NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
The following condensed consolidated financial statements as of September 30, 2012 have not been audited, and the condensed consolidated financial statements as of December 31, 2011 have been derived from audited consolidated financial statements. These financial statements have been prepared by Southern Trust Securities Holding Corp. and Subsidiaries (collectively, the “Company”) in accordance with accounting principles generally accepted in the Unites States (“GAAP”) for interim financial information and the instructions to the quarterly report on Form 10-Q and Rule 8-03 of Regulation S-X. We are providing herein the consolidated interim statements of financial condition of Southern Trust Securities Holding Corp. and Subsidiaries (collectively the "Company") as of September 30, 2012 and December 31, 2011, and the related consolidated interim statements of operations and comprehensive income (loss) for the three and nine months ended September 30, 2012 and 2011, cash flows for nine months ended September 30, 2012 and 2011 and the consolidated interim statements of changes in stockholders equity and comprehensive income (loss) for the nine months ended September 30, 2012. Certain information and footnote disclosures normally included in the financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. The consolidated interim financial statements should be read in conjunction with the Company's audited Consolidated Financial Statements and related notes contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2011 as filed with the SEC.
The information furnished in this report reflects all adjustments consisting of only normal recurring adjustments, which are in the opinion of management necessary for a fair presentation of the results for the interim periods. The results of operations for the nine months ended September 30, 2012 are not necessarily indicative of results that may be expected for the fiscal year ending December 31, 2012
Southern Trust Securities Holding Corp. (the "Holding Corp.”) owns Southern Trust Securities, Inc. ("STS"), Southern Trust Metals, Inc. (“STM”), Southern Trust Securities Asset Management, Inc. ("STSAM"), and Loreley Overseas Corporation (“LOR”). Additionally, on October 23, 2006, the Company formed Kiernan Investment Corp. (“KIC”) as an international business company in Belize. KIC has had very limited operations since inception.
The Holding Corp. contributed $105,653 in cash to form a new company, IPWM, España S.A. ("IPWM Spain") under a partnership agreement with a Swiss Financial Group, International Private Wealth Management, SA (“IPWM, SA”), in exchange for a 50.01% interest and control of the newly created company. During July 2008, IPWM Spain commenced operations and opened offices in the cities of Barcelona, Spain, San Sebastian, Spain and Marbella, Spain. IPWM Spain had limited operations for the nine months ended September 30, 2012 and the year ended December 31, 2011.
The Holding Corp. is a Florida corporation and was organized on January 14, 1998. STS, a Florida corporation, was organized on June 10, 1999 and is registered as an introducing broker/dealer with the Securities and Exchange Commission (“SEC”). STS is a member of the Financial Industry Regulatory Authority (“FINRA”) and National Futures Association (“NFA”). STS operates as an introducing broker clearing customer trades on a fully disclosed basis through clearing firms. Under this basis, it forwards all customers transactions to another broker who carries all customers’ accounts and maintains and preserves books and records. Pershing, LLC currently performs certain of the transaction clearing functions and related services for STS. STSAM, a Florida corporation formed on November 22, 2005, is a fee-based investment advisory company which offers its services to retail customers. STM, a Florida corporation was formed on October 29, 2009, to capitalize on investor interest in the trading of precious metals such as gold, silver, platinum, and palladium. LOR, a British Virgin Islands corporation, was formed on May 19, 2004, and acts as an international intermediary for STM’s international trading transactions; the corporation had been inactive until 2010.
SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
|
3.
|
Summary of significant accounting policies
|
Basis of Presentation and Principles of Consolidation
The consolidated interim financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”).
The accompanying consolidated interim financial statements include the accounts of the Holding Corp. and its wholly-owned subsidiaries, STS, STM, STSAM, LOR, and KIC. IPWM Spain’s assets and liabilities are consolidated with those of the Company and the outside investor’s 49.99% interest in IPWM Spain is included in the accompanying consolidated interim financial statements as a noncontrolling interest. All intercompany balances and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of consolidated interim financial statements in conformity with GAAP requires management to make estimates and assumptions that affect certain reported amounts of assets and liabilities at the date of the consolidated interim financial statements, as well as their related disclosures. Such estimates and assumptions also affect the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
The Company considers short-term interest bearing investments with initial maturities of three months or less to be cash equivalents. Cash and cash equivalents consist of cash in banks, free credit on investment accounts and money market accounts.
Government and Other Regulation
The business of STS is subject to significant regulation by various governmental agencies and self-regulatory organizations. Such regulation includes, among other things, periodic examinations by these regulatory bodies to determine whether the Company is conducting and reporting its operations in accordance with the applicable requirements of these organizations.
Property and Equipment
Property and equipment is stated at cost less accumulated depreciation and amortization. Improvements are amortized using the straight-line method over the shorter of the estimated useful lives of the respective assets or the lease term. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. Repairs and maintenance are expensed as incurred while betterments and improvements are capitalized. When property and equipment are retired, sold, or otherwise disposed of, the asset’s carrying amount and related accumulated depreciation are removed from the accounts and any gain or loss is included in operations.
Long-Lived Assets
In accordance with Financial Accounting Standard Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 360 “Property, Plant, and Equipment,” the Company records impairment losses on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets’ carrying amounts. There were no impairment charges during the nine months ended September 30, 2012 and 2011.
SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
|
3.
|
Summary of significant accounting policies (continued)
|
Fair Value of Financial Instruments – Definition and Hierarchy
In accordance with GAAP, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., the “exit price”) in an orderly transaction between market participants at the measurement date.
In determining fair value, the Company uses various valuation approaches. In accordance with GAAP, a fair value hierarchy for inputs is used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are those that market participants would use in pricing the asset or liability based on market data obtained from sources independent of the Company. Unobservable inputs reflect the Company’s assumptions about the inputs market participants would use in pricing the asset or liability developed based on the best information available in the circumstances.
The fair value hierarchy is categorized into three levels based on the inputs as follows:
Level 1 – Inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities the Company has the ability to access.
Level 2 - Valuations based on quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly.
Level 3 - Valuations based on inputs that are unobservable and significant to the overall fair value measurement.
The availability of valuation techniques and observable inputs can vary from security to security and is affected by a wide variety of factors including, the type of security, whether the security is new and not yet established in the marketplace, and other characteristics particular to the transaction. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Those estimated values do not necessarily represent the amounts that may be ultimately realized due to the occurrence of future circumstances that cannot be reasonably determined.
Because of the inherent uncertainty of valuation, those estimated values may be materially higher or lower than the values that would have been used had a ready market for the securities existed. Accordingly, the degree of judgment exercised by the Company in determining fair value is greatest for securities categorized in Level 3. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes, the level in the fair value hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement.
Fair value is a market-based measure considered from the perspective of a market participant rather than an entity-specific measure. Therefore, even when market assumptions are not readily available, the Company’s own assumptions are set to reflect those that market participants would use in pricing the asset or liability at the measurement date. The Company uses prices and inputs that are current as of the measurement date, including periods of market dislocation. In periods of market dislocation, the observability of prices and inputs
may be reduced for many securities. This condition could cause a security to be reclassified to a lower level within the fair value hierarchy.
SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
|
3.
|
Summary of significant accounting policies (continued)
|
Fair Value of Financial Instruments – Definition and Hierarchy (continued)
Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in Note 5. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular instruments. Changes in assumptions or in market conditions could significantly affect the estimates.
Valuation Techniques
The Company values investments in securities that are freely tradable and are listed on a national securities exchange or reported on the NASDAQ national market at their last sales price as of the last business day of the year.
Derivative Contracts
The Company records its derivative activities at fair value. Gains and losses from derivative contracts are included in trading income in the consolidated statements of operations. Derivative contracts include future and option contracts related to foreign currencies, government bonds and other securities.
The fair value of the derivative contracts traded by the Company is generally based on quoted prices in active markets on national exchanges. The derivative contracts, such as options and futures, which are listed on a national securities exchange or reported on the NASDAQ national market, are generally categorized in Level 1 of the fair value hierarchy.
Offsetting of Amounts Related to Certain Contracts
The Company has elected to offset fair value amounts recognized for cash collateral receivables and payables against fair value amounts recognized for net derivative positions executed with the same counterparty under the same master netting arrangement. At September 30, 2012 and December 31, 2011, the Company offset cash collateral receivables of approximately $20,000 and $9,000 against its net derivative positions, respectively.
Broker Receivable and Payable to Customers
As part of its operations STM collects funds from customers and remits the amounts to the respective clearing broker. The receivable and payable amounts are stated at the amounts transferred. Upon liquidation of customer positions, STM typically remits the proceeds back to the customer after deducting commission and other fees. As further discussed in Note 14, the Company is dependent upon clearing brokers to satisfy its obligations to the Company in order for the Company to liquidate its payable to the customers.
SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
|
3.
|
Summary of significant accounting policies (continued)
|
Securities Transactions
Revenues for executing customer securities transactions and associated expenses are recorded as earned and incurred, on a trade date basis. Securities owned are valued at fair value. Unrealized appreciation or depreciation is reflected in income currently.
Commissions
Commissions and related clearing expenses are recorded on a trade-date basis as securities transactions occur.
Investment Banking Fees
Investment banking fees include fees, net of syndication expenses, arising from securities offerings in which the Company acts as an underwriter or agent. Investment banking revenues also include fees earned in providing financial advisory services. These revenues are recorded in accordance with the terms of the investment banking agreements.
Managed Account Fees
Managed account fees are primarily earned based on a percentage of assets under management. Fees are computed and due at specified intervals, generally quarterly and recorded when earned.
Investments-Equity Method to Cost Method
Investee companies that are not consolidated, but over which the Company exercises significant influence, are accounted for under the equity method of accounting. Whether or not the Company exercises significant influence with respect to an Investee depends on an evaluation of several factors including, among others, representation on the Investee company’s board of directors and ownership level, which is generally a 20% to 50% interest in the voting securities of the Investee company. Under the equity method of accounting, an Investee company’s accounts are not reflected within the Company’s Consolidated Statements of Financial Condition and Statements of Operations; however, the Company’s share of the earnings or losses of the Investee company, Nexo Emprendimientos S.A., is reflected in the caption ‘‘Equity in income (loss) of NEXO Emprendimientos SA” in the Consolidated Statements of Operations. The Company’s carrying value in an equity method Investee company is reflected in the caption ‘‘Investment in Nexo Emprendimientos, S.A.” in the Company’s Consolidated Statements of Financial Condition.
The Company purchased an additional 12.2% interest on May 26, 2011, raising its overall interest in Nexo to 29.5%. This required the Company to change its method of accounting for this investment from the cost method to the equity method. According to ASC 323-10-35-33, the investment, results of operations (current and prior periods presented), and retained earnings of the investor shall be adjusted retroactively as if the equity method had been in effect during all previous periods in which the investment was held.
As a result of the method change noted in the prior paragraph, the 2010 investment accumulated deficit was adjusted to give effect to equity method accounting. The change to equity method affected the net loss for the first nine months of 2011 through retrospective application of the equity method.
SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
|
3.
|
Summary of significant accounting policies (continued)
|
Investments-Equity Method to Cost Method (continued)
|
|
|
Three Months
Ended
September 30, 2011
As originally
Reported
|
|
|
Effect of
Correction of
Error in
Retrospective
Application of
Equity Method
|
|
|
Three Months Ended
September 30, 2011
Giving Effect to
Correction of
Error in Retrospective
Application of
Equity Method
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity in income of
NEXO Emprendimientos SA
|
|
$
|
(240,918
|
)
|
|
$
|
(154,614
|
)
|
|
$
|
(395,532
|
)
|
|
|
|
|
|
|
Effect of
Correction of
Error in
Retrospective
Application of
Equity Method
|
|
|
Nine Months Ended
Giving Effect to
Correction of
Error in
Retrospective
Application of
Equity Method
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity in income of
NEXO Emprendimientos SA
|
|
$
|
(374,288
|
)
|
|
$
|
(283,746
|
)
|
|
$
|
(658,034
|
)
|
On March 21,2012, Nexo executed a debt for equity exchange which resulted in the issuance of new shares by Nexo, reducing the Company’s level of ownership in Nexo from 29.5% to 25.13%. On May 10, 2012, the Company exercised a put option to sell 2,184,250 of its 9,621,582 shares of Nexo to ProBenefit, S.A., thereby reducing its ownership to 19.42%. On May 10, 2012, the Company began recording its investment in Nexo under the cost method of accounting.
On September 28, 2012, Nexo converted debt to equity thereby reducing the Company’s interest from 19.42% to 14.90%.
The fair value of our cost method investment is not estimated if there are no identified events or changes in circumstances that may have an adverse effect on the fair value of the investment. The Company does not believe there are any events which occurred in the three months ended September 30, 2012 that would indicate impairment. Additionally, the Company believes that it is not practicable to estimate the fair value of this investment without incurring excessive costs.
SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
|
3.
|
Summary of significant accounting policies (continued)
|
Income Taxes
The Company files a consolidated income tax return with its subsidiaries. The Company accounts for income taxes in accordance with FASB ASC Topic 740 “Income Taxes”, which requires accounting for deferred income taxes under the asset and liability method. Deferred income tax assets and liabilities are computed for difference between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on the enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce the deferred income tax assets to the amount expected to be realized.
The determination of the Company’s provision for income taxes requires significant judgment, the use of estimates, and the interpretation and application of complex tax laws. Significant judgment is required in assessing the timing and amounts of deductible and taxable items and the probability of sustaining uncertain tax positions. The benefits of uncertain tax positions are recorded in the Company’s consolidated financial statements only after determining a more-likely-than-not probability that the uncertain tax positions will withstand challenge, if any, from tax authorities. When facts and circumstances change, the Company reassesses these probabilities and records any changes in the consolidated interim financial statements as appropriate.
In accordance with GAAP, the Company is required to determine whether a tax position of the Company is more likely than not to be sustained upon examination by the applicable taxing authority, including resolution of any related appeals or litigation processes, based on the technical merits of the position. The tax benefit to be recognized is measured as the largest amount of benefit that is greater than fifty percent likely of being
realized upon ultimate settlement. De-recognition of a tax benefit previously recognized could result in the Company recording a tax liability that would reduce stockholders’ equity. This policy also provides guidance on thresholds, measurement, de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition that is intended to provide better consolidated financial statement comparability among different entities. Management’s conclusions regarding this policy may be subject to review and adjustment at a later date based on factors including, but not limited to, on-going analyses of and changes to tax laws, regulations and interpretations thereof. Generally, the tax filings are no longer subject to income tax examinations by major taxing authorities for years before 2008. Any potential examinations may include questioning the timing and amount of deductions, the nexus of income among various tax jurisdictions and compliance with U.S. federal, state and local tax laws. The Company's management does not expect that the total amount of unrecognized tax benefits will materially change over the next twelve months.
SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
|
3.
|
Summary of significant accounting policies (continued)
|
Interest and Penalty Recognition on Unrecognized Tax Benefits
The Company recognizes interest accrued related to unrecognized tax benefits in interest expense and penalties in other operational expenses. No interest expense or penalties have been recognized as of and for the nine month periods ended September 30, 2012 and 2011 and the year ended December 31, 2011.
Foreign Currency Adjustments
The financial position and results of operations of the Company’s foreign subsidiary is measured using the foreign subsidiary’s local currency as the functional currency in accordance with FASB ASC Topic 830, “Foreign Currency Matters.” Revenues and expenses of such subsidiary have been translated into U.S. dollars at average exchange rates prevailing during the period. Assets and liabilities have been translated at the rates of exchange as of the balance sheet date. The resulting translation gain and loss adjustments are recorded directly as a separate component of stockholders’ equity. Foreign currency translation adjustments resulted in a gain (loss) of $4,907 and ($1,470) for the three and nine months ended September 30, 2012, respectively, and a (loss) of ($18,781) and a gain of $2,779.
Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the consolidated results of operations as incurred.
Comprehensive Income (Loss)
The Company complies with FASB ASC Topic 220, “Comprehensive Income,” which establishes rules for the reporting and display of comprehensive income (loss) and its components. FASB ASC Topic 220 requires the
Company’s change in foreign currency translation adjustments to be included in other comprehensive income (loss), and is reflected as a separate component of stockholders’ equity.
Fair Value of Financial Instruments
The approximate fair value of the mortgage loan as of September 30, 2012 and December 31,2011 was $860,000 and $944,000, respectively. The carrying amount of all other financial assets and liabilities that qualify as financial instruments under FASB ASC Topic 825, “Financial Instruments,” approximate their carrying amounts presented in the accompanying consolidated statements of financial condition at September 30, 2012 and December 31, 2011.
Loss Per Common Share
The Company complies with the accounting and disclosure requirements of FASB ASC 260, “Earnings Per Share.” Basic loss per common share is computed by dividing net loss available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings per common share is computed by dividing net income attributable to the Company by the combination of dilutive common share equivalents, comprised of shares issuable under the Company’s share-based compensation plans, stock warrants and shares of common stock issuable upon the conversion of the Series C 8% convertible preferred stock and the weighted average number of common shares outstanding during the reporting period.
SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
|
3.
|
Summary of significant accounting policies (continued)
|
Loss Per Common Share (continued)
Employee stock options to purchase approximately 8,510,000 shares of common stock during the three months
and nine months ended September 30, 2012, were outstanding but not included in the computation of diluted earnings per common share because the stock option’s exercise prices were less than the average market price of the common stock while they were outstanding, and therefore, the effect on diluted earnings per common share would be anti-dilutive.
For the three months ended September 30, 2012 the 2,080,000 shares of common stock issuable upon the conversion of the Series C 8% convertible preferred stock were outstanding but not included in the computation of diluted earnings per share because the effect would be anti-dilutive. For the nine months ended September 30, 2012 the 2,080,000 shares of common stock issuable upon the conversion of the Series C 8% convertible preferred stock were outstanding and included in the computation of diluted earnings per share.
Employee stock options to purchase approximately 5,010,000 shares of common stock, 4,500 warrants and 2,080,000 shares of common stock issuable upon the conversion of the Series C 8% convertible preferred stock during the three and nine months ended September 30, 2011, were outstanding but not included in the computation of diluted earnings per common share because the effect would be anti-dilutive.
Loss Contingencies
The Company recognizes contingent losses that are both probable and estimable. In this context, the Company defines probability as circumstances under which events are likely to occur. In regards to legal cost, the Company records such costs as incurred.
Funds received from court awarded legal settlements
The Company accounts for funds received from court awarded legal settlements on the cash basis. These funds are reported as miscellaneous income on the consolidated statements of operations.
Investment
The Company classifies its common stock investment in AR Growth Finance Corp. (“AR Growth”) as available-for-sale in accordance with FASB ASC Topic 320, “Investments-Debt and Equity securities.” Available-for-sale investments are carried on the consolidated statements of financial condition at their fair value with the current period adjustments to the carrying value recorded in accumulated other comprehensive income (loss).
Stock-Based Compensation
The Company complies with FASB ASC Topic 718 “Compensation – Stock Compensation,” which establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. It also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. FASB ASC Topic 718 focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. FASB ASC Topic 718 requires an entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award (with limited exceptions). That cost will be recognized over the period during which an employee is required to provide service in exchange for the award
,
the requisite service period (usually the vesting period). No compensation costs are recognized for equity instruments for which employees do not render the requisite service. The grant-date fair value of employee share options and similar instruments will be estimated using option-pricing models adjusted for the unique characteristics of those instruments (unless observable market prices for the same or similar instruments are available). If an equity award is modified after the grant date, incremental compensation cost will be recognized in an amount equal to the excess of the fair value of the modified award over the fair value of the original award immediately before the modification. Based on stock options and stock awards that vested during
the three and nine months
ended
September 30
, 2012, the Company recorded approximately $
77,000
and $
205,00
0, respectively, as compensation expense under FASB ASC 718
and $46,000 and $142,000, respectively, during the three and nine months ended September 30, 2011.
SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
|
3.
|
Summary of significant accounting policies (continued)
|
Nonemployee awards
The fair value of equity instruments issued to a nonemployee is measured by using the stock price and other measurement assumptions as of the date of either: (i) a commitment for performance by the nonemployee has been reached; or (ii) the counterparty’s performance is complete. Expenses related to nonemployee awards are generally recognized in the same period as the Company incurs the related liability for goods and services received. The Company recorded stock compensation of approximately $0 and $9,200 for the three and nine months ended September 30, 2012, respectively, and $0 and $0 for the three and nine months ended September 30, 2011, related to consulting services.
Recently Adopted Accounting Pronouncements
On June 16, 2011, the FASB issued ASU No. 2011-05, “Presentation of Comprehensive Income (Topic 220),” which requires companies to report total net income, each component of comprehensive income, and total comprehensive income on the face of the income statement, or as two consecutive statements. The components of comprehensive income will not be changed, nor does the ASU affect how earnings per share is calculated or reported. These amendments will be reported retrospectively upon adoption. The adoption of the ASU had no material impact on the Company’s consolidated financial statements.
In May 2011, the FASB issued an accounting standard update which works to achieve common fair value measurement and disclosure requirements in GAAP and International Financial Reporting Standards. The update both clarifies the FASB’s intent about the application of existing fair value guidance, and also changes certain principles regarding measurement and disclosure. The update is effective prospectively and is effective for annual periods beginning after December 15, 2011. The adoption of the ASU had no material impact on the Company’s consolidated financial statements.
STS, the Company’s broker-dealer subsidiary, has clearing agreements with clearing brokers to provide execution and clearing services on behalf of its customers on a fully disclosed basis. All customer records and accounts are maintained by the clearing brokers. STS maintains a deposit with one of the clearing brokers. A termination fee may apply if the Company were to terminate its relationship with the respective clearing broker.
SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
|
5.
|
Fair value measurements
|
The Company's assets and liabilities recorded at fair value have been categorized based upon a fair value hierarchy in accordance with GAAP guidance for fair value measurement. See Note 3 for a discussion of the Company's policies regarding this hierarchy.
Cash and cash equivalents, receivables, as well as accounts payable and accrued expenses, and other current liabilities, as reflected in the consolidated interim financial statements, approximate fair value because of the short-term maturity of these instruments.
Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
|
|
|
|
September 30, 2012
|
|
|
December 31, 2011
|
|
|
|
Fair Value
|
|
Carrying
|
|
|
Fair
|
|
|
Carrying
|
|
|
Fair
|
|
|
|
Hierarchy
|
|
Amount
|
|
|
Value
|
|
|
Amount
|
|
|
Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mortgage payable at
7.28% due 2020
|
Level 3
|
|
$
|
655,809
|
|
|
$
|
860,461
|
|
|
$
|
700,739
|
|
|
$
|
943,735
|
|
The fair value estimates of these financial instruments were based upon a discounted cash flow analysis taking into consideration current rates.
The Company's financial assets and liabilities measured at fair value on a recurring basis include those securities classified as securities owned on the consolidated statements of financial condition.
SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
|
5.
|
Fair value measurements (Continued)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quoted Prices
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
in Active
|
|
|
Significant
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Markets
|
|
|
Other
|
|
|
Significant
|
|
|
|
|
|
Balance
|
|
|
|
|
for Identical
|
|
|
Observable
|
|
|
Unobservable
|
|
|
Collateral
|
|
|
as of
|
|
|
|
|
Assets
|
|
|
Inputs
|
|
|
Inputs
|
|
|
Held
|
|
|
September 30,
|
|
|
|
|
(Level 1)
|
|
|
(level 2)
|
|
|
(Level 3)
|
|
|
at Broker
|
|
|
2012
|
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Securities owned, at fair value:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Money market
|
|
$
|
618,790
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
618,790
|
|
|
Options and futures
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
20,774
|
|
|
|
20,774
|
|
|
Corporate bonds
|
|
|
597,072
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
597,072
|
|
|
Equity securities
|
|
|
464,095
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
464,095
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
1,679,957
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
20,774
|
|
|
$
|
1,700,731
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment in A/R Growth
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
common stock
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
22,370
|
|
|
$
|
-
|
|
|
$
|
22,370
|
|
|
|
|
Quoted
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Prices in Active
|
|
|
Significant
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Markets
|
|
|
Other
|
|
|
Significant
|
|
|
|
|
|
Balance
|
|
|
|
|
For Identical
|
|
|
Observable
|
|
|
Unobservable
|
|
|
Collateral
|
|
|
as of
|
|
|
|
|
Assets
|
|
|
Inputs
|
|
|
Inputs
|
|
|
Held
|
|
|
December 31,
|
|
|
|
|
(Level 1)
|
|
|
(level 2)
|
|
|
(Level 3)
|
|
|
at Broker
|
|
|
2011
|
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Securities owned, at fair value:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Money market
|
|
$
|
250,766
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
250,766
|
|
|
Options and futures
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
8,744
|
|
|
|
8,744
|
|
|
Corporate bonds
|
|
|
501,064
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
501,064
|
|
|
Equity securities
|
|
|
197,379
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
197,379
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
949,209
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
8,744
|
|
|
$
|
957,953
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment in A/R Growth
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
common stock
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
22,370
|
|
|
$
|
-
|
|
|
$
|
22,370
|
|
SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
|
5.
|
Fair value measurements (continued)
|
Derivatives
In the normal course of business, the Company utilizes derivative contracts in connection with its proprietary trading activities. Investments in derivative contracts are subject to additional risks that can result in a loss of all or part of an investment. The Company’s derivative activities and exposure to derivative contracts are classified by the following primary underlying risks: interest rate, credit, foreign currency exchange rate, commodity price, and equity price risks. In addition to its primary underlying risks, the Company is also subject to additional counterparty risk due to inability of its counterparties to meet the terms of their contracts.
Options
The Company is subject to equity price risk in the normal course of pursuing its investment objectives. Option contracts give the Company the right, but not the obligation, to buy or sell within a limited time, a financial instrument, commodity or currency at a contracted price that may also be settled in cash, based on differentials between specified indices or prices.
The Company is exposed to counterparty risk from the potential that a seller of an option contract does not sell or purchase the underlying asset as agreed under the terms of the option contract. The maximum risk of loss from counterparty risk to the Company is the fair value of the contracts and the premiums paid to purchase its open option contracts. The Company considers the credit risk of the intermediary counterparty to its option transactions in evaluating potential credit risk.
Futures Contracts
The Company is subject to equity price risk in the normal course of pursuing its investment objectives. The Company may use futures contracts to gain exposure to, or hedge against, changes in the value of equities. A futures contract represents a commitment for the future purchase or sale of an asset at a specified price on a specified date. At September 30, 2012, there are three futures contracts held and are classified by commodity price risk, the fair value of which amounted to approximately ($6,200). At December 31, 2011, the fair value of open contracts amounted to approximately ($500) and is reflected in the Securities Owned at fair value caption of the accompanying consolidated statements of financial condition.
SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
|
6.
|
Property and equipment, net
|
Property and equipment, net consisted of the following at:
|
|
|
September 30,
|
|
|
December 31,
|
|
|
|
|
2012
|
|
|
2011
|
|
|
|
|
|
|
|
|
|
|
Building and improvements
|
|
$
|
1,075,942
|
|
|
$
|
1,075,942
|
|
|
|
|
|
|
|
|
|
|
|
|
Land
|
|
|
725,000
|
|
|
|
725,000
|
|
|
|
|
|
|
|
|
|
|
|
|
Furniture and fixtures
|
|
|
76,134
|
|
|
|
72,178
|
|
|
|
|
|
|
|
|
|
|
|
|
Office equipment
|
|
|
109,705
|
|
|
|
69,652
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,986,781
|
|
|
|
1,942,772
|
|
|
|
|
|
|
|
|
|
|
|
|
Less: accumulated depreciation and amortization
|
|
|
(435,319
|
)
|
|
|
(387,144
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
1,551,462
|
|
|
$
|
1,555,628
|
|
Depreciation and amortization expense for the three months ended September 30, 2012 and 2011 was $16,128 and $15,826, respectively. Depreciation for the nine months ending September 30, 2012 and September 30, 2011 was $48,175 and $47,453, respectively.
Notes payable consisted of the following at September 30, 2012:
|
Mortgage payable to a bank, secured by the
building, monthly payments of $9,207, including
interest at 7.28% per annum, due July 20, 2020.
|
|
$
|
655,809
|
|
|
|
|
|
|
|
|
Maturities of notes payable are approximately
as follows at September 30, 2012:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2012
|
|
$
|
16,000
|
|
|
2013
|
|
|
65,000
|
|
|
2014
|
|
|
70,000
|
|
|
2015
|
|
|
76,000
|
|
|
2016
|
|
|
81,000
|
|
|
Thereafter
|
|
|
348,000
|
|
|
|
|
|
|
|
|
|
|
$
|
656,000
|
|
SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
The Company files a consolidated income tax return with its subsidiaries. Income taxes are charged by the Company based on the amount of income taxes the subsidiaries would have paid had they filed their own income tax returns. In accordance with FASB ASC Topic 740, “Accounting for Income Taxes,” allocation of the consolidated income tax expense is necessary when separate financial statements are prepared for the affiliates. As a result, the Company uses a method that allocates current and deferred taxes to members of the consolidated group by applying the liability method to each member as if it were a separate taxpayer.
The Company had no income tax expense (benefit) for the nine month periods ended September 30, 2012 and 2011. At December 31, 2011, the Company had approximately $5.5 million of net operating losses (“NOL”) carry-forwards for federal and state income tax purposes. These losses are available for future years and expire through 2031. Utilization of these losses may be severely or completely limited if the Company undergoes an ownership change pursuant to Internal Revenue Code Section 382.
The Company has taken a full valuation allowance against the other timing differences and the deferred asset attributable to the NOL carry-forwards at September 30, 2012 and December 31, 2011, respectively, due to the uncertainty of realizing the future tax benefits.
The Company is authorized to issue 100 million shares of common stock, no par value and 10 million shares of preferred stock of which 2.5 million shares have been designated as Series C 8% convertible preferred stock, no par value.
In June 2011, the Company issued 2,979,591 shares of its no par value common stock for $1,042,857 cash. These shares were deemed to have been issued pursuant to an exemption provided by Section 4(2) of the Act, which exempts from registration “transactions by an issuer not involving any public offering.”
In June 2011, the Company issued 1,864,857 shares of its no par value common stock at an agreed value of $0.23 per share, in connection with its purchase of an additional 12.2% equity investment in Nexo Emprendimientos S.A. (“Nexo”), a credit card and consumer loan financing company based in Sunchales, Argentina. These shares were deemed to have been issued pursuant to an exemption provided by Section 4(2) of the Act, which exempts from registration “transactions by an issuer not involving any public offering.”
SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
No Series C preferred stock was sold during the nine months ended September 30, 2012 and 2011. The Series C 8% Convertible Preferred Stock provides for non-cumulative dividends at the rate of 8% per year. Subject to certain restrictions, the Series C 8% Convertible Preferred Stock shall automatically convert into shares of the Company’s Common Stock upon any of the following events: (i) the sale by the Corporation of all or substantially all of its assets; (ii) the consummation of a merger or a consolidation in which the Corporation is not the survivor or (iii) the sale or exchange of all or substantially all of the outstanding shares of the Corporation’s common stock. The Series C 8% Convertible Preferred Stock is redeemable, at the option of the Company, for cash in the amount of $11.00 per share of Series C Convertible Preferred Stock or for shares of the Company’s Common Stock in accordance with a conversion rate.
The holders of preferred stock have liquidation preferences over the holders of the Company’s common stock.
The Company accounts for its stock option awards under FASB ASC Topic 718 “Compensation—Stock compensation.” The fair value of each option is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions used for each grant for the nine months ended September 30, 2012; risk free interest rate between 1.53% and 2.22%, no dividend yield, expected lives of ten years and volatility between 140.32% and 157.01%. The expected term of stock option awards granted is generally based upon the “simplified” method for “plain vanilla” options discussed in SEC Staff Accountng Bulletin (“SAB”) No. 107, as amended by SAB No. 110. The expected volatility is derived from historical volaltility of the Company’s stock on the OTCBB for a period that matches the expected term of the option.
The risk free interest rate is the yield from a Treasury bond or note corresponding to the expected term of the option.
Options vest ratably between one and ten years and are
exercisable
over ten years. The Company granted 3,550,000 options to employees during the nine month period ended September 30, 2012. During the current quarter, an employee forfeited 50,000 stock options.
During the three and nine months ended September 30, 2012, the Company recognized stock-based compensation expense of approximately $77,000 and $205,000, respectively, and $46,000 and $142,000, respectively, during the three and nine months ended September 30, 2011.
This expense is reported within Employee compensation and benefits in the accompanying consolidated statements of operations.
The Company has not paid cash dividends and does not expect to pay cash dividends in the future. Forfeiture rates are based on management’s estimates.
SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
|
11.
|
Stock options (continued)
|
|
Options Outstanding
|
|
|
|
|
|
|
|
|
Options Exercisable
|
|
|
|
|
|
Number
|
|
|
Weighted
|
|
|
|
|
|
Number
|
|
|
|
|
|
|
|
|
Outstanding
|
|
|
Average
|
|
|
Weighted
|
|
|
Exercisable
|
|
|
Weighted
|
|
|
|
|
|
at
|
|
|
Remaining
|
|
|
Average
|
|
|
at
|
|
|
Average
|
|
|
Exercise
|
|
|
September 30,
|
|
|
Contractual
|
|
|
Exercise
|
|
|
September 30,
|
|
|
Exercise
|
|
|
Price
|
|
|
2012
|
|
|
Life
|
|
|
Price
|
|
|
2012
|
|
|
Price
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
0.25
|
|
|
|
4,250,000
|
|
|
|
8.1
|
|
|
$
|
0.25
|
|
|
|
1,305,000
|
|
|
$
|
0.25
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
0.35
|
|
|
|
3,500,000
|
|
|
|
9.5
|
|
|
|
0.35
|
|
|
|
-
|
|
|
|
0.35
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
0.50
|
|
|
|
200,000
|
|
|
|
4.3
|
|
|
|
0.50
|
|
|
|
200,000
|
|
|
|
0.50
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
0.75
|
|
|
|
100,000
|
|
|
|
6.3
|
|
|
|
0.75
|
|
|
|
75,000
|
|
|
|
0.75
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1.00
|
|
|
|
400,000
|
|
|
|
4.5
|
|
|
|
1.00
|
|
|
|
400,000
|
|
|
|
1.00
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1.50
|
|
|
|
60,000
|
|
|
|
6.1
|
|
|
|
1.50
|
|
|
|
52,500
|
|
|
|
1.50
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8,510,000
|
|
|
|
8.3
|
|
|
$
|
0.35
|
|
|
|
2,032,500
|
|
|
$
|
0.47
|
|
SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
|
11.
|
Stock options (continued)
|
The following is a summary of all option activity through September 30, 2012:
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
|
|
Number of
|
|
|
Weighted
|
|
|
Remaining
|
|
|
Aggregate
|
|
|
|
|
Shares
|
|
|
Average
|
|
|
Term
|
|
|
Instrinsic
|
|
|
|
|
Outstanding
|
|
|
Price
|
|
|
(in years)
|
|
|
Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options outsanding at December 31, 2011
|
|
|
5,010,000
|
|
|
$
|
0.34
|
|
|
|
8.3
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Granted in 2012
|
|
|
3,550,000
|
|
|
$
|
0.35
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Forfeited in 2012
|
|
|
(50,000
|
)
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options outstanding at September 30, 2012
|
|
|
8,510,000
|
|
|
$
|
0.35
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at September 30, 2012
|
|
|
2,032,500
|
|
|
$
|
0.47
|
|
|
|
7.6
|
|
|
$
|
-
|
|
|
|
|
|
|
|
Weighted Average
|
|
|
|
|
Stock
|
|
|
Grant Date
|
|
|
|
|
Options
|
|
|
Fair Value
|
|
|
|
|
|
|
|
|
|
|
Options unvested, December 31, 2011
|
|
|
3,491,667
|
|
|
$
|
0.25
|
|
|
|
|
|
|
|
|
|
|
|
|
Options granted
|
|
|
3,550,000
|
|
|
$
|
0.11
|
|
|
|
|
|
|
|
|
|
|
|
|
Options forfeited
|
|
|
(50,000
|
)
|
|
$
|
0.13
|
|
|
|
|
|
|
|
|
|
|
|
|
Options vested
|
|
|
(514,167
|
)
|
|
$
|
0.26
|
|
|
|
|
|
|
|
|
|
|
|
|
Options unvested, September 30, 2012
|
|
|
6,477,500
|
|
|
$
|
0.17
|
|
SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
|
11.
|
Stock options (continued)
|
Cash flows resulting from excess tax benefits are to be classified as part of cash flows from financing activities. Excess tax benefits are realized tax benefits from tax deductions of exercised options in excess of the deferred tax asset attributable to the compensation cost for such options. There were no options exercised during the nine months ended September 30, 2012 and 2011; therefore, the Company did not receive any cash payments or recognize any tax benefits from options exercised during the nine month periods ended September 30, 2012 and 2011.
|
12.
|
Net capital requirement
|
STS is a member of FINRA and is subject to the SEC Uniform Net Capital Rule 15c3-1. This Rule requires the maintenance of minimum net capital and requires that the ratio of aggregate indebtedness to net capital, both as defined, shall not exceed 15 to 1 and that equity capital may not be withdrawn or dividends paid if the resulting net capital ratio would exceed 10 to 1. STS is also subject to the Commodity Futures Trading Commission’s minimum financial requirements which require that STS maintain net capital, as defined for securities brokers and dealers, equal to or in excess of the greater of $45,000 or the amount of net capital required by the SEC Rule 15c3-1. At September 30, 2012, STS’s net capital was approximately $833,000 which was approximately $733,000 in excess of its minimum requirement of $100,000. STS’s ratio of aggregate indebtedness to net capital was 0.57 to 1 as of September 30, 2012.
|
13.
|
Exemption from Rule 15c3-3
|
The Company is exempt from the SEC Rule 15c3-3 pursuant to the exemptive provision under sub-paragraph (k) (2) (ii) and, therefore, is not required to maintain a “Special Reserve Bank Account for the Exclusive Benefit of Customers.”
SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
|
14.
|
Concentration of risk
|
Off-balance Sheet Risk
Pursuant to a clearance agreement, certain of the Company’s subsidiaries introduce all of its securities transactions to a clearing broker on a fully-disclosed basis. All of the customers' money balances and long and short security positions are carried on the books of the clearing broker. In addition, STM has entered into several clearance agreements with clearing brokers. In accordance with the clearance agreements, certain of the Company’s subsidiaries have agreed to indemnify the clearing broker for losses, if any, which the clearing brokers may sustain from carrying securities transactions introduced by the Company.
In accordance with industry practice and regulatory requirements, certain of the Company’s subsidiaries and the clearing broker monitor collateral on the customers' accounts. In addition, the receivable from clearing broker is pursuant to the clearance agreement.
The maximum potential amount of future payments that certain of the Company’s subsidiaries could be required to make under these indemnifications cannot be estimated. However, the Company believes that it is unlikely it will have to make material payments under these arrangements and has not recorded any contingent liability in the consolidated financial statements for these indemnifications.
In the normal course of business, the Company’s customer 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.
Credit Risk
The Company maintains its cash in financial institutions, which at times, may exceed federally insured limits. The Company has not experienced any losses in such accounts and believes it is not subject to any significant credit risk on cash.
|
15.
|
Commitments and contingencies
|
Legal Claims
In the ordinary course of business, incidental to the Company’s operations, the Company retains outside counsel to address claims with which the Company is involved. As of September 30, 2012, the Company was not aware of any legal proceedings, which management has determined to be material to its business operations; however, the Company has been named in the following two actions which it is vigorously defending and which actions, based on management's assessment in coordination with outside litigation counsel, the Company believes to be frivolous and without merit:
On December 7, 2010, the Company filed a FINRA arbitration against Joseph Meuse, Rosewood Securities, LLC, BP Capital, LLC, and China Values Technology, Inc. The FINRA filing was amended on January 18, 2011, before FINRA commenced serving the respondents. The Company sought to recover compensation it was entitled to receive for acting as placement agent under an agreement involving an offering of securities in a reverse merger into a publicly traded company, Respondent China Valves, which closed on May 18, 2009.
SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
|
15.
|
Commitments and contingencies (continued)
|
Legal Claims (continued)
The Agreement provided that the Company would receive 23,490 warrant shares of China Valves, but it only received 5,739 warrant shares. Thus, the Company sued the respondents to recover the additional 17,751 warrant shares that it should have received on May 18, 2009, their value, lost profits, and lost opportunity costs caused by the failure to timely deliver the shares as required. The respondents, in response to the Company’s pre-filing demands for payment, each blamed the other for the claimed failures to timely deliver the missing warrant shares.
On April 7, 2011, the Company entered into a Settlement Agreement (“Agreement”) with BP Capital, LLC, for which Joseph Meuse as managing member (“BP Capital”) and Joseph Meuse (“Meuse”) an individual. The Agreement provided that Meuse will make a payment to the Company in the amount of $125,000, in full settlement with Meuse and BP Capital. The payment was made by Meuse to the Company in five (5) installments, with the first payment of $25,000 due on the date of the signing of the Agreement and four successive payments of $25,000 due thirty (30) days following each prior payment until the full payment has been made. On April 2, 2012, the Company received payment of the remaining balance in accordance in satisfaction of the Agreement. These amounts were included in the applicable consolidated statement of operations as other miscellaneous income.
Employment Agreements
On January 4, 2007, the Company entered into employment agreements with several of its key executives. The agreements are for two to three-year duration and renew automatically for one year unless either party provides notice of non-renewal 30 days prior to the anniversary date of the agreement or the agreement is earlier terminated in accordance with its terms. Two of the agreements are for two-year duration with total compensation of $247,000 per year. The third agreement is for three-year duration with total compensation of $150,000 per year. In July 2009, two of the Company's executive officers, Robert Escobio, CEO, and Kevin Fitzgerald, President, agreed to take a reduction in salary, commencing in July 2009, with the right to request payment pursuant to the terms of their employment agreements, when the Company’s financial condition will allow it to do so.
As part of the agreements, the Company granted 4,500,000 shares of common stock vesting over five years to one of the executives, reduced to 3,500,000 shares pursuant to a stock waiver agreement entered into on November 18, 2009; on August 4, 2010, the executive waived his right, title, and interest to vest the remaining 3,000,000 shares, the balance after 500,000 were vested and issued in December 2009. Also, as part of the
employment agreements, the Company granted 922,389 shares vesting equally over eighteen months to another executive, and 200,000 options to the third executive exercisable on December 31, 2007 for a period of ten years.
SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
|
15.
|
Commitments and contingencies (continued)
|
Employment Agreements (continued)
One of the key executive’s agreements provides for a lump-sum payment of $5 million and the repurchase of all shares based on their fair market value, if his employment is terminated as a result of a change of control. Should the executive’s employment be terminated for any other reason, the Company would have to pay him $2 million and repurchase all of his shares based on their fair market value. Lastly, another agreement provides for a lump-sum payment of $1 million to one of the executives if his employment is terminated due to change of control.
|
16.
|
Investment in AR Growth Finance Corp. and Nexo Emprendimientos S.A.
|
The following presents statements of operations for Nexo Emprendimientos S.A. (“Nexo”). Such summary information has been provided herein based upon the individual significance of the unconsolidated equity investments to the consolidated information of the Company. The three months and six months ended June 30, 2012 shows the financial results through May 10, 2012, the exercise date of the put option for the Nexo investment. On this date, the Company’s interest in Nexo decreased from 25.13% to 19.42% resulting in a change from the equity method to the cost method of accounting for the investment prospectively.
|
|
For the Period
July 1 through
|
|
|
For the Period
January 1 through
|
|
|
|
September 30,
2012
|
|
September 30,
2011
|
|
|
May 10,
2012
|
|
|
September 30,
2011
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
(a)
|
|
$
|
450,694
|
|
|
$
|
885,684
|
|
|
$
|
2,520,717
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of services
|
(a)
|
|
|
(1,791,482
|
)
|
|
|
(1,417,297
|
)
|
|
|
(5,380,189
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating loss
|
(a)
|
|
|
(1,340,788
|
)
|
|
|
(531,612
|
)
|
|
|
(2,859,472
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
(a)
|
|
|
(1,341,041
|
)
|
|
|
(531,785
|
)
|
|
|
(2,418,636
|
)
|
(a) On May 10, 2012, the Company changed from the equity method to the cost method due to the exercise of a put option. As a result, no comparable numbers are presented for the three months ended September 30, 2012.
On May 10, 2012, the Company exercised a put option which required ProBenefit, S.A., an Argentine financial services holding company to repurchase 2,184,250 shares of Nexo Emprendimientos S.A. for $1,200,000 which resulted in a gain on those shares of approximately $750,000. At September 10, 2012, the final payment of $500,000 was received as the final payment of the $1,200,000. The Company has a second exercise option to sell to ProBenefit, S.A. the 3,458,396 Nexo shares ("Second Exercise Group") held by the Company for a purchase price of $1,900,000. The Second Exercise Group may be exercised at any time during the period September 1, 2014 through September 1, 2015.
The impact of any dilution to the Company’s ownership in equity method investments is recorded in Equity in income (loss) of Nexo Emprendimientos S.A. in the Statement of Operations and Comprehensive Income (Loss), in accordance with ASC 323-10.
SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
|
17.
|
Related Party Transactions
|
On July 6, 2012, the Holding Corp. established a short-term revolving intercompany loan of up to $300,000 to STS. At September 30, 2012, the intercompany loan balance was $242,559.
On September 11, 2012, STS received a placement fee of $100,000 from the Holding Corp. for services related to the completion of the Nexo put transaction.
On May 2, 2012, plaintiffs of the Pope Investments, et. al. matter re-filed the previously dismissed case in the Supreme Court of the State of New York. On July 25,2012, the Company responded accordingly and filed a motion to dismiss with the Supreme Court of the State of New York, based upon lack of jurisdiction, failure to state a valid cause of action against Southern Trust Securities Holding Corp. (“STSHC”) and the previous dismissal of the case. On October 17, 2012, the action was discontinued by the Court and Plaintiffs are unable to maintain another action against the Company arising out of the transaction.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations contain “forward-looking statements” including statements about our beliefs and expectations. There are many risks and uncertainties that could cause actual results to differ materially from those discussed in the forward-looking statements. We may use words such as “anticipates,” “believes,” “plans,” “expects,” “future,” “intends,” and similar expressions to identify these forward-looking statements. Prospective investors should not place undue reliance on these forward-looking statements, which apply only as of the date of this quarterly report.
All forward-looking statements are based on information available to us on the date of this filing, and we assume no obligation to update such statements. The following discussion should be read in conjunction with the consolidated financial statements and the related notes included in this Quarterly Report on Form 10-Q.
We were formed as a Florida corporation on January 14, 1998. We are the holding company for STS, which is registered as an introducing broker-dealer with the SEC and is a member of, or subject to regulations of, the SEC, FINRA, the NFA, the CFTC, SIPC and the MSRB. We are also the holding company for both: (i) STSAM a fee-based investment advisory service registered with the State of Florida, which offers its services to retail customers, (ii) Southern Trust Metals, a trader of primarily gold, silver, platinum and palladium, and (iii) Loreley Overseas Corporation (“LOR”), which acts as an international intermediary for STM’s international trading transactions.
Our principal business is the business of STS. We offer clients access to all major domestic and international securities and options exchanges, as well as trading in fixed income products, corporate, government, agencies, municipals, and emerging market debt. We also offer fixed and variable annuities and life insurance. We currently offer hundreds of domestic and international mutual funds, as well as retirement plans. We manage portfolios for individuals, pension funds, retirement plans, foundations, trusts and corporations. Our corporate services facilitate restricted stock dispositions and employee stock option exercises. Our offshore services give clients access to foreign trusts and corporations, which they can use to structure their financial planning.
Our investment banking group provides traditional as well as innovative securities transaction structures. Our focus is on merger and acquisition services, private placements convertible into publicly-traded shares, and private placements bridging to public offerings through reverse mergers into publicly-traded shell corporations.
Southern Trust Metals, Inc. (STM) was formed to capitalize on investor interest in the trading of precious metals such as gold, silver, platinum, and palladium. STS is a separate subsidiary of STSHC and separately managed. STM will work with its own clients to generate new business through the innovative trading of metals.
Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States, which require us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to the valuation of securities owned and deferred tax assets. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.
Valuation of Investments in Securities at Fair Value – Definition and Hierarchy
FASB ASC Topic 820 “Fair Value Measurements and Disclosures” provides a framework for measuring fair value under generally accepted accounting principles in the United States and requires expanded disclosures regarding fair value measurements. ASC 820 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (i.e., the “exit price”) in an orderly transaction between market participants at the measurement date.
In determining fair value, the Company uses various valuation approaches. In accordance with generally accepted accounting principles (“GAAP”), a fair value hierarchy for inputs is used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are those that market participants would use in pricing the asset or liability based on market data obtained from sources independent of the Company. Unobservable inputs reflect the Company’s assumptions about the inputs market participants would use in pricing the asset or liability developed based on the best information available in the circumstances.
The fair value hierarchy is categorized into three levels based on the inputs as follows:
Level 1
– Inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities the Company has the ability to access.
Level 2
- Valuations based on quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly.
Level 3 -
Valuations based on inputs that are unobservable and significant to the overall fair value measurement.
The availability of valuation techniques and observable inputs can vary from security to security and is affected by a wide variety of factors including, the type of security, whether the security is new and not yet established in the marketplace, and other characteristics particular to the transaction. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Those estimated values do not necessarily represent the amounts that may be ultimately realized due to the occurrence of future circumstances that cannot be reasonably determined.
Because of the inherent uncertainty of valuation, those estimated values may be materially higher or lower than the values that would have been used had a ready market for the securities existed. Accordingly, the degree of judgment exercised by the Company in determining fair value is greatest for securities categorized in Level 3. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes, the level in the fair value hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement.
Fair value is a market-based measure considered from the perspective of a market participant rather than an entity-specific measure. Therefore, even when market assumptions are not readily available, the Company’s own assumptions are set to reflect those that market participants would use in pricing the asset or liability at the measurement date. The Company uses prices and inputs that are current as of the measurement date, including periods of market dislocation. In periods of market dislocation, the observability of prices and inputs may be reduced for many securities. This condition could cause a security to be reclassified to a lower level within the fair value hierarchy.
Valuation Techniques
The Company values investments in securities that are freely tradable and are listed on a national securities exchange or reported on the NASDAQ national market at their last sales price as of the last business day of the year. At September 30, 2012, all of the Company’s investments classified as securities owned on the consolidated statements of financial condition are classified as Level 1 investments on the fair value hierarchy table in Note 5, Fair value measurements. The Company’s investment in A/R Growth’s common stock is classified as Level 3.
Clearing Arrangements.
STS does not carry accounts for customers or perform custodial functions related to customers’ securities. STS introduces all of its customer transactions, which are not reflected in these financial statements, to its primary clearing broker, which maintains the customers’ accounts and clears such transactions. These activities may expose us to off-balance-sheet risk in the event that customers do not fulfill their obligations with the primary clearing broker, as we have agreed to indemnify our primary clearing broker for any resulting losses. We continually assess risk associated with each customer who is on margin credit and record an estimated loss when we believe collection from the customer is unlikely. Our losses incurred from these arrangements were not significant for the nine month periods ended September 30, 2012 and 2011.
Stock-Based Compensation
The Company complies with FASB ASC Topic 718 “Compensation – Stock Compensation,” which establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. It also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. FASB ASC Topic 718 focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. FASB ASC Topic 718 requires an entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award (with limited exceptions). That cost will be recognized over the period during which an employee is required to provide service in exchange for the award the requisite service period (usually the vesting period). No compensation costs are recognized for equity instruments for which employees do not render the requisite service.
The grant-date fair value of employee share options and similar instruments will be estimated using option-pricing models adjusted for the unique characteristics of those instruments (unless observable market prices for the same or similar instruments are available). If an equity award is modified after the grant date, incremental compensation cost will be recognized in an amount equal to the excess of the fair value of the modified award over the fair value of the original award immediately before the modification. Based on stock options and stock awards that vested during the three and nine months ended September 30, 2012, the Company recorded approximately $77,000 and $205,000, respectively, as compensation expense under FASB ASC 718 and $46,000 and $142,000, respectively, during the three and nine months ended September 30, 2011.
Revenue Recognition.
Commissions and related clearing expenses are recorded on a trade-date basis as security transactions occur. Riskless principal transactions in regular-way trades are recorded on the trade date, as if they had settled.
Investment banking revenue includes private placement agency fees earned through our participation in private placements of equity and convertible debt securities and fees earned as financial advisor in mergers and acquisitions and similar transactions. Merger and acquisition fees and other advisory service revenue are generally earned and recognized only upon successful completion of the engagement. Unreimbursed expenses associated with private placement and advisory transactions are recorded as expenses as incurred.
Asset management (or managed accounts) fees are primarily earned based on a percentage of assets under management. Fees are computed and due at specified intervals, generally quarterly and recorded when earned. We also offer fee-based investment advisory services to our customers and independent registered investment advisors through our wholly-owned subsidiary, STSAM.
Deferred Tax Valuation Allowance.
We account for income taxes in accordance with the provision of FASB ASC Topic 740, “Income Taxes,” which requires accounting for deferred income taxes under the asset and liability method. Deferred income tax asset and liabilities are computed for difference between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on the enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce the deferred income tax assets to the amount expected to be realized. We have concluded that it is more likely than not that our deferred tax assets as of September 30, 2012 and December 31, 2011 will not be realized based on the scheduling of deferred tax assets and projected taxable income.
The amount of the deferred tax assets actually realized, however, could vary if there are differences in the timing or amount of future reversals of existing deferred tax assets or changes in the actual amounts of future taxable income. Should we determine that we will be able to realize all or part of the deferred tax asset in the future, an adjustment to the deferred tax asset will be recorded in the period such determination is made.
Net Capital Requirement.
Our broker-dealer subsidiary, STS, is a member of FINRA and is subject to the SEC Uniform Net Capital Rule 15c3-1. This rule requires the maintenance of minimum net capital and requires that the ratio of aggregate indebtedness to net capital, both as defined, shall not exceed 15 to 1 and that equity capital may not be withdrawn or dividends paid if the resulting net capital ratio would exceed 10 to 1. STS is also subject to the Commodity Futures Trading Commission’s minimum financial requirements which requires it to maintain net capital, as defined for securities brokers and dealers, equal to or in excess of the greater of $45,000 or the amount of net capital required by the SEC Rule 15c3-1. At September 30, 2012, STS’s net capital was approximately $833,000, which was approximately $733,000 in excess of its minimum requirement of $100,000. STS’s ratio of aggregate indebtedness to net capital was 0.57 to 1 as of September 30, 2012.
Commissions and Clearing Costs.
Commissions and clearing costs include commissions paid to our employee registered representatives, independent contractor arrangements and fees paid to clearing entities for certain clearance and settlement services. Commissions paid to registered representatives vary according to the contracted payout percentage and clearing costs generally fluctuate based on revenues generated on trades and on the volume of transactions.
Accounting for Contingencies
.
We accrue for contingencies in accordance with FASB ASC Topic 450, “Contingencies,” when it is probable that a liability or loss has been incurred and the amount can be reasonably estimated. Contingencies by their nature relate to uncertainties that require our exercise of judgment both in assessing whether or not a liability or loss has been incurred and estimated the amount of probable loss. We did not record an accrual for contingencies at either September 30, 2012 or December 31, 2011.
Results of Operations for the three months ended September 30, 2012 and 2011
The following table sets for a summary of financial highlights.
|
|
|
Three Months Ended
September 30,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
%
|
|
|
|
|
2012
|
|
|
2011
|
|
|
Change
|
|
|
Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Statement of operations data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
670,903
|
|
|
$
|
763,355
|
|
|
$
|
(92,452
|
)
|
|
|
-12
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expenses
|
|
|
973,071
|
|
|
|
851,924
|
|
|
|
121,147
|
|
|
|
14
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity method income (loss)
|
|
|
-
|
|
|
|
(395,532
|
)
|
|
|
395,532
|
|
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net (Loss) applicable to
common stockholders
|
|
|
(302,343
|
)
|
|
|
(491,101
|
)
|
|
|
188,758
|
|
|
|
38
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Loss) per common share
|
|
$
|
(0.02
|
)
|
|
$
|
(0.03
|
)
|
|
|
|
|
|
|
|
|
For the three month period ended September 30, 2012, we reported a net loss applicable to common stockholders of $302,343, a decrease in income of $188,758 (38%) from the net loss of $491,101 reported for the three months ended September 30, 2011. This decrease in net income applicable to common stockholders is primarily attributable to a $92,452 decrease in revenue and a $121,147 increase in expenses, partially offset by a decrease in loss in equity of an affiliate of $395,532.
Revenues
For the three months ended September 30, 2012, commissions decreased $62,311 (22%) to $219,266 from $281,577 reported for the three months ended September 30, 2011. Commissions include all revenue received by Southern Trust Securities, Inc. (“STS”) and its registered representatives on an agency basis, and are primarily derived from transactions in OTC securities and options. This decrease in commissions is primarily the result of a decrease in trading activity offset by give-up commissions generated by the Chicago office. IPWM Spain also had a drop in commissions from the comparable quarters.
Our trading revenues decreased $31,553, or 7%, to $396,157 for the three months ended September 30, 2012 from $427,710 reported for the three months ended September 30, 2011. Trading profits are generated mainly from fixed income products sold to our customers on a riskless trading principal basis.
Even though the markets and the economy have been struggling, we have been able to maintain core customers with a primary focus in fixed income products despite a slight decline in the current quarter.
Our ability to increase our trading revenues will depend mostly on future economic conditions and our ability to generate more customer accounts. The decrease in trading revenue is primarily attributable to a decrease in trading volume and customer accounts from the comparable quarter.
We had no investment banking fees revenue for the three month periods ended September 30, 2012 and 2011.
Managed account fees increased $6,443 (34%) to $25,553 for the three months ended September 30, 2012 from $19,110 reported for the three months ended September 30, 2011. Managed account fees are primarily earned based on a percentage of assets under management and the related fees are computed and due at specified intervals, generally quarterly and recorded when earned. The primary reason for the increase is related to the overall increase in activity of accounts under management by the Company.
For the three months ended September 30, 2012, we reported interest and dividend income of $29,927, a $17,858 increase (148%) from the $12,069 reported for the three months ended September 30, 2011. This increase is attributed to an increase in margin interest income earned by STM.
For the three month months ended September 30, 2012 and 2011, we reported other income of $0, a $22,889 decrease from the $22,889 reported for the three months ended September 30, 2011. This decrease is primarily attributable to a $20,000 legal settlement payment received in August 2011.
Expenses
We reported commissions and clearing fees expenses of $394,817 and $443,106 for the three month periods ended September 30, 2012 and 2011, respectively, a decrease of $48,289, or 11%. The decrease is primarily due to the decrease in trading revenue reported by STM and a decrease in commission revenue reported by STS. Our broker-dealer, STS, shares a varying percentage of commissions with its registered representatives based on arrangements between STS and each registered representative and based on the nature of the product from which commissions are earned. The portion of the commission paid to a registered representative is an expense on our consolidated statements of operations under “commission and clearing fees.” Also included in “commissions and clearing fees” are referral fees STS pays to foreign finders for transactions effectuated by STS and its registered representatives at the request of such foreign finders. These revenues, which are directly identifiable and attributable to any registered representative or foreign finder, are commonly known as “compensable revenues
.
” Commissions paid to registered representatives are variable in nature and are based on a pre-determined percentage of compensable revenues generated.
Compensable revenues include revenues derived from commissions, trading income, investment banking fees
and managed account fees. Any other income recognized by us (for example interest and dividend income generated from our investment portfolio) is not considered compensable revenue and thus no payouts to registered representatives are made. Commissions paid registered representatives represent 50% and 49% of total compensable revenues for the three month periods ended September 30, 2012 and 2011, respectively. Clearing fees are costs paid to third party service providers who provide clearance services for our sales transactions. Fees are assessed based on the type of product and, according to the mix of products and volume generated.
Employee compensation and benefits increased $121,467 (68%) to $299,798 for the three months ended September 30, 2012 from $178,331 reported for the three months ended September 30, 2011. This increase is primarily attributable to an increase in staffing for the Company’s Chicago office as well as higher equity compensation expenses relating to options awarded to certain key employees. For the three month periods ended September 30, 2012 and 2011, we recorded approximately $77,000 and $46,000, respectively, an increase of $31,000 (67%). The vesting period for the equity compensation awards range from twelve to 120 months.
Occupancy costs decreased $622 (4%) to $14,061 for the three months ended September 30, 2012 from $14,683 reported for the three months ended September 30, 2011. Major expenses included under occupancy costs are property taxes, depreciation, and common repair and maintenance of our office building.
Communications and market data expenses represent mostly charges on our terminals used to monitor and analyze real-time financial market data movements, telephone expenses, licenses and registration expenses associated with our broker-dealer operations. Communications and market data expenses increased $43,471, or 167% to $69,572 for the three months ended September 30, 2012 from $26,101 reported for the three months ended September 30, 2011. This increase is primarily attributable to higher communications costs incurred due to the opening of the Chicago office.
Professional fees decreased $10,915 (13%) for the three months ended September 30, 2012 to $70,278 from $81,193 for the three months ended September 30, 2011, due a decrease in legal and professional fees. As of September 30, 2012, there are no material legal disputes that may have an adverse impact on our consolidated financial statements.
Travel and entertainment expenses increased $9,613 (36%) for the three months ended September 30, 2012 to $36,350 from $26,737 for the three months ended September 30, 2011, due to an increase in travel activity in the current quarter.
Depreciation and amortization expense increased $302 (2%) for the three months ended September 30, 2012 to $16,128 from $15,826 for the three months ended September 30, 2011. This increase is due to fixed asset purchases which have taken place in the current year.
Interest expense decreased $1,128 (8%) to $12,396 for the three months ended September 30, 2012 from $13,524 incurred for the three months ended September 30, 2012. This decrease is due to a reduction of principal balances on our outstanding loans.
Our other operational expenses include miscellaneous expenses and insurance premiums. Other operational expenses increased $7,248 (14%), to $59,671 for the three months ended September 30, 2012 from $52,423 reported for the three months ended September 30, 2011. The increase is primarily attributable to additional costs related to the Chicago office.
The Company had previously acquired an additional 12.2% interest in Nexo, increasing its holdings to 29.5%, the Company changed its method of accounting for this investment from the cost method to the equity method. The Company’s interest was reduced to 25.13% based on a debt to equity conversion which Nexo executed. Under the equity method, the Company recorded its proportionate share of the earnings or losses of Nexo.
On May 10, 2012, the Company exercised a put option to sell 2,184,250 shares of Nexo to ProBenefit S.A., thereby reducing its ownership to 19.42%. The Company changed its method of accounting from the equity method to the cost method of accounting for this investment prospectively.
On September 28, 2012, Nexo converted debt to equity thereby reducing the Company’s interest from 19.42% to 14.90%.
Results of Operations for the nine months ended September 30, 2012 and 2011
The following table sets forth a summary of financial highlights.
|
|
|
Nine Months Ended
September 30,
|
|
|
|
|
|
|
|
|
|
|
2012
|
|
|
2011
|
|
|
Change
|
|
|
Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Statement of operations data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
2,302,422
|
|
|
$
|
2,358,292
|
|
|
$
|
(55,870
|
)
|
|
|
-2
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expenses
|
|
|
2,807,379
|
|
|
|
2,609,967
|
|
|
|
197,412
|
|
|
|
8
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gain on exercise of put option
|
|
|
750,242
|
|
|
|
-
|
|
|
|
750,242
|
|
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity method income (loss)
|
|
|
210,607
|
|
|
|
(658,034
|
)
|
|
|
868,641
|
|
|
|
132
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) applicable to
common stockholders
|
|
|
449,582
|
|
|
|
(969,624
|
)
|
|
|
1,419,206
|
|
|
|
146
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) per common share
|
|
$
|
0.02
|
|
|
$
|
(0.06
|
)
|
|
|
|
|
|
|
|
|
For the nine month period ended September 30, 2012, we reported a net income applicable to common stockholders of $449,582, an increase in income of $1,419,206 (146%) from the net loss of $969,624 reported for the nine months ended September 30, 2011. This increase in net income applicable to common stockholders is primarily attributable to the gain from the exercise of the put option and an increase in equity method income, partially offset by an increase of $197,412 in expenses and a decrease in revenue of $55,870.
Revenues
For the nine months ended September 30, 2012, commissions decreased $250,213 (30%) to $589,553 from $839,766 reported for the nine months ended September 30, 2011. Commissions include all revenue received by Southern Trust Securities, Inc. (“STS”) and its registered representatives on an agency basis, and are primarily derived from transactions in OTC securities and options. This decrease in commissions is primarily the result of a STS commissions during the period.
Our trading revenues increased $41,500, or 3%, to $1,366,220 for the nine months ended September 30, 2012 from $1,324,720 reported for the nine months ended September 30, 2011. Trading profits are generated mainly from fixed income products sold to our customers on a riskless trading principal basis. Even though the markets and the economy have been struggling for the last few quarters, we have continued to acquire new customers interested in investing in fixed income products. Our ability to increase our trading revenues will depend mostly on future economic conditions and our ability to generate more customer accounts. The increase in trading revenue is primarily attributable to an increase in trading volume and customer accounts from the comparable period.
We had no material investment banking fees revenue for the nine month periods ended September 30, 2012 and 2011. Investment banking fees are generally determined as a percentage of the size of the deal or contract and are recognized when the transaction is completed and closed. Market conditions for private securities transactions have been weak; however, we remain committed to this aspect of our business, as a full service boutique broker-dealer.
Managed account fees increased $15,328 (26%) to $73,180 for the nine months ended September 30, 2012 from $57,852 reported for the nine months ended September 30, 2011. Managed account fees are primarily earned based on a percentage of assets under management and the related fees are computed and due at specified intervals, generally quarterly and recorded when earned.
For the nine months ended September 30, 2012, we reported interest and dividend income of $77,302, a $42,941 increase (125%) from the $34,361 reported for the nine months ended September 30, 2011. This increase may be attributed to an increase in margin interest income earned by STM and interest and dividend income earned from investments held by STS.
For the nine month periods ended September 30, 2012 and 2011, we reported other income of $196,167, a $98,278 increase from the $97,889 reported for the nine months ended September 30, 2011. This increase is primarily attributable to the $173,846 in other fees related to storage, transportation, insurance and platform fees on customer accounts managed by STM.
Expenses
We reported commissions and clearing fees expenses of $1,163,829 and $1,297,077 for the nine month periods ended September 30, 2012 and 2011, respectively, a decrease of $133,248 (10%). The decrease is primarily due to the decrease in commission revenue reported by STS, partially offset by an increase in trading revenue reported by STS. Our broker-dealer, STS, shares a varying percentage of commissions with its registered representatives based on arrangements between STS and each registered representative and based on the nature of the product from which commissions are earned. The portion of the commission paid to a registered
representative is an expense on our consolidated statements of operations under “commission and clearing fees.” Also included in “commissions and clearing fees” are referral fees STS pays to foreign finders for
transactions effectuated by STS and its registered representatives at the request of such foreign finders. These revenues, which are directly identifiable and attributable to any registered representative or foreign finder, are commonly known as “compensable revenues
.
” Commissions paid to registered representatives are variable in nature and are based on a pre-determined percentage of compensable revenues generated.
Compensable revenues include revenues derived from commissions, trading income, investment banking fees
and managed account fees. Any other income recognized by us (for example interest and dividend income generated from our investment portfolio) is not considered compensable revenue and thus no payouts to registered representatives are made. Commissions paid registered representatives represent 50% and 49% of
total compensable revenues for the nine month periods ended September 30, 2012 and 2011, respectively. Clearing fees are costs paid to third party service providers who provide clearance services for our sales transactions. Fees are assessed based on the type of product and, according to the mix of products and volume generated.
Employee compensation and benefits increased $177,961 (32%) to $729,864 for the nine months ended September 30, 2012 from $551,903 reported for the nine months ended September 30, 2011. This increase is primarily attributable to an increase in staffing for the Company’s Chicago office as well as higher equity compensation expenses relating to options awarded to certain key employees. For the nine month periods ended September 30, 2012 and 2011, we recorded approximately $205,000 and $142,000, respectively, an increase of $63,000. The vesting period for the equity compensation awards range from twelve to 120 months.
Occupancy costs decreased $534 (1%) to $47,458 for the nine months ended September 30, 2012 from $47,992 reported for the nine months ended September 30, 2011. Major expenses included under occupancy costs are property taxes, depreciation, and common repair and maintenance of our office building.
Communications and market data expenses represent mostly charges on our terminals used to monitor and analyze real-time financial market data movements, telephone expenses, licenses and registration expenses
associated with our broker-dealer operations. Communications and market data expenses increased $84,860 (80%) to $191,220 for the nine months ended September 30, 2012 from $106,360 reported for the nine months ended September 30, 2011. This increase is primarily attributable to higher phone, quote data and research costs from the opening of the Chicago office.
Professional fees increased $36,024 (12%) for the nine months ended September 30, 2012 to $341,824 from $305,800 for the nine months ended September 30, 2011, due to higher audit, legal and other professional fees. As of September 30, 2012, there are no material legal disputes that may have an adverse impact on our consolidated financial statements.
Travel and entertainment expenses increased $11,218 (19%) for the nine months ended September 30, 2012 to $69,494 from $58,276 for the nine months ended September 30, 2011.
Other operational expenses include miscellaneous expenses and insurance premiums. Other operational expenses increased $23,844 (16%), to $177,501 for the nine months ended September 30, 2012 from $153,657 reported for the nine months ended September 30, 2011. The increase is primarily attributable to higher insurance costs in the current year.
Interest expense decreased $3,435 (8%) to $38,014 for the nine months ended September 30, 2012 from $41,449 incurred for the nine months ended September 30, 2011. The decrease is primarily attributable to a lower principal balance on the note payable.
Depreciation and amortization expense increased $722 (2%) for the nine months ended September 30, 2012 to $48,175 from $47,453 for the nine months ended September 30, 2011. This increase is due to fixed asset purchases made in the current year.
As a result of the acquisition of the additional 12.2% interest in Nexo, thereby increasing its holdings to 29.5%, the Company changed its method of accounting for this investment from the cost method to the equity method. The Company’s interest was reduced to 25.13% based on a debt to equity conversion which Nexo executed. Under the equity method, the Company recorded its proportionate share of the earnings or losses of Nexo.
On May 10, 2012, the Company exercised a put option to sell 2,184,250 shares of Nexo to ProBenefit S.A.,
thereby reducing its ownership to 19.42%. The Company changed its method of accounting from the equity method to the cost method of accounting for this investment prospectively.
On September 28, 2012, Nexo converted debt to equity which further reduced the Company’s interest to 14.90%.
Liquidity and Capital Resources
The following sets forth a summary of financial condition data:
|
|
|
As of
|
|
|
As of
|
|
|
|
|
|
|
|
|
|
|
September 30,
|
|
|
December 31,
|
|
|
|
|
|
% of
|
|
|
|
|
2012
|
|
|
2011
|
|
|
Change
|
|
|
Change
|
|
|
Financial condition data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equilvalents
|
|
$
|
592,693
|
|
|
$
|
339,445
|
|
|
$
|
253,248
|
|
|
|
75
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Securities owned
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
at fair value
|
|
|
1,700,731
|
|
|
|
957,953
|
|
|
|
742,778
|
|
|
|
78
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
|
9,237,712
|
|
|
|
9,213,316
|
|
|
|
24,396
|
|
|
|
0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Notes payable
|
|
|
655,809
|
|
|
|
700,739
|
|
|
|
(44,930
|
)
|
|
|
(6
|
%)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders' equity
|
|
|
4,174,634
|
|
|
|
3,506,206
|
|
|
|
668,428
|
|
|
|
19
|
%
|
As of September 30, 2012, liquid assets consisted primarily of cash and cash equivalents of approximately $592,693 and securities owned of approximately $1,700,731 for a total of $2,293,424, which is $996,026 higher than the approximately $1,297,398 in liquid assets as of December 31, 2011. Historically, we have financed our business primarily through cash generated by our brokerage operations, as well as proceeds from our private placement of preferred stock and issuance of common stock.
Cash and cash equivalents increased approximately $253,248 to $592,693 at September 30, 2012, as compared to $339,445 at December 31, 2011, which results from the following:
|
Net income
|
|
$
|
455,892
|
|
|
|
|
|
|
|
|
Adjustments to reconcile net income to net cash
provided by operating activities
|
|
|
(698,668
|
)
|
|
|
|
|
|
|
|
Changes in operating assets and liabilities
|
|
$
|
(613,567
|
)
|
|
|
|
|
|
|
|
Net cash used by operating activities
|
|
$
|
(856,343
|
)
|
|
|
|
|
|
|
|
Investing activities
|
|
$
|
1,155,991
|
|
|
|
|
|
|
|
|
Financing activities
|
|
$
|
(44,930
|
)
|
|
|
|
|
|
|
|
Effect of foreign exchange rate changes
on cash and cash equivalents
|
|
$
|
(1,470
|
)
|
|
|
|
|
|
|
|
Net increase in cash and cash equivalents
|
|
$
|
253,248
|
|
Cash used by our operating activities for the nine months ended September 30, 2012 was approximately $856,343, comprised of net income of $455,892, noncash reconciling adjustments of $698,668, and changes in operating assets and liabilities of $613,567. Noncash reconciling adjustments include stock-based compensation charges of $214,006, depreciation and amortization of $48,175, loss in equity of affiliate of $210,607 and gain on sale of equity investment of $750,242.
The $613,567 change in operating assets and liabilities is primarily attributable to an increase of $746,614 in due from clearing broker and an increase of $105,455 in accounts payable and accrued expenses offset by a decrease of $742,778 in securities owned, a decrease of $704,557 in payable to customers, a decrease of $14,833 in commissions receivable and a decrease of $3,468 in other assets. 100% of the $704,557 decrease in payable to customers and $794,300 (100%) of the $746,614 increase in due from clearing brokers is attributable to payables associated with our metals trading subsidiary and receivables due from clearing brokers processing transactions on behalf of our metals trading subsidiary, respectively. For the nine months ended September 30, 2012 and 2011, we reported gross trading revenue of approximately $1,366,220 and $1,324,720, respectively, a decrease of approximately $41,500, or 3%.
Cash provided by investing activities was $1,155,991 and cash used in investing activities was $1,001,968 for the nine month periods ended September 30, 2012 and 2011, respectively. The $1,155,991 was primarily due to the proceeds from the sale of equity investment of $1,200,000 offset by equipment purchases of $44,009. Cash used in our financing activities was approximately $44,930, which represents principal payments on notes payable during the nine months ended September 30, 2012
In response to the current economic environment, we have implemented changes to our capital management practices to ensure we will be able to continue to meet our obligations. Specifically certain employee salaries and payout percentages were reduced in July 2009 and continue to be reduced to match current business levels and recent employee resignations will not be immediately filled. We have also undertaken the task of reviewing the other general expenses incurred with the objective cost reductions.
Since we have primarily financed our operations through cash flows generated by our brokerage operations and proceeds from private placements of preferred stock, we are currently exploring an additional offering of preferred stock. There can be no assurance that we will be able to complete this offering on terms acceptable to us, if at all.
The following is a table summarizing our significant commitments as of September 30, 2012, consisting of debt payments related to our notes payable:
|
Year ending December 31,
|
|
Total
|
|
|
|
|
|
|
|
2012
|
|
$
|
16,000
|
|
|
2013
|
|
|
65,000
|
|
|
2014
|
|
|
70,000
|
|
|
2015
|
|
|
76,000
|
|
|
2016
|
|
|
81,000
|
|
|
Thereafter
|
|
|
348,000
|
|
|
|
|
|
|
|
|
Total commitments
|
|
$
|
656,000
|
|