13).
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, which was recognized as operating expense during the year
ending December 31, 2002, as the performance criteria under the agreement
were fully satisfied.
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 $116,905 at December 31, 2003, in the event that
their employment is terminated.
F-40
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
CHEX EMPLOYMENT AGREEMENTS:
Chex has entered into three-year employment agreements with seven of its
employees, which expire at various dates through February 2006. 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
$915,332 at December 31, 2003. The amounts are to be paid in monthly
installments over the duration of the original contract terms.
In 2002, the Company 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, 2003 and 2002, the Company has recorded $182,498 and
$189,717, respectively, of prepaid amounts on casino contracts and has
recorded $587,099 and $622,361, respectively, of accrued liabilities on
casino contracts.
Pursuant to the contracts, the Native American owned casinos have not waived
their sovereign immunity.
EMPLOYEE BENEFIT PLAN (CHEX):
In January 2003, the Company's subsidiary, Chex, adopted a 401(k) retirement
plan (the "Plan"), which covers defined eligible employees of Chex.
Eligible employees are able to contribute a portion of their compensation
to the Plan, subject to an annual Internal Revenue Service deferral limit.
Employee contributions are 100% vested when made. Company contributions
are discretionary. During 2003, Chex made a matching contribution of 100%
on the first 3% of employee deferrals and 50% on employee deferrals
between 3% and 5%. Contribution expense was approximately $89,000 for the
year ended December 31, 2003.
F-41
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
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.
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 was $5.76 per share
(the market price of the common stock at the date of grant was $5.24 per
share). The warrants were exercisable through August 2006. The common
stock and warrants were valued at approximately $410,000, which was
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 was $5.76 per share (the
market price of the common stock at the date of grant was $5.24 per
share). The warrants were exercisable through August 2006.
F-42
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
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 were 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 was 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 $455,000 of the total proceeds were
allocated to the warrants, resulting in an imputed dividend rate of 9.4%.
Each warrant is exercisable until July 2004 at an exercise price of $5.78
per share.
Because the Series H Preferred Stock contained an immediate beneficial
conversion feature, net loss applicable to common stockholders was
increased by $507,000 for the year ended December 31, 2001, the amount of
the discount resulting from the beneficial conversion feature.
SERIES I CONVERTIBLE PREFERRED STOCK:
In August 2001, prior to the merger, the Company issued 4,000 shares of 6%,
Series I convertible preferred stock (the "Series I Preferred Stock")
along with warrants to purchase 400,000 shares of common stock for $1,000
per share, which is the stated value per share (total proceeds of
$4,000,000 less issue costs of approximately $500,000). The warrants were
valued at $264,000 using the Black-Scholes option pricing model, and
therefore $264,000 of the total proceeds were allocated to the warrants,
resulting in an imputed dividend rate of 6.4%.
The Series I Preferred Stock is convertible, together with any accrued but
unpaid dividends, at any time into shares of the Company's common stock at
a conversion price per share equal to the lesser of $5.98 or 65% of the
average closing price of the Company's common stock as specified in the
agreement.
Because the Series I Preferred Stock contained an immediate beneficial
conversion feature, net loss applicable to common stockholders was
increased by $2,417,000 for year ended December 31, 2001, the amount of
the discount resulting from the beneficial conversion feature.
F-43
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
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. Dividends are payable in cash, or at the Company's
option, in shares of the Company's common stock. Cumulative unpaid
dividends are approximately $283,000 (approximately $177 per share) at
December 31, 2003. 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 date
stipulated in the registration rights agreement, the Company incurred
approximately $263,600 in penalties for the year ended December 31, 2002,
which is payable in cash, and was 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. The Company paid approximately
$49,000 and $39,000 of the penalties during 2003 and 2002, respectively.
The remaining amounts are to be paid when requested by the holders.
From August through November 2001, 1,010 shares of Series I Preferred Stock,
plus cumulative unpaid dividends of $3,020, were converted into 359,958
shares of common stock, at an average conversion price of $2.81 per share.
In addition, 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. In addition, 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.
During the year ended December 31, 2003, the Company redeemed 90 shares of
Series I preferred stock, plus cumulative unpaid dividends of $22,766, for
$122,776. 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 $38,430 for the year
ended December 31, 2003.
F-44
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
SERIES D AND SERIES G PREFERRED STOCK:
SERIES D CONVERTIBLE PREFERRED 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 $60,000 (approximately $147
per share) at December 31, 2003. 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.
During the year ended December 31, 2003, 167 shares of Series D preferred
stock, plus cummulative unpaid dividends of $49,135 were converted into
467,253 shares of common stock at conversion prices of $0.25 to $0.66 per
share.
SERIES G CONVERTIBLE PREFERRED STOCK:
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. Dividends are payable in cash or, at the Company's
option, in shares of the Company's common stock. Cumulative unpaid
dividends are approximately $90,000 (approximately $243 per share) at
December 31, 2003. 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 were to automatically convert into common stock on
August 31, 2003. However, the Company has been negotiating with the holder
to extend the terms; therefore the holder has not elected to convert the
shares to common stock. The Series G Preferred Stock was 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.
F-45
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
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 average conversion prices of $0.28 to
$2.33 per share.
SERIES J CONVERTIBLE PREFERRED STOCK:
During the fourth quarter of 2002, the Company issued 1,380 shares of 6%,
Series J convertible 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 presented as preferred treasury stock
at December 31, 2002 (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.
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. The
shares were issued in November 2001. 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 304,856 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.
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.
F-46
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
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 367,835 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.
During the year ended December 31, 2003, the Company issued 3,453,224 shares
of common stock upon the conversion of 3,326,724 warrants and 126,500
stock options for $1,869,490 (net of offering costs of $241,373) at an
average conversion price of $0.53 per share. Of these shares, 225,000 were
issued to a subsidiary of the Company at exercise prices of $0.38 to $0.50
per share. The shares issued to the subsidiary are presented as common
treasury stock. Accordingly, common treasury stock was increased by
$105,050.
During the year ended December 31, 2003, accounts and notes payable of
$298,535 were converted into 388,817 shares of common stock at conversion
prices of $0.64 to $0.93 per share, the market price of the common stock
at the date of issuance.
In December 2003, the Company issued 107,110 shares of common stock as
contingent consideration for accounts payable. As the shares of common
stock are sold by the holder, the amounts received will be paid to the
Company to reduce a liability of approximately $163,000 recorded in its
financial statements.
STOCK SUBSCRIPTION RECEIVABLE:
In December 2003, Chex sold 1,000,000 shares of Equitex common stock owned
by Chex and which represent treasury stock of the Company, in exchange for
an $800,000 promissory note. The note is presented as a component of
stockholders' equity at December 31, 2003. The note has an interest rate
of 7% per annum and is payable in three installments of principal and
interest through June 30, 2004. The promissory note is secured by a pledge
agreement which grants Chex a security interest in 700,000 of the
purchased shares.
F-47
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
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.
In January 2003, Chex converted 650 shares of the Company's Series J
Preferred Stock plus unpaid dividends of $8,884 into 1,647,211 shares of
common stock. The cost of the preferred stock was $650,000, which has been
reclassified from preferred treasury stock to common treasury stock.
In June 2003, Chex purchased 300,000 shares of Equitex common stock from its
affiliate, Equitex 2000 for $0.69 per share (the market price of the
common stock at the date of the purchase). The cost of the shares
($207,000) has been classified as treasury stock.
During the year ended December 31, 2003, Chex exercised warrants to purchase
225,000 shares of Equitex common stock at exercise prices of $0.385 to
$0.50 per share. The cost of these shares issued ($105,050) has been
classified as treasury stock.
During the year ended December 31, 2003, Chex sold 1,226,000 shares of
Equitex common stock between $0.57 and $1.00 per share (the market prices
of the common stock at the date of each sale). The stock was acquired at
an average cost of approximately $0.47 per share and the cost of the
shares sold ($575,968) has been reclassified from treasury stock. The
excess between the sales price over the cost of the shares sold ($576,034)
has been classified as additional paid in capital.
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 (the "1993
Option Plans"). 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.
F-48
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
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.
In January 2003, the Company adopted the 2003 Stock Option Plan (the "2003
Plan"). Common stock reserved for options under the 2003 Plan total
3,500,000.
In May and June 2003 the Company granted five-year options to purchase
1,400,000 shares of common stock to directors, officers and employees of
the Company (which includes 760,000 options to Chex employees) and 100,000
options to a consultant for services. The options have exercise prices
between $0.68 and $1.03 per share (the market price of the common stock at
the respective grant dates). The options granted to the consultant were
valued at $19,000 based upon the Black-Scholes option pricing model.
No stock options were granted in 2002. In 2003 and 2001, stock options were
granted to officers, directors, employees and consultants of the Company
as follows:
Number Option
Option type Grantee of shares price
----------- ---------- --------- ---------
2003 Incentive Directors 528,000 $ 1.03
Incentive Officers 100,000 $ 1.03
Incentive Employees 772,000 $ 0.68
Incentive Consultant 100,000 $ 0.68
---------
1,500,000
=========
2001 Incentive Employee 10,000 $ 6.00
Incentive Director 11,000 $ 6.00
---------
21,000
=========
In November 2003, the Company reduced the exercise price of certain existing
stock options previously issued to employees to purchase up to 730,000
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, Accounting for Certain Transactions involving Stock Compensation.
Through December 31, 2003, recharacterization of these options as variable
awards resulted in additional compensation expense of $73,000.
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, 2003, recharacterization of the options as
variable awards did not materially affect compensation expense.
F-49
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
A summary of the status of stock options outstanding and exercisable and
weighted average exercise prices is as follows:
2003 Plan 1999 Plan Total
---------------------------- ---------------------------- ---------------------------
Weighted Weighted Weighted
average average average
exercise exercise exercise
Shares price Shares price Shares(1) price(1)
----------- ------------- ----------- ----------- ------------- -----------
January 1, 2001 $ - 1,700,000 $ 6.14 1,786,400 $ 5.99
Forfeited - - (21,000) 5.50 (21,000) 5.50
Granted - - 21,000 6.00 21,000 6.00
Exercised - - - - - -
----------- ------------- ----------- ----------- ------------- -----------
December 31, 2001 1,700,000 6.14 1,786,400 5.99
Forfeited - - - - - -
Granted - - - - - -
Exercised - - - - - -
----------- ------------- ----------- ----------- ------------- -----------
December 31, 2002 1,700,000 6.14 1,786,400 5.99
Forfeited - - - - - -
Granted 1,500,000 0.83 - - 1,500,000 0.83
Exercised 126,500 0.68 - - 126,500 0.68
----------- ------------- ----------- ----------- ------------- -----------
December 31, 2003 1,373,500 $ 0.84 1,700,000 $ 6.14 3,159,900 $ 3.75
=========== ============= =========== =========== ============= ===========
Options exercisable at December 31, 2003, expire from January 2004 through
June 2008.
(1) Total shares and the calculation for the weighted average exercise price
includes 86,400 options outstanding from the 1993 Option Plans with an
exercise price of $3.00. There have been no changes in the number of options
issued under the 1993 Option Plans during the three years ended December 31,
2001, 2002 and 2003.
WARRANTS:
In July 2001, in connection with the issuance of the Series H Preferred
Stock, the Company issued warrants to purchase 239,500 shares of common
stock at an exercise price of $5.00 per share (the market price at the
date of grant was $5.45) to an investment banker as offering costs. The
warrants were valued at $252,000 using the Black-Scholes option pricing
model.
In September 2001, the Company issued warrants to purchase 350,000 shares of
common stock at prices ranging from $4 to $10 per share (the market price
at the date of measurement was $4.00) to a consultant for services
rendered under a deferred compensation agreement. The warrants were valued
at $333,000 on the date of commitment based upon the Black-Scholes option
pricing model.
In November and December 2001, the Company reduced the exercise price of
certain existing warrants to purchase up to 165,333 shares of the
Company's common stock. As a result of the reduction in exercise price,
the Company recognized an additional $66,000 of stock based compensation
expense related to these repriced warrants, which is included in the
Company's operating expenses for the year ended December 31, 2001.
F-50
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 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.
In December 2001, the Company issued three-year warrants to purchase 17,000
shares of the Company's common stock at $3.55 per share (the market price
of the common stock at the date of grant) to a consultant for services
provided to the Company. These warrants were valued at $18,400 based upon
the Black-Scholes option pricing model, which is included in the Company's
operating expenses for the year ended December 31, 2001.
In January 2002, the Company issued three-year warrants to purchase an
additional 53,333 shares of the Company's common stock at prices ranging
from $3.50 to $5.00 per share (the market price of the common stock at the
date of grant was $3.55) to a holder of the Company's convertible
preferred stock. These warrants were valued at $53,000 based upon the
Black-Scholes option pricing model. In addition, the Company issued
warrants to purchase 20,000 shares of common stock at prices ranging from
$4 to $5 per share (the market price at the date of grant was $3.95) to
unrelated parties as additional consideration for convertible promissory
notes.
In December 2002, the Company issued warrants to purchase 100,000 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 2003, the Company also issued warrants to consultants and
unrelated parties to purchase 500,000 shares of the Company's common stock
at prices ranging from $0.41 to $0.54 per share (the market price of the
common stock at the dates of the grant). These warrants were valued at
$76,000 based upon the Black-Scholes option pricing model.
In April 2003, the Company issued warrants to consultants for services to
purchase 70,000 shares of common stock at $0.52 per share (the market
price of the common stock at the dates of the grant). These warrants were
valued at $12,500 based upon the Black-Scholes option pricing model.
In May 2003 the Company issued warrants to consultants for services to
purchase 950,000 shares of common stock at prices ranging from $0.68 to
$0.90 per share (the market price of the common stock at the dates of the
grant). These warrants were valued at $146,500 based upon the
Black-Scholes option pricing model. A related party received 200,000 of
these warrants.
F-51
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
During the year ended December 31, 2003, the Company reduced the exercise
price of certain existing warrants to purchase up to 1,489,726 shares of
the Company's common stock to induce the holders to exercise these
warrants. The warrants were initially issued in connection with the sale
of preferred stock. As a result of the reduction in the exercise price,
loss applicable to common stockholders was increased by $375,000 for the
year ended December 31, 2003.
During the year ended December 31, 2003, the Company reduced the exercise
price of certain existing warrants to purchase up to 230,006 shares of the
Company's common stock, including 80,000 warrants issued to Chex. As a
result of the reduction in exercise price, the Company recognized an
additional $28,000 of stock based compensation expense relating to these
repriced warrants.
The fair value of each warrant and option granted to non-employees during
2003, 2002 and 2001 was estimated on the date of grant using the
Black-Scholes option-pricing model. The following weighted average
assumptions were utilized:
2003 2002 2001
---------- --------- ---------
Expected dividend yield 0 0 0
Expected stock price volatility 86% 84% 54%
Risk-free interest rate 1.25% 2.0% 3.8%
Expected life of warrants 0.85 years 1.3 years 1.3 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.
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.
F-52
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
As of and for the year ended December 31, 2003, segment results were as follows:
Cash
Credit card disbursement Corporate
services services activities Total
-------------- ------------ ----------- ------------
(Key and Nova) (Chex)
Revenues $ 415,253 $ 18,104,995 $ - $ 18,520,248
Depreciation and amortization - 1,093,767 25,967 1,119,734
Stock based compensation - - 355,000 355,000
Interest expense 33 1,312,570 39,521 1,352,124
Interest income 72,543 49,911 122,454
Income tax expense - 38,000 - 38,000
Net income (loss) 6,975 (197,784) (4,386,416) (4,577,225)
Intangible assets - 3,358,393 - 3,358,393
Goodwill - 5,636,000 - 5,636,000
Total assets 413,332 22,204,885 3,639,533 26,257,750
Capital expenditures - 413,152 11,022 424,174
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 $ 881,577 $ 19,580,399 $ - $ 20,461,766
Depreciation and amortization - 1,152,901 284 1,153,185
Stock based compensation - - 419,303 419,303
Interest expense - 1,529,438 65,793 1,595,231
Interest income 89,021 35,379 124,400
Income tax expense - - 55,000 55,000
Net income (loss) (2,525,866) 757,271 (2,550,405) (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 - 428,375 2,570 430,945
F-53
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
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 $ 1,756,550 $ 1,373,158 $ 14,771 $ 3,144,479
Depreciation and amortization 31,369 99,932 - 131,301
Stock based compensation - - 2,132,234 2,132,234
Interest expense - 102,733 137,160 239,893
Income tax expense (515,000) - (57,500) (572,500)
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 8,411,894 25,491,723 1,445,538 35,349,155
Capital expenditures 32,347
15. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED):
Selected unaudited quarterly financial data for the years ended 2003, 2002
and 2001, is summarized below.
2003 quarters
---------------------------------------------------------------------
First Second Third Fourth
quarter quarter quarter (a) quarter (b)
--------------- --------------- -------------- ---------------
Revenues $ 4,702,999 $ 4,662,227 $ 4,910,317 $ 4,244,705
Net loss (306,685) (453,150) (761,714) (3,055,676)
Preferred stock beneficial conversion
features, deemed dividends and other
transactions (27,360) (60,330) (295,300) (195,860)
Income (loss) from continuing operations (278,241) (442,755) (739,164) (3,041,224)
Loss from discontinued operations (28,444) (10,395) (22,550) (14,452)
Net loss applicable to common
shareholders (334,045) 513,480 (1,057,014) (3,251,536)
Basic and diluted loss per common
share (c) (0.01) (0.02) (0.04) (0.11)
F-54
EQUITEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
2003 quarters
---------------------------------------------------------------------
First Second Third Fourth
quarter quarter quarter (a) quarter (b)
--------------- --------------- -------------- ---------------
Revenues $ 5,156,740 $ 5,271,669 5,316,875 4,716,692
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
Income (loss) from continuing operations (526,105) (41,840) (2,101,016) 1,278,360
Loss from discontinued operations (232,123) 9,383 (264,312) (2,436,347)
Net loss applicable to common
shareholders (811,228) (117,457) (2,452,328) (1,058,567)
Basic and diluted loss per common
share (c) (0.04) (0.01) (0.10) (0.04)
(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) Includes approximately $1,400,000 of expense recorded in the fourth
quarter of 2003 under a bonus agreement with the Company's president. In
addition, during the fourth quarter of 2003 the Company recorded an
allowance of $250,000 on a note receivable due from Paymaster Jamaica,
recorded a $256,000 discount on a note receivable due from a customer and
the Company recorded approximately $300,000 in professional expenses
relating to litigation and merger and acquisition activities.
(c) The sum of earnings per share for the four quarters may differ from the
annual earnings per share due to the required method of computing
weighted average number of shares in the respective periods.
F-55