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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q/A
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended December 31, 2005
or
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________
Commission File Number 000-22996
GILMAN + CIOCIA, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 11-2587324
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
11 RAYMOND AVENUE
POUGHKEEPSIE, NEW YORK 12603
(Address of principal executive offices)(Zip code)
(845) 486-0900
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, or a non-accelerated filer. See definition of
"accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange
Act.
Large Accelerated Filer |_| Accelerated Filer |_| Non-accelerated Filer |X|
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act) |_| Yes |X| No
As of February 13, 2006, 10,505,061 shares of the issuer's common stock,
$0.01 par value, were outstanding.
Page 1
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS Page
Consolidated Balance Sheets as of December 31, 2005 and
June 30, 2005 3
Consolidated Statements of Operations for the Three Months
and Six Months Ended December 31, 2005 and December 31, 2004 4
Consolidated Statements of Cash Flows for the Six
Months Ended December 31, 2005 and December 31, 2004 5
Disclosures to Consolidated Statements of Cash Flows 6
Notes to Consolidated Financial Statements 7-15
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 15
Item 3. Quantitative and Qualitative Disclosures About Market Risk 23
Item 4. Controls and Procedures 23
PART II - OTHER INFORMATION 24
Item 1A. Risk Factors 24
Item 3. Defaults Upon Senior Securities 29
Item 6. Exhibits 29
SIGNATURES 30
Page 2
Explanatory Note
This Form 10Q/A is being filed as a result of a decision by management, in
consultation with the Board of Directors of Gilman + Ciocia, Inc. (the
"Company"), that the Company should amend and restate its financial statements
for its interim financial statements contained in its Form 10-Q for the quarter
ended December 31, 2005.
Management concluded that its previously issued financial statements for the
interim quarter ended December 31, 2005 should not be relied upon because of
certain grouping and presentation errors contained therein. The Company made
these determinations based on discussions with the Staff of the Division of
Corporation Finance of the Securities and Exchange Commission (the "Commission")
regarding certain accounting matters raised during a Staff review of the
Company's periodic filings. The grouping and presentation errors include the
following:
o The Company's consolidated statement of cash flow contained a grouping
error; the line item titled Receivables from Officers, Shareholders and
Employees was reclassified from operating activities to investing
activities.
As a result the following restatements were made for each period presented
on the Consolidated Statement of Cash Flows:
o For the Six Months Ended December 31, 2005; (1) net cash used
in operating activities was restated from $507,397 to
$474,369, a decrease in net cash used in operating activities
of $33,028; and (2) net cash used in investing activities was
restated from $134,585 to $167,613, an increase in net cash
used in investing activities of $33,028;
o For the Six Months Ended December 31, 2004; (1) net cash used
in operating activities was restated from $29,450 to $127,925,
an increase in net cash used in operating activities of
$98,475; and (2) net cash provided by investing activities was
restated from $144,900 to $243,375, an increase in net cash
provided by investing activities of $98,475.
o The Company's stock based compensation table contained an error in Note 9
of the Company's Notes to Consolidated Financial Statements. The
exercisable number of options outstanding at December 31, 2005 should have
been 1,373,500 an increase of 210,000 for options that were actually
vested.
The Company has quantified the impact of these errors on the Restated Periods
and there is no impact to the Company's net income (loss) for the relevant
periods.
PART I - FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
Unaudited Audited
December 31, June 30,
2005 2005
-----------------------------
Assets
Cash & Cash Equivalents $ 576,802 $ 667,054
Marketable Securities 309,607 511,832
Trade Accounts Receivable, Net 3,062,817 3,102,521
Receivables from Officers, Shareholders
and Employees, net 318,584 285,556
Due From Office Sales - Current 254,467 280,719
Prepaids and Other Current Assets 567,287 905,277
-----------------------------
Total Current Assets 5,089,564 5,752,959
Property and Equipment (less accumulated depreciation of $5,349,705
at December 31, 2005 and $5,090,906 at June 30, 2005) 1,210,531 1,040,725
Goodwill 3,838,087 3,837,087
Intangible Assets (less accumulated amortization of $4,955,089 at
December 31, 2005 and $4,908,805 at June 30, 2005) 4,650,690 5,311,002
Due from Office Sales - Non Current 846,237 700,781
Other Assets 541,510 493,158
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Total Assets $ 16,176,619 $ 17,135,712
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Liabilities and Shareholders' Equity (Deficit)
Accounts Payable and Accrued Expenses $ 10,184,617 $ 10,452,087
Current Portion of Notes Payable and Capital Leases 6,676,153 7,253,939
Deferred Income 545,203 310,800
Due to Related Parties 2,685,328 1,568,809
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Total Current Liabilities 20,091,301 19,585,635
Deferred Income Long Term 183,333 --
Long Term Portion of Notes Payable and Capital Leases 336,037 282,424
-----------------------------
Total Liabilities $ 20,610,671 $ 19,868,059
Shareholders' Equity (Deficit)
Preferred Stock, $0.001 par value; 100,000 shares authorized; no
shares issued and outstanding at December 31, 2005 and June 30, 2005,
respectively $ -- $ --
Common Stock, $0.01 par value 20,000,000 shares authorized; 10,475,061
and 10,409,876 shares issued at December 31, 2005 and June 30, 2005 104,750 104,098
Additional Paid in Capital 30,227,291 30,207,474
Treasury Stock 1,326,838 at December 31, 2005 and June 30, 2005
shares of common stock, at cost (1,306,288) (1,306,288)
Retained Deficit (33,459,805) (31,737,631)
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Total Shareholders' Equity (Deficit) (4,434,052) (2,732,347)
-----------------------------
Total Liabilities & Shareholders' Equity (Deficit) $ 16,176,619 $ 17,135,712
=============================
See Notes to the Consolidated Financial Statements
Page 3
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three Months Ended For the Six Months Ended
December 31, December 31,
2005 2004 2005 2004
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Revenues
Financial Planning Services $ 11,226,446 $ 12,955,993 $ 23,254,049 $ 25,168,931
Tax Preparation Fees 320,987 436,930 783,814 953,991
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Total Revenues 11,547,433 13,392,923 24,037,863 26,122,922
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Operating Expenses
Commissions 6,575,559 8,050,550 14,309,703 15,966,193
Salaries 2,006,005 2,550,545 4,319,776 5,021,367
General & Administrative 1,815,676 1,349,504 3,700,051 3,359,587
Advertising 342,687 179,585 665,475 483,081
Brokerage Fees & Licenses 320,706 397,933 767,651 756,257
Rent 576,686 426,156 1,085,337 889,902
Depreciation & Amortization 256,073 301,403 520,004 612,026
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Total Operating Expenses 11,893,392 13,255,676 25,367,997 27,088,413
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Income/(Loss) from Continuing Operations
Before Other Income and Expenses (345,959) 137,247 (1,330,134) (965,491)
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Other Income/(Expenses)
Interest and Investment Income 16,594 5,972 36,982 57,155
Interest Expense (244,239) (217,855) (450,932) (423,804)
Other Income/(Expense), Net 6,773 42,250 21,911 76,047
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Total Other Income/(Expense) (220,872) (169,633) (392,039) (290,602)
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Loss from Continuing Operations
Before Income Taxes (566,831) (32,386) (1,722,173) (1,256,093)
---------------------------------------------------------------------------------
Income Taxes/(Benefit) -- -- -- --
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Net Loss $ (566,831) $ (32,386) $ (1,722,173) $ (1,256,093)
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Weighted Average Number of Common
Shares Outstanding
Basic Shares 9,143,984 8,990,108 9,143,621 8,919,382
Diluted Shares 9,143,984 8,990,108 9,143,621 8,919,382
Basic Loss Per Share:
Loss from Continuing Operations
Before Income Taxes $ (0.06) $ (0.00) $ (0.19) $ (0.14)
Net Loss $ (0.06) $ (0.00) $ (0.19) $ (0.14)
Diluted Loss Per Share:
Loss from Continuing Operations
Before Income Taxes $ (0.06) $ (0.00) $ (0.19) $ (0.14)
Net Loss $ (0.06) $ (0.00) $ (0.19) $ (0.14)
See Notes to the Consolidated Financial Statements
Page 4
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Six Months Ended
December 31,
2005 2004
Restated Restated
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Cash Flows from Operating Activities:
Net Loss: $(1,722,173) $(1,256,093)
Adjustments to reconcile net loss to net cash provided by/(used in)
operating activities:
Depreciation and amortization 520,004 612,024
Issuance of common stock for debt penalties, interest and other 20,469 35,837
Amortization of debt discount 40,613 80,885
(Gain)/loss on sale of discontinued operations (15,114) --
(Gain)/loss on sale of equipment and properties -- (31,182)
Changes in assets and liabilities:
Accounts receivable, net 39,704 41,779
Prepaid and other current assets 339,407 227,560
Change in marketable securities 202,225 544,725
Other assets (49,770) 3,693
Accounts payable and accrued expenses (267,470) (387,153)
Other liabilities 417,736 --
------------------------------
Net cash provided by operating activities: $ (474,369) $ (127,925)
Cash Flows from Investing Activities:
Capital expenditures (455,914) (189,457)
Receivables from officers, shareholders and employees (33,028) 98,475
Due from office sales 195,064 165,819
Cash paid for acquisitions, net of cash acquired (34,914) (125,212)
Proceeds from the sale of property and equipment 161,179 293,750
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Net cash provided by/(used in) investing activities: $ (167,613) $ 243,375
Cash Flows from Financing Activities:
Proceeds from bank and other loans 1,175,843 1,233,011
Payments of bank loans and capital lease obligations (624,113) (1,263,203)
------------------------------
Net cash provided by/(used in) financing activities: $ 551,730 $ (30,192)
Net change in cash and cash equivalents $ (90,252) $ 85,258
Cash and cash equivalents at beginning of period $ 667,054 $ 498,543
Cash and cash equivalents at end of period $ 576,802 $ 583,803
See Notes to the Consolidated Financial Statements and Supplemental Disclosures
to Consolidated Statements of Cash Flows
Page 5
Supplemental Disclosures to Consolidated Statements of Cash Flows
For the Six Months Ended
December 31,
2005 2004
Restated Restated
------------------------
Cash Flow Information
Cash payments during the year for:
Interest $ 129,212 $ 172,219
Supplemental Disclosure of Non-Cash Transactions
Common stock issued in connection with
acquisitions/other $ (4,129) $ 5,760
Issuance of common stock for debt default
penalties and interest $ 24,600 $ 30,077
Equipment acquired under capital leases $ 157,085 $ 155,357
Page 6
GILMAN + CIOCIA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND NATURE OF BUSINESS
Description of the Company and Overview
Gilman + Ciocia, Inc. (together with its wholly owned subsidiaries, the
"Company") is a corporation that was organized in 1981 under the laws of the
State of New York and reincorporated under the laws of the State of Delaware in
1993. The Company provides federal, state and local tax preparation services to
individuals, predominantly in the middle and upper income tax brackets, and
financial planning services, including securities brokerage, insurance and
mortgage agency services. For the fiscal year ended June 30, 2005, approximately
88.0% of the Company's revenues were derived from commissions on financial
planning services and approximately 12.0% were derived from fees for tax
preparation services. For the six months ended December 31, 2005, approximately
97.0% of the Company's revenues were derived from financial planning services.
As of December 31, 2005, the Company had 34 offices operating in four states
(New York, New Jersey, Connecticut and Florida). The Company's 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 the Company's web site at www.gilcio.com.
As a result of a number of defaults under its agreements with Wachovia Bank,
National Association ("Wachovia"), on November 27, 2002 the Company entered into
a debt forbearance agreement with Wachovia and subsequently amended the debt
forbearance agreement as of June 18, 2003, March 4, 2004 and March 1, 2005.
Another of the Company's lenders, Travelers Insurance Company ("Travelers"), has
claimed several defaults under its distribution financing agreement with the
Company, but acknowledged that it was subject to the terms of a subordination
agreement with Wachovia (the "Subordination Agreement"), which restricts the
remedies it can pursue against the Company. The Company's debt to Rappaport
Gamma Limited Partnership (the "Rappaport Loan") was due on October 30, 2002.
The Rappaport Loan is subordinated to the Wachovia loan. The Rappaport Loan was
sold to a group of Company management and employees (the "Purchasing Group") on
April 29, 2005. The members of the Purchasing Group include Prime Partners,
Inc., of which Michael Ryan, the President and Chief Executive Officer and a
director of the Company, is a director, an Officer and a significant
shareholder, James Ciocia, the Chairman of the Company, Christopher Kelly,
former General Counsel of the Company, Kathryn Travis, the Secretary and a
director of the Company, Dennis Conroy, the Chief Accounting Officer of the
Company, Ted Finkelstein, the Assistant General Counsel of the Company, and
certain other Company employees. The Purchasing Group agreed to reduce the
principal balance of the Rappaport Loan from $1.0 million to $750,000 and extend
the maturity date to April 29, 2009. The Purchasing Group, as holders of the
Rappaport Loan, are entitled to receive, in the aggregate, 180,000 shares of the
Company's common stock annually while the debt remains unpaid. As a result of
these defaults, the Company's debt as to those lenders has been classified as
current liabilities on its financial statements. Upon the purchase of the
Rappaport Loan by the Purchasing Group, however, the Rappaport Loan was
reclassified as a related party transaction. See Note 8 to Notes to Consolidated
Financial Statements for a discussion of the Company's debt.
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
have been omitted pursuant to such rules and regulations. However, the Company
believes that the disclosures are adequate to make the information presented not
misleading. The Consolidated Balance Sheets as of December 31, 2005, the
Consolidated Statements of Operations for the three and six months ended
Page 7
December 31, 2005 and 2004 and the Consolidated Statements of Cash Flows for the
six months ended December 31, 2005 and 2004 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 the Company's financial position and results of operations.
The operating results for the three and six months ended December 31, 2005 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 the Company's Annual Report on Form 10-K for the fiscal year ended
June 30, 2005.
Fiscal years are denominated by the year in which they end. Accordingly, Fiscal
2005 refers to the year ended June 30, 2005.
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, the Company,
including its wholly owned subsidiary Prime Capital Services, Inc. ("PCS"), has
been named as a defendant in various customer arbitrations. These claims result
from the actions of brokers affiliated with PCS. Under the PCS registered
representatives contract, each registered representative has indemnified the
Company for these claims. In accordance with Statement of Financial Accounting
Standards ("SFAS") No. 5 "Accounting for Contingencies," the Company has
established liabilities for potential losses from such arbitrations and other
legal actions, investigations and proceedings. In establishing these
liabilities, the Company's 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 such arbitrations and other
legal actions, investigations and 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 such matters, 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. As of December
31, 2005, the Company has accrued approximately $0.7 million for these matters.
A majority of these claims are covered by the Company's errors and omissions
insurance policy. While the Company will vigorously defend itself in these
matters, and will assert insurance coverage and indemnification to the maximum
extent possible, there can be no assurance that these matters will not have a
material adverse impact on its financial position.
Cash and Cash Equivalents
The Company considers 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. Recoverability of an asset to be held and used is
measured by a comparison of the carrying amount of the asset to future net cash
flows expected to be generated by the asset. If such assets are considered to be
impaired, the impairment to be recognized is measured by the amount by which the
Page 8
carrying amount of the asset exceeds the fair value of the asset. The
measurement of the future net cash flows to be generated is subject to
management's reasonable expectations with respect to the Company's future
operations and future economic conditions which may affect those cash flows. The
Company tests goodwill for impairment annually 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. The measurement of
fair value, in lieu of a public market for such assets or a willing unrelated
buyer, relies on management's reasonable estimate of what a willing buyer would
pay for such assets. Management's estimate is based on its knowledge of the
industry, what similar assets have been valued at in sales transactions and
current market conditions.
Revenue Recognition
The Company recognizes 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.
Net Income (Loss) Per Share
In accordance with SFAS No. 128, "Earnings Per Share", basic net income/(loss)
per share is computed using the weighted average number of common shares
outstanding during each period. Differences between basic and diluted shares are
due to the assumed exercise of stock options included in the diluted loss per
share computation.
Fair Value of Financial Instruments
The carrying amounts of financial instruments, including cash and cash
equivalents, accounts receivable, notes receivable, and accounts payable,
approximated fair value as of December 31, 2005, because of the relatively
short-term maturity of these instruments and their market interest rates. Since
the long-term debt is in default, it is not possible to estimate its value.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of
credit risk consist of trade receivables. The majority of the Company's trade
receivables are commissions earned from providing financial planning services
that include securities/brokerage services and insurance and mortgage agency
services. As a result of the diversity of services, markets and the wide variety
of customers, the Company does not consider itself to have any significant
concentration of credit risk.
Segment Disclosure
Management believes the Company operates as one segment.
Other Significant Accounting Policies
Other significant accounting policies, not involving the same level of
measurement uncertainties as those discussed above, are nevertheless important
to an understanding of the financial statements. These policies require
difficult judgments on complex matters that are often subject to multiple
sources of authoritative guidance. Certain of these matters are among topics
currently under reexamination by accounting standards setters and regulators.
Although no specific conclusions reached by these standard setters appear likely
to cause a material change in the Company's accounting policies, outcomes cannot
be predicted with confidence. Refer to Note 2 to Consolidated Financial
Statements included in the Company's Fiscal 2005 10-K, which discusses
accounting policies that must be selected by management when there are
acceptable alternatives.
3. RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the Financial Accounting Standards Board issued SFAS 123-R.
SFAS 123-R is a revision of SFAS No. 123, as amended, Accounting for Stock-Based
Compensation ("SFAS 123"), and supersedes Accounting Principles Board Opinion
("APB") No. 25, Accounting for Stock Issued to Employees ("APB 25"). SFAS 123-R
eliminates the alternative to use the intrinsic value method of accounting that
was provided in SFAS 123, which generally resulted in no compensation expense
recorded in the financial statements related to the issuance of stock options.
SFAS 123-R requires that the cost resulting from all share-based payment
transactions be recognized in the financial statements. SFAS 123-R establishes
fair value as the measurement objective in accounting for share-based payment
arrangements and requires all companies to apply a fair-value-based measurement
method in accounting for generally all share-based payment transactions with
employees.
Page 9
On July 1, 2005 (the first day of its 2006 fiscal year), the Company adopted
SFAS 123-R. The Company adopted SFAS 123-R using a modified prospective
application, as permitted under SFAS 123-R. Accordingly, prior period amounts
have not been restated. Under this application, the Company is required to
record compensation expense 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. Per the provisions of SFAS 123-R, the
Company has adopted the policy to recognize compensation expense on a
straight-line attribution method.
4. COMMITMENTS AND CONTINGENCIES
Commitments
The Company has renewed its clearing agreement for a five-year term beginning
September 2005. The economic terms, recorded as part of deferred revenue, will
be amortized over the five-year term of this agreement ratably.
Litigation
On February 4, 2004, the Company was served with a Summons and a Shareholder's
Class Action and Derivative Complaint with the following caption: "Gary Kosseff,
Plaintiff, against James Ciocia, Thomas Povinelli, Michael P. Ryan, Kathryn
Travis, Seth A. Akabas, Louis P. Karol, Edward H. Cohen, Steven Gilbert and
Doreen Biebusch, Defendants and Gilman & Ciocia, Inc., Nominal Defendant". The
action was filed in the Court of Chancery of the State of Delaware in and for
New Castle County under Civil Action No. 188-N. The nature of the action is that
the Company, its Board of Directors and its management, breached their fiduciary
duty of loyalty in connection with the sale of offices to Pinnacle Taxx
Advisors, LLC ("Pinnacle") in 2002. The action alleges that the sale to Pinnacle
was for inadequate consideration and without a fairness opinion by independent
financial advisors, without independent legal advice and without a thorough
evaluation and vote by an independent committee of the Board of Directors. The
action prays for the following relief: a declaration that the Company, its Board
of Directors and its management breached their fiduciary duty and other duties
to the plaintiff and to the other members of the purported class; a rescission
of the Asset Purchase Agreement; unspecified monetary damages; and an award to
the plaintiff of costs and disbursements, including reasonable legal, expert and
accountants fees. On March 15, 2004, counsel for the Company and for all
defendants filed a motion to dismiss the lawsuit. On June 18, 2004, counsel for
the plaintiff filed an Amended Complaint. On July 12, 2004, counsel for the
Company and for all defendants filed a motion to dismiss the Amended Complaint.
On March 8, 2005, oral argument was heard on the motion to dismiss, and on July
29, 2005 the case Master delivered his draft report denying the motion. The
parties have briefed exceptions to the report, after review of which the Master
will deliver his final report. While the Company will vigorously defend itself
in this matter, there can be no assurance that this lawsuit will not have a
material adverse impact on its financial position.
The Company is the subject of a formal investigation by the SEC. The
investigation concerns, among other things, the restatement of the Company's
financial results for the fiscal year ended June 30, 2001 and the fiscal
quarters ended March 31, 2001 and December 31, 2001 (which have been previously
disclosed in the Company's amended quarterly and annual reports for such
periods), the Company's delay in filing its Form 10-K for Fiscal 2002 and 2003,
the Company's delay in filing its Form 10-Q for the quarter ended September 30,
2002 and the Company's past accounting and recordkeeping practices. The Company
had previously received informal, non-public inquiries from the SEC regarding
certain of these matters. The Company and its executives have complied fully
with the SEC's investigation and will continue to comply fully. The Company does
not believe that the investigation will have a material affect on the Company's
Consolidated Financial Statements.
Subsequent to an NASD examination of PCS, the NASD on August 12, 2005 accepted a
Letter of Acceptance, Waiver and Consent ("AWC") submitted by PCS, in which PCS
agreed to be censured and fined $200,000, and to recompense certain customers of
PCS who purchased mutual fund "B" shares. Without admitting or denying the
alleged violations, PCS agreed to the findings by the NASD that certain
supervisory deficiencies existed between June 2002 and July 2003. The acceptance
of the AWC concludes the matter.
Page 10
On September 6, 2005, the Company received an informal inquiry from the SEC
regarding annuity sales by the Company's registered representatives during the
period January 1, 2002 through August 1, 2005. The Company will cooperate fully
with the SEC in connection with this informal inquiry. Management believes that
a number of other broker-dealers have received similar informal inquiries. The
Company cannot predict whether the SEC will take any enforcement action against
the Company based on the annuity sales practices of the Company. The Company has
fully complied with all requests for documentation and will comply with any
further requests.
The Company and PCS are defendants and respondents in lawsuits and NASD
arbitrations in the ordinary course of business. On December 31, 2005, there
were 32 pending lawsuits and arbitrations, of which 14 were against PCS and/or
its registered representatives. In accordance with SFAS No. 5 "Accounting for
Contingencies," the Company has established liabilities for potential losses
from such complaints, legal actions, investigations and proceedings. In
establishing these liabilities, the Company's 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, 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. Management accrued $0.7
million as a reserve for potential settlements, judgments and awards. PCS has
errors & omissions coverage that will cover a portion of such matters. In
addition, under the PCS registered representatives contract, each registered
representative is responsible for covering costs in connection with these
claims. While the Company will vigorously defend itself 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 its financial position.
5. LIQUIDITY AND CASH FLOW
During the six months ended December 31, 2005, the Company incurred a net loss
of $1.7 million and at December 31, 2005 had a working capital deficit position
of $15.0 million. At December 31, 2005 the Company had $0.6 million of cash and
cash equivalents and $3.1 million of trade accounts receivables, net, to fund
short-term working capital requirements.
The Company believes that it has completed the necessary steps to meet its cash
flow requirements throughout Fiscal 2006 and 2007, though due to the seasonality
of the Company's business the Company may at times employ short term financing.
For the six months ended December 31, 2005, Prime Partners, Inc. ("Prime
Partners"), of which Michael P. Ryan, the Company's President, is a director, an
Officer and a significant shareholder, provided short-term demand loans to the
Company in the aggregate amount of $1.6 million for working capital purposes.
These loans pay 10% interest per annum. As of December 31, 2005, the Company
owed Prime Partners $1.8 million. On February 13, 2006, the Company owed Prime
Partners $1.6 million. Prime Partners has indicated to the Company that it may
demand some of the outstanding loan balance on or before April 15, 2006. There
can be no assurance that Prime Partners will extend further loans to the
Company. In the absence of loans from Prime Partners, the Company may not have
access to sufficient funds to meet its working capital needs.
6. ACQUISITIONS
On November 22, 2005, the Company entered into an asset purchase agreement to
purchase a tax practice. The purchase price is equal to a percentage of gross
revenue generated from the preparation of tax returns of the clients purchased
during the period November 22, 2005 through December 31, 2006. The Company paid
a down payment of $20,000 on November 22, 2005. The balance of the purchase
price will be paid in May 2006 and January 2007, based on the gross revenue
generated.
Page 11
7. BUSINESS COMBINATIONS AND SOLD OFFICES
The Company has financed the sale of five offices and two subsidiaries with the
receipt of notes to be paid over various terms up to 144 months. These notes
have guarantees from the respective office purchaser and certain default
provisions. Most of these notes are non-interest bearing and have been recorded
with an 8% discount, and one note bears interest at 9% per annum.
The scheduled payments for the balance of the term of these notes are as
follows:
2006 $ 129,951
2007 250,191
2008 236,578
2009 164,918
2010 139,530
Thereafter 459,475
-----------
Total $ 1,380,643
Less Allowance 279,939
-----------
Total $ 1,100,704
-----------
8. DEBT
The Company is in default on substantially all of its debt.
On December 26, 2001, the Company closed a $7.0 million financing (the "Loan")
with Wachovia. The Loan consisted of a $5.0 million term loan ("Term Loan") and
a $2.0 million revolving letter of credit ("Revolving Credit Loan"). On November
27, 2002, the Company and Wachovia entered into a forbearance agreement (the
"Forbearance Agreement") whereby Wachovia agreed to forbear from acting on
certain defaults of financial covenants by the Company under the Revolving
Credit Loan and under the Term Loan. Under the Forbearance Agreement and several
amendments thereto, Wachovia deleted several large pre-maturity principal
payments, increased the "Applicable Margin" to 4%, changed the Company's
reporting requirements under the Loan and extended the due date of the Loan (the
"Maturity Date") several times. Pursuant to Amendment No. 3 to the Forbearance
Agreement ("Amendment No. 3"), dated as of March 1, 2005, the amortization
schedule was extended by approximately 16 months and the Maturity Date was
extended to March 10, 2008. Under Amendment No. 3, the Company will pay Wachovia
principal on the Loan of $66,205.42 monthly, plus interest. The Company is in
technical default of several other provisions of the Loan, the Forbearance
Agreement and the amendments to Forbearance Agreement. However, the Company does
not believe that Wachovia will issue a note of default for any of these
technical defaults.
The Company's $5.0 million distribution financing agreement with Travelers
closed on November 1, 2000. On September 24, 2002, the Company received a notice
from Travelers alleging that the Company was in default under its distribution
financing agreement with Travelers due to nonpayment of a $0.1 million penalty
for failure to meet sales production requirements as specified in the
distribution financing agreement. The Company responded with a letter denying
that the Company was in default. Although the Traveler's notice stated that all
unpaid interest and principal under the distribution financing agreement were
immediately due and payable and that Travelers reserved its rights and remedies
under the distribution financing agreement, it also stated that Travelers
intended to comply with the terms of the Subordination Agreement between
Travelers and Wachovia. The Subordination Agreement greatly restricts the
remedies that Travelers could pursue against the Company. No further notices
have been received from Travelers. No payments have been made to Travelers since
April 2003. Pursuant to the terms of the Subordination Agreement and the
Forbearance Agreement, the Company is not permitted to make payments to
Travelers.
On October 30, 2001, the Company borrowed $1.0 million from Rappaport pursuant
to a written note without collateral and without stated interest. The Rappaport
Loan was due and payable on October 30, 2002. Additionally, the Rappaport Loan
provided that: Rappaport receive 100,000 shares of Rule 144 restricted common
stock of the Company upon the funding of the Rappaport Loan, subject to
adjustment so that the value of the 100,000 shares was $300,000 when the Rule
144 restrictions were removed; there was a penalty of 50,000 shares to be issued
Page 12
to Rappaport if the Rappaport Loan was not paid when due and an additional
penalty of 10,000 shares per month thereafter until the Rappaport Loan was paid
in full. On December 26, 2001, Rappaport agreed to subordinate the Rappaport
Loan to the $7.0 million Wachovia Loan. In consideration of the subordination,
the Rappaport Loan was modified by increasing the 10,000 shares penalty to
15,000 shares per month and by agreeing to issue 50,000 additional shares to
Rappaport if the Rappaport Loan was not paid in full by March 31, 2002, subject
to adjustment so that the value of the shares issued was $150,000 when the Rule
144 restrictions were removed. By June 30, 2005, Rappaport had received a total
of 1,345,298 shares for all interest and penalties. The Rappaport Loan, together
with 785,298 shares of Company common stock held by Rappaport, were sold to a
group of Company management and employees on April 29, 2005 for the amount of
$750,000. The Purchasing Group, as holders of the Rappaport Loan, are entitled
to receive, in the aggregate, as interest, 180,000 shares of the Company's
common stock annually while the debt remains unpaid. See also Note 1 to Notes to
Consolidated Financial Statements.
If the Company does not comply with the financial covenants and other
obligations in its agreements relating to the Wachovia, Travelers or Rappaport
loans, or its agreements with other lenders, and such lenders elected to pursue
their available remedies, the Company's operations and liquidity would be
materially adversely affected and the Company could be forced to cease
operations. The Company has retained a financial advisor to assist the Company
in further discussions with its lenders. The financial advisor was involved in
the Company's discussions with Wachovia that resulted in the Amendment No. 3
described above. There can be no guarantee, however, that the lenders will agree
to terms in the future that are more favorable to the Company than the current
arrangements with the lenders.
9. STOCK BASED COMPENSATION
In December 2004, the Financial Accounting Standards Board issued SFAS 123-R.
SFAS 123-R is a revision of SFAS No. 123, as amended, Accounting for Stock-Based
Compensation ("SFAS 123"), and supersedes Accounting Principles Board Opinion
("APB") No. 25, Accounting for Stock Issued to Employees ("APB 25"). SFAS 123-R
eliminates the alternative to use the intrinsic value method of accounting that
was provided in SFAS 123, which generally resulted in no compensation expense
recorded in the financial statements related to the issuance of stock options.
SFAS 123-R requires that the cost resulting from all share-based payment
transactions be recognized in the financial statements. SFAS 123-R establishes
fair value as the measurement objective in accounting for share-based payment
arrangements and requires all companies to apply a fair-value-based measurement
method in accounting for generally all share-based payment transactions with
employees.
On July 1, 2005 (the first day of its 2006 fiscal year), the Company adopted
SFAS 123-R. The Company adopted SFAS 123-R using a modified prospective
application, as permitted under SFAS 123-R. Accordingly, prior period amounts
have not been restated. Under this application, the Company is required to
record compensation expense 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. Per the provisions of SFAS 123-R, the
Company has adopted the policy to recognize compensation expense on a
straight-line attribution method.
Prior to 2000, the Company accounted for plans under the recognition and
measurement provisions of APB 25, and related Interpretations. Effective July 1,
2000, the Company adopted the fair value recognition provisions of SFAS No. 123,
"Accounting for Stock-based Compensation", prospectively to all employee awards
granted, modified, or settled after January 1, 2002. Awards under the Company's
plans vest over periods ranging from immediately to five years. Therefore, the
cost related to stock-based employee compensation included in the determination
of net income for the six months ended December 31, 2005 and 2004 is less than
that which would have been recognized if the fair value based method had been
applied to all awards since the original effective date of SFAS No. 123. The
following table illustrates the effect on net income and earnings per share if
the fair value based method had been applied to all outstanding and unvested
awards in each period under SFAS No. 123. The reported and pro forma net income
and earnings per share for the three months and the six months ended December
31, 2005 in the table below are the same since compensation expense is
calculated under the provisions of FAS 123-R. These amounts for the three months
and the six months ended 2005 are included in the table below only to provide
the detail for a comparative presentation to the three months and the six months
ended December 31, 2004.
Page 13
For the three months ended For the six months ended
December 31, December 31,
2005 2004 2005 2004
-----------------------------------------------------------------
Net Loss as reported $ (566,831) $ (32,386) $ (1,722,173) $ (1,256,093)
Add: Stock-based employee compensation
expenses included in reported net
loss, net of related tax effects 33 -- 322 --
Deduct: Total stock-based compensation
expense determined under fair value based
method for all awards, net of related taxes (33) (14,902) (322) (34,149)
-----------------------------------------------------------------
Proforma Net Loss $ (566,831) $ (47,288) $ (1,722,173) $ (1,290,242)
Basic and diluted earnings/(loss) per share:
As reported - Basic $ (0.06) $ (0.00) $ (0.19) $ (0.14)
Proforma - Basic $ (0.06) $ (0.01) $ (0.19) $ (0.14)
As reported - Diluted $ (0.06) $ (0.00) $ (0.19) $ (0.14)
Proforma - Diluted $ (0.06) $ (0.01) $ (0.19) $ (0.14)
The effects of applying SFAS No. 123 in the proforma net loss disclosures above
are not likely to be representative of the effects on proforma disclosures of
future years.
Changes in the Company's stock option activity during the six months ended
December 31, 2005 were as follows:
Outstanding at June 30, 2005 1,709,950
Grants
Canceled (113,828)
Expired (222,622)
Exercised --
----------
Outstanding - December 31, 2005 1,373,500
Exercisable - December 31, 2005 1,373,500
During the six months ended December 31, 2005, the Company issued no shares of
stock in connection with earnout agreements associated with the acquisition of
client lists.
10. RELATED PARTY TRANSACTIONS
For the six months ended December 31, 2005, Prime Partners, of which Michael
Ryan, the Company's President, is a director, an Officer and a significant
shareholder, provided short term loans to the Company in the aggregate amount of
$1.6 million for working capital purposes. These loans pay 10% interest per
annum. As of December 31, 2005, the Company owed Prime Partners $1.8 million.
See Note 1 to Notes to Consolidated Financial Statements for a description of
the purchase of the Rappaport Loan by a group of Company management and
employees.
Page 14
11. SUBSEQUENT EVENTS
On January 20, 2006, the Company entered into an asset purchase agreement to
purchase a tax practice. The purchase price is equal to a percentage of gross
revenue generated from the preparation of tax returns of the clients purchased
during the period January 20, 2006 through December 31, 2006, or $0.2 million,
whichever is greater. The Company paid a down payment of $75,000 on January 20,
2006. The balance of the purchase price will be paid in July 2006 and March
2007, based on the gross revenue generated, or $0.2 million, whichever is
greater.
Effective January 31, 2006, Christopher Kelly resigned as General Counsel of the
Company. The Company has hired a new General Counsel, Daniel Wieneke, whose
anticipated start date is late February 2006.
On February 13, 2006, the Company owed Prime Partners $1.6 millon in short-term
demand loans. Prime Partners has indicated to the Company that it may demand
some of the outstanding loan balance on or before April 15, 2006. There can be
no assurance that Prime Partners will extend further loans to the Company. In
the absence of loans from Prime Partners, the Company may not have access to
sufficient funds to meet its working capital needs.
12. RESTATEMENTS
In May 2006, management concluded that its previously issued financial
statements for its interim financial statements contained in its Form 10-Q for
the quarter ended December 31, 2005 should not be relied upon because of certain
grouping and presentation errors contained therein. The Company made these
determinations based on discussions with the Staff of the Division of
Corporation Finance of the Securities and Exchange Commission (the "Commission")
regarding certain accounting matters raised during a Staff review of the
Company's periodic filings. The grouping and presentation errors include the
following:
o The Company's consolidated statement of cash flow contained a grouping
error; the line item titled Receivables from Officers, Shareholders and
Employees was reclassified from operating activities to investing
activities.
As a result the following restatements were made for each period presented
on the Consolidated Statement of Cash Flows:
o For the Six Months Ended December 31, 2005; (1) net cash used
in operating activities was restated from $507,397 to
$474,369, a decrease in net cash used in operating activities
of $33,028; and (2) net cash used in investing activities was
restated from $134,585 to $167,613, an increase in net cash
used in investing activities of $33,028;
o For the Six Months Ended December 31, 2004; (1) net cash used
in operating activities was restated from $29,450 to $127,925,
an increase in net cash used in operating activities of
$98,475; and (2) net cash provided by investing activities was
restated from $144,900 to $243,375, an increase in net cash
provided by investing activities of $98,475.
o The Company's stock based compensation table contained an error in Note 9
of the Company's Notes to Consolidated Financial Statements. The
exercisable number of options outstanding at December 31, 2005 should have
been 1,373,500 an increase of 210,000 for options that were actually
vested.
The Company has quantified the impact of these errors on the financial
statements and there is no impact to the Company's net income/(loss) for the
relevant periods.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The information contained in this Form 10-Q and the exhibits hereto may contain
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933 (the "Securities Act") and Section 21E of the Securities Exchange
Act of 1934 (the "Exchange Act"). Such statements, including statements
regarding the implementation and impact of accounting treatments, working
capital needs and sources, the effects of defaults under the Company's loan
arrangements, expectations regarding the sale of Company assets, expenses,
estimates of timing for and contributions to future profitability, if any, the
effects of the Company's delisting from Nasdaq, resources necessary to comply
with Sarbanes-Oxley Section 404, and effects of the SEC's investigation of the
Company, the Company's product mix and its emphasis on certain products, and the
Company's revenues and the seasonal nature of its revenues are based upon
current information, expectations, estimates and projections regarding the
Company, the industries and markets in which the Company operates, and
management's assumptions and beliefs relating thereto. Words such as "will,"
"plan," "expect," "remain," "intend," "estimate," "approximate," and variations
thereof and similar expressions are intended to identify such forward-looking
statements. These statements speak only as of the date on which they are made,
are not guarantees of future performance, and involve certain risks,
uncertainties and assumptions that are difficult to predict. Therefore, actual
outcomes and results could materially differ from what is expressed, implied or
forecast in such forward-looking statements. Such differences could be caused by
a number of factors including, but not limited to, the uncertainty of laws,
legislation, regulations, supervision and licensing by federal, state and local
authorities and their impact on the lines of business in which the Company and
its subsidiaries are involved; unforeseen compliance costs; changes in economic,
political or regulatory environments; the impact on the Company if one or more
of the Company's lenders elects to pursue its available remedies as a result of
the Company's default under applicable loan documents with such lender; changes
in competition and the effects of such changes; the departure of key Company
personnel; the inability to implement the Company's strategies; changes in
management and management strategies; the Company's inability to successfully
design, create, modify and operate its computer systems and networks;
litigation, arbitration and investigations involving the Company; decreased
liquidity and share price and difficulty raising capital, resulting from our
delisting from Nasdaq and other factors; the impact of our delisting from Nasdaq
on our business generally and on our share price and the trading market in our
securities; internal control deficiencies and the Company's potential inability
to remedy them; and risks described from time to time in reports and
registration statements filed by the Company and its subsidiaries with the SEC.
Readers should take these factors into account in evaluating any such
forward-looking statements. The Company undertakes no obligation to update
publicly or revise any forward-looking statements, whether as a result of new
information, future events or otherwise. The reader should, however, consult
further disclosures the Company may make in future filings of its Annual Report
on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K.
Where appropriate, prior years financial statements reflect reclassifications to
conform to the current year presentation.
The following discussion should be read in conjunction with the Company's
Consolidated Financial Statements and related Notes thereto set forth in Item 1.
"Financial Statements".
Page 15
OVERVIEW
The Company provides federal, state and local tax preparation services to
individuals, predominantly in the middle and upper income tax brackets, and
financial planning services, including securities brokerage, insurance and
mortgage agency services. In Fiscal 2005, 88.0% of the Company's revenues were
derived from commissions on financial planning services and 12.0% were derived
from fees for tax preparation services. For the six months ended December 31,
2005, 97.0% of the Company's revenues were derived from commissions on financial
planning services and 3.0% were earned from fees for tax preparation services.
As of December 31, 2005, the Company had 34 offices operating in four states
(New York, New Jersey, Connecticut and Florida).
The Company provides financial planning services through its 34 Company owned
offices and through independently owned and operated financial planning offices.
The Company's financial planning clients generally are introduced to the Company
through the Company's tax return preparation services and educational workshops.
The Company believes that its tax preparation business is inextricably
intertwined with its financial planning activities. The independent offices use
a variety of marketing tools to attract new clients. Future profitability will
likely come from the two channels leveraging off each other, improving client
base retention and growth.
All of the Company's financial planners are employees or independent contractors
of the Company and registered representatives of Prime Capital Services, Inc.
("PCS"), a wholly owned subsidiary of the Company. PCS conducts a securities
brokerage business providing regulatory oversight and products and sales support
to its registered representatives, who provide investment products and 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 National
Association of Securities Dealers, Inc. ("NASD"). The Company also has a wholly
owned subsidiary, Asset & Financial Planning, Ltd. ("AFP"), which is registered
with the SEC as an investment advisor. Almost all of the financial planners are
also authorized agents of insurance underwriters. The Company is also a licensed
mortgage broker. As a result, the Company also earns revenues from commissions
for acting as an insurance agent and a mortgage broker. The Company has the
ability to process insurance business through Prime Financial Services, Inc.
("PFS"), its wholly owned subsidiary, which is a licensed insurance broker, as
well as through other licensed insurance brokers.
A majority of the financial planners located in Company offices are also tax
preparers. The Company's tax preparation business is conducted predominantly in
February, March and April. During the tax season, the Company significantly
increases the number of employees involved in tax preparation. During the 2005
tax season, the Company prepared approximately 26,000 United States tax returns.
During the three months ended December 31, 2005, the Company had a loss from
continuing operations before other income and expenses of $0.3 million compared
to a gain of $0.1 million during the three months ended December 31, 2004.
At December 31, 2005 the Company had a working capital deficit of $15.0 million.
At December 31, 2005 the Company had $0.6 million of cash and cash equivalents
and $3.1 million of trade accounts receivables, net, to fund short-term working
capital requirements.
The Company believes that it has completed the necessary steps to meet its cash
flow requirements for the fiscal years ending June 30, 2006 and 2007, though due
to the seasonality of the Company's business the Company may at times employ
short-term financing. See Note 9 of Notes to Consolidated Financial Statements
included in the Fiscal 2005 10-K for a discussion of the Company's debt.
If the Company does not comply with the financial covenants and other
obligations in its agreements relating to the Wachovia, Travelers or Rappaport
loans, or its agreements with other lenders, and such lenders elected to pursue
their available remedies, the Company's operations and liquidity would be
materially adversely affected and the Company could be forced to cease
operations. The Company has retained a financial advisor to assist the Company
in further discussions with its lenders. The financial advisor was involved in
the Company's discussions with Wachovia that resulted in Amendment No. 3 (see
Note 8 to Notes to Consolidated Financial Statements). There can be no
guarantee, however, that the lenders will agree to terms in the future that are
more favorable to the Company than the current arrangements with the lenders.
Page 16
The Company continues to redefine its product mix, placing a smaller emphasis on
the sale of annuities, while putting a greater emphasis on the sale of other
financial products that generate recurring income. The Company expects that this
trend will continue in future quarters. The Company is attempting to increase
revenue by, among other things, implementing its recently reestablished
representative recruiting program. If this program is not successful in
generating additional revenue, the anticipated decreases in the sales of
annuities, which typically generate higher upfront commissions, may result in
continued downward pressure on total revenues in future quarters until the
Company starts to more significantly benefit from the affect of the greater sale
of products that generate recurring income. The Company expects that it will
continue to control levels of salary and general and administrative expenses,
while increasing spending on marketing efforts to build brand awareness and
attract new clients. The Company cannot predict whether its marketing efforts
will have the desired effects.
Except as noted, the numbers and explanations presented below represent results
from continuing operations only.
RESULTS OF OPERATIONS - THREE MONTHS ENDED DECEMBER 31, 2005 COMPARED TO THREE
MONTHS ENDED DECEMBER 31, 2004
The following table presents revenue by product line:
Unaudited
For the Three Months Ended December 31,
Revenue by Product Line 2005 2004 % Variance
--------------------------------------------
Brokerage $ 8,539,782 $ 9,666,459 -11.7%
Insurance 200,556 956,795 -79.0%
Advisory 2,241,299 2,012,732 11.4%
Tax 320,987 436,930 -26.5%
Lending Services 174,694 124,995 39.8%
Marketing 70,115 195,012 -64.0%
--------------------------------------------
Total $11,547,433 $13,392,923 -13.8%
============================================
The following table presents brokerage revenue by product type:
Brokerage Revenue by Product Type
Mutual Funds $ 1,283,340 $ 1,342,262 -4.4%
Equities, Bonds & UIT 289,321 335,976 -13.9%
Annuities 4,588,704 6,074,813 -24.5%
Limited Partnerships 56,775 85,621 -33.7%
Variable Life 78,767 86,775 -9.2%
Trails 1,864,231 1,351,234 38.0%
Miscellaneous Income 121,171 44,659 171.3%
Gain/Loss Firm Trading 227,969 355,448 -35.9%
Unrealized Gain/(Loss) on Firm Trading 29,504 (10,329) 385.6%
-------------------------------------
Total $ 8,539,782 $ 9,666,459 -11.7%
=====================================
The Company's total revenues for the three months ended December 31, 2005 were
$11.5 million compared to $13.4 million for the three months ended December 31,
2004, a decrease of $1.8 million or 13.8%. The majority of this decrease was
attributable to a decrease in revenues from the Company's annuity and insurance
business. The volatility of the insurance revenue is indicative of the fact that
the Company's insurance department tends to focus on large premium cases.
Page 17
The Company's total revenues for the three months ended December 31, 2005
consisted of $11.2 million for financial planning services and $0.3 million for
tax preparation services. Financial planning services represented 97.0% and tax
preparation services represented 3.0% of the Company's total revenues during the
three months ended December 31, 2005. The Company's total revenues for the three
months ended December 31, 2004 consisted of $13.0 million for financial planning
services and $0.4 million for tax preparation services. Financial planning
services represented 97.0% and tax preparation fees represented 3.0% of the
Company's total revenues during the three months ended December 31, 2004.
The Company continues to redefine its product mix, placing a smaller emphasis on
annuities, while increasing sales of other financial products that generate
recurring income. This emphasis is evidenced by this quarter's results,
including a $1.1 million decline in brokerage revenue, resulting largely from a
$1.5 million decline in annuity revenue, which was offset by a net increase of
$0.4 million from every major brokerage services product type, other than
annuities, compared with the same quarter last year.
For the three months ended December 31, 2005, revenues from annuity sales were
$4.6 million compared with $6.1 million in the same quarter last year,
representing a 24.5% drop in annuity revenue. The decline in revenue from
annuity sales is consistent with the Company's goal of having a more level
recurring revenue stream.
For the three months ended December 31, 2005, revenues from recurring revenue
sources (advisory and trails) increased to $4.1 million, up $0.7 million from
$3.4 million for the three months ended December 31, 2004, representing a 22.0%
increase in recurring revenue. The increase in recurring revenues is the result
of higher assets under management and assets under custody.
As indicated in the following table, as of December 31, 2005, assets under AFP
management increased $47.6 million, to $560.2 million, up from $512.6 million
for the same period last year. This increase is attributable to increases in
assets under management, as well as market fluctuations. As of December 31,
2005, total Company assets under custody were $4.3 billion, up $164.5 million
from the fiscal year ended June 30, 2005.
The following table presents the market values of assets under AFP management:
Market Value as of December 31,
2005 2004 % Variance
------------------------------------------
Annuities 340,330,253 334,828,541 1.6%
Brokerage 219,871,338 177,756,764 23.7%
------------------------------------------
Total Assets Under Management $560,201,591 $512,585,305 9.3%
==========================================
The following table presents the market values of total Company assets under
custody:
Total Company
Market Value as of Assets Under Custody
------------------ ---------------------
12/31/2005 $4,262,634,300
9/30/2005 4,232,288,300
6/30/2005 4,098,175,100
12/31/2004 3,996,890,000
9/30/2004 3,775,395,900
The Company's commission expense for the three months ended December 31, 2005
was $6.6 million, a decrease of $1.5 million or 18.3% from $8.1 million for the
three months ended December 31, 2004. This decrease is attributable to decreased
financial planning revenue resulting primarily from decreased sales of annuities
and insurance products.
The Company's other operating expenses for the three months ended December 31,
2005 was $5.3 million or 46.1% of revenues, an increase of 2.2%, compared to
$5.2 million or 38.9% of revenues for the three months ended December 31, 2004.
The increase in operating expenses was attributable to an increase in general
Page 18
and administrative, rent and advertising, partially offset by decreases in
salaries, brokerage fees and licenses and depreciation and amortization.
General and administrative expenses increased by 34.5% in the three months ended
December 31, 2005 compared with the same period last year. This increase is
primarily attributable to increases in professional fees attributable to
litigation and increased insurance expense.
Rent expense increased 35.3% to $0.6 million for the three months ended December
31, 2005 compared with $0.4 million for the same period last year. Rent has been
increasing as the Company relocated an office to the Greenvale section of Nassau
County, Long Island, and opened new offices in Ft. Lauderdale, Florida and
Williamsville, New York, larger more prominent retail locations which are
generally more expensive to lease.
Advertising expenses increased 90.8% to $0.3 million in the three months ended
December 31, 2005. This increase is primarily attributable to the outsourcing of
the Company's telemarketing efforts. The increased expense from outsourcing,
however, was partially offset by a decrease in salaries for telemarketing staff.
Salaries decreased by $0.5 million, or 21.3% in the three months ended December
31, 2005 compared with the same period last year. This decrease is attributable
to outsourcing the telemarketing center, continued efforts to reduce
administrative salary costs and decreased contributions by the Company to health
care costs due to greater health care contributions from the Company's
representatives.
Brokerage fees and licenses were $0.3 million for the three months ended
December 31, 2005, compared with $0.4 million for the same period last year.
This decrease is mostly attributable to the benefits from the renewed clearing
agreement executed in September 2005.
The Company's loss from continuing operations before other income and expenses
for the three months ended December 31, 2005 was $0.3 million compared with
income of $0.1 million for the three months ended December 31, 2004, an
increased loss of $0.5 million. This increased loss was primarily attributable
to decreased financial planning revenue and increases in advertising expenses
due to the outsourcing of the telemarketing center as well as increases in
professional fees attributable to litigation.
The Company's loss from continuing operations for the three months ended
December 31, 2005 was $0.6 million compared with a loss of $32, 386 for the
three months ended December 31, 2004, an increased loss of $0.5 million. This
increased loss was primarily attributable to decreased financial planning
revenue, increases in advertising expenses due to the outsourcing of the
telemarketing center, increases in professional fees attributable to litigation,
and slightly higher interest expense.
Page 19
RESULTS OF OPERATIONS - SIX MONTHS ENDED DECEMBER 31, 2005 COMPARED TO SIX
MONTHS ENDED DECEMBER 31, 2004
The following table presents revenue by product line:
Unaudited
For the Six Months Ended December 31,
Revenue by Product Line 2005 2004 % Variance
-----------------------------------------------
Brokerage $17,042,247 $18,316,839 -7.0%
Insurance 952,105 1,662,971 -42.7%
Advisory 4,441,290 4,181,540 6.2%
Tax 783,814 953,991 -17.8%
Lending Services 379,016 333,799 13.5%
Marketing 439,391 673,782 -34.8%
-----------------------------------------------
Total $24,037,863 $26,122,922 -8.0%
===============================================
The following table presents brokerage revenue by product type:
Brokerage Revenue by Product Type
Mutual Funds $ 2,535,957 $ 2,410,824 5.2%
Equities, Bonds & UIT 618,450 605,093 2.2%
Annuities 9,585,135 11,603,109 -17.4%
Limited Partnerships 148,791 98,811 50.6%
Variable Life 151,579 112,424 34.8%
Trails 3,316,057 2,682,339 23.6%
Miscellaneous Income 148,016 80,186 84.6%
Gain/Loss Firm Trading 513,964 672,464 -23.6%
Unrealized Gain/(Loss) on Firm Trading 24,298 51,589 -52.9%
-----------------------------------------------
Total $17,042,247 $18,316,839 -7.0%
===============================================
The Company's total revenues for the six months ended December 31, 2005 were
$24.0 million compared to $26.1 million for the six months ended December 31,
2004, a decrease of $2.1 million or 8.0%. The majority of this decrease was
attributable to a decrease in revenues from the Company's annuity and insurance
business.
The Company's total revenues for the six months ended December 31, 2005
consisted of $23.3 million for financial planning services and $0.8 million for
tax preparation services. Financial planning services represented 97.0% and tax
preparation services represented 3.0% of the Company's total revenues during the
six months ended December 31, 2005. The Company's total revenues for the six
months ended December 31, 2004 consisted of $25.2 million for financial planning
services and $1.0 million for tax preparation services. Financial planning
services represented 96.0% and tax preparation fees represented 4.0% of the
Company's total revenues during the six months ended December 31, 2004.
The Company continues to redefine its product mix, placing a smaller emphasis on
annuities, while increasing sales of other financial products that generate
recurring income. This emphasis is evidenced by the Company's results for the
six months results ending December 31, 2005, where by revenues from every major
brokerage services product type, other than annuities, increased compared with
the same period last year.
For the six months ended December 31, 2005, revenues from annuity sales were
$9.6 million compared with $11.6 million for the same six months last year,
representing a 17.4 % drop in annuity revenue. The decline in revenue from
annuity sales is consistent with the Company's goal of having a more level
recurring revenue stream.
For the six months ended December 31, 2005, revenues from recurring revenue
sources (advisory and trails) increased to $7.8 million, up $0.9 million from
$6.9 million for the six months ended December 31, 2004, representing a 13.0%
increase in recurring revenue. The increase in recurring revenues is the result
of higher assets under management and assets under custody.
The Company's commission expense for the six months ended December 31, 2005 was
$14.3 million, a decrease of $1.7 million or 10.4% from $16.0 million for the
six months ended December 31, 2004. This decrease is attributable to decreased
financial planning revenue resulting primarily from decreased sales of annuities
and insurance products.
The Company's other operating expenses for the six months ended December 31,
2005 was $11.1 million or 46.0% of revenues, flat compared to $11.1 million or
42.6% of revenues for the six months ended December 31, 2004. Other operating
expenses remained flat mostly due to lower salaries year over year, offset by
increases in general and administrative costs, rent and advertising compared
with last year.
Page 20
Salaries decreased by $0.7 million, or 14.0% in the six months ended December
31, 2005 compared with the same period last year. This decrease is attributable
to outsourcing the telemarketing center, continued efforts to reduce
administrative salary costs and decreased contributions by the Company to health
care costs due to greater health care contributions from the Company's
representatives.
Rent expense increased 22.0% to $1.1 million for the six months ended December
31, 2005 compared with the same period last year. Rent has been increasing as
the Company relocated an office to the Greenvale section of Nassau County, Long
Island, and opened new offices in Ft. Lauderdale, Florida and Williamsville, New
York, larger more prominent retail locations which are generally more expensive
to lease.
Advertising expenses increased 37.8% to $0.7 million in the six months ended
December 31, 2005 compared with $0.5 million for the six months ended December
31, 2004. This increase is primarily attributable to the outsourcing of the
Company's telemarketing efforts. The increased expense from outsourcing,
however, was partially offset by a decrease in salaries for telemarketing staff.
General and administrative expenses increased by 10.1% in the six months ended
December 31, 2005 compared with the same period last year. This increase is
primarily attributable to increases in professional fees attributable to
litigation.
The Company's loss from continuing operations before other income and expenses
for the six months ended December 31, 2005 was $1.3 million compared with $1.0
million for the six months ended December 31, 2004, an increased loss of $0.4
million. This increased loss was primarily attributable to decreased financial
planning revenue mostly in annuities and the insurance product line, offset
slightly by favorability in operating expenses.
The Company's loss from continuing operations for the six months ended December
31, 2005 was $1.7 million compared with $1.3 million for the six months ended
December 31, 2004, an increased loss of $0.5 million. This increased loss was
primarily attributable to decreased financial planning revenue, lower interest
and investment income and other income, and slightly higher interest expense.
LIQUIDITY AND CAPITAL RESOURCES
The Company's revenues have been, and are expected to continue to be,
significantly seasonal. As a result, the Company must generate sufficient cash
during the tax season to fund any operating cash flow deficits in the first half
of the following fiscal year. Operations during the non-tax season are primarily
focused on financial planning services along with some ongoing accounting and
corporate tax revenue. Since its inception, the Company has utilized funds from
operations and borrowings to support operations and finance working capital
requirements. As of December 31, 2005 the Company had $0.6 million in cash and
cash equivalents and $0.3 million in marketable securities. 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 December 31, 2005 the Company was in compliance with this regulation.
The Company believes that it has completed the necessary steps to meet its cash
flow requirements throughout Fiscal 2006 and 2007, though due to the seasonality
of the Company's business the Company may at times employ short term financing.
Due to the Company's defaults on its credit facilities (see Note 8 to Notes to
Consolidated Financial Statements), the Company has not had access to banks or
other lenders or the capital markets generally for access to capital. Since
2002, the Company's only source of loan financing has been Prime Partners, of
which Michael Ryan, the Company's President, is a director, an Officer and a
significant shareholder. For the three months ended December 31, 2005, Prime
Partners loaned the Company an additional $1.0 million. These loans pay 10%
interest per annum. As of December 31, 2005, the Company owed Prime Partners
$1.8 million. There can be no assurance that Prime Partners will extend further
loans to the Company. In the absence of loans from Prime Partners, the Company
may not have access to sufficient funds to meet its working capital needs.
Page 21
On February 17, 2004, the Company closed the sale of all of the stock of North
Ridge Securities Group and North Shore Capital Management Corp. The Company
received $0.2 million in cash at the closing, $37,500 was paid to Wachovia
against the principal of the Wachovia Loan, and the $0.9 million balance is to
be paid to the Company by the purchaser in monthly payments pursuant to the
terms of a promissory note maturing on April 1, 2016. The interest rate on the
note is equal to the prime rate at JP Morgan Chase Bank plus 2%, but the
interest rate cannot exceed 8% until January 1, 2009.
As of August 5, 2005, the Company sold its tax preparation and financial
planning businesses associated with its Colorado Springs, Colorado office. The
tax preparation business was sold to former employees of the Company for total
consideration of $0.4 million, $0.1 million of which was paid in cash to the
Company at closing, and $0.3 million of which is subject to a promissory note
that matures on January 1, 2012. The financial planning business was sold to a
former employee of the Company for total consideration of $47,100, $23,600 of
which was paid in cash to the Company at closing, and $23,600 of which was
subject to a promissory note that matured and was paid on October 1, 2005.
In view of the Company's efforts to increase revenues, the Company does not
currently anticipate selling significant amounts of additional assets.
Accordingly, the Company does not anticipate receiving significant funds in the
near future from asset sales to meet its working capital needs.
The Company's net cash used in operating activities was $0.5 million for the six
months ended December 31, 2005, compared with net cash used in operating
activities of $0.1 million for the six months ended December 31, 2004. The
increase of $0.3 million in net cash used in operating activities was primarily
attributable to lower earnings for the six months ended December 31, 2005, the
higher levels of prepaid expenses at December 31, 2005 and declines in
marketable securities due to a reduced number of positions held by the Company's
bond traders as of December 31, 2005, partially offset by increases in other
liabilities as of December 31, 2005.
Net cash used in investing activities was $0.2 million for the six months ended
December 31, 2005 compared to net cash provided by investing activities of $0.2
million for the six months ended December 31, 2004. The decrease was
attributable to increased capital expenditures related to the opening of the
Company's new office locations, offset by a larger gain from the sale of
property and equipment in the six months ended December 31, 2004.
The Company's cash flows provided by financing activities were $0.6 million for
the six months ended December 31, 2005, compared with cash flows used in
financing activities of $30,192 for the six months ended December 31, 2004. The
improvement is due primarily to lower principal payments on bank loans.
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
The Company has renewed its clearing agreement for a five-year term beginning
September 2005. The economic terms will be amortized over the five-year term of
this agreement ratably.
There are no off balance sheet changes that need to be disclosed.
MARKET FOR COMPANY'S COMMON EQUITY
The shares of the Company's common stock were delisted from The Nasdaq National
Market in August 2002 and are now traded on what is commonly referred to as the
"pink sheets". As a result, an investor may find it more difficult to dispose of
or obtain accurate quotations as to the market value of the securities. In
addition, the Company is subject to Rule 15c2-11 promulgated by the SEC. If the
Company fails to meet criteria set forth in such Rule (for example, by failing
to file periodic reports as required by the Exchange Act), various practice
requirements are imposed on broker-dealers who sell securities governed by the
Rule to persons other than established customers and accredited investors. For
these types of transactions, the broker-dealer must make a special suitability
determination for the purchaser and have received the purchaser's written
consent to the transactions prior to sale. Consequently, the Rule may have a
Page 22
material adverse effect on the ability of broker-dealers to sell the Company's
securities, which may materially affect the ability of shareholders to sell the
securities in the secondary market. The delisting could make trading the
Company's shares more difficult for investors, potentially leading to further
declines in the share price. It would also make it more difficult for the
Company to raise additional capital. Due to the delisting, the Company would
also incur additional costs under state blue-sky laws if the Company were to
sell equity.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
To date, the Company's exposure to market risk has been limited and it is not
currently hedging any market risk, although it may do so in the future. The
Company does not hold or issue any derivative financial instruments for trading
or other speculative purposes. The Company is exposed to market risk associated
with changes in the fair market value of the marketable securities that it
holds. The Company's revenue and profitability may be adversely affected by
declines in the volume of securities transactions and in market liquidity, which
generally result in lower revenues from trading activities and commissions.
Lower securities price levels may also result in a reduced volume of
transactions, as well as losses from declines in the market value of securities
held by the Company in trading and investment positions. Sudden sharp declines
in market values of securities and the failure of issuers and counterparts to
perform their obligations can result in illiquid markets in which the Company
may incur losses in its principal trading activities.
The Company's obligations under its Wachovia and Travelers credit facilities
bear interest at floating rates and therefore, the Company is impacted by
changes in prevailing interest rates.
ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
In performing its audit of our Consolidated Financial Statements for Fiscal
2005, our former independent auditors, Radin Glass & Co., LLP ("Radin Glass"),
notified our Board of Directors of several reportable conditions in internal
controls under standards established by the American Institute of Certified
Public Accountants. Reportable conditions involve matters coming to the
attention of our auditors relating to significant deficiencies in the design or
operation of internal controls that, in their judgment, could adversely affect
our ability to record, process, summarize, and report financial data consistent
with the assertions of management in the consolidated financial statements.
Radin Glass stated that, while none of the items identified by them individually
are individually a material weakness, the combined effect of these issues and
the inability to produce timely and accurate financial statements is a material
weakness.
Although Radin Glass noted significant improvements in the structure of the
accounting department, and designed its audit procedures to address the matters
described below in order to obtain reasonable assurance that the financial
statements are free of material misstatement and to issue an unqualified audit
report, certain of the internal control deficiencies noted by Radin Glass had
been noted in their internal control letter regarding the Company's Consolidated
Financial Statements for Fiscal 2004. In Fiscal 2005, Radin Glass, while noting
some improvements have been made in the Company's internal controls, still
identified a number of internal control deficiencies and the Company continues
to work to remedy those deficiencies.
These significant deficiencies in the design and operation of our internal
controls included (i) the need to hire additional staffing and change the
structure of the finance/accounting department in order to provide better
coordination and communication between the legal and finance/accounting
departments; (ii) the need to provide training to existing and new personnel in
SEC reporting requirements; (iii) the lack of integration of the general ledger
system with other recordkeeping systems; (iv) the need for formal control
systems for journal entries and closing procedures; (v) the need to document
internal controls over financial reporting; and (vi) the needs to form an
independent audit committee, an internal audit department and to provide
internal review procedures for schedules, SEC reports and filings prior to
submission to the auditors and/or filing with the SEC.
Page 23
Management believes that such deficiencies represent a material weakness in
internal control over financial reporting that, by themselves or in combination,
result in a more likelihood that a material misstatement in our financial
statements will not be prevented or detected by our employees in the normal
course of performing their assigned functions.
The Company continues its efforts to remediate these conditions and has and will
continue to implement enhanced procedures to accelerate improvement of its
internal controls. For example, (a) the Company continues to implement specific
changes in its internal controls with more formalized, structured and timely
review and analysis of journal entries, accounting data and reports prepared,(b)
has submitted SEC filings within the prescribed due dates for the last eight
quarters, (c) hired a new General Counsel with SEC significant knowledge,
replaced accounting staff and hired a Controller with SEC significant knowledge.
The Company's 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 the Company in the reports that it files or submits 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 or
officers and principal financial officers, as appropriate, to allow timely
decisions regarding required disclosure.
The Company has carried out an evaluation as of the end of the quarter ended
December 31, 2005 under the supervision and with the participation of the
Company's management, including its Chief Executive Officer and Chief Accounting
Officer, of the disclosure controls and procedures of the Company as defined in
Exchange Act Rule 13(a)-15(e). In designing and evaluating disclosure controls
and procedures, the Company and its 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. Due to
the material weakness in internal control over financial reporting previously
noted and insufficient passage of time to test the enacted changes to determine
if such changes are effective as at and prior to December 31, 2005, hence
management concludes that the Company's disclosure controls and procedures are
ineffective.
Changing laws, regulations and standards relating to corporate governance and
public disclosure, including the Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley"),
and newly enacted SEC regulations have created additional compliance
requirements for companies such as ours. We are committed to maintaining high
standards of internal controls over financial reporting, corporate governance
and public disclosure. As a result, we intend to invest appropriate resources to
comply with evolving standards, and this investment may result in increased
general and administrative expenses and a diversion of management time and
attention from revenue-generating activities to compliance activities. In
particular, a great deal of management time and attention will be required to
comply on a timely basis with the internal control requirements of Section 404
of Sarbanes-Oxley, and without significant additional staff or resources it will
be difficult to achieve timely compliance.
Changes in Internal Controls
Except as described above, no change occurred in the Company's internal controls
concerning financial reporting during the quarter ended December 31, 2005 that
has materially affected or is reasonably likely to materially affect the
Company's internal controls over financial reporting.
PART II - OTHER INFORMATION
ITEM 1A. RISK FACTORS
Significant Deficiencies in Internal Controls Over Financial Reporting;
Increased Compliance Expense
Page 24
The Company was advised by its former outside auditors Radin Glass of the
existence of certain reportable conditions involving significant deficiencies in
the design and operation of the Company's internal controls over financial
reporting that could adversely affect the Company's ability to record, process,
summarize and report financial data consistent with the assertions of management
in the financial statements. Although none of these conditions individually
constitutes a material weakness, collectively, these deficiencies and the
Company's inability to produce timely accurate financial statements is a
material weakness. A material weakness is defined as a reportable condition in
which the design or operation of one or more of the internal control components
does not reduce to a relatively low level the risk that misstatements caused by
error or fraud in amounts that would be material in relation to the financial
statements being audited may occur and not be detected within a timely period by
employees in the normal course of performing their assigned functions. Changing
laws, regulations and standards relating to corporate governance and public
disclosure, including the Sarbanes-Oxley Act of 2002, and newly enacted SEC
regulations have created additional compliance requirements for companies such
as ours. We are committed to maintaining high standards of internal controls
over financial reporting, corporate governance and public disclosure. As a
result, we intend to invest appropriate resources to comply with evolving
standards, and this investment may result in increased general and
administrative expenses and a diversion of management time and attention from
revenue-generating activities to compliance activities. See Item 4."Controls and
Procedures."
Our substantial debt and decreased access to capital could result in
insufficient funds to meet our working capital requirements
The Company has been operating with low levels of capital during recent periods.
While the Company itself is not subject to any minimum capital requirement, it
requires working capital to pay salaries, pay vendors, including landlords, and
otherwise operate its business. At December 31, 2005 the Company had a working
capital deficit of $15.0 million and the Company has regularly borrowed from
Prime Partners, an affiliate of Michael Ryan, the Chief Executive Officer and
director of the Company, to pay its obligations. In Fiscal 2005, Prime Partners
extended short-term demand loans to the Company in the aggregate amount of $1.6
million for working capital purposes. At December 31, 2005, the Company owed
Prime Partners $1.8 million. On February 13, 2006, the Company owed Prime
Partners $1.6 million. Prime Partners has indicated to the Company that it may
demand some of the outstanding loan balance on or before April 15, 2006. There
can be no assurance that Prime Partners will extend further loans to the
Company. In the absence of loans from Prime Partners, the Company may not have
access to sufficient funds to meet its working capital needs.
The expense and diversion of management attention which result from litigation
could have an adverse effect on our operating results and could harm our ability
to effectively manage our business
If the Company were to be found liable to clients for misconduct alleged in
civil proceedings, the Company's operations may be adversely affected. Many
aspects of the Company's business involve substantial risks of liability.
Broker-dealers such as PCS are subject to claims by dissatisfied clients,
including claims alleging they were damaged by improper sales practices such as
unauthorized trading, churning, sale of unsuitable securities, use of false or
misleading statements in the sale of securities, mismanagement and breach of
fiduciary duty. Broker-dealers may be liable for the unauthorized acts of their
retail brokers and independent contractors if they fail to adequately supervise
their conduct. PCS is currently a defendant/respondent in numerous such
proceedings. It should be noted, however, that PCS maintains securities
broker-dealer's professional liability insurance to insure against this risk,
but the insurance policy contains a deductible (presently $50,000) and a
cumulative cap on coverage (presently $3,000,000). In addition, certain
activities engaged in by brokers may not be covered by such insurance. The
adverse resolution of any legal proceedings involving the Company could have a
material adverse effect on its business, financial condition, and results of
operations or cash flows.
The delisting of Company shares could make trading the Company's shares more
difficult for investors, potentially leading to further declines in the share
price
The shares of the Company's common stock were delisted from The Nasdaq National
Market in August 2002 and are now traded on what is commonly referred to as the
"pink sheets". As a result, an investor may find it more difficult to dispose of
or obtain accurate quotations as to the market value of the securities. In
addition, the Company is subject to Rule 15c2-11 promulgated by the SEC. If the
Company fails to meet criteria set forth in such Rule (for example, by failing
to file periodic reports as required by the Exchange Act), various practice
requirements are imposed on broker-dealers who sell securities governed by the
Rule to persons other than established customers and accredited investors. For
Page 25
these types of transactions, the broker-dealer must make a special suitability
determination for the purchaser and have received the purchaser's written
consent to the transactions prior to sale. Consequently, the Rule may have a
material adverse effect on the ability of broker-dealers to sell the Company's
securities, which may materially affect the ability of shareholders to sell the
securities in the secondary market. The delisting could make trading the
Company's shares more difficult for investors, potentially leading to further
declines in the share price. It would also make it more difficult for the
Company to raise additional capital. Due to the delisting, the Company would
also incur additional costs under state blue-sky laws if the Company were to
sell equity.
There are general business risks that could adversely affect the Company
If the financial planners that the Company presently employs or recruits do not
perform successfully, the Company's operations may be adversely affected. The
Company plans to continue to expand in the area of financial planning, by
expanding the business of presently employed financial planners and by
recruiting additional financial planners. The Company's revenue growth will in
large part depend upon the expansion of existing business and the successful
integration and profitability of the recruited financial planners. The Company's
growth will also depend on the successful operation of independent financial
planners who are recruited to join the Company. The financial planning channel
of the Company's business has generated an increasing portion of the Company's
revenues during the past few years, and if such channel does not continue to be
successful, the Company's revenue may not increase.
The Consolidated Financial Statements do not include any adjustments that might
result due to these events or from the uncertainties of a shift in the Company's
business.
The Company may choose to open new offices. When the Company opens a new office,
the Company incurs significant expenses to build out the office and to purchase
furniture, equipment and supplies. The Company has found that a new office
usually suffers a loss in its first year of operation, shows no material profit
or loss in its second year of operation and does not attain profitability, if
ever, until its third year of operation. Therefore, the Company's operating
results could be materially adversely affected in any year that the Company
opens a significant number of new offices. If the financial markets deteriorate,
the Company's financial planning channel will suffer decreased revenues. The
Company's revenue and profitability may be adversely affected by declines in the
volume of securities transactions and in market liquidity, which generally
result in lower revenues from trading activities and commissions. Lower
securities price levels may also result in a reduced volume of transactions as
well as losses from declines in the market value of securities held in trading,
investment and underwriting positions. In periods of low volume, the fixed
nature of certain expenses, including salaries and benefits, computer hardware
and software costs, communications expenses and office leases, will adversely
affect profitability. Sudden sharp declines in market values of securities and
the failure of issuers and counterparts to perform their obligations can result
in illiquid markets in which the Company may incur losses in its principal
trading and market making activities.
The dependence on technology software and systems and the Company's inability to
provide assurance that their fail safe systems will be effective could adversely
affect the Company's operations
As an information-financial services company with a subsidiary broker dealer,
the Company is greatly dependent on technology software and systems and on the
Internet to maintain customer records, effect securities transactions and
prepare and file tax returns. In the event that there is an interruption to the
systems due to internal systems failure or from an external threat, including
terrorist attacks, fire and extreme weather conditions, the Company's ability to
prepare and file tax returns and to process financial transactions could be
affected. The Company has offsite backup, redundant and remote failsafe systems
in place to safeguard against these threats but there can be no assurance that
such systems will be effective to prevent malfunction and adverse effects on
operation.
The competition from other companies may adversely affect operations
If competitors in the industry began to encroach upon the Company's market
share, the Company's operations may be adversely affected. The income tax
preparation and financial planning services industries are highly competitive.
The Company's competitors include companies specializing in income tax
preparation as well as companies that provide general financial services. The
Company's principal competitors are H&R Block and Jackson Hewitt in the tax
preparation field and many well-known national brokerage and insurance firms in
the financial services field. Many of these competitors have larger market
Page 26
shares and significantly greater financial and other resources than the Company.
The Company may not be able to compete successfully with such competitors.
Competition could cause the Company to lose existing clients, slow the growth
rate of new clients and increase advertising expenditures, all of which could
have a material adverse effect on the Company's business or operating results.
The competition from departing employees and the Company's ability to enforce
such contractual provisions could adversely affect the Company's operating
results
The Company attempts to contractually restrict departing employees and financial
planners from competing with the Company following their separation from the
Company. However, as a practical matter, enforcement of such contractual
provisions prohibiting small scale competition by individuals may be difficult.
As a result, departing employees and financial planners have in the past and may
in the future compete with the Company. These people have the advantage of
knowing the Company's methods and, in some cases, having access to the Company's
clients. No assurance can be given that the Company will be able to retain its
most important employees and financial planners or that the Company will be able
to prevent competition from them or successfully compete against them. If a
substantial amount of such competition from former employees and financial
planners occurs, the corresponding reduction of revenue may materially adversely
affect the Company's operating results.
The departure of key personnel could adversely affect the Company's operations
If any of the Company's key personnel were to leave its employ, the Company's
operations may be adversely affected. The Company believes that its ability to
successfully implement its business strategy and operate profitably depends on
the continued employment of James Ciocia, its Chairman of the Board, Michael
Ryan, its President and Chief Executive Officer, Kathryn Travis, its Secretary,
Carole Enisman, its Executive Vice President of Operations, and Dennis Conroy,
its Chief Accounting Officer. Michael Ryan and Carole Enisman are married. If
any of these individuals become unable or unwilling to continue in his or her
present position, the Company's business and financial results could be
materially adversely affected.
The bankruptcy of a key director could adversely affect the confidence of
potential investors of the Company's common stock
On December 28, 2005, Stephen J. Gilbert, a director of the Company, filed a
motion to convert his personal Chapter 11 case to a Chapter 7 case. The
bankruptcy of a key director could adversely affect the confidence of potential
investors of the Company's common stock.
Tax return preparation malpractice and the Company's uninsured liability in such
cases could materially adversely affect the Company's business and operating
results
The Company's business of preparing tax returns subjects it to potential civil
liabilities for violations of the Internal Revenue Code or other regulations of
the IRS, although the Company has never been assessed with material civil
penalties or fines. If a Company violation resulted in a material fine or
penalty, the Company's operating results would be materially adversely affected.
In addition, the Company does not maintain any professional liability or
malpractice insurance policies for tax preparation. The Company has never been
the subject of a tax preparation malpractice lawsuit, however, the significant
uninsured liability and the legal and other costs relating to such claims could
materially adversely affect the Company's business and operating results.
In addition, making fraudulent statements on a tax return, willfully delivering
fraudulent documents to the IRS and unauthorized disclosure of taxpayer
information can constitute criminal offenses. If the Company were to be charged
with a criminal offense and found guilty, or if any of its employees or
executives were convicted of a criminal offense, in addition to the costs of
defense and possible fines, the Company would likely experience an adverse
effect to its reputation, which could directly lead to a decrease in revenues
from the loss of clients.
The Company does not hire a large number of CPA's, which could affect the
Company's ability to provide adequate IRS representation services to the
marketplace. The Company utilizes a significant number of seasonal employees who
are not certified public accountants or tax attorneys, to provide tax
preparation services. Under state law, the Company is not allowed to provide
legal tax advice and the Company does not employ nor does it retain any tax
attorneys on a full time basis. Because most of the Company's employees who
prepare tax returns are not certified public accountants, tax attorneys or
otherwise enrolled to practice before the IRS, such employees of the Company are
strictly limited as to the roles they may take in assisting a client in an audit
with the IRS. These limitations on services that the Company may provide could
hinder the Company's ability to market its services.
Page 27
Furthermore, the small percentage of CPA's or tax attorneys available to provide
assistance and guidance to the Company's tax preparers may increase the risk of
the improper preparation of tax returns by the Company. The improper preparation
of tax returns could result in significant defense expenses and civil liability.
The loss of trademarks could cause the Company's revenues to decline
If the Company were to lose its trademarks or other proprietary rights, the
Company could suffer decreased revenues. The Company believes that its
trademarks and other proprietary rights are important to its success and its
competitive position. The Company has registered its "Gilman + Ciocia"
trademark. However, the actions taken by the Company to establish and protect
its trademarks and other proprietary rights may be inadequate to prevent
imitation of its services and products by others or to prevent others from
claiming violations of their trademarks and proprietary rights by the Company.
In addition, others may assert rights in the Company's trademarks and other
proprietary rights. If the Company were to lose the exclusive right to its
trademarks, its operations could be materially adversely affected.
The decision not to pay dividends could impact the marketability of the
Company's common stock
The Company's decision not to pay dividends could negatively impact the
marketability of the Company's common stock. Since its initial public offering
of securities in 1994, the Company has not paid dividends and it does not plan
to pay dividends in the foreseeable future. The Company currently intends to
retain future earnings, if any, to finance the growth of the Company. It is very
likely that dividends will not be distributed in the near future, which may
reduce the marketability of the Company's common stock.
The impediments to third party control could adversely affect the price and
liquidity of the Company's common stock
The ability of a third party to acquire control of the Company is made more
difficult by the Company's classified board of directors, which would prevent a
third party from immediately electing a new board of directors, and by the
Company's ability to issue preferred stock without shareholder approval. These
impediments to third party control could potentially adversely affect the price
and liquidity of the Company's common stock.
The low trading volume of the Company's common stock increases volatility, which
could impair the Company's ability to obtain equity financing
Low trading volume in the Company's common stock increases volatility, which
could result in the impairment of the Company's ability to obtain equity
financing. As a result, historical market prices may not be indicative of market
prices in the future. The Company's market price may be impacted by changes in
earnings estimates by analysts, economic and other external factors and the
seasonality of the Company's business. Fluctuations or decreases in the trading
price of the common stock may adversely affect the stockholders' ability to buy
and sell the common stock and the Company's ability to raise money in a future
offering of common stock. The shares of the Company's common stock were delisted
from The NASDAQ National Market in August 2002, and the market price of the
Company's shares has dramatically declined since the delisting.
The release of restricted common stock may have an adverse affect on the market
price of the common stock
The release of various restrictions on the possible future sale of the Company's
Common Stock may have an adverse affect on the market price of the common stock.
Based on information received from the Company's transfer agent, approximately
5.8 million shares of the common stock outstanding are "restricted securities"
under Rule 144 of the Securities Act of 1933, as amended (the "Securities Act").
In general, under Rule 144, a person who has satisfied a one year holding period
may, under certain circumstances, sell, within any three month period, a number
of shares of "restricted securities" that do not exceed the greater of one
percent of the then outstanding shares of common stock or the average weekly
trading volume of such shares during the four calendar weeks prior to such sale.
Rule 144 also permits, under certain circumstances, the sale of shares of common
stock by a person who is not an "affiliate" of the Company (as defined in Rule
144) and who has satisfied a two year holding period, without any volume or
other limitation.
The securities industry rules could materially affect the Company's business
If a material risk inherent to the securities industry was to be realized, the
value of the Company's common stock may decline. The securities industry, by its
very nature, is subject to numerous and substantial risks, including the risk of
declines in price level and volume of transactions, losses resulting from the
ownership, trading or underwriting of securities, risks associated with
principal activities, the failure of counterparties to meet commitments,
customer, employee or issuer fraud risk, litigation, customer claims alleging
improper sales practices, errors and misconduct by brokers, traders and other
Page 28
employees and agents (including unauthorized transactions by brokers), and
errors and failure in connection with the processing of securities transactions.
Many of these risks may increase in periods of market volatility or reduced
liquidity. In addition, the amount and profitability of activities in the
securities industry are affected by many national and international factors,
including economic and political conditions, broad trends in industry and
finance, level and volatility of interest rates, legislative and regulatory
changes, currency values, inflation, and the availability of short-term and
long-term funding and capital, all of which are beyond the control of the
Company.
Several current trends are also affecting the securities industry, including
increasing consolidation, increasing use of technology, increasing use of
discount and online brokerage services, greater self-reliance of individual
investors and greater investment in mutual funds. These trends could result in
the Company facing increased competition from larger broker-dealers, a need for
increased investment in technology, or potential loss of clients or reduction in
commission income. These trends or future changes could have a material adverse
effect on the Company's business, financial condition, and results of operations
or cash flows.
If new regulations are imposed on the securities industry, the operating results
of the Company may be adversely affected. The SEC, the NASD, the NYSE and
various other regulatory agencies have stringent rules with respect to the
protection of customers and maintenance of specified levels of net capital by
broker-dealers. The regulatory environment in which the Company operates is
subject to change. The Company may be adversely affected as a result of new or
revised legislation or regulations imposed by the SEC, the NASD, other U.S.
governmental regulators or SRO's. The Company also may be adversely affected by
changes in the interpretation or enforcement of existing laws and rules by the
SEC, other federal and state governmental authorities and SRO's.
PCS is subject to periodic examination by the SEC, the NASD, SRO's and various
state authorities. PCS sales practice operations, recordkeeping, supervisory
procedures and financial position may be reviewed during such examinations to
determine if they comply with the rules and regulations designed to protect
customers and protect the solvency of broker-dealers. Examinations may result in
the issuance of letters to PCS, noting perceived deficiencies and requesting PCS
to take corrective action. Deficiencies could lead to further investigation and
the possible institution of administrative proceedings, which may result in the
issuance of an order imposing sanctions upon PCS and/or their personnel.
The Company's business may be materially affected not only by regulations
applicable to it as a financial market intermediary, but also by regulations of
general application. For example, the volume and profitability of the Company's
or its clients' trading activities in a specific period could be affected by,
among other things, existing and proposed tax legislation, antitrust policy and
other governmental regulations and policies (including the interest rate
policies of the Federal Reserve Board) and changes in interpretation or
enforcement of existing laws and rules that affect the business and financial
communities.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
See Note 7 to Notes to Consolidated Financial Statements herein.
ITEM 6. EXHIBITS
31.1 Rule 13a-14(a) Certification of Chief Executive Officer.
31.2 Rule 13a-14(a) Certification of 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 Chief Accounting Officer Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
GILMAN + CIOCIA, INC.
Dated: June 15, 2006 By: /s/ Michael P. Ryan
---------------------------
Chief Executive Officer
Dated: June 15, 2006 By: /s/ Dennis Conroy
---------------------------
Chief Accounting Officer
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