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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 MARCH 31, 2003.
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 March 31, 2003 3
and June 30, 2002
Consolidated Statements of Operations for the Three Months
and Nine Months Ended March 31, 2003 and 2002 4
Consolidated Statements of Cash Flows for the Nine Months
Ended March 31, 2003 and 2002 5-6
Consolidated Statement of Stockholders' Equity (Deficit) for
the Nine Months Ended March 31, 2003 7
Notes to Consolidated Financial Statements 8-18
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 19-25
Item 3. Quantitative and Qualitative Disclosure About Market Risks 25
Item 4. Controls and Procedures 25
PART II-OTHER INFORMATION
Item 1. Legal Proceedings 27
Item 4. Submission of Matters to a Vote of Security Holders 27
Item 5. Other Information 27
Item 6. Exhibits and Reports on Form 8-K 27
SIGNATURES AND CERTIFICATIONS
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
GILMAN + CIOCIA, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
UNAUDITED AUDITED
ASSETS March 31, 2003 June 30, 2002
-------------------- ------------------
Current Assets:
Cash and cash equivalents $ 1,394,695 $ 2,223,806
Marketable securities 1,403,730 1,759,742
Accounts receivable, net of allowance for doubtful accounts of
$461,559 and $614,972, respectively 5,860,701 6,958,346
Receivables from officers, stockholders and employees, net 821,022 1,129,092
Income taxes receivable 135,273 748,678
Prepaid expenses and other current assets 534,903 150,810
Assets held for sale 102,211 4,736,375
-------------------- ------------------
Total current assets 10,252,535 17,706,849
Non Current assets:
Property and equipment, net of accumulated depreciation of $4,111,602
and $3,203,347, respectively 2,447,894 3,239,502
Goodwill 5,264,858 5,264,858
Intangible assets, net of accumulated amortization of $4,997,382 and
$4,284,173, respectively 8,647,896 9,303,400
Other assets 1,515,046 1,657,904
-------------------- ------------------
Total assets $ 28,128,229 $ 37,172,513
==================== ==================
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current Liabilities
Accounts payable and accrued expenses $ 14,385,795 $ 12,808,741
Long-term debt 12,180,450 12,393,867
Liabilities held for sale 1,696,457 3,407,335
Income taxes payable 69,674 -
-------------------- ------------------
Total current liabilities 28,332,376 28,609,943
Non Current Liabilities:
Long-term debt, net of current portion 509,855 851,501
Other Liabilities 11,000 -
-------------------- ------------------
Total liabilities 28,853,231 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; 9,994,561
and 9,203,027 shares issued respectively 99,945 92,030
Additional paid-in capital 29,834,005 29,534,307
Treasury Stock 271,320 and 263,492 shares of common stock, respectively, at cost (1,071,406) (1,065,996)
Note receivable (105,000) (105,000)
Accumulated deficit (29,482,546) (20,744,272)
-------------------- ------------------
Total stockholders' equity (deficit) (725,002) 7,711,069
-------------------- ------------------
Total liabilities and stockholders' equity (deficit) $ 28,128,229 $ 37,172,513
==================== ==================
The accompanying notes are an integral part of these consolidated financial
statements.
3
GILMAN + CIOCIA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
UNAUDITED
For the Three Months Ended For the Nine Months Ended
March 31, March 31,
2003 2002 2003 2002
-------------- -------------- -------------- --------------
REVENUES:
Financial planning services $ 12,005,985 $ 15,282,971 $ 41,172,700 $ 45,737,036
Tax preparation fees 3,728,017 4,245,821 4,705,114 5,304,355
e1040.com - 29,473 - 53,445
Direct mail services - - - 505,407
-------------- -------------- -------------- --------------
Total revenues 15,734,002 19,558,265 45,877,814 51,600,243
-------------- -------------- -------------- --------------
OPERATING EXPENSES:
Salaries and commissions 11,813,339 16,602,737 38,073,775 45,733,432
General and administrative 1,977,664 3,225,372 6,446,888 7,619,144
Advertising 397,152 508,186 456,023 1,299,678
Brokerage fees & licenses 215,181 366,111 1,104,579 1,266,400
Rent 710,858 888,584 2,400,804 2,696,886
Depreciation and amortization 557,183 1,010,841 1,580,215 2,412,914
Loss on sale of equipment - - 85,325 -
Goodwill impairment loss 133,750 133,750
-------------- -------------- -------------- --------------
Total operating expenses 15,671,377 22,735,581 50,147,609 61,162,204
-------------- -------------- -------------- --------------
Income (loss) from operations 62,625 (3,177,316) (4,269,795) (9,561,961)
OTHER INCOME (EXPENSE):
Interest and investment income 66,860 127,038 71,449 292,912
Interest expense (344,704) (434,086) (1,546,997) (1,413,945)
Other income (expense) - 12,212 - 80,959
-------------- -------------- -------------- --------------
Total other income (expense) (277,844) (294,836) (1,475,548) (1,040,074)
-------------- -------------- -------------- --------------
Loss before provision (benefit) for income taxes (215,219) (3,472,153) (5,745,343) (10,602,034)
Provision (benefit) for income taxes 15,000 305,865 66,500 (3,472,135)
-------------- -------------- -------------- --------------
Total loss from continuing operations (230,219) (3,778,018) (5,811,843) (7,129,899)
============== ============== ============== ==============
DISCONTINUED OPERATIONS:
Income (loss) from operations of discontinued operations (235,104) 3,036,302 (1,376,789) 3,254,300
Income (loss) on sales of discontinued operations 1,137,048 - (1,543,142)
Provision for income taxes - 1,034,200 6,500 1,064,465
-------------- -------------- -------------- --------------
Total income (loss) from discontinued operations 901,944 2,002,102 (2,926,431) 2,189,835
-------------- -------------- -------------- --------------
-------------- -------------- -------------- --------------
Net income (loss) 671,725 (1,775,916) (8,738,274) (4,940,064)
============== ============== ============== ==============
Basic and diluted per share data:
Loss from continuing operations $ (0.02) $ (0.43) $ (0.62) $ (0.83)
Gain (loss) from discontinued operations 0.09 0.23 (0.31) 0.25
============== ============== ============== ==============
Net income (loss) per share, basic and diluted 0.07 (0.20) (0.93) (0.58)
============== ============== ============== ==============
Weighted average shares, basic and diluted 9,666,747 8,767,965 9,338,851 8,572,640
============== ============== ============== ==============
The accompanying notes are an integral part of these consolidated financial
statements.
4
GILMAN + CIOCIA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
UNAUDITED
For the nine months ended
March 31,
2003 2002
-------------- ---------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (8,738,274) $ (4,940,064)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 2,221,975 2,801,382
Gain on sale of mailing service business (194,434)
Loss (gain) on sale of discontinued operations 1,543,142
Amortization of debt discount - 325,661
Issuance of common stock for debt default penalties
and interest 301,000 -
Provision (benefit) for income taxes - (3,472,135)
Loss (Gain) on sale of property and equipment 85,325 (23,581)
Unrealized losses on securities held for trading 34,732 -
Amortization of deferred and other compensation expense - 148,976
Income recognized from joint ventures, net (66,747) -
Bad debt expense 5,000 200,000
Goodwill imp airment loss - 133,750
Loss on asset repurchase agreement - 188,221
Changes in assets and liabilities:
Accounts receivable, net 1,216,131 (2,008,999)
Prepaid and other current assets (277,987) 40,176
Receivables from officers, stockholders and employees 306,964 (32,721)
Increase in other assets 84,970 (536,685)
Accounts payable and accrued expenses 1,952,992 2,020,637
Income taxes receivable (payable) 683,078 1,080,890
Increase in other liabilities 11,000 -
Marketable securities 330,022 30,246
Increase in deferred tax asset - (75,065)
-------------- ---------------
NET CASH USED IN OPERATING ACTIVITIES (306,677) (4,313,745)
-------------- ---------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (120,951) (801,553)
Cash paid for acquisitions, net of cash acquired (150,187) (226,250)
Cash paid for sale of business (25,000) -
Proceeds from sale of discontinued operatons 1,011,630 347,000
Proceeds from joint venture distributions 90,000 -
Proceeds from sale of property and equipment 14,000 106,370
Proceeds on asset purchase agreement - 342,580
-------------- ---------------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES 819,492 (231,853)
-------------- ---------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Acquisition of treasury stock (5,410) (90,682)
Proceeds from bank and other loans 704,544 9,427,046
Payments of bank and capital lease obligations (2,041,060) (7,080,414)
Reissuance of treasury stock - 283,005
Net proceeds from the issuance of common stock and - -
exercise of common stock options and warrants - 9,625
-------------- ---------------
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES (1,341,926) 2,548,580
-------------- ---------------
Net decrease in cash (829,111) (1,997,018)
Cash and cash equivalents at beginning of period 2,223,806 5,413,674
-------------- ---------------
Cash and cash equivalents at end of period $ 1,394,695 $ 3,416,656
============== ===============
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 nine months ended
March 31,
2003 2002
----------- -------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for:
Interest $ 433,165 $ 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
Issuance of common stock for debt default penalties and interest 301,000 -
Equipment acquired under capital leases 70,860 325,795
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 STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED MARCH 31, 2003
(UNAUDITED)
Total
Common Stock Additional Paid-In Accumulated Treasury Stock Note Stockholders'
Equity
Shares Amount Capital Deficit Shares Amount Receivable (Deficit)
------------------- ------------ ------------- --------- ----------- ----------- --------------
Balance at July 1, 2002 9,203,027 $92,030 $29,534,307 $(20,744,272) 263,492 $(1,065,996) $(105,000) $ 7,711,069
Net loss - - - (8,738,274) - - - (8,738,274)
Purchase of treasury stock - - - - 7,828 (5,410) - (5,410)
Issuance of stock in
connection with earnout
agreement 16,534 165 6,448 - - - - 6,613
Issuance of stock in
connection with default
on note payable 775,000 7,750 293,250 - - - - 301,000
---------- -------- ------------ ------------- --------- ----------- ----------- --------------
Balance at
March 31, 2003 9,994,561 $99,945 $29,834,005 $(29,482,546) 271,320 $(1,071,406) $(105,000) $ (725,002)
========== ======== ============ ============= ========= ============ =========== ==============
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 it 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 sheets as of March 31, 2003 and June 30,
2002, the consolidated statements of operations for the three and nine months
ended March 31, 2003 and 2002, the consolidated statements of cash flows for the
nine months ended March 31, 2003 and 2002 and the consolidated statement of
stockholders equity for the nine months ended March 31, 2003 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 nine months ended March 31,
2003 and 2002 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 March 31, 2003 and June 30, 2002 management has recorded a full
valuation allowance against the net deferred tax asset.
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 nine months ended March 31, 2003 and
9
2002, outstanding options and warrants of 3,431,595 million and 5,244,594
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 March 31, 2003 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/close 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 nine months ended March 31, 2003, the Company sold forty seven of its
offices. In accordance with SFAS 144 assets and liabilities associated with
these offices have been reclassified 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.
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 had no immediate impact and is
not expected to have a material impact on the Company's financial position or
results of operations.
In December 2002, SFAS No. 148, "Accounting for Stock-Based
Compensation--Transition and Disclosure", ("SFAS 148"), was issued, amending
SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"). 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 8). 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 March 31, 2003, 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 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.
11
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 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 was 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.
During the quarter ended December 31st, 2002, 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.
During the quarter ended March 31st, 2003, the Company recognized a $1,159,229
gain on the sale of these offices. This gain consists of the write-off of a note
payable ($700,000) and related accrued interest ($144,443) totaling $844,443 and
cash received of $314,786. The note and related accrued interest were payable to
Mr. Povinelli and were written off as a result of Pinnacle's default under the
Initial Note. Mr. Povinelli personally guaranteed the Initial Note and the
Company's management believes it can offset unpaid amounts due the Company from
Pinnacle with amounts payable by the Company to Mr. Povinelli.
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
$1,470,937, $1,353,397, $955,183, $496,185, $377,902, and $611,560 for the
Fiscal years ending March 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 nine months ended March 31st, 2003 the Company sold/closed 11 of its
offices. 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. Three offices were sold/closed during
the quarter ended September 30th, 2003 ("Q1 offices"), three offices were sold
during the quarter ended December 31st, 2002 ("Q2 offices") and five offices
were sold during the quarter ended March 31st, 2003 ("Q3 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. The $305,919
loss consists of the sale of assets net of liabilities assumed, totaling
$317,919, less cash received of $12,000.
The Q3 offices were sold for an aggregate purchase price of $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. The Company recognized an
$85,522 loss on the sale of these offices. The $85,522 loss consists of the sale
of assets net of liabilities assumed, totaling $329,933, less cash received of
$285,455, less a promissory note received of $130,000.
12
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:
March 31, 2003 June 30, 2002
-------------- -------------
Accounts receivable, net $ 20,969 $ 1,832,489
Other current assets - 408,084
Property and equipment, net 81,242 851,653
Other long-term assets - 59,529
Intangible assets, net - 1,584,620
-------------- -------------
Total assets held for sale $ 102,211 $ 4,736,375
-------------- -------------
Accounts payable and accrued expenses 846,457 1,692,335
Other current liabilities 850,000 1,715,000
-------------- -------------
Total liabilities held for sale $ 1,696,457 $ 3,407,335
-------------- -------------
Approximate direct operating revenues and operating expenses of the Pinnacle
Purchased Offices and Other Purchased Offices included on the accompanying
statements of operations for the three and nine months ended March 31, 2003 and
2002 were as follows:
For the three months ended March 31 For the nine months ended March 31
2003 2002 2003 2002
----------- ----------- ------------- -----------
Revenues:
Financial planning services $ 337,264 $ 3,776,750 $ 3,949,027 $ 11,167,212
Tax preparation fees 9,558 5,527,296 891,193 7,247,856
E1040.com - - - -
Direct mail services - - -
----------- ----------- ------------- ------------
Total revenue 346,822 9,304,046 4,840,220 18,415,068
----------- ----------- ------------- ------------
Operating Expenses:
Salaries and commissions $ 355,107 $ 4,493,017 $ 4,603,890 $ 11,096,026
General and administrative 112,848 616,787 494,214 1,387,976
Advertising 27,109 382,501 45,697 517,379
Rent 86,862 619,118 915,902 1,751,782
Depreciation and amortization - 137,181 157,306 388,465
Goodwill and intangible assets impairment loss - - - -
----------- ----------- ------------- ------------
Total operating expenses 581,926 6,248,604 6,217,009 15,141,628
----------- ----------- ------------- ------------
Income (loss) from operations $ (235,104) $ 3,055,442 $ (1,376,789) $ 3,273,440
----------- ----------- ------------- ------------
Other income (expense) $ - $ (19,140) $ - $ (19,140)
----------- ----------- ------------- ------------
Net Income (Loss) $ (235,104) $ 3,036,302 $ (1,376,789) $ 3,254,300
=========== =========== ============= ============
13
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.
14
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
March 31, 2003 and June 30, 2002, the term loan had an outstanding principle
balance of $4.29 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.
15
Stock option activity during the nine months ended March 31, 2003 was as
follows:
UNAUDITED
--------------------------
Outstanding June 30, 2002 4,819,594
Grants 70,000
Cancels (2,182,999)
Exercises -
--------------------------
Outstanding - March 31, 2003 2,706,595
--------------------------
Exercisable - March 31, 2003 2,284,845
--------------------------
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 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:
Nine Months Ended March 31,
--------------- -------------
2003 2002
--------------- -------------
Net loss:
As reported $ (8,738,274) $ (4,940,064)
Pro forma (8,775,130) $ (6,454,726)
Basic and diluted net loss per share:
As reported $ (0.93) $ (0.58)
Pro forma $ (0.94) $ (0.75)
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.
16
Quarter Ended March 31, Nine Months Ended March 31,
2003 2002 2003 2002
-------------- ------------ -------------- -------------
REVENUES:
Company Tax Offices
Tax Preparation Business $ 3,728,017 $ 4,245,821 $ 4,705,114 $ 5,304,355
Financial Planning Business 4,405,196 5,650,902 12,523,525 18,403,372
-------------- ------------ -------------- -------------
Total Company Tax Offices 8,133,213 9,896,723 17,228,639 23,707,727
Broker Dealer Operations 11,711,826 19,263,914 42,391,149 46,207,234
Direct mail services - - - 505,407
e1040.com - 29,473 - 53,445
Intercompany revenue (4,111,037) (9,631,845) (13,741,974) (18,873,570)
-------------- ------------ -------------- -------------
Total revenue $ 15,734,002 $ 19,558,265 $ 45,877,814 $ 51,600,243
-------------- ------------ -------------- -------------
INCOME (LOSS) FROM OPERATIONS:
Company Tax Offices $ 325,353 $ (1,410,074) $ (4,561,096) $ (7,028,245)
Broker Dealer Operations (262,597) (1,260,336) 291,581 (1,047,643)
Direct mail services - (12,921) - (424,171)
e1040.com (131) (493,985) (280) (1,061,902)
-------------- ------------ -------------- -------------
Total income (loss) from
operations $ 62,625 $ (3,177,316) $ (4,269,795) $ (9,561,961)
-------------- ------------ -------------- -------------
DEPRECIATION AND AMORTIZATION:
Company Tax Offices $ 221,826 $ 456,366 $ 803,610 $ 1,230,059
Broker Dealer Operations 335,357 230,627 776,605 672,685
Direct mail services - - - 13,496
e1040.com - 323,848 - 496,674
-------------- ------------ -------------- -------------
Total depreciation and
amortization $ 557,183 $ 1,010,841 $ 1,580,215 $ 2,412,914
-------------- ------------ -------------- -------------
INTEREST EXPENSE:
Company Tax Offices $ (335,061) $ (250,250) $ (1,485,382) $ (872,868)
Broker Dealer Operations (9,643) (14,407) (61,615) (42,974)
e1040.com - (169,429) - (498,103)
-------------- ------------ -------------- -------------
Total interest expense $ (344,704) $ (434,086) $ (1,546,997) $ (1,413,945)
-------------- ------------ -------------- -------------
INTEREST AND INVESTMENT INCOME:
Company Tax Offices $ 66,788 $ 61,187 $ 71,055 $ 109,548
Broker Dealer Operations 72 65,851 394 183,364
e1040.com - - - -
-------------- ------------ -------------- -------------
Total interest income $ 66,860 $ 127,038 $ 71,449 $ 292,912
-------------- ------------ -------------- -------------
OTHER INCOME (EXPENSES):
Company Tax Offices $ - $ (8,127) $ - $ (144,438)
Broker Dealer Operations - - - -
Direct mail services - 20,339 - 225,073
e1040.com - - - 324
-------------- ------------ -------------- -------------
Total other income (expenses) $ - $ 12,212 $ - $ 80,959
-------------- ------------ -------------- -------------
INCOME (LOSS) BEFORE TAXES:
Company Tax Offices $ 57,080 $ (1,607,266) $ (5,975,423) $ (8,334,193)
Broker Dealer Operations (272,168) (1,208,890) 230,360 (907,253)
Direct mail services - 7,418 - 199,095
e1040.com (131) (663,415) (280) (1,559,683)
-------------- ------------ -------------- -------------
Total loss before taxes $ (215,219) $ (3,472,153) $ (5,745,343) $ (10,602,034)
-------------- ------------ -------------- -------------
17
Quarter Ended March 31, Nine Months Ended March 31,
2003 2002 2003 2002
-------------- -------------- -------------- -------------
IDENTIFIABLE ASSETS:
Company Tax Offices $ 34,140,563 $ 49,307,699 $ 34,140,563 $ 49,307,699
Broker Dealer Operations 21,209,863 21,420,549 21,209,863 21,420,549
Intercompany elimination (27,222,197) (19,219,799) (27,222,197) (19,219,799)
-------------- -------------- -------------- -------------
Total identifiable assets $ 28,128,229 $ 51,508,449 $ 28,128,229 $ 51,508,449
-------------- -------------- -------------- -------------
CAPITAL EXPENDITURES:
Company Tax Offices $ - $ 6,575 $ - $ 541,571
Broker Dealer Operations 36,491 160,121 120,951 259,982
e1040.com - - - -
-------------- -------------- -------------- -------------
Total capital expenditures $ 36,491 $ 166,696 $ 120,951 $ 801,553
-------------- -------------- -------------- -------------
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 nine months of Fiscal 2003, approximately 10.3% of the
Company's revenues were earned from tax preparation services and 89.7% 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.
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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 MARCH 31, 2003 COMPARED TO THREE
MONTHS ENDED MARCH 31, 2002
The Company's revenues for the three months ended March 31, 2003 were
$15,734,002 compared to $19,558,265 for the three months ended March 31, 2002, a
decrease of $3,824,263 or 20%. Of the total decrease, $3,276,986 was
attributable to a reduction in the Company's financial planning business,
$517,804 was attributable to a reduction in the Company's tax preparation fees
and $29,473 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 March 31, 2003 consisted
of $12,005,985 for financial planning services and $3,728,017 for tax
preparation fees. Financial planning services represented 76.3% and tax
preparation fees represented 23.7% of the Company's total revenues during the
three months ended March 31, 2003. The Company's total revenues for the three
months ended March 31, 2002 consisted of $15,282,971 for financial planning
services, $4,245,821 for tax preparation fees and $29,473 for e1040.com.
Financial planning services represented 78.1%, tax preparation fees represented
21.7% and e1040.com represented 0.2% of the Company's total revenues during the
three months ended March 31, 2002.
The Company's operating expenses for the three months ended March 31, 2003 were
$15,671,377 or 99.6% of revenues, a decrease of $7,064,204 or 31.1%, compared to
$22,735,581 or 116.2% of revenues for the three months ended March 31, 2002. The
decrease in operating expenses was attributable to decreases in salaries and
commissions of $4,789,398, general and administrative expenses of $1,247,708,
advertising expense of $111,034, brokerage fees and licenses of $150,930, rent
expense of $177,726, depreciation and amortization of $453,658 and impairment
losses of $133,750.
Salaries and commissions decreased $4,789,398 or 28.9% in the three months ended
March 31, 2003 to $11,813,339 from $16,602,737 during the three months ended
March 31, 2002. This decrease is primarily attributable to lower financial
planning commission expense and tax preparation commission expense associated
with lower financial planning revenue and lower tax preparation revenue and
decreases in personnel and related costs associated with corporate overhead.
General and administrative expenses decreased $1,247,708 or 38.7% in the three
months ended March 31, 2003 to $1,977,664 from $3,225,372 during the three
months ended March 31, 2002. This decrease is primarily attributable to
decreases in professional fees, financial planner bad debt expense, general
office and operating expenses associated with field offices and a gain realized
upon the favorable settlement of a vendor payable, partially offset by an
increased legal accrual.
Advertising expenses decreased $111,034 or 21.9% in the three months ended March
31, 2003 to $397,152 from $508,186 during the three months ended March 31, 2002.
This decrease is primarily attributable to reductions in
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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 $150,930 or 41.2% in the three
months ended March 31, 2003 to $215,181 from $366,111 during the three months
ended March 31, 2002. This decrease is primarily attributable to a decrease of
clearing fees as a result of lower financial planning revenues and lower
brokerage licenses as a result of lower planner headcount.
Rent expense decreased $177,726 or 20.0% in the three months ended March 31,
2003 to $710,858 from $888,584 during the three months ended March 31, 2002.
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 $453,658 or 44.9% in the three
months ended March 31, 2003 to $557,183 from $1,010,841 during the three months
ended March 31, 2002. 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 attributable to impairment decreased $133,750 to $0 during the three
months ended March 31, 2003 from $133,750 during the three months ended March
31, 2002.
The Company's income from operations for the three months ended March 31, 2003
was $62,625 as compared to a loss of $3,177,316 for the three months ended
March 31, 2002, an increase of $ 3,239,942 or 102.0%. This decrease in loss was
attributable to the net reduction in operating expenses highlighted above
partially offset by the reduction in revenues described above.
The Company's loss before the provision or benefit of income taxes for the three
months ended March 31, 2003 was $215,219 compared to $3,472,153 for the three
months ended March 31, 2002. This decrease in loss of $3,256,934 or 93.8% was
attributed to the net decrease in loss from operations of $3,239,941 highlighted
above and by a net decrease in other expenses, net, of $16,992. The net decrease
in other expenses, net, includes a decrease in interest expense of $89,382
offset by a decrease in interest and investment income of $60,178. The decrease
in interest expense is primarily attributable to reductions in debt and debt
discount amortization. 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 March 31, 2003 was $230,219 compared to $3,778,018 for the
three months ended March 31, 2002. This decreased loss of $3,547,799 or 93.9%
was attributable to a decrease in the income tax provision of $290,865 and the
changes in the revenues and expenses highlighted above.
The Company had income from discontinued operations for the three months ended
March 31, 2003 of $901,944 compared to $2,002,102 for the three months ended
March 31, 2002. For the nine months ended March 31, 2003 the loss was $2,926,431
compared to a gain of $2,189,835 for the nine months ended March 31, 2002. In
the three months ended March 31, 2003, the Company realized a gain of $1,159,229
from the Pinnacle sale, which includes a release of two notes payable totalling
$700,000 and accrued interest of $144,443, from Thomas Povinelli, which is being
credited against the current amount due from Pinnacle under the Asset Purchase
Agreement.
RESULTS OF OPERATIONS - NINE MONTHS ENDED MARCH 31, 2003 COMPARED TO THE NINE
MONTHS ENDED MARCH 31, 2002
The Company's revenues for the nine months ended March 31, 2003 were $45,877,814
compared to $51,600,243 for the nine months ended March 31, 2002, a decrease of
$5,722,429 or 11.1%. Of the total decrease, $4,564,336 was attributable to a
reduction in the Company's financial planning business, $599,241 was
attributable to a reduction in the Company's tax preparation fees, $53,445
was attributable to a reduction in e1040.com revenue and $505,407 was
attributable to a reduction in Direct mail services.
The Company's total revenues for the nine months ended March 31, 2003 consisted
of $41,172,700 for financial planning services and $4,705,114 for tax
preparation fees. Financial planning services represented 89.7% and tax
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preparation fees represented 10.3% of the Company's total revenues during the
nine months ended March 31, 2003. The Company's total revenues for the nine
months ended March 31, 2002 consisted of $45,737,036 for financial planning
services, $5,304,355 for tax preparation fees and $53,445 for e1040.com and
$505,407 for Direct mail services. Financial planning services represented
88.6%, tax preparation fees represented 10.3% and e1040.com represented 0.1% and
Direct mail services represented 1.0% of the Company's total revenues during the
nine months ended March 31, 2002.
The Company's operating expenses for the nine months ended March 31, 2003 were
$50,147,609 or 109.3% of revenues, a decrease of $11,014,595 or 18.0%, compared
to $61,162,204 or 118.5% of revenues for the nine months ended March 31, 2002.
The decrease in operating expenses was attributable to decreases in salaries and
commissions of $7,659,657, general and administrative expenses of $1,172,256,
advertising expense of $843,655, brokerage fees and licenses of $161,821, rent
expense of $296,082, depreciation and amortization of $832,699 and impairment
losses of $133,750, offset partially by an increase in loss on sale of equipment
of $85,325.
Salaries and commissions decreased $7,659,657 or 16.7% in the nine months ended
March 31, 2003 to $38,073,775 from $45,733,432 during the nine months ended
March 31, 2002. This decrease is primarily attributable to lower financial
planning commission expense and tax preparation commission expense associated
with lower financial planning revenue and lower tax preparation revenue and
decreases in personnel and related costs associated with corporate overhead.
General and administrative expenses decreased $1,172,256 or 15.4% in the nine
months ended March 31, 2003 to $6,446,888 from $7,619,144 during the nine months
ended March 31, 2002. This decrease is primarily attributable to decreases in,
planner bad debt expense, general office and operating expenses associated with
field offices and a gain realized upon the favorable settlement of
vendor payable, offset slightly by an increase in professional fees.
Advertising expenses decreased $843,655 or 64.9% in the nine months ended March
31, 2003 to $456,023 from $1,299,678 during the nine months ended March 31,
2002. 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 $161,821 or 12.8% in the nine
months ended March 31, 2003 to $1,104,579 from $1,266,400 during the nine months
ended March 31, 2002. This decrease is primarily attributable to a decrease of
clearing fees as a result of lower financial planning revenues and lower
brokerage licenses as a result of lower planner headcount.
Rent expense decreased $296,082 or 11.0% in the nine months ended March 31, 2003
to $2,400,804 from $2,696,886 during the nine months ended March 31, 2002. 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 $832,699 or 34.5% in the nine
months ended March 31, 2003 to $1,580,215 from $2,412,914 during the nine months
ended March 31, 2002. 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 attributable to impairment losses decreased $133,750 to $0 during the
nine months ended March 31, 2003 from $133,750 during the nine months ended
March 31, 2002, offset by an increase in loss on sale of equipment of $85,325.
The Company's loss from operations for the nine months ended March 31, 2003 was
$4,269,795 as compared to a loss of $9,561,961 for the nine months ended March
31, 2002, a decrease of $5,292,166 or 55.4%. 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 nine
months ended March 31, 2003 was $5,745,343 compared to $10,602,034 for the nine
months ended March 31, 2002. This decrease in loss of $4,856,691 or 45.8% was
attributed to the net increase in loss from operations of $5,292,166 highlighted
above and
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by a net increase in other expenses, net, of $435,474. The net increase in other
expenses, net, includes an increase in interest expense of $133,052 a
decrease in interest and investment income of $221,463, and a decreases of
$80,959 in other income expense. 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 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
nine months ended March 31, 2003 was $5,811,843 compared to $7,129,899 for the
nine months ended March 31, 2002. This decreased loss of $1,318,056 or 18.5% was
attributable to the decrease of income tax benefit of $3,538,635 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 March 31, 2003 compared to a valuation
allowance of zero on the Company's current and deferred tax assets at March 31,
2002.
LIQUIDITY AND CAPITAL RESOURCES
The Company' 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 March 31, 2003 and
June 30, 2002 the company had $1.4 and $2.2 million in cash and cash equivalents
and $1.4 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 $165,786 and had excess
net capital of $392,706.
For North Ridge, the minimum required regulatory net capital was $30,049 and had
excess net capital of $43,074.
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 executed an asset
purchase agreement (the "Purchase Agreement") with Pinnacle Taxx Advisors LLC
("Pinnacle") dated as of September 1, 2002, 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 net purchase price payable by Pinnacle is $4,745,463. (See Note 5.)
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 $1,333,158 consisting of $387,455
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 $306,677 and
$4,313,746 for the nine months ended March 31, 2003 and 2002, respectively. The
decrease of $4,007,069 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 $819,492 for the nine months
ended March 31, 2003 as compared to $231,853 of cash used for the nine months
ended March 31, 2002. The decrease of $1,051,345 in cash used is primarily
attributed to proceeds received on sale of discontinued operations of $1,011,630
and to the reduction of capital expenditures of $680,602. Offsetting the
increase in cash provided by investing activities were the elimination of
proceeds received on sale of Progressive Mailing services of $347,000 and the
elimination of proceeds received on asset purchase agreement of $342,580.
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Net cash used in financing activities totaled $1,341,926 for the nine months
ended March 31, 2002 as compared to net cash provided by financing activities of
$2,548,580 for the nine months ended March 31, 2002. The decrease in cash
provided by financing activities of $3,890,506 is attributed to a decrease in
proceeds from bank and other loans of $8,722,502 offset by a decrease in payouts
of bank and capital lease obligations of $5,039,354.
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.
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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
March 31, 2003 and June 30, 2002, the term loan had an outstanding principle
balance of $4.29 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.
As discussed in the Notes to Consolidated Financial Statements included in this
Form 10-Q, our recurring losses from operations and requirement for additional
financing raise substantial doubt about our ability to continue as a going
concern. Management and the Board of Directors are currently exploring a number
of strategic alternatives and are also continuing to identify and implement
internal actions to improve the Company's liquidity or financial performance.
These alternatives may include selling further assets, which in any such case
could result in significant changes in our business plan.
CONTRACTUAL OBLIGATION AND COMMERCIAL COMMITMENTS
The table below summarizes our contractual obligations for the five years
subsequent to March 31, 2003 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 $12,877,172 12,688,289 45,320 54,423 89,140
Operating leases 10,956,290 3,739,513 5,100,966 1,481,751 634,060
Capital leases 730,337 399,035 306,177 25,125
----------- ----------- ----------- ----------- -----------
Total contractual cash obligations $24,563,799 $16,826,837 $ 5,452,463 $ 1,561,299 $ 723,200
=========== =========== =========== =========== ===========
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 $1,470,937, $1,353,397, $955,183, $496,185, $377,902, and
$611,560 for the Fiscal years ending March 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,
25
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 third 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.
26
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.
The Company has become aware that it is the subject of a formal investigation by
the 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.
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.
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.
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.
27
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
28
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 am 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
29
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 am 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
30