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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------------
FORM 10-Q
{x} QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934.
For the Quarterly Period Ended DECEMBER 31, 2002.
Commission File Number 000-22996
GILMAN + CIOCIA, INC.
(Exact name of the registrant as specified in its charter)
DELAWARE 11-2587324
(State or jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
11 RAYMOND AVENUE
POUGHKEEPSIE, NEW YORK 12603
(address of principal executive offices)
(845)485-3300
(Issuer's Telephone Number)
Indicate by checkmark whether the registrant: (1) has filed 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 past 90 days. Yes {X} No { }
As of July 2, 2003, 10,063,446 shares of the issuer's common stock, $0.01
par value, were outstanding.
TABLE OF CONTENTS
PART I-FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS Page
Consolidated Balance Sheets as of December 31, 2002 3
and June 30, 2002
Consolidated Statements of Operations for the Three Months
and Six Months Ended December 31, 2002 and 2001 4
Consolidated Statements of Cash Flows for the Six Months
Ended December 31, 2002 and 2001 5-6
Consolidated Statement of Stockholders' Equity (Deficit) for the
Six Months Ended December 31, 2002 7
Notes to Consolidated Financial Statements 8-18
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 19-24
Item 3. Quantitative and Qualitative Disclosure About Market Risks 24
Item 4. Controls and Procedures 24
PART II-OTHER INFORMATION
Item 1. Legal Proceedings 26
Item 4. Submission of Matters to a Vote of Security Holders 26
Item 5. Other Information 26
Item 6. Exhibits and Reports on Form 8-K 26
SIGNATURES AND CERTIFICATIONS
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
GILMAN & CIOCIA, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
UNAUDITED AUDITED
ASSETS December 31, 2002 June 30, 2002
------------------- -------------------
Current Assets:
Cash and cash equivalents $ 509,462 $ 2,223,806
Marketable securities 1,305,059 1,759,742
Accounts receivable, net of allowance for doubtful
accounts of $461,559 and $614,972, respectively 5,454,442 6,958,346
Receivables from officers, stockholders and employees, net 848,912 1,129,092
Income taxes receivable 135,624 748,678
Prepaid expenses and other current assets 53,608 150,810
Assets held for sale 503,685 4,736,375
------------------- -------------------
Total current assets 8,810,792 17,706,849
Non Current assets:
Property and equipment, net of accumulated depreciation of
$3,820,607 and $3,203,347, respectively 2,636,425 3,239,502
Goodwill 5,264,858 5,264,858
Intangible assets, net of accumulated amortization of
$4,810,271 and $4,284,173, respectively 8,874,003 9,303,400
Other assets 1,444,240 1,657,904
------------------- -------------------
Total assets $ 27,030,318 $ 37,172,513
=================== ===================
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current Liabilities
Accounts payable and accrued expenses $ 12,723,957 $ 12,808,741
Long-term debt 12,596,400 12,393,867
Liabilities related to assets held for sale 2,521,651 3,407,335
Income taxes payable 56,738 -
------------------- -------------------
Total current liabilities 27,898,746 28,609,943
Non Current Liabilities:
Long-term debt, net of current portion 538,092 851,501
Other Liabilities 11,000 -
------------------- -------------------
Total liabilities 28,447,838 29,461,444
------------------- -------------------
Contingencies (Note 4)
Stockholders' Equity:
Preferred stock, $0.001 par value; 100,000 shares
authorized none issued and outstanding - -
Common stock, $0.01 par value, 20,000,000 shares
authorized; 9,919,561 and 9,203,027 shares issued
and outstanding, respectively 99,195 92,030
Additional paid-in capital 29,813,755 29,534,307
Treasury Stock 270,480 and 263,492 shares of common
stock, respectively, at cost (1,071,205) (1,065,996)
Note receivable (105,000) (105,000)
Accumulated deficit (30,154,265) (20,744,272)
------------------- -------------------
Total stockholders' equity (deficit) (1,417,520) 7,711,069
------------------- -------------------
Total liabilities and stockholders' equity
(deficit) $ 27,030,318 $ 37,172,513
=================== ===================
The accompanying notes are an integral part of these consolidated
balance sheets.
3
GILMAN & CIOCIA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
UNAUDITED
For the Three Months Ended For the Six Months Ended
December 31, December 31,
2001 2001
Restated Restated
2002 (See Note 2) 2002 (See Note 2)
-------------- -------------- --------------- -------------
REVENUES:
Financial planning services $ 14,427,273 $ 14,780,582 $ 29,166,715 $ 30,454,066
Tax preparation fees 408,438 499,465 977,097 1,058,534
e1040.com -- 2,148 -- 23,972
Direct Mail Services -- -- -- 505,407
-------------- -------------- --------------- -------------
Total revenues 14,835,711 15,282,195 30,143,812 32,041,979
-------------- -------------- --------------- -------------
OPERATING EXPENSES:
Salaries and commissions 13,612,124 13,642,067 26,260,435 29,130,695
General and administrative 2,406,371 2,214,928 4,469,224 4,393,772
Advertising 33,414 175,824 58,871 791,491
Brokerage fees & licenses 521,644 453,922 889,398 900,289
Rent 752,521 949,703 1,689,946 1,808,302
Depreciation and amortization 460,710 720,866 1,023,032 1,402,073
Loss on sale of equipment 85,325 - 85,325 -
-------------- -------------- --------------- -------------
Total operating expenses 17,872,109 18,157,310 34,476,231 38,426,622
-------------- -------------- --------------- -------------
Loss from operations (3,036,398) (2,875,115) (4,332,419) (6,384,643)
OTHER INCOME (EXPENSE):
Interest and investment income 129 95,824 4,594 165,873
Interest expense (713,845) (512,428) (1,202,293) (979,858)
Other income (expense) - 16,043 - 68,747
-------------- -------------- --------------- -------------
Total other income (expense) (713,716) (400,561) (1,197,699) (745,238)
-------------- -------------- --------------- -------------
Loss before provision (benefit) for income taxes (3,750,114) (3,275,676) (5,530,118) (7,129,881)
Provision (benefit) for income taxes 13,600 (1,752,000) 51,500 (3,778,000)
-------------- -------------- --------------- -------------
Total loss from continuing operations (3,763,714) (1,523,676) (5,581,618) (3,351,881)
-------------- -------------- --------------- -------------
DISCONTINUED OPERATIONS:
Income (loss) from operations of discontinued operations (473,419) 170,625 (1,141,685) 217,999
Income (loss) on sales of discontinued operations (2,160,110) - (2,680,190)
Provision for income taxes 1,400 60,265 6,500 30,265
-------------- -------------- --------------- -------------
Total loss from discontinued operations (2,634,929) 110,360 (3,828,375) 187,734
-------------- -------------- --------------- -------------
-------------- -------------- --------------- -------------
Net Loss (6,398,643) (1,413,316) (9,409,993) (3,164,147)
============== ============== =============== =============
Basic and diluted per share data:
Loss from continuing operations $ (0.40) $ (0.18) $ (0.61) $ (0.39)
Gains (Loss) from discontinued operations (0.28) 0.01 (0.42) 0.02
============== ============== =============== =============
Net income (loss) per share, basic and diluted $ (0.68) $ (0.17) $ (1.03) $ (0.37)
============== ============== =============== =============
Weighted average shares, basic and diluted 9,418,381 8,567,958 9,178,467 8,481,892
============== ============== =============== =============
The accompanying notes are an integral part of these consolidated
financial statements.
4
GILMAN & CIOCIA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
UNAUDITED
For the Six Months Ended
December 31,
2001
2002 Restated (See Note 2)
------------ ---------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(9,409,993) $(3,164,147)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 1,587,705 1,524,796
Loss from discontinued operations
Loss (gain) on sale of discontinued operations 2,680,190
Gain on sale of mailing service business - (194,434)
Amortization of debt discount - 128,563
Issuance of common stock for debt default penalties
and interest 280,000 -
Provision (benefit) for income taxes - (3,778,000)
Loss (Gain) on sale of property and equipment 85,325 (23,581)
Unrealized losses on securities held for trading 133,676 -
Amortization of deferred and other compensation expense - 90,465
Bad debt expense 5,000 -
Loss on asset repurchase agreement - 176,984
Changes in assets and liabilities:
Accounts receivable, net 2,000,928 2,577,123
Prepaid and other current assets 93,308 212,053
Receivables from officers, stockholders and employees 279,074 446,379
Increase in other assets 100,178 1,779,897
Accounts payable and accrued expenses 92,923 (1,205,983)
Income taxes receivable (payable) 669,787 39,970
Increase in other liabilities 11,000 -
Marketable securities 130,728 -
Increase in deferred tax asset - (2,376,168)
------------ ------------
NET CASH USED IN OPERATING ACTIVITIES OF CONTINUING OPERATIONS (1,260,171) (3,766,083)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (84,460) (458,085)
Cash paid for acquisitions, net of cash acquired (106,607) (216,250)
Proceeds from (purchases of) marketable securities, net - 29,447
Proceeds from sale of discontinued operations 324,114 347,000
Proceeds from joint venture distribution 90,000 -
Proceeds from sale of property and equipment 14,000 106,370
Proceeds on asset purchase agreement - 342,580
------------ ------------
NET CASH PROVIDED BY INVESTING ACTIVITIES OF CONTINUING OPERATIONS 237,047 151,062
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Acquisition of treasury stock (5,209) (72,476)
Proceeds from bank and other loans 625,000 8,470,000
Payments of bank and capital lease obligations (1,311,011) (6,604,707)
Reissuance of treasury stock - 151,429
Net proceeds from the issuance of common stock and
exercise of common stock op tions and warrants - 9,625
------------ ------------
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES OF CONTINUING OPERATIONS (691,220) 1,953,871
------------ ------------
Net decrease in cash (1,714,344) (1,661,150)
Cash and cash equivalents at beginning of period 2,223,806 5,413,674
------------ ------------
Cash and cash equivalents at end of period $ 509,462 $ 3,752,524
============ ============
The accompanying notes are an integral part of these consolidated
financial statements.
5
GILMAN & CIOCIA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
UNAUDITED
For the Six Months Ended
December 31, 2001
2002 Restated (See Note 2)
------------------ ------------------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for:
Interest $ 279,816 $ 1,130,669
================ ========================
Income taxes $ - $ 146,165
================ ========================
SUPPLEMENTAL DISCLOSURE OF NONCASH TRANSACTIONS:
Re-issuance of treasury stock at fair value - 119,831
Common stock and options issued in connection with
business combinations 6,613 936,464
Equipment acquired under capital leases 4,887 325,795
Issuance of common stock for debt default penalties
and interest 280,000 -
Issuance of common stock upon loan obligation - 300,000
Details of business combinations:
Fair value of assets acquired $ - $ 1,456,750
Less: Liabilities assumed - (306,927)
Less: Stock issued - (933,573)
------------------ -------------------------
Cash paid for acquisitions $ - $ 216,250
================ ========================
The accompanying notes are an integral part of these consolidated
financial statements.
6
GILMAN & CIOCIA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE SIX MONTHS ENDED DECEMBER 31, 2002
UNAUDITED
Common Stock Additional Accumulated
Paid-In
Shares Amount Capital Deficit
----------- ----------- -------------- --------------
Balance at July 1, 2002 9,203,027 $ 92,030 $ 29,534,307 $(20,744,272)
Net loss - - - (9,409,993)
Purchase of treasury stock - - - -
Issuance of stock in connection
with earnout agreement 16,534 165 6,448 -
Issuance of stock in connection
with default on note payable 700,000 7,000 273,000 -
----------- ----------- -------------- --------------
Balance at December 31, 2002 9,919,561 $ 99,195 $ 29,813,755 $ (30,154,265)
=========== =========== ============== ==============
Total
Treasury Stock Note Stockholders'
Equity
Shares Amount Receivable (Deficit)
----------- ------------ -------------- --------------
Balance at July 1, 2002 263,492 $(1,065,996) $ (105,000) $ 7,711,069
Net loss - - - (9,409,993)
Purchase of treasury stock 6,988 (5,209) - (5,209)
Issuance of stock in connection
with earnout agreement - - - 6,613
Issuance of stock in connection
with default on note payable - - - 280,000
----------- ------------ -------------- --------------
Balance at December 31, 2002 270,480 $(1,071,205) $ (105,000) $ (1,417,520)
=========== ============ ============== ==============
The accompanying notes are an integral part of these consolidated
financial statements.
7
GILMAN + CIOCIA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND NATURE OF BUSINESS
(a) Description of the Company
Gilman + Ciocia, Inc. and subsidiaries (the "Company" or "G+C"), which is
incorporated in Delaware, provides income tax preparation and financial planning
services to individuals and businesses. The Company has six active wholly owned
subsidiaries, Prime Capital Services, Inc ("PCS") and North Ridge Securities,
Inc. ("North Ridge"), which are registered broker-dealers pursuant to the
provisions of the Securities Exchange Act of 1934; Prime Financial Services,
Inc. ("PFS") and North Shore Capital Management, Inc. ("North Shore"), which
manage PCS and North Ridge, respectively, as well as sell life insurance and
fixed annuities; Asset and Financial Planning, Ltd. ("AFP"), an asset management
business; and e1040.com, Inc. ("e1040"), an internet tax preparation business.
As of June 30, 2002, the Company expanded its role in the fixed income
marketplace. The Company may, from time to time, hold inventory positions in
bonds.
The Company provides federal, state and local tax preparation and financial
planning services to individuals predominantly in the middle and upper income
brackets. As of December 31, 2002 the Company had 54 offices operating in 17
states. To complement its tax preparation services, the Company also provides
financial planning services to its tax preparation clients and others. These
financial planning services include securities brokerage services, insurance and
mortgage agency services.
(b) 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 sheet as of December 31, 2002, the
consolidated statements of operations for the three and six months ended
December 31, 2002 and 2001, the consolidated statements of cash flows for the
six months ended December 31, 2002 and 2001 and the consolidated statement of
stockholders equity for the six months ended December 31, 2002 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, 2002 and 2001 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 year ended June 30, 2002.
(c) Accounting Policies
The preparation of our financial statements in conformity with accounting
principles generally accepted in the United States of America requires us 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. Our estimates, judgments and assumptions are
continually evaluated based on available information and experience. Because of
the use of estimates inherent in the financial reporting process, actual results
could differ from those estimates.
Certain of our accounting policies require higher degrees of judgment than
others in their application. These include: impairment of intangible assets,
valuation of customer receivables and income tax recognition of deferred tax
items. Our policy and related procedures for impairment of intangible assets,
valuation of customer receivables and income tax recognition of deferred tax
items are summarized below.
8
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
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 in sales transactions and current
market conditions.
Valuation of customer receivables
Provisions for allowance for doubtful accounts are made based on historical loss
experience adjusted for specific credit risks. Measurement of such losses
requires consideration of the company's historical loss experience, judgments
about customer credit risk, and the need to adjust for current economic
conditions.
Income tax recognition of deferred tax items
We recognize deferred tax assets and liabilities based on the differences
between the financial statement carrying amounts and the tax basis of assets and
liabilities. Significant management judgment is required in determining our
deferred tax assets and liabilities. Management makes an assessment of the
likelihood that our deferred tax assets will be recovered from future taxable
income, and to an amount that it believes is more likely than not to be
realized. As of December 31, 2002 and June 30, 2002, management has recorded a
full valuation allowance against the net deferred tax assets.
Revenue Recognition
The Company recognizes all revenues associated with income tax preparation,
accounting services and direct mail services 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.
Commission revenue and expenses on sales of life insurance policies are
recognized when the policies are effective.
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.
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. Diluted net income (loss) per share gives effect
to all potentially dilutive securities that were outstanding during each period.
For the three and six months ended December 31, 2002 and
9
2001, outstanding options and warrants of 3,749,391 million and 5,174,594
million, respectively to purchase shares of common stock were not included in
the computation of diluted net income (loss) per share because to do so would
have an antidilutive effect for the periods presented.
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. Also see Note 1 to our June 30, 2002 consolidated
Financial Statements included in our Form 10-K, which discusses accounting
policies that must be selected by management when there are acceptable
alternatives.
(d) Liquidity and cash flow
The Company's December 31, 2002 consolidated financial statements were prepared
assuming the Company will continue as a going concern. The Company had suffered
losses from operations that raised substantial doubt about its ability to
continue as a going concern. The Company's ability to continue as a going
concern and its future success is dependent upon its ability to reduce costs,
generate revenues and, if required, obtain financing in the near term to: (1)
satisfy its current obligations and commitments, and (2) continue its growth.
The Company believes that it will be able to complete the necessary steps in
order to meet its cash flow requirements throughout fiscal 2003. Management's
plans in this regard include, but are not limited to, the following:
On November 26, 2002, the Company finalized a transaction pursuant to
an asset purchase agreement (the "Purchase Agreement") with Pinnacle,
whereby Pinnacle an entity controlled by Thomas Povinelli and David
Puyear, former executive officers of the Company, purchased certain
assets of the Company. The effective date of the closing under the
Purchase Agreement was September 1, 2002. The Company sold to Pinnacle
47 offices ("Pinnacle Purchased Offices") and all tangible and
intangible net assets (the "Purchased Assets") which are associated
with the operations of the Pinnacle Purchased Offices, together
representing approximately $17,690,000 or approximately 19.0% of the
Company's annual revenue for the fiscal year ended June 30, 2002.
Included in the net assets sold to Pinnacle was approximately
$1,550,000 in debt plus accrued interest of approximately $280,000 and
other payables of approximately $400,000, which were to be assumed by
Pinnacle, subject to creditor approval. As part of the sale of the
Purchased Offices 137 employees of the Purchased Offices were
terminated by the Company as of November 15, 2002 and were hired by
Pinnacle. In addition, all registered representatives of the Purchased
Offices licensed with Prime Capital Services, Inc. (a wholly owned
broker dealer subsidiary of the Company) transferred their
registrations to Royal Alliance Associates ("Royal").
In addition to the Pinnacle transaction, the Company completed the
sale/closure of 11 additional offices from July 1st, 2002 through
March 31st, 2003. The aggregate sales price for the 11 offices was
$1,363,158 consisting of $417,455 cash and $945,703 in promissory
notes due the Company. Due to uncertainties associated with the
payment of these promissory notes management has reserved $815,703 of
the balance due.
On November 27, 2002, the Company negotiated a forbearance agreement
with Wachovia Bank, National Association, formerly known as First Union
National Bank ("Wachovia") whereby Wachovia agreed to forbear from
acting on certain defaults of financial covenants by the Company under
debt owed to Wachovia and extended the due date of its debt until
November 1, 2003 (See Note 7). By an Amendment to Forbearance Agreement
dated as of June 18, 2003, the Company and Wachovia amended the
Forbearance Agreement to change, among other things, the following
provisions of the Forbearance Agreement: the Maturity Date was extended
to July 1, 2004; the Company's reporting requirements to Wachovia were
changed; the May 10, 2003 and June 10, 2003 principal payments of
$250,000 were rescheduled; principal payments in amounts of $250,000
are now due on March 10, 2004, April 10, 2004, May 10, 2004 and June
10, 2004; and the Company will be required to pay to Wachovia fifty
(50%) percent of the excess over $1,000,000 of any lump sum payment
received from Pinnacle Tax Advisors, LLC.
In addition to the above activities the following business initiatives are also
ongoing and are expected to provide additional working capital to the Company:
1. Management has engaged in an extensive campaign to reduce
corporate overhead, consisting primarily of closing the White
Plains executive offices and consolidating those functions into
the Poughkeepsie, New York home office. This has resulted in
savings of approximately $170,000 per month.
2. The Company's current strategy is not to actively pursue
acquisitions.
3. The Company has negotiated with certain strategic vendors to
settle current liabilities.
Management believes that these actions will be successful. However, there can be
no assurance that the Company
10
will generate sufficient revenues or reduce costs to provide positive cash flows
from operations to permit the Company to realize its plans. The accompanying
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
2. RECLASSIFICATION FOR DISCONTINUED OPERATIONS
During the six months ended December 31, 2002, the Company sold certain of its
offices and was in negotiations for the sale of other offices at December 31,
2002. In accordance with SFAS 144 assets, and liabilities associated with these
offices have been reclassified and are included on the accompanying balance
sheets as assets and liabilities held for sale, and the results of these
operations have been reclassified and are separately presented for all reporting
periods as discontinued operations in the accompanying statements of operations.
11
3. RECENT ACCOUNTING PRONOUNCEMENTS
In July 2002, SFAS No. 146, "Accounting for Costs Associated with Exit or
Disposal Activities" ("SFAS 146") was issued. SFAS 146 addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies EITF 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred
in a Restructuring)." The principal difference between SFAS 146 and EITF 94-3
relates to the timing of liability recognition. Under SFAS 146, a liability for
a cost associated with an exit or disposal activity is recognized when the
liability is incurred. Under EITF 94-3, a liability for an exit cost was
recognized at the date of an entity's commitment to an exit plan. The provisions
of SFAS 146 are effective for exit or disposal activities that are initiated
after December 31, 2002. The adoption of SFAS 146 is not expected to have a
material impact on the Company's financial position or results of operations.
In December 2002, the FASB issued SFAS No. 148 ("SFAS 148"), "Accounting for
Stock-Based Compensation--Transition and Disclosure", amending FASB Statement
No. 123 ("SFAS 123"), "Accounting for Stock-Based Compensation. SFAS 148
provides two additional alternative transition methods for recognizing an
entity's voluntary decision to change its method of accounting for stock-based
employee compensation to the fair-value method. In addition, SFAS 148 amends the
disclosure requirements of SFAS 123 so that entities will have to (1) make
more-prominent disclosures regarding the pro forma effects of using the
fair-value method of accounting for stock-based compensation, (2) present those
disclosures in a more accessible format in the footnotes to the annual financial
statements, and (3) include those disclosures in interim financial statements.
(See Note 9). SFAS 148's transition guidance and provisions for annual
disclosures are effective for fiscal years ending after December 15, 2002;
earlier application is permitted. Management is assessing the effects, if any,
of SFAS 148 on the financial statements of the Company.
In November 2002, FASB Interpretation 45, Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others (FIN 45), was issued. FIN 45 requires a guarantor entity, at the
inception of a guarantee covered by the measurement provisions of the
interpretation, to record a liability for the fair value of the obligation
undertaken in issuing the guarantee. The Company previously did not record a
liability when guaranteeing obligations unless it became probable that the
Company would have to perform under the guarantee. FIN 45 applies prospectively
to guarantees the Company issues or modifies subsequent to December 31, 2002,
but has certain disclosure requirements effective for interim and annual periods
ending after December 15, 2002. At December 31, 2002, the Company has certain
guarantees related to operating leases which have been included in the Company's
operating lease commitments included in Management's Discussion and Analysis.
Management is currently evaluating the effect FIN 45 may have on the Company's
financial statements as a result of the sale of offices to Pinnacle, which
included the assumption by Pinnacle of certain leases of such offices, on
November 26, 2002, as it relates to Note 5.
In January 2003, the FASB issued FASB Interpretation 46 (FIN 46), Consolidation
of Variable Interest Entities. FIN 46 clarifies the application of Accounting
Research Bulletin 51, Consolidated Financial Statements, for certain entities
that do not have sufficient equity at risk for the entity to finance its
activities without additional subordinated financial support from other parties
or in which equity investors do not have the characteristics of a controlling
financial interest ("variable interest entities"). Variable interest entities
within the scope of FIN 46 will be required to be consolidated by their primary
beneficiary. The primary beneficiary of a variable interest entity is determined
to be the party that absorbs a majority of the entity's expected losses,
receives a majority of its expected returns, or both. FIN 46 applies immediately
to variable interest entities created after January 31, 2003, and to variable
interest entities in which an enterprise obtains an interest after that date. It
applies in the first fiscal year or interim period beginning after June 15,
2003, to variable interest entities in which an enterprise holds a variable
interest that it acquired before February 1, 2003. Management is evaluating the
impact, if any, that adoption of the provisions of FIN 46 will have upon its
financial condition or results of operations.
4. CONTINGENCIES
Litigation
The Company is engaged in lawsuits in the ordinary course of business that
management believes will not have a material effect on its financial position.
SEC Investigation
The Company has become aware that it is the subject of a formal investigation by
the Securities and Exchange Commission ("SEC"). The Company believes that 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 a Form 10-K for the fiscal year ended
June 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. On March 13, 2003, three of the Company's
executives received subpoenas from the SEC requesting them to produce documents
and provide testimony in connection with the formal investigation. In addition,
on March 19, 2003 the Company received a subpoena requesting documents in
connection with such investigation. The Company and its executives intend to
comply fully with the requests contained in the subpoenas and with the SEC's
investigation. The Company does not believe that the investigation will have a
material effect on the Company's consolidated financial statements.
401(k) Plan
As of June 30, 2002 the Company was subject to penalties from the United States
Department of Labor related to the Company's 401(k) plan. During the period from
January 1, 2002 through June 30, 2002, prior management borrowed several 401(k)
Plan payments from the withholdings of Company employees. As of June 30, 2002,
the principal amount borrowed by prior management from employee withholding
payments and owed by the Company to the 401(k) Plan was approximately $332,000.
Since August 16, 2002 when new management was installed, all withholding
payments from employees to the 401(k) Plan have been made on a timely basis. In
addition, new management caused the Company to repay all amounts borrowed from
the employee withholding payments with the final repayment being made on
November 6, 2002. The Company reimbursed all employee 401(k) plan accounts for
any lost profits resulting from the Company borrowings and the Company made
contributions to the employee
12
accounts so that each account would have a minimum 4% return during the period
that the borrowings were outstanding. The Company has reviewed the borrowings
with the United States Department of Labor which is determining if any interest
or penalties should be imposed.
5. SALE OF OFFICES
SALES OF ASSETS
PINNACLE TAXX ADVISORS
On November 26, 2002, the Company finalized a transaction pursuant to an asset
purchase agreement (the "Purchase Agreement") with Pinnacle, whereby Pinnacle an
entity controlled by Thomas Povinelli and David Puyear, former executive
officers of the Company, purchased certain assets of the Company. The effective
date of the closing under the Purchase Agreement was September 1, 2002. The
Company sold to Pinnacle 47 offices ("Pinnacle Purchased Offices") and all
tangible and intangible net assets (the "Purchased Assets") which are associated
with the operations of the Pinnacle Purchased Offices, together representing
approximately $17,690,000 or approximately 19.0% of the Company's annual revenue
for the fiscal year ended June 30, 2002. Included in the net assets sold to
Pinnacle was approximately $1,550,000 in debt plus accrued interest of
approximately $280,000 and other payables of approximately $400,000, which were
to be assumed by Pinnacle, subject to creditor approval. As part of the sale of
the Purchased Offices 137 employees of the Purchased Offices were terminated by
the Company as of November 15, 2002 and were hired by Pinnacle. In addition, all
registered representatives of the Purchased Offices licensed with Prime Capital
Services, Inc. (a wholly owned broker dealer subsidiary of the Company)
transferred their registrations to Royal Alliance Associates ("Royal").
The net purchase price payable by Pinnacle after it assumed all liabilities and
payables was $4,745,463, subject to final adjustments. The sum of $3,422,108,
(the "Closing Payment"), was paid pursuant to a promissory note (the "Initial
Note") which was given by Pinnacle to the Company at the date of closing (the
"Closing"), with interest at 10% commencing 30 days from the Closing. The
Initial Note is guaranteed by Mr. Povinelli and Mr. Puyear, and Mr. Povinelli
has pledged his entire holdings of the Company's common stock to secure the
Initial Note. The Initial Note is due and payable on the earlier of February 26,
2003 or on the date that Pinnacle closes a debt or equity financing. The balance
of the purchase price of $1,323,355, subject to adjustment and less certain
debts of the Company that Pinnacle assumed, will be paid pursuant to a second
promissory note (the "Second Note") which is secured by Pinnacle's assets. The
Initial Note and the Second Note are secured by collateral assignment of 75% of
Pinnacle's commission overrides to be paid to Pinnacle from Royal each month up
to $250,000, pursuant to an agreement between Pinnacle and Royal. The Second
Note is payable in three equal consecutive annual installments, with interest
calculated at the prime rate of Pinnacle's primary lender in effect as of the
Closing, on the first, second and third anniversaries of the Closing.
The Company recognized a $1,509,229 loss on the sale of these offices. This loss
consists of the sale of assets net of liabilities assumed, totaling $1,685,343,
less cash received of $176,114.
As a result of the transaction with Pinnacle a gain of approximately $4.6
million had been calculated by management in December 2002, however due to the
uncertainties associated with payment on the Initial Note and Second Note, the
Company will defer the gain recognition until proceeds from payment of cash or
collateral by Pinnacle are received on the Initial Note and Second Note. As of
May 2003, the Company has received certain payments from Royal, totaling
$490,900 pursuant to the assignment above but has not received certain payments
required under the Closing Payment and an Equipment Sublease. The Company's
position is that Pinnacle is now in default under the Initial Note, the Second
Note and the Equipment Sublease. Accordingly, on May 16, 2003, the Company
initiated a lawsuit against Pinnacle seeking payments for all amounts due. By
agreement dated March 31, 2003, the Company entered into a Stock Purchase
Agreement with Mr. Povinelli whereby he transferred 1,048,616 of his Company
shares back to the Company for a credit of approximately $ 230,000 against the
principal due on the Initial Note. The effective date of the transfer was June
6, 2003 when Mr. Povinelli executed and delivered to the Company a stock power
for all of his shares. After the commencement of the lawsuit, Pinnacle agreed to
give the Company a direct assignment of its income and fixed annuity revenue
from InsurMark and Career Brokerage in addition to 75% of Pinnacle's commission
overrides being paid to the Company by Royal.
The Company believes that its litigation against Pinnacle will be successful,
but there is no assurance that all amounts owed by Pinnacle to the Company will
be collected. Aggregate operating lease commitment amounts with respect to the
equipment subleases and rent leases assigned to Pinnacle in November 2002 are
$1,510,887, $1,393,398, $1,096,838, $541,487, $409,456, and $647,534 for the
Fiscal years ending December 31, 2003, 2004, 2005, 2006, 2007, and thereafter.
(See Contractual Obligation and Commercial Commitments schedule). The Company
will remain liable to landlords for all of the leases assigned to Pinnacle and
will have to pay the rent for the offices if Pinnacle does not pay.
OTHER SALES OF ASSETS
During the six months ended December 31, 2002 the Company sold/closed 6 of its
offices. The aggregate sales price for the 6 offices was $120,000 which was paid
in full. Three offices were sold/closed during the quarter ended September 30th,
2003 ("Q1 offices") and three offices were sold during the quarter ended
December 31, 2002 ("Q2 offices").
The Q1 offices were sold/closed for an aggregate price of $120,000 which was
paid in full during the first quarter. The Company recognized a $520,080 loss on
the sale of these offices. The $520,080 loss consists of the sale of assets net
of liabilities assumed, totaling $640,080, less cash received of $120,000.
The Q2 offices were sold for an aggregate purchase price equal to 75% of 2003
gross tax revenue payable after the 2003 tax season. The Company received a down
payment of $12,000. Due to uncertainties associated with the calculation of the
full amount due, management has elected to fully reserve the balance due. The
Company recognized a $305,919 loss on the sale of these offices. This loss
consists of the sale of assets net of liabilities assumed, totaling $317,919,
less cash received of $12,000.
In addition to the six offices above, the Company has sold 5 additional offices
during quarter ended Match 31, 2003. The aggregate sales price for the 5 offices
was $1,231,158 consisting of $285,455 cash and $945,703 in promissory notes due
the Company. Due to uncertainties associated with the payment of these
promissory notes management has reserved $815,703 of the balance due.
6. DISCONTINUED OPERATIONS
The assets and liabilities attributable to the sale of offices, which have been
classified in the consolidated balance sheets as assets and liabilities held for
sale, consist of the following:
13
December 31, 2002 June 30, 2002
----------------- -------------
Accounts receivable, net $ 173,858 $ 1,832,489
Other current assets - 408,084
Property and equipment, net - 851,653
Other long-term assets - 59,529
Intangible assets, net 329,827 1,584,620
----------------- -------------
Total assets held for sale $ 503,685 $ 4,736,375
----------------- -------------
Accounts payable and accrued expenses 971,651 1,692,335
Other current liabilities 1,550,000 1,715,000
----------------- -------------
Total liabilities held for sale $ 2,521,651 $ 3,407,335
----------------- -------------
Operating results of discontinued operations included in the statements of
operations, which includes all offices, for the three and six months ended
December 31, 2002 and 2001 related to the sale of offices is summarized as
follows:
For the three months ended For the six months ended
December 31, December 31,
2002 2001 2002 2001
----------- ----------- ----------- ----------
Revenues:
Financial planning services $ 1,302,266 $ 3,691,634 $ 3,611,763 $ 7,390,462
Tax preparation fees 207,722 805,011 881,635 1,720,561
Direct mail services - - -
----------- ----------- ----------- -----------
Total revenue 1,509,988 4,496,645 4,493,398 9,111,023
----------- ----------- ----------- -----------
Operating Expenses:
Salaries and commissions $ 1,590,998 $ 3,195,969 $ 4,248,783 $ 6,603,009
General and administrative 94,606 382,123 381,366 771,189
Advertising 6,667 29,877 18,588 134,878
Rent 236,474 588,325 829,040 1,132,664
Depreciation and amortization 54,662 129,726 157,306 251,284
----------- ----------- ----------- -----------
Total operating expenses 1,983,407 4,326,020 5,635,083 8,893,024
----------- ----------- ----------- -----------
Income (loss) from operations $ (473,419) $ 170,625 $(1,141,685) $ 217,999
----------- ----------- ----------- -----------
Other income $ - $ $ $
----------- ----------- ----------- -----------
Net Income (loss) $ (473,419) $ 170,625 $(1,141,685) $ 217,999
=========== =========== =========== ===========
14
7. DEBT
Merrill Lynch and EAB
As of June 30, 2000, the Company had a $10.0 million credit facility with
Merrill Lynch. This facility consisted of three separate loans including: a line
of credit of $4.0 million and two revolver loans totaling $6.0 million. On
November 1, 2000, the Company closed an $11.0 million financing with Travelers
Insurance Company ("Travelers") and European American Bank ("EAB") and
simultaneously paid Merrill Lynch the entire balance owed it on the outstanding
credit facility, terminating its lending relationship with Merrill Lynch.
Wachovia
The EAB senior credit facility totaled $6.0 million and was structured as a line
of credit for a term that expired on October 30, 2001. The Company received an
extension until a replacement facility was finalized on December 26, 2001. On
December 26, 2001, the Company closed a $7.0 million financing (the "Loan") with
Wachovia Bank, National Association, formerly First Union National Bank
("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"). The interest
rate on the term loan and the revolving credit loan is LIBOR plus 2.75%. The
term loan was being amortized over five years and the revolving credit loan had
a term of two years.
On November 27, 2002, the Company and Wachovia entered into a forbearance
agreement dated as of November 27, 2002 (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. The Company had changed its control without Wachovia's consent and failed
to meet requirements under the Loan to pay scheduled debt service and to
maintain certain financial ratios including senior funded debt to EBITDA. The
Company paid the debt service to Wachovia and, Wachovia agreed to forbear from
enforcing its default remedies and extended the time of payment for the Loan to
November 1, 2003 ("Maturity Date"). Pursuant to the Forbearance Agreement the
interest rate charged on the Loans was increased by 1% to LIBOR plus 3.75%.
With respect to the revolving credit loan, during the period of forbearance the
Company is obligated to make interest payments monthly until the Maturity Date.
Principal payments in the amount of $250,000 each were due on March 10, 2003,
April 10, 2003, May 10, 2003 and June 10, 2003, with the remaining principal
balance due on the Maturity Date. The Company timely made the $250,000 principal
payment due on March 10, 2003 and on April 10, 2003. In an Amendment to
Forbearance Agreement entered into between the Company and Wachovia as of June
18, 2003, Wachovia rescheduled the May 10, 2003 and June 10, 2003 payments and
the Company did not make these payments.
With respect to the term loan, during the period of forbearance the Company is
obligated to make its regular payments of principal in the amount of $83,333
plus interest until the Maturity Date when remaining principal balance is due.
In addition, commencing on May 1, 2003, the Company is obligated to make
payments on the 10th day of each month to Wachovia in an amount equal to 50% of
the amount of cash and marketable securities possessed by the Company that
exceeds $1,500,000 on the last day of the preceding month. However, amounts
contained in the broker-dealer reserve to the extent of regulatory requirements
and historical levels will not be included in the calculation of cash and
marketable securities for purposes of this payment.
On March 5, 2003, the Company received a notice of default from the attorneys
for Wachovia. Wachovia alleged that the Company was in default for the following
reasons: selling eleven offices without the written consent of Wachovia; failing
to remit to Wachovia the proceeds of the sales of the offices; and failing to
provide to Wachovia the monthly reports required under the Forbearance
Agreement. By letter dated March 10, 2003, counsel for Wachovia advised the
Company that Wachovia rescinded the notice of default.
Wachovia also consented to the sale of certain Company offices. Wachovia's
forbearance and consent were made in reliance on the Company's agreement that it
would obtain Wachovia's prior consent for all future sales of offices and that
the cash payments received or to be received from the approved sales would be
remitted to Wachovia in reduction of the Company's scheduled principal payments.
Upon a subsequent review of the Forbearance Agreement, on March 21, 2003 the
Company notified the attorneys for Wachovia that it was not in compliance with
the following provisions of the Forbearance Agreement: late filing of several
local personal property tax returns and late payment of the taxes owed; late
payment of several local license fees and late payment of several vendors of
materials and supplies; and failure to make rent payments on a few vacant
offices for which the Company was negotiating workout payments with the
landlords. The total amount due for these payables was not material and the
Company was verbally advised by counsel to Wachovia that Wachovia would not
issue a notice of default for any of the items.
At a meeting with Wachovia on May 13, 2003, the Company notified Wachovia that
it was in technical default under the Forbearance Agreement for failing to pay
payroll tax withholdings due which resulted from a bookkeeping error from
switching to a new payroll company. All payroll tax withholdings were
immediately paid by the Company after discovering the error.
By an Amendment to Forbearance Agreement dated as of June 18, 2003, the Company
and Wachovia amended the Forbearance Agreement to change, among other things,
the following provisions of the Forbearance Agreement: the Maturity Date was
extended to July 1, 2004; the Company's reporting requirements to Wachovia were
changed; the May 10, 2003 and June 10, 2003 principal payments of $250,000 were
rescheduled; principal payments in amounts of $250,000 are now due on March 10,
2004, April 10, 2004, May 10, 2004 and June 10, 2004; and the Company will be
required to pay to Wachovia fifty (50%) percent of the excess over $1,000,000 of
any lump sum payment received from Pinnacle Tax Advisors, LLC.
15
Travelers
The Company's credit facility with Travelers closed on November 1, 2000. It was
a $5 million debt financing. As part of the debt facility financing with
Travelers, the Company issued warrants to purchase 725,000 shares of the
Company's common stock. Of this amount, 425,000 warrants were issued to purchase
at $4.23 per share, representing the average closing price for 20 days before
the effective date. The 425,000 warrants were exercisable before May 2, 2003. As
of May 2003, the warrants were not exercised and subsequently expired. The
remaining warrants to purchase 300,000 shares of the Company's common stock were
awarded on February 28, 2002 with a strike price of $2.43 and will expire on
October 31, 2005. The value as determined by an external appraisal of these
warrants issued on February 28, 2002, was set at $300,000. The warrant
valuations were treated as a debt discount and are being amortized over the
five-year term of the Debt Facility under the effective interest rate method.
The amortization of the debt discount for the Fiscal years ended June 30, 2002
and June 30, 2001, was approximately $256,600 and $166,000, respectively. At
December 31, 2002 and June 30, 2002 the term loan had an outstanding principal
balance of $4.23 and $4.07 million, respectively.
On September 24, 2002, the Company received a notice from the attorneys for
Travelers alleging that the Company was in default under its debt facility with
Travelers due to nonpayment of a $100,000 penalty for failure to meet sales
production requirements as specified in the debt facility. The Company sent a
letter to the attorneys denying that the Company was in default. Although the
Traveler's notice stated that all unpaid interest and principal under the Debt
Facility were immediately due and payable and that Travelers reserved its rights
and remedies under the debt facility, it also stated that Travelers intended to
comply with the terms of a subordination agreement between Travelers and
Wachovia. Such subordination agreement greatly restricts the remedies which
Travelers could pursue against the Company.
Rappaport
On October 30, 2001, the Company borrowed $1,000,000 from Rappaport Gamma, Ltd.,
pursuant to a written note without collateral and without stated interest (the
"Loan"). The Loan was due and payable on October 30, 2002. Additionally, the
Loan provided that: Rappaport receive 100,000 shares of Rule 144 restricted
shares of common stock of the Company upon the funding of the 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
to Rappaport if the Loan was not paid when due and an additional penalty of
10,000 shares per month thereafter until the Loan was paid in full. The 100,000
shares were issued on October 31, 2001 at a value of $3 per share. On December
26, 2001, Rappaport subordinated the Loan to the $7,000,000 being loaned to the
Company by Wachovia. In consideration of the subordination, the 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 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. The Loan
was not paid by March 31, 2002. Accordingly, Rappaport was issued 95,298 common
shares with a value of $150,000 on May 7, 2002 for the March 31, 2002 penalty.
When the Rule 144 holding period was satisfied in October, 2002 with respect to
the 100,000 shares of the Company's common stock issued to Rappaport on the
funding of the Loan, the stock price was $.40 per share. As a result, on October
31, 2002, Rappaport was issued an additional 650,000 common shares to be added
to the 100,000 shares issued upon the funding of the Loan so that the total
value of the original shares issued was $300,000. By June 30, 2003, Rappaport
will have received a total of 1,015,298 shares for all interest and penalties
and will receive 15,000 shares per month as additional penalties until the Loan
is paid in full.
8. STOCK-BASED COMPENSATION
The Company has established various stock - based compensation plans for its
officers, directors, key employees and consultants. See Fiscal year ended June
30, 2002 Annual Report on form 10-K for description of the Company's stock-based
compensation plans.
Stock option activity during the six months ended December 31, 2002 was as
follows:
Outstanding June 30, 2002 4,819,594
Grants -
Cancels (1,495,203)
Exercises -
---------
Outstanding - December 31, 2002 3,324,391
---------
Exercisable - December 31, 2002 2,617,930
---------
The Company follows the disclosure-only provisions of SFAS 123 and applies APB
No. 25 "Accounting for Stock Issued to Employees" and related interpretations in
accounting for its stock option plans. If compensation expense
16
for stock options awarded under the Company's plans had been determined in
accordance with SFAS No. 123, the Company's pro forma net loss and pro forma net
loss per share would have been as follows:
Six Months Ended December 31,
--------------------------------
2002 2001
-------------- --------------
Net loss:
As reported $ (9,409,993) $ (3,164,147)
Pro forma $ (9,510,351) $ (4,328,128)
Basic and diluted net loss per share:
As reported $ (1.03) $ (0.37)
Pro forma $ (1.04) $ (0.51)
The effects of applying SFAS 123 in the pro forma net loss disclosures above are
not likely to be representative of the effects on pro forma disclosures of
future years.
9. SEGMENTS OF BUSINESS
The Company's reportable segments are strategic business units that offer
different products and services or are managed separately and have unique and
distinctly different business models. The Company has three reportable segments
including Company Tax Offices, Broker Dealer Operations and e1040.com.
Company Tax Offices provide integrated tax and financial services through
Company managed offices. The Company's Broker Dealer Operations represent the
financial planning and securities business that clears through either PCS or
North Ridge. All Company employed Registered Representatives are licensed with
either of these broker dealers. e1040.com is an online tax preparation service
that provides tax customers tax return preparation under a fully automated
option or with live tax preparer assistance.
Three Months Ended December 31, Six Months Ended December 31,
2001 2001
2002 (Restated) 2002 (Restated)
------------ ------------ ------------ ------------
REVENUES:
Company Tax Offices
Tax Preparation Business $ 408,438 $ 499,465 $ 977,097 $ 1,058,534
Financial Planning Business 4,104,175 6,785,481 8,118,329 12,752,470
------------ ------------ ------------ ------------
Total Company Tax Offices 4,512,613 7,284,946 9,095,426 13,811,004
Broker Dealer Operations 14,847,021 17,626,943 30,679,323 35,784,177
e1040.com - 2,148 - 23,972
Direct mailing services - - - 505,407
Intercompany revenue (4,523,923) (9,631,842) (9,630,937) (18,082,581)
------------ ------------ ------------ ------------
Total revenue $ 14,835,711 $ 15,282,195 $ 30,143,812 $ 32,041,979
------------ ------------ ------------ ------------
INCOME (LOSS) FROM OPERATIONS:
Company Tax Offices $ (2,441,533) $ (2,158,269) $ (4,886,448) $ (5,618,170)
Broker Dealer Operations (594,555) (392,760) 554,178 212,694
Direct mailing services - (90,173) - (411,250)
e1040.com (310) (233,913) (149) (567,917)
------------ ------------ ------------ ------------
Total income (loss) from operations $ (3,036,398) $ (2,875,115) $ (4,332,419) $ (6,384,643)
------------ ------------ ------------ ------------
DEPRECIATION AND AMORTIZATION:
Company Tax Offices $ 295,051 $ 411,052 $ 581,784 $ 773,693
Broker Dealer Operations 165,659 223,401 441,248 442,058
Direct mailing services - - - 13,496
e1040.com - 86,413 - 172,826
------------ ------------ ------------ ------------
Total depreciation and amortization $ 460,710 $ 720,866 $ 1,023,032 $ 1,402,073
------------ ------------ ------------ ------------
17
Quarter Ended December 31, Six Months Ended December 31,
2002 2001 2002 2001
------------ ------------ ------------ ------------
INTEREST EXPENSE:
Company Tax Offices $ (683,745) $ (332,155) $ (1,150,321) $ (622,617)
Broker Dealer Operations (30,100) (14,868) (51,972) (28,567)
e1040.com - (165,405) - (328,674)
------------ ------------ ------------ ------------
Total interest expense $ (713,845) $ (512,428) $ (1,202,293) $ (979,858)
------------ ------------ ------------ ------------
INTEREST AND INVESTMENT INCOME:
Company Tax Offices $ 15 $ 29,997 $ 4,267 $ 48,362
Broker Dealer Operations 114 65,827 327 117,511
e1040.com - - - -
------------ ------------ ------------ ------------
Total interest income $ 129 $ 95,824 $ 4,594 $ 165,873
------------ ------------ ------------ ------------
OTHER INCOME (EXPENSES):
Company Tax Offices $ - $ 5,663 $ - $ (136,400)
Broker Dealer Operations - - - -
Direct mail services - 10,380 - 204,823
e1040.com - - - 324
------------ ------------ ------------ ------------
Total other income(expenses) $ - $ 16,043 $ - $ 68,747
------------ ------------ ------------ ------------
LOSS BEFORE TAXES:
Company Tax Offices $ (3,125,258) $ (2,454,684) $ (6,032,497) $ (6,328,735)
Broker Dealer Operations (624,546) (341,801) 502,528 301,637
Direct mail services - (79,872) - (206,516)
e1040.com (310) (399,319) (149) (896,267)
------------ ------------ ------------ ------------
Total loss before taxes $ (3,750,114) $ (3,275,676) $ (5,530,118) $ (7,129,881)
------------ ------------ ------------ ------------
IDENTIFIABLE ASSETS:
Company Tax Offices $ 33,159,423 $ 49,307,699 $ 33,159,423 $ 49,307,699
Broker Dealer Operations 20,717,009 21,420,549 20,717,009 21,420,549
Intercompany elimination (26,846,114) (19,219,799) (26,846,114) (19,219,799)
------------ ------------ ------------ ------------
Total identifiable assets $ 27,030,318 $ 51,508,449 $ 27,030,318 $ 51,508,449
------------ ------------ ------------ ------------
CAPITAL EXPENDITURES:
Company Tax Offices $ - $ 6,575 $ - $ 198,103
Broker Dealer Operations 45,516 160,121 84,460 259,982
e1040.com - - - -
------------ ------------ ------------ ------------
Total capital expenditures $ 45,516 $ 166,696 $ 84,460 $ 458,085
------------ ------------ ------------ ------------
18
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 and Section 21E of the Securities Exchange Act of 1934. Such
statements 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;
changes in competition and the effects of such changes; 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 involving the Company and
risks described from time to time in reports and registration statements filed
by the Company and its subsidiaries with the Securities and Exchange Commission.
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.
OVERVIEW
The Company is a preparer of federal, state and local income tax returns for
individuals predominantly in middle and upper income brackets. In addition,
while preparing tax returns clients often consider other aspects of their
financial needs, such as investments, insurance, pension and estate planning.
The Company capitalizes on this situation by making financial planning services
available to clients. The financial planners who provide such service are
employees or independent contractors of the Company and are Registered
Representatives of the Company's broker/dealer subsidiaries. The Company and/or
its broker/dealer subsidiaries earn a share of commissions (depending on what
service is provided) from the services that the financial planners provide to
the clients in transactions for securities, insurance and related products.
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. In addition, the Company owns a 50% equity interest in
GTAX/CB, an insurance broker.
During the first half of Fiscal 2003, approximately 3.2% of the Company's
revenues were earned from tax preparation services and 96.8% were earned from
all financial planning and related services.
The Company's financial planning clients generally are introduced to the Company
through the Company's tax preparation services. The Company believes that its
tax return preparation business is inextricably intertwined with and is a
necessary adjunct to its financial planning activities. Neither segment would
operate as profitably by itself and the two segments leverage off each other
improving profitability and client retention.
19
Critical Accounting Policies
The preparation of financial statements in conformity with generally accepted
accounting principles requires us to make estimates and assumptions. These
estimates and assumptions affect the reported amounts of assets and liabilities
and the disclosures of contingent assets and liabilities at the date of the
financial statements, as well as the reported amounts of revenue and expenses
during a reporting period. Actual results can differ from those estimates, and
it is possible that the differences could be material.
We believe the following accounting policies, which are described in the Notes
to Consolidated Financial Statements included in this Form 10Q, are critical to
the accuracy of the more significant judgments and estimates used in the
preparation of our consolidated financial statements:
o Discontinued operations
o Revenue recognition
o Valuation of goodwill and other intangibles
o Income tax recognition of deferred tax items
o Valuation of customer receivables
RESULTS OF OPERATIONS - THREE MONTHS ENDED DECEMBER 31, 2002 COMPARED TO THREE
MONTHS ENDED DECEMBER 31, 2001
The Company's revenues for the three months ended December 31, 2002 were
$14,835,711 compared to $15,282,195 for the three months ended December 31,
2001, a decrease of $446,484 or 2.9%. Of the total decrease, $353,309 was
attributable to a reduction in the Company's financial planning business,
$91,027 was attributable to a reduction in the Company's tax preparation fees
and $2,148 was attributable to a reduction in e1040.com revenue. The general
economic weakness as well as the slowdown in the financial services sector, in
which the company operates, is a major contributor to the decline in revenues.
The Company's total revenues for the three months ended December 31, 2002
consisted of $14,427,273 for financial planning services and $408,438 for tax
preparation fees. Financial planning services represented 97.3% and tax
preparation fees represented 2.7% of the Company's total revenues during the
three months ended December 31, 2002. The Company's total revenues for the three
months ended December 31, 2001 consisted of $14,780,582 for financial planning
services, $499,465 for tax preparation fees and $2,148 for e1040.com. Financial
planning services represented 96.7%, tax preparation fees represented 3.3% and
e1040.com represented 0.01% of the Company's total revenues during the three
months ended December 31, 2001.
The Company's operating expenses for the three months ended December 31, 2002
were $17,872,109 or 120.5% of revenues, a decrease of $285,201 or 1.6%, compared
to $18,157,310 or 118.8% of revenues for the three months ended December 31,
2001. The decrease in operating expenses was attributable to decreases in
salaries and commissions of $29,943, advertising of $142,410, rent of 197,182,
depreciation and amortization of $260,156, offset by increases in general and
administrative expenses of $191,443, brokerage fees and licenses of $67,722 and
loss on equipment sales of $85,325.
Salaries and commissions decreased $29,943 or 0.2% in the three months ended
December 31, 2002 to $13,612,124 from $13,642,067 during the three months ended
December 31, 2001. This decrease is primarily attributable to decreases in
personnel and related costs associated with corporate overhead offset by
decreases in financial planning margins due to a change in financial planning
product mix.
General and administrative expenses increased $191,443 or 8.6% in the three
months ended December 31, 2002 to $2,406,371 from $2,214,928 during the three
months ended December 31, 2001. This increase is primarily attributable to
increases in professional fees offset by decreases in financial planner bad debt
expenses and recruiting expenses.
Advertising expenses decreased $142,410 or 81.0% in the three months ended
December 31, 2002 to $33,414 from $175,824 during the three months ended
December 31, 2001. This decrease is primarily attributable to reductions in
direct mail costs as a result of the Company's evaluation of the effectiveness
of its direct response advertising.
20
Brokerage fees and licenses expenses increased $67,722 or 14.9% in the three
months ended December 31, 2002 to $521,644 from $453,922 during the three months
ended December 31, 2001. This increase is primarily attributable to new
regulatory fees required for registered investment advisors.
Rent expense decreased $197,182 or 20.8% in the three months ended December 31,
2002 to $752,521 from $949,703 during the three months ended December 31, 2001.
This decrease is primarily attributed to the consolidation of corporate overhead
facilitates and the termination of leases associated with closed or merged
offices.
Depreciation and amortization expense decreased $260,156 or 36.1% in the three
months ended December 31, 2002 to $460,710 from $720,866 during the three months
ended December 31, 2001. This decrease is primarily attributable to lower fixed
assets and intangible balances as a result of reduced capital spending, the sale
of equipment and impairment losses.
Losses on the sale of equipment increased $85,325 during the three months ended
December 31, 2002 from $0 during the three months ended December 31, 2001. The
loss includes the book value of the equipment at the time of sale of $99,325
less sale proceeds of $14,000.
The Company's loss from operations for the three months ended December 31, 2002
was $3,036,398 as compared to a loss of $2,875,115 for the three months ended
December 31, 2001, an increase of $161,283 or 5.6%. This increase in loss was
attributable to the reduction in revenues described above partially offset by
the net reduction in operating expenses described.
The Company's loss before the provision or benefit of income taxes for the three
months ended December 31, 2002 was $3,750,114 compared to $3,275,676 for the
three months ended December 31, 2001. This increase in loss of $474,438 or 14.5%
was attributed to the net increase in loss from operations of $161,283
highlighted above and by a net increase in other expenses, net, of $313,155. The
net increase in other expenses, net, includes an increase in interest expense of
$201,417 and a decrease in interest and investment income of $95,695. The
increase in interest expense is primarily attributable to the issuance of common
stock to satisfy certain obligations under the Rappaport loan agreement. Also
see footnote 7 - Debt Rappaport. The decrease in interest and investment income
is primarily attributable to lower earnings from the Company's joint ventures
accounted for under the equity method.
The Company's loss after income tax provision from continuing operations for the
three months ended December 31, 2002 was $3,763,714 compared to $1,523,676 for
the three months ended December 31, 2001. This increased loss of $2,240,038 or
147.0% was attributable to the decrease of income tax benefit of $1,765,600
offset by the changes in the revenues and expenses highlighted above. The
decrease in income tax benefit is attributable to a full valuation allowance on
the Company's current and deferred tax assets at December 31, 2002 compared to a
valuation allowance of zero on the Company's current and deferred tax assets at
December 31, 2001.
The Company had a loss from Discontinued Operations for the three months ended
December 31, 2002 of $2,634,929 compared to a gain of $110,360 for the three
months ended December 31, 2001.
RESULTS OF OPERATIONS - SIX MONTHS ENDED DECEMBER 31, 2002 COMPARED TO THE SIX
MONTHS ENDED DECEMBER 31, 2001
The Company's revenues for the six months ended December 31, 2002 were
$30,143,812 compared to $32,041,979 for the six months ended December 31, 2001,
a decrease of $1,898,167 or 5.9%. Of the total decrease, $1,287,351 was
attributable to a reduction in the Company's financial planning business,
$81,437 was attributable to a reduction in the Company's tax preparation fees,
$23,972 was attributable to a reduction in e1040.com revenue and $505,407
reduction in Direct mail services.
The Company's total revenues for the six months ended December 31, 2002
consisted of $29,166,715 for financial planning services and $977,097 for tax
preparation fees. Financial planning services represented 96.8% and tax
preparation fees represented 3.2% of the Company's total revenues during the six
months ended December 31, 2002. The Company's total revenues for the six months
ended December 31, 2001 consisted of $30,454,066 for financial
21
planning services, $1,058,534 for tax preparation fees, $23,972 for e1040.com
and $505,407 for Direct mail services. Financial planning services represented
95.0%, tax preparation fees represented 3.3%, e1040.com represented 0.1% and
Direct mail services represented 1.6% of the Company's total revenues during the
six months ended December 31, 2001.
The Company's operating expenses for the six months ended December 31, 2002 were
$34,476,231 or 114.4% of revenues, a decrease of $3,950,391 or 10.3%, compared
to $38,426,622 or 119.9% of revenues for the six months ended December 31, 2001.
The decrease in operating expenses was attributable to decreases in salaries and
commissions of $2,870,260, advertising of $732,620, brokerage fees and licenses
of $10,891, rent of $118,356, depreciation and amortization of $379,041 offset
by an increase in loss on equipment sales of $85,325 partially offset by an
increase in general and administrative expenses of $75,452.
Salaries and commissions decreased $2,870,260 or 9.9% in the six months ended
December 31, 2002 to $26,260,435 from $29,130,695 during the six months ended
December 31, 2001. This decrease is primarily attributable to decreases in
personnel and related costs associated with corporate overhead offset by
decreases in financial planning margins due to a change in financial planning
product mix.
General and administrative expenses increased $75,452 or 1.7% in the six months
ended December 31, 2002 to $4,469,224 from $4,393,772 during the six months
ended December 31, 2001. This increase is primarily attributable to increases in
professional fees and insurance expenses, partially offset by lower telephone,
client settlement and planner bad debt expenses.
Advertising expenses decreased $732,620 or 92.6% in the six months ended
December 31, 2002 to $58,871 from $791,491 during the six months ended December
31, 2001. This decrease is primarily attributable to reductions in direct mail
costs as a result of the Company's evaluation of the effectiveness of its direct
response advertising.
Brokerage fees and licenses expenses decreased $10,891 or 1.2% in the six months
ended December 31, 2002 to $889,398 from $900,289 during the six months ended
December 31, 2001. This decrease is primarily attributable to reduced planner
headcount in the broker-dealer segment.
Rent expense decreased $118,356 or 6.6% in the six months ended December 31,
2002 to $1,689,946 from $1,808,302 during the six months ended December 31,
2001. This decrease is primarily attributed to the consolidation of corporate
overhead facilitates and the termination of leases associated with closed or
merged offices.
Depreciation and amortization expense decreased $379,041 or 27.0% in the six
months ended December 31, 2002 to $1,023,032 from $1,402,073 during the six
months ended December 31, 2001. This decrease is primarily attributable to lower
fixed assets and intangible balances as a result of reduced capital spending,
the sale of equipment and impairment losses.
Losses on the sale of equipment increased $85,325 during the six months ended
December 31, 2002 from $0 during the six months ended December 31, 2001. The
loss includes the book value of the equipment at the time of sale of $99,325
less sale proceeds of $14,000.
The Company's loss from operations for the six months ended December 31, 2002
was $4,332,419 as compared to a loss of $6,384,643 for the six months ended
December 31, 2001, a decrease of $2,052,224 or 32.1%. This decrease in loss was
attributable to the net reduction in operating expenses described above,
partially offset by the reduction of revenues.
The Company's loss before the provision or benefit of income taxes for the six
months ended December 31, 2002 was $5,530,118 compared to $7,129,881 for the six
months ended December 31, 2001. This decrease in loss of $1,599,763 or 22.4% was
attributed to the net decrease in loss from operations of $2,052,224 highlighted
above, offset partially by a net increase in other expenses, net, of $452,461.
The net increase in other expenses, net, includes an increase in interest
expense of $222,435 and a decrease in interest and investment income of
$161,279. The increase in interest expense is primarily attributable to the
issuance of common stock to satisfy certain obligations under the Rappaport loan
agreement (See Note 7). The decrease in interest and investment income is
22
primarily attributable to lower earnings from the Company's joint ventures
accounted for under the equity method.
The Company's loss after income tax provision from continuing operations for the
six months ended December 31, 2002 was $5,581,618 compared to $3,351,881 for the
six months ended December 31, 2001. This increased loss of $2,229,737 or 66.5%
was attributable to the decrease of income tax benefit of $3,829,500 offset by
the changes in the revenues and expenses highlighted above. The decrease in
income tax benefit is attributable to a full valuation allowance on the
Company's current and deferred tax assets at December 31, 2002 compared to a
valuation allowance of zero on the Company's current and deferred tax assets at
December 31, 2001.
The loss from Discontinued Operations for the six months ended December 31, 2002
was $3,828,375 compared to a gain of $187,734 for the six months ended
December 31, 2001. The increased loss of $4,016,109 is primarily due to the
loss on the sale of Pinnacle of $2,874,624.
LIQUIDITY AND CAPITAL RESOURCES
The Company's revenues have been partly seasonal and are expected to continue to
be somewhat seasonal. As a result, the Company must generate sufficient cash
during the tax season, in addition to its available bank credit, 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 on going accounting and corporate tax revenue. Since
its inception, the Company has utilized funds from operations, proceeds from its
initial public offering and bank borrowings to support operations, finance
working capital requirements and complete acquisitions. As of December 31, 2002
and June 30, 2002 the company had $0.5 and $2.2 million in cash and cash
equivalents and $1.3 and $1.8 million in marketable securities, respectively.
PCS and North Ridge are subject to the SEC's Uniform Net Capital Rule 15c 3-1
(PCS) and 15c 3-3 (North Ridge), which require the maintenance of minimum
regulatory net capital and that the ratio of aggregate indebtedness to net
capital, both as defined, shall not exceed the greater of 15 to 1 or $100,000
and $25,000, respectively. For PCS, the minimum required regulatory net capital
was $204,759 and had excess net capital of $205,462. For North Ridge, the
minimum required regulatory net capital was $38,580 and had excess net capital
of $67,230.
In August 2002, the Company entered into an agreement granting an option to a
group of current management, led by Thomas Povinelli, the Company's former Chief
Executive Officer and David Puyear, the Company's former Chief Financial
Officer, to leave the Company along with employees who wish to join them. Under
the terms of this agreement, Messrs. Povinelli and Puyear could purchase a
portion of the Company's offices and the tax and financial planning revenue
associated with such offices. On November 26, 2002 the Company finalized a
transaction pursuant to an asset purchase agreement (the "Purchase Agreement")
with Pinnacle Taxx Advisors LLC ("Pinnacle"), whereby Pinnacle, an entity
controlled by Thomas Povinelli and David Puyear, purchased certain assets of the
Company. The Company sold to Pinnacle 47 offices ("Purchased Offices") and all
tangible and intangible assets which are associated with the operations of the
offices. As part of the sale all employees of the Purchased Offices were
terminated by the Company as of November 15, 2002 and were hired by Pinnacle.
The total unadjusted purchase price payable by Pinnacle is $4,745,463.
In addition to the Pinnacle transaction, the Company completed the sale/closure
of 11 additional offices from July 1st, 2002 through March 31st, 2003. The
aggregate sales price for the 11 offices was $1,363,158 consisting of $417,455
cash and $945,703 in promissory notes due the Company. Due to uncertainties
associated with the payment of these promissory notes management has reserved
$815,703 of the balance due.
The Company's cash flows used in operating activities totaled $1,260,171 and
$3,766,083 for the six months ended December 31, 2002 and 2001, respectively.
The decrease of $2,505,912 in cash used is due to the implementation of
management plans to reduce operating costs, the disposal of certain offices, and
improved collections of accounts receivables. These decreases in cash flow used
in operating activities were offset by net payments of accounts payable and
accrued expenses.
Net cash provided by investing activities totaled $237,047 and $151,062 for the
six months ended December 31, 2002 and 2001, respectively. The increase in cash
provided of $85,985 is primarily attributed to a reduction in capital
expenditures of $373,625, a decrease in cash paid for acquisitions of $109,643
and the realization of proceeds received from the sale of business of $324,114,
offset by the elimination of proceeds from the sale of mailing services of
$347,000 and the elimination of $342,580 in proceeds from asset purchase
agreement.
Net cash used in financing activities totaled $691,220 for the six months ended
December 31, 2002 as compared to $1,953,871 of cash provided by financing
activities for the six months December 31, 2001, respectively. The decrease in
cash provided by financing activities of $2,645,091 is attributed to a decrease
in proceeds from bank and other loans of $7,845,000 offset by a decrease in
payments of banks and capital lease obligations of $5,293,696, and a decrease in
acquisition of treasury stock of $67,267.
Merrill Lynch and EAB
As of June 30, 2000, the Company had a $10.0 million credit facility with
Merrill Lynch. This facility consisted of three separate loans including: a line
of credit of $4.0 million and two revolver loans totaling $6.0 million. On
November 1, 2000, the Company closed an $11.0 million financing with Travelers
Insurance Company ("Travelers") and European American Bank ("EAB") and
simultaneously paid Merrill Lynch the entire balance owed it on the outstanding
credit facility, terminating its lending relationship with Merrill Lynch.
23
Wachovia
The EAB senior credit facility totaled $6.0 million and was structured as a line
of credit for a term that expired on October 30, 2001. The Company received an
extension until a replacement facility was finalized on December 26, 2001. On
December 26, 2001, the Company closed a $7.0 million financing (the "Loan") with
Wachovia Bank, National Association, formerly First Union National Bank
("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"). The interest
rate on the term loan and the revolving credit loan is LIBOR plus 2.75%. The
term loan was being amortized over five years and the revolving credit loan had
a term of two years.
On November 27, 2002, the Company and Wachovia entered into a forbearance
agreement dated as of November 27, 2002 (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. The Company had changed its control without Wachovia's consent and failed
to meet requirements under the Loan to pay scheduled debt service and to
maintain certain financial ratios including senior funded debt to EBITDA. The
Company paid the debt service to Wachovia and, Wachovia agreed to forbear from
enforcing its default remedies and extended the time of payment for the Loan to
November 1, 2003 ("Maturity Date"). Pursuant to the Forbearance Agreement the
interest rate charged on the Loans was increased by 1% to LIBOR plus 3.75%.
With respect to the revolving credit loan, during the period of forbearance the
Company is obligated to make interest payments monthly until the Maturity Date.
Principal payments in the amount of $250,000 each were due on March 10, 2003,
April 10, 2003, May 10, 2003 and June 10, 2003, with the remaining principal
balance due on the Maturity Date. The Company timely made the $250,000 principal
payment due on March 10, 2003 and on April 10, 2003. In an Amendment to
Forbearance Agreement entered into between the Company and Wachovia as of June
18, 2003, Wachovia rescheduled the May 10, 2003 and June 10, 2003 payments and
the Company did not make these payments.
With respect to the term loan, during the period of forbearance the Company is
obligated to make its regular payments of principal in the amount of $83,333
plus interest until the Maturity Date when remaining principal balance is due.
In addition, commencing on May 1, 2003, the Company is obligated to make
payments on the 10th day of each month to Wachovia in an amount equal to 50% of
the amount of cash and marketable securities possessed by the Company that
exceeds $1,500,000 on the last day of the preceding month. However, amounts
contained in the broker-dealer reserve to the extent of regulatory requirements
and historical levels will not be included in the calculation of cash and
marketable securities for purposes of this payment.
On March 5, 2003, the Company received a notice of default from the attorneys
for Wachovia. Wachovia alleged that the Company was in default for the following
reasons: selling eleven offices without the written consent of Wachovia; failing
to remit to Wachovia the proceeds of the sales of the offices; and failing to
provide to Wachovia the monthly reports required under the Forbearance
Agreement. By letter dated March 10, 2003, counsel for Wachovia advised the
Company that Wachovia rescinded the notice of default.
Wachovia also consented to the sale of certain Company offices. Wachovia's
forbearance and consent were made in reliance on the Company's agreement that it
would obtain Wachovia's prior consent for all future sales of offices and that
the cash payments received or to be received from the approved sales would be
remitted to Wachovia in reduction of the Company's scheduled principal payments.
Upon a subsequent review of the Forbearance Agreement, on March 21, 2003 the
Company notified the attorneys for Wachovia that it was not in compliance with
the following provisions of the Forbearance Agreement: late filing of several
local personal property tax returns and late payment of the taxes owed; late
payment of several local license fees and late payment of several vendors of
materials and supplies; and failure to make rent payments on a few vacant
offices for which the Company was negotiating workout payments with the
landlords. The total amount due for these payables was not material and the
Company was verbally advised by counsel to Wachovia that Wachovia would not
issue a notice of default for any of the items.
At a meeting with Wachovia on May 13, 2003, the Company notified Wachovia that
it was in technical default under the Forbearance Agreement for failing to pay
payroll tax withholdings due which resulted from a bookkeeping error from
switching to a new payroll company. All payroll tax withholdings were
immediately paid by the Company after discovering the error.
By an Amendment to Forbearance Agreement dated as of June 18, 2003, the Company
and Wachovia amended the Forbearance Agreement to change, among other things,
the following provisions of the Forbearance Agreement: the Maturity Date was
extended to July 1, 2004; the Company's reporting requirements to Wachovia were
changed; the May 10, 2003 and June 10, 2003 principal payments of $250,000 were
rescheduled; principal payments in amounts of $250,000 are now due on March 10,
2004, April 10, 2004, May 10, 2004 and June 10, 2004; and the Company will be
required to pay to Wachovia fifty (50%) percent of the excess over $1,000,000 of
any lump sum payment received from Pinnacle Tax Advisors, LLC.
Travelers
The Company's credit facility with Travelers closed on November 1, 2000. It was
a $5 million debt financing. As part of the debt facility financing with
Travelers, the Company issued warrants to purchase 725,000 shares of the
Company's common stock. Of this amount, 425,000 warrants were issued to purchase
at $4.23 per share, representing the average closing price for 20 days before
24
the effective date. The 425,000 warrants were exercisable before May 2, 2003. As
of May 2003, the warrants were not exercised and subsequently expired. The
remaining warrants to purchase 300,000 shares of the Company's common stock were
awarded on February 28, 2002 with a strike price of $2.43 and will expire on
October 31, 2005. The value as determined by an external appraisal of these
warrants issued on February 28, 2002, was set at $300,000. The warrant
valuations were treated as a debt discount and are being amortized over the
five-year term of the Debt Facility under the effective interest rate method.
The amortization of the debt discount for the Fiscal years ended June 30, 2002
and June 30, 2001, was approximately $256,600 and $166,000, respectively. At
December 31, 2002 and June 30, 2002, the term loan had an outstanding principal
balance of $4.23 and $4.07 million, respectively.
On September 24, 2002, the Company received a notice from the attorneys for
Travelers alleging that the Company was in default under its debt facility with
Travelers due to nonpayment of a $100,000 penalty for failure to meet sales
production requirements as specified in the debt facility. The Company sent a
letter to the attorneys denying that the Company was in default. Although the
Traveler's notice stated that all unpaid interest and principal under the Debt
Facility were immediately due and payable and that Travelers reserved its rights
and remedies under the debt facility, it also stated that Travelers intended to
comply with the terms of a subordination agreement between Travelers and
Wachovia. Such subordination agreement greatly restricts the remedies which
Travelers could pursue against the Company.
Rappaport
On October 30, 2001, the Company borrowed $1,000,000 from Rappaport Gamma, Ltd.,
pursuant to a written note without collateral and without stated interest (the
"Loan"). The Loan was due and payable on October 30, 2002. Additionally, the
Loan provided that: Rappaport receive 100,000 shares of Rule 144 restricted
shares of common stock of the Company upon the funding of the 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
to Rappaport if the Loan was not paid when due and an additional penalty of
10,000 shares per month thereafter until the Loan was paid in full. The 100,000
shares were issued on October 31, 2001 at a value of $3 per share. On December
26, 2001, Rappaport subordinated the Loan to the $7,000,000 being loaned to the
Company by Wachovia. In consideration of the subordination, the 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 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. The Loan
was not paid by March 31, 2002. Accordingly, Rappaport was issued 95,298 common
shares with a value of $150,000 on May 7, 2002 for the March 31, 2002 penalty.
When the Rule 144 holding period was satisfied in October, 2002 with respect to
the 100,000 shares of the Company's common stock issued to Rappaport on the
funding of the Loan, the stock price was $.40 per share. As a result, on October
31, 2002, Rappaport was issued an additional 650,000 common shares to be added
to the 100,000 shares issued upon the funding of the Loan so that the total
value of the original shares issued was $300,000. By June 30, 2003, Rappaport
will have received a total of 1,015,298 shares for all interest and penalties
and will receive 15,000 shares per month as additional penalties until the Loan
is paid in full.
CONTRACTUAL OBLIGATION AND COMMERCIAL COMMITMENTS
The table below summarizes our contractual obligations for the five
years subsequent to December 31, 2002 and thereafter. The amounts represent the
maximum future cash contractual obligations.
Payment Due by Period
----------------------
2004 2006 After
Contractual Obligations Total 2003 to 2005 to 2007 2007
- ----------------------- ----- ---- ------- ------- ----
Debt $13,957,864 13,776,416 45,164 54,244 82,040
Operating leases 11,860,596 3,917,496 5,545,257 1,696,692 701,151
Capital leases 846,921 484,991 346,761 15,169
----------- ----------- ----------- ----------- ---------
Total contractual cash obligations $26,665,381 $18,178,903 $ 5,937,182 $ 1,766,105 $ 783,191
=========== =========== =========== =========== =========
Subsequent to year end, the Company entered into an agreement with
Pinnacle Taxx Advisors ("Pinnacle"), an entity controlled by Thomas Povinelli
and David Puyear, former executive officers of the Company, whereby the Company
sold to Pinnacle 47 offices ("Purchased Offices") and all tangible and
intangible assets which are associated with the operations of such offices (See
Note 5). In connection with the agreement all operating leases associated with
the Purchased Offices were assigned to Pinnacle. Aggregate operating lease
commitment amounts included in the table above with respect to the leases
assigned to Pinnacle in November 2002 are $1,510,887, $1,393,398, $1,096,838,
$541,487, $409,456, and $647,534 for the Fiscal years ending December 31, 2003,
2004, 2005, 2006, 2007, and thereafter.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
Market Risk and Sensitivity Analysis
There has been no material changes in market risk from those reported at June
30, 2002.
ITEM 4. CONTROLS AND PROCEDURES.
The Company's senior management is responsible for establishing and maintaining
a system of disclosure controls and procedures (as defined in Rule 13a-14 and
15d-14 under the Securities Exchange Act of 1934 (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 Securities and
Exchange Commission'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 Act is accumulated and communicated to the issuer's
management, including its principal executive officer or officers and principal
financial officer or officers, or persons performing similar functions, as
appropriate to allow timely decisions regarding required disclosure.
During the second fiscal quarter of fiscal 2003, the Company took certain steps
to improve internal controls in four offices relating to disbursement
authorization procedures. The affected offices represent approximately
$3,000,000 in tax preparation revenue and the general and administrative
disbursements in question totaled approximately $682,000.
The Company has not in the past consistently recorded the option plan pursuant
to which options were granted. The Company is implementing new record keeping
procedures regarding options that will ensure this information is accurately
recorded and processed.
The Company has evaluated the effectiveness of the design and operation of its
disclosure controls and procedures under the supervision of and with the
participation of management, including the Chief Executive Officer and Chief
Accounting Officer, within 90 days prior to the filing date of this report.
Based on that evaluation, our Chief Executive Officer and Chief Accounting
Officer have concluded that our disclosure controls and procedures are effective
in timely alerting them to material information required to be included in our
periodic Securities and Exchange Commission filings. The Company has recently
taken steps to enable such information to be processed and incorporated into our
periodic filings in such a manner that such filings are made on a timely basis.
These steps include the improvement of the process by which internal reports are
generated in order to facilitate review of necessary information by our outside
auditors and the consolidation of internal financial reporting for the Company
and all of its subsidiaries under the Chief Accounting Officer. The Company
believes that, in the future, it will be able to file its periodic reports
within the time frame required by Securities and Exchange Commission
regulations.
Subsequent to the evaluation discussed above, there have been no significant
changes in our internal controls or other factors that could significantly
affect these controls after such evaluation.
25
GILMAN + CIOCIA, INC. AND SUBSIDIARIES
PART II-OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
The Company is engaged in lawsuits in the ordinary course of business that
management believes will not have a material effect on its financial position.
On May 16, 2003, the Company initiated a lawsuit against Pinnacle Tax Advisors
LLC ("Pinnacle") in the New York State Supreme Court, Westchester County (Index
Number 03-08045), seeking payments for all amounts due under the Asset Purchase
Agreement dated as of September 1, 2002 and under the closing notes and other
closing agreements dated as of November 26, 2002. (See Notes to the Consolidated
Financial Statements). By Order to Show Cause signed by Justice Kenneth W.
Rudolph on May 16, 2003, the Company made a motion seeking, among other items, a
preliminary injunction prohibiting Pinnacle from disposing or encumbering its
assets outside of the normal course of business or in contravention of the
Security Agreement it executed in favor of the Company at the closing, and
prohibiting Pinnacle from transferring its assets outside of the State of New
York except in the ordinary course of business. By Stipulation dated May 29,
2003, which will be "So Ordered" by Justice Rudolph, Pinnacle consented to the
preliminary injunctive relief demanded by the Company. In addition, Pinnacle
consented to other interim relief including assigning to the Company all
receivables and related contract revenue from Pinnacle's insurance and fixed
annuity business due or to become due to Pinnacle from Career Brokerage, BISYS
Insurance Services, Inc. and the BISYS Group, and InsurMark, Inc. The litigation
is now in the discovery phase. The Company believes that its litigation against
Pinnacle will be successful, but there is no assurance that all amounts owed by
Pinnacle to the Company will be collected.
SEC Investigation
The Company has become aware that it is the subject of a formal investigation by
the Securities and Exchange Commission ("SEC"). The Company believes that 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 a Form 10-K for the fiscal year ended
June 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. On March 13, 2003, three of the Company's
executives received subpoenas from the SEC requesting them to produce documents
and provide testimony in connection with the formal investigation. In addition,
on March 19, 2003 the Company received a subpoena requesting documents in
connection with such investigation. The Company and its executives intend to
comply fully with the requests contained in the subpoenas and with the SEC's
investigation. The Company does not believe that the investigation will have a
material effect on the Company's consolidated financial statements.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
On July 1, 2002, a group of the Company's stockholders (the "Concerned
Stockholders"), including the Company's present President and Chief Executive
Officer, Michael Ryan, and two of the Company's directors, James Ciocia and
Kathryn Travis, filed a Preliminary Consent Statement on Schedule 14A with the
Securities and Exchange Commission ("SEC"). On August 2, 2002, a revised and
definitive version of such consent statement (the "Consent Statement")was filed
with the SEC. On August 9, 2002, as previously disclosed in the Company's
Current Report on Form 8-K filed on August 9, 2002, Michael Ryan, Thomas
Povinelli, David Puyear and the Company entered into an agreement (the
"Agreement") pursuant to which the Company agreed to adopt in a modified form
the resolutions proposed in the Consent Statement, and Michael Ryan agreed to
cause the Consent Statement and the accompanying consent solicitation to be
withdrawn. On August 15, 2002, the Concerned Stockholders withdrew the Consent
Statement.
In connection with the Agreement, on August 8, 2002, the Board expanded the size
of the Board to a total of nine directors, and Edward H. Cohen, Steve Gilbert
and Michael Ryan were appointed to the Board to fill the vacancies created by
such expansion, to serve until the next annual meeting of stockholders of the
Company at which their respective class of directors is to be elected. As part
of the Agreement, the Company granted Thomas Povinelli, the Company's former
President and Chief Executive Officer, and David Puyear, the Company's former
Chief Financial Officer, with an option to purchase a group of Company offices.
Pursuant to the Agreement, the Board elected Michael Ryan as the Company's
President and, upon Mr. Povinelli's resignation in September 2002, as Chief
Executive Officer. The Company also agreed to reimburse Mr. Ryan for the legal
fees, printing expenses, and solicitation fees incurred by him in connection
with the Solicitation, provided that such reimbursement does not exceed
$250,000.
ITEM 5. OTHER INFORMATION.
As previously disclosed on the Company's Current Report on Form 8-K, filed on
September 4, 2002, and as discussed in the Company's Annual Report on Form 10-K,
filed on March 31, 2003 and amended on April 11, 2003, the Company has engaged
Grant Thornton LLP to serve as the Company's independent auditors upon
terminating its relationship with Arthur Andersen LLP. On May 16, 2003, Louis
Karol, Esq. and Doreen Biebusch voluntarily resigned from the Board.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits:
99.1 Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
99.2 Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
Reports on Form 8-K:
Current Report on Form 8-K filed with the SEC on July 17, 2002.
26
Current Report on Form 8-K filed with the SEC on August 9, 2002.
Current Report on Form 8-K filed with the SEC on September 4, 2002.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
GILMAN + CIOCIA, INC.
(Registrant)
Dated: July 3, 2003 By: /s/ Michael P. Ryan
--------------------------
Michael P. Ryan
Chief Executive Officer
Dated: July 3, 2003 By: /s/ Michael Mannion
--------------------------
Michael Mannion
Chief Accounting Officer
27
CERTIFICATION
I, Michael P. Ryan, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Gilman + Ciocia, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: July 3, 2003
/s/ Michael P. Ryan
------------------------
Chief Executive Officer
28
CERTIFICATION
I, Michael Mannion, hereby certify that:
1. I have reviewed this quarterly report on Form 10-Q of Gilman + Ciocia, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: July 3, 2003
/s/ Michael Mannion
------------------------
Chief Accounting Officer
29