| GILMAN CIOCIA, INC. | |
Supplemental Disclosures to Consolidated Statements of Cash Flows (unaudited) | |
| (in thousands) | |
| | | For the Nine Months Ended
March 31, | |
| | | 2010 | | | 2009 | |
| Cash Flow Information | | | | | | |
| Cash payments during the year for: | | | | | | |
| Interest | | $ | 333 | | | $ | 236 | |
| | | | | | | | | |
| | | | | | | | | |
| Supplemental Disclosure of Non-Cash Transactions | | | | | | | | |
Issuance of common stock for services, interest and other | | $ | 30 | | | $ | 15 | |
| Equipment acquired under capital leases | | $ | 4 | | | $ | 231 | |
| Fair value recognition on legacy accounts payable | | $ | (14 | ) | | $ | (23 | ) |
See Notes to the Unaudited Consolidated Financial Statements
GILMAN CIOCIA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. ORGANIZATION AND NATURE OF BUSINESS
Description of the Company
Gilman Ciocia, Inc. (together with its wholly owned subsidiaries, “we”, “us”, “our” or the “Company”) was founded in 1981 and is incorporated under the laws of the State of Delaware. We provide federal, state and local tax preparation services to individuals, predominantly in the middle and upper income tax brackets, accounting services to small and midsize companies and financial planning services, including securities brokerage, investment management services, insurance and financing services. As of March 31, 2010, we had 27 company-owned offices operating in three states (New York, New Jersey, and Florida) and 41 independently operated offices providing financial planning services in 11 states.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying Consolidated Financial Statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles (“GAAP”) have been omitted pursuant to such rules and regulations. However, we believe that the disclosures are adequate to make the information presented not misleading. The Consolidated Balance Sheet as of March 31, 2010, the Consolidated Statements of Operations for the three months and nine months ended March 31, 2010 and 2009 and the Consolidated Statements of Cash Flows for the nine months ended March 31, 2010 and 2009 are unaudited. The Consolidated Financial Statements reflect all adjustments (consisting only of normal recurring adjustments) that are, in the opinion of management, necessary for a fair presentation of our financial position and results of operations. The operating results for the three months and nine months ended March 31, 2010 are not necessarily indicative of the results to be expected for any other interim period or any future year. These Consolidated Financial Statements should be read in conjunction with the audited financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2009.
Fiscal years are denominated by the year in which they end. Accordingly, fiscal 2009 refers to the year ended June 30, 2009.
The Consolidated Financial Statements include the accounts of the Company and all majority owned subsidiaries from their respective dates of acquisition. All significant inter-company transactions and balances have been eliminated. Where appropriate, prior years financial statements reflect reclassifications to conform to the current year presentation.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles 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 these estimates. Furthermore, we, including our wholly owned subsidiary Prime Capital Services, Inc. (“PCS”), have been named as a defendant in various customer arbitrations. These claims result from the actions of brokers affiliated with PCS. In addition, under the PCS registered representatives contract, each registered representative has indemnified us for these claims. We have established liabilities for potential losses from such complaints, legal actions, government investigations and proceedings. In establishing these liabilities, our management uses its judgment to determine the probability that losses have been incurred and a reasonable estimate of the amount of losses. In making these decisions, we base our judgments on our knowledge of the situations, consultations with legal counsel and our historical experience in resolving similar matters. In many lawsuits, arbitrations and regulatory proceedings it is not possible to determine whether a liability has been incurred or to estimate the amount of that liability until the matter is close to resolution. However, accruals are reviewed regularly and are adjusted to reflect our estimates of the impact of developments, rulings, advice of counsel and any other information pertinent to a particular matter. Because of the inherent difficulty in predicting the ultimate outcome of legal and regulatory actions, we cannot predict with certainty the eventual loss or range of loss related to such matters. If our judgments prove to be incorrect, our liability for losses and contingencies may not accurately reflect actual losses that result from these actions, which could materially affect results in the period other expenses are ultimately determined. A majority of these claims are covered by our errors and omissions insurance policy. While we will vigorously defend ourselves in these matters, and will assert insurance coverage and indemnification to the maximum extent possible, there can be no assurance that these lawsuits and arbitrations will not have a material adverse impact on our financial position.
Cash and Cash Equivalents
We consider all highly liquid investments with an original maturity of three months or less to be cash equivalents. Cash equivalents include investments in money market funds and are stated at cost, which approximates market value. Cash at times may exceed FDIC insurable limits.
Impairment of Intangible Assets
Impairment of intangible assets results in a charge to operations whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. We test goodwill for impairment annually (during our fourth quarter) or more frequently whenever events occur or circumstances change, which would more likely than not reduce the fair value of a reporting unit below its carrying amount.
Revenue Recognition
Company Owned Offices - - We recognize all revenues associated with income tax preparation, accounting services and asset management fees upon completion of the services. Financial planning services include securities and other transactions. The related commission revenue and expenses are recognized on a trade-date basis. Marketing revenue associated with product sales is recognized quarterly based on production levels. Marketing event revenues are recognized at the commencement of the event offset by its cost.
Independent Offices - We recognize 100% of all commission revenues and expenses associated with financial planning services including securities and other transactions on a trade-date basis. Our independent offices are independent contractors who may offer other products and services of other unrelated parties. These same offices are responsible for paying their own operating expenses, including payroll compensation for their staff.
Net Income/(Loss) Per Share
Basic net income/(loss) per share is computed using the weighted average number of common shares outstanding during each period. Options to purchase 2,632,298 common shares at an average price of $0.19 per share and options to purchase 2,470,213 common shares at an average price of $0.19 per share were outstanding during the three months and nine months ended March 31, 2010, respectively, but were not included in the computation of diluted earnings per share. They were not included during the three months ended March 31, 2010 because to do so would be anti-dilutive and because the options’ exercise prices were greater than the average market price of the common shares and they were not included in the nine months ended March 31, 2010 because the options’ exercise prices were greater than the average market price of the common shares.
Options to purchase 1,188,383 common shares at an average price of $0.21 per share and options to purchase 541,513 common shares at an average price of $0.28 per share were outstanding during the three months and nine months ended March 31, 2009, respectively, but were not included in the computation of diluted earnings per share. They were not included during the three months ended March 31, 2009 because to do so would be anti-dilutive and because the options’ exercise prices were greater than the average market price of the common shares and they were not included in the nine months ended March 31, 2009 because the options’ exercise prices were greater than the average market price of the common shares.
Fair Value of Financial Instruments
The carrying amounts of financial instruments, including cash and cash equivalents, marketable securities, accounts receivable, notes receivable, accounts payable and debt, approximated fair value as of March 31, 2010 because of the relatively short-term maturity of these instruments and their market interest rates.
Contingent Consideration
In December 2007, the Financial Accounting Standards Board (“FASB”) amended its guidance on business combinations. The new accounting guidance supersedes or amends other authoritative literature although it retains the fundamental requirements that the acquisition method of accounting (previously referred to as “purchase method”) be used for all business combinations and that an acquirer be identified for each business combination. The new guidance also establishes principles and requirements for how the acquirer (a) recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed and any noncontrolling interest in an acquiree; (b) recognizes and measures the goodwill acquired in a business combination or a gain from a bargain purchase; and (c) determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of a business combination. The new guidance also requires the acquirer to expense, as incurred, costs relating to any acquisitions. This new accounting guidance issued by the FASB on business combinations was effective for us July 1, 2009. During the nine months ended March 31, 2010 we entered into two asset purchase agreements which include contingent consideration based upon gross revenue generated in future periods. At the time of acquisition we recognized a liability of $0.3 million representing anticipated future contingency payments. See Note 8.
Prior to the accounting guidance issued by the FASB on business combinations which was effective for us July 1, 2009, we entered into two asset purchase agreements during fiscal 2009 and four asset purchase agreements during fiscal 2008 which include contingent consideration based upon gross revenue generated in future periods. No liability will be recorded until the contingency is determined beyond a reasonable doubt. Based on an estimate of these future revenues, we expect we will have a contingent liability of $0.7 million, subject to change based on actual future revenues earned.
Concentration of Credit Risk
Financial instruments that potentially subject us to concentrations of credit risk consist of trade receivables. The larger portion of our trade receivables are commissions earned from providing financial planning services that include securities brokerage services, insurance and financing services. Our remaining trade receivables consist of revenues recognized for accounting and tax services provided to businesses and individual tax payers. As a result of the diversity of services, markets and the wide variety of customers, we do not consider ourselves to have any significant concentration of credit risk.
Segment Disclosure
Management believes the Company operates as one segment.
3. RECENT ACCOUNTING PRONOUNCEMENTS
In January 2010, the FASB issued guidance on fair value measurements and disclosure. This guidance amends the fair value measurements and disclosures by improving the disclosure of fair value measurements. We have adopted the Codification in the period ending March 31, 2010. The adoption of the Codification did not result in any change in our significant accounting policies.
Effective for interim and annual periods ending after September 15, 2009, the FASB Accounting Standards CodificationTM (the “Codification”) is the single source of authoritative literature of GAAP. The Codification consolidates all authoritative accounting literature into one internet-based research tool, which supersedes all pre-existing accounting and reporting standards, excluding separate rules and other interpretive guidance released by the SEC. New accounting guidance is now issued in the form of Accounting Standards Updates, which update the Codification. We have adopted the Codification in the period ending September 30, 2009. The adoption of the Codification did not result in any change in our significant accounting policies.
In August 2009, the FASB issued guidance on measuring liabilities at fair value. This guidance amends the fair value measurements and disclosures by providing additional guidance clarifying the measurement of liabilities at fair value. The adoption of the new accounting guidance did not have a significant impact on our consolidated financial statements.
In June 2009, the FASB amended its guidance on Variable Interest Entities (“VIE’s”). The amended guidance changes how a company determines when an entity that is sufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. It also requires a company to provide additional disclosures about its involvement with VIE’s and any significant changes in risk exposure due to that involvement. The requirements of the amended accounting guidance are effective for us July 1, 2010 and early adoption is prohibited. We are currently assessing the impact this amended accounting guidance will have on our consolidated financial statements.
In December 2007, the FASB amended its guidance on business combinations. The new accounting guidance supersedes or amends other authoritative literature although it retains the fundamental requirements that the acquisition method of accounting (previously referred to as “purchase method”) be used for all business combinations and that an acquirer be identified for each business combination. The new guidance also establishes principles and requirements for how the acquirer (a) recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed and any noncontrolling interest in an acquiree; (b) recognizes and measures the goodwill acquired in a business combination or a gain from a bargain purchase; and (c) determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of a business combination. The new guidance also requires the acquirer to expense, as incurred, costs relating to any acquisitions. In April 2009, the FASB amended its guidance further by amending and clarifying the accounting for assets acquired and liabilities assumed in a business combination that arise from contingencies. This new accounting guidance issued by the FASB on business combinations was effective for us July 1, 2009 and resulted in our recording a liability contingent upon future earnings generated by the acquisitions made during the three months ended March 31, 2010. When new information about the possible outcome of the contingency is obtained and it results in our estimates of future earnings being lower than originally anticipated we are required to recognize additional expense at that time. If our estimates of such future earnings are higher than anticipated we cannot recognize a gain until which time the contigency is resolved.
In April 2008, the FASB issued guidance on the determination of the useful life of an intangible asset. This guidance amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. This new accounting guidance was effective for us July 1, 2009 and will be applied prospectively to business combinations that have an acquisition date on or after July 1, 2009. The adoption of the new accounting guidance did not have a significant impact on our consolidated financial statements.
All other new accounting pronouncements issued but not yet effective or adopted have been deemed not to be relevant to us, hence are not expected to have any impact once adopted.
4. COMMITMENTS AND CONTINGENCIES
Litigation
On June 30, 2009, the SEC executed an Order Instituting Administrative and Cease-And-Desist Proceedings (the “Instituting Order”) Pursuant to Section 8A of the Securities Act, Sections 15(b) and 21(c) of the Exchange Act, and Section 203(f) of the Investment Advisors Act of 1940 (the “Advisors Act”) against the Company, PCS, Michael P. Ryan, the Company’s President and CEO (“Ryan”), Rose M. Rudden, the Chief Compliance Officer of PCS (“Rudden”) and certain other current and former Company employee representatives registered with PCS (the “Representatives”). The Instituting Order alleged that the Company, PCS and the Representatives engaged in fraudulent sales of variable annuities to senior citizens and that Ryan, Rudden and two of the Representatives failed to supervise the variable annuity transactions.
The Instituting Order alleged that PCS willfully: engaged in fraudulent conduct in the offer, purchase and sale of securities; failed to make and keep current certain books and records relating to its business for prescribed periods of time; and failed reasonably to supervise with a view to prevent and detect violations of the federal securities statutes, rules and regulations by the Representatives.
The Instituting Order alleged that the Company aided, abetted and caused PCS to engage in fraudulent conduct in the offer, purchase and sale of securities.
The Instituting Order alleged that Ryan, Rudden and two of the Representatives failed reasonably to supervise with a view to preventing and detecting violations of the federal securities statutes, rules and regulations by the Representatives.
The Instituting Order alleged that four of the Representatives willfully: engaged in fraudulent conduct in the offer, purchase and sale of securities; and aided, abetted and caused PCS to fail to keep current certain books and records relating to its business for prescribed periods of time.
Hearings were held before an Administrative Law Judge commencing on December 1, 2009 and ending January 15, 2010. On March 16, 2010, the SEC approved the Offer of Settlement by the Company and PCS regarding the Instituting Order (the “Settlement”). The SEC executed an Order Making Findings and Imposing Remedial Sanctions Pursuant to Section 8A of the Securities Act, Sections 15(b) and 21(c) of the Securities Exchange Act, and Section 203(f) of the Investment Advisers Act of 1940 as to PCS and the Company (the “Settlement Order”).
A settlement was not reached with the SEC by Ryan, Rudden and the Representatives. We are awaiting a decision by the Administrative Law Judge concerning Ryan, Rudden and the Representatives.
Except as to the SEC’s jurisdiction over them and the subject matter of the Instituting Order, the Company and PCS agreed to the Settlement without admitting or denying the findings contained in the Settlement Order. The Company and PCS chose to settle to avoid costly and protracted litigation.
Under the terms of the Settlement, the Company and PCS agreed to certain undertakings including retaining an Independent Compliance Consultant to conduct a comprehensive review of their supervisory, compliance and other policies, practices and procedures related to variable annuities. The Independent Compliance Consultant will submit a report to the SEC at the conclusion of its review.
In addition, the Company and PCS consented to certain sanctions pursuant to Section 8A of the Securities Act and Sections 15(b) and 21(c) of the Exchange Act. PCS shall cease and desist from committing or causing any violations and any future violations of Section 17(a) of the Securities Act and Sections 10(b), 15(c) and 17(a) of the Exchange Act and Rules 10b-5 and 17a-3 thereunder. The Company shall cease and desist from committing or causing any violations and any future violations of Section 17(a) of the Securities Act and Sections 10(b) and 15(c) of the Exchange Act and Rule 10b-5 thereunder. PCS and the Company were censured.
PCS agreed to pay disgorgement of $97,389.05 and prejudgment interest of $46,873.53, for a total payment of $144,262.58 within twenty (20) days from the issuance of the Settlement Order, which was paid on March 29, 2010. The Company agreed to pay civil penalties of $450,000 and disgorgement of $1.00. Payment of the civil penalties by the Company shall be made in the following installments: $53,824.28 was to be paid within twenty (20) days of the issuance of the Settlement Order, which was paid on March 29, 2010; $198,087.86 is to be paid within 180 days from the issuance of the Settlement Order; and $198,087.86 is to be paid within 364 days from the issuance of the Settlement Order, with post-judgment interest due on the second and third installments. A copy of the Offer of Settlement is annexed hereto as Exhibit 10.1 and a copy of the Settlement Order is annexed hereto as Exhibit 10.2.
In addition, all claims involving the variable annuity sales practices of certain registered representatives of PCS that involve the Instituting Order have been interrelated by the insurance carrier (the “Interrelated Claims”). The total remaining insurance coverage for Interrelated Claims has been reduced from $1.0 million to $0.4 million after settling claims. As a result of this decreased insurance coverage, we could be required to pay significant additional costs out of pocket, which would have a material adverse effect on our working capital and our results of operations.
On or about March 10, 2010, an arbitration was filed with FINRA which may be subject to the reduced insurance coverage for Interrelated Claims. The Company believes that this arbitration will be covered by our insurance. The Company estimates that the range of possible exposure from this arbitration in excess of insurance coverage is zero to $150.0 thousand. While we will vigorously defend ourselves in this arbitration, and will assert insurance coverage and indemnification to the maximum extent possible, there can be no assurance that this arbitration will not have a material adverse impact on our financial position.
The Company and PCS are defendants and respondents in lawsuits and Financial Industry Regulatory Authority (“FINRA”) arbitrations in the ordinary course of business. PCS has errors and omissions insurance coverage that will cover a portion of such matters. In addition, under the PCS registered representatives contract, each registered representative is responsible for covering awards, settlements and costs in connection with these claims. While we will vigorously defend ourselves in these matters, and will assert insurance coverage and indemnification to the maximum extent possible, there can be no assurance that these lawsuits and arbitrations will not have a material adverse impact on our financial position. At March 31, 2010 we have accrued $0.1 million for potential settlements, judgments and awards.
5. EQUITY
On October 31, 2008 we commenced the Gilman Ciocia Common Stock and Promissory Note Offering, a private offering of our securities pursuant to SEC Regulation D (the “Offering”). The Offering was amended on December 8, 2008, September 3, 2009, December 16, 2009 and February 11, 2010. The securities offered for sale in the Offering, as amended are: $3.8 million of notes with interest at 10.0% (the “Notes”) and $0.4 million, or 3.5 million shares of our $0.01 par value common stock with a price of $0.10 per share (the “Shares”). During the nine months ended March 31, 2010, we issued another $2.5 million of Notes bringing the total issued through March 31, 2010, to $2.1 million of Notes due on July 1, 2010, $1.7 million of Notes due on July 1, 2011 and $0.1 million, or 1.3 million Shares.
6. FAIR VALUE MEASUREMENTS
The fair value measurement provision defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles, and expands disclosures about fair value measurements. This statement applies under other accounting pronouncements that require or permit fair value measurements, the FASB having previously concluded in those accounting pronouncements that fair value is a relevant measurement attribute.
Valuation techniques for fair value are based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our best estimate, considering all relevant information. These valuation techniques involve some level of management estimation and judgment. The valuation process to determine fair value also includes making appropriate adjustments to the valuation model outputs to consider risk factors.
The fair value hierarchy of our inputs used in the determination of fair value for assets and liabilities during the current period consists of three levels. Level 1 inputs are comprised of unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date. Level 2 inputs include quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; inputs other than quoted prices that are observable for the asset or liability; and inputs that are derived principally from or corroborated by observable market data by correlation or other means. Level 3 inputs incorporate our own best estimate of what market participants would use in pricing the asset or liability at the measurement date where consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model. If inputs used to measure an asset or liability fall within different levels of the hierarchy, the categorization is based on the lowest level input that is significant to the fair value measurement of the asset or liability. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.
We have significant legacy accounts payable balances that are at least four years old and that we believe will never require a financial payment for a variety of reasons. Accordingly, we opted to use the cost approach as our valuation technique to measure the fair value of our legacy accounts payable. Based on historical payouts we have established an estimate of fifteen cents on the dollar on these legacy balances that we would potentially pay out. The income recorded during the nine months ended March 31, 2010 and the nine months ended March 31, 2009 was $13.8 thousand and $23.4 thousand, respectively.
The following table sets forth the liabilities as of March 31, 2010 which is recorded on the balance sheet at fair value on a recurring basis by level within the fair value hierarchy. These are classified based on the lowest level of input that is significant to the fair value measurement:
| | | Quoted Prices in Active | |
| (in thousands) | Total Fair Value | Markets for Identical | Significant Unobservable |
| Description | of Liability | Assets (Level 1) | Inputs (Level 3) |
| Marketable securities | $ 18 | $ 18 | $ - |
| Accounts payable greater than 4 years old | $ 5 | $ - | $ 5 |
The carrying value of our cash and cash equivalents, accounts payable and other current liabilities approximate fair value because of their short-term maturity. All of our other significant financial assets, financial liabilities and equity instruments are either recognized or disclosed in the consolidated financial statements together with other information relevant for making a reasonable assessment of future cash flows, interest rate risk and credit risk. Where practicable the fair values of financial assets and financial liabilities have been determined and disclosed; otherwise only available information pertinent to fair value has been disclosed.
7. GOODWILL AND OTHER INTANGIBLE ASSETS
A reconciliation of the change in the carrying value of goodwill for the nine month period ended March 31, 2010 is as follows (in thousands):
| Balance at June 30, 2009 | | $ | 4,029 | |
Adjustment to purchase accounting (1) | | | 62 | |
| Balance at March 31, 2010 | | $ | 4,091 | |
(1) During fiscal 2008 and 2009, we purchased six tax preparation and accounting practices. Initial purchase prices are adjusted based on contingency payments made subsequent to the original purchase date.
Other intangible assets subject to amortization are comprised of the following at:
(in thousands) | March 31, 2010 | | June 30, 2009 |
| Customer Lists | $ 7,024 | | $ 6,543 |
| Broker-Dealer Registration | 100 | | 100 |
| Non-Compete Contracts | 805 | | 763 |
| House Accounts | 600 | | 600 |
| Administrative Infrastructure | 500 | | 500 |
| Independent Contractor Agreements | 3,100 | | 3,100 |
| Intangible Assets at Cost | 12,129 | | 11,606 |
| Less: Accumulated Amortization and Impairment | (7,444) | | (6,892) |
| Intangible Assets, Net | $ 4,685 | | $ 4,714 |
Amortization expense for both the three months ended March 31, 2010 and March 31, 2009 was $0.2 million. Amortization expense for the nine months ended March 31, 2010 and March 31, 2009 was $0.6 million and $0.5 million, respectively.
8. ACQUISITIONS
During the nine months ended March 31, 2010 we entered into asset purchase agreements to purchase two tax preparation, accounting and financial planning businesses. In each case, the purchase price is equal to a percentage of gross revenue generated from the preparation of tax returns, accounting services and financial planning revenues from clients generated during a five-year period. Commencing on March 31, 2010 and each 90-day period thereafter, we will pay the seller an installment payment based on a percentage of gross revenues generated during a five-year period after the closing date less all prior payments received. In accordance with the FASB’s amended guidance on business combinations we recorded a liability of $0.3 million representing the future contingency payments described above. These anticipated payments have been discounted at a per annum rate of 10%. The final anticipated payments are subject to change based on the actual gross revenues generated from these acquisitions.
During fiscal 2009 and 2008, we entered into asset purchase agreements to purchase six tax preparation, accounting and financial planning businesses. In each case, the purchase price is equal to a percentage of gross revenue generated from the preparation of tax returns, accounting services and financial planning revenues from clients generated during a one to five-year period. Commencing on the first quarter end after the acquisition date and each 90-day period thereafter, we will pay the seller an installment payment based on a percentage of gross revenues generated during a one to five-year period after the closing date less all prior payments received. Payments made as of March 31, 2010 totaled $1.5 million in the aggregate. No liability will be recorded until the contingency is determinable beyond a reasonable doubt. Based on an estimate of these future revenues, we expect we will have a contingent liability of $0.7 million, subject to change based on actual future revenues earned.
9. DEBT
| | | March 31, | | | June 30, | |
| (in thousands) | | 2010 | | | 2009 | |
| Private Offering Notes | | $ | 2,902 | | | $ | 745 | |
| Note Payable for Insurance | | | 38 | | | | 88 | |
| Capitalized Lease Obligations | | | 439 | | | | 692 | |
| Total | | | 3,379 | | | | 1,525 | |
| Less: Current Portion | | | (1,736 | ) | | | (427 | ) |
| Total | | $ | 1,643 | | | $ | 1,098 | |
On October 31, 2008 we commenced the Offering, which was amended on December 8, 2008, September 3, 2009, December 16, 2009 and February 11, 2010. The securities offered for sale in the Offering, as amended are: $3.8 million of Notes and $0.4 million, or 3.5 million Shares. During the nine months ended March 31, 2010, we issued another $2.5 million of Notes bringing the total issued through March 31, 2010, to $2.1 million of Notes due on July 1, 2010, $1.7 million of Notes due on July 1, 2011 and $0.1 million, or 1.3 million Shares.
On January 27, 2009, Carole Enisman, Executive Vice President of Operations purchased a $0.2 million Note of the $3.8 million of Notes. On November 24, 2009 Ms. Enisman purchased an additional $40.0 thousand Note and Michael Ryan, President and Chief Executive Officer purchased a $38.0 thousand Note of the $3.8 million Notes. The Notes with Ms. Enisman were amended on March 2, 2010 extending the due date to July 1, 2011. The Note with Mr. Ryan was amended on April 19, 2010 extending the due date to July 1, 2011. On December 3, 2008 and August 19, 2009, three trusts, of which James Ciocia, Chairman of the Board is a trustee, purchased an aggregate of $0.6 million of Notes of the $3.8 million of the Notes. The Carole Enisman, Michael Ryan and James Ciocia as trustee purchases are included in related party debt.
10. STOCK BASED COMPENSATION
We account for stock-based compensation using a modified prospective application. Under this application, we are required to record compensation expense using a fair-value-based measurement method for all awards granted after the date of adoption and for the unvested portion of previously granted awards that remain outstanding at the date of adoption. We have adopted the policy to recognize compensation expense on a straight-line attribution method.
Changes in our stock option activity during the nine months ended March 31, 2010 were as follows:
| | | Shares | | | Weighted Average Exercise Price | |
| Outstanding, June 30, 2009 | | | 2,175,800 | | | $ | 0.20 | |
| Granted | | | 499,998 | | | | 0.15 | |
| Exercised | | | - | | | | - | |
| Expired | | | - | | | | - | |
| Canceled | | | (43,500 | ) | | | 0.18 | |
| Outstanding, March 31, 2010 | | | 2,632,298 | | | $ | 0.19 | |
| | | | | | | | | |
| Exercisable, March 31, 2010 | | | 10,000 | | | $ | 6.00 | |
The range of exercise prices for the outstanding options at March 31, 2010 is between $0.10 and $6.00.
During the nine months ended March 31, 2010, 43,500 outstanding options at an exercise price of $0.18 were canceled as a result of employees terminating employment prior to fully vesting.
On October 2, 2009, pursuant to the Company’s 2007 Stock Incentive Plan (the “2007 Plan”), we granted to the independent members of our Board of Directors and Jim Ciocia, our Chairman of the Board, in aggregate, $30.0 thousand in common stock options, or 499,998 common stock options each with an exercise price of $0.15 and a five-year term which vest as to 20.0% of the shares annually commencing one year after the date of grant and which have a Black-Scholes value at the time of grant determined based on the closing price of our common stock on the date of grant. Additionally, on October 2, 2009 we issued in the aggregate to these same board members $30.0 thousand in common stock, or 499,998 shares of restricted common stock.
11. ACCRUED EXPENSES
Accrued expenses consist of the following:
| (in thousands) | | March 31, | | | June 30, | |
| | | 2010 | | | 2009 | |
| | | | |
| Accrued compensation | | $ | 529 | | | $ | 251 | |
| Accrued bonus | | | 15 | | | | 58 | |
| Accrued related party compensation and bonus | | | 89 | | | | 146 | |
| Accrued vacation | | | 145 | | | | 127 | |
| Accrued settlement fees | | | 446 | | | | 380 | |
| Accrued audit fees & tax fees | | | 177 | | | | 163 | |
| Accrued interest | | | 43 | | | | 23 | |
| Accrued other | | | 156 | | | | 278 | |
| Accrued acquisitions short term | | | 112 | | | | 46 | |
| Total Accrued Expenses | | $ | 1,712 | | | $ | 1,472 | |
12. RELATED PARTY DEBT AND TRANSACTIONS
| | | March 31, | | | June 30, | |
| (in thousands) | | 2010 | | | 2009 | |
| | | | | | | |
| Prime Partners Note (a) (c) | | $ | 623 | | | $ | 739 | |
| Trust Note (b) (c) (d) | | | 570 | | | | 470 | |
| Ciocia as Trustee Note (e) | | | 600 | | | | 300 | |
| Enisman and Ryan Note (f) | | | 248 | | | | 170 | |
| Finkelstein Note (g) | | | 50 | | | | 50 | |
| Other Officer’s Notes | | | 16 | | | | 49 | |
| Total | | | 2,107 | | | | 1,778 | |
| Less: Current Portion | | | (1,881 | ) | | | (1,252 | ) |
| Total | | $ | 226 | | | $ | 526 | |
(a) During fiscal 2007, Prime Partners loaned us an aggregate of $1.7 million at an interest rate of 10%. During fiscal 2007, we repaid $0.7 million to Prime Partners and as of June 30, 2007, we owed Prime Partners $2.8 million. Michael Ryan is a director, an officer and a significant shareholder of Prime Partners. On August 16, 2007, Prime Partners sold to Prime Partners II, LLC $1.5 million of the $2.8 million owed to it by the Company. Prime Partners II, LLC is a limited liability company. Michael Ryan is a significant member and a manager of Prime Partners II, LLC. On August 20, 2007, Prime Partners II, LLC converted the $1.5 million of our debt into 15.4 million shares of our common stock. As of June 30, 2008, we owed Prime Partners a total of $1.3 million in principal. A $1.0 million note to Prime Partners dated as of January 31, 2008 was due on June 30, 2008 (the “$1.0 Million Note”). On December 26, 2007, we entered into a promissory note in the amount of $0.3 million with Prime Partners for related party debt which was previously included in accrued expenses. The note pays interest at the rate of 10.0% per annum. The note is payable over 31 months and the first payment of approximately $11.0 thousand was paid in January 2008 and continues to be paid monthly.
(b) A trust, of which Mr. Finkelstein is the trustee (“the Trust”), made a short-term loan to Prime Partners for $0.3 million on July 18, 2006, which paid interest at 10% per annum. On October 16, 2006, the Trust made an additional short-term loan to Prime Partners for $0.2 million, which accrued interest at 10% per annum. As of June 30, 2008, Prime Partners owed the Trust $0.5 million in principal pursuant to a promissory note dated January 31, 2008 (the “Old Note”). As security for the total loan in the amount of $0.5 million, Prime Partners gave the Trust a security interest in the note related to the sale of two of our offices that we assigned to Prime Partners and a security interest in the notes that we owed to Prime Partners.
(c) As of September 1, 2008, Prime Partners assigned $0.5 million from the $1.0 Million Note to the Trust in payment of the Old Note. As of September 1, 2008, we entered into a new $0.5 million promissory note with Prime Partners at 10% interest to be paid in arrears through the end of the previous month on the 15th day of each month commencing on October 15, 2008 and principal due on or before July 1, 2009 (the “New Prime Partners Note”). The New Prime Partners Note was amended as of June 30, 2009 to extend the due date of principal to July 1, 2010. The New Prime Partners Note was again amended as of May 5, 2010 to extend the due date of principal to July 1, 2011.
(d) As of September 1, 2008, we entered into a new $0.5 million promissory note with the Trust (the “New Trust Note”). The New Trust Note was amended on January 30, 2009. The New Trust Note provided for 10% interest to be paid in arrears through the end of the previous month on the 15th day of each month commencing on October 15, 2008. The principal of the New Trust Note was to be paid to the Trust as follows: $117.5 thousand on March 31, 2009, April 30, 2009, May 31, 2009 and June 30, 2009. On May 8, 2009 the New Trust Note was amended to extend the full principal payment of $0.5 million to June 30, 2009. The New Trust Note was again amended as of September 25, 2009 to extend the due dates of principal to be paid as follows: $120.0 thousand due on March 1, 2010 and $175.0 thousand due on April 1, 2010 and April 15, 2010. We gave the Trust a collateral security interest in all of its assets, including the stock of PCS, subordinate only to the outstanding security interest of Wachovia Bank. We agreed that the only loan debt principal that we were permitted to pay until the New Trust Note was paid in full were: the existing Wachovia debt which was paid in full on March 31, 2009, the scheduled principal payments on certain executive notes with de minimis balances and the scheduled principal payments to Prime Partners for the $0.3 million Promissory Note dated December 26, 2007. No payments of loan principal could be paid to any other existing or future lenders, including to Prime Partners on the New Prime Partners Note. Prime Partners and Ted Finkelstein guaranteed the New Trust Note. The guarantee of Prime Partners was secured by a collateral assignment of the promissory note dated January 23, 2004 between Daniel R. Levy and the Company in the original amount of $0.9 million which was assigned to Prime Partners, Inc. on June 26, 2006. On November 30, 2009 the New Trust Note was amended, increasing the principal by $0.1 million to $0.6 million. The additional $0.1 million was payable on demand by the Trust. On April 15, 2010, the $0.6 million Trust Note was paid in full.
(e) On December 3, 2008, three trusts of which James Ciocia is a trustee, purchased an aggregate of $0.3 million of the Notes issued pursuant to the Offering in reliance upon the exemption from registration in Rule 506 of Regulation D. On August 19, 2009, these trusts purchased an additional $0.3 million of the Notes. See Note 9.
(f) On January 27, 2009, Carole Enisman, Executive Vice President of Operations, purchased a $0.2 million Note pursuant to the Offering. On November 24, 2009 Ms. Enisman purchased an additional $40.0 thousand Note and Michael Ryan, President and Chief Executive Officer, purchased a $38.0 thousand Note of the $3.8 million Notes. The Notes with Ms. Enisman were amended on March 2, 2010 extending the due date to July 1, 2011. The Note with Mr. Ryan was amended on April 19, 2010 extending the due date to July 1, 2011. See Note 9.
(g) On November 28, 2008 we issued a promissory note in the amount of $50.0 thousand to Ted Finkelstein, our Vice President, General Counsel and Secretary. The note provided for 10.0% interest to be paid monthly with the principal balance to be paid before June 30, 2009. The promissory note was amended as of June 30, 2009 to extend the due date of principal to May 1, 2010. On May 4, 2010, the $50.0 thousand Finkelstein Note was paid in full.
At March 31, 2010, the aggregate amount we owed to related parties was $2.1 million.
13. SUBSEQUENT EVENTS
We evaluated for disclosure purposes subsequent events through May 14, 2010.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Item 2 contains forward-looking statements. Forward-looking statements in this Quarterly Report on Form 10-Q are subject to a number of risks and uncertainties, some of which are beyond our control. Our actual results, performance, prospects, or opportunities could differ materially from those expressed in or implied by the forward-looking statements. Additional risks of which we are not currently aware or which we currently deem immaterial could also cause our actual results to differ, including those discussed in the sections entitled “Forward-Looking Statements” and “Risk Factors” included elsewhere in this Quarterly Report as well as those risk factors discussed in the section entitled “Risk Factors” in our annual report on Form 10-K.
Overview
We provide federal, state and local income tax return preparation for individuals predominantly in middle and upper income brackets and accounting services to small and midsize companies and financial planning services, including securities brokerage, investment management services, insurance and financing services. Clients often consider other aspects of their financial needs such as investments, insurance, pension and estate planning, while having their tax returns prepared by us. We believe that our tax return preparation and accounting services are inextricably intertwined with our financial planning activities. The two channels leverage off each other, improving economies of scale and client retention. The financial planners who provide such services are our employees or independent contractors and are registered representatives of Prime Capital Services, Inc. (“PCS”), a wholly owned subsidiary. PCS conducts a securities brokerage business providing regulatory oversight and products and sales support to its registered representatives, who sell investment products and provide services to their clients. PCS earns a share of commissions from the services that the financial planners provide to their clients in transactions for securities, insurance and related products. PCS is a registered securities broker-dealer with the Securities and Exchange Commission (“SEC”) and a member of the Financial Industry Regulatory Authority (“FINRA”). We also have a wholly owned subsidiary, Asset & Financial Planning, Ltd. (“AFP”), which is registered with the SEC as an investment advisor. Almost all of our financial planners are also authorized agents of insurance underwriters. We have the capability of processing insurance business through PCS and Prime Financial Services, Inc. (“PFS”), a wholly owned subsidiary, which are licensed insurance brokers, as well as through other licensed insurance brokers. We are a licensed mortgage broker in the States of New York and Pennsylvania. GC Capital Corporation, a wholly owned subsidiary of the Company, is a licensed mortgage broker in the State of Florida. PCS also earns revenues from its strategic marketing relationships with certain product sponsors (“PCS Marketing”) which enables PCS to efficiently utilize its training, marketing and sales support resources.
The Company office financial planning clients generally are introduced to us through our tax return preparation services, accounting services and educational workshops. We believe that our tax return preparation and accounting services are inextricably intertwined with our financial planning activities in our Company offices and that overall profitability will depend, in part, on the two channels leveraging off each other since many of the same processes, procedures and systems support sales from both channels. Accordingly, management views and evaluates the Company as one segment.
We also provide financial planning services through approximately 41 independently owned and operated offices in 11 states. We benefit from economies of scale associated with the aggregate production of both Company offices and independently owned offices.
Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K can be obtained, free of charge, on our web site at www.gtax.com.
For the three months ended March 31, 2010, approximately 31.0% of our revenues were earned from tax preparation and accounting services and approximately 69.0% were earned from all financial planning and related services, of which approximately 70.0% were earned from brokerage commissions, 25.0% from asset management, 3.0% from insurance, 1.0% from lending services and 1.0% from PCS Marketing.
The tax preparation business is a highly seasonal business. The first and second quarters of our fiscal year are typically our weakest quarters and the third quarter of our fiscal year is typically our strongest.
During the three months ended March 31, 2010, we had net income of $0.8 million compared to net income of $0.4 million during the three months ended March 31, 2009. Financial planning revenues were higher by $1.5 million for the three months ended March 31, 2010 versus the same period last year with corresponding commission expense also higher by $1.1 million as a result of the increased revenues. Tax preparation and accounting services revenue increased slightly year over year, mostly due to an increase in average client fees and two small acquisitions that were made in the three months ended March 31, 2010, offset in part by declines in the number of returns filed as a result of general economic conditions.
We are attempting to increase revenue by, among other things, continuing to put forth a strong financial representative recruiting effort. The financial impact of new recruits could take several months for revenue on new accounts to become recognizable. If this program is not successful in generating additional revenue, the result will be continued downward pressure on total revenues in future quarters until we start to more significantly benefit from the effect of the greater sale of products that generate recurring income. We expect that we will continue to control overall operating expenses, while continuing to spend on marketing efforts to build brand awareness and attract new clients. We cannot predict whether our marketing efforts will have the desired effects.
We believe that the significant turmoil in the financial markets that began in 2008 and which continued into the first quarter of fiscal 2010, and the related erosion of investor confidence will continue to negatively impact our operating results. To help mitigate the negative impact on our operating results in fiscal 2010, we implemented more cost cutting strategies in the first quarter of fiscal 2010, mostly in the way of staff reductions. We remain committed, however, to investing in the continuing development of our network of financial representatives and to acquiring additional tax preparation and accounting firms to increase our client base and accounting business as part of our long-term strategy for growing our revenues and earnings.
Managed Assets
As indicated in the following table, as of March 31, 2010, assets under AFP management increased 3.4%, or $19.9 million, to $606.6 million, from $586.7 million as of December 31, 2009. This increase is mostly attributable to improved market conditions offset in part by net removed money under management. As of March 31, 2010, total Company securities under custody were $3.8 billion, down 0.4%, or $14.6 million from December 31, 2009.
The following table presents the market values of assets under AFP management:
(in thousands) Market Value as of | | Annuities | | | Brokerage | | | Total Assets Under Management | |
| | | | | | | | | | |
| 3/31/2010 | | $ | 263,829 | | | $ | 342,737 | | | $ | 606,566 | |
| 12/31/2009 | | $ | 274,658 | | | $ | 312,023 | | | $ | 586,681 | |
| 9/30/2009 | | $ | 283,186 | | | $ | 288,813 | | | $ | 571,999 | |
| 6/30/2009 | | $ | 275,321 | | | $ | 248,394 | | | $ | 523,715 | |
The following table presents the market values of total Company securities under custody. The numbers do not include fixed annuities.
(in thousands) Market Value as of | | Total Company Securities Under Custody | |
| | | | |
| 3/31/2010 | | $ | 3,791,299 | |
| 12/31/2009 | | $ | 3,805,862 | |
| 9/30/2009 | | $ | 3,687,054 | |
| 6/30/2009 | | $ | 3,349,106 | |
RESULTS OF OPERATIONS – THREE MONTHS ENDED MARCH 31, 2010 COMPARED TO THREE MONTHS ENDED MARCH 31, 2009
Revenue
The following table presents revenue by product line and brokerage revenue by product type:
| | | For the Three Months Ended March 31, | |
(in thousands) Consolidated Revenue Detail | | 2010 | | | 2009 | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| Revenue by Product Line | | | | | | | | | | | | | | | |
| Brokerage Commissions Revenue | | $ | 6,213 | | | $ | 5,196 | | | | 19.6 | % | | | 48.4 | % | | | 46.0 | % |
| Insurance Commissions | | | 218 | | | | 221 | | | | -1.4 | % | | | 1.7 | % | | | 1.9 | % |
Advisory Fees (1) | | | 2,187 | | | | 1,691 | | | | 29.3 | % | | | 17.0 | % | | | 15.0 | % |
| Tax Preparation and Accounting Fees | | | 3,996 | | | | 3,983 | | | | 0.3 | % | | | 31.1 | % | | | 35.2 | % |
| Lending Services | | | 92 | | | | 109 | | | | -15.6 | % | | | 0.7 | % | | | 1.0 | % |
| Marketing Revenue | | | 137 | | | | 104 | | | | 31.7 | % | | | 1.1 | % | | | 0.9 | % |
| Total Revenue | | $ | 12,843 | | | $ | 11,304 | | | | 13.6 | % | | | 100.0 | % | | | 100.0 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Brokerage Commissions Revenue by Product Type | | | | | | | | | | | | | | | | | | | | |
| Mutual Funds | | $ | 1,150 | | | $ | 667 | | | | 72.4 | % | | | 9.0 | % | | | 5.9 | % |
| Equities, Bonds & Unit Investment Trusts | | | 350 | | | | 249 | | | | 40.6 | % | | | 2.7 | % | | | 2.2 | % |
| Annuities | | | 1,912 | | | | 2,408 | | | | -20.6 | % | | | 14.9 | % | | | 21.3 | % |
Trails (1) | | | 2,062 | | | | 1,359 | | | | 51.7 | % | | | 16.1 | % | | | 12.0 | % |
| All Other Products | | | 739 | | | | 513 | | | | 44.1 | % | | | 5.7 | % | | | 4.6 | % |
| Brokerage Commissions Revenue | | $ | 6,213 | | | $ | 5,196 | | | | 19.6 | % | | | 48.4 | % | | | 46.0 | % |
(1) Advisory fees represent the fees charged by the Company’s investment advisors on client’s assets under management and is calculated as a percentage of the assets under management, on an annual basis. Trails are commissions earned by PCS as the broker dealer each year a client’s money remains in a mutual fund or in a variable annuity account, as compensation for services rendered to the client. Advisory fees and trails represent recurring revenue. While these fees generate substantially lower first year revenue than most commission products and are more susceptible to fluctuations in the financial markets, the recurring nature of these fees provides a platform for accelerating future revenue growth.
The following table sets forth a breakdown of our consolidated financial planning revenue by company-owned offices and independent offices for the three months ended March 31, 2010 and 2009:
| | For Three Months Ended March 31, |
| (in thousands) | 2010 | % of Total | 2009 | % of Total |
| Company-Owned Offices | $ 4,262 | 48.2% | $ 3,596 | 49.1% |
| Independent Offices | 4,585 | 51.8% | 3,725 | 50.9% |
| Total | $ 8,847 | | $ 7,321 | |
Our total revenues for the three months ended March 31, 2010 were $12.8 million compared to $11.3 million for the three months ended March 31, 2009, an increase of $1.5 million or 13.6%. Our total revenues for the three months ended March 31, 2010 consisted of $8.8 million for financial planning services and $4.0 million for tax preparation and accounting services. Financial planning services represented approximately 69.0% and tax preparation and accounting services represented approximately 31.0% of our total revenues during the three months ended March 31, 2010. Our total revenues for the three months ended March 31, 2009 consisted of $7.3 million for financial planning services and $4.0 million for tax preparation and accounting services. Financial planning services represented approximately 65.0% and tax preparation fees and accounting services represented approximately 35.0% of our total revenues during the three months ended March 31, 2009.
For the three months ended March 31, 2010, financial planning revenue was $8.8 million compared to $7.3 million for the same period last year. Financial planning revenue has increased 20.8% for the three months ended March 31, 2010 compared with the same period last year as the financial markets continue to improve. For the three months ended March 31, 2010, revenues from trails and advisory fees increased to $4.2 million, up $1.2 million or 39.3% from the three months ended March 31, 2009. The increase in recurring revenues is mostly attributable to more assets under management at December 31, 2009, at which time fees are determined and revenue is recognized during the three months ended March 31, 2010, compared with the same period last year. We continue to remain committed to our strategy of growing our recurring revenues in an effort to mitigate any negative impact a volatile market may have on our other revenue streams. This is evidenced by growth in our new money under management which had a net increase of $69.9 million for the twelve months ended December 31, 2009.
Tax preparation and accounting services revenue was $4.0 million for the three months ended March 31, 2010, relatively unchanged from the same period last year as increases from acquisitions made during the three months ended March 31, 2010 were offset in part by declines in the number of returns filed as a result of general economic conditions. We believe a significant portion of the attrition came in the form of fewer overall tax returns filed with the IRS, a result of the recent recessionary period in the U.S. economy. Historically, recessionary periods result in high unemployment, the result of which is lower taxable income and fewer individual tax filings. Additionally, we believe the prior year’s three months ended March 31, 2009 saw some spillover from the prior year as a result of the 2008 economic stimulus that resulted in more tax filings as taxpayers whose income is below the filing requirements did so in an effort to receive the stimulus.
Expenses
Our total operating expenses for the three months ended March 31, 2010 were $12.0 million, up $1.1 million or 10.2%, compared to $10.9 million for the three months ended March 31, 2009. This increase is mostly due to an increase in commission expense of $1.1 million, mostly a result of the $1.5 million increase in financial planning revenues and to a lesser extent the higher commission payouts on the independent channel compared with the employee channel.
Commission expense was $6.3 million for the three months ended March 31, 2010, compared with $5.2 million for the same period last year. Commission expense increased $1.1 million mostly due to the $1.5 million increase in financial planning revenues and to a lesser extent the higher commission payouts on the independent channel compared with the employee channel. Financial planning commission expense as a percentage of financial planning revenue was approximately 64.0% and 62.0% for the three months ended March 31, 2010 and March 31, 2009, respectively. This increase as a percentage of revenue is attributable to financial planning revenue generated through our independent channel representing 51.8% of the total financial planning revenue where commission pay out rates are higher than on the employee channel compared with the same period last year when our independent channel generated 50.9% of the total financial planning revenue.
Salaries, which consist primarily of salaries, related payroll taxes and employee benefit costs, increased by $31.0 thousand, or 1.3% for the three months ended March 31, 2010 compared to the same period last year mostly due to salaries related to acquisitions and new payroll taxes imposed by the State of New York, offset in part by savings from staff cuts.
General and administrative expenses were relatively unchanged for the three months ended March 31, 2010 compared to the same period last year. On June 30, 2009, the SEC executed an Order Instituting Administrative and Cease-And-Desist Proceedings (the “Instituting Order”) Pursuant to Section 8A of the Securities Act, Sections 15(b) and 21(c) of the Exchange Act, and Section 203(f) of the Advisors Act against the Company, PCS, Michael P. Ryan, the Company’s President and CEO (“Ryan”), Rose M. Rudden, the Chief Compliance Officer of PCS (“Rudden”) and certain other current and former Company employee representatives registered with PCS (the “Representatives”). The resulting increase in litigation costs associated with the Instituting Order and an increase in bad debt expense due to acquisition related accounting services were offset by our efforts to reduce general and administrative expenses.
Advertising expense decreased by $38.0 thousand, or 5.5%, for the three months ended March 31, 2010 compared with the same period last year. This decrease is primarily attributable to our efforts to reduce our advertising spending and to find more cost effective advertising channels to grow brand awareness.
Brokerage fees and licenses increased $33.0 thousand, or 10.4% for the three months ended March 31, 2010 compared with the same period last year. This increase is mostly due to the increase in market values of accounts under management with third party money managers in AFP.
Rent expense decreased by $53.0 thousand, or 7.0% for the three months ended March 31, 2010 compared to the same period last year. The decrease is a result of renegotiating lower rents at a number of company owned offices, downsizing the corporate office and downsizing or relocating a number of company owned offices to smaller locations, offset in part by acquisitions and annual rent increases on existing leases.
Depreciation and amortization expense increased by $16.0 thousand, or 5.6% for the three months ended March 31, 2010 compared with the same period last year. The increase in depreciation and amortization is a result of increased amortization due to acquisitions.
Our net income from operations before other income and expense increased to $0.9 million for the three months ended March 31, 2010 compared to $0.4 million for the three months ended March 31, 2009. The increase in net income from operations was primarily attributable to an increase in financial planning revenues of $1.5 million as the financial markets continue to improve offset by related commission expense of $1.1 million.
Total other income/(expense) was a net expense of $0.1 million for the three months ended March 31, 2010, an increase of $62.0 thousand compared with the same period last year. This increase is mostly the result of higher interest expense due to the issuance of private offering notes.
Our net income for the three months ended March 31, 2010 was $0.8 million, or $0.01 per basic and diluted share, compared with net income of $0.4 million, or $0.00 per basic and diluted share for the three months ended March 31, 2009. The increase in net income was primarily attributable to an increase in financial planning revenues of $1.5 million as the financial markets continue to improve offset by related commission expense of $1.1 million.
RESULTS OF OPERATIONS – NINE MONTHS ENDED MARCH 31, 2010 COMPARED TO NINE MONTHS ENDED MARCH 31, 2009
Revenue
The following table presents revenue by product line and brokerage revenue by product type:
| | | For the Nine Months Ended March 31, | |
(in thousands)Consolidated Revenue Detail | | 2010 | | | 2009 | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| Revenue by Product Line | | | | | | | | | | | | | | | |
| Brokerage Commissions Revenue | | $ | 18,701 | | | $ | 18,173 | | | | 2.9 | % | | | 59.9 | % | | | 58.9 | % |
| Insurance Commissions | | | 723 | | | | 914 | | | | -20.9 | % | | | 2.3 | % | | | 3.0 | % |
Advisory Fees (1) | | | 5,926 | | | | 6,018 | | | | -1.5 | % | | | 19.0 | % | | | 19.5 | % |
| Tax Preparation and Accounting Fees | | | 5,323 | | | | 5,209 | | | | 2.2 | % | | | 17.1 | % | | | 16.9 | % |
| Lending Services | | | 241 | | | | 254 | | | | -5.1 | % | | | 0.8 | % | | | 0.8 | % |
| Marketing Revenue | | | 291 | | | | 265 | | | | 9.8 | % | | | 0.9 | % | | | 0.9 | % |
| Total Revenue | | $ | 31,205 | | | $ | 30,833 | | | | 1.2 | % | | | 100.0 | % | | | 100.0 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Brokerage Commissions Revenue by Product Type | | | | | | | | | | | | | | | | | | | | |
| Mutual Funds | | $ | 3,258 | | | $ | 2,298 | | | | 41.8 | % | | | 10.4 | % | | | 7.4 | % |
| Equities, Bonds & Unit Investment Trusts | | | 1,043 | | | | 760 | | | | 37.2 | % | | | 3.3 | % | | | 2.5 | % |
| Annuities | | | 6,037 | | | | 8,829 | | | | -31.6 | % | | | 19.4 | % | | | 28.6 | % |
Trails (1) | | | 5,831 | | | | 4,893 | | | | 19.2 | % | | | 18.7 | % | | | 15.9 | % |
| All Other Products | | | 2,532 | | | | 1,393 | | | | 81.8 | % | | | 8.1 | % | | | 4.5 | % |
| Brokerage Commissions Revenue | | $ | 18,701 | | | $ | 18,173 | | | | 2.9 | % | | | 59.9 | % | | | 58.9 | % |
(1) Advisory fees represent the fees charged by the Company’s investment advisors on client’s assets under management and is calculated as a percentage of the assets under management, on an annual basis. Trails are commissions earned by PCS as the broker dealer each year a client’s money remains in a mutual fund or in a variable annuity account, as compensation for services rendered to the client. Advisory fees and trails represent recurring revenue. While these fees generate substantially lower first year revenue than most commission products and are more susceptible to fluctuations in the financial markets, the recurring nature of these fees provides a platform for accelerating future revenue growth.
The following table sets forth a breakdown of our consolidated financial planning revenue by company-owned offices and independent offices for the nine months ended March 31, 2010 and 2009:
| | For Nine Months Ended March 31, |
| (in thousands) | 2010 | % of Total | 2009 | % of Total |
| Company-Owned Offices | $12,473 | 48.2% | $12,658 | 49.4% |
| Independent Offices | 13,409 | 51.8% | 12,966 | 50.6% |
| Total | $25,882 | | $25,624 | |
Our total revenues for the nine months ended March 31, 2010 were $31.2 million compared to $30.8 million for the nine months ended March 31, 2009, an increase of $0.4 million or 1.2%. Our total revenues for the nine months ended March 31, 2010 consisted of $25.9 million for financial planning services and $5.3 million for tax preparation and accounting services. Financial planning services represented approximately 83.0% and tax preparation and accounting services represented approximately 17.0% of our total revenues during the nine months ended March 31, 2010. Our total revenues for the nine months ended March 31, 2009 consisted of $25.6 million for financial planning services and $5.2 million for tax preparation and accounting services. Financial planning services represented approximately 83.0% and tax preparation fees and accounting services represented approximately 17.0% of our total revenues during the nine months ended March 31, 2009.
For the nine months ended March 31, 2010, financial planning revenue was $25.9 million compared to $25.6 million for the same period last year. This increase in financial planning revenue is mostly attributable to improvements in market conditions compared with the same period last year. For the nine months ended March 31, 2010, revenues from trails and advisory fees increased to $11.8 million, up $0.8 million from $10.9 million for the nine months ended March 31, 2009, representing a 7.8% increase in recurring revenue. The increase in recurring revenues is mostly attributable to higher assets under management and securities under custody at June 30, 2009, September 30, 2009 and December 31, 2009, at which time fees are determined and revenue is recognized during the nine months ended March 31, 2010, compared with the same period last year. We continue to remain committed to our strategy of growing our recurring revenues in an effort to mitigate any negative impact a volatile market may have on our other revenue streams. This is evidenced by growth in our new money under management which had a net increase of $39.1 million for the nine months ended March 31, 2010.
Tax preparation and accounting services revenue was $5.3 million for the nine months ended March 31, 2010 compared to $5.2 million for the same period last year. The majority of this increase in tax preparation and accounting services revenue is attributable to the additional revenue generated from the two tax preparation and accounting businesses acquired in each of the third quarters of fiscal 2010 and 2009 and increases in average client fees, offset in part by attrition as a result of general economic conditions.
Expenses
Our total operating expenses for the nine months ended March 31, 2010 were $32.5 million, up $0.6 million or 1.9%, compared to $31.8 million for the nine months ended March 31, 2009. This increase in operating expenses was primarily attributable to increased commission expense of $0.6 million mostly due to the mix of financial planning revenue generated on the independent channel compared with the employee channel, increased settlement claims of $0.3 million as a result of the Instituting Order, increases in insurance premiums of $0.1 million as a result of higher premiums due to market conditions and an increase in depreciation and amortization of $0.1 million due to increased depreciation associated with capital expenditures made during fiscal 2009 due to the relocation of one office and an increase in amortization due to acquisitions. These were offset in part by decreased advertising costs of $0.3 million attributable to our efforts to reduce advertising spending and to find more cost effective advertising channels to grow brand awareness, and decreased brokerage fees of $0.1 million mostly due to cost controls put in place during the three months ended December 31, 2009.
Commission expense was $17.3 million for the nine months ended March 31, 2010, compared with $16.7 million for the same period last year. Commission expense increased $0.6 million mostly due mix of financial planning revenue generated on the independent channel compared with the employee channel and to a lesser extent the $0.3 million increase in financial planning revenues. Financial planning commission expense as a percentage of financial planning revenue was approximately 64.0% and 62.0% for the nine months ended March 31, 2010 and March 31, 2009, respectively. This increase as a percentage of revenue is attributable to financial planning revenue generated through our independent channel representing 51.8% of the total financial planning revenue where commission pay out rates are higher than on the employee channel compared with the same period last year when our independent channel generated 50.6% of the total financial planning revenue.
Salaries, which consist primarily of salaries, related payroll taxes and employee benefit costs, were relatively unchanged for the nine months ended March 31, 2010 compared to the same period last year mostly due to savings from staff cuts offset by salaries related to acquisitions and new payroll taxes imposed by the State of New York.
General and administrative expenses increased $0.4 million, or 12.6% in the nine months ended March 31, 2010 compared with the same period last year. This increase is primarily attributable to an increase in settlement claims of $0.3 million as a result of the Instituting Order and an increase in insurance of $0.1 million as a result of higher premiums due to market conditions.
Advertising expense decreased by $0.3 million, or 21.3%, for the nine months ended March 31, 2010 compared with the same period last year. This decrease is primarily attributable to our efforts to reduce advertising spending and to find more cost effective advertising channels to grow brand awareness.
Brokerage fees and licenses decreased $0.1 million, or 11.2% for the nine months ended March 31, 2010 compared with the same period last year. This decrease is mostly due to cost controls put in place during the three months ended December 31, 2009.
Rent expense remained relatively unchanged for the nine months ended March 31, 2010 compared to the same period last year mostly due to renegotiating lower rents at a number of company owned offices, downsizing the corporate office and downsizing or relocating a number of company owned offices to smaller locations, offset by acquisitions and annual rent increases on existing leases.
Depreciation and amortization expense increased by $0.1 million, or 9.1% for the nine months ended March 31, 2010 compared with the same period last year. The increase in depreciation and amortization is a result of increased depreciation associated with capital expenditures made during fiscal 2009 due to the relocation of one office and an increase in amortization due to acquisitions.
Our loss from operations before other income and expense increased to $1.2 million for the nine months ended March 31, 2010 compared to $1.0 million for the nine months ended March 31, 2009. The increase in loss from operations was primarily attributable to increased commission expense of $0.6 million mostly due to the mix of financial planning revenue generated on the independent channel compared with the employee channel and increased settlement claims of $0.3 million as a result of the Instituting Order, offset in part by increased financial planning revenues of $0.3 million due to improved market conditions, increased tax preparation revenues of $0.1 million due to acquisitions, and decreased advertising costs of $0.3 million attributable to our efforts to reduce advertising spending and to find more cost effective advertising channels to grow brand awareness.
Total other income/(expense) was a net expense of $0.3 million for the nine months ended March 31, 2010, an increase of $0.1 million compared with the same period last year. This increase is mostly the result of higher interest expense due to the issuance of private offering notes.
Our net loss for the nine months ended March 31, 2010 was $1.5 million, or $(0.02) per basic and diluted share, compared with net loss of $1.2 million, or $(0.01) per basic and diluted share for the nine months ended March 31, 2009. The increase in net loss was primarily increased commission expense of $0.6 million mostly due to the mix of financial planning revenue generated on the independent channel compared with the employee channel, increased settlement claims of $0.3 million as a result of the Instituting Order, and an increase in other income/(expense) of $0.1 million due to higher interest expense due to the issuance of private offering notes. These were offset in part by increased financial planning revenues of $0.3 million due to improved market conditions, increased tax preparation revenues of $0.1 million due to acquisitions, and decreased advertising costs of $0.3 million attributable to our efforts to reduce advertising spending and to find more cost effective advertising channels to grow brand awareness.
LIQUIDITY AND CAPITAL RESOURCES
During the nine months ended March 31, 2010, we realized a net loss of $1.5 million and at March 31, 2010 we had a working capital deficit of $4.2 million. At March 31, 2010 we had $0.8 million of cash and cash equivalents and $3.1 million of trade accounts receivable, net, to fund short-term working capital requirements. PCS is subject to the SEC's Uniform Net Capital Rule 15c3-1, which requires that PCS maintain minimum regulatory net capital of $100,000 and, in addition, that the ratio of aggregate indebtedness to net capital, both as defined, shall not exceed 15 to one. At March 31, 2010 we were in compliance with this regulation.
On October 31, 2008 we commenced the Gilman Ciocia Common Stock and Promissory Note Offering, a private offering of our securities pursuant to SEC Regulation D (the “Offering”). The Offering was amended on December 8, 2008, September 3, 2009, December 16, 2009 and February 11, 2010. The securities offered for sale in the Offering, as amended are: $3.8 million of notes with interest at 10.0% (the “Notes”) and $0.4 million, or 3.5 million shares of our $0.01 par value common stock with a price of $0.10 per share (the “Shares”). During the nine months ended March 31, 2010, we issued another $2.5 million of Notes bringing the total issued through March 31, 2010, to $3.8 million of Notes and $0.1 million, or 1.3 million Shares.
As of June 30, 2009 we owed a trust, of which Ted Finkelstein, our Vice President and General Counsel, is the trustee, $0.5 million in principal pursuant to a promissory note (the “New Trust Note”) dated September 1, 2008 and subsequently amended on January 30, 2009, and May 8, 2009. The New Trust Note was again amended as of September 25, 2009 to extend the due dates of principal to be paid as follows: $120.0 thousand due on March 1, 2010 and $175.0 thousand due on April 1, 2010 and April 15, 2010. On November 30, 2009 the New Trust Note was amended, increasing the principal by $0.1 million to $0.6 million. The additional $0.1 million was payable on demand by the Trust. On April 15, 2010, the $0.6 million Trust Note was paid in full.
As of March 31, 2010 we have $2.2 million of debt obligations and $1.2 million of related party notes becoming due on or before July 1, 2010. Through May 14, 2010 we made payments of $0.1 million in notes and $0.6 million in related party notes. In addition, we have amended $0.6 million of related party notes to extend the due dates of principal to July 1, 2011. Our ability to satisfy these and other obligations depends on our future financial performance, which will be subject to prevailing economic, financial, and business conditions. Capital requirements, at least in the near term, are expected to be provided by cash flows from operating activities, cash on hand at March 31, 2010, extensions of due dates on existing notes or a combination thereof. To the extent future capital requirements exceed cash on hand plus cash flows from operating activities, we anticipate that working capital will be financed by the further sales of securities through private offerings and by pursuing financing through outside lenders. We are also continuing to control operating expenses and are implementing our acquisition strategy to increase earnings and cash flow. While management believes that capital may be available, there is no assurance that such capital can be secured. Additionally, there can be no assurance that our cost control measures will provide the capital needed which could adversely impact our business, nor can we assure the extensions of due dates on existing notes.
While we believe that payments to tax preparation and accounting practices which we have acquired have been and will continue to be funded through cash flow generated from those acquisitions, we need additional capital to fund initial payments on future acquisitions. If we do not have adequate capital to fund those future acquisitions, we may not be able to acquire all of the acquisitions available to us which could result in our not fully realizing all of the revenue which might otherwise be available to us.
On June 30, 2009, the SEC executed an Order Instituting Administrative and Cease-And-Desist Proceedings (the “Instituting Order”) Pursuant to Section 8A of the Securities Act, Sections 15(b) and 21(c) of the Exchange Act, and Section 203(f) of the Advisors Act against the Company, PCS, Michael P. Ryan, the Company’s President and CEO (“Ryan”), Rose M. Rudden, the Chief Compliance Officer of PCS (“Rudden”) and certain other current and former Company employee representatives registered with PCS (the “Representatives”). The Instituting Order alleged that the Company, PCS and the Representatives engaged in fraudulent sales of variable annuities to senior citizens and that Ryan, Rudden and two of the Representatives failed to supervise the variable annuity transactions. Hearings were held before an Administrative Law Judge commencing on December 1, 2009 and ending January 15, 2010. On March 16, 2010, the SEC approved the Offer of Settlement by the Company and PCS regarding the Instituting Order (the “Settlement”). The SEC executed an Order Making Findings and Imposing Remedial Sanctions Pursuant to Section 8A of the Securities Act, Sections 15(b) and 21(c) of the Securities Exchange Act, and Section 203(f) of the Investment Advisers Act of 1940 as to PCS and the Company (the “Settlement Order”). Except as to the SEC’s jurisdiction over them and the subject matter of the Instituting Order, the Company and PCS agreed to the Settlement without admitting or denying the findings contained in the Settlement Order. The Company and PCS chose to settle to avoid costly and protracted litigation.
PCS agreed to pay disgorgement of $97,389.05 and prejudgment interest of $46,873.53, for a total payment of $144,262.58 within twenty (20) days from the issuance of the Settlement Order, which was paid on March 29, 2010. The Company agreed to pay civil penalties of $450,000 and disgorgement of $1.00. Payment of the civil penalties by the Company shall be made in the following installments: $53,824.28 was to be paid within twenty (20) days of the issuance of the Settlement Order, which was paid on March 29, 2010; $198,087.86 is to be paid within 180 days from the issuance of the Settlement Order; and $198,087.86 is to be paid within 364 days from the issuance of the Settlement Order, with post-judgment interest due on the second and third installments.
In addition, all claims involving the variable annuity sales practices of certain registered representatives of PCS that involve the Instituting Order have been interrelated by the insurance carrier (the “Interrelated Claims”). The total remaining insurance coverage for Interrelated Claims has been reduced from $1.0 million to $0.4 million after settling claims. As a result of this decreased insurance coverage, we could be required to pay significant additional costs out of pocket, which would have a material adverse effect on our working capital and our results of operations.
On or about March 10, 2010, an arbitration was filed with FINRA which may be subject to the reduced insurance coverage for Interrelated Claims. The Company believes that this arbitration will be covered by our insurance. The Company estimates that the range of possible exposure from this arbitration in excess of insurance coverage is zero to $150.0 thousand. While we will vigorously defend ourselves in this arbitration, and will assert insurance coverage and indemnification to the maximum extent possible, there can be no assurance that this arbitration will not have a material adverse impact on our financial position.
Our net cash used in operating activities was $1.2 million for the nine months ended March 31, 2010, compared with net cash used in operating activities of $7.0 thousand for the nine months ended March 31, 2009. The increase in net cash used in operating activities was primarily attributable to higher commissions earned toward the end of the period that were not collected as of March 31, 2010, the timing of the procurement of insurance policies as well as higher insurance premiums recorded in prepaid expense, the increase in deferred costs of our Notes issuance, and an increase in net loss for the nine months ended March 31, 2010, offset in part by higher commission expense at the end of the period not yet paid.
Net cash used in investing activities was $0.9 million for the nine months ended March 31, 2010 compared with $1.0 million for the nine months ended March 31, 2009 as we decreased our capital expenditures year over year in an effort to continue controlling costs, offset in part by payments made for acquisitions.
Net cash provided by financing activities was $2.2 million for the nine months ended March 31, 2010 compared with net cash provided by financing activities of $0.5 million for the nine months ended March 31, 2009. This increase in cash provided by financing activities was due primarily to the proceeds from the additional sales of our Notes and the financing of insurance premiums that were secured in the first quarter of fiscal 2010, whereas, in the prior year, financing of insurance premiums had been secured in the fourth quarter of fiscal 2009.
CRITICAL ACCOUNTING POLICIES
Use of Estimates
The preparation of our financial statements in conformity with GAAP requires management to adopt accounting policies and make estimates and judgments that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates under different assumptions and judgments and uncertainties, and potentially could result in materially different results under different conditions. These critical accounting estimates are reviewed periodically by our independent auditors and the audit committee of our board of directors.
Our critical accounting estimates have not changed materially from those disclosed in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K, for the year ended June 30, 2009 as filed with the SEC.
Recent Accounting Pronouncements
In January 2010, the FASB issued guidance on fair value measurements and disclosure. This guidance amends the fair value measurements and disclosures by improving the disclosure of fair value measurements. We have adopted the Codification in the period ending March 31, 2010. The adoption of the Codification did not result in any change in our significant accounting policies.
Effective for interim and annual periods ending after September 15, 2009, the FASB Accounting Standards CodificationTM (the “Codification”) is the single source of authoritative literature of U.S. generally accepted accounting principles (“GAAP”). The Codification consolidates all authoritative accounting literature into one internet-based research tool, which supersedes all pre-existing accounting and reporting standards, excluding separate rules and other interpretive guidance released by the SEC. New accounting guidance is now issued in the form of Accounting Standards Updates, which update the Codification. We have adopted the Codification in the period ending September 30, 2009. The adoption of the Codification did not result in any change in our significant accounting policies.
In August 2009, the FASB issued guidance on measuring liabilities at fair value. This guidance amends the fair value measurements and disclosures by providing additional guidance clarifying the measurement of liabilities at fair value. The adoption of the new accounting guidance did not have a significant impact on our consolidated financial statements.
In June 2009, the FASB amended its guidance on Variable Interest Entities (“VIE’s”). The amended guidance changes how a company determines when an entity that is sufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. It also requires a company to provide additional disclosures about its involvement with VIE’s and any significant changes in risk exposure due to that involvement. The requirements of the amended accounting guidance are effective for us July 1, 2010 and early adoption is prohibited. We are currently assessing the impact this amended accounting guidance will have on our consolidated financial statements.
In December 2007, the FASB amended its guidance on business combinations. The new accounting guidance supersedes or amends other authoritative literature although it retains the fundamental requirements that the acquisition method of accounting (previously referred to as “purchase method”) be used for all business combinations and that an acquirer be identified for each business combination. The new guidance also establishes principles and requirements for how the acquirer (a) recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed and any noncontrolling interest in an acquiree; (b) recognizes and measures the goodwill acquired in a business combination or a gain from a bargain purchase; and (c) determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of a business combination. The new guidance also requires the acquirer to expense, as incurred, costs relating to any acquisitions. In April 2009, the FASB amended its guidance further by amending and clarifying the accounting for assets acquired and liabilities assumed in a business combination that arise from contingencies. This new accounting guidance issued by the FASB on business combinations was effective for us July 1, 2009 and resulted in our recording a liability contingent upon future earnings generated by the acquisitions made during the three months ended March 31, 2010. When new information about the possible outcome of the contingency is obtained and it results in our estimates of future earnings being lower than originally anticipated we are required to recognize additional expense at that time. If our estimates of such future earnings are higher than anticipated we cannot recognize a gain until which time the contigency is resolved.
In April 2008, the FASB issued guidance on the determination of the useful life of an intangible asset. This guidance amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. This new accounting guidance was effective for us July 1, 2009 and will be applied prospectively to business combinations that have an acquisition date on or after July 1, 2009. The adoption of the new accounting guidance did not have a significant impact on our consolidated financial statements.
All other new accounting pronouncements issued but not yet effective or adopted have been deemed not to be relevant to us, hence are not expected to have any impact once adopted.
ITEM 4T. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
Our senior management is responsible for establishing and maintaining a system of disclosure controls and procedures (as defined in Rule 13a-15 and 15d-15 under the Exchange Act) designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer's management, including its principal executive officer and principal financial officer, to allow timely decisions regarding required disclosure.
We have carried out an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and Principal Financial and Chief Accounting Officer, of our disclosure controls and procedures. In designing and evaluating disclosure controls and procedures, we and our management recognize that any disclosure controls and procedures, no matter how well designed and operated, can only provide reasonable assurance of achieving the desired control objective. As of March 31, 2010, our Chief Executive Officer and Principal Financial and Chief Accounting Officer conclude that our disclosure controls and procedures are effective.
Changes in Internal Controls
During the three months ended March 31, 2010, there were no changes in our internal controls over financial reporting that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On June 30, 2009, the SEC executed an Order Instituting Administrative and Cease-And-Desist Proceedings (the “Instituting Order”) Pursuant to Section 8A of the Securities Act, Sections 15(b) and 21(c) of the Exchange Act, and Section 203(f) of the Investment Advisors Act of 1940 (the “Advisors Act”) against the Company, PCS, Michael P. Ryan, the Company’s President and CEO (“Ryan”), Rose M. Rudden, the Chief Compliance Officer of PCS (“Rudden”) and certain other current and former Company employee representatives registered with PCS (the “Representatives”). The Instituting Order alleged that the Company, PCS and the Representatives engaged in fraudulent sales of variable annuities to senior citizens and that Ryan, Rudden and two of the Representatives failed to supervise the variable annuity transactions.
The Instituting Order alleged that PCS willfully: engaged in fraudulent conduct in the offer, purchase and sale of securities; failed to make and keep current certain books and records relating to its business for prescribed periods of time; and failed reasonably to supervise with a view to prevent and detect violations of the federal securities statutes, rules and regulations by the Representatives.
The Instituting Order alleged that the Company aided, abetted and caused PCS to engage in fraudulent conduct in the offer, purchase and sale of securities.
The Instituting Order alleged that Ryan, Rudden and two of the Representatives failed reasonably to supervise with a view to preventing and detecting violations of the federal securities statutes, rules and regulations by the Representatives.
The Instituting Order alleged that four of the Representatives willfully: engaged in fraudulent conduct in the offer, purchase and sale of securities; and aided, abetted and caused PCS to fail to keep current certain books and records relating to its business for prescribed periods of time.
Hearings were held before an Administrative Law Judge commencing on December 1, 2009 and ending January 15, 2010. On March 16, 2010, the SEC approved the Offer of Settlement by the Company and PCS regarding the Instituting Order (the “Settlement”). The SEC executed an Order Making Findings and Imposing Remedial Sanctions Pursuant to Section 8A of the Securities Act, Sections 15(b) and 21(c) of the Securities Exchange Act, and Section 203(f) of the Investment Advisers Act of 1940 as to PCS and the Company (the “Settlement Order”).
A settlement was not reached with the SEC by Ryan, Rudden and the Representatives. We are awaiting a decision by the Administrative Law Judge concerning Ryan, Rudden and the Representatives.
Except as to the SEC’s jurisdiction over them and the subject matter of the Instituting Order, the Company and PCS agreed to the Settlement without admitting or denying the findings contained in the Settlement Order. The Company and PCS chose to settle to avoid costly and protracted litigation.
Under the terms of the Settlement, the Company and PCS agreed to certain undertakings including retaining an Independent Compliance Consultant to conduct a comprehensive review of their supervisory, compliance and other policies, practices and procedures related to variable annuities. The Independent Compliance Consultant will submit a report to the SEC at the conclusion of its review.
In addition, the Company and PCS consented to certain sanctions pursuant to Section 8A of the Securities Act and Sections 15(b) and 21(c) of the Exchange Act. PCS shall cease and desist from committing or causing any violations and any future violations of Section 17(a) of the Securities Act and Sections 10(b), 15(c) and 17(a) of the Exchange Act and Rules 10b-5 and 17a-3 thereunder. The Company shall cease and desist from committing or causing any violations and any future violations of Section 17(a) of the Securities Act and Sections 10(b) and 15(c) of the Exchange Act and Rule 10b-5 thereunder. PCS and the Company were censured.
PCS agreed to pay disgorgement of $97,389.05 and prejudgment interest of $46,873.53, for a total payment of $144,262.58 within twenty (20) days from the issuance of the Settlement Order, which was paid on March 29, 2010. The Company agreed to pay civil penalties of $450,000 and disgorgement of $1.00. Payment of the civil penalties by the Company shall be made in the following installments: $53,824.28 was to be paid within twenty (20) days of the issuance of the Settlement Order, which was paid on March 29, 2010; $198,087.86 is to be paid within 180 days from the issuance of the Settlement Order; and $198,087.86 is to be paid within 364 days from the issuance of the Settlement Order, with post-judgment interest due on the second and third installments. A copy of the Offer of Settlement is annexed hereto as Exhibit 10.1 and a copy of the Settlement Order is annexed hereto as Exhibit 10.2.
In addition, all claims involving the variable annuity sales practices of certain registered representatives of PCS that involve the Instituting Order have been interrelated by the insurance carrier (the “Interrelated Claims”). The total remaining insurance coverage for Interrelated Claims has been reduced from $1.0 million to $0.4 million after settling claims. As a result of this decreased insurance coverage, we could be required to pay significant additional costs out of pocket, which would have a material adverse effect on our working capital and our results of operations.
On or about March 10, 2010, an arbitration was filed with FINRA which may be subject to the reduced insurance coverage for Interrelated Claims. The Company believes that this arbitration will be covered by our insurance. The Company estimates that the range of possible exposure from this arbitration in excess of insurance coverage is zero to $150.0 thousand. While we will vigorously defend ourselves in this arbitration, and will assert insurance coverage and indemnification to the maximum extent possible, there can be no assurance that this arbitration will not have a material adverse impact on our financial position.
The Company and PCS are defendants and respondents in lawsuits and FINRA arbitrations in the ordinary course of business. As such, we have established liabilities for potential losses from such complaints, legal actions, investigations and proceedings. In establishing these liabilities, our management uses its judgment to determine the probability that losses have been incurred and a reasonable estimate of the amount of the losses. In making these decisions, we base our judgments on our knowledge of the situations, consultations with legal counsel and our historical experience in resolving similar matters. In many lawsuits, arbitrations and regulatory proceedings, including the formal order of investigation being conducted by the SEC, it is not possible to determine whether a liability has been incurred or to estimate the amount of that liability until the matter is close to resolution. However, accruals are reviewed regularly and are adjusted to reflect our estimates of the impact of developments, rulings, advice of counsel and any other information pertinent to a particular matter. Because of the inherent difficulty in predicting the ultimate outcome of legal and regulatory actions, we cannot predict with certainty the eventual loss or range of loss related to such matters. If our judgments prove to be incorrect, our liability for losses and contingencies may not accurately reflect actual losses that result from these actions, which could materially affect results in the period other expenses are ultimately determined. PCS has errors and omissions insurance coverage that will cover a portion of such matters. In addition, under the PCS registered representatives contract, each registered representative is responsible for covering awards, settlements and costs in connection with these claims. While we will vigorously defend ourselves in these matters, and will assert insurance coverage and indemnification to the maximum extent possible, there can be no assurance that these lawsuits and arbitrations will not have a material adverse impact on our financial position.
ITEM 1A. RISK FACTORS
Risk factors and uncertainties associated with our business have not changed materially from those disclosed in Part I, Item 1A of our 2009 Annual Report on Form 10-K as filed with the SEC on September 25, 2009.
ITEM 5. OTHER INFORMATION
The Company held its annual meeting of stockholders on January 27, 2010. At this meeting:
1. The stockholders elected John Levy, Nelson Obus and Allan Page as Class C directors. As Class C directors, Mr. Levy, Mr. Obus and Mr. Page will serve until the Annual Meeting of Stockholders with respect to the fiscal year ending June 30, 2012, and in each case until a successor is elected and qualified or until his earlier death, resignation or removal. The following directors were not up for election at the 2010 Annual Meeting of Stockholders and continue to serve on our board: Edward Cohen and Frederick Wasserman (Class A directors, each for a term expiring at the 2011 annual meeting of stockholders) and James Ciocia and Michael Ryan (Class B directors, each for a term expiring at the 2012 annual meeting of stockholders).
2. The stockholders ratified the appointment of Sherb & Co., LLP as the Company's independent auditors for the fiscal year ending June 30, 2010.
| The following table sets forth the results of votes of stockholders for the matters acted upon: |
| | | | | |
| Matters | For | Against | Withheld | Abstained |
| 1. | Elect the following directors: | | | | |
| John Levy as Class C Director | 68,756,008 | - | 2,559,187 | - |
| Nelson Obus as Class C Director | 68,747,605 | - | 2,567,590 | - |
| Allan Page as Class C Director | 68,753,805 | - | 2,561,390 | - |
| | | | | |
| 2. | Ratify the appointment of Sherb & Co., LLP as the Company's independent auditors for the fiscal year ending June 30, 2010 | 77,386,356 | 221,229 | - | 9,973 |
ITEM 6. EXHIBITS
| 10.1 | Offer of Settlement of Prime Capital Services, Inc. and Gilman Ciocia, Inc. |
| 10.2 | Order Making Findings and Imposing Remedial Sanctions Pursuant to Section 8A of the Securities Act and Sections 15(b) and 21(c) of the Securities Exchange Act as to Prime Capital Services, Inc. and Gilman Ciocia, Inc. |
| 31.1 | Rule 13a-14(a) Certification of Chief Executive Officer. |
| 31.2 | Rule 13a-14(a) Certification of Principal Financial and Chief Accounting Officer. |
| 32.1 | Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| 32.2 | Certification of Principal Financial and Chief Accounting Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | GILMAN CIOCIA, INC. | |
| | | | |
| | | | |
| By: | /s/ Michael Ryan | |
| | | Chief Executive Officer | |
| | | | |
| | | | |
| By: | /s/ Karen Fisher | |
| | | Principal Financial and
Chief Accounting Officer | |
