Adfitech q4 2011 Financials

8/13/2019 Adfitech q4 2011 Financials

1/25

Adfitech, Inc.

Annual ReportPeriods Ended December 31, 2011 and 2010


2/25


3/25

www.e ideba i l l y . com 3

1601 N.W. Expressway, Ste 1900|Oklahoma City, OK 73118-1429|T 405.478.3400|F 405.478.5673|EOE

Independent Auditors Report on Supplementary Information

The Stockholders and Board of Directors

Adfitech, Inc.

Edmond, Oklahoma

We have audited the consolidated financial statements of Adfitech, Inc. as of December 31, 2011 and

2010 and for the periods from January 1, 2011 through December 31, 2011 and March 15, 2010 through

December 31, 2010, and our report thereon dated March 30, 2012, which expressed an unqualified

opinion on those financial statements, appears on page 9. Our audit was conducted for the purpose of

forming an opinion on the consolidated financial statements as a whole. The Annual Report and

Managements Discussion and Analysis of Financial Condition and Results of Operations, which is the

responsibility of management, are presented for the purpose of additional analysis and are not a required

part of the financial statements. Such information has not been subjected to the auditing procedures

applied in the audit of the consolidated financial statements, and, accordingly, we do not express an

opinion or provide any assurance on it.

Oklahoma City, OK

March 30, 2012


4/25

ADFITECH, INC.BUSINESS (Unaudited)

PERIODS ENDED DECEMBER 31, 2011 AND 2010

History and Nature of Operations

Adfitech, Inc. (Adfitech, the Company, we, our or us ) was incorporated in 1983 and is recognized nationallyas a leading provider of outsourced services for residential mortgage lenders. The Company was acquired by CentexCorp. in 1996 and subsequently sold to Thornburg Mortgage, Inc. (Thornburg) in 2006. Adfitech is now anindependent company operating from their state-of-the-art 20-acre corporate campus in Edmond, Oklahoma. Our over400 corporate clients nationwide are serviced by over 500 dedicated employees who provide outsourcing support tothe mortgage industry. Our residential mortgage loan services include (i) pre-funding and post-funding quality control;(ii) fraud review; (iii) post-funding services, including stacking, insuring, shipping and delivery of loans to investors,warehouse banks, custodian and/or servicers; and (iv) due diligence on loans being purchased or securitized. Weobtain lists of closed loans from our customers portfolios and perform validation work through random or directedsampling and auditing. Our comprehensive process involves fact verification, employment checks, backgroundchecks, credit reports, consistency verification, underwriting guideline adherence, fraud detection and property valuevalidation.

In 2011, the Company formed a wholly-owned subsidiary, VLN, Inc. (VLN), primarily to obtain mortgage lendinglicenses in all 50 states for the purpose of enhancing the spectrum of services offered by Adfitech. VLN has beencapitalized to meet the largest minimum capital requirements required to obtain a state mortgage lending license.

Bankruptcy Proceedings and Emergence from Chapter 11

On May 1, 2009, Thornburg and four of its affiliates filed petitions in the United States Bankruptcy Court for the Districtof Maryland seeking relief under Chapter 11 of the United States Bankruptcy Code. Adfitech was one of those fouraffiliates whose inclusion in the filing was necessitated solely as a result of Adfitechs guarantee of over $1.64 billionof Thornburgs debt.

Subsequently, on November 2, 2009, to alleviate an ongoing burden to Adfitechs operations, an order was issued

severing the administration of Adfitechs reorganization from Thornburgs reorganization. The Company consummatedits reorganization under Chapter 11 of the Bankruptcy Code and emerged from bankruptcy on March 15, 2010 (theEffective Date), under the terms of its Second Amended Plan of Reorganization (Plan of Reorganization), whichwas confirmed by the Bankruptcy Court on March 2, 2010. The U.S. Bankruptcy Court entered the Final Decree onAugust 5, 2010.

In accordance with the Financial Accounting Standards Board Accounting Standards Codification (ASC) 852-10,Reorganizations, the Company adopted fresh-start accounting on the Effective Date because the holders of theexisting voting shares immediately prior to confirmation received less than 50% of the voting stock of the emergingentity and the reorganization value of the assets of the emerging entity immediately before the date of confirmationwas less than the total of all postpetition liabilities and allowed claims. Under fresh-start accounting, all assets andliabilities are restated to reflect their reorganization value which approximates fair value at the date of reorganization.

The liabilities of reorganized Adfitech (the Successor) consist of post-petition liabilities and new 8% senior notespayable. In accordance with fresh-start accounting, the gain on forgiveness of debt was reflected on thePredecessors financial statement of operations for the period January 1 through March 14, 2010. In addition, theretained earnings of the Predecessor at March 14, 2010 was eliminated as of March 15, 2010 and the Successorsfinancial statements reflected no beginning retained earnings. The distributions made on March 15, 2010, under ourPlan of Reorganization, at the Companys emergence from bankruptcy, was included on the Predecessors financialstatements. The accompanying Statements of Operations and Cash Flows include the operations and cash flows forthe short period March 15 through December 31, 2010 of the Successor.

4


5/25

ADFITECH, INC.BUSINESS (Unaudited)


Significant Customers

Adfitech currently has three significant customers that each accounted for more than 10% of our revenues in 2011 andone significant customer that accounted for more than 10% of our revenues in 2010, as well as numerous othercustomers. Revenues from the significant customers totaled 38%, 26% and 11%, respectively, of Adfitechs revenuesin 2011. Revenues from the significant customer in 2010 totaled 84% of Adfitechs revenues for the period March 15through December 31, 2010.

The loss of or significant decline in volume from any of the significant customers would have a material adverse effecton our business. We are focusing our sales efforts on expanding our customer base to lessen the effect that the lossor decline in volume of any of these customers would have on our business. In addition, if we experience a declinein revenues that is expected to be ongoing, we are able to decrease our headcount and overtime levels to help reducethe impact of the revenue decline.

Employees

As of March 9, 2012, Adfitech had a total of 561 employees, including 512 full-time employees.

Properties

Adfitech owns its corporate campus in Edmond, Oklahoma consisting of approximately 72,000 square feet of officespace on 20 acres.

Legal Proceedings

The Company is not a party to any material pending legal proceeding.

5


6/25


7/25

ADFITECH, INC.MANAGEMENT'S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Unaudited)PERIODS ENDED DECEMBER 31, 2011 AND 2010

Results of Operations

Revenues totaled $29.5 million for the year ended December 31, 2011 and reflected a significant decline comparedto 2010's run rate. We experienced a significant decrease in quality control and imaging revenues during 2011.However, these declines were partially offset by a significant increase in post-closing and reverification services. Asa result of the changes in the mortgage industry, there was a significant increase in the demand for our services in2008 and 2009 as mortgage investors wanted independent reviews of their new and existing loans; consequently, ourrevenues grew to record levels in 2009. This higher level of revenues continued in 2010, but, as expected, did notcontinue in 2011 as we returned back to normal levels after the unprecedented volumes of the previous two years.However, our revenues in 2011 did include $776,000 from a new servicing review pilot program, $589,000 of whichwas recognized during the fourth quarter. Although we are pursuing continuation of this program, we are uncertainif we will recognize additional revenues from the program in 2012. Overall, we expect revenues in 2012 to increasesignificantly compared to 2011, primarily due to increased sales efforts and the resolution of some of the mortgageindustrys legal and procedural delays that occurred in 2011.

Total compensation and benefits expenses were $22.2 million for the year ended December 31, 2011, including $18.0million of salaries, wages and related payroll taxes. The salaries, wages and related payroll taxes reflected asignificant decline compared to 2010's run rate resulting primarily from a substantial decrease in overtime pay due tothe decline in revenues. Compensation and benefits expenses also included $3.1 million of employee healthinsurance costs which decreased significantly, compared to 2010's run rate, primarily due to the Companys conversionto a fully insured health plan as of January 1, 2011. Also included in compensation and benefits expenses for 2011were $734,000 of executive bonuses and stock compensation expense which were substantially lower than 2010'srun rate primarily due to the bonuses awarded upon the Companys emergence from bankruptcy on March 15, 2010.We expect total compensation and benefits expenses to increase significantly in 2012, compared to 2011, consistentwith the projected revenue trend.

Depreciation and amortization expense totaled $1.9 million and $1.5 million, respectively, for the year ended

December 31, 2011 and the period March 15 through December 31, 2010, including $1.4 million and $1.1 million,respectively, of amortization of identifiable intangible assets recorded in accordance with fresh-start accounting asa result of the Companys emergence from bankruptcy. We expect depreciation and amortization in 2012 to beconsistent with 2011.

Other operating expenses totaled $3.5 million for the year ended December 31, 2011. Included in other operatingexpenses were direct loan review costs ($763,000), telephone and utilities ($343,000), building maintenance andsupplies ($214,000), expensed equipment ($229,000), postage, overnight and other mailing costs ($263,000), generaloffice supplies and expense ($277,000), insurance ($172,000), marketing and advertising ($133,000), and legal andprofessional fees ($274,000). Other operating expenses reflected a significant increase compared to 2010's run rateprimarily due to a large increase in direct loan review costs resulting from the changes in revenue mix and timingdifferences. In addition, we experienced higher legal and professional fees, resulting from ongoing increased legaland audit fees related to the new corporate structure, as well as higher recruitment fees. These increases were

partially offset by lower telephone expenses, due to fees included in 2010 for upgrading the functionality of the phonesystem, and lower advertising costs, due to higher marketing and public relations efforts in 2010. We expect otheroperating expenses to increase significantly in 2012 consistent with the revenue trend.

We incurred $1.3 million of interest expense for the year ended December 31, 2011, compared to $1.2 million for theperiod March 15 through December 31, 2010, on the 8% senior notes payable issued on March 15, 2010 inconjunction with our Plan of Reorganization. The decline resulted from the senior note repurchases completed during2010. We expect a small decrease in interest expense in 2012 due to the senior note repurchases completed in 2011.

During 2011, the Company repurchased senior notes with a face value of $401,000 for $261,000, resulting in a gainof $140,000. During the period March 15 through December 31, 2010, the Company repurchased senior notes with

7


8/25


9/25

www.e ideba i l l y . com 9

1601 N.W. Expressway, Ste 1900|Oklahoma City, OK 73118-1429|T 405.478.3400|F 405.478.5673|EOE

Independent Auditors Report

The Stockholders and Board of Directors

Adfitech, Inc.

Edmond, Oklahoma

We have audited the accompanying consolidated balance sheets of Adfitech, Inc. as of December 31,

2011 and 2010 and the related consolidated statements of operations, stockholders' equity, and cash flows

for the periods from January 1, 2011 through December 31, 2011 and March 15, 2010 through December

31, 2010. 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 consideration of

internal control over financial reporting as a basis for designing audit procedures that are appropriate in

the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Companys

internal control over financial reporting. Accordingly, we do not express such an opinion. An audit also

includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial

statements, assessing the accounting principles used and significant estimates made by management, as

well as evaluating the overall financial statement presentation. We believe our audits provide a reasonable

basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material

respects, the financial position of Adfitech, Inc. as of December 31, 2011 and 2010, and the results of

their operations and cash flows for the periods from January 1, 2011 through December 31, 2011 and

March 15, 2010 through December 31, 2010 in conformity with accounting principles generally accepted

in the United States of America.

As discussed in Note 2 to the consolidated financial statements, on March 2, 2010, the United States

Bankruptcy Court for the District of Maryland confirmed the Companys Second Amended Plan of

Reorganization (the Plan). The Plan became effective March 15, 2010 and the Company emerged from

Chapter 11 of Title 11 of the U.S. Bankruptcy Code (Chapter 11). In connection with its emergence

from Chapter 11, the Company adopted fresh-start reporting pursuant to Financial Accounting Standards

Board Accounting Standards Codification (ASC) 852-10,Reorganizations, as of March 15, 2010 as

further described in Note 2 to the consolidated financial statements.

Oklahoma City, OKMarch 30, 2012


10/25


11/25

ADFITECH, INC.CONSOLIDATED BALANCE SHEETS

DECEMBER 31, 2011 AND 2010(Amounts in thousands, except share data)

December 31, December 31,

2011 2010

ASSETS

Current assets:Cash $ 4,457 $ 4,724Trade accounts receivable 5,937 3,633Prepaid income taxes 168 235Deferred income taxes 106 219Other prepaid expenses and other current assets 158 360

Total current assets 10,826 9,171

Property, plant and equipment, net 9,522 9,526

Other assetsDeferred indenture costs, net 112 125Goodwill 2,943 2,943Other intangibles, net 10,040 11,431Other 42 25

Total assets $ 33,485 $ 33,221

LIABILITIES AND STOCKHOLDERS EQUITY

Current liabilities:Accounts payable $ 677 $ 410Accrued liabilities 1,328 1,528

Total current liabilities 2,005 1,938

Long-term deferred income taxes 3,712 3,999Senior notes payable 15,327 15,728

Total liabilities 21,044 21,665

Stockholders equity:Common stock - $0.01 par value; 10,000,000 shares authorized, 6,466,010 and 6,349,760 shares outstanding 64 64Additional paid-in capital 9,562 9,251Retained earnings 2,815 2,241

Total stockholders equity 12,441 11,556

Total liabilities and stockholders equity $ 33,485 $ 33,221

The accompanying Notes to Consolidated Financial Statements are an integral part of the financial statements.

11


12/25

ADFITECH, INC.CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY

PERIODS ENDED DECEMBER 31, 2011 AND 2010(Amounts in thousands except share data)

AdditionalCommon Common Paid-in Retained

Shares Stock Capital Earnings Total

Balance at March 14, 2010 $ $ $ $

Issuance of new common stock in

accordance with Plan of Reorganization 5,876,760 59 8,165 8,224

Proceeds from private placement,

net of offering costs 473,000 5 877 882

Stock-based compensation 209 209

Net income 2,241 2,241

Balance at December 31, 2010 6,349,760 $ 64 $ 9,251 $ 2,241 $ 11,556

Stock-based compensation 116,250 311 311

Net income 574 574

Balance at December 31, 2011 6,466,010 $ 64 $ 9,562 $ 2,815 $ 12,441


12


13/25

ADFITECH, INC.CONSOLIDATED STATEMENTS OF CASH FLOWSPERIODS ENDED DECEMBER 31, 2011 AND 2010

(Amounts in thousands)

January 1 - March 15 -December 31, December 31,

2011 2010

Cash flows from operating activities:Net income $ 574 $ 2,241Adjustments to reconcile net income to net cash

flow provided by operating activities:Bad debt expense 59 32Depreciation and amortization 1,855 1,450Gain on senior note repurchases (140) (990)Stock-based compensation 311 209Reorganization expenses 289Deferred income taxes (174) 184Changes in assets - decrease (increase):

Trade accounts receivable (2,363) 67Prepaid income taxes 67 (235)Other prepaid expenses and other current assets 202 (161)Other assets (17) (21)

Changes in liabilities - (decrease) increase:Accounts payable 267 206Accrued income taxes (395)Accrued liabilities (200) 509

Net cash flow provided by operating activities before reorganization items 441 3,385

Cash flows from reorganization activities:Reorganization expenses paid (1,100)

Net cash flow used in reorganization activities (1,100)

Cash flows from investing activities:Purchases of property, plant and equipment (447) (627)

Net cash flow used in investing activities (447) (627)

Cash flows from financing activities:Proceeds from stock issuance, net of offering costs 882Senior note repurchases (261) (6,282)

Net cash flow used in financing activities (261) (5,400)

Net decrease in cash (267) (3,742)

Cash, beginning of period 4,724 8,466

Cash, end of period $ 4,457 $ 4,724

Supplemental Disclosures of Cash Flow Information:

Interest paid $ 1,258 $ 1,154

Income taxes paid $ 467 $ 1,985


13


14/25


15/25

ADFITECH, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


Accounts Receivable and Concentrations of Credit Risk

The Companys exposure to concentration of credit risk consists primarily of trade accounts receivable. We performongoing credit evaluations of our customers and adjust credit limits based upon payment history and the customers

current creditworthiness, as determined by our review of their current credit information. We continuously monitorcollections and payments from our customers. Our policy is to record an allowance for doubtful accounts whenconsidered necessary. However, because our historical experience of bad debts has been less than % of revenues,we have recorded bad debt expense for any specific customer collection issues that we have identified when theyarise. We will record an allowance for doubtful accounts in the future if we determine we have collection issues thatexceed 1% of the accounts receivable balance. We currently have three significant customers and at times have largesales to one or more individual customers that constitute a significant amount of the Companys accounts receivablebalance. A significant change in the liquidity or financial position of such customers could have a material adverseimpact on the collectibility of our accounts receivables and our future operating results. (See Note 10.)

Financial Instruments

The Companys financial assets and liabilities consist of cash, accounts receivable, accounts payable, accruedliabilities and notes payable. The carrying values of cash, accounts receivable, accounts payable and accruedliabilities approximate their fair values based upon their short-term nature. The carrying value of notes payableapproximates the fair value as the interest rate approximates market rates.

Property, Plant and Equipment

In accordance with fresh-start accounting, the Company restated its property, plant and equipment to fair value uponits emergence from bankruptcy. All subsequent additions are carried at cost. Depreciation has been calculated usingthe straight-line method over the estimated useful lives of the respective classes of assets as follows:

Asset Type Life

Buildings and improvements 33 - 40 yearsFurniture and fixtures 3 - 7 yearsComputer hardware and software 2 - 5 years

Improvements that extend the useful life of an asset are capitalized. Maintenance and repairs are charged to expenseas incurred. We review property, plant and equipment for impairment value whenever events or changes in businesscircumstances indicate that the carrying amount of the assets may not be fully recoverable.

Deferred Indenture Costs

Deferred indenture costs are amortized over the life of the related senior notes payable. At December 31, 2011 and2010, we had deferred indenture costs of $112,000 and $125,000, respectively. These costs were net of accumulatedamortization of $24,000 and $11,000 at December 31, 2011 and 2010, respectively.

Goodwill and Other Intangibles

Goodwill and other intangibles were recorded under fresh-start accounting upon our emergence from bankruptcy.Goodwill represents the excess of the reorganization value of Adfitech, as determined for the Plan of Reorganization,over the fair value of tangible and identifiable intangible assets. The Company accounts for goodwill and otherindefinite-lived intangibles under ASC Topic 350, Intangibles - Goodwill and Other, which does not permit amortization,but requires the Company to test goodwill and other indefinite-lived assets for impairment annually or whenever eventsor circumstances indicate impairment may exist. The other intangibles were recorded based upon their fair value atthe reorganization date and included tradenames/trademark, internally developed software and customer relationships.

15


16/25


17/25



calculated on the basis of weighted average outstanding common shares. Diluted earnings per share is calculatedon the basis of basic weighted average common shares adjusted for the dilutive effect of the outstanding stock awards.

Comprehensive Income

The Company had no items of comprehensive income other than net income for the periods January 1 throughDecember 31, 2011 and March 15 through December 31, 2010.

NOTE 2 - EMERGENCE FROM BANKRUPTCY AND FRESH-START ACCOUNTING

The Company consummated its reorganization under Chapter 11 of the Bankruptcy Code and emerged frombankruptcy on March 15, 2010 under the terms of its Second Amended Plan of Reorganization (see Note 1).

The Plan of Reorganization provided for the following:

Administrative Convenience Class - The holders of the administrative convenience class claims of $6,000 were paid

in full.

Senior Note Guarantee Claims - The holders of the senior note guarantee claims of $304,747,000 received a cashdistribution of $2.5 million, $23 million of 8% senior notes payable and 5,876,760 shares of the Successor. The cashdistribution was based upon the amount of the Successors cash balance in excess of $5.0 million on the EffectiveDate and was limited to $2.5 million.

Subordinated Note Guarantee Claims - The holders of the subordinated note guarantee claims of $1,335,381,000 didnot receive or retain any distribution or any property under the Plan of Reorganization.

Common Stock - The holders of the Predecessors common stock did not receive or retain any distribution or anyproperty under the Plan of Reorganization. All of the Predecessors common stock was cancelled on the EffectiveDate.

In accordance with ASC 852-10, Reorganizations, the Company adopted fresh-start accounting on the Effective Datebecause the holders of the existing voting shares immediately prior to confirmation received less than 50% of thevoting stock of the emerging entity and the reorganization value of the assets of the emerging entity immediately beforethe date of confirmation was less than the total of all postpetition liabilities and allowed claims. It was determined thatAdfitechs reorganization value was $37,465,000 as follows:

Present value of discounted cash flows of emerging entity $ 14,257,000Present value of terminal value 14,210,000Working capital in excess of operational requirements 7,878,000Value of undeveloped land 1,120,000

$ 37,465,000

The present value of cash flows was based upon four years of projected cash flows discounted at 20.2%. The terminalvalue was calculated based on free cash flow of the final year, grown at 5% in perpetuity, discounted by the discountrate less the implied growth rate. The working capital in excess of operational requirements was based upon the cashflow projections and managements experience and history of working capital requirements. Advisors andmanagement discussed various scenarios in the development of the reorganization valuation model; the model utilizedfor the reorganization valuation represents the most likely projected case. Some of these discussions are incorporatedin the specific company premium that is part of the discount rate calculation. Among the variables considered in thispremium are the sensitivities of the valuation assumptions to market conditions, including those related to Adfitechs

17


18/25


19/25



The effects of the Plan of Reorganization and fresh-start accounting on our financial position at March 15, 2010 wereas follows:

Predecessor March 15, 2010 Successor

March 14, Effects of Fresh-Start March 15,2010 Plan Adjustments 2010

(Amounts in thousands)

AssetsCash $ 11,463 $ (2,506) (a) $ $ 8,466

(491) (b)Trade accounts receivable 3,732 3,732Deferred income taxes 216 216Prepaid expenses and other current assets 199 199

Total current assets 15,610 (2,997) 12,613

Property, plant and equipment, net 7,307 1,929 (d) 9,236

Deferred indenture costs 136 (b) 136Goodwill 9,152 (6,209) (d) 2,943Other intangibles 12,533 (d) 12,533Other assets 4 4

Total Assets $ 32,073 $ (2,861) $ 8,253 $ 37,465

Liabilities and Stockholders Equity (Deficit)

Accounts payable $ 204 $ $ $ 204Accrued reorganization expenses 1,166 (355) (b) 811Accrued income taxes 395 395Other accrued liabilities 1,019 1,019

Total current liabilities 2,784 (355) 2,429

Notes payable 23,000 (c) 23,000Long-term deferred income taxes 906 2,906 (d) 3,812Liabilities subject to compromise 1,640,134 (2,506) (a)

(1,637,628) (c)

Stockholders equity (deficit)Common stock - predecessor 102 (102) (c) Common stock - successor 59 (c) 59Additional paid-in capital - predecessor 19,854 (19,854) (c) Additional paid-in capital - successor 8,165 (c) 8,165Accumulated deficit (1,631,707) 1,626,360 (c) 5,347 (d)

Total stockholders equity (deficit) (1,611,751) 1,614,628 5,347 8,224Total liabilities & stockholders equity (deficit) $ 32,073 $ (2,861) $ 8,253 $ 37,465

(a) To record payment of allowed administrative convenience claims and $2.5 million distribution to senior noteguarantee claims.(b) To record payment of post-petition administrative claims including professional fees and debt issuance costs.(c) To record issuance of new senior notes payable and common stock, cancellation of predecessors common stock,and discharge of remaining liabilities subject to compromise.(d) To adjust the assets and liabilities to their reorganization value, including the allocation of the excess of thereorganization value over the fair value of tangible and identifiable intangible assets to the Successors goodwill, andto eliminate the Predecessors accumulated deficit.

19


20/25


21/25

ADFITECH, INC.NOTES TOCONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


The accrued liabilities under Adfitechs previously self-insured health plan totaled $402,000 at December 31, 2010and represented the estimated unpaid claims remaining under our self-insured health plan that was terminated as ofDecember 31, 2010. This amount does not reflect $158,000 of amounts receivable for related stop-loss refunds thatwere included in other current assets at December 31, 2010. There were no estimated unpaid claims remaining at

December 31, 2011.

NOTE 6 - SENIOR NOTES PAYABLE

In conjunction with our Plan of Reorganization, we issued $23 million of senior notes payable on March 15, 2010. Thenotes bear interest at an annual rate of 8.0%. Interest is payable in quarterly installments on March 15, June 15,September 15 and December 15. The principal balance is due in full on March 15, 2020. The notes payable arecollateralized by a first security interest in all of the Company's assets. During the year ended December 31, 2011,the Company repurchased senior notes payable with a face value of $401,000 and recognized a gain of $140,000on these repurchases. During the period March 15 through December 15, 2010, the Company repurchased seniornotes payable with a face value of $7,272,000 and recognized a gain of $990,000 on these repurchases. The seniornotes had an outstanding balance of $15,327,000 and $15,728,000 at December 31, 2011 and 2010, respectively.

The indenture agreement contains covenants prohibiting or limiting certain activities of the Company including paymentof dividends, purchase of certain investments and various other payments, the creation of debts or liens, sales ofassets, participation in mergers, etc. The Company was in compliance with all of the covenants on this loan for 2011and 2010.

NOTE 7 - INCOME TAXES

The provision for income taxes consisted of the following:


2011 2010(Amounts in thousands)

Current:Federal $ 444 $ 1,146State 64 217

508 1,363

Deferred:Federal (136) 165State (39) 19

(175) 184

Total provision for income taxes $ 333 $ 1,547

The reconciliation of income taxes computed at the U.S. federal statutory tax rate to the effective tax rate is as follows:


2011 2010(Amounts in thousands)

Federal income tax provision at the statutory rate $ 308 $ 1,288State taxes, net of federal benefit 22 156Effect of non-deductible reorganization expenses 98Other 3 5

$ 333 $ 1,547

21


22/25


23/25



On May 19, 2011, the Board of Directors approved the Adfitech, Inc. Long-term Incentive Plan (the Plan). The Planprovides for the grant of incentive and nonqualified stock options, restricted stock awards, restricted stock units andstock appreciation rights (collectively Stock Awards) to eligible employees and directors, with any stock optionsissued to directors to be nonqualified stock options. A total of 1,000,000 shares of common stock is authorized for

issuance under the Plan, with a maximum of 500,000 shares to be issued as incentive stock options. At December31, 2011, 723,000 shares of common stock were available for future Stock Award grants, including 223,000 sharesavailable for future incentive stock option grants. All stock options issued under this Plan must have an exercise priceof no less than fair market value on the grant date. All other terms and conditions of the Stock Awards are determinedby Adfitechs compensation committee, subject to the provisions of the Plan. During 2011, the Board granted 277,000incentive stock options at an exercise price of $3.01, the fair market value on the grant date. These options areexercisable for a period of 4 years from the grant date and vest at 25% per year.

The fair value of each option is estimated on the date of grant using the Black-Scholes-Merton formula with thefollowing weighted average assumptions for the options granted in 2011: expected volatility of 32.3%; no dividendsexpected; risk-free interest rate of 1.9% and expected option life of 4.0 years. No options were granted during theperiod ended December 31, 2010.

The following table summarizes the stock option activity during 2011:

WeightedAverage

Weighted ContractualIncentive Average Remaining Aggregrate

Stock Exercise Term IntrinsicOptions Price (Years) Value

Outstanding at December 31, 2010 $ Granted 277,000 3.01Exercised $

Forfeited Outstanding at December 31, 2011 277,000 $ 3.01 3.4 $

None of the options outstanding at December 31, 2011 were exercisable. At December 31, 2011, Adfitech had$191,000 of unrecognized compensation cost related to incentive stock options that will be recognized over a weightedaverage period of 3.4 years.

We recognize compensation expense using the straight-line method over the requisite service period. Thecompensation expense for stock-based compensation totaled $311,000 for the year ended December 31, 2011 and$209,000 for the period March 15 through December 31, 2010.

NOTE 9 - EARNINGS PER SHARE

Basic earnings per share is calculated on the basis of weighted average outstanding common shares. Dilutedearnings per share is calculated on the basis of basic weighted average common shares adjusted for the dilutive effectof outstanding stock awards. The following table reconciles the numerator and denominators of the basic and dilutedearnings per common share computation for the periods January 1 through December 31, 2011 and March 15 throughDecember 31, 2010. The Companys incentive stock options were not included in the computation of diluted earningsper share for the year ended December 31, 2011 because their exercise price was less than the average market priceof the common stock outstanding. There were no incentive stock options outstanding during 2010.

23


24/25


25/25



NOTE 13 - SUBSEQUENT EVENTS

We evaluated our December 31, 2011 financial statements for subsequent events through March 30, 2012, the datethe financial statements were issued. We are not aware of any subsequent events which would require recognition

in these financial statements.

Adfitech q4 2011 Financials

Documents