NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
1. BASIS OF PRESENTATION
The accompanying interim consolidated financial statements of Empire
Financial Holding Company ("EFH") and its wholly owned subsidiaries; Empire
Financial Group, Inc. ("EFG"), Empire Investment Advisors, Inc. ("EIA"), and
Jesup & Lamont Securities Corporation ("Jesup"), (collectively, the
"Company")are unaudited; however, in the opinion of management, the interim
consolidated financial statements reflect all adjustments, consisting only of
normal recurring adjustments, necessary for a fair presentation of the results
for the interim periods. All intercompany balances and transactions have been
eliminated in consolidation. Certain footnote disclosures normally included in
financial statements prepared in accordance with accounting principles generally
accepted in the United States of America have been condensed or omitted pursuant
to the applicable rules and regulations of the Securities and Exchange
Commission. The results of operations for the nine months ended September 30,
2007, are not necessarily indicative of the results to be expected for the year
ending December 31, 2007. These consolidated financial statements should be read
in conjunction with the consolidated financial statements and notes for the year
ended December 31, 2006 appearing in the Company's Annual Report on Form 10-KSB
for the year ended December 31, 2006, as filed with the Securities and Exchange
Commission.
Use of Estimates
GENERAL. The preparation of financial statements in conformity 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 financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
CLEARING ARRANGEMENTS. We do not carry accounts for customers or
perform custodial functions related to customers' securities. We introduce all
of our customer transactions, to our clearing brokers, who maintain our
customers' accounts and clear such transactions. Additionally, the clearing
brokers provide the clearing and depository operations for our proprietary
securities transactions. These activities may expose us to off-balance-sheet
risk in the event that customers do not fulfill their obligations with the
primary clearing brokers, as we have agreed to indemnify our clearing brokers
for any resulting losses. We continually assess risk associated with each
customer who is on margin credit and record an estimated loss when we believe
collection from the customer is unlikely.
CUSTOMER CLAIMS, LITIGATION AND REGULATORY MATTERS. In the normal
course of business, we have been and continue to be the subject of civil actions
and arbitrations arising out of customer complaints relating to our broker
dealer activities, as an employer and as a result of other business activities.
FAIR VALUE. "Marketable securities owned" and "Securities sold, but not
yet purchased" on our consolidated statement of financial condition are carried
at fair value or amounts that approximate fair value, with related unrealized
gains and losses recognized in our results of operations. The determination of
fair value is fundamental to our financial condition and results of operations
and, in certain circumstances, it requires management to make complex judgments.
7
EMPIRE FINANCIAL HOLDING COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
Fair values are based on listed market prices, where possible. If
listed market prices are not available or if the liquidation of our positions
would reasonably be expected to impact market prices, fair value is determined
based on other relevant factors, including dealer price quotations, and
marketability. Warrants received from investment banking engagements are
generally valued using the Black-Scholes option valuation model and management
may reduce the value if there is a restriction as to when the warrants may be
exercised. The Black-Scholes method uses assumptions such as volatility,
interest rates, and dividend yields to determine the value.
VALUATION OF DEFERRED TAX ASSETS. Deferred income taxes reflect the net
tax effects of temporary differences between the carrying amounts of assets and
liabilities for financial reporting purposes and the amounts used for income tax
purposes.
GOODWILL AND OTHER INTANGIBLE ASSETS. The Company applies SFAS 142,
Goodwill and Other Intangible Assets and performs an annual impairment test.
Application of the goodwill impairment test requires judgment, including the
identification of reporting units, assignment of assets and liabilities to
reporting units, assignment of goodwill to reporting units, and determination of
the fair value of each reporting unit. The fair value of each reporting unit is
estimated using a discounted cash flow methodology. This requires significant
judgments including estimation of future cash flows, which is dependent on
internal forecasts, estimation of the long-term rate of growth of the Company's
business, the useful life over which cash flows will occur, and determination of
the Company's weighted average cost of capital. Changes in these estimates and
assumptions could materially affect the determination of fair value and/or
goodwill impairment for each reporting unit. The Company has selected September
30 as the date on which it performs its annual goodwill impairment test.
In connection with its acquisitions, the Company has applied the
provisions of SFAS No. 141 "Business Combinations" using the purchase method of
accounting. The assets and liabilities assumed were recorded at their estimated
fair values. The excess purchase price over the fair value of net tangible
assets and identifiable intangible assets acquired was recorded as goodwill.
The additions to goodwill include the excess purchase price over the
fair value of net tangible assets and identifiable intangible assets acquired
and acquisition costs.
EXPENSE RECOGNITION OF EMPLOYEE STOCK OPTIONS. Effective January 1,
2006, the Company adopted the provisions of Statement of Financial Standards No.
123 (revised 2004), Share-Based Payment ("SFAS No. 123 (R)"), which is a
revision of SFAS No. 123. SFAS No. 123 (R) supersedes APB Opinion No. 25,
Accounting for Stock Issued to Employees, and amends FASB Statement No. 95,
Statement of Cash Flows.
2. RECENTLY ISSUED ACCOUNTING PRINCIPLES
In September 2006, the Financial Accounting Standards Board ("FASB")
issued FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes
(an interpretation of FASB Statement No. 109)", which became effective for
fiscal years beginning after December 15, 2006. This interpretation was issued
to clarify the accounting for uncertainty in income taxes recognized in the
financial statements by prescribing a recognition threshold and measurement
attribute for the financial statement recognition and measurement of a tax
position taken or expected to be taken in a tax return. The Company adopted this
interpretation effective January 1, 2007. The adoption did not have any effect
on the Company's financial statements.
8
EMPIRE FINANCIAL HOLDING COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
3. STOCK BASED COMPENSATION
Effective January 1, 2006, the Company adopted the provisions of
Statement of Financial Standards No. 123 (revised 2004), Share-Based Payment
("SFAS No. 123 (R)"), which is a revision of SFAS No. 123. SFAS No. 123 (R)
supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and
amends FASB Statement No. 95, Statement of Cash Flows. Generally, the approach
to accounting for share-based payments in SFAS No. 123(R) is similar to the
approach described in SFAS No. 123. However, SFAS No. 123(R) requires all new
share-based payments to employees, including grants of employee stock options,
to be recognized in the financial statements based on their fair values. Pro
forma disclosure of the fair value of new share-based payments is no longer an
alternative to financial statement recognition.
Prior to 2006, the Company accounted for its employee stock option
plans under the intrinsic value method, in accordance with the provisions of
Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued
to Employees", and related interpretations. Compensation expense related to the
granting of employee stock options is recorded over the vesting period only, if,
on the date of grant, the fair value of the underlying stock exceeds the
option's exercise price. The Company had adopted the disclosure-only
requirements of SFAS No. 123, "Accounting for Stock-Based Compensation", which
allowed entities to continue to apply the provisions of APB No. 25 for
transactions with employees and provide pro forma net income and pro forma
income per share disclosures for employee stock grants made as if the fair value
based method of accounting in SFAS No. 123 had been applied to these
transactions.
During the nine months ended September 30, 2007, the Company granted
options to acquire 535,300 shares, of the Company's common stock, with exercise
prices of $1.97 - $4.31 per share, which had an aggregate fair value of
$757,284. The Company recorded a compensation charge of $383,179 for the nine
months ended September 30, 2007, relating to the amortization of the fair value
associated with options granted. The Company will amortize the remaining values
over the remaining vesting periods of the options.
The Black-Scholes option valuation model is used to estimate the fair
value of the options granted. The model includes subjective input assumptions
that can materially affect the fair value estimates. The model was developed for
use in estimating the fair value of traded options that have no vesting
restrictions and that are fully transferable. Options issued under the Company's
option plan have characteristics that differ from traded options. Principal
assumptions used in applying the Black-Scholes model for the nine months ending
September 30, 2007 are outlined below. In selecting these assumptions, we
considered the guidance for estimating expected volatility as set forth in SFAS
No. 123(R). Volatility is a measure of the amount by which the Company's common
stock price has fluctuated (historical volatility) or is expected to fluctuate
(expected volatility).
Expected dividend yield: None
Risk free interest rate: 5.16%
Expected life: 3 - 5 years
Expected volatility: 58%
9
EMPIRE FINANCIAL HOLDING COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
Had the Company determined compensation expense of employee stock
options issued prior to January 1, 2006, based on the estimated fair value of
the stock options at the grant date and consistent with the guidelines of SFAS
123, its net loss would have been the pro forma amounts indicated below:
Nine months ended Three months ended
September 30, September 30,
-------------------------- --------------------------
2007 2006 2007 2006
----------- ----------- ----------- -----------
Net loss applicable to common
stockholders as reported .................. $(5,300,932) $ (115,680) $(1,996,510) $ (533,917)
Subtract stock-based employee compensation
expense related to stock options determined
under fair value method ................... (479,732) (353,593) (244,956) (135,763)
----------- ----------- ----------- -----------
Pro forma ............................... $(5,780,664) $ (469,273) $(2,241,466) $ (669,680)
=========== =========== =========== ===========
Net loss per share applicable to common
stockholders:
As reported:
Basic: ................................ $ (0.49) $ (0.02) $ (0.18) $ (0.08)
=========== =========== =========== ===========
Diluted: .............................. $ (0.49) $ (0.02) $ (0.18) $ (0.08)
=========== =========== =========== ===========
Pro forma:
Basic: ................................ $ (0.53) $ (0.07) $ (0.20) $ (0.10)
=========== =========== =========== ===========
Diluted: .............................. $ (0.53) $ (0.07) $ (0.20) $ (0.10)
=========== =========== =========== ===========
|
4. NOTES RECEIVABLE
The Company has advanced funds to certain registered representatives in
five Company owned offices.
The notes receivable, by location, at September 30, 2007, were as
follows:
Amount
--------
New York ....................................... $200,000
Longwood ....................................... 7,222
Boca Raton ..................................... 4,545
Boston ......................................... 17,000
San Francisco .................................. 490,000
--------
Total notes receivable ......................... $718,767
========
|
5. MARKETABLE SECURITIES OWNED, AT MARKET VALUE
At September 30, 2007, marketable securities owned included $508,614 of
securities which were received as a result of the Company calling secured demand
notes receivable from two of its employees to recover trading losses incurred by
them during 2006. The recovered trading losses were included in trading income
for the year ended December 31, 2006.
10
EMPIRE FINANCIAL HOLDING COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
6. INTANGIBLE ASSETS
At September 30, 2007, intangible assets consisted of the following:
Trademarks ..................................... $ 3,282,077
Customer lists ................................. 1,157,266
Goodwill - Jesup ............................... 8,431,830
Goodwill - Long Island Office .................. 4,840,335
-----------
$17,711,508
Less: accumulated amortization ................. (106,084)
-----------
$17,605,424
===========
|
During the three months ended September 30, 2007, the Company recorded
goodwill totaling $450,000 as an adjustment of the acquisition purchase price of
the Long Island office.
Amortization expense for intangible assets totaled $28,932 and $86,796
for the three months and nine months ended September 30, 2007, respectively.
The estimated annual aggregate amortization expense related to
amortizable intangible assets for 2007 and the five succeeding fiscal years are
as follows:
Year ending December 31, 2007 .................. $126,978
Year ending December 31, 2008 .................. 160,728
Year ending December 31, 2009 .................. 160,728
Year ending December 31, 2010 .................. 160,728
Year ending December 31, 2011 .................. 160,728
Year ending December 31, 2012 .................. 160,728
|
The Company has selected September 30 as the date on which it performs
its annual goodwill impairment test. We performed our annual goodwill impairment
test as of September 30, 2007, and determined we had no goodwill impairment at
that date.
7. ACCOUNTS PAYABLE, ACCRUED EXPENSES AND OTHER LIABILITIES
At September 30, 2007, accounts payable, accrued expenses and other
liabilities consisted of the following:
Accrued commissions and management fees ........ 150,855
Accrued payroll and taxes ...................... 682,080
Accrued rent ................................... 102,598
Accrued preferred stock dividends .............. 165,404
Accrued interest expense ....................... 211,666
Accrued expenses for Long Island acquisition ... 685,696
Other accrued expenses and accounts payable .... 291,862
----------
$2,290,161
==========
|
11
EMPIRE FINANCIAL HOLDING COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
8. SHORT-TERM LOANS - RELATED PARTIES
On June 14, 2007, EFH obtained a short-term loan from EFH Partners LP,
a related party in the amount of $1 million. The loan bore no interest but a
one-time fee of 7.5% or $75,000, was paid to the Company's clearing firm. The
loan was payable on demand. On June 26, 2007, a $500,000 payment was made. A
second payment of $500,000 was made on July 6, 2007, paying in full the
outstanding balance.
9. LINE OF CREDIT PAYABLE
On January 31, 2007, we obtained a $2 million credit line from Fifth
Third Bank. At September 30, 2007 we have drawn $1,999,450 of the line. The line
expires on February 1, 2008. The credit line carries interest payable monthly at
Fifth Third Bank's prime rate and is subject to two debt covenants. The first
covenant requires the Company to maintain net capital as defined under Net
Capital Rule (Rule 15c3-1) under the Securities Exchange Act of 1934 in an
amount at least equal to the amount drawn under the credit line. The Company was
in compliance with the first covenant at September 30, 2007. The second covenant
requires the Company to maintain tangible net worth of at least $6 million. The
Company is in violation of the second covenant and has not obtained a waiver.
Although it has not given any indication it intends to do so, Fifth Third Bank
could call the line of credit at anytime. The interest expense through September
30, 2007 was $125,171.
10. NOTES PAYABLE
Notes payable at September 30, 2007 consisted of the following:
Convertible notes payable to investors, interest payable quarterly
at 6.5%. The notes mature March 28, 2012 and are convertible into
common stock at $2.39 per share ................................. $ 6,387,158
Unsecured note payable to Jesup & Lamont Holding Corporation.
The note accrues interest at four percent per annum with interest
and principal payable at maturity on October 1, 2011 ............ $ 2,500,000
Subordinated note payable to EFH Partners, with interest at four
percent payable at maturity on April 1, 2008 .................... $ 1,000,000
Unsecured note payable to an independent registered representative
which accrues interest at five percent per annum. Principal
and interest is payable on demand ............................... $ 246,533
-----------
$10,133,691
Less: Unamortized discount on note to Jesup & Lamont Holding Corp. (391,482)
-----------
$ 9,742,209
===========
|
12
EMPIRE FINANCIAL HOLDING COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
The annual maturities of principal on the notes payable are as follows:
Year ending December 31, 2007 .................. $ 246,533
Year ending December 31, 2008 .................. 1,000,000
Year ending December 31, 2009 .................. -
Year ending December 31, 2010 .................. -
Year ending December 31, 2011 .................. 2,500,000
Thereafter ..................................... 6,387,158
-----------
$10,133,691
===========
|
Interest expense related to notes payable totaled $511,760 and $72,709
for the nine months ended September 30, 2007 and 2006, respectively.
On March 23, 2007, the Company filed an amended Form 8-K which
disclosed that as of March 7, 2007, the Company had entered into binding
agreements dated as of March 6, 2007 to sell $8,018,052 of units in a private
placement to 32 accredited individual and institutional investors. The final
closing in March 2007 resulted in the Company selling $7,282,434 of units in a
private placement to 31 accredited individual and institutional investors. The
units consisted of an aggregate principal amount of $6,387,158 of convertible
debentures, convertible into 2,672,437 shares of common stock, 296,922 shares of
common stock, and five-year warrants to purchase 1,484,610 shares of common
stock. The debentures have a term of five years, pay interest at 6.5% per annum,
and are convertible to common stock at a price of $2.39 per share. The
debentures contain a provision whereby the Company may require the holders to
convert their debentures in the event that the Company's common stock trades at
a price above $7.50 per share for 20 consecutive days or more. The warrants are
exercisable after six months from the date of issue at a price of $2.62 per
share, and contain provisions for cashless exercise in the event that one year
after the date of issuance the shares underlying the warrants may not be resold
pursuant to an effective registration statement. Each share of common stock
underlying the units is priced at $2.39, the closing price of the Company's
common stock on March 6, 2007.
On March 7, 2007 the Company also entered into binding registration
rights agreements dated as of March 6, 2007, to register all 4,453,969 shares of
the common stock included in and underlying the units. The Company filed its
registration statement Form S-3 as required under the registration rights
agreements under on May 1, 2007, and the registration became effective on May
18, 2007. No further listing, registration or contingent requirements exist.
The total separate purchase prices of the debentures, common stock and
warrants were $6,387,158, $709,685, and $185,591, respectively.
The Company considered SFAS 133 and EITF 00-19 in recording this
private placement. We accounted for the warrants as equity, recording the
warrants at the minimum purchase of $0.125 per share required by the AMEX rules
for an "at the market offering". The debentures, common stock and warrants were
all recorded at their face value purchase prices which were determined to be
their fair values upon sale of the securities.
13
EMPIRE FINANCIAL HOLDING COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
11. TRADING INCOME
Trading income includes market making revenues which consist of net
realized and net unrealized gains and losses on securities traded for the
Company's own account. Trading revenues are generated from the difference
between the price paid to buy securities and the amount received from the sale
of securities. Volatility of stock prices, which can result in significant price
fluctuations in short periods of time, may result in trading gains or losses.
Gains or losses are recorded on a trade date basis.
Trading revenues consisted of the following:
Nine months ended Three months ended
September 30, September 30,
-------------------------- --------------------------
2007 2006 2007 2006
----------- ----------- ----------- -----------
Net realized gains and losses $ 7,136,854 $ 8,464,009 $ 2,019,930 $ 2,696,564
Unrealized gains ............ 1,067,221 1,367,109 252,606 1,001,465
Unrealized losses ........... (1,888,994) (2,061,578) (280,747) (1,133,582)
----------- ----------- ----------- -----------
Trading income, net ......... $ 6,315,081 $ 7,769,540 $ 1,991,789 $ 2,564,447
=========== =========== =========== ===========
|
14
EMPIRE FINANCIAL HOLDING COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
12. EARNINGS PER SHARE
Basic earnings (loss) per share are computed by dividing income (loss)
available to common stockholders by the weighted-average number of common shares
outstanding for the period. Diluted earnings (loss) per share considers 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 shared in the earnings of the entity.
Calculation of net income (loss) per share is as follows:
Nine months ended Three months ended
September 30, September 30,
---------------------------- ----------------------------
2007 2006 2007 2006
------------ ------------ ------------ ------------
Numerator for earnings (loss) per share:
Net income (loss) ............................ $ (5,173,432) $ 56,442 $ (1,949,776) $ (464,278)
Preferred stock dividends .................... $ 127,500) $ (172,122) $ (46,734) $ (69,639)
------------ ------------ ------------ ------------
Loss attributable to common
stockholders ................................ $ (5,300,932) $ (115,680) $ (1,996,510) $ (533,917)
============ ============ ============ ============
Denominator for loss per share:
Basic weighted-average shares ................ 10,847,537 6,991,413 11,082,381 7,009,037
Diluted weighted-average shares:
Stock options ................................ - - - -
Warrants ..................................... - - - -
Convertible preferred stock Series B ......... - - - -
Convertible preferred stock Series C ......... - - - -
Convertible preferred stock Series D ......... - - - -
Convertible preferred stock Series E ......... - - - -
Convertible preferred stock Series F ......... - - - -
Convertible notes ............................ - - - -
------------ ------------ ------------ ------------
Diluted weighted-average shares .............. 10,847,537 6,991,413 11,082,381 7,009,037
============ ============ ============ ============
Basic and diluted loss per share:
Basic loss per share ........................... $ (0.49) $ (0.02) $ (0.18) $ (.08)
============ ============ ============ ============
Diluted loss per share ......................... $ (0.49) $ (0.02) $ (0.18) $ (.08)
============ ============ ============ ============
Due to their anti-dilutive effect, the following
potential common shares have been excluded from
the computation of diluted earnings per share:
Stock options ................................ 3,984,443 1,878,761 3,984,443 1,878,761
Warrants ..................................... 3,664,180 2,327,445 3,664,180 2,327,445
Convertible preferred stock Series B ......... - 1,166,666 - 1,166,666
Convertible preferred stock Series C ......... 353,100 353,100 353,100 353,100
Convertible preferred stock Series D ......... - 100,000 - 100,000
Convertible preferred stock Series E ......... - 178,291 - 178,291
Convertible preferred stock Series F ......... 819,987 866,139 819,987 866,139
Convertible notes ............................ 2,672,437 134,089 2,672,437 134,089
Convertible notes - anti-dilution shares ..... 481,892 - 481,892 -
Common stock subscribed ...................... 1,622,718 - 1,622,718 -
Warrants for common stock subscribed ......... 811,359 - 811,359 -
------------ ------------ ------------ ------------
Total common shares .......................... 14,410,116 7,004,491 14,410,116 7,004,491
============ ============ ============ ============
|
15
EMPIRE FINANCIAL HOLDING COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
13. EQUITY
For the nine months ended September 30, 2007, the Company recorded the
following stock, warrant and unit transactions:
On August 24, 2007, the Company filed a Form 8-K which disclosed that
as of August 20, 2007, the Company had entered into agreements to sell
$2,250,000 of units in a private placement to 4 accredited individual and
institutional investors, of which it subsequently took down funds representing
the placement of $2,000,000 of units to 3 accredited institutional investors.
The units consist of 1,622,718 shares of Common Stock for $1,898,580.06, and
five-year non-redeemable warrants to purchase 811,359 shares of common stock for
$101,419.94. The warrants are exercisable after six months from the date of
issue at a price of $1.40 per share. Each share of common stock underlying the
units is priced at $1.17, the closing price of the Company's common stock on
August 20, 2007. The subscription included Empire's agreement to register all
2,434,077 shares of common stock included in and underlying the units. Pursuant
to the terms of the agreements, Empire must pay partial liquidated damages in
the amount of 1% per month of the purchase price, subject to a cap of an overall
aggregate payment of 10% of the purchase price, upon certain failures to
register all shares of common stock underlying the units within 120 days of the
closing date of the transaction. Empire will pay total cash commissions of
$80,000 in connection with these transactions.
The closing of the transaction is subject to fulfillment of certain
conditions. The above sales were made for investment by accredited investors and
will be issued without registration under the Securities Act of 1933, as
amended, pursuant to the exemptions provided under sections 4(6) and 4(2)
thereof, and pursuant to the exemption provided by Regulation D. All the
securities are restricted securities and will bear a restrictive legend and be
subject to stop transfer restrictions. None of the shares of common stock
included in and underlying the units will be issued until the American Stock
Exchange has approved its listing.
On March 23, 2007, the Company filed an amended Form 8-K which
disclosed that as of March 7, 2007, the Company had entered into binding
agreements dated as of March 6, 2007 to sell $8,018,052 of units in a private
placement to 32 accredited individual and institutional investors. The final
closing in March 2007 resulted in the Company selling $7,282,434 of units in a
private placement to 31 accredited individual and institutional investors. The
units consisted of an aggregate principal amount of $6,387,158 of convertible
debentures, currently convertible into 2,672,437 shares of common stock, 296,922
shares of common stock, and five-year warrants to purchase 1,484,610 shares of
common stock. The debentures have a term of five years, pay interest at 6.5% per
annum, and are convertible to common stock at a price of $2.39 per share. The
debentures contain a provision whereby the Company may require the holders to
convert their debentures in the event that the Company's common stock trades at
a price above $7.50 per share for 20 consecutive days or more. The warrants are
exercisable after nine months from the date of issue at a price of $2.62 per
share, and contain provisions for cashless exercise in the event that one year
after the date of issuance the shares underlying the warrants may not be resold
16
EMPIRE FINANCIAL HOLDING COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
pursuant to an effective registration statement. Each share of common stock
underlying the units is priced at $2.39, the closing price of the Company's
common stock on March 6, 2007. On March 7, 2007 the Company also entered into
binding registration rights agreements dated as of March 6, 2007, to register
all 4,453,969 shares of the common stock included in the units. The Company
filed its registration statement as required under the registration rights
agreements under Form S-3 on May 1, 2007, and the registration became effective
on May 18, 2007. No further listing, registration or contingent requirements
exist.
Two outside investors converted their shares of Series F Preferred
Stock for 46,152 shares of common stock.
An employee received 200,000 shares of restricted stock which had been
provided for in 2006 for the acquisition of Jesup & Lamont. The stock was valued
at $632,000 and increased goodwill by this amount.
An employee bought from two outside investors two convertible notes
with a combined face value of $100,000 which convert to common at $2.00 per
share. On conversion of these notes he received 50,000 shares of common stock.
An outside consultant was issued 85,000 share of common stock at $1.25
per share. The stock was issued as compensation for consulting services
rendered.
An outside legal firm was issued 23,450 shares of common stock at $1.30
per share. The stock was issued as compensation for legal services rendered.
A preferred stockholder and ex-officer of the Company was issued 15,858
shares of common stock at $1.67 per share. The stock was issued as payment for
dividends owed from 2006.
In 2000, the Company adopted its Incentive Compensation Plan (the
"Plan"). The Plan is designed to serve as an incentive for retaining directors,
employees, consultants and advisors. Stock options, stock appreciation rights
and restricted stock options may be granted to certain persons in proportion to
their contributions to the overall success of the Company as determined by the
Board of Directors.
On September 28, 2007, the Company's stockholders approved the new 2007
Incentive Compensation Plan, which authorizes 4,000,000 shares of the Company's
common stock to be eligible for grant of awards under the Plan. Its purpose and
terms are the same as those of the 2000 Incentive Compensation Plan.
At September 30, 2007, the Company had outstanding options to purchase
3,984,443 shares of the Company's common stock. These options have been granted
to officers, directors and key employees. Of the 3,984,443 options, 1,670,921
options were granted to employees, 1,420,000 were granted to officers who are
not members of the Board of Directors, 625,000 were granted to officers who are
members of the Board of Directors and 268,522 were granted to current outside
members of the Board of Directors.
17
EMPIRE FINANCIAL HOLDING COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
14. INCOME TAXES
The federal and state income tax provisions are summarized as follows:
Nine Three
months months
ended ended
September 30, September 30,
2007 2007
-------- --------
Current
Federal ................... $ - $ -
State ..................... - -
-------- --------
- -
-------- --------
Deferred
Federal ................... - -
State ..................... - -
-------- --------
- -
-------- --------
$ - $ -
======== ========
|
Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes. Management
believes that, based on current operations and future projections, the benefit
arising from deferred tax assets totaling $2,117,000 will be realized. However,
Management also believes any additional deferred tax assets which could be
recorded may not be realized, and accordingly, we recorded a valuation allowance
totaling $4,044,000 at September 30, 2007. The components of the Company's
deferred tax assets at September 30, 2007 were as follows:
Deferred tax assets:
Net operating loss carryforwards ........... $ 6,257,000
Amortization of intangibles ................ 1,035,000
-----------
Deferred tax assets ........................ 7,292,000
-----------
Deferred tax liabilities:
Value of warrants received for services .... (853,000)
Amortization of goodwill and trademarks .... (278,000)
-----------
Deferred tax liabilities ................... (1,131,000)
-----------
Net deferred tax assets ...................... 6,161,000
Less: Valuation allowance ................. (4,044,000)
-----------
Net deferred tax assets .................... $ 2,117,000
===========
|
18
EMPIRE FINANCIAL HOLDING COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
The Company has net operating loss carryforwards for federal tax
purposes of approximately $15,643,000 which expire in years 2022 through 2026.
The amount deductible per year is limited to approximately $576,000 under
current tax regulations for EFG and EFH and EIA combined and $640,000 for Jesup.
The intangibles being amortized are primarily Internal Revenue Code Section 197
intangibles that must be amortized over 15 years for tax purposes. Specifically,
the intangibles are customer base intangibles that have been fully amortized or
written off due to impairment as required under SFAS 142.
15. ACQUISITION OF LONG ISLAND OFFICE
On March 26, 2007, (the "Effective Date"), we acquired all the assets
and operations of an independent broker office of supervisory jurisdiction
("OSJ") located in New York ("the Long Island office"). We paid (i) $4,162,856
by canceling notes owed to the Company by the OSJ, and (ii) $921,068 in accrued
liabilities, for 100% of the OSJ's assets and operations. The total purchase
price was $5,083,924.
Prior to the Effective Date, neither the Registrant nor any of its
affiliates, nor any officer or director of the Registrant or any associate of
any such officer or director, had any material relationship with the OSJ, except
that the OSJ was an Office of Supervisory Jurisdiction (as such term is defined
by the NASD) of the Registrant.
Under the acquisition, the Company recorded (i) furniture and equipment
with a fair value of $163,090, (ii) security deposits of $80,499, (iii) customer
list of $450,000, and (iv) goodwill of $4,390,335.
16. COMMITMENTS AND CONTINGENCIES
Regulatory and Legal Matters
During 2005, we received and executed a settlement offer from the
Securities and Exchange Commission. This settlement offer resolved an
enforcement action that was brought against EFG, in May of 2004, for trading
mutual fund shares on behalf of clients.
In connection with the settlement, EFG deposited $350,000 into an
escrow account pending ratification by the SEC's main office in Washington D.C.
On May 11, 2007, we notified the SEC that we were withdrawing our settlement
offer related to the enforcement action brought against EFG in May of 2004. On
June 14, 2007 we withdrew the $350,000 from escrow. On August 23, 2007, we
received a letter from the SEC stating this investigation was completed and no
further action would be pursued.
A competing brokerage firm commenced arbitration by filing a Statement
of Claim on October 14, 2005 before the NASD alleging, among other things, that
EFG improperly solicited Claimant's brokers for employment with EFG. To that
end, Claimant has asserted claims against the Company for tortious interference
with contract and unfair competition. Claimant seeks $10,000,000 in damages from
the Company. The Company denies the material allegations of the Statement of
Claim and is vigorously defending this action. The Company has also asserted a
counterclaim against Claimant for unfair competition. The parties appeared for
the several hearings in this arbitration in 2007. Additional hearing dates have
been scheduled in 2008. This claim is associated with the Long Island office
that EFG acquired in March 2007.
19
EMPIRE FINANCIAL HOLDING COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
Customer Complaints and Arbitration
From time to time, EFG and Jesup may be a defendant or co-defendant in
arbitration matters incidental to its retail brokerage services business. EFG
and Jesup may contest the allegations of the complaints in these cases and
carries error and omission insurance policy to cover such incidences. The policy
terms require that the Company pay a deductible of $100,000 per incident. In the
opinion of management, based on discussions with legal counsel, the outcome of
any pending matters will not result in a material adverse affect on the
financial position or results of operations of the Company or its subsidiaries.
The Company's subsidiaries' business involves substantial risks of
liability, including exposure to liability under federal and state securities
laws in connection with the underwriting or distribution of securities and
claims by dissatisfied clients for fraud, unauthorized trading, churning,
mismanagement and breach of fiduciary duty. In recent years there has been an
increasing incidence of litigation involving the securities industry, including
class actions which generally seek rescission and substantial damages. In the
ordinary course of business, the Company operating through its subsidiaries and
its principals are, and may become party to additional legal or regulatory
proceedings or arbitrations. The Company is not currently involved in any
additional legal or regulatory proceeding or arbitrations, the outcomes of which
are expected to have a material adverse impact on the Company's business.
Due to the uncertain nature of litigation in general, we are unable to
estimate a range of possible loss related to lawsuits and legal fees filed
against us, and in accordance with SFAS 5 have not accrued any liability with
regards to these matters.
17. NET CAPITAL REQUIREMENTS AND VIOLATIONS OF BROKER DEALER SUBSIDIARIES
Our broker dealer subsidiaries, EFG and Jesup, are subject to the
requirements of the Net Capital Rule (Rule 15c3-1) under the Securities Exchange
Act of 1934, which requires the maintenance of minimum net capital and requires
that the ratio of aggregate indebtedness to net capital, both as defined, should
not exceed 15 to 1. Net capital and related ratio of aggregate indebtedness to
net capital, as defined, may fluctuate on a daily basis.
On February 6, 2006, EFG received a letter from the National
Association of Securities Dealers ("NASD") threatening disciplinary action for
failure to maintain required net capital during the period from September 2003
to February 14, 2005 while the Company was under different management, and
alleging its violation of other NASD rules. The NASD calculated the range of net
capital deficiencies during that period as between approximately $488,000 and
$1.833 million.
On April 25, 2006, the Company notified the NASD and Securities and
Exchange Commission (SEC) that as a result of a routine examination of the
Company in April 2005, the Company was under the minimum net capital requirement
for that period. It was determined that the trading operation was not properly
terminating, in the computer trading platforms, for the stocks in which the
Company makes a market. The technical error made it appear that the Company was
making a market in between 39 and 78 more stocks. The Company also utilized a
restricted stock position for net capital purposes that was eligible to become
unrestricted but the Company had not yet submitted the documents to the transfer
agent to have it cleared.
20
EMPIRE FINANCIAL HOLDING COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
In August 2007, EFG received a Notice of Acceptance of Letter of
Acceptance, Waiver and Consent from the NASD ("AWC") dated July 30, 2007. The
AWC settles all matters in the preceding paragraphs in return for EFG's payment
of a fine in the amount of $145,000. On August 22, 2007 payment was to the NASD
in this amount.
On August 11, 2006, EFG was notified by the NASD that they considered
secured demand notes receivable from employees totaling $1,348,357 as
non-allowable assets which would have placed EFG in a net capital violation.
Before giving effect to the NASD position, EFG had determined that its net
capital at June 30, 2006 was $885,923, which exceeded the minimum net capital
requirement by $364,423 (an excess amount challenged by the NASD). Although the
Company disagreed with the NASD position, as a result of the notification from
the NASD, on August 11, 2006, the Company called the demand notes and ordered
its clearing company to sweep the securities pledged as collateral for the notes
from a segregated account and deposit the securities in the name of EFG in its
general marketable securities account. EFG then reclassified the amounts
previously recorded as secured demand notes receivable to marketable securities
owned, at market value. Further, pursuant to a request by the NASD, the Company
also filed a net capital deficiency notification under Exchange Act Rule 17a-11
with the SEC and NASD on August 11, 2006.
At September 30, 2007, EFG reported net capital of $1,388,237, which
was $853,237 above the required net capital of $535,000. At September 30, 2007,
Jesup reported net capital of $810,475, which was $710,475 above the required
net capital of $100,000.
On May 2, 2007, Jesup filed a net capital deficiency notification under
Exchange Act Rule 17a-11 with the SEC and NASD related to a net capital
deficiency as of March 9, 2007. This deficiency, which amounted to approximately
$5,258,000, occurred for one day as a result of Jesup's participation in a firm
commitment underwriting. The deficiency was cured when the underwriting was
completed.
The Company believes these matters will not have a material adverse
effect.
The ratio of aggregate indebtedness to net capital was 0.67 to 1 for
EFG and .85 to 1 for Jesup. EFG and Jesup are exempt from Rule 15c3-3 under
Paragraph (k)(2)(ii) of the Rule as all customer transactions are cleared
through other broker dealers on a fully-disclosed basis.
We have received the final approved Membership Agreement from the NASD
for our acquisition of Jesup.
21
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion of our financial condition and results of
operations should be read in conjunction with the Selected Consolidated
Financial Data and the Consolidated Financial Statements and Notes thereto
included in our Annual Report on Form 10-KSB for the year ended December 31,
2006, as previously filed with the Securities and Exchange Commission. Our
significant accounting policies are disclosed in the Notes to Consolidated
Financial Statements found in our Annual Report on Form 10-KSB for the year
ended December 31, 2006.
This Form 10-QSB contains statements about future events and
expectations which are, "forward looking statements". Any statement in this Form
10-QSB that is not a statement of historical fact may be deemed to be a forward
looking statement. Forward-looking statements represent our judgment about the
future and are not based on historical facts. These statements include:
forecasts for growth in the number of customers using our service, statements
regarding our anticipated revenues, expense levels, liquidity and capital
resources and other statements including statements containing such words as
"may," "will," "expect," "believe," "anticipate," "intend," "could," "estimate,"
"continue" or "plan" and similar expressions or variations. These statements
reflect the current risks, uncertainties and assumptions related to various
factors including, without limitation, fluctuations in market prices,
competition, changes in securities regulations or other applicable governmental
regulations, technological changes, management disagreements and other factors
described under the heading "Factors affecting our operating results, business
prospects, and market price of stock" contained in our Annual Report on Form
10-KSB for the year ended December 31, 2006, as previously filed with the SEC.
Based upon changing conditions, should any one or more of these risks or
uncertainties materialize, or should any underlying assumptions prove incorrect,
actual results may vary materially from those described in this report as
anticipated, believed, estimated or intended. We undertake no obligation to
update, and we do not have a policy of updating or revising, these
forward-looking statements. Except where the context otherwise requires, the
terms "we," "us," or "our" refer to Empire Financial Holding Company and its
wholly-owned subsidiaries.
RESULTS OF OPERATIONS:
Three months ended September 30, 2007 compared to three months ended
September 30, 2006:
Revenues:
Total revenues for the three months ended September 30, 2007 were
$12,146,527, an increase of $5,693,822, or 88%, over total revenues of
$6,452,705 for the same period in 2006, of which 93% was due to the acquisition
of Jesup. This increase is primarily due to the reasons described below:
Commissions and fees revenues for the three months ended September 30,
2007 were $8,530,032, an increase of $5,106,322 or approximately 149%, from our
commissions and fees revenues of $3,423,710 for the comparable period in 2006,
of which 65% was due to the acquisition of Jesup. The increase was primarily due
to the acquisition of Jesup, which accounted for approximately 39% of our
commissions and fees revenues for the three month period ended September 30,
2007. Commissions and fees revenues accounted for approximately 70% and 53%, of
our total revenues for the three month periods ended September 30, 2007 and
2006, respectively.
22
For the three months ended September 30, 2007 trading income was
$1,991,789, a decrease of $572,658, or approximately 22%, from our trading
income of $2,564,447 for the comparable period in 2006. Trading income accounted
for approximately 17% and 40%, of our total revenues for the three month periods
ended September 30, 2007 and 2006, respectively.
For the three months ended September 30, 2007, our investment banking
revenues were $1,624,706, an increase of $1,160,158, or approximately 250%, from
our investment banking revenues of $464,548 for the comparable period in 2006.
The increase was primarily due to the growth and maturing of our investment
banking department. Investment banking revenues accounted for approximately 13%
and 7% of our revenues for the three month periods ended September 30, 2007 and
2006, respectively.
Expenses:
Employee compensation and benefits increased 125% to $5,521,709 for the
three months ending September 30, 2007 from $2,449,795 for the same period in
2006. The increase was primarily due to the acquisition of Jesup, which
accounted for approximately 38% of our employee compensation and benefits for
the three month period ended September 30, 2007.
Commissions and clearing costs were $6,193,056 and $3,574,761 for the
three months ending September 30, 2007 and 2006, respectively. The increase of
$2,618,295, or 73%, was due primarily to the acquisition of Jesup, which
accounted for approximately 33% of our commissions and clearing costs for the
three month period ended September 30, 2007.
General and administrative expenses and communications and data
processing for the three months ending September 30, 2007 increased
approximately 93% to $2,189,507 from $1,133,687 for the three months ended
September 30, 2006. The increase was due primarily to the acquisition of Jesup,
which accounted for approximately 33% of our general and administrative expenses
and communications and data processing for the three month period ended
September 30, 2007.
Interest expense for the three months ending September 30, 2007
increased to $234,440 as compared to $161,659 for the three months ending
September 30, 2007. This interest was for cash interest related to bridge notes,
convertible notes, and other debt in 2007.
As a result of the net loss and the increase in the deferred tax
valuation allowance, there was no provision for income taxes for the three
months ended September 30, 2007 and 2006.
As a result of the items discussed in the preceding paragraphs, the
Company incurred a net loss of $1,949,776 for the three months ended September
30, 2007 as compared to a net loss of $464,278 for the three months ended
September 30, 2006.
Nine months ended September 30, 2007 compared to nine months ended September 30,
2006:
Revenues:
Total revenues for the nine months ended September 30, 2007 were
$40,222,229, an increase of $17,409,842 or approximately 76%, over total
revenues of $22,812,387 for the same period in 2006, of which 95% was due to the
acquisition of Jesup. This increase is primarily due to the reasons described
below:
23
Commissions and fees revenues for the nine months ended September 30,
2007 were $25,467,103, an increase of $12,353,646 or approximately 94%, from our
commissions and fees revenues of $13,113,457 for the comparable period in 2006,
of which 99% was due to the acquisition of Jesup. The increase was primarily due
to the acquisition of Jesup, which accounted for approximately 48% of our
commissions and fees revenues for the nine month period ended September 30,
2007. Commissions and fees revenues accounted for approximately 63% and 57%, of
our total revenues for the nine month periods ended September 30, 2007 and 2006,
respectively.
For the nine months ended September 30, 2007 trading income was
$6,315,081, a decrease of $1,454,459, or approximately 19%, from our trading
income of $7,769,540 for the comparable period in 2006. The decrease was
primarily due to losses incurred from proprietary trading. Trading income
accounted for approximately 16% and 34%, of our total revenues for the nine
month periods ended September 30, 2007 and 2006, respectively.
For the nine months ended September 30, 2007, our investment banking
revenues were $8,440,045, an increase of $6,510,655, or approximately 337%, from
our investment banking revenues of $1,929,390 for the comparable period in 2006.
The increase was primarily due to the growth and maturing of our investment
banking department. Investment banking revenues accounted for approximately 21%
and 9% of our revenues for the nine month periods ended September 30, 2007 and
2006, respectively.
Expenses:
Employee compensation and benefits increased 97% to $14,792,630 for the
nine months ending September 30, 2007 from $7,508,151 for the same period in
2006. The increase was primarily due to the acquisition of Jesup, which
accounted for approximately 31% of our employee compensation and benefits for
the nine month period ended September 30, 2007, and the acquisition of our Long
Island office.
Commissions and clearing costs were $22,748,034 and $12,223,771 for the
nine months ending September 30, 2007 and 2006, respectively. The increase of
$10,524,263, or 86%, was due primarily to the acquisition of Jesup, which
accounted for approximately 46% of our commissions and clearing costs for the
nine month period ended September 30, 2007.
General and administrative expenses and communications and data
processing for the nine months ending September 30, 2007 increased approximately
131% to $7,131,239 from $3,087,403 for the nine months ended September 30, 2006.
The increase was due primarily to increased activity in the Long Island office
and the acquisition of Jesup, which accounted for approximately 40% of our
general and administrative expenses and communications and data processing for
the nine month period ended September 30, 2007.
Interest and other income for the nine months ended September 30, 2007
included $350,000 of other income related to the withdrawal of escrow for an SEC
settlement and the reversal of the expense previously recorded.
Interest expense for the nine months ending September 30, 2007
increased to $1,173,616 as compared to $207,397 for the nine months ending
September 30, 2006. A total of $285,065 of the interest expense in 2007 was
amortization of debt discount. The remaining $888,551 was for cash interest
related to bridge notes, convertible notes, and other debt in 2007.
As a result of the net loss and the increase in the valuation allowance
against the deferred tax assets, the provision for income taxes was zero for the
nine months ended September 30, 2007.
24
As a result of the items discussed in the preceding paragraphs, the
Company incurred a net loss of $5,173,432 for the nine months ended September
30, 2007 as compared to net income of $56,442 for the nine months ended
September 30, 2006.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 2007, we had $36,841,202 in assets, approximately 35%
of which consisted of cash or assets readily convertible into cash. We have
financed our business primarily through private placements of stock and debt
offerings.
Stockholders' equity increased $8,779,138 to $16,804,857 at September
30, 2007, compared to $8,025,719 at September 30, 2006. This increase is
primarily due to the acquisition of Jesup and the sales and/or conversion of our
preferred and common stock and convertible debt.
Due to the net loss incurred during the quarter, and non cash items
offset by changes in operating assets and liabilities, net cash used by
operations for the nine months ended September 30, 2007 was $7,507,769 as
opposed to net cash used by operations for the same period in 2006 of
$1,452,856.
Cash used in investing activities for the nine months ended September
30, 2007 was $84,623 as compared to $2,895,164 for the same period in 2006. In
2007, the Company received $127,955 related to notes receivable issued to
provide capital to expand its independent office in Uniondale, NY and offices in
San Francisco, California and Boca Raton, Florida. The Company used $212,578 to
purchase furniture and equipment. For the same period in 2006, the Company
issued notes receivable for $3,339,193, received $591,113 on these notes and
used $147,084 for the purchase of furniture and equipment.
Cash provided from financing activities for the nine months ending
September 30, 2007 was $6,737,005. The Company raised $6,387,158 from the
issuance of interest bearing investor notes, $895,276 from the sale of common
stock and $2,000,000 from subscriptions for an additional sale of units of
common stock and warrants. The Company received proceeds of $1,999,450 from a
line of credit and made payments against notes payable of $4,190,050. The
Company also received proceeds of $1,000,000 from short-term loans and repaid
$1,000,000 on these loans.
Goodwill and Other Intangible Assets. The Company applies SFAS 142,
Goodwill and Other Intangible Assets and performs an annual impairment test.
Under SFAS 142, the fair value of an asset (or liability) is the amount at which
that asset (or liability) could be bought (or incurred) or sold (or settled) in
a current transaction between willing parties, that is, other than in a forced
or liquidation sale. Thus, the fair value of a reporting unit refers to the
amount at which the unit as a whole could be bought or sold in a current
transaction between willing parties. Quoted market prices in active markets are
the best evidence of fair value and shall be used as the basis for the
measurement, if available. However, the market price of an individual equity
security (and thus the market capitalization of a reporting unit with publicly
traded equity securities) may not be representative of the fair value of the
reporting unit as a whole. The quoted market price of an individual equity
security, therefore, need not be the sole measurement basis of the fair value of
a reporting unit. Substantial value may arise from the ability to take advantage
of synergies and other benefits that flow from control over another entity.
25
Consequently, measuring the fair value of a collection of assets and liabilities
that operate together in a controlled entity is different from measuring the
fair value of that entity's individual equity securities. An acquiring entity
often is willing to pay more for equity securities that give it a controlling
interest rather than an investor who would pay for a number of equity securities
representing less than a controlling interest. That control premium may cause
the fair value of a reporting unit to exceed its market capitalization.
Our goodwill was recorded for acquisitions which are less than one year
old. We believe we have not nearly begun to realize the fair value of these
acquisitions or the synergies which we believe will be realized from combining
with our pre-acquisition operations.
We have determined that the fair value of each reporting unit is best
estimated using a discounted cash flow methodology.
Application of the goodwill impairment test requires judgment,
including the identification of reporting units, assignment of assets and
liabilities to reporting units, assignment of goodwill to reporting units, and
determination of the fair value of each reporting unit. The fair value of each
reporting unit is estimated using a discounted cash flow methodology. This
requires significant judgments including estimation of future cash flows, which
is dependent on internal forecasts, estimation of the long-term rate of growth
of the Company's business, the useful life over which cash flows will occur, and
determination of the Company's weighted average cost of capital. Changes in
these estimates and assumptions could materially affect the determination of
fair value and potential goodwill impairment for each reporting unit. The
Company has selected September 30 as the date on which it will perform its
annual goodwill impairment test. We performed our annual goodwill impairment
test as of September 30, 2007, and determined we had no goodwill impairment at
that date.
If the Company subsequently determines its goodwill and other
intangible assets have been impaired, the Company may have to write off a
portion or all of such goodwill and other intangible assets. If all goodwill and
other intangible assets were written off, the Company would record a non cash
loss approximating $17.6 million to operations and stockholders' equity.
We have only recently started to realize the benefit from the many
operational changes we have made since our major change in ownership control
which occurred approximately only two years ago. For example, investment banking
is becoming a primary line of business. Investment banking revenues for the
years ended December 31, 2005 and 2004, totaled $266,410 and $0, respectively.
However, investment banking revenues totaled $3,543,625 for the year ended
December 31, 2006, and already totals $8,440,045 for the nine months ended
September 30, 2007.
The Company plans to raise additional debt and equity capital in 2007
and 2008 for working capital. The Company also has an acquisition plan which
contemplates raising debt and equity capital to finance the acquisitions.
The Company has implemented many operating changes which are expected
to benefit operations in the future. The more notable of these changes have been
to eliminate our proprietary trading and consolidate operations of our broker
dealers. The pro forma summary set forth below summarizes the impact on our net
loss, cash and net capital as if these changes had been made as of January 1,
2007.
26
PRO FORMA SUMMARY
($Millions)
3 MONTHS 9 MONTHS 9 MONTHS 9 MONTHS
--------ENDED SEPTEMBER 30, 2007--------
BROKERS'
NET NET NET
LOSS LOSS CASH CAPITAL
---- ---- ---- -------
Balances as reported
at September 30, 2007: $(2.0) $(5.3) $0.1 $2.2
Net adjustments related to
proprietary trading 0.2 4.5 4.1 1.3
Net adjustments related to
other operations 0.3 1.0 1.3 1.0
----- ----- ---- ----
Pro forma balances $(1.5) $ 0.2 $5.5 $4.5
----- ----- ---- ----
Additional adjustments for
recurring non cash expenses:
FAS 123 stock
compensation 0.1 0.4
Depreciation and
amortization 0.2 0.9
----- -----
Pro forma balances on
cash basis $(1.2) $ 1.5 $5.5 $4.5
===== ===== ==== ====
|
OFF-BALANCE SHEET ARRANGEMENTS
Clearing Arrangements. We do not carry accounts for customers or
perform custodial functions related to customers' securities. We introduce all
of our customer transactions, to our clearing brokers, who maintain our
customers' accounts and clear such transactions. Additionally, the clearing
brokers provide the clearing and depository operations for our proprietary
securities transactions. These activities may expose us to off-balance-sheet
risk in the event that customers do not fulfill their obligations with the
primary clearing brokers, as we have agreed to indemnify our clearing brokers
for any resulting losses. We continually assess risk associated with each
customer who is on margin credit and record an estimated loss when we believe
collection from the customer is unlikely.
Customer Claims, Litigation and Regulatory Matters. In the normal
course of business, we have been and continue to be the subject of civil actions
and arbitrations arising out of customer complaints relating to our broker
dealer activities, as an employer and as a result of other business activities.
We have sold securities which we do not currently own and therefore
will be obligated to purchase the securities at a future date. We have recorded
these obligations in our financial statements at September 30, 2007 at the
market values of the securities and will incur a loss if the market value
increases subsequent to September 30, 2007. The occurrence of these off-balance
sheet losses could impair our liquidity and force us to reduce or curtail
operations.
27
ITEM 3. CONTROLS AND PROCEDURES
Management, with the participation of our President and the Chief
Financial Officer, carried out an evaluation of the effectiveness of our
"disclosure controls and procedures" (as defined in the Securities Exchange Act
of 1934, as amended (the "Exchange Act") Rules 13a-15(e) and 15-d-15(e)) as of
the end of the period covered by this report (the "Evaluation Date"). Based upon
that evaluation, the Chief Executive Officer and the Chief Financial Officer
concluded that, as of the Evaluation Date, our disclosure controls and
procedures are effective to ensure that information required to be disclosed by
us in the reports that we file or submit under the Exchange Act (i) is recorded,
processed, summarized and reported, within the time periods specified in the
SEC's rules and forms and (ii) is accumulated and communicated to our
management, including its Chief Executive and Chief Financial Officers, as
appropriate to allow timely decisions regarding required disclosure.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING. There were no
changes in our internal controls over financial reporting that occurred during
the period covered by this report that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.
PART II - OTHER INFORMATION