U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
Commission File Number 1-31292
EMPIRE FINANCIAL HOLDING COMPANY
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(Exact name of registrant as specified in its charter)
FLORIDA 56-3627212
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(State or Other Jurisdiction (IRS Employer
of Incorporation) Identification Number)
1385 WEST STATE ROAD
LONGWOOD, FLORIDA 32750
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (407) 774-1300
Securities Registered Pursuant to Section 12(b) of the Act:
Title Of Each Class Name Of Each Exchange On Which Registered
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COMMON STOCK, $.01 PAR VALUE AMERICAN STOCK EXCHANGE
Securities Registered Pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if there is no disclosure of delinquent filers in
response to Item 405 of Regulation S-K contained in this form, and no disclosure
will be contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [ ] No [X]
The aggregate market value of the voting stock held by non-affiliates of the
registrant as of June 30, 2002 computed by reference to the average bid and
asked prices of registrant's common stock reported on the American Stock
Exchange on such date was $3,127,000.
The number of shares outstanding of registrant's Common Stock, $.01 par value
per share, as of March 31, 2003 was 4,787,800.
DOCUMENTS INCORPORATED BY REFERENCE
None.
TABLE OF CONTENTS
Page
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PART I........................................................................1
Item 1. Business........................................................1
Item 2. Legal Proceedings..............................................11
Item 3. Submission Of Matters To A Vote Of Security Holders............12
PART II......................................................................13
Item 4. Market For Common Equity And Related Stockholder Matters.......13
Item 5. Selected Financial Data........................................15
Item 6. Management's Discussion And Analysis...........................16
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.....30
Item 8. Financial Statements And Supplementary Data....................30
Item 9. Changes In And Disagreements With Accountants On
Accounting And Financial Disclosure.........................30
PART III.....................................................................31
Item 10. Directors And Executive Officers Of The Registrant.............31
Item 11. Executive Compensation.........................................32
Item 12. Security Ownership Of Certain Beneficial Owners
And Management..............................................35
Item 13. Certain Relationships And Related Transactions.................36
Item 14. Controls And Procedures........................................37
PART IV......................................................................38
Item 15. Exhibits And Reports On Form 8-K...............................38
(i)
This Form 10-K contains statements about future events and expectations
which are, "forward looking statements". Any statement in this 10-K that is not
a statement of historical fact may be deemed to be a forward looking statement.
Forward-looking statements represent our judgment about the future and are not
based on historical facts. These statements include: forecasts for growth in the
number of customers using our service, statements regarding our anticipated
revenues, expense levels, liquidity and capital resources and other statements
including statements containing such words as "may," "will," "expect,"
"believe," "anticipate," "intend," "could," "estimate," "continue" or "plan" and
similar expressions or variations. These statements reflect the current risks,
uncertainties and assumptions related to various factors including, without
limitation, fluctuations in market prices, competition, changes in securities
regulations or other applicable governmental regulations, technological changes,
management disagreements and other factors described under the heading "Factors
affecting our operating results, business prospects, and market price of stock"
and elsewhere in this report and in other filings made by us with the SEC. Based
upon changing conditions, should any one or more of these risks or uncertainties
materialize, or should any underlying assumptions prove incorrect, actual
results may vary materially from those described in this report as anticipated,
believed, estimated or intended. We undertake no obligation to update, and we do
not have a policy of updating or revising, these forward-looking statements.
Except where the context otherwise requires, the terms "we," "us," or "our"
refer to the business of Empire Financial Holding Company and its wholly-owned
subsidiaries.
PART I
ITEM 1. BUSINESS
OVERVIEW
We are a financial brokerage services firm serving institutional,
retail and wholesale customers that operates in two business segments: brokerage
and advisory services, and order execution and clearing services. Our services
are delivered through the Internet and traditional means.
We have several operating subsidiaries, including, Empire Financial
Group, Inc., which conducts our retail discount and full service brokerage
operation and services independent registered representatives; Empire Investment
Advisors, Inc., which began providing financial and investment advisory products
and services in May 2001; and Advantage Trading Group, Inc., which conducts our
securities order execution and clearing operations.
Our brokerage and advisory business provides financial brokerage
services directly to our retail customers, including individuals and small to
mid-sized institutions such as hedge funds, money managers, mutual funds and
pension funds. We also provide services to unaffiliated broker dealers and other
financial institutions that want to provide expanded services to their retail
customers under their own brand label. In May 2001, we began offering fee-based
investment advisory services to our customers, independent registered investment
advisors and unaffiliated broker dealers through our wholly owned subsidiary
Empire Investment Advisors. Services include access to separate account money
managers, managed mutual fund portfolios, asset allocation tools, separate
account manager and mutual fund research, due diligence and quarterly
performance review.
Our securities order execution services involve filling orders to
purchase or sell securities received from approximately 75 independent broker
dealers on behalf of their retail and institutional customers. We typically act
as principal in these transactions and derive our order execution trading
revenues, net, from the difference between the price paid when a security is
bought and the price received when that security is sold. We also provide
clearing services to Empire Financial Group, Inc. and unaffiliated broker
dealers. Our clearing services involve account settlement and delivery
functions.
In April 2002, we raised $6 million through an initial public offering
of 1,000,000 shares of common stock. Following the offering, our common stock
has been listed on the American Stock Exchange.
RECENT DEVELOPMENTS
ESTABLISHMENT OF SPECIAL COMMITTEES. On March 28, 2003, we established
two special committees of directors. One of the special committees is authorized
and empowered to manage the business and operations of both Empire Financial
Group, Inc. and Empire
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Investment Advisors, Inc. The second special committee is authorized and
empowered to manage the business and operations of Advantage Trading Group, Inc.
The foregoing special committees shall each automatically cease to exist upon
the earlier of (a) the consummation of the spin-off of Advantage Trading Group,
Inc. from our company as described below and (b) June 30, 2003.
PROPOSED SPIN-OFF. On March 28, 2003, we entered into a non-binding
letter of intent with our principal shareholders, Kevin M. Gagne and Richard L.
Goble, dated March 28, 2003, confirming our interest in effectuating a spin-off
of one of our wholly-owned subsidiaries, Advantage Trading Group, Inc. The
consummation of the spin-off is subject to the execution of a definitive
agreement between us and our principal shareholders that would provide for,
among other things, (a) that we would distribute to all holders of our common
stock, all shares of the common stock of Advantage Trading Group, Inc. (b) that
we and the principal shareholders shall take all reasonable or necessary
measures to effectuate the spin-off, (c) that each of the principal shareholders
will vote in favor of this distribution, if the Securities and Exchange
Commission, the American Stock Exchange or the State of Florida requires
approval of the spin-off by our shareholders and (d) that the spin-off and other
related transactions will be tax free to us and our shareholders.
The definitive agreement would also provide that subsequent to the
consummation of the spin-off, Mr. Goble and Mr. Gagne would exchange their
shares of our common stock and Advantage common stock, so that Mr. Goble will
receive shares of Advantage common stock and Mr. Gagne will receive shares of
our common stock. Following the share exchange, Mr. Goble would own
approximately 80% of the Advantage common stock and Mr. Gagne would own
approximately 80% of our common stock.
There is no assurance that the definitive agreement will be executed or
the distribution of Advantage common stock described above will be consumated.
RESOLUTION OF MANAGEMENT AND ADMINISTRATIVE DISAGREEMENTS. In
connection with the approval of the proposed spin-off and establishment of the
special committees of directors discussed above and as a result of other action
taken by the board of directors, all management and administrative disagreements
between our Co-Chairmen of the Board and Co-Chief Executive Officers have been
resolved. However, the Co-Chairmen of the Board and Co-Chief Executive Officers
may disagree in the future regarding management and administrative decisions.
Our bylaws, the Co-Chairmen's and Co-Chief Executive Officer's respective
employment agreements and certain resolutions we adopted provide that our board
of directors shall resolve any disagreements that may arise in the future. If
the board of directors does not resolve such disagreements in a timely manner,
our business may be materially adversely affected.
OUR COMPANY
Our principal executive offices are located at 1385 West State Road
434, Longwood, Florida 32750, and our telephone number is 1-800-lowfees
(1-800-569-3337). Our website is located at www.empirenow.com. Information
contained in or connected to our web site is not part of this report. We do not
make our periodic filings available on our website at this time. However, for
those persons that make a request in writing (Attn: Randy Cupples) or by e-mail
(randy@empirenow.com), we will provide free of charge our Annual Reports on Form
10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, and
amendments to these reports, our proxy statements and/or reports filed by
officers and directors with the Securities and Exchange Commission under Section
16(a) of the Securities Exchange Act. These reports are also available on the
Securities Exchange Commission website at www.sec.gov by searching the EDGAR
database for our company's filings.
SECURITIES BROKERAGE, EXECUTION AND CLEARING INDUSTRY
The securities brokerage business involves the purchase and sale of
securities. A retail customer who desires to purchase or sell a specific
security usually places a securities order with a broker dealer. Broker dealers,
including us, charge retail customers a commission or fee for processing these
orders. Our commissions and fees revenues are derived entirely from commissions
or fees charged to retail customers.
In order to fill the customer's order, the broker dealer generally
places an order with an order execution service or market maker. The order
execution service or market maker most often fills the order as principal by
either buying or selling the specific security. Both order execution service
firms and market makers obtain net
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revenues from the difference between the price paid when a specific security is
bought and the price received when that security is sold. We offer order
execution services to approximately 75 broker dealers and derive our order
execution trading revenues, net, from these differences.
Each securities transaction also involves clearing activities including
sending a confirmation to both the buyer and seller, obtaining payment from the
buyer and custody of the security from the seller, and delivering payment to the
seller and the security to the buyer. Companies that provide clearing services
receive a fee for these services from the broker dealers involved. As of March
31, 2003, we provided clearing services for most of the securities transactions
initiated by our retail customers and eight unaffiliated broker dealers.
BROKERAGE AND ADVISORY SEGMENT
We provide financial brokerage services directly to our retail
customers, including individuals and small to mid-sized institutions such as
hedge funds, money managers, mutual funds and pension funds. Approximately 71%
of our 2002 revenues, approximately 53% of our 2001 revenues and approximately
38% of revenues for 2000 were derived from commissions and fees generated in
connection with our retail financial brokerage services. Our retail customers
may place their securities orders online through our secure website located at
www.empirenow.com or via telephone by calling our retail trading desk at
1-877-lowfees (1-877-569-3337). We charge our customers an agreed upon brokerage
commission. Our online retail trading commissions start at $5.00 per trade and
our broker assisted trades start at $19.00 per trade.
In July 2001, we acquired specified assets of Centennial Capital
Management Inc., consisting primarily of contract rights with independent
registered representatives with an estimated useful life of approximately 3.3
years for a price of approximately $2.1 million, and assumed specified
liabilities, primarily contract obligations. Centennial Management was in the
business of processing securities transactions for, and providing other support
services to, independent registered representatives located throughout the
United States.
We also provide services to unaffiliated broker dealers and other
financial institutions that want to provide expanded services to their retail
customers under their own brand label. We refer to this as private label
brokerage services. As of December 31, 2002, we provided private label brokerage
services to 27 financial institutions. We provide their retail customers with
the same level of service and full range of products offered to our own retail
customers. We also charge their retail customers commissions and fees similar to
those charged to our own retail customers. We pay these institutions fees based
on transaction volume generated by their retail customers.
In May 2001, we began offering fee-based investment advisory services
to our customers, independent registered investment advisors and unaffiliated
broker dealers through our wholly owned subsidiary Empire Investment Advisors.
These services are web-based and are delivered through a platform that combines
a variety of independent third party providers. Services include access to
separate account money managers, managed mutual fund portfolios, asset
allocation tools, separate account manager and mutual fund research, due
diligence and quarterly performance review. We charge our customers an
all-inclusive fee for these services, which is based on assets under management.
As of March 31,2003, the annual fee was equal to approximately 85 basis points
times the assets under management.
RETAIL BROKERAGE SERVICES
(i) DISCOUNT RETAIL BROKERAGE
We provide discount securities brokerage services to retail investors,
including both individuals and small to mid-sized institutions such as hedge
funds, money managers, mutual funds and pension funds. We charge our
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customers an agreed upon brokerage commission. Our online retail trading
commissions' start at $5.00 per trade and our broker assisted trades as well as
our independent contractor trades start at $19.00 per trade. Our client support
representatives are available from 8:00 a.m. to 7:00 p.m. eastern time. Our
services allow for after hours trading.
Customers can directly place orders to buy and sell NASDAQ and
exchange-listed securities, as well as equity and index options, through our
automated order processing system. We support a range of order types, including
market orders, limit orders (good-till-cancelled or day), stop orders and short
sales. Our system automatically checks the parameters of an order, together with
the customer's buying power and positions held, prior to executing an order. All
listed market orders, subject to certain size limitations, are executed at the
National Best Bid/Offer, or NBBO, or better at the time of receipt by a third
market firm or exchange. The NBBO is a dynamically updated representation of the
combined highest bid and lowest offer quoted across all United States stock
exchanges and market makers registered in a specific stock. Eligible orders are
exposed to the marketplace for possible price improvement, but in no case are
orders executed at a price inferior to the NBBO. Limit orders are executed based
on an indicated price and time priority. All NASDAQ market orders, subject to
certain size limitations, are executed at the Best Bid/Offer or better at the
time of receipt by the market maker.
Our retail brokerage services are readily accessible to our brokerage
customers through multiple gateways:
o Internet Access. Customers using personal computers can access our
brokerage services through the Internet by direct modem access. Our
website, www.empirenow.com, combines an easy-to-use interface with the
trading capabilities and financial content that experienced investors
demand. We have designed our website to appeal to a broad range of
retail investors, from novice to more sophisticated investors,
particularly those seeking competitively priced online services. We
intend to continually develop the features of our website and to
position ourselves as the high value/low cost provider in our pricing
segment.
o Voice Telephone. We provide customers with a toll-free number to access
our brokers and other client support representatives. We also provide
our clients with direct access to our registered representatives and
principals through our client support desk to allow them to execute
trades other than online. Our brokers are committed to using their
trading desks to obtain for our clients the fastest execution of their
order at the best possible price at the time the order is given. As of
December 31, 2002, our retail client support division consisted of 16
employees, of which 11 are registered representatives and principals.
o Touch-tone Telephone. We have implemented a touch-tone telephone system
to provide an alternate delivery channel for customers to access
automated quote information, place stock and option orders, review
account balances and check messages from any touch-tone telephone.
(ii) FULL SERVICE RETAIL BROKERAGE SERVICES
We also service retail customers through a nationwide network of
independent registered representatives. The representatives provide their own
offices and utilize our clearing, execution and web-based services to provide
access to investments to their client base. We receive a small percentage of the
revenue generated by the representatives in exchange for providing back office
support. As of December 31, 2002, we had approximately 31 fully independent
branch offices, which we refer to as Offices of Supervisory Jurisdiction or
OSJ's, providing these services.
We recruit experienced, highly productive independent financial
advisors by offering them an attractive compensation package and the
independence of owning and operating their own branch office. Generally, each
branch office pays substantially all costs associated with establishing and
operating the branch in return for a relatively high portion of gross commission
revenue. We provide regulatory, compliance and other support services to the
branch office financial advisors. This program allows expansion of brokerage
operations with relatively minimal capital outlay.
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We offer full customer brokerage services using corporate equity and
debt securities, U.S. government securities, municipal securities, mutual funds,
variable annuity and variable life insurance products, general insurance,
portfolio planning and management, cash management services, and portfolio
tracking.
PRIVATE LABEL BROKERAGE SERVICES
Various financial institutions are increasingly seeking to enter the
securities brokerage business. Given the time and the complexity involved in
obtaining the necessary regulatory approvals, one efficient method for financial
institutions to enter the securities brokerage business is to contract with a
third-party provider of online investing solutions in order to provide this
packaged solution to their customers. We offer private label brokerage services
to broker dealers and other financial institutions that want to provide expanded
services to their retail customers. As of March 31, 2003, we provided private
label brokerage services for 27 financial institutions and are marketing these
services to other broker dealers, banks, savings and loan institutions, credit
unions, insurance companies, financial planners and various other financial
institutions.
Our private label brokerage solutions are designed to provide our full
range of retail customer brokerage services through the financial institution's
website. The website screens have the financial institution's look and feel,
with a reference to Empire Financial Group, Inc. as the provider for the
services. Customers that use our services through these other financial
institutions have accounts directly with us and are treated as our customers. We
charge these customers similar fees as we charge our own retail customers and
pay these institutions fees based on transaction volume generated by their
retail customers.
Our primary target market includes smaller institutions that may lack
the resources to efficiently implement their own brokerage solution. Our
services benefit these institutions by allowing them to retain customers and
their customer credit balances, create additional revenue sources and increase
traffic to their own websites, potentially leading to additional business. We
have developed our own Internet-based software systems to provide such services
tailored to the needs of these institutions while providing the same level and
range of products and services we offer to our own retail customers. We believe
that this strategy will allow us to grow rapidly and efficiently by gaining
access to the customer bases of other financial institutions.
INVESTMENT ADVISORY SERVICES
In May 2001, we began offering fee-based investment advisory services
to our customers, independent registered investment advisors and unaffiliated
broker dealers through our wholly owned subsidiary, Empire Investment Advisors,
Inc. These services are web-based and are delivered through a platform that uses
a variety of independent third party providers. We believe these services enable
us to establish more comprehensive relationships with our customers. The
investment advisory services we provide include:
o investment portfolio planning with recommendations on overall portfolio
allocations for different types of investments based on customers' long
term needs;
o recommendations regarding mutual fund and separate account manager
investments; access to separate account money managers, managed mutual
fund portfolios and asset allocation tools;
o manager and mutual fund due diligence; and,
o portfolio performance review and reallocation.
We do not provide recommendations regarding investment in individual equity
securities. These services are provided via an all-inclusive, low cost fee based
on assets under management. As of March 31, 2003, the fee is approximately 85
basis points per annum of the value of our customer's managed assets. Empire
Investment Advisors, Inc. is registered as an investment adviser in all 50
states under the Investment Adviser's Act of 1940.
Our investment advisory services provide a competitive advantage to the
Empire Capital Management Division of Empire Financial Group, Inc. The
independent registered representatives of this division can offer the product
and services of Empire Investment Advisors, Inc. to their retail clients upon
licensing with Empire
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Investment Advisors, Inc. High net worth clients and commission adverse clients
can now have money management services that compete with banks and other
financial institutions.
ANCILLARY RETAIL BROKERAGE SERVICES
We offer the following ancillary services:
MARKET DATA AND FINANCIAL INFORMATION. During trading hours, we
continually receive a direct line, or feed, of detailed quote data, market
information and news. Our retail customers can create their own personal list of
stocks and options for quick access to current pricing information. We provide
our customers free access to delayed quotes, including stocks, options, major
market indices, most active issues and largest gainers and losers for the major
exchanges. Real-time quotes are also available for a small fee. Upon placing an
order, a customer is provided with a real-time bid and asked quote, at no extra
charge. We also offer our customers a streaming real-time quote service for
$19.95 per month, which entitles the customer to receive unlimited quotes per
month. Our alliances and content provider relationships allow us to offer access
to breaking news, charts, market commentary and analysis and company financial
information. Our website, www.empirenow.com, provides comprehensive investment
research content as well as access to SEC filings of public companies, among
other features.
PORTFOLIO TRACKING AND RECORDS MANAGEMENT. Customers have online access
to a listing of all their portfolio assets held with us, including data on the
date of purchase, cost basis, current price and current market value. The system
automatically calculates unrealized profits and losses for each asset held.
Information provided to our customers also includes total short-term or
long-term gain/loss and commissions paid. Detailed account balance and
transaction information includes cash and money fund balances, buying power, net
market portfolio value, dividends paid, interest earned, deposits and
withdrawals. Customers can also create watch lists to include any number of
stocks, options, mutual funds and other financial investments a customer is
interested in tracking. All transaction and portfolio records are automatically
updated to reflect trading activity. Buy and sell orders placed when the markets
are closed are automatically submitted prior to the next day's market opening.
Online account holders receive electronic notification of order execution, and
all customers receive printed trade confirmations and detailed monthly
statements. We also provide for the transmittal of proxy, annual report and
tender offer materials to customers. We offer our online customers electronic
confirmations and are planning to offer electronic statements.
CASH MANAGEMENT SERVICES. Customer payments received through the mail
or federal wire system are credited to customer accounts. We also provide cash
management services to our customers. For example, funds not invested in
securities earn interest in a credit interest program or can be invested in
money market funds. In addition, we provide free checking services and debit
cards for our customer accounts through a commercial bank. We are exploring the
expansion of these services.
ACCOUNT SECURITY. We use a combination of proprietary and industry
standard security measures to protect customers' assets. Customers are assigned
unique account numbers, user identifications and passwords that must be used
each time they log on to our system. We rely on encryption and authentication
technology to provide the security necessary to effect the confidential exchange
of information. We do not plan to share customer data with third parties.
STRATEGIC MARKETING EFFORTS
We plan to increase our brand recognition to attract new retail
customers. We are developing a comprehensive marketing plan to build market
awareness, educate the investing public about our services and broaden and
enhance brand name recognition and loyalty. In July 2001, we acquired Centennial
Capital Management, Inc. which added a full-service brokerage capability. We are
actively pursuing additional alliances with various companies to increase
trading volume and operational efficiencies, to further enhance name recognition
and to diversify our income stream. In addition, we regularly examine new ways
to provide additional products and services to our current clients, as well as
new clients, including, for example, banks and other financial institutions
seeking to provide expanded services to their customers. We also intend to
expand our market share through, among other things, television, direct-response
advertising, advertising on our own and other websites, a public relations
program and live seminars.
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COMPETITION
The market for brokerage services, particularly over the Internet, is
rapidly expanding and extremely competitive. This competition is expected to
continue to grow in the future. Major competitors include Charles Schwab & Co.
Inc., E*Trade Group, Inc., TD Waterhouse Group, Inc., Ameritrade Holding
Corporation and Fidelity Brokerage Services, Inc. In addition, we compete with
financial institutions and investing services that offer online brokerage
services. We believe the major competitive factors for brokerage services
include cost, service, quality, ease of use and customer satisfaction.
Some of the strongest competition comes from companies who have greater
marketing, financial and technical resources than ours. These competitors can
offer a wider range of services and financial products than we can. Some of our
competitors also have greater name recognition and more extensive client bases.
These competitors may be able to respond more quickly to new or changing
opportunities, technologies and client requirements and may be able to undertake
more extensive promotional activities, offer more attractive terms to clients
and adopt more aggressive pricing policies. Moreover, current and potential
competitors have established or may establish cooperative relationships among
themselves or with third parties or may consolidate to enhance their services
and products. We expect that new competitors or alliances among competitors will
emerge and may acquire significant market share.
ORDER EXECUTION AND CLEARING SERVICES
Our securities order execution services involve filling orders to
purchase or sell securities received from approximately 75 independent broker
dealers on behalf of their retail and institutional customers. We typically act
as principal in these transactions and derive our order execution trading
revenues, net, from the difference between the price paid when a security is
bought and the price received when that security is sold. Therefore, we seek to
take advantage of daily stock price fluctuations to maximize our revenues. We
typically do not receive a fee or commission for providing order execution
services. Approximately 29% of our 2002 revenues, approximately 47% of our
revenues for the year ended December 31, 2001 and approximately 62% of our
revenues for the year ended December 31, 2000 were derived from these services.
We reduce the expenses associated with our order execution services by clearing
our own trades. We believe our ability to clear transactions, unlike many other
order execution firms, provides us with a competitive advantage in that we are
able to control costs and provide better service. We normally close out our
trade positions at the end of each day and do not maintain securities inventory.
This helps us reduce our exposure to market volatility and lowers our overall
risk profile.
We also provide clearing services to other unaffiliated broker dealers.
Our clearing services involve account settlement and delivery functions. To
date, we have been engaged by eight unaffiliated broker dealers to provide these
services.
ORDER EXECUTION SERVICES
We provide order execution services for equity and bond securities to
approximately 75 broker dealers. Our trade execution capabilities allow us to
handle orders telephonically or electronically. Order execution services consist
of filling orders received from independent broker dealers to buy securities or
sell securities. We typically act as principal in these transactions and derive
our order execution trading revenue, net, from the difference between the price
we pay when we buy a security and the price we receive when we sell that
security. We typically do not receive a fee or commission for providing order
execution services.
Our order execution trading revenues, net, are dependent on our ability
to take advantage of daily stock price fluctuations. Thus, we must be able to
evaluate and act rapidly on market trends and manage risk successfully. Our
methodology focuses on the dynamic, real-time analysis of market activity and
price movements, which enables us to increase our revenues and manage risk
better. Additionally, we have developed an internal trade order and risk
management software application we refer to as the "e-blotter," which allows
real-time analysis of our trading positions in individual securities and
monitoring of our short and long positions and our aggregate profits and losses.
We normally close out our trade positions at the end of each day and do
not maintain securities inventories, which reduces our exposure to risk from
market volatility.
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CLEARING OPERATIONS
Clearing operations include the confirmation, receipt, settlement,
custody and delivery functions involved in securities transactions. Our clearing
capabilities allow us to realize significant cost savings that permit us to
competitively price our services. Performing our own clearing operations allows
us to retain customer free credit balances and securities for use in margin
lending activities subject to SEC and NASD rules. In March 2001, we entered into
a three-year agreement with Automated Data Processing, Inc. for the provision of
computer services to support order entry, order routing, securities processing,
customer statements, tax reporting, regulatory reporting and other services
necessary to the management of a brokerage clearing business.
The retail customer accounts we clear are carried on a fully disclosed
basis with our subsidiary, Advantage Trading Group, Inc. Our clients' securities
positions and credit balances carry $2,000,000 insurance coverage through Lloyds
of London that is supplemental to standard SIPC protection for clients' accounts
up to $500,000 subject to a limitation of $100,000 for claims for cash balances.
All customer credit balances are subject to immediate withdrawal from our
clearing firm, at the discretion of the customer.
We make margin loans to customers collateralized by securities held in
their accounts. Margin lending is subject to the margin requirements of the
Federal Reserve and NASD and our internal policies, which are more stringent
than those requirements. Under applicable NASD rules, in the event of a decline
in the market value of the securities in a margin account, we are obligated to
require the customer to deposit additional securities or cash in the account so
that at all times the customer's equity in the account is at least 25% of the
value of the securities in the account. Our internal requirement, however, is
that the customer's equity not fall below 35%. If it does, the customer will be
required to increase the account's equity to 40%. We also restrict access to
margin lending with regard to trading of certain stocks we determine to be too
volatile. Margin lending to customers constitutes the major portion of the basis
on which our net capital requirements are determined under the SEC's Net Capital
Rule. To the extent these activities expand, our net capital requirements will
increase.
We primarily provide clearing services to our affiliated broker dealer,
Empire Financial Group, Inc. and it's Empire Capital Management Division of
independent registered representatives. We also provide clearing services to
unaffiliated broker dealers. We have been engaged by eight unaffiliated broker
dealers to provide clearing services. We provide an online order entry,
execution and information system that is integrated with our clearing
operations. We believe that providing these online capabilities combined with
our clearing services will strengthen our existing relationships with
independent broker dealers and will attract additional broker dealer clients.
ANCILLARY RETAIL BROKERAGE SERVICES
We offer the following ancillary services:
SECURITIES BORROWING. We borrow securities both to cover short sales
and to complete customer transactions in the event a customer fails to deliver
securities by the required settlement date. We collateralize such borrowings by
depositing cash or securities with the lender and receive a rebate, in the case
of cash collateral, or pay a fee calculated to yield a negotiated rate of
return. Securities borrowing transactions are executed pursuant to written
agreements with counter parties that require the securities borrowed be marked
to market on a daily basis and that additional collateral be furnished in the
event of changes in the market value of the securities. The securities usually
are marked to market on a daily basis through the facilities of the various
national clearing organizations. We do not currently engage in securities
lending, but may do so in the future.
CASH MANAGEMENT SERVICES. Customer payments received through the mail
or federal wire system are credited to customer accounts. We also provide cash
management services to our customers. For example, funds not invested in
securities earn interest in a credit interest program or can be invested in
money market funds.
ACCOUNT SECURITY. We use a combination of proprietary and industry
standard security measures to protect customers' assets. Customers are assigned
unique account numbers, user identifications and passwords that must be
8
used each time they log on to our system. We rely on encryption and
authentication technology to provide the security necessary to effect the
confidential exchange of information. We do not plan to share customer data with
third parties.
TECHNOLOGY
We believe our proprietary systems and software allow us to maintain
low fixed processing and labor costs in our order execution businesses. By
developing proprietary software applications, we are able to customize and
better control our operations and reduce our dependence on third-party software
vendors. Our proprietary software applications include a customized trade order
and risk management system, which we refer to as the "e-blotter." This system
allows real-time analysis of our trading positions in individual securities and
reduces our potential exposure to losses from trade volatility. We have also
developed and implemented a web-based order system that directly links our
broker dealer retail customers to our order execution services employees and a
trading system that permits our customers to trade equity securities, options
and mutual funds. This system allows us to process trade transactions more
effectively by maximizing the use of our execution and clearing services in
trade orders we receive.
STRATEGIC MARKETING EFFORTS
We are developing a comprehensive marketing plan to attract more
clients and broker dealers to clear their trades through us, as well as build
market awareness, educate the investing public about our services and broaden
and enhance brand name recognition and loyalty. We are actively pursuing
additional alliances with various companies to increase trading volume and
operational efficiencies, to further enhance name recognition and to diversify
our income stream. In addition, we regularly examine new ways to provide
additional products and services to our current clients, as well as new clients,
including, for example, banks and other financial institutions seeking to
provide expanded services to their customers.
COMPETITION
We provide order execution services for equity and bond securities to
approximately 75 independent broker dealers. The market for these services is
rapidly evolving and intensely competitive. We expect competition to continue to
intensify in the future. We compete primarily with wholesale, national and
regional broker dealers and trade execution firms such as Knight/Trimark Group
and Schwab Capital Markets, as well as electronic communications networks, which
provide a direct trading venue to institutional and retail investors. We compete
primarily on the basis of execution quality, customer service and technology.
Some of the strongest competition comes from companies who have greater
marketing, financial and technical resources than ours. These competitors can
offer a wider range of services and financial products than we can. Some of our
competitors also have greater name recognition and more extensive client bases.
These competitors may be able to respond more quickly to new or changing
opportunities, technologies and client requirements and may be able to undertake
more extensive promotional activities, offer more attractive terms to clients
and adopt more aggressive pricing policies. Moreover, current and potential
competitors have established or may establish cooperative relationships among
themselves or with third parties or may consolidate to enhance their services
and products. We expect that new competitors or alliances among competitors will
emerge and may acquire significant market share.
9
GOVERNMENT REGULATION
(i) BROKER DEALER REGULATION
The securities industry is subject to extensive regulation under
federal and state law. The SEC is the federal agency responsible for
administering the federal securities laws. In general, broker dealers are
required to register with the SEC under the Securities Exchange Act of 1934 or
the Exchange Act. Our subsidiaries, Empire Financial Group, Inc. and Advantage
Trading Group, Inc., are broker dealers registered with the SEC. Under the
Exchange Act, every registered broker dealer that does business with the public
is required to be a member of and is subject to the rules of the NASD. The NASD
has established conduct rules for all securities transactions among broker
dealers and private investors, trading rules for the over-the-counter markets
and operational rules for its member firms. The NASD conducts examinations of
member firms, investigates possible violations of the federal securities laws
and its own rules, and conducts disciplinary proceedings involving member firms
and associated individuals. The NASD administers qualification testing for all
securities principals and registered representatives for its own account and on
behalf of the state securities authorities.
We are also subject to regulation under state law. Empire Financial
Group, Inc. and Advantage Trading Group, Inc. are registered as broker dealers
in all 50 states and in Puerto Rico. An amendment to the federal securities laws
prohibits the states from imposing substantive requirements on broker dealers
that exceed those imposed under federal law. This amendment, however, does not
preclude the states from imposing registration requirements on broker dealers
that operate within their jurisdiction or from sanctioning these broker dealers
for engaging in misconduct.
(ii) NET CAPITAL REQUIREMENTS; LIQUIDITY
As registered broker dealers and members of the NASD, Empire Financial
Group, Inc. and Advantage Trading Group, Inc. are subject to the Net Capital
Rule. The Net Capital Rule, which specifies minimum net capital requirements for
registered broker dealers, is designed to measure the general financial
integrity and liquidity of a broker dealer and requires that at least a minimum
part of its assets be kept in relatively liquid form. In general, net capital is
defined as net worth (assets minus liabilities), plus qualifying subordinated
borrowings and certain discretionary liabilities, and less certain mandatory
deductions that result from excluding assets that are not readily convertible
into cash and from valuing conservatively certain other assets. Among these
deductions are adjustments which reflect the possibility of a decline in the
market value of an asset prior to disposition.
Failure to maintain the required net capital may subject a firm to
suspension or revocation of registration by the SEC and suspension or expulsion
by the NASD and other regulatory bodies and ultimately could require the firm's
liquidation. The Net Capital Rule prohibits payments of dividends, redemption of
stock, the prepayment of subordinated indebtedness and the making of any
unsecured advance or loan to a shareholder, employee or affiliate, if the
payment would reduce the firm's net capital below a certain level.
The Net Capital Rule also provides that the SEC may restrict for up to
20 business days any withdrawal of equity capital, or unsecured loans or
advances to shareholders, employees or affiliates if the capital withdrawal,
together with all other net capital withdrawals during a 30-day period, exceeds
30% of excess net capital and the SEC concludes that the capital withdrawal may
be detrimental to the financial integrity of the broker dealer. In addition, the
Net Capital Rule provides that the total outstanding principal amount of certain
of a broker dealer's subordinated indebtedness, the proceeds of which are
included in its net capital, may not exceed 70% of the sum of the outstanding
principal amount of all subordinated indebtedness included in net capital, par
or stated value of capital stock, paid in capital in excess of par, retained
earnings and other capital accounts for a period in excess of 90 days.
Empire Financial Group, Inc. and Advantage Trading Group, Inc. are
members of the Securities Investor Protection Corporation which provides, in the
event of the liquidation of a broker dealer, protection for clients' accounts up
to $500,000, subject to a limitation of $100,000 for claims for cash balances.
We also carry $2,000,000 additional insurance through Lloyds of London on client
accounts that we clear.
10
(iii) INVESTMENT ADVISERS ACT
Our subsidiary, Empire Investment Advisers, Inc., is registered with
the SEC as an investment adviser under the Investment Advisers Act of 1940.
Registration by the SEC does not represent an endorsement of Empire Investment
Advisers, Inc. by the SEC. Empire Investment Advisers, Inc. must comply with
rules that govern the way it conducts its business, including the information
that must be given to clients, records that must be maintained, compliance
procedures and ethical requirements that must be enforced, and terms that must
be included in advisory agreements. As an investment adviser, Empire Investment
Advisers, Inc. is a fiduciary for its clients, and must act with loyalty and
care in the performance of its duties.
(iv) ADDITIONAL REGULATION
Due to the increasing popularity and use of the Internet and other
online services, various regulatory authorities are considering laws and/or
regulations with respect to the Internet or other online services covering
issues such as user privacy, pricing, copyrights and quality of services. The
growth and development of the market for online commerce may prompt more
stringent consumer protection laws that may impose additional burdens on those
companies conducting business online. Moreover, the recent increase in the
number of complaints by online traders could lead to more stringent regulations
of online trading firms and their practices by the SEC, NASD and other
regulatory agencies.
Furthermore, the applicability to the Internet and other online
services of existing laws in various jurisdictions governing issues such as
property ownership, sales and other taxes and personal privacy is uncertain and
may take years to resolve. As our services are available over the Internet in
multiple states and foreign countries, and as we have numerous clients residing
in these states and foreign countries, these jurisdictions may claim that we are
required to qualify to do business as a foreign corporation in each such state
and foreign country.
EMPLOYEES
As of December 31, 2002, we had 61 full-time employees and 125
independent contractors. Of these, there were 8 employees in management, 33
employees providing operation and client support for our retail and order
execution and clearing services, and 20 employees providing order execution
services to our correspondents and retail client base. The independent
contractors provide retail services to our customers. No employee is covered by
a collective bargaining agreement or is represented by a labor union. We
consider our employee and independent contractor relations to be good.
FACILITIES
Our principal executive offices consist of 11,800 square feet of a
19,400 square foot facility located in Longwood, Florida. This facility is owned
by G&G Holdings, Inc., an entity owned by Kevin M. Gagne and Richard L. Goble.
Our subsidiaries Empire Financial Group, Inc. and Advantage Trading Group, Inc.
have each entered into leases with G&G Holdings, Inc. which expire on May 31,
2009 and provide for an average rent of approximately $23,000 per month, plus
sales and property taxes.
We also have approximately 31 fully independent branch offices
throughout the United States. We do not have lease agreements for our branch
offices or any direct financial commitment. The rent for these facilities is an
obligation of the independent contractors who are located in each of them.
We have also entered into a one year lease to accommodate the sales
support staff of the Empire Capital Management Division. This administrative
office is located at 1536 Dunwoody Village Parkway in Atlanta, Georgia and has
two full-time employees. The monthly payment on this facility is $1,152.
ITEM 2. LEGAL PROCEEDINGS
Our business involves substantial risks of liability, including
exposure to liability under federal and state securities laws in connection with
the underwriting or distribution of securities and claims by dissatisfied
clients for fraud, unauthorized trading, churning, mismanagement and breach of
fiduciary duty. In recent years there has been
11
an increasing incidence of litigation involving the securities industry,
including class action which generally seek rescission and substantial damages.
In the ordinary course of business, we and our principals are, and may
become a party to legal or regulatory proceedings or arbitrations. We are not
currently involved in any legal or regulatory proceeding or arbitrations, the
outcome of which is expected to have a material adverse impact on our business.
ITEM 3. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the
fourth quarter of 2002.
12
PART II
ITEM 4. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock began trading on the American Stock Exchange (ASE) on
April 9, 2002 under the symbol "EFH". Set forth below is high and low price
information for the common stock as reported on the ASE for each period
presented.
2002 High Sales Price Low Sales Price
---- ---------------- ---------------
Second Quarter ................. $ 4.00 $ 3.80
Third Quarter .................. 1.75 1.60
Fourth Quarter ................. .92 .91
-------- --------
2003 High Sales Price Low Sales Price
---- ---------------- ---------------
First Quarter (through March 27) $ 1.30 $ .89
As of March 28, 2003, there were 254 holders of record of the common
stock.
We paid dividends to our shareholders in the past. Prior to completion
of our IPO, we were an S corporation for federal and state income tax purposes
and our taxable income was taxed directly to our initial shareholders. We
distributed $1,200,000 to our initial shareholders in April 2001 related to
their tax liability for our taxable income for 2000 and we distributed a total
of $732,294 in April and October 2002 related to their tax liability for our
taxable income for 2001.
In October 2002 we made a partial distribution of approximately
$135,000 and we plan to make an additional distribution of approximately $60,000
to the initial shareholders related to their personal income taxes arising from
our taxable income from January 1, 2002 until completion of the IPO in April
2002.
We became a C corporation effective with the consummation of our IPO
and, except as noted above, we do not intend to pay any dividends to our
shareholders for the foreseeable future. We intend to retain any earnings to
finance the development and expansion of our business. Payment of dividends in
the future will be subject to the discretion of our board of directors and will
depend on our ability to generate earnings, our need for capital and our overall
financial condition among other factors.
Our Registration Statement on Form S-1, Registration No. 333-86365, was
declared effective by the Securities and Exchange Commission on April 9, 2002.
The offer and sale of all of the 1,000,000 shares of our common stock, $.01 par
value per share, registered by the Registration Statement occurred on April 9,
2002. The underwriters of the offering were Keefe, Bruyette & Woods, Inc. and
Empire Financial Group, Inc., one of our wholly-owned subsidiaries.
The aggregate price of the shares offered and sold pursuant to the
Registration Statement was $6,000,000. The total expenses we incurred relating
to the offering was $957,384, including underwriting commissions and other fees.
Of this amount, $230,000 involved payments to Empire Financial Group, Inc. and
the remaining balance involved payments to others. The net offering proceeds to
us after deducting the total expenses incurred in the offering was $5,042,616.
Of the net proceeds we used approximately $1.7 million for the purchase of
Centennial Capital Management, approximately $1.1 million to repurchase our
stock and approximately $400,000 for general corporate expenses. The remaining
approximately $1.8 million is included in our working capital. We determined
following the offering that repurchasing stock for the purpose of stabilizing
the price was an appropriate use of funds that had not been contemplated at the
time of the IPO. The business initiatives discussed in our prospectus under use
of proceeds have not yet been undertaken and we are evaluating the proper use of
our working capital.
13
During April and November 2002, we repurchased 212,200 shares of our
common stock sold in the public offering. This was done to stabilize the market
for our stock. The total cost of the common stock purchased was $1,135,197 and
is included as treasury stock on the accompanying statement of financial
condition.
Effective April 9, 2002, we granted 677,950 stock options pursuant to
our 2000 Incentive Compensation Plan at a price of $6.00, which was the offering
price in our initial public offering as of that date. Of the total stock
options, 340,200 vest over a five year schedule commencing April 9, 2002. The
remaining 200,000 vested immediately upon grant, however, only 100,000 can be
sold during the first twelve months commencing April 9, 2002, and thereafter,
20,000 may be sold per year on a cumulative basis.
14
ITEM 5. SELECTED FINANCIAL DATA
The following selected consolidate financial data is qualified by
reference to, and should be read in conjunction with our consolidated financial
statements and the notes to those statements and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" appearing elsewhere
in this report. Prior to our IPO in April 2002, we were taxed as S Corporations,
and, accordingly, our taxable income has been taxed directly to our
shareholders. Unaudited pro forma information assumes that we were subject to
federal income taxes and taxed as a C corporation at the statutory rates for the
periods presented.
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Statement of Income Data:
Revenues:
Clearing and order execution
trading revenues, net...... $4,886,933 $7,724,244 $14,117,905 $10,441,910 $5,681,892
Commissions and fees......... 13,001,503 10,428,857 10,939,186 6,134,454 2,022,433
Order flow................... 37,968 52,005 456,184 102,806 149,246
Interest..................... 349,732 741,812 2,694,630 829,381 66,675
Other........................ 204,572 563,341 234,784 89,752 13,753
----------- ----------- ----------- ----------- ----------
$18,480,708 $19,510,259 $28,442,689 $17,598,303 $7,933,999
----------- ----------- ----------- ----------- ----------
Expenses:
Employee compensation and
benefits................... $7,934,805 7,545,078 11,541,916 5,938,502 2,715,069
Commission and clearing costs 6,672,360 4,210,434 3,821,323 1,631,139 1,345,528
Order flow payments.......... 1,001,593 2,183,296 3,391,663 2,775,599 1,661,488
Interest..................... 76,881 582,301 1,130,222 463,345 44,363
Communications and data
processing................. 762,036 527,474 1,242,610 807,187 179,975
General and administrative... 3,426,608 2,629,370 4,183,744 1,923,101 627,699
Advertising.................. 82,019 297,025 533,634 601,104 269,293
Impairment loss ............. 1,001,474
----------- ----------- ----------- ----------- ----------
20,957,776 17,974,978 25,845,112 14,139,977 6,843,415
----------- ----------- ----------- ----------- ----------
Net income (loss).............. (2,477,068) $1,535,281 $2,597,577 $3,458,326 $1,090,584
=========== =========== =========== =========== ==========
Earnings (loss) per share--
basic and diluted............ ($0.54) $0.38 $0.65 $0.86 $0.27
=========== =========== =========== =========== ==========
Unaudited pro forma
information:
Income (loss) before income
taxes...................... (2,477,068) $1,535,281 $2,597,577 $3,458,326 $1,090,584
Provision for income taxes... 0 577,700 977,500 1,300,000 410,000
----------- ----------- ----------- ----------- ----------
Net income (loss)............ (2,477,068) $957,581 $1,620,077 $2,158,326 $680,584
=========== =========== =========== =========== ==========
Pro forma earnings (loss)
per share-- basic and
diluted.................... ($0.54) $0.24 $0.41 $0.54 $0.17
=========== =========== =========== =========== ==========
Weighted average shares
outstanding-- basic and
diluted.................... 4,587,494 4,000,000 4,000,000 4,000,000 4,000,000
Balance Sheet Data (at period
end):
Total assets................... $13,494,633 $17,575,416 $18,551,857 $22,166,240 $8,860,788
Total liabilities.............. 9,608,500 14,605,340 15,174,912 19,016,198 6,921,498
Shareholders' equity........... 3,886,133 2,970,076 3,376,945 3,150,042 1,939,290
15
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS
INTRODUCTION
We were incorporated in Florida during February 2000. Our business is
conducted entirely through our wholly owned subsidiaries. We acquired all of the
outstanding capital stock of Empire Financial Group, Inc. and Advantage Trading
Group, Inc. from our co-chief executive officers, co-presidents and co-chairmen
of the board, Kevin M. Gagne and Richard L. Goble, the former co-owners of these
entities pursuant to a share exchange agreement. We subsequently formed Empire
Investment Advisors, Inc. Accordingly, the following discussion and analysis of
our financial condition and results of operations is based on the combined
results of these businesses.
Empire Financial Group, Inc. is our financial brokerage services
subsidiary providing discount brokerage services directly to retail and
institutional customers. Our retail customers can place their securities orders
online through our secure website located at www.empirenow.com or over the
telephone at 1-800-lowfees (1-800-569-3337). We provide our retail customers
access to useful financial products and services through our website and by
telephone. Our customers may, upon request, also receive advice from our brokers
regarding mutual funds and bonds. Our brokers do not provide advice regarding
specific equity securities or options.
Empire Financial Group, Inc. also provides services to unaffiliated
broker dealers and other financial institutions that want to provide expanded
services to their retail customers under their own brand label. We refer to this
as private label brokerage services. As of December 31, 2002 we provided private
label brokerage services to 12 financial institutions. We provide their retail
customers with the same level of service and full range of products offered to
our own retail customers. We also charge our client's customer commissions and
fees similar to those charged to our own retail customers. We pay these
institutions fees based on transaction volume generated by their retail
customers.
In July 2001, we purchased specified assets of Centennial Capital
Management Inc., consisting primarily of contract rights with independent
registered representatives with an estimated useful life of approximately 3.3
years, and assumed specified liabilities, primarily contract obligations.
Centennial was in the business of processing securities transactions for, and
providing other support services to, independent registered representatives
located throughout the United States. After we completed this transaction, most
of these independent registered representatives began to process securities
transactions through us. For a fee and a participation in their revenues, we
provide these representatives with back office support, client statements and
reports, branch office regulatory compliance and advisory services. These
representatives typically pay all of their office and marketing expenses. The
addition of these registered representatives did not require us to hire any
additional support staff personnel, except for two prior employees of Centennial
Management. We did, however, open an administrative office in Atlanta, Georgia.
The purchase price was based upon the revenues generated by the former
Centennial independent registered representatives who chose to process
securities transactions through us during the three months ended December 31,
2001, and was determined to be approximately $2,126,000.
In May 2001, we began offering fee-based investment advisory services
to our customers, independent registered investment advisors and unaffiliated
broker dealers through our wholly owned subsidiary Empire Investment Advisors.
These services are web-based and are delivered through a platform that combines
a variety of independent third party providers. Services include access to
separate account money managers, managed mutual fund portfolios, asset
allocation tools, separate account manager and mutual fund research, due
diligence and quarterly performance review. We charge our customers an
all-inclusive fee for these services, which is based on
16
assets under management. As of March 31, 2003 the annual fee is equal to
approximately 85 basis points times the assets under management.
Advantage Trading Group, Inc., our securities order execution
subsidiary, provides execution services involving filling orders to purchase or
sell securities received from approximately 75 independent broker dealers on
behalf of their retail customers. We typically act as principal in these
transactions and derive our order execution trading revenues, net, from the
difference between the price paid when a security is bought and the price
received when that security is sold. We typically do not receive a fee or
commission for providing order execution services. At the end of each day, we
normally close out our trade positions and do not maintain securities inventory
in order to reduce our risks from market volatility.
Advantage Trading Group, Inc. added clearing capabilities for our order
execution business in 1996 and for our financial brokerage services business in
1998. Prior to that, we cleared all of our customer equity and option
transactions through third-party clearing firms that processed our trades,
prepared transaction confirmations and acted as the custodian for our customers'
securities. Clearing services involve the confirmation, receipt, settlement,
custody and delivery functions involved in securities transactions. We began
hiring associates to perform these functions in August 1997 and incurred
significant non-recurring costs to hire and train our associates, as well as
systems integration costs during this period. The addition of clearing
capabilities has allowed us to clear almost all of our total trades and to
realize significant cost savings that allow us to competitively price our
services. Our direct costs per transaction that we clear have decreased
approximately 67% since implementing clearing operations.
As of December 31, 2002, our subsidiary, Advantage Trading Group, Inc.,
provided clearing services for approximately 75% of the transactions initiated
by our subsidiary Empire Financial Group, Inc. including approximately 90% of
Empire Financial Group, Inc.'s retail transactions. In addition Advantage
provides clearing services to eight unaffiliated broker dealers.
CRITICAL ACCOUNTING POLICIES
Our discussion and analysis of our financial condition and results of
operations are based on our consolidated financial statements which have been
prepared in conformity with accounting principles generally accepted in the
United States of America. Because we operate in the financial services industry,
we follow certain accounting guidance used by the brokerage industry. Our
consolidated balance sheet is not separated into current and noncurrent assets
and liabilities. Certain financial assets, such as investment securities are
carried at fair market value on our consolidated statements of financial
condition while other assets are carried at historic values.
USE OF ESTIMATES
Note 2 to Consolidated Financial Statements contains a summary of our
significant accounting policies, many of which require the use of estimates and
assumptions that affect the amounts reported in the consolidated financial
statements for the periods presented. We believe that of our significant
accounting policies, the valuation of customer lists (see also Note 5 to
Consolidated Financial Statements) is based on estimates and assumptions that
require complex, subjective judgments which can materially impact reported
result.
MARKET-MAKING ACTIVITIES
Securities owned and securities sold, not yet purchased, which
primarily consist of listed and OTC stocks and listed option contracts, are
carried at market value and are recorded on a trade date basis. Market value is
estimated daily using market quotations available from major securities
exchanges and dealers.
SOURCES AND DESCRIPTION OF REVENUES
CLEARING AND ORDER EXECUTION TRADING REVENUES, NET
Approximately 29% of our 2002 revenues, approximately 47% of our 2001
revenues, and approximately 62% of our revenues for 2000 consist of clearing and
order execution trading revenues, net. We also provide clearing services to
Empire Financial Group, Inc. and unaffiliated broker dealers. Our clearing
services involve account settlement and delivery functions. Order execution
revenues are generated from the difference between the price we pay to buy
securities and the price we are paid when we sell
17
securities. Volatility of stock prices, which can result in significant price
fluctuations in short periods of time, may result in trading gains or losses.
Our order execution trading revenues are dependent on our ability to evaluate
and act rapidly on market trends and manage risk successfully. We typically act
as principal in these transactions and do not receive a fee or commission for
providing order execution services.
COMMISSIONS AND FEES
Approximately 70% of our 2002 revenues, approximately 53% of our 2001
revenues and approximately 38% of our revenues for 2000 consist of commissions
and fees. Commissions and fees include revenues generated from transactional
fees charged to retail and institutional customers. Commissions and fees also
include mutual fund transaction commissions and trailer fees, which are periodic
fees paid by mutual funds as an incentive to keep assets invested with them over
time. Transactional fees charged to retail and institutional customers are
primarily affected by changes in transaction volumes and changes in the
commission or fee rates charged per transaction. The significant growth in our
daily average trading volumes in the U.S. and major global equities markets,
combined with our introduction of online trading services, has increased our
trading volume.
ORDER FLOW
Less than 1% of our 2002 and 2001 revenues and approximately 2% of our
revenues for 2000 consist of order flow payments. We send retail transactions to
other broker dealers for execution in exchange for monthly payments, referred to
as order flow payments, based on the number of shares involved in the
transactions.
INTEREST
Approximately 2% of our 2002 revenues, approximately 4% of our 2001
revenues and approximately 9% of our revenues for 2000 consist of interest
revenues. Interest revenues consist of profits from the interest we charge
retail customers when they borrow from us, as well as interest earned on our
interest-bearing assets.
OTHER
Approximately 1% of our 2002 revenues, approximately 3% of our 2001
revenues and approximately 1% of our revenues for 2000 consist of other income.
Other income derives from miscellaneous fees (other than the clearing and order
execution trading revenues, net and commissions and fees described above)
charged to clients.
DESCRIPTION OF OPERATING EXPENSES
EMPLOYEE COMPENSATION AND BENEFITS
Employee compensation and benefits, which include salaries and wages,
incentive compensation and related employee benefits and taxes, are our largest
operating expenses, accounting for approximately 38% of our expenses during
2002, approximately 42% of our expenses during 2001 and approximately 45% of our
expenses for 2000. Our registered representatives, who make up approximately 80%
of our employees, are compensated primarily on a performance basis. Therefore, a
significant portion of compensation and benefits expense will fluctuate based on
our operating revenue.
COMMISSIONS AND CLEARING COSTS
Commissions and clearing costs include commissions paid to independent
brokers, fees paid to floor brokers and exchanges for trade execution costs,
fees paid to third-party vendors for data processing services and fees paid to
clearing entities for certain clearance and settlement services. Commissions and
clearing costs generally fluctuate based on transaction volume. Approximately
32% of our 2002 expenses, approximately 23% of our 2001 fiscal year expenses and
approximately 15% of our expenses for 2000 consist of commissions and clearing
costs.
ORDER FLOW PAYMENTS
We make payments to other broker dealers to compensate them for
directing trades to us for execution. We make these payments monthly based on
either per share prices or total transaction value. Approximately 5% of our
18
2002 expenses, approximately 12% of our 2001 expenses and approximately 13% of
our expenses for 2000 consist of order flow payments.
INTEREST
Interest expenses consist of interest charges associated with our
interest-bearing liabilities such as customer credit balances and draws against
our short-term bank loan, accounting for less than 1% of our 2002 expenses,
approximately 3% of our expenses during 2001 and approximately 4% for 2000.
COMMUNICATIONS AND DATA PROCESSING
Communications and data processing expenses consist primarily of costs
related to our computer systems. Communications expenses include costs
associated with traditional communications expenses, such as voice telephone,
and the costs to maintain our Internet access capabilities. These costs also
include amounts paid to provide customers access to automated quote information,
stock and option orders or account balance information. Approximately 4% of our
2002 expenses, approximately 3% or our 2001 expenses and approximately 5% of our
expenses for 2000 consist of communications and data processing.
GENERAL AND ADMINISTRATIVE
Our general and administrative expenses consist primarily of legal,
accounting and other professional fees, software consulting fees, travel and
entertainment expenses, insurance coverage, depreciation, occupancy expenses and
other similar operating expenses, and accounted for approximately 16% of our
expenses for 2002, approximately 15% of our expenses during 2001 and
approximately 16% of our expenses for 2000.
ADVERTISING
Advertising expenses include television, online, print and direct mail
advertising expenses and other costs incurred to create brand awareness, promote
our product and service offerings and introduce new products and services. These
expenses accounted for less than 1% of our expenses in 2002 and approximately 2%
of our expenses during 2001 and 2000.
RESULTS OF OPERATIONS
DECEMBER 31, 2002 COMPARED WITH DECEMBER 31, 2001
In July 2001, we acquired certain assets of Centennial Capital
Management, Inc., a securities broker dealer that provides a diversified range
of retail brokerage services through independent financial advisors located in
50 states. Approximately five months of the Centennial operations, $2,366,000
and $1,925,000 of revenues and expenses, respectively, are included in our
operating results for the year ended December 31, 2001.
Total revenues for year ended December 31, 2002 decreased $1,029,551,
or 5%, to $18,480,708 from $19,510,259 reported for the year ended December 31,
2001. This decrease was primarily due to the reasons described below:
o Clearing and order execution trading revenues, net in 2002 decreased
$2,837,311, or 37%, to $4,886,933 from $7,724,244 in 2001, primarily
due to an approximate 30% decrease in the number of order execution
transactions and a decrease of approximately 7% in the profitability
per order execution transaction primarily as a result of
decimalization. The number of order execution trade transactions
decreased from 240,825 during 2001 to 169,225 during 2002 due to a
decline in the market and the economy.
o Commissions and fee revenues in 2002 increased $2,572,646, or 25% to
$13,001,503 from $10,428,857 in 2001, primarily due to an increase in
revenues earned in connection with our full service brokerage
operations. In 2002, we processed approximately 149,400 transactions
for our retail customers, versus approximately 134,000 in 2001, an
increase of approximately 12%. Furthermore, our retail customer
accounts totaled approximately 31,382 at December 31, 2002 compared to
19
approximately 27,935 at December 31, 2001, an increase of approximately
12%, or a decrease of approximately 11% after reducing the December 31,
2002 total by approximately 6,500 retail customer accounts added
through acquisitions. In addition, clearing fees in 2002 increased
$722,184, or 118% to $1,333,465 from $611,281 in 2001. This increase in
clearing fees revenue is attributable to the increase in transactions
cleared.
o Order flow revenues in 2002 decreased $14,037, or 27%, to $37,968 from
$52,005 in 2000, primarily reflecting a decrease in the number of
trades for which order flow payments were received by us.
o Interest revenues in 2002 decreased $392,080, or approximately 53%, to
$349,732 in 2002 from $741,812 in 2001 a decrease primarily
attributable to a decrease in retail customers' margin account
balances. The average month end customer margin balance for the year
ended December 31, 2002 was $6,425,300, compared to $9,155,000 for the
year ended December 31, 2001, a decrease of $2,729,700, or 30%. This
decrease is offset by the decrease in interest expense paid during
2002.
o Other revenues in 2002 decreased $358,769, or 64%, to $204,572 from
$563,341 in 2001, primarily as a result of the decrease in
miscellaneous income and fee revenues.
Total operating expenses in 2002 increased $2,982,798, or 17%, to
$20,957,776 from $17,974,978 in 2001, primarily due to reasons described below:
o Commissions and clearing costs in 2002 increased $2,461,926, or 58.5%
to $6,672,360 from $4,210,434 in 2001. This increase is primarily
attributable to commissions and related costs incurred in connection
with acquisitions consumated during 2002, partially offset by the
overall decrease in volume and clearing costs associated with our
existing institutional and retail operations. In 2002, we processed
149,400 transactions for our institutional and retail customers versus
134,000 in 2001, an increase of approximately 12%. When compared to
related revenues, commissions and clearing costs increased by a greater
percentage because of costs incurred in connection with the
acquisitions consummated during 2002, partially offset by savings
realized through our clearing operations.
o Order flow payments decreased $1,181,703, or 54%, to $1,001,593 in 2002
from $2,183,296 in 2001. This decrease is primarily attributable to a
reduction in the number of trade transactions that required order flow
payments.
o Interest expense in 2002 decreased $505,420, or 87%, to $76,881 from
$582,301 in 2001, primarily due to a decrease in interest incurred on
short-term borrowings and interest paid on customer credit balances. A
portion of the decrease is attributable to smaller customer credit
balances for which we pay interest. The average outstanding month end
customer credit balance was approximately $7,209,000 in 2002, as
compared to approximately $7,581,000 in 2001. The remaining decrease is
attributable to decreased borrowings and lower interest rates on our
short-term borrowing arrangement. At December 31, 2002 we had no short
term borrowings outstanding and at December 31, 2001 our interest rate
on short-term borrowing was 3%.
o Communications and data processing expenses in 2002 increased $234,562,
or 44%, to $762,036 from $527,474 in 2001. This increase is primarily
attributable to the addition of "non-capitalized" equipment to our
"back office" platform, increasing our costs by approximately $185,700
from 2001. Our system technology has been changed, thereby reducing our
costs while increasing our capacity to serve our customer base.
o General and administrative expenses in 2002 increased $797,237, or 30%,
to $3,426,608 from $2,629,370 in 2001. This increase is primarily
attributable to the increase of approximately $675,000 for amortization
of intangible assets, the increase of $131,000 in computer consulting
expenses, $110,000 in stationary, printing, and office supplies,
$153,000 in rental expense, $72,557 in professional fees and $81,702 in
client entertainment and marketing.
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o Advertising expenses in 2002 decreased $215,006, or 72%, to $82,019
from $297,025 in 2001. This decrease in advertising was primarily due
to ongoing changes in our overall marketing program, which includes an
increasing use of Internet and other "non-traditional" marketing venues
while decreasing the use of traditional marketing venues. As a
percentage of total revenues, advertising expenses were approximately
0.5% in 2002 and 2% in each of 2001 and 2000.
o We performed an impairment analysis of our intangible assets. A "one
time" adjustment of approximately $1.001 million was charged to
expense, increasing the December 31, 2002 operating loss.
As a result of the foregoing factors, net income in 2002 decreased
$4,012,349 to ($2,477,068) compared to $1,535,281 in 2001.
DECEMBER 31, 2001 COMPARED WITH DECEMBER 31, 2000
In July 2001, we acquired certain assets of Centennial Capital
Management, Inc., a securities broker dealer that provides a diversified range
of retail brokerage services through independent financial advisors located in
50 states. Approximately five months of the Centennial operations, $2,366,000
and $1,925,000 of revenues and expenses, respectively, are included in our
operating results for the year ended December 31, 2001.
Total revenues for year ended December 31, 2001 decreased $8,932,430,
or 31%, to $19,510,259 from $28,442,689 reported for the year ended December 31,
2000. This decrease was primarily due to the reasons described below:
o Clearing and order execution trading revenues, net in 2001 decreased
$6,393,661, or 45%, to $7,724,244 from $14,117,905 in 2000, primarily
due to an approximate 20% decrease in the number of order execution
transactions and a decrease of approximately 39% in the profitability
per order execution transaction primarily as a result of
decimalization. The number of order execution trade transactions
decreased from 302,806 during 2000 to 240,825 during 2001.
o Commissions and fee revenues in 2001 decreased $510,329, or 5% to
$10,428,857 from $10,939,186 in 2000, primarily due to a decrease in
retail trading volume, partially offset by $2,366,000 in revenues
earned from the Centennial operations. In 2001, we processed
approximately 134,000 transactions for our retail customers, versus
approximately 143,000 in 2000, a decrease of approximately 6%.
Furthermore, our retail customer accounts totaled approximately 27,935
at December 31, 2001 compared to approximately 11,340 at December 31,
2000, an increase of approximately 146%, or approximately 5% after
reducing the December 31, 2001 total by approximately 16,000 retail
customer accounts added with the acquisition of Centennial. This
decrease is also attributable to a decrease in clearing fees revenue.
Clearing fees in 2002 decreased $70,346, or 10% to $611,281 from
$681,657 in 2000. The decrease in clearing fees revenue is attributable
to the decrease in transactions cleared.
o Order flow revenues in 2001 decreased $404,179, or 89%, to $52,005 from
$456,184 in 2000, primarily reflecting a decrease in the number of
trades for which order flow payments were received by us.
o Interest revenues in 2001 decreased $1,952,818, or 72%, to $741,812 in
2001 from $2,694,630 in 2000, a decrease primarily attributable to a
decrease in retail customers' margin account balances. The average
month end customer margin balance for the year ended December 31, 2001
was $9,155,000, compared to $20,107,000 for the year ended December 31,
2000, a decrease of $10,952,000, or 54%.
o Other revenues in 2001 increased $328,557, or 140%, to $563,341 from
$234,784 in 2000, primarily as a result of the increase in
miscellaneous income and fee revenues.
Total operating expenses in 2001 decreased $7,870,134, or 30%, to
$17,974,978 from $25,845,112 in 2000, primarily due to reasons described below:
21
o Employee compensation and benefits in 2001 decreased $3,996,838, or
35%, to $7,545,078 from $11,541,916 in 2000. The decrease in employee
compensation and benefits was primarily due to a decrease in the number
of employees. At December 31, 2001 we employed 65 people as compared to
100 people at December 31, 2000, a decrease of 35%.
o Commissions and clearing costs in 2001 increased $389,111, or 10% to
$4,210,434 from $3,821,323 in 2000. This increase is primarily
attributable to commissions and related costs incurred in connection
with the retail operations acquired from Centennial, partially offset
by the overall decrease in volume and clearing costs associated with
our existing institutional and retail operations. In 2001, we processed
134,474 transactions for our institutional and retail customers versus
142,756 in 2000, a decrease of approximately 6%. When compared to
related revenues, commissions and clearing costs increased by a greater
percentage because of costs incurred in connection with the acquisition
of Centennial, partially offset by savings realized through our
clearing operations.
o Order flow payments decreased $1,208,367, or 36%, to $2,183,296 in 2001
from $3,391,663 in 2000. This decrease is primarily attributable to a
reduction in the number of trade transactions that required order flow
payments.
o Interest expense in 2001 decreased $547,921, or 49%, to $582,301 from
$1,130,222 in 2000, primarily due to a decrease in interest incurred on
short-term borrowings and interest paid on customer credit balances. A
portion of the decrease is attributable to smaller customer credit
balances for which we pay interest. The average outstanding month end
customer credit balance was approximately $7,581,000 in 2001, as
compared to approximately $13,205,000 in 2000. The remaining decrease
is attributable to decreased borrowings and lower interest rates on our
short-term borrowing arrangement. At December 31, 2001 and 2000, our
interest rate on short-term borrowing was 2.75% and 7.0%, respectively.
o Communications and data processing expenses in 2001 decreased $715,136,
or 58%, to $527,474 from $1,242,610 in 2000. This decrease is primarily
attributable to the overall decrease in volume of transactions
processed for order execution and retail trades, costs savings
associated with a change in vendors providing certain data processing
services, and costs savings incurred in connection with the continued
growth of our clearing operations.
o General and administrative expenses in 2001 decreased $1,534,374, or
37%, to $2,629,370 from $4,183,744 in 2000. This decrease is primarily
attributable to a decrease of approximately $854,000 for costs incurred
in connection with a discontinued registration filing with the
Securities and Exchange Commission (primarily professional fees, filing
and registration fees, and printing costs), $442,000 in computer
consulting expenses, $37,000 in depreciation expense, $99,000 in
stationary, printing, and office supplies, $154,000 in customer
write-offs, $192,000 in travel expenses, $293,000 loss on disposal of
furniture and computers, partially offset by an increase of $31,000 in
recruiting expenses $36,000 in client expenses, $62,000 in insurance
expense, $33,000 in professional fees, $26,000 in seminars and trade
shows, $33,000 in quote services, $38,000 in pre-employment expenses,
$65,000 in registration fees, and $266,000 in amortization of customer
list.
o Advertising expenses in 2001 decreased $236,609, or 44%, to $297,025
from $533,634 in 2000. This decrease in advertising was primarily due
to ongoing changes in our overall marketing program, which includes an
increase use of the Internet and volume discount purchasing of
television space for advertising our products. As a percentage of total
revenues, advertising expenses were approximately 2% in each of 2001
and 2000.
As a result of the foregoing factors, net income in 2001 decreased
$1,062,296, or 41%, to $1,535,281 compared to $2,597,577 in 2000. Net income
does not reflect provisions for income taxes, given that we were an S
corporation prior to our IPO in April 2002.
22
LIQUIDITY AND CAPITAL RESOURCES
We maintain a highly liquid balance sheet with the majority of our
assets consisting of cash and cash equivalents and receivables from customers,
brokers, dealers and clearing brokers arising from customer-related securities
transactions. Receivables from customers consist primarily of collateralized
customer margin loans, which are typically secured with marketable equity
securities.
At December 31, 2002, we had shareholder's equity of $3,886,133,
representing an increase of $916,057 from December 31, 2001. At December 31,
2001, we had shareholders' equity of $2,970,076, representing a decrease of
$406,869 from shareholders' equity of $3,376,945 December 31, 2000. Cash and
cash equivalents at December 31, 2002 were $4,146,857 compared to $2,327,029 at
December 31, 2001 and $3,195,892 at December 31, 2000.
Net cash provided by operating activities was $1,828,618 in 2002 and
$3,362,392 in 2001 versus $5,999,454 used in operating activities in 2000. Our
net cash provided by or used in operating activities is materially impacted by
changes in the brokerage-related assets and liabilities of our subsidiary,
Advantage Trading Group, Inc.
Net cash used in investing activities was $283,113 in 2002, compared to
net cash used by investing activities of $376,150 in 2001 and $190,917 in 2000.
The decrease in 2002 was primarily due to a decrease in the purchase of property
and equipment, partially offset by payments made (net of cash acquired) in
connection with certain acquisitions consumated during 2002. The decrease in
2001 was primarily due to a decrease in the purchase of property and equipment,
partially offset by payments made (net of cash acquired) in connection with the
purchase of certain assets and liabilities of Centennial.
Net cash provided by financing activities was $274,323 in 2002,
compared to $3,855,150 used in financing activities for 2001. The net increase
in 2002 was due to the issuance of our common stock less the purchase of
treasury stock, payment of short-term borrowings, payment of contracts payable
and shareholder distributions. Net cash used in financing activities was
$3,855,150 in 2001, compared to $5,684,986 used by financing activities in 2000.
The net decrease in 2001 was due to payments of $1,913,000 on our short-term
bank loans plus $1,942,150 distributed to our shareholders.
We have entered into three brokerage credit agreements with a
commercial bank, pursuant to which the bank may, without any obligation to do
so, advance to us the lesser of $25,000,000 or a percentage of the market value
of our available collateral that is pledged to the bank. Borrowings under the
agreements are due on demand and bear interest at rates quoted, from time to
time, by the bank to us, which is currently the federal funds rate plus 100
basis points. The average interest rates charged by the bank to us were 2.75%
during 2002, 5.0% during 2001 and 7.3% during 2000. Our available collateral
under these agreements includes securities owned by our customers in margin
accounts and securities owned by us which we elect to pledge to the bank. Our
margin agreements with our customers permit us to pledge their securities as
collateral for our bank loans. At December 31, 2002 we had no securities
pledged. As of December 31, 2001, we had approximately $9,121,000 in securities
owned by our customers in margin accounts and approximately $1,894,164 of
securities owned by us eligible to pledge to the bank and could borrow from the
bank, to the extent permitted by the bank, at least $6,264,747. The amount owed
to the bank under these agreements was $1,032,000 at December 31, 2001, and it
was collateralized by $4,053,000 of securities owned by our customers in margin
accounts that were pledged to the bank. At December 31, 2000, the aggregate
amount owed to the bank was $2,945,000 and was collateralized by $9,315,000 of
securities owned by our customers in margin accounts that were pledged to the
bank. The term of our current agreements expire May 31, 2003.
Prior to our IPO in April 2002, we were an S corporation for federal
and state income tax purposes and our taxable income had been taxed directly to
our initial shareholders. We distributed $1,200,000 to our shareholders in April
2001 related to their tax liability for our taxable income for 2000 and
distributed $732,294 in April and October 2002 related to their tax liability
for our net income for 2001. In October 2002, we made a partial distribution of
$133,647 and we plan to make an additional distribution of approximately $60,000
to the initial shareholders related to their income taxes arising from our
taxable income from January 1, 2002 until completion of the IPO.
23
Based on currently proposed plans and assumptions relating to the
implementation of our business plan, we believe that our cash flow from
operations, cash on hand plus lines of credit, will enable us to fund our
planned operations, for at least 12 months and thereafter. If not, or if our
plans change, or our assumptions change or prove to be inaccurate, or if our
operating cash flow otherwise proves to be insufficient to implement our
business plans, we may require additional financing and may seek to raise funds
through financings or other sources. We cannot assure you that additional funds
will be available in adequate amounts or on acceptable terms. If funds are
needed but not available, our business would be harmed.
NET CAPITAL REQUIREMENTS
Our broker dealer subsidiaries, Advantage Trading Group, Inc. and
Empire Financial Group, Inc., are subject to the requirements of the Uniform Net
Capital Rule (Rule 15c3-1) under the Securities Exchange Act of 1934. This rule
requires that aggregate indebtedness, as defined, not exceed 15 times net
capital, as defined. Rule 15c3-1 also provides for an "alternative net capital
requirement" which, if elected, requires that net capital be equal to the
greater of $250,000 or 2% of aggregate debit items computed in applying the
formula for determination of reserve requirements. Net capital positions of each
of our broker dealer subsidiaries were as follows:
December 31, December 31, December 31,
2002 2001 2000
---- ---- ----
Advantage Trading Group, Inc.:
Alternative method elected November
1999)
Net capital............................ $2,460,080 $1,798,877 $2,630,281
Required net capital................... 250,000 250,000 258,668
---------- ---------- ----------
Excess net capital..................... $2,210,080 $1,548,877 $2,371,613
========== ========== ==========
Net capital as percentage of aggregate
debit items.......................... 30% 16% 20.34%
Empire Financial Group, Inc.:
Net capital............................ $ 476,235 $330,491 $877,012
Required net capital................... 250,000 250,000 250,000
---------- ---------- ----------
Excess net capital..................... $ 226,235 $ 80,491 $627,012
========== ========== ==========
Ratio of aggregate indebtedness to net
Capital.............................. 4.01 to 1 4.90 to 1 1.21 to 1
SUBSEQUENT EVENTS
On March 28, 2003, we established two special committees of directors.
One of the special committees is authorized and empowered to manage the business
and operations of both Empire Financial Group, Inc. and Empire Investment
Advisors, Inc. The second special committee is authorized and empowered to
manage the business and operations of Advantage Trading Group, Inc. The
foregoing special committees shall each automatically cease to exist upon the
earlier of (a) the consummation of the spin-off of Advantage Trading Group, Inc.
from our company as described below and (b) June 30, 2003.
On March 28, 2003, we entered into a non-binding letter of intent with
our principal shareholders, Kevin M. Gagne and Richard L. Goble, dated March 28,
2003, confirming our interest in effectuating a spin-off of one of our
wholly-owned subsidiaries, Advantage Trading Group, Inc. The consummation of the
spin-off is subject to the execution of a definitive agreement between us and
our principal shareholders that would provide for, among other things, (a) that
we would distribute to all holders of our common stock, all shares of the common
stock of Advantage Trading Group, Inc. (b) that we and the principal
shareholders shall take all reasonable or necessary measures to effectuate the
spin-off, (c) that each of the principal shareholders will vote in favor of this
distribution, if the Securities and Exchange Commission, the American Stock
Exchange or the State of Florida requires approval
24
of the spin-off by our shareholders and (d) that the spin-off and other related
transactions will be tax free to us and our shareholders.
The definitive agreement would also provide that subsequent to the
consummation of the spin-off, Mr. Goble and Mr. Gagne, would exchange their
shares of our common stock and Advantage common stock, so that Mr. Goble will
receive shares of Advantage common stock and Mr. Gagne will receive shares of
our common stock. Following the share exchange, Mr. Goble would own
approximately 80% of the Advantage common stock and Mr. Gagne would own
approximately 80% of our common stock.
There is no assurance that the definitive agreement will be executed or
the distribution of Advantage common stock described above will be consummated.
In connection with the approval of the proposed spin-off and
establishment of the special committees of directors discussed above and as a
result of other action taken by the board of director, all management and
administrative disagreements between our Co-Chairmen of the Board and Co-Chief
Executive Officers have been resolved. However, the Co-Chairmen of the Board and
Co-Chief Executive Officers may disagree in the future regarding management and
administrative decisions. Our bylaws, the Co-Chairmen's and Co-Chief Executive
Officer's respective employment agreements and certain resolutions we adopted
provide that our board of directors shall resolve any disagreements that may
arise in the future. If the board of directors does not resolve such
disagreements in a timely manner, our business may be materially adversely
affected.
ACCOUNTING STANDARDS
In June 2001, the FASB issued Statement of Financial Accounting
Standards No. 143, "Accounting for Asset Retirement Obligations" ("SFAS 143"),
which establishes standards of accounting for asset retirement obligations
arising from the acquisition, construction, or development and/or the normal
operation of a long-lived asset. SFAS 143 is effective for financial statements
issued for fiscal years beginning after June 15, 2002. We adopted SFAS 143 as of
January 1, 2003.
In April 2002, Statement of Financial Accounting Standards No. 145
("SFAS 145") was issued, which rescinded SFAS Statements No. 4, 44, and 64,
amended No. 13 and contained technical corrections. As a result of SFAS 145,
gains and losses from extinguishments of debt will be classified as
extraordinary items only if they meet the criteria in APB Opinion No. 30, that
they are unusual and infrequent and not part of the entity's recurring
operations. We adopted SFAS 145 as of January 1, 2003.
In July 2002, the FASB issued SFAS 146, which addresses significant
issues regarding the recognition, measurement, and reporting of costs that are
associated with exit and disposal activities, including restructuring activities
that are currently accounted for pursuant to guidance that the Emerging Issues
Task Force has set forth in EITF Issue No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(Including Certain Costs Incurred in a Restructuring)." SFAS 146 revises the
accounting for certain lease termination costs and employee termination
benefits, which are generally recognized in connection with restructuring
charges. The provisions of SFAS 146 are effective for exit or disposal
activities that are initiated after December 31, 2002, with early adoption
encouraged. We have not determined what impact, if any, will occur once SFAS is
adopted on January 1, 2003.
In November 2002, the FASB issued Interpretation No. 45 ("FIN 45"),
"Guarantor's Accounting and Disclosure Requirements for Guarantee, Including
Indirect Guarantees of Indebtedness of Others", which addresses the disclosures
to be made by a guarantor in its interim and annual financial statements about
its obligations under guarantees. FIN 45 also requires the recognition of a
liability by a guarantor at the inception of certain guarantees that are entered
into or modified after December 31, 2002.
25
FACTORS AFFECTING OUR OPERATING, BUSINESS PROSPECTS AND MARKET PRICE OF STOCK
DECREASED TRANSACTION VOLUME COULD CONTINUE TO REDUCE OUR REVENUES.
Our revenues depend on the volume of securities transactions that we
handle for our customers. Transaction volume in the securities industry can
fluctuate widely both in markets where prices are rising and also in markets
where prices are falling and in connection with changes in regulatory
requirements, industry practices or other factors. Our securities transaction
volume decreased approximately 11.5% during 2002 compared to 2001 on top of a
16% decline during 2001 compared to 2000. Our order execution transaction volume
decreased approximately 30% between 2001 and 2002 and approximately 20% between
2000 and 2001. Further decreases in the volume of transactions could result in
reduced revenues and adversely affect our profitability.
OUR REVENUES COULD BE REDUCED SIGNIFICANTLY DUE TO MARKET PRICE FLUCTUATIONS.
Our order execution services involve the purchase and sale of
securities predominantly as principal, instead of buying and selling securities
as an agent for our customers. As a result, we own securities or are required to
buy securities to complete customer transactions. During the period that we own
the securities, market prices could fluctuate significantly which could result
in lost revenues to us and adversely affect our profitability.
A REDUCTION IN OUR COMMISSION RATES COULD ADVERSELY AFFECT OUR REVENUES AND
PROFITABILITY.
Intense competition from existing and new brokerage services may harm
our business. The market for online brokerage services is relatively new,
rapidly evolving, intensely competitive and has few barriers to entry. We expect
competition to continue and intensify in the future. Discount brokerage firms
may continue to reduce their commission rates in an effort to offer the lowest
transaction costs to investors. Because many of our competitors have
significantly greater financial, technical, marketing and other resources, offer
a wider range of products and services and have more extensive client bases than
we do, they may be able to respond more quickly to new or changing
opportunities, technologies and client requirements than us. They may also be
able to undertake more extensive promotional activities, offer more attractive
terms to clients and adopt more aggressive pricing policies than us. Moreover,
current and potential competitors have established or may establish cooperative
relationships among themselves or with third parties or may consolidate to
enhance their services and products. Many of these firms have greater
transaction volume and offer a wider range of services than we do, which allows
them to compensate for lower commission rates. Our commission fees for online
trading start at $5.00 per trade.
OUR INDEPENDENT REGISTERED REPRESENTATIVES COULD LEAVE OR AFFILIATE WITH A
COMPETITOR.
The independent registered representatives can terminate their
relationship with us on little or no notice and could associate with another
broker dealer. The independent registered representatives can transfer their
client accounts which could adversely affect our revenues.
DISAGREEMENTS BETWEEN OUR CO-CHIEF EXECUTIVE OFFICERS COULD HINDER OUR GROWTH.
Our management team is currently headed by our co-chairmen, co-chief
executive officers and co-presidents, Kevin M. Gagne and Richard L. Goble. Our
co-chairmen of the board and co-chief executive officers may disagree in the
future regarding management and administrative decisions. Our bylaws, the
co-chairmen's and co-chief executive officer's respective employment agreements
and certain resolutions we adopted provide that our board of directors shall
resolve any disagreements that may arise in the future. If the board of
directors does not resolve any disagreements in a timely manner, our business
may be materially adversely affected.
SINCE KEVIN M. GAGNE AND RICHARD L. GOBLE OWN MOST OF OUR COMMON STOCK AND
CONTROL US, MINORITY SHAREHOLDERS WILL HAVE LITTLE SAY IN THE DIRECTION OF THE
COMPANY.
26
Our co-chairmen, co-chief executive officers and co-presidents, Kevin
M. Gagne and Richard L. Goble, beneficially own approximately 80% of our common
stock. Accordingly, these two individuals control us and have the power to,
among other matters, to elect all directors, increase our authorized capital
stock or cause us to dissolve, merge or sell our assets. Messrs. Gagne and Goble
have also entered into a voting agreement under which they have agreed that
corporate actions requiring their vote as shareholders will require the approval
of both of them, so that neither of them can act unilaterally, thus
strengthening their collective control of us. The voting agreement provides
that, if Messrs. Gagne and Goble are unable to agree as to a particular proposal
to be voted upon by our shareholders, (a) they each agree to vote their shares
of our common stock in favor of adjourning the shareholder meeting to a future
date and (b) if they still cannot agree, they each agree to abstain from voting,
which may have the effect of preventing the other shareholders from approving
the proposal. Messrs. Gagne and Goble also have entered into a shareholder
agreement pursuant to which each of them has granted to the other a right of
first refusal (except in limited circumstances) to purchase any shares of our
common stock owned by them, thus further strengthening their collective control
of us.
Each of Messrs. Gagne and Goble also has entered into an employment
agreement with us for an initial term expiring on December 31, 2005. As a
result, they have the right to control our business and operations as our most
senior officers.
A REDUCTION IN ORDER FLOW PAYMENTS COULD NEGATIVELY IMPACT REVENUES.
We have arrangements with various investment banking and securities
brokerage firms under which we pay them to send their trade orders to us for
execution. This is known as paying for order flow. To attract order flow, we
must be competitive on:
o providing enhanced liquidity to our customers;
o the speed of our order execution;
o payment for order flow;
o the sophistication of our trading technology; and
o the quality of our customer service.
Loss of the ability to have orders routed to us in this manner could reduce our
transaction volume and therefore reduce our revenues and adversely affect our
profitability.
WE ARE SUBJECT TO SECURITIES REGULATION AND FAILURE TO COMPLY COULD SUBJECT US
TO PENALTIES OR SANCTIONS THAT COULD HARM OUR BUSINESS.
Our business is subject to federal and state laws regulating the
securities industry. In addition, the Securities and Exchange Commission, or the
SEC, the National Association of Securities Dealers, Inc., or the NASD, and
other self-regulatory organizations, as well as the various stock exchanges and
state securities commissions, require strict compliance with their rules and
regulations. Broker dealers are subject to regulations covering all aspects of
the securities business, including sales methods, trade practices among broker
dealers, use and safekeeping of clients' funds and securities, capital
structure, record keeping and the conduct of directors, officers and employees.
Errors in performing clearing functions and failure to comply with
related regulatory requirements could create liabilities to affected customers
and lead to civil penalties imposed by the SEC or the NASD. Clearing services
include the confirmation, receipt, settlement and delivery functions involved in
securities transactions. Clearing securities firms are subject to substantially
more regulatory control and examination than non-clearing firms because clearing
operations involve substantial risks of liability to customers due to clerical
errors related to the handling of customer funds and securities. We are also
required to maintain cash or qualified securities in a special reserve bank
account for the exclusive benefit of our customers.
27
Failure to comply and disputes concerning compliance with any of these
laws, rules or regulations could result in substantial expenses for us as well
as censure, fines, the issuance of cease and desist orders or suspension or
expulsion as a broker dealer.
POTENTIAL GOVERNMENTAL REGULATION OF THE INTERNET AND ONLINE COMMERCE COULD HARM
OUR BUSINESS.
Our business could be harmed by future legislation or regulation, the
application of laws and regulations from jurisdictions whose laws do not
currently apply to our business or the application of existing laws and
regulations to the Internet and other online services. The adoption of any
additional laws or regulations may decrease the growth of the Internet or other
online services, which could, in turn, decrease the demand for our trading
systems and services and increase our cost of doing business.
FAILURE TO COMPLY WITH NET CAPITAL REQUIREMENTS COULD SUBJECT US TO SUSPENSION
OR REVOCATION OF OUR BROKER DEALER REGISTRATION BY THE SEC OR EXPULSION BY THE
NASD.
We are subject to stringent rules promulgated by the SEC, the NASD and
various other regulatory agencies with respect to the maintenance of specific
levels of net capital by securities brokers. Failure to maintain the required
net capital may subject us to suspension or revocation of registration by the
SEC and suspension or expulsion by the NASD or other regulatory bodies and
ultimately could require our liquidation. In addition, a change in the net
capital rules, the imposition of new rules or any unusually large charge against
our net capital could limit our operations that require the intensive use of
capital, such as the financing of client account balances.
FAILURE TO QUALIFY AS A FOREIGN CORPORATION COULD RESULT IN THE IMPOSITION OF
TAXES AND PENALTIES THAT WOULD INCREASE OUR COSTS.
Our subsidiaries Advantage Trading Group, Inc. and Empire Financial
Group, Inc. are both currently registered as broker dealers in all 50 states as
well as Puerto Rico, but are qualified to do business as a foreign corporation
in only a few states. Because our services are available over the Internet and
we have customers in many states, we and/or any of our subsidiaries may be
required to qualify as a foreign corporation. If we fail to qualify as a foreign
corporation in states that may require such qualifications, we may be penalized.
EMPLOYEE MISCONDUCT COULD RESULT IN REGULATORY SANCTIONS AND UNANTICIPATED
COSTS.
Because our business involves handling cash and marketable securities
on behalf of our customers, employee misconduct could result in unknown and
unmanaged risks or losses. Misconduct by employees could also include binding us
to transactions that exceed authorized limits or present unacceptable risks or
hiding from us unauthorized or unsuccessful activities.
IF OUR RETAIL CUSTOMERS DO NOT REPAY US FOR CREDIT WE EXTEND TO THEM, OUR
FINANCIAL CONDITION COULD BE NEGATIVELY IMPACTED.
Periods of volatile markets increase the risks inherent in extending
credit to the extent that we permit our retail customers to purchase securities
on a margin basis. Under such circumstances the value of the collateral held by
us could fall below the amount borrowed by the customer. We may then be required
to sell or buy securities at prevailing market prices and incur losses to
satisfy customer obligations. As of December 31, 2002, we had extended
approximately $5,772,000 in credit to our retail customers, accounting for
approximately 42% of our total assets. We may be required to sell or buy
securities at prevailing market prices and incur losses to satisfy customer
obligations which could have a substantial negative impact on our financial
condition.
IF WE ARE UNABLE TO KEEP UP WITH RAPID TECHNOLOGICAL CHANGES IN A COST-EFFECTIVE
MANNER, WE MAY LOSE BUSINESS.
Our future success will depend, in part, on our ability to develop and
use new technologies, respond to technological advances, enhance our existing
services and products, and develop new services and products in a timely and
cost-effective manner. The market for brokerage services and, particularly,
electronic brokerage services over the Internet, is characterized by rapid
technological change, changing client requirements, frequent service and product
28
enhancements and introductions, and emerging industry standards. The
introduction of services or products embodying new technologies and the
emergence of new industry standards can render existing services or products
obsolete and unmarketable.
INTERRUPTION OR LOSS OF CONTENT PROVIDED BY THIRD PARTIES COULD CAUSE US TO LOSE
CUSTOMERS, HARMING OUR BUSINESS.
We rely on third-party content providers for much of the financial
information we offer through our website and are therefore dependent on the
ability of third-party content providers to deliver content in a timely and
consistent manner. Interruption or termination of our existing third-party
content supply would require us to seek content from other third parties. Delays
in obtaining replacement content could cause us to lose customers.
DISRUPTION OF OUR COMPUTER SYSTEMS AND/OR THOSE OF OUR VENDORS AND SYSTEMS
FAILURES COULD CAUSE OUR REVENUES TO DECLINE AND OUR BUSINESS REPUTATION TO
SUFFER.
We rely heavily on various electronic media. We receive trade orders
using the Internet and telephone. In addition, we process trade orders through
our own systems and those of Bear Stearns Securities Corp., ABN Amro
Incorporated, The Vantra Group, Inc. and Automated Data Processing, Inc. These
methods of trading are heavily dependent on the integrity of the electronic
systems supporting them.
Heavy system traffic during peak trading times could cause our systems
to operate at unacceptably low speeds or fail altogether. Any significant
degradation or failure of our computer systems, those of our vendors, or any
other systems in the trading process (e.g., online service providers, record
keeping and data processing functions performed by third parties and third-party
software such as Internet browsers) could cause clients to suffer delays in
trading. These delays could cause substantial losses for our clients and could
subject us to claims from clients for losses, including litigation claiming
fraud or negligence. Our computer systems are also vulnerable to damage or
interruption from human error, natural disasters, power loss, sabotage or
computer viruses.
IF OUR SYSTEMS SECURITY IS COMPROMISED, OUR REPUTATION MAY SUFFER AND WE MAY
LOSE BUSINESS.
Any compromise of our systems' security could harm our business. The
secure transmission of confidential information over public networks is a
critical element of our operations. We and our vendors rely on encryption and
authentication technology to provide the security and authentication necessary
to effect secure transmission of confidential information over the Internet.
However, advances in computer capabilities, new discoveries in the field of
cryptography or other events or developments may result in a compromise of our
systems' security.
CLAIMS OF INFRINGEMENT MAY INCREASE OUR COSTS AND DISRUPT OUR BUSINESS.
Other parties may claim that we infringe on their intellectual property
rights. Regardless of whether any such claims are valid, claims of infringement
could be time-consuming and expensive to defend, could divert our resources and
our management's attention. If we are forced to stop using any software, systems
or processes that are important to run our operations, our business may be
disrupted and our costs significantly increased.
IF WE ARE UNABLE TO OBTAIN ADDITIONAL CAPITAL WHEN WE NEED IT, WE MAY NOT BE
ABLE TO EFFECTIVELY COMPETE IN THE MARKETPLACE.
We anticipate that our available cash resources will be sufficient to
meet our presently anticipated working capital and capital expenditure
requirements for at least the next 12 months. In the future, however, we may
need to raise additional funds in order to support further expansion, develop
new or enhanced services and products, respond to competitive pressures, acquire
complementary businesses or technologies or respond to unanticipated
requirements. We cannot assure you that additional financing will be available
when needed on terms favorable to us or on terms that will not result in
dilution to our existing shareholders. Our lines of credit are subject to annual
renewal in May of each year. As of December 31, 2002 we had no outstanding
29
balance under these lines of credit. We cannot assure you that our lines of
credit will be renewed and if it not renewed it may affect our ability to
operate.
WE RELY ON RELATIVELY FEW KEY PERSONNEL TO PROVIDE CRITICAL MANAGEMENT
FUNCTIONS.
If one or more of such individuals leave the Company, our ability to
manage our operations may be impeded and our business could be adversely
impacted.
WE MAY BE DELISTED FROM THE AMERICAN STOCK EXCHANGE WHICH WOULD REDUCE OUR
STOCKHOLDER LIQUIDITY.
On February 7, 2003, Gregory M. Misiak and James J. Schweiger, two of
our independent directors who were on our audit committee, resigned from our
board of directors. The rules of the American Stock Exchange require that each
issuer listed on the AMEX have an audit committee comprised of at least three
independent directors. As a result of their resignations, our board of directors
and audit committee have only one independent director. We are requesting that
the AMEX temporarily waive its independent director requirement while we search
for two independent directors to fill these seats. If AMEX does not grant our
request and allow us the opportunity to elect two new independent directors or
if we cannot fill the two vacated seats in a timely manner, the AMEX may delist
our securities. If our common stock is not listed on AMEX it may be more
difficult for our stockholders to trade our stock.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk represents the risk of loss that may result from the
potential change in the value of a financial instrument as a result of
fluctuations in interest rates and market prices. We have established policies,
procedures and internal processes governing our management of market risks in
the normal course of our business operations.
Advantage Trading Group, Inc, which provides our clearing operations,
seeks to control the risks associated with its customer activities by requiring
customers to maintain margin collateral in compliance with various regulatory
and internal guidelines. Advantage monitors required margin levels daily and,
pursuant to such guidelines, requires the customers to deposit additional
collateral, or to reduce positions, when necessary.
As a fundamental part of our brokerage business, we hold short-term
interest earning assets, mainly funds required to be segregated in compliance
with federal regulations for customers. We had no requirement for such funds at
December 31, 2002. We invest such funds primarily in short-term fixed-rate U.S.
Treasury Bills and repurchase agreements. Our interest earning assets are
financed by short-term interest bearing liabilities totaling $5,911,966 at
December 31, 2002 and $8,990,457 at December 31, 2001 in the form of customer
cash balances. We earn a net interest spread on the difference between amounts
earned on customer margin loans and amounts paid on customer credit balances.
Since we establish the rate paid on customer cash balances, a substantial
portion of our interest rate risk is under our direct management. We generally
move rates earned on loans in lockstep with rates paid on credit balances to
maintain a consistent net interest spread, and, therefore, do not anticipate
that changes in interest rates will have a material effect on our earnings and
cash flows.
Our revenues and financial instruments are denominated in U.S. dollars,
and we have not invested in derivative financial instruments or derivative
commodity instruments
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements of Empire Financial Holding
Company the accompanying notes thereto and the independent accountants' reports
are included as part of this Form 10-K and immediately follow the signature page
of this Form 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
30
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth the names, ages and positions held with
respect to each director and executive officer:
Name Age Position
---- --- --------
Richard L. Goble............42 Co-Chief Executive Officer, Co-President and
Co-Chairman of the Board
Kevin M. Gagne..............43 Co-Chief Executive Officer, Co-President and
Co-Chairman of the Board
George R. Cupples...........52 Chief Financial Officer/Compliance and
Secretary
John J. Tsucalas............63 Director
Richard L. Goble is our co-chairman of the board, co-chief executive
officer and co-president. He is also the president of Advantage Trading Group,
Inc. Mr. Goble is responsible for the creation, development and management of
our execution and clearing operations.
Kevin M. Gagne is our co-chairman of the board, co-chief executive
officer and co-president. He is also the president of Empire Financial Group,
Inc., which he co-founded in 1990. Mr. Gagne was responsible for the creation of
Empire's online trading operations and development of our institutional
operations.
George R. Cupples is our chief financial officer and has been our
compliance officer and controller since August 1999. Mr. Cupples also became our
secretary on March 20, 2003. From 1990 to 1999, Mr. Cupples worked for the SEC
as an examiner of broker dealers for compliance with various federal and NASD
rules and regulations. His activities also included reviewing litigation
involving broker dealers in enforcement proceedings. From 1982 to 1990, he
worked for the NASD examining broker dealers for compliance with net capital
requirements, customer protection, sales practices and supervisory procedures
John J. Tsucalas became a director upon completion of our IPO in April
2002. Since February 2000, Mr. Tsucalas has been chief executive officer and
chief financial officer of Littlefield Adams & Company, a company engaged in the
sale of men's apparel. He held these positions on an interim basis from July
1999 to February 2000. Since 1979 Mr. Tsucalas has also operated his own
corporate financial services company, John James Tsucalas & Co. He is a
chartered financial analyst.
DIRECTOR COMPENSATION
We pay non-employee directors an annual retainer of $5,000, in addition
to $500 per meeting, plus travel reimbursements. In addition, each non-employee
director received stock options covering 20,000 shares of our common stock at an
exercise price equal to the initial offering price of $6.00 per share under our
2000 Incentive Compensation Plan.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 requires our
directors, executive officers and persons who own more than ten percent of their
outstanding common stock, to file with the Securities and Exchange Commission,
or SEC, initial reports of ownership and reports of changes in ownership of
common stock. Such persons are required by SEC regulations to furnish us with
copies of all such reports they file.
To our knowledge, based solely on a review of the copies of such
reports furnished to us and written representations that no other reports are
required, Section 16(a) filing requirements applicable to our officers,
directors and greater than ten percent beneficial owners have been filed timely.
31
ITEM 11. EXECUTIVE COMPENSATION
The following table summarizes all compensation paid during the last
three fiscal years to our co-chief executive officers and each other executive
officer whose annual compensation exceeded $100,000 during the three years
ending December 31, 2002.
Summary Compensation Table
Annual
Fiscal Compensation Other Annual
Name and Principal Position Year Salary Bonus Compensation
--------------------------- ---- ------ ------- ------------
Richard L. Goble ............................ 2002 $358,900 -- $432,971
Co-Chief Executive Officer and ............ 2001 108,000 $200,000 600,000
Co-Chairman of the Board .................. 2000 302,160 -- 700,000
Kevin M. Gagne .............................. 2002 358,900 -- 432,971
Co-Chief Executive Officer and ............ 2001 108,000 200,000 600,000
Co-Chairman of the Board .................. 2000 302,160 -- 700,000
George R. Cupples ........................... 2002 126,300 -- --
Chief Finance/Compliance Officer .......... 2001 127,700 -- --
2000 120,200 -- --
Donald A. Wojnowski Jr ...................... 2002 103,579 -- 471,438
Vice President, Business Development ...... 2001 132,024 -- 106,472
2000 60,000 -- 131,751
"Bonus" for Messrs. Gagne and Goble consists of a $200,000 bonus earned
by each individual for fiscal year 2001, half of which was paid during 2001 and
the other half of which was paid during 2002.
"Other Annual Compensation" for Messrs. Goble and Gagne consists of
distributions to these individuals as shareholders related to their tax
liability for our taxable income for the prior calendar year and for Mr.
Wojnowski consists of brokerage commissions.
Mr. Wojnowski resigned as Vice President, Business Development, in
February 2003.
EMPLOYMENT AGREEMENTS
We have employment agreements with each of Messrs. Gagne and Goble
which provide that each of them shall serve as our co-chairman of the board,
co-chief executive officer and co-president. Each of these agreements provides
for annual base compensation of $375,000. In addition, each of these agreements
provides incentive and other compensation and benefits to the executive. These
employment agreements have an initial term expiring on December 31, 2005.
Beginning on January 1, 2003, and each following January 1, the term of each
agreement will be automatically extended for one additional year unless we give
written notice of termination to the employee not later than at least 180 days
prior to that date. As a result, if we elect to terminate either of these
agreements we will be obligated to employ the employee for at least two and a
half years after making this election to terminate. These agreements may also be
terminated by us after a conviction of (and such conviction is sustained on all
appeals) or the entry of a plea of guilty by the employee to a felony, if the
employee materially breaches the agreement which is not cured within ten days,
if the employee commits any act or omission constituting willful misconduct,
gross negligence, fraud, misappropriation, embezzlement or competitive business
activities which we believe could cause us material harm or upon the employee's
disability as defined in the employment agreement. Each of these employment
agreements contains confidentiality provisions and also non-competition
provisions during the term of the agreement and for two years thereafter, which
prohibits him from engaging in the securities brokerage business in the State of
Florida or using the Internet.
32
Messrs. Gagne and Goble each may terminate his agreement at any time
upon 90 days prior written notice. If either Mr. Gagne or Mr. Goble terminates
his agreement because he is assigned duties that are materially inconsistent
with his current position, because of our material breach of his agreement or as
a result of a change in control or if we terminate the agreement without cause,
then we must compensate him for the remainder of the term. In the event we
terminate the agreement because of the employee's disability, we must pay that
employee his base salary until the earlier of nine months after his termination
or the date on which his long-term disability insurance payments begin.
We have also entered into an employment agreement with Donald Wojnowski
Jr., effective as of December 27, 2000, which provides that he shall serve as
Vice President, Business Development. Mr. Wojnowski resigned in February 2003 as
Vice President, Business Development, but continues to serve as our employee.
INDEMNIFICATION AGREEMENTS
We have entered into indemnification agreements with each of our
directors and executive officers. Under these agreements, we have agreed to
indemnify them against certain liabilities and expenses in proceedings other
than those we bring against them that they become involved in because of their
status as a director, officer or agent of ours. In order to be entitled to
indemnification, they must have acted in good faith and in a manner they
reasonably believed to be in or not opposed to our best interests and, with
respect to any criminal proceedings, had no reasonable cause to believe their
conduct was unlawful. With respect to any action brought by us or in our right,
a director or executive officer will also be indemnified, to the extent not
prohibited by law, for liabilities and expenses they reasonably incur if a court
determines they acted in good faith and in a manner they reasonably believed to
be in or not opposed to our best interests. Under the terms of the agreement, no
legal action can be brought by us or on our behalf against a former officer or
director more than two years after the officer or director has ceased serving us
in that capacity, if the action would give rise to a claim for indemnification.
OPTION GRANTS IN FISCAL 2002
The following table sets forth each grant of stock options during the
fiscal year ended December 31, 2002 to each of the named executive officers. No
stock appreciation rights were granted to these individuals during that year.
Individual Grants
---------------------------------------------------
% of Total Potential Realizable Value
Number of Options at Assumed Annual Rates
Securities Granted to of Stock Price Appreciation
Underlying Employees Exercise or for Option Term (1)
Options in Fiscal Base Price Expiration ---------------------------
Name Granted Year (per share) Date 5% 10%
---- ------- ---- ----------- ---------- ---------- ---------
Richard L. Goble......... -- -- -- -- -- --
Kevin M. Gagne........... -- -- -- -- -- --
George R. Cupples........ 50,000 8.7% $6.00 5/30/2012 $188,668 $478,123
Donald A. Wojnowski Jr... 200,000 34.8% $6.00 5/30/2012 754,674 1,912,491
- ----------------
(1) Potential realizable value is based on the assumption that the common stock
price appreciates at the annual rate shown, compounded annually, from the
date of grant until the end of the option term. The amounts have been
calculated based on the requirements promulgated by the Securities and
Exchange Commission. The actual value, if any, a named executive officer
may realize will depend on the excess of the stock price over the exercise
price on the date the option is exercised, if the executive were to sell
the shares on the date of exercise. Therefore, the value realized may not
be equal to or near the potential realizable value as calculated in this
table.
33
AGGREGATED OPTION EXERCISES IN 2002 AND FISCAL YEAR-END OPTION VALUE TABLE
The following table sets forth certain information concerning the
exercise of stock options by the named executive officers during the fiscal year
ended December 31, 2002 and unexercised stock options held by the named
executive officers as of December 31, 2002. There were no exercises of options
during 2002.
Number of Securities Underlying Value of Unexercised In-the-Money
Unexercised Options Held as of -----------------------------------
December 31, 2002 Options as of December 31, 2002 (1)
Name Exercisable Unexercisable Exercisable Unexercisable
Richard L. Goble............... -- -- -- --
Kevin M. Gagne................. -- -- -- --
George R. Cupples.............. -- 50,000 -- --
Donald A. Wojnowski Jr......... 100,000 100,000 -- --
- --------------------
(1) Value of unexercised in-the-money options is the sum of the value of each
option granted, calculated on a grant by grant basis. The value of each
option is equal to of the product of the number of shares that could be
acquired upon the exercise of unexercised options as of the end of 2002
multiplied by the difference between the exercise price for the grant and
the year-end market price, of $0.92 per share, excluding grants for which
the difference is equal to or less than zero. All grants had an exercise
price greater than the year-end market price.
2000 INCENTIVE COMPENSATION PLAN
We adopted the 2000 Incentive Compensation Plan, which is designed to
serve as an incentive for retaining qualified and competent directors,
employees, consultants and advisors. Stock options, stock appreciation rights
and restricted stock options will be granted to certain persons in proportion to
their contributions to our overall success as determined by the board of
directors, or committee thereof, in their sole discretion.
Our board of directors, or a committee thereof, administers and
interprets the 2000 Plan and is authorized to grant options to all eligible
employees, directors and executive officers (whether current or former
employees), as well as consultants and independent contractors. The 2000 Plan
provides for the granting of both "incentive stock options" (as defined in
Section 422 of the Internal Revenue Code of 1986, as amended) and non-statutory
stock options. Incentive stock options may only be granted, however, to
employees. Options can be granted under the 2000 Plan on the terms and at the
prices determined by the board of directors, or a committee thereof, except that
the per share exercise price of incentive stock options granted under the 2000
Plan will not be less than the fair market value of the common stock on the date
of grant and, in the case of an incentive stock option granted to a 10%
shareholder, the per share exercise price will not be less than 110% of the fair
market value as defined in the 2000 Plan.
34
Options under the 2000 Plan that would otherwise qualify as incentive
stock options will not be treated as incentive stock options to the extent that
the aggregate fair market value of the shares covered by the incentive stock
options which are exercisable for the first time by any individual during any
calendar year exceeds $100,000.
Options and stock appreciation rights granted under the 2000 Plan would
not be exercisable after the period or periods specified in the option
agreement. Options and stock appreciation rights granted under the 2000 Plan are
exercisable no later than ten years from the date of the grant. Incentive stock
options are not transferable. The optionee may transfer non-statutory stock
options and stock appreciation rights by will or the laws of descent and
distribution. Adjustments in the number of shares subject to options and stock
appreciation rights granted under the 2000 Plan can be made by the board of
directors or the appropriate committee in the event of a stock dividend or
re-capitalization resulting in a stock split-up, combination or exchange of
shares. The maximum number of shares which may be granted as restricted stock or
underlying stock options or SARs is 1,000,000.
For each grant of restricted stock under the 2000 Plan, there shall be
established a restricted period, which shall be no less than six months and no
greater than five years and which may vary among the recipients of the
restricted stock. Shares of restricted stock cannot be sold or otherwise
transferred during the restricted period, but otherwise the holder of restricted
stock shall have the same rights as all of our other shareholders. In the event
that a holder of restricted stock leaves our employment during the restricted
period (other than as a result of death or disability), then all shares of
restricted stock that are still subject to the restrictions shall be forfeited
and returned to us. If a holder is terminated as an employee by us without cause
or by mutual agreement between the holder and us, then the administrator of the
2000 Plan, in its discretion, may release some or all of the shares from the
restrictions.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table provides information as of December 31, 2002 with
respect to compensation plans (including individual compensation arrangements)
under which our equity securities are authorized for issuance.
Equity Compensation Plan Information
----------------------------------------------------------------------
Number of securities
remaining available
for future issuance
Number of securities under equity
to be issued upon compensation plans
exercise of Weighted-average (excluding securities
outstanding options, exercise price of reflected in
warrants and rights outstanding options, column (a)
Plan Category (in thousands) warrants and rights (in thousands)
------------- -------------- ------------------- --------------
(a) (b) (c)
Equity compensation plans approved
by security holders............... 648,100 $6.00 351,900
Equity compensation plans not
approved by security holders(1)... -- -- --
------- ----- -------
Total................................ 648,100 $6.00 351,900
------- ----- -------
35
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT
The following table sets forth as of April 10, 2003 the information
regarding beneficial ownership of our common stock, by (1) each person who owns
beneficially more than 5% of our outstanding common stock, (2) each of our
directors, (3) each of our executive officers and (4) all directors and
executive officers as a group.
Number of
Shares Owned
Subject to Total Number
Exercise of of Shares
Number of Shares Options or Beneficially Percentage of
Name and Address of Beneficial Owner Owned Warrants Owned Outstanding
------------------------------------ ----- -------- ----- -----------
Richard L. Goble(1).................... 2,093,100 -- 2,093,100 43.7
Kevin M. Gagne (2)..................... 2,018,100 -- 2,018,100 42.2
George R. Cupples...................... 100 10,000 10,100 *
John J. Tsucalas....................... 1,500 20,000 21,500 *
Donald A. Wojnowski Jr. ............... 13,500 120,000 133,500 2.7
All directors and executive officers
as a group (7 persons).............. 4,121,200 150,000 4,271,200 86.5
- ----------------
* less than 1%
(1) Held by Richard L. Goble as trustee of the Goble Family Trust except for
5,100 shares held by G&G Holdings, Inc.
(2) Held by Kevin M. Gagne as trustee of the Gagne First Revocable Trust except
for 5,100 shares held by G&G Holdings, Inc.
The business address of all directors and executive officers is c/o
Empire Financial Holding Company, 1385 West State Road 434, Longwood, Florida
32750.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
We lease the facilities where our principal offices are located from
G&G Holdings, Inc., a corporation owned by our principal shareholders,
co-chairmen of the board and co-chief executive officers, Messrs. Gagne and
Goble. The lease expires on May 31, 2009 and provides for average rent of
approximately $23,000 per month, plus sales and property taxes.
Prior to our IPO, we acquired all of the outstanding capital stock of
each of Advantage Trading Group, Inc., Empire Financial Group, Inc. and Empire
Investment Advisors, Inc. from Messrs. Gagne and Goble in exchange for a total
of 4,000,000 shares of our common stock, issued in equal amounts to Messrs.
Gagne and Goble.
From time to time we paid dividends to our existing shareholders,
Messrs. Gagne and Goble, during 2000, 2001 and 2002 in the amounts of
$2,646,986, $1,942,150 and $865,941, respectively. Prior to our IPO in April
2002, we were an S corporation for federal and state tax purposes, and our
taxable income is a direct liability of our shareholders. As payment to Messrs.
Gagne and Goble, to assist them in the payment of their estimated income tax
liability related to our 2001 taxable income prior to the offering, we made a
distribution to them in April and October 2002 of a total of $732,294 which
equals approximately 39.1% of our taxable income from January 1, 2001 through
December 31, 2001. We made a partial distribution of $133,647 in October 2002
and plan to make an additional distribution of approximately $60,000 to Messrs.
Gagne and Goble related to their income taxes arising from our taxable income
from January 1, 2002 until completion of the IPO.
On March 28, 2003, we entered into a non-binding letter of intent with
our principal shareholders, Kevin M. Gagne and Richard L. Goble, dated March 28,
2003, confirming our interest in effectuating a spin-off of one of our
wholly-owned subsidiaries, Advantage Trading Group, Inc. The consummation of the
spin-off is subject to the execution of a definitive agreement between us and
our principal shareholders that would provide for, among other things, (a) that
we would distribute to all holders of our common stock, all shares of the common
stock of Advantage Trading Group, Inc. (b) that we and the principal
shareholders shall take all reasonable or necessary measures to effectuate the
spin-off, (c) that each of the principal shareholders will vote in favor of this
distribution,
36
if the Securities and Exchange Commission, the American Stock Exchange or the
State of Florida requires approval of the spin-off by our shareholders and (d)
that the spin-off and other related transactions will be tax free to us and our
shareholders.
The definitive agreement would also provide that subsequent to the
consummation of the spin-off, Mr. Goble and Mr. Gagne would exchange their
shares of our common stock and Advantage common stock, so that Mr. Goble will
receive shares of Advantage common stock and Mr. Gagne will receive shares of
our common stock. Following the share exchange, Mr. Goble would own
approximately 80% of the Advantage common stock and Mr. Gagne would own
approximately 80% of our common stock.
There is no assurance that the definitive agreement will be executed or
the distribution of Advantage common stock described above will be consummated.
ITEM 14. CONTROLS AND PROCEDURES
Within the 90 days prior to the date of this Annual Report, we
evaluated the effectiveness of the design and operation of our disclosure
controls and procedures and our internal controls and procedures for financial
reporting. This evaluation was done under the supervision and with the
participation of management, including our CEOs and CFO.
Disclosure controls are procedures that are designed with the objective
of ensuring that information required to be disclosed in our reports filed under
the Securities Exchange Act of 1934, such as this annual report, is recorded,
processed, summarized and reported within the time periods specified by the
Securities and Exchange Commission. Disclosure controls are also designed with
the objective of ensuring that the information is accumulated and communicated
to our management, including our CEOs and CFO, as appropriate to allow timely
decisions regarding required disclosure. Internal controls are procedures that
are designed with the objective of providing reasonable assurance that (1) our
transactions are properly authorized; (2) our assets are safeguarded against
unauthorized or improper use; and (3) our transactions are properly recorded and
reported, all to permit the preparation of our financial statements in
conformity with generally accepted accounting principles.
Our management, including the CEOs and CFO, does not expect that our
disclosure controls or our internal controls will prevent all error and fraud. A
control system, no matter how well operated, can provide only reasonable, not
absolute, assurance that the objectives of the control system are met. Further,
the design of a control system must reflect the fact that there are resource
constraints, and the benefits of controls must be considered relative to their
costs. Because of the inherent limitations in all control systems, no evaluation
of controls can provide absolute assurance that all control issues and instances
of fraud, if any, have been detected. The design of any system of controls also
is based in part upon assumptions about the likelihood of future events, and
there can be no assurance that any design will succeed in achieving its stated
goals under all potential future conditions; over time, control may become
inadequate because of changes in conditions, or the degree of compliance with
the policies or procedures may deteriorate. Because of the inherent limitations
in a cost-effective control system, misstatements due to error or fraud may
occur and not be detected.
The CEO/CFO evaluation of our disclosure controls and internal controls
included a review of the controls' objectives and design, the controls'
implementation and the effect of the controls on the information generated for
use in this annual report. In the course of our evaluation, we sought to
identify data errors, controls problems or acts of fraud and to confirm that
appropriate corrective action, including process improvements, were being
undertaken. This type of evaluation will be done on a quarterly basis so that
the conclusions concerning controls effectiveness can be reported in our
quarterly reports on Form 10-Q and annual reports on Form 10-K. Our internal
controls are also evaluated by our independent auditors in connection with their
audit and review activities. The overall goals of these evaluation activities
are to monitor our disclosure controls and our internal controls and to make
modifications as necessary our intent in this regard is that the disclosure
controls and the internal controls will be maintained as dynamic systems that
change (including with improvements and corrections) as conditions warrant.
Among other matters, we sought in our evaluation to determine whether
there were any "significant deficiencies" or "material weaknesses" in our
internal controls. In the professional auditing literature, "significant
deficiencies" are referred to as "reportable conditions"; these are control
issues that could have a significant adverse effect on the ability to record,
process, summarize and report financial data in the financial statements.
37
A "material weakness" is defined in the auditing literature as a particularly
serious reportable condition where the internal control does not reduce to a
relatively low level the risk that misstatements caused by error or fraud may
occur in amounts that would be material in relation to the financial statements
and not be detected within a timely period by employees in the normal course of
performing their assigned functions.
In accord with SEC requirements, the CEOs and CFO note that, since the
date of the evaluation to the date of this annual report, there have been no
significant changes in internal controls or in other factors that could
significantly affect internal controls, including any corrective actions with
regard to significant deficiencies and material weaknesses. However, management
believes that we are still adapting to being a public company and that our
internal controls may be improved. Management is reviewing possible improvement.
Based upon our evaluation, our CEOs and CFO have concluded that our
disclosure controls are generally effective to ensure that material information
relating to Empire Financial Holding Company and its subsidiaries is made known
to management, including the CEOs and CFO, particularly during the period when
our periodic reports are being prepared, and that our internal controls are
generally effective to provide reasonable assurance that our financial
statements are fairly presented in conformity with generally accepted accounting
principles. Management is reviewing ways to improve both our disclosure controls
and our internal controls.
PART IV
ITEM 15. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
2.1 Share Exchange Agreement among the Registrant, Kevin M. Gagne and Richard L. Goble (1)
2.2 Amended and Restated Share Exchange Agreement among the Registrant, Kevin M. Gagne and
Richard L. Goble (1)
3.1 Registrant's Articles of Incorporation(1)
3.2 Registrant's Bylaws(1)
3.3 Amendment to Sections 3.9 and 4.16 of Registrant's Bylaws.
4.1 Form of Underwriter's Warrant Agreement, including Form of Warrant Certificate(1)
4.2 Form of Registrant's Common Stock Certificate(1)
9.1 Voting Agreement between Kevin M. Gagne and Richard L. Goble(1)
10.1 2000 Stock Option Plan(1)
10.2 Employment Agreement between the Registrant and Kevin M. Gagne(1)
10.3 Employment Agreement between the Registrant and Richard L. Goble(1)
10.4 Employment Agreement between the Registrant and Donald A. Wojnowski Jr.(1)
10.5 Lease between Advantage Trading Group, Inc. and G&G Holdings, Inc. relating to principal
offices of Registrant located at 1385 W. Highway 434, Longwood, Florida(1)
10.6 Lease between Empire Financial Group, Inc. and G&G Holdings, Inc. relating to principal
offices of Registrant located at 1385 W. Highway 434, Longwood, Florida(1)
10.7 Form of Indemnification Agreement between the Registrant and each of its directors and
executive officers(1)
10.8 Clearing Agreement between Empire Financial Group, Inc. and Bear Stearns Securities Corp.(1)
10.9 Firm Inventory Credit Agreement between Advantage Trading Group, Inc. and Mercantile Bank
National Association (now named Firstar Corporation), as amended(1)
10.10 Remote Processing Agreement between SunGard Financial Systems, Inc. and Advantage Trading
Group, Inc.(1)
10.11 Shareholders Agreement by and among the Registrant, Kevin M. Gagne and Richard L. Goble(1)
10.12 Letter Agreement dated August 23, 2000 between the Registrant and Donald A. Wojnowski Jr.(1)
10.13 Brokerage Credit Agreement between Advantage Trading Group, Inc. and Firstar Bank, N.A.(1)
10.14 Letter of Intent, dated March 28, 2003, by and between Empire Financial Holding Company,
Kevin M. Gagne and Richard L. Goble(2)
21.1 Subsidiaries of the Registrant
99.1 Co-Principal Executive Officer Certification Pursuant to 18
U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
The Sarbanes-Oxley Act of 2002.
99.2 Co-Principal Executive Officer Certification Pursuant to 18
U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
The Sarbanes-Oxley Act of 2002.
99.3 Principal Financial Officer Certification Pursuant to 18
U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
The Sarbanes-Oxley Act of 2002.
38
- ------------------
(1) Incorporated by reference to the same exhibit number filed as part of
Empire Financial Holding Company's Registration Statement on Form S-1,
Registration No. 333-86365.
(2) Incorporates by reference to the same exhibit number filed as an exhibit to
Empire Financial Holding Company's Current Report on Form 8-K dated March
28, 2003.
(b) Reports on Form 8-K.
The Company filed the following reports on Form 8-K during the year
ended December 31, 2002:
A report on Form 8-K was filed on October 29, 2002 reporting on Item 5,
Other Events.
39
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
EMPIRE FINANCIAL HOLDING COMPANY
By: /s/ Richard L. Goble
Richard L. Goble,
Co-Chief Executive Officer
By: /s/ Kevin M. Gagne
Kevin M. Gagne,
Co-Chief Executive Officer
By: /s/ George R. Cupples
George R. Cupples,
Chief Financial Officer
(Principal Accounting Officer)
Dated April 17, 2003
In accordance with the Securities Exchange Act of 1934, this report has
been signed below by the following persons on behalf of the registrant in the
capacities and on the dates indicated.
SIGNATURES TITLE DATE
---------- ----- ----
/s/ Richard L. Goble Co-Chief Executive Officer and Director April 17, 2003
- -------------------- (Co-Principal Executive Officer)
Richard L. Goble
/s/ Kevin M. Gagne Co-Chief Executive Officer and Director April 17, 2003
- ------------------ (Co-Principal Executive Officer)
Kevin M. Gagne
/s/ George R. Cupples Chief Financial Officer April 17, 2003
- --------------------- (Principal Accounting Officer)
George R. Cupples
/s/ John J. Tsucalas Director April 17, 2003
- --------------------
John J. Tsucalas
40
CERTIFICATION
I, Richard L. Goble, Co-Chief Executive Officer of Empire Financial
Holding Company, certify that:
1. I have reviewed this annual report on Form 10-K of Empire Financial Holding
Company;
2. Based on my knowledge, this annual 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 annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual 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 annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this annual 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
annual report (the "Evaluation Date"); and
c) Presented in this annual 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
annual 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: April 17, 2003
/s/ Richard L. Goble
- --------------------
Richard L. Goble
Co-Chief Executive Officer
41
CERTIFICATION
I, Kevin M. Gagne, Co-Chief Executive Officer of Empire Financial
Holding Company, certify that:
1. I have reviewed this annual report on Form 10-K of Empire Financial Holding
Company;
2. Based on my knowledge, this annual 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 annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual 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 annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this annual 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
annual report (the "Evaluation Date"); and
c) Presented in this annual 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
annual 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: April 17, 2003
/s/ Keith M. Gagne
- ------------------
Kevin M. Gagne
Co-Chief Executive Officer
42
CERTIFICATION
I, George R. Cupples, Chief Financial Officer of Empire Financial
Holding Company, certify that:
1. I have reviewed this annual report on Form 10-K of Empire Financial Holding
Company;
2. Based on my knowledge, this annual 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 annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual 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 annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this annual 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
annual report (the "Evaluation Date"); and
c) Presented in this annual 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
annual 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: April 17, 2003
/s/ George R. Cupples
- ---------------------
George R. Cupples
Chief Financial Officer
43
EMPIRE FINANCIAL HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
TABLE OF CONTENTS
Report of Independent Certified Public Accountants .................... F-2
Consolidated Statements of Financial Condition
December 31, 2002 and 2001 .......................................... F-3
Consolidated Statements of Operations
Years Ended December 31, 2002, 2001 and 2000 ........................ F-5
Consolidated Statements of Changes in Stockholders' Equity
Years Ended December 31, 2002, 2001 and 2000 ........................ F-6
Consolidated Statements of Cash Flows
Years Ended December 31, 2002, 2001 and 2000 ........................ F-7
Notes to Consolidated Financial Statements ............................ F-9
Schedule II - Valuation and Qualifying Accounts and Reserves .......... F-28
F-1
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of
Empire Financial Holding Company and subsidiaries
We have audited the accompanying consolidated statements of financial condition
of Empire Financial Holding Company and subsidiaries as of December 31, 2002,
and 2001, and the related consolidated statements of operations and
shareholders' equity and cash flows for the years ended December 31, 2002, 2001
and 2000. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audits to obtain reasonable assurance about whether the consolidated
financial statements are free from material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the consolidated financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Empire Financial
Holding Company and subsidiaries at December 31, 2002 and 2001, and the results
of its operations and its cash flows for the years ended December 31, 2002, 2001
and 2000 in conformity with accounting principles generally accepted in the
United States of America.
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed in the Table of
Contents to the Consolidated Financial Statements is presented for purposes of
complying with the Securities and Exchange Commission's rules and is not part of
the basic financial statements. This schedule has been subjected to the auditing
procedures applied in the audits of the basic financial statements and in our
opinion, fairly states in all material respects the financial data required to
be set forth therein in relation to the basic financial statements taken as a
whole.
Sweeney, Gates & Co.
Ft. Lauderdale, Florida
March 25, 2003 except for Note 3
which is as of March 28, 2003
F-2
EMPIRE FINANCIAL HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 2002 AND 2001
2002 2001
---- ----
ASSETS
Cash and cash equivalents ........................ $ 4,146,857 $ 2,327,029
Receivables from customers ....................... 5,772,216 8,774,765
Receivables from brokers and dealers and
clearing organizations ........................ 1,723,621 3,776,626
Deposits at clearing organizations ............... 631,687 535,237
Income taxes receivable .......................... 351,000 -
Property and equipment, net of accumulated
depreciation of $163,962 and
$90,752, respectively .......................... 109,879 111,466
Customer lists, net .............................. 331,390 1,811,777
Other assets ..................................... 427,983 238,516
----------- -----------
Total assets ......................... $13,494,633 $17,575,416
=========== ===========
Continued
The accompanying notes are an integral part of these
consolidated financial statements.
F-3
EMPIRE FINANCIAL HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 2002 AND 2001
2002 2001
---- ----
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Short-term borrowings from bank ................ $ - $ 1,032,000
Accounts payable, accrued expenses
and other liabilities ........................ 3,413,044 2,731,576
Payable to customers ........................... 5,661,667 8,990,457
Payable to brokers and dealers and clearing
Organizations ................................ 472,436 116,152
Due to S corporation stockholders .............. 61,353 -
Contract payable ............................... - 1,735,155
----------- -----------
Total liabilities ........................ 9,608,500 14,605,340
----------- -----------
Stockholders' equity:
Preferred stock, $.01 par value, 1,000,000
shares authorized; none issued and outstanding - -
Common stock, $.01 par value, 100,000,000
shares authorized; 5,000,000 issued and
outstanding in 2002 and 4,000,000 shares
issued and outstanding in 2001 ............... 50,000 40,000
Additional paid-in capital ..................... 8,350,095 500,691
Retained earnings .............................. (3,378,765) 2,429,385
Treasury stock, at cost, 212,200 shares at
December 31, 2002 ............................ (1,135,197) -
----------- -----------
Total stockholders' equity ............... 3,886,133 2,970,076
----------- -----------
Total liabilities and stockholders' equity $13,494,633 $17,575,416
=========== ===========
The accompanying notes are an integral part of these
consolidated financial statements.
F-4
EMPIRE FINANCIAL HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
2002 2001 2000
---- ---- ----
Revenues:
Clearing and order execution trading
revenues, net ................... $ 4,886,933 $ 7,724,244 $14,117,905
Commissions and fees ................ 13,001,503 10,428,857 10,939,186
Order flow .......................... 37,968 52,005 456,184
Interest ............................ 349,732 741,812 2,694,630
Other ............................... 204,572 563,341 234,784
------------ ----------- -----------
18,480,708 19,510,259 28,442,689
Expenses:
Employee compensation and benefits .. 7,934,805 7,545,078 11,541,916
Commissions and clearing costs ...... 6,672,360 4,210,434 3,821,323
Order Flow Payments ................. 1,001,593 2,183,296 3,391,663
Interest ............................ 76,881 582,301 1,130,222
Communications and data processing .. 762,036 527,474 1,242,610
General and administrative .......... 3,426,608 2,629,370 4,183,744
Advertising ......................... 82,019 297,025 533,634
Impairment loss ..................... 1,001,474 - -
------------ ----------- -----------
20,957,776 17,974,978 25,845,112
------------ ----------- -----------
Net income (loss) ....................... $ (2,477,068) $ 1,535,281 $ 2,597,577
============ =========== ===========
Earnings (loss) per share -
basic and diluted ................... ($ 0.54) $ 0.38 $ 0.65
============ =========== ===========
Unaudited pro forma information (Note 4):
Income (loss) before income taxes ... (2,477,068) 1,535,281 2,597,577
Provisions for income taxes ......... - 577,700 977,500
------------ ----------- -----------
Net income (loss) ....................... $ (2,477,068) $ 957,581 $ 1,620,077
============ =========== ===========
Pro forma earnings (loss) per share -
basis and diluted ................... ($ 0.54) $ 0.24 $ 0.41
============ =========== ===========
Weighted average shares outstanding ..... 4,587,494 4,000,000 4,000,000
============ =========== ===========
The accompanying notes are an integral part of these
consolidated financial statements.
F-5
EMPIRE FINANCIAL HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
Common Stock Additional Treasury Stock
-------------------- paid-in Retained -----------------------
Shares Amount capital earnings Shares Amount
--------- -------- ----------- ----------- -------- -----------
Balance at January 1, 2000 ............. 4,000,000 $ 40,000 $ 224,379 $ 2,885,663 -- $ --
Capital contribution ................... -- -- 276,312 -- -- --
Net income ............................. -- -- -- 2,597,577 -- --
Stockholders' distribution ............. -- -- -- (2,646,986) -- --
--------- -------- ----------- ----------- -------- -----------
Balance at December 31, 2000 ........... 4,000,000 40,000 500,691 2,836,254 -- --
Net income ............................. -- -- -- 1,535,281 -- --
Stockholders' distribution ............. -- -- -- (1,942,150) -- --
--------- -------- ----------- ----------- -------- -----------
Balance at December 31, 2001 ........... 4,000,000 40,000 500,691 2,429,385 -- --
Contribution to capital of undistributed
retained earnings from S corporation
termination on April 9, 2002 ........ -- -- 3,331,082 (3,331,082) -- --
Stockholders' distribution ............. -- -- (865,941) -- -- --
Distribution to be paid to S Corporation
stockholders ....................... -- -- (61,353) -- -- --
Issuance of common stock ............... 1,000,000 10,000 5,032,616 -- -- --
Issuance of stock options for services . -- -- 413,000 -- -- --
Purchase of treasury stock ............. -- -- -- -- (212,200) (1,135,197)
Net loss ............................... -- -- -- (2,477,068) -- --
--------- -------- ----------- ----------- -------- -----------
Balance at December 31, 2002 ........... 5,000,000 $ 50,000 $ 8,350,095 $(3,378,765) (212,200) $(1,135,197)
========= ======== =========== =========== ======== ===========
The accompanying notes are an integral part of these
consolidated financial statements.
F-6
EMPIRE FINANCIAL HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
2002 2001 2000
---- ---- ----
Operating activities:
Net income (loss) .................................... $(2,477,068) $ 1,535,281 $ 2,597,577
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation ....................................... 73,210 88,044 124,800
Amortization of customer lists ..................... 690,403 266,438 --
Impairments ........................................ 1,001,474 -- --
Non-cash charge for options issued for services ... 413,000 -- --
Loss on disposal of furniture and equipment ........ -- 45,846 93,634
Non-cash contributions of rental expense ........... -- -- 276,312
Change in assets and liabilities:
Receivable from Customers......................... 3,002,549 3,213,816 3,596,421
Receivable from brokers and dealers and
clearing organizations ......................... 2,053,005 (1,463,127) (95,351)
Deposits at clearing organizations ............... (96,450) 171,908 4,154
Income taxes receivable .......................... (351,000) -- --
Other assets ..................................... (189,465) (104,087) 177,980
Accounts payable, accrued expenses
and other liabilities .......................... 681,468 (171,011) 1,010,049
Payable to customers ............................. (3,328,792) 206,492 (1,985,349)
Payable to brokers and dealers
and clearing organizations ..................... 356,284 (427,208) 199,227
----------- ----------- -----------
Net cash provided by operating activities ........ 1,828,618 3,362,392 5,999,454
----------- ----------- -----------
Investing activities:
Purchases of property and equipment .................. (71,623) (33,045) (190,917)
Purchase of assets ................................... (211,490) (343,060) --
----------- ----------- -----------
Net cash used in investing activities ............ $ (283,113) $ (376,105) $ (190,917)
----------- ----------- -----------
Continued
The accompanying notes are an integral part of these
consolidated financial statements.
F-7
EMPIRE FINANCIAL HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
2002 2001 2000
---- ---- ----
Financing activities:
Issuance of common stock ............................. $ 5,042,616 $ -- $ --
Payments of contracts payable ........................ (1,735,155) -- --
Purchase of treasury stock ........................... (1,135,197) -- --
Payment of short-term borrowings from bank ........... (1,032,000) (1,913,000) (3,038,000)
Stockholder distributions ............................ (865,941) (1,942,150) (2,646,986)
----------- ----------- -----------
Net cash provided by (used in) financing activities 274,323 (3,855,150) (5,684,986)
----------- ----------- -----------
Net increase (decrease) in cash and cash equivalents ... 1,819,828 (868,863) 123,551
Cash and cash equivalents at beginning of year ......... 2,327,029 3,195,892 3,072,341
----------- ----------- -----------
Cash and cash equivalents at end of year ............... $ 4,146,857 $ 2,327,029 $ 3,195,892
=========== =========== ===========
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest ........................................... $ 76,881 $ 526,347 $ 1,130,222
=========== =========== ===========
Income taxes ....................................... $ 351,000 $ -- $ --
=========== =========== ===========
The accompanying notes are an integral part of these
consolidated financial statements.
F-8
EMPIRE FINANCIAL HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
1. NATURE OF BUSINESS
ORGANIZATION AND OPERATIONS - Empire Financial Holding Company (the "Company"),
a Florida corporation, was formed on February 16, 2000 to acquire Empire
Financial Group, Inc. ("Empire Group"), Advantage Trading Group, Inc.
("Advantage") and Empire Investment Advisors, Inc. ("Advisors"). All
subsidiaries are wholly owned and all intercompany transactions and accounts
have been eliminated in consolidation.
Empire Group, incorporated in Florida on August 20, 1990, is a securities broker
dealer, which provides discount brokerage services to retail and institutional
customers. Advantage, incorporated in Florida on July 18, 1995, is a securities
broker dealer, which acts as principal in providing order execution services for
independent broker dealers and also acts as a clearing broker for its affiliate,
Empire Group and other broker dealers. Advisors, incorporated in Florida on
September 10, 1999, is a fee-based investment advisory service, which offers its
services to retail customers. The Company's executive office is located in
Longwood, Florida. The Company operates in two primary business segments, retail
brokerage services (Empire Group and Advisors) and order execution services
(Advantage).
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CASH AND CASH EQUIVALENTS - The Company considers all highly liquid investments
with an initial maturity of three months or less to be cash equivalents for
purposes of the consolidated statement of cash flows.
RECEIVABLES FROM AND PAYABLE TO CUSTOMERS - Accounts receivable from and payable
to customers include amounts due on cash and margin transactions. Securities
owned by customers are held as collateral for receivables.
SECURITIES OWNED AND SECURITIES SOLD, NOT YET PURCHASED - Securities owned,
which are readily marketable, and securities sold, not yet purchased (short
sales), are recorded at market value with unrealized gains or losses reflected
in income. At December 31, 2002 and 2001, the Company had securities owned of
approximately $22,000 and $4,172 respectively. At December 31, 2002 and 2001,
the Company did not have any securities sold, not yet purchased.
PROPERTY AND EQUIPMENT - Property and equipment are recorded at cost. Leasehold
improvements are capitalized, while repair and maintenance costs are charged to
operations as incurred. When assets are retired or disposed of, the cost and
accumulated depreciation thereon are removed from the accounts, and any gains or
losses are included in operations. Leasehold improvements are amortized using
the straight-line method over the lease term. Depreciation and amortization on
furniture and equipment are provided utilizing the straight-line method over the
estimated useful lives of the related assets, which range from five to seven
years. The Company recorded losses on the disposal of property and equipment of
$0, $45,846, and $93,634 for the years ended December 31, 2002, 2001, and 2000,
respectively, which have been recorded in general and administrative expenses in
the consolidated statements of operations.
F-9
EMPIRE FINANCIAL HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
IMPAIRMENT OF LONG-LIVED ASSETS - The Company evaluates the recoverability of
its property and equipment and other assets in accordance with Statement of
Financial Accounting Standards Board No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets" ("SFAS 144"). SFAS 144 requires recognition of
impairment of long-lived assets in the event the net book value of such assets
exceeds the estimated future undiscounted cash flows attributable to such assets
or the business to which such assets relate. SFAS 144 excludes goodwill and
intangible assets. When an asset exceeds its expected cash flows, it is
considered to be impaired and is written down to fair value, which is determined
based on either discounted future cash flows or appraised values. The provisions
of SFAS 144 are effective for financial statements issued for fiscal years
beginning after December 15, 2001. The Company adopted the statement for the
year ending December 31, 2002. No impairments were recognized during the year
ended December 31, 2002.
CUSTOMER LISTS - Purchased customer lists are amortized over the estimated
useful lives of the customers. A significant portion of the customer lists is
amortized over thirty-nine (39) months. Periodically, management tests the
customer lists to determine the viability. If sufficient revenues are not
produced, an impairment is recognized. Additionally, the Company must continue
to periodically review intangible assets. See Footnote 5 for discussion.
SECURITIES TRANSACTIONS - Securities transactions and the related revenues and
expenses are recorded on the trade date.
CLEARING AND ORDER EXECUTION TRADING REVENUES, NET - We provide clearing
services to Empire Financial Group, Inc. and unaffiliated broker dealers. Our
clearing services involve account settlement and delivery functions. Order
execution trading revenues, net, are generated from the difference between the
price paid to buy securities and the amount received from the sale of
securities. Volatility of stock prices, which can result in significant price
fluctuations in short periods of time, may result in trading gains or losses.
The Company typically acts as principal in these transactions and does not
receive a fee or commission for providing order execution services.
COMMISSIONS AND FEES - Commissions and fees include revenues generated from
transactional fees charged to retail and institutional customers. Commissions
and fees also include mutual fund transaction sales commissions and trailer
fees, which are periodic fees paid by mutual funds as an incentive to keep
assets invested with them over time.
ORDER FLOW REBATES - Empire and other brokerages utilize the Company as a
clearing agent. The Company executes the trades and then rebates back to the
brokerage firm for whom they are clearing an agreed upon amount for each trade
in exchange for the flow of orders.
DEFERRED REVENUE - The Company defers commission revenue on annuity contracts
when the issuer has a right to charge back commissions should the annuity owner
surrender the contract. Commission revenue is recorded when charge back
provisions expire.
ADVERTISING - Advertising costs are expensed as incurred.
F-10
EMPIRE FINANCIAL HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
INCOME TAXES - The Company, Empire Group, Advantage and Advisors, each, with the
consent of their shareholders, elected to be "S" Corporations under the Internal
Revenue Code until April 9, 2002, at which time the Company completed its public
offering and terminated its' S corporation election. Until that date, all
taxable income or loss flowed through to the stockholders. Accordingly, no
income tax expense or liability is recorded in the accompanying financial
statements to April 9, 2002. The pro forma adjustments shown in the consolidated
statements of operations reflect provisions for income taxes computed based upon
statutory tax rates as if the Company had been subject to federal and state
taxation during 2001 and 2000.
After April 9, 2002, the Company accounts for income taxes according to
Statement of Financial Accounting Standard No. 109, "Accounting for Income
Taxes", which requires an asset and liability approach to financial accounting
and reporting for income taxes. Deferred income tax assets and liabilities are
computed annually for differences between the financial and tax basis of assets
and liabilities that will result in taxable or deductible amounts in the future,
based on enacted tax laws and rates applicable to the periods in which the
differences are expected to affect taxable income. A valuation allowance is
recognized if, based on the weight of available evidence, it is more likely than
not that some portion or all of the deferred asset will not be realized. Income
tax expense is the tax payable or refundable for the period, plus or minus the
change during the period in deferred tax assets and liabilities.
MANAGEMENT ESTIMATES AND ASSUMPTIONS - The preparation of financial statements
in conformity with accounting principles generally accepted in the United States
of America requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period. Actual results could
differ from those estimates.
FAIR VALUE OF FINANCIAL INSTRUMENTS - The financial instruments of the Company
are reported in the accompanying consolidated statement of financial condition
at their carrying values, which approximate their fair values due to their
short-term nature.
EARNINGS PER SHARE - Basic earnings per share is computed by dividing income
(loss) available to common stockholders by the weighted-average number of common
shares outstanding for the period. Diluted earnings per share considers the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised or resulted in the issuance of common stock. Options
totaling 648,100 shares for the year ended December 31, 2002, were not included
in the computation of net loss per share because the effect of inclusion would
be anti-dilutive.
SEGMENT REPORTING - The Company reports its segment information according to
Statement of Financial Accounting Standards Board No. 131, "Disclosures about
Segments of an Enterprise and Related Information" ("SFAS 131"). The segments
are reported based on management's approach for making operating decisions and
addressing performance.
RECLASSIFICATIONS - Certain amounts in 2001 have been reclassified to conform to
the 2002 presentation.
F-11
EMPIRE FINANCIAL HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
RECENT ACCOUNTING PRONOUNCEMENTS -
In June 2001, the FASB issued Statement of Financial Accounting Standards No.
143, " Accounting for Asset Retirement Obligations" ("SFAS No. 143") which
establishes standards of accounting for asset retirement obligations arising
from the acquisition, construction, or development and/or the normal operation
of a long-lived asset. SFAS is effective for fiscal years beginning after June
15, 2002. The Company will adopt SFAS 143 on January 1, 2003.
In April of 2002, Statement of Financial Accounting Standards No. 145 ("SFAS
145") was issued, which rescinded SFAS Statements No. 4, 44 and 64, amended No.
13 and contained technical corrections. As a result of SFAS 145, gains and
losses from extinguishments of debt will be classified as extraordinary items
only if they meet the criteria in APB Opinion No. 30, that they are unusual and
infrequent and not part of an entity's recurring operations. The Company will
adopt SFAS 145 on January 1, 2003.
In July 2002, the FASB issued SFAS 146, which addresses significant issues
regarding the recognition, measurement, and reporting of costs that are
associated with exit and disposal activities, including restructuring activities
that are currently accounted for pursuant to the guidance that the Emerging
Issues Task Force ("EITF") has set forth in EITF Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (Including Certain Costs Incurred in a Restructuring)". SFAS 146
revises the accounting for certain lease termination costs and employee
termination benefits, which are generally recognized in connection with
restructuring charges. The provisions of SFAS 146 are effective for exit or
disposal activities that are initiated after December 31, 2002. The Company has
not determined what impact, if any, will occur once SFAS 146 is adopted on
January 1, 2003.
In November 2002, the FASB issued Interpretation No. 45 ("FIN 45"), "Guarantor's
Accounting and Disclosure Requirements for Guarantee, Including Indirect
Guarantees of Indebtedness of Others", which addresses the disclosures to be
made by a guarantor in its interim and annual financial statements about its
obligations under guarantees. FIN 45 also requires the recognition of a
liability by a guarantor at the inception of certain guarantees that are entered
into or modified after December 31, 2002.
3. SUBSEQUENT EVENTS AND MANAGEMENT'S PLAN
As shown on the accompanying financial statements, the Company incurred a net
loss of $2,477,068 for the year ended December 31, 2002. Management believes it
has sufficient liquidity and cash resources to sustain the operations of the
Company for the next twelve months. Also, the Company's co-chairmen of the board
and co-CEOs have had management and administrative disputes which may have
adversely affected the Company's business, operations and results of operations.
In response to these losses and disputes, management and the board of directors
have developed a plan to effectuate the return of the Company to profitability
and to resolve any future management and administrative disputes and have
entered into a non-binding letter of intent to distribute the stock of Advantage
to the stockholders of the Company, which would result in splitting the
Company's business segments (retail brokerage and order execution services). See
note 16 for business segment information.
F-12
EMPIRE FINANCIAL HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
3. SUBSEQUENT EVENTS AND MANAGEMENT'S PLAN (CONTINUED)
Management and the board of directors have taken, and intend to take, such
actions as may be necessary, including the reduction of costs, so that the
Company will return to profitability. In addition, on March 28, 2003, (a) the
board of directors established two separate board committees to operate each of
the Company's wholly owned subsidiaries and (b) the Company executed a
non-binding letter of intent that provided for the execution of a definitive
agreement which would provide for, no later than June 30, 2003, among other
things: (1) the distribution of all of the common stock of Advantage to holders
of the Company's common stock; (2) the registration of Advantage's common stock
with the Securities and Exchange Commission; (3) the resignation by one of the
Company's co-chairmen of the board and co-chief executive officers from all
offices held in the Company, Empire Group and Advisors, and resignation by the
other of all offices held in Advantage; and (4) mutual releases of any claims
among the parties. In addition, the definitive agreement would provide that
within 90 days of the distribution of Advantage's common stock, the Company's
co-chairmen and co-chief executive officers will sell or exchange with each
other all shares held by one in the Company for all shares held by the other in
Advantage. There is no assurance that the definitive agreement will be executed
or the distribution of Advantage common stock described above will be
consummated and, therefore, the accompanying financial statements do not reflect
the affect of this distribution.
Notwithstanding the actions described above, any disputes between the
co-chairmen of the board and co-CEO's that are not resolved in a timely manner
may materially adversely affect the operations and financial condition of the
Company and affect the ability of the Company to regain profitability.
There is also no assurance that management's business plan will be successful or
that the Company will achieve profitability. The financial statements do not
include any adjustments that might result from the outcome of these
uncertainties.
4. PRO FORMA INFORMATION
The Company's and its subsidiaries S corporations election automatically
terminated on April 9, 2002, with the completion of its public offering. Prior
to that date, Empire Group, Advantage and Advisors, individually, with the
consent of their stockholders, elected to be taxed as S corporations, which
provide for taxable income of the respective companies to be included in the
income tax returns of the individual stockholders. The pro forma adjustments
shown in the consolidated statements of operation reflect provisions for income
taxes computed based on statutory tax rates as if the Company had been subject
to federal and state taxation during the periods presented.
F-13
EMPIRE FINANCIAL HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
5. ACQUISITION OF CUSTOMER LISTS AND IMPAIRMENT
On July 23, 2001, the Company acquired certain assets and assumed certain
liabilities of Centennial Capital Management, Inc. ("Centennial"). Centennial
was a securities broker dealer that provided a diversified range of retail
brokerage services through independent registered representatives. The
transaction has been accounted for as a purchase effective as of August 1, 2001.
The purchase price of $1,735,155 was based on the revenues of the former
Centennial representatives for the three months ended December 31, 2001, and was
reduced by the amount of assumed liabilities. The allocation of the purchase
price is as follows:
Cash ................................ $ 25,000
Receivable from clearing organization 22,571
Customer lists ...................... 2,078,214
-----------
2,125,785
Total liabilities assumed ......... (390,630)
-----------
Net assets acquired ................. $ 1,735,155
===========
The revenue, net income and identifiable assets have been assigned to the retail
brokerage services segment for segment information purposes.
Since the acquisition did not meet the conditions of a significant acquisition
at the 20% or greater threshold, pro forma information has not been provided.
The customer list is being amortized at the projected average life of a
registered representative and customers, which is estimated by the Company to be
3.3 years. In December of 2002, as a result of far lower revenues than
anticipated and lower expected future cash flows, the Company determined that a
partial impairment of the customer lists was required. Therefore, an impairment
charge of $965,358 was recorded.
During the year ended December 31, 2002, the Company purchased two customer
lists and registered representative relationships for $144,464. The
consideration for both acquisitions was based on percentages of gross revenues
generated or received by the Company. Revenues generated during the year ended
December 31, 2002 were less than anticipated and therefore, the Company recorded
impairment charges totaling $36,116.
F-14
EMPIRE FINANCIAL HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
5. ACQUISITION OF CUSTOMER LISTS AND IMPAIRMENT OF INTANGIBLE ASSETS
(CONTINUED)
At December 31, 2002, customer lists consisted of the following:
Customer lists at cost ......... $ 2,356,731
Less accumulated amortization (1,023,867)
Less impairment charges ..... (1,001,474)
-----------
$ 331,390
===========
Amortization for the year ending December 31, 2002 was $690,403. Estimated
amortization expense for the years ended December 31, 2003 and 2004 is
approximately $166,000.
6. CLEARING AGREEMENTS
In connection with its retail brokerage services business, the Company has
clearing agreements with three unaffiliated firms. Under such agreements, the
clearing brokers provide the Company execution and clearing services on a fully
disclosed basis. In order to facilitate transactions with the unaffiliated
clearing brokers, the Company maintained deposits of approximately $121,000 and
$125,000 at December 31, 2002 and 2001, respectively, at the three unaffiliated
firms. The deposits are included in deposits at clearing organizations in the
consolidated statements of financial condition.
7. RECEIVABLE FROM AND PAYABLE TO CUSTOMERS
Receivable from and payable to customers arise from cash and margin transactions
executed by the Company on the customers' behalf. Receivables are collateralized
by securities owned by customers with an estimated fair value of $6,697,000 and
$9,121,000 at December 31, 2002 and 2001, respectively. Such collateral is not
reflected in the accompanying consolidated statements of financial condition.
F-15
EMPIRE FINANCIAL HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
8. RECEIVABLE FROM AND PAYABLE TO BROKERS AND DEALERS AND CLEARING
ORGANIZATIONS
Amounts receivable from and payable to brokers and dealers and clearing
organizations consisted of the following at December 31, 2002 and 2001:
2002 2001
---- ----
Receivable:
Securities failed to deliver ............. $ 62,197 $ 258,810
Deposits on securities borrowed .......... 928,800 1,358,100
Other amounts due from brokers and dealers 732,624 2,159,716
---------- ----------
$1,723,621 $3,776,626
========== ==========
Payable:
Securities failed to received ............ $ 207,257 $ 10,414
Payable to clearing organizations ........ 139,874 18,749
Order flow payable ....................... 40,416 86,989
Correspondent payable .................... 51,498 -
Settlement payable ....................... 33,391
---------- ----------
$ 472,436 $ 116,152
========== ==========
Deposits on securities borrowed represent cash on deposit with other brokers and
dealers relating to securities borrowed. If these deposits are not returned, the
Company could sustain a loss if the market value of the securities borrowed
declines.
9. ACCOUNTS PAYABLE, ACCRUED EXPENSES AND OTHER LIABILITIES
At December 31, 2002 and 2001, accounts payable, accrued expenses and other
liabilities consisted of the following:
2002 2001
---- ----
Accounts payable .... $ 479,596 $ 440,054
Cash overdrafts ..... 1,092,139 835,053
Accrued payroll ..... 534,765 467,645
Accrued payroll taxes 30,677 41,240
Accrued rent ........ 150,454 276,312
Other accrued expenses 606,176 171,272
Deferred revenue .... 519,237 500,000
---------- ----------
$3,413,044 $2,731,576
========== ==========
F-16
EMPIRE FINANCIAL HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
10. SHORT-TERM BORROWINGS FROM BANKS AND CASH OVERDRAFT
The Company maintains three lines of credit totaling $25,000,000 with a
commercial bank collateralized by customer margin account securities and Company
owned securities. Borrowings under the lines of credit bear interest at the
bank's prime rate on commercial loans plus 2%. Loan amounts are restricted to a
percentage of the market value of the related customer margin accounts or firm
collateral securities, as applicable. The term of the current agreements expire
on May 31, 2003, but are subject to termination at any time at the bank's
discretion. The average interest rates on the lines of credit were approximately
2.75% and 5.0% during the years ended December 31, 2002 and 2001, respectively.
At December 31, 2002, 2001, the Company pledged approximately $ 0 and $4,036,000
respectively, of non-fully or partially paid customer securities against the
outstanding line of credit balances of $0 and $1,032,000 respectively.
Additionally, at December 31, 2002 and 2001, the Company had cash overdrafts of
approximately $ 1,092,000 and $579,000 due to the same bank. At December 31,
2001, the Company had a cash overdraft of approximately $256,000 due to another
bank. The cash overdrafts are recorded in accounts payable on the statements of
financial condition.
11. EQUITY
On April 9, 2002, the Company sold 1,000,000 shares of common stock for
$6,000,000. The total expenses incurred by the Company relating to the offering
were $957,384, including underwriting commissions and other expenses. The net
amount to the Company after deducting the total expenses incurred in the
offering was $5,042,616. As of the date of the offering, the Company and its
subsidiaries terminated their S corporation status and the Company will be taxed
thereafter as a C corporation. The stockholders contributed all the retained
earnings through April 9, 2002 totaling $3,331,082 to additional paid-in
capital. The Company distributed $865,941 to the stockholders for the payment of
individual income taxes while the Company was an S corporation. The Company
accrued estimated payments to the stockholders for income taxes for 2002 in the
approximate amount of $60,000.
During April 2002 and November 2002, the Company repurchased 212,200 shares of
its common stock. The total cost of the stock repurchased was $1,135,197 and is
included as treasury stock on the accompanying financial statements.
During March 2000, the Company adopted the 2000 Incentive Compensation Plan (the
"Plan"). The Plan is designed to serve as an incentive for retaining directors,
employees, consultants and advisors. Stock options, stock appreciation rights
and restricted stock options may be granted to certain persons in proportion to
their contribution the overall success of the Company as determined by the board
of directors or a committee thereof. Effective April 9, 2002, the Company
granted 677,950 options for common stock, including 87,500 granted to
consultants. All options, except for 200,000, vest over five years and expire in
ten years from the date of grant. The 200,000 options vest immediately but only
100,000 can be sold within the first year.
F-17
EMPIRE FINANCIAL HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
11. EQUITY (CONTINUED)
The following table summarizes stock options at December 31, 2002:
Outstanding Stock Options Exercisable Stock Options
-------------------------------------------------------- ------------------------------------
Weighted Weighted
Average Weighted Average Weighted-
Remaining Average Remaining average
Exercise Contractual Exercise Contractual exercise
Price range Shares Life Price Shares Life price
----------- ------ ---- ----- ------ ---- -----
$ 6.00 648,100 9.28 $ 6.00 100,000 9.28 $ 6.00
The following table summarizes stock option activity for the year ended December
31, 2002:
Weighted
Average
Exercise
Shares Price
------ -----
Outstanding at beginning of year - $ 0.00
Granted 677,950 6.00
Exercised - 0.00
Cancelled (29,850) 6.00
-----------
Outstanding at end of year 648,100 $ 6.00
===========
Exercisable at end of year 100,000
===========
Weighted average fair value of
Options granted during the year $ 4.72
-----------
The Company accounts for stock options using SFAS No. 123, "Accounting for
Stock-Based Compensation." As permitted by SFAS No. 123, the Company has chosen
to apply APB Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25)
and related interpretations in accounting for its Plan. Accordingly, no
compensation cost has been recognized for employee options granted under the
Plan.
F-18
EMPIRE FINANCIAL HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
11. EQUITY (CONTINUED)
As required by SFAS 123, pro forma disclosures regarding net income (loss) and
earnings (loss) per share must be computed as if the Company had accounted for
its employee stock options under the fair value method. The fair value for these
options was estimated at the date of grant using the Black-Scholes
option-pricing model with the following assumptions used for grants in 2002:
For the year ended
December 31, 2002
-----------------
Risk free interest rate 5.22%
Expected lives 10
Expected volatility 92.00%
Expected dividend yield -
The Company's pro forma information under SFAS 123 for the years ended December
31, 2002 were as follows:
As Pro
Reported Forma
-------- -----
Net loss $ (2,477,068) $ (5,215,573)
============== ==============
Net loss per share - basic
and diluted $ (.54) $ (1.14)
============== ==============
On April 9, 2002, the Company issued 87,500 options to consultants and charged
operations for the fair value of the options in the amount of $413,000, using
the Black Scholes Option Model using the same assumptions as above. Since
operations were charged for these options, the pro forma information above does
not duplicate these options.
12. INCOME TAXES
The Company was taxed as an S Corporation until April 9, 2002. On this date, the
Company terminated its S election and, thereafter is taxed as a C corporation.
F-19
EMPIRE FINANCIAL HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
12. INCOME TAXES (CONTINUED)
The tax effects generated after the Company became a C corporation, consisting
of temporary differences and net operating loss carryforwards, which create
deferred tax assets as of December 31, 2002, are as follows:
Intangible assets ...... $ 575,000
Deferred revenue ....... 195,000
Net operating losses ... 200,000
------------
970,000
Less valuation allowance (970,000)
------------
Net deferred tax asset . $ --
============
Deferred taxes are recognized for temporary differences between the basis of
assets and liabilities for financial statement and income tax purposes. The
difference relates primarily to net operating losses, intangible assets (use of
different lives for tax and financial purposes) and deferred revenue (taxable
for tax and not recognized as revenue for financial purposes). A valuation
allowance has been recorded due to the uncertainty of realizing the net deferred
tax asset.
The Company had available at December 31, 2002, a net operating loss
carryforward for federal and state tax purposes of approximately $500,000 that
could be applied against taxable income in subsequent years through December 31,
2022. The tax effect of the net operating loss is approximately $200,000.
Reconciliation of the differences between income tax benefit computed at the
federal and state statutory tax rates and the provision for income tax benefit
for the years ended December 31, 2002 was as follows:
Income tax loss at federal statutory tax rate (34.00)%
State taxes, net of federal benefit ......... (3.63)%
Valuation allowance 37.63%
------
Provision for income taxes .................. --%
------
F-20
EMPIRE FINANCIAL HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
13. COMMITMENTS AND CONTINGENCIES
RELATED PARTY COMMITMENTS
In November 1999, the Company entered into a lease agreement for operating
facilities with a corporation owned by the two controlling stockholders of the
Company. The lease contains escalating rental payments and expires in May 2009.
Rental expense is reflected on a straight-line basis over the term of the lease.
During the year ended December 31, 2001, the stockholders deferred payment of
rent, and for the year ended December 2000, the stockholders waived payment of
rent by the Company. For the year ended December 31, 2000, $276,312 was recorded
as contributed to capital. During the year ended December 31, 2002, the Company
overpaid the rent in the amount of $25,668. This amount is recorded as prepaid
rent and will be utilized to offset rent payments in 2003.
At December 31, 2002, future minimum annual lease payments for the next five
years, all of which relate to the operating facilities lease, were as follows:
2003 $ 263,868
2004 277,062
2005 290,918
2006 305,460
2007 320,726
OTHER COMMITMENTS AND CONTINGENCIES
The Company has entered into employment agreements (the "Agreements") with the
co-chief executive officers of the Company. The terms of the Agreements
commenced on April 9, 2002, the date the initial public offering was completed,
and extend through December 31, 2005, unless cancelled earlier as provided for
in the Agreements. The Agreements provide a base salary of $375,000 for each
co-chief executive officer, plus bonuses and incentive compensation to be
decided at the discretion of the board of directors. The Agreements
automatically extend for a period of one additional year commencing January 3,
2003, and each year thereafter, unless written notice is delivered by either of
the co-chief executive officers or the Company terminating the Agreement(s) by
giving one hundred eighty (180) days notice of termination prior to January 1 of
any year. The minimum amount to be paid to both of the co-chief executive
officers under the Agreements in any full year is $750,000.
F-21
EMPIRE FINANCIAL HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
13. COMMITMENTS AND CONTINGENCIES (continued)
The Company entered into an employment agreement (the "Agreement") with Donald
Wojnowski Jr., the vice president of development of the Company on December 27,
2000. Mr. Wojnowski resigned in February 2003 as Vice President, Business
Development, but continues to serve as an employee of the Company.
Except for the Company's Atlanta office, the Company does not have lease
agreements for its branch offices. The rent for the branch offices is paid by
the independent registered representatives located in those offices. The
Company's Atlanta office lease expires on August 31, 2004.
At December 31, 2002, future minimum annual rental payments for the Atlanta
office were as follows:
2003 14,479
2004 9,875
-------
$24,354
-------
The Company is a defendant or co-defendant in various lawsuits incidental to its
retail brokerage services business. The Company is contesting the allegations of
the complaints in these cases. In view of the number and diversity of claims
against the Company, the number of jurisdictions in which litigation is pending
and the inherent difficulty of predicting the outcome of litigation and other
claims, management cannot state with certainty the eventual outcome of pending
litigation or other claims. In the opinion of management, based on discussions
with legal counsel, the outcome of the matters will not result in a material
adverse effect on the financial position or results of operations of the
Company.
14. NET CAPITAL AND RESERVE REQUIREMENTS
The broker dealer subsidiaries of the Company are subject to the Securities and
Exchange Commission Uniform Net Capital Rule 15c3-1 and the requirements of the
securities exchanges of which they are members. This rule requires that
aggregate indebtedness, as defined, not exceed 15 times net capital, as defined.
Rule 15c3-1 also provides for an alternative net capital requirement which, if
elected, requires that net capital be equal to the greater of $250,000 or 2% of
aggregate debit items computed in applying the formula for determination of
reserve requirements. Advantage elected to use the alternative net capital
calculation for the years ended December 31, 2002 and 2001.
The Company is subject to SEC Uniform Net Capital Rule 15c3-1, which requires
the maintenance of minimum net capital equal to $250,000 and requires that the
ratio of aggregate indebtedness to net capital, both as defined, shall not
exceed 15 to 1. Net capital and the related ratio of aggregate indebtedness to
net capital, as defined, may fluctuate on a daily basis. At December 31, 2002,
the Company had net capital of $476,235, which was $226,235 in excess of its
required net capital of $250,000. The Company's ratio of aggregate indebtedness
to net capital was 4.01 to 1. The Company claims exemption from Rule 15c3-3
under Paragraph (k)(2)(ii) of the Rule as all customer transactions are cleared
through other broker-dealers on a fully disclosed basis.
F-22
EMPIRE FINANCIAL HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
14. NET CAPITAL AND RESERVE REQUIREMENTS (continued)
Net capital positions of the Company's broker dealer subsidiaries were as
follows at December 31, 2002 and 2001:
2002 2001
---- ----
Advantage Trading Group:
Net capital as a percentage of aggregate
Debit items ................................ 30.00% 16.00%
Net capital .................................. $2,460,080 $1,798,877
Required net capital ......................... $ 250,000 $ 250,000
Empire Group
Ratio of aggregate indebtedness to net capital 4.01 to 1 4.90 to 1
Net capital .................................. $ 476,235 $ 330,491
Required net capital ......................... $ 250,000 $ 250,000
Advantage is also subject to Rule 15c3-3 under the Securities Exchange Act of
1934, which specifies certain conditions under which brokers and dealers
carrying customer accounts are required to maintain cash or qualified securities
in a special reserve bank account for the exclusive benefit of customers.
Amounts to be maintained, if required, are computed in accordance with a formula
defined in the Rule. At December 31, 2002 and 2001, Advantage was not required
to maintain cash or securities in a special reserve account. However, Advantage
had on deposit in the special reserve account approximately $419,132 and
$478,000 at December 31, 2002 and 2001, respectively.
Empire Group is exempt from the provisions of Rule 15c3-3 under Paragraph
(k)(2)(ii) of the Rule as it clears all transactions with and for customers on a
fully disclosed basis with affiliated and unaffiliated clearing brokers.
15. OFF-BALANCE SHEET RISK
In the normal course of business, the Company purchases and sells securities as
principal for its own account and on behalf of its customers. If either the
customer or a broker dealer fails to perform, the Company could be required to
discharge the obligations of the non-performing party. In these circumstances,
the Company could sustain a loss of the market value if the security contract is
different from the contract value of the transaction.
In addition, the Company may sell securities it does not own and will,
therefore, be obligated to purchase such securities at a future date and may
incur a loss if the market value of the securities increases subsequent to the
date of sale. At December 31, 2002 and 2001, the Company had sold no securities
that it did not own.
F-23
EMPIRE FINANCIAL HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
15. OFF-BALANCE SHEET RISK (CONTINUED)
In the normal course of business, the Company's customer clearance activities
involve the execution, settlement, and financing of various customer securities
transactions. These activities may expose the Company to off-balance sheet risk
in the event the customer or other broker is unable to fulfill its contracted
obligations and the Company has to purchase or sell the financial instrument
underlying the contract at a loss.
The Company's customer securities activities are transacted on either a cash or
margin basis. In margin transactions, the Company extends credit to its
customers, subject to various regulatory and internal margin requirements,
collateralized by cash and securities in the customers' accounts. In connection
with these activities, the Company executes and clears customer transactions
involving the sale of securities not yet purchased, substantially all of which
are transacted on a margin basis subject to individual exchange regulations.
Such transactions may expose the Company to significant off-balance sheet risk
in the event margin requirements are not sufficient to fully cover losses that
customers may incur. In the event the customer fails to satisfy its obligations,
the Company may be required to purchase or sell financial instruments at
prevailing market prices to fulfill customer's obligations. The Company seeks to
control the risks associated with its customer activities by requiring customers
to maintain margin collateral in compliance with various regulatory and internal
guidelines. The Company monitors margin levels daily and requires the customer
to deposit additional collateral pursuant to such guidelines or to reduce
positions.
The Company's customer financing and securities settlement activities require
the Company to pledge customer securities as collateral in support of various
secured financing sources such as bank loans and securities loaned. In the event
other parties are unable to meet contractual obligations to return customer
securities pledged as collateral, the Company may be exposed to the risk of
acquiring the securities at prevailing market prices in order to satisfy its
customer obligations. The Company controls this risk by monitoring the market
value of securities pledged on a daily basis and by requiring adjustments of
collateral levels in the event of excess market exposure. In addition, the
Company establishes credit limits for such activities and monitors compliance on
a daily basis.
16. FINANCIAL INFORMATION BY BUSINESS SEGMENT
The Company operates in two primary business segments - retail brokerage
services and order execution services. Retail brokerage services (including sale
of equities, mutual funds and fixed income products) are provided on a discount
basis to retail and institutional customers through online trading or through
the branches of Empire Group. Retail brokerage services also include services
provided through Advisors. Order execution services are conducted through
Advantage, which fills orders to purchase or sell securities received from
independent broker dealers on behalf of their retail customers. Advantage
typically acts as principal in these transactions and derives order execution
trading revenues, net, from the difference between the price paid when a
security is bought and the price received when that security is sold. Advantage
does not typically receive a fee or commission for providing order execution
services. Advantage normally closes out of its trade positions at the end of
each day and does not maintain securities inventory in order to reduce the risks
from market volatility. Advantage also clears securities transactions for its
own account and for its affiliate, Empire Group plus other unaffiliated broker
dealers. The expenses of the Company and its identifiable assets are carried as
corporate in the segment information.
F-24
EMPIRE FINANCIAL HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
16. FINANCIAL INFORMATION BY BUSINESS SEGMENT (continued)
The accounting policies of the Company's segments are the same as those
described in the "Nature of Business and Summary of Significant Accounting
Policies." All of the Company's financial transactions are transacted in the
United States, and all long-lived assets are located in the United States.
Information concerning operations in these segments of business is as follows at
December 31, 2002. 2001 and 2000:
2002 2001 2000
---- ---- ----
Revenue:
Clearing and order execution
services ................... $ 8,316,913 $ 9,438,659 $ 16,492,993
Retail brokerage services .... 13,841,355 10,587,008 13,014,486
Eliminations ................. (3,677,560) (515,408) (1,064,790)
------------ ------------ ------------
$ 18,480,708 $ 19,510,259 $ 28,442,689
============ ============ ============
Net Income (loss):
Clearing and order execution
services ................... $ (981,344) $ 990,191 $ 1,368,385
Retail brokerage services .... (1,261,139) 811,528 1,229,192
Corporate .................... (234,585) (266,438)
------------ ------------ ------------
$ (2,477,068) $ 1,535,281 $ 2,597,577
============ ============ ============
Identifiable assets:
Clearing and order execution
services ................... $ 10,657,069 $ 14,049,396 $ 16,506,832
Retail brokerage services .... 2,961,433 2,539,131 2,045,025
Corporate .................... 7,115,750 - -
Eliminations ................. (7,239,619) 986,889 -
------------ ------------ ------------
$ 13,494,633 $ 17,575,416 $ 18,551,857
============ ============ ============
Eliminations represent revenues, investments in subsidiaries, receivables and
payables from intercompany transactions. Most intercompany transactions are the
result of clearing operations between Empire Group and Advantage. Certain
amounts in 2001 have been reclassified to conform to the 2002 presentation.
F-25
EMPIRE FINANCIAL HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
17. SELECTED QUARTERLY DATA
2002
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Net sales ....................... $5,450,590 $ 4,604,827 $ 4,550,434 $ 3,874,857
Income (loss) before income taxes 901,698 (405,738) (455,043) (2,517,985)
Provision for income taxes ...... - - - -
---------- ----------- ----------- -----------
Net Income (loss) ............... $ 901,698 $ (405,738) $ (455,043) $(2,517,985)
========== =========== =========== ===========
Basic and diluted earnings (loss)
per share .................... $ 0.23 $ (.09) $ (.09) $ (0.59)
========== =========== =========== ===========
Unaudited pro forma
Information:
Income (loss) before taxes $ 901,698 $ (405,738)
Provision for income taxes 340,000 (153,000)
---------- -----------
Net income (loss) ............ $ 561,698 $ (252,738)
========== ===========
Pro forma earnings (loss) per
share - basic and diluted .... $ 0.14 $ (.05)
========== ===========
Weighted average shares
Outstanding .................. 4,000,000 4,740,112 4,802,800 4,795,952
========== =========== =========== ===========
F-26
EMPIRE FINANCIAL HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
17. SELECTED QUARTERLY DATA
2001
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Net sales ....................... $6,932,845 $ 4,093,220 $ 4,167,075 $ 4,317,119
Income (loss) before income taxes 904,915 (28,730) 296,525 362,571
Provision for income taxes ...... $ - - - -
---------- ----------- ----------- -----------
Net Income (loss) ............... $ 904,915 $ (28,730) $ 296,525 $ 362,571
========== =========== =========== ===========
Basic and diluted earnings (loss)
per share .................... $ 0.23 $ 0.00 $ 0.07 $ 0.08
========== =========== =========== ===========
Unaudited pro forma
Information:
Income (loss) before taxes $ 904,915 $ (28,730) $ 296,525 $ 362,571
Provision for income taxes (341,000) 11,000 (111,615) (136,085)
---------- ----------- ----------- -----------
Net income (loss) ............ $ 563,915 $ (17,730) $ 184,910 $ 226,486
========== =========== =========== ===========
Pro forma earnings (loss) per
share - basic and diluted .... $ 0.14 $ 0.00 $ 0.05 $ 0.05
========== =========== =========== ===========
Weighted average shares
Outstanding .................. 4,000,000 4,000,000 4,000,000 4,000,000
========== =========== =========== ===========
In the fourth quarter of 2002, the Company recorded an impairment charge of
$1,001,500, see Note 5. In the second quarter of 2002, the Company recorded a
$413,000 charge for options issued to consultants.
EMPIRE FINANCIAL HOLDING COMPANY AND SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFYING
ACCOUNTS AND RESERVES
Balance at Additions Charges Additions Deductions for
Beginning of to Costs and Charged to payments or Balance at End
Period Expenses Other Accounts Write-offs of Period
------ -------- -------------- ---------- ------
Year ended
December 31, 2002:
Allowance for impairment
of intangible assets $ -- $ 1,001,474 $ -- $ -- $ 1,001,474
====== =========== ===== ===== ===========
The deferred income tax valuation has been omitted because such information is
disclosed in note 12 to the consolidated financial statements.
F-27