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MERR > SEC Filings for MERR > Form 10-K on 1-Apr-2013All Recent SEC Filings

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Form 10-K for MERRIMAN HOLDINGS, INC


1-Apr-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis should be read in conjunction with our consolidated financial statements and the notes thereto in Part II, Item 8 to this Annual Report on Form 10-K. This discussion contains forward-looking statements reflecting our current expectations. Actual results and the timing of events may differ significantly from those projected in forward- looking statements due to a number of factors, including those set forth in Item 1A "Risk Factors" of this Annual Report on Form 10-K.

Overview

Merriman Holdings, Inc. and subsidiaries (the Company), is a financial services holding company that provides capital markets services, corporate services, and investment banking through its primary operating subsidiary, Merriman Capital, Inc. (hereafter MC). MC is registered with the Securities and Exchange Commission (SEC) as a broker-dealer and is a member of the Financial Industry Regulatory Authority (FINRA) and Securities Investor Protection Corporation (SIPC).

Our mission is to be the leader in advising, financing, trading and investing in fast-growing companies under $1 billion in market capitalization. We originate differentiated equity research, brokerage and trading services primarily to institutional investors, as well as investment banking and advisory services to our fast-growing corporate clients.

We are headquartered in San Francisco, with an additional office in New York, NY. As of December 31, 2012, we had 32 employees.

Executive Summary

Our total revenues in 2012 decreased 41% to approximately $12,919,000 due to a 54% and 36% decrease in our commission and investment banking revenues, respectively, partially offset by a 31% and 115% increase in our principal transaction revenue and capital markets advisory fees, respectively. Net loss for 2012 was 13% less than that of 2011. Our net cash used in operating activities increased by approximately $500,000 primarily due to a reduction in commission and bonus payables and accrued liabilities.

Commissions - Commission revenue from institutional brokerage business decreased by 54% to $6,200,000 in 2012 from $13,411,000 in 2011. The decrease was primarily because we had fewer producers in 2012. The brokerage business continues to face increasing challenges, including the proliferation of electronic communication networks which have reduced commission rates and profitability in the brokerage industry. Many large investment banks have responded to lower margins within their equity brokerage divisions by reducing research coverage, particularly for smaller companies, consolidating sales and trading services, and reducing headcount of sales and trading professionals.

Principal Transactions - Principal transactions resulted in a $535,000 loss in 2012, 31% less than the $777,000 loss in 2011 mostly due to market performance. Principal transaction revenue consists of customer principal trades, profits from our market making and proprietary trading activities, and unrealized gain/(loss) on trading inventory and securities received in connection with certain investment banking transactions.

Our marketable security positions are accounted for on a trade date basis and marked to market value daily. Returns from market making and proprietary trading activities tend to be more volatile than those from customer agency and principal activities.

Investment Banking - Our investment banking revenues, including FEP's, decreased 36% to $5,372,000 in 2012 from $8,440,000 in 2011. The decrease is comprised of a $1,385,000 or 26% decrease in investment banking revenues and a $1,683,000 or 53% decrease in FEP's revenues. Decrease in investment banking revenues was primarily due to the decrease in number of deals closed. The number of large deals (over $250,000 in fees and excluding FEP's) closed in 2012 was 4 versus 7 in 2011.

Other Revenues - During 2007, MC began offering services to sponsor companies on the Domestic and International OTCQX markets. This offering has been designed to enable domestic and non-U.S. companies to obtain greater exposure to U.S. institutional investors without the expense and regulatory burdens of listing on traditional U.S. exchanges. The Domestic and International OTCQX market tiers do not require full SEC registration or Sarbanes Oxley compliance. Listing on the market requires the sponsorship of a qualified investment bank called a Designated Advisor for Disclosure (DAD) for domestic companies or a Principal American Liaison (PAL) for non-U.S. companies. MC was the first U.S. investment bank to achieve DAD and PAL designations. Revenues earned from these activities increased 115% to $1,882,000 in 2012 from $876,000 in 2011 primarily due to increase in the number of clients, 61 in 2012 versus 29 in 2011.

Employees -During 2011, our headcount was reduced in an effort to eliminate certain unprofitable revenue activities. At December 31, 2012 and 2011, the Company had 32 and 35 employees, respectively.

Business Developments - We continue to invest in business areas that we believe will increase the awareness of our franchise and contribute to future revenue opportunities such as hosting investor conferences, introducing management teams of fast-growing companies to institutional investors, marketing, and other business development activities. We continue to implement cost cutting measures in 2012. We expect significant improvements in our operating results to be primarily driven by increases in our various revenue sources.

Results of Operations

The following table sets forth the results of operations for the years ended December 31, 2012 and 2011:

                                                         Year Ended December 31,
                                                          2012             2011

   Revenues
   Commissions                                        $  6,199,912     $ 13,411,312
   Principal transactions                                 (535,458 )       (777,495 )
   Investment banking                                    5,372,046        8,439,569
   Advisory and other                                    1,882,485          875,894

   Total revenues                                       12,918,985       21,949,280

   Operating expenses
   Compensation and benefits                            12,084,591       17,889,400
   Brokerage and clearing fees                             593,681        1,395,820
   Professional services                                   599,121        1,359,004
   Occupancy and equipment                               1,673,686        1,912,617
   Communications and technology                         1,084,234        1,954,384
   Depreciation and amortization                            20,787          125,726
   Travel and entertainment                                401,860          894,959
   Legal services and litigation settlement expense        427,023          710,841
   Cost of underwriting capital                            197,600           97,625
   Other                                                 1,261,417        1,898,884

   Total operating expenses                             18,344,000       28,239,260

   Operating loss                                       (5,425,015 )     (6,289,980 )

   Other income                                             15,000           51,601
   Interest income                                             452            6,249
   Interest expense                                       (250,646 )       (378,239 )
   Amortization of debt discount                          (122,742 )        (93,269 )
   Loss on early extinguishment of debt                          -       (1,183,917 )
   Loss on equity exchange                              (1,086,329 )              -

   Net loss before income taxes                         (6,869,280 )     (7,887,555 )
   Income tax expense                                            -           (6,107 )

   Net loss                                             (6,869,280 )     (7,893,662 )
   Preferred stock cash dividend                           (42,061 )       (491,334 )

   Net loss attributable to common shareholders       $ (6,911,341 )   $ (8,384,996 )

Our total revenues in 2012 decreased 41% to approximately $12,919,000 due to a 54% and 36% decrease in our commission and investment banking revenues, respectively, partially offset by a 31% and 115% increase in our principal transaction revenue and capital markets advisory fees, respectively.

Investment Banking Revenue

Our investment banking activity includes the following:

Capital Raising - Capital raising includes private placements of equity and debt instruments and underwritten public offerings.

Financial Advisory - Financial advisory includes advisory assignments with respect to mergers and acquisitions, divestures, restructurings and spin-offs.

The following table sets forth our revenue and transaction volumes from our investment banking activities for the years ended December 31:

                                                  2012              2011
        Revenue:
        Capital raising                       $   4,082,279     $   6,580,948
        Financial advisory                        1,289,767         1,858,621

        Total investment banking revenue      $   5,372,046     $   8,439,569

        Transaction Volumes:
        Public offerings:
        Capital underwritten participations   $  54,350,005     $ 356,964,000
        Number of transactions                            5                 9
        Private placements:
        Capital raised                        $ 288,460,500     $ 652,300,000
        Number of transactions                           10                12
        Financial advisory:
        Transaction amounts                   $ 125,000,000     $ 160,000,000
        Number of transactions                            7                 3

Our investment banking revenues, including FEP's, decreased 36% to $5,372,000 in 2012 from $8,440,000 in 2011. The decrease is comprised of a $1,385,000 or 26% decrease in investment banking revenues and a $1,683,000 or 53% decrease in FEP's revenues. Decrease in investment banking revenues was primarily due to the decrease in number of deals closed and our strategic shift to having FEP become our core banking revenue. The number of large deals (over $250,000 in fees and excluding FEP's) closed in 2012 was 4 versus 7 in 2011. As a percentage of total revenues, investment banking revenues, including FEP's, contributed 42% in 2012 comparing to 38% in 2011.

During the years ended December 31, 2012 and 2011, no one single investment banking client accounted for more than 10% of our total revenues.

Commissions and Principal Transactions Revenue

Our broker-dealer activities include the following:

Commissions - Commissions include revenue resulting from executing stock trades for exchange-listed securities, over-the-counter securities and other transactions as agent.

Principal Transactions - Principal transactions consist of a portion of dealer spreads attributed to our securities trading activities as principal in NASDAQ-listed and other securities, and include transactions derived from our activities as a market-maker. Principal transactions also include gains and losses resulting from market price fluctuations that occur while holding positions in our trading security inventory.

The following table sets forth our revenue and losses and several operating metrics which we utilize in measuring and evaluating performance and the results of our trading operations:

                                                       2012              2011

    Commissions:
    Commissions on institutional equities          $   6,199,912     $  13,411,312

    Principal transactions:
    Customer principal transactions, proprietary
    trading and market making                      $    (171,160 )   $     188,559
    Investment portfolio                                (364,298 )        (966,054 )

    Total principal transaction revenue            $    (535,458 )   $    (777,495 )

    Transaction Volumes:
    Number of shares traded                          359,157,876       538,327,146

Commission revenue was approximately $6,200,000 or 48% of total revenue in 2012, representing a $7,211,000 or 54% decrease from that in 2011. The decrease was primarily due to lower trading volume as a result of the Company having fewer sales producers in 2012, as well as the dramatic overall decline in equity trading volumes in the U.S.

Principal transaction revenue consists of four different activities - customer principal trades, market making, and realized and unrealized gains and losses in our investment portfolio. As a broker-dealer, we account for all of our marketable security positions on a trade date basis and as a result, all security positions are marked to fair market values. Returns from market making activities tend to be more volatile than acting as agent or principal for customers.

For 2012, principal transaction losses were approximately $535,000, consisting of a $364,000 net loss on our investment portfolios and a $926,000 net loss in proprietary trading and market making, partially offset by a $755,000 gain from customer principal transactions. For 2011, principal transaction losses were approximately $777,000, consisting of a $966,000 net loss on our investment portfolios and a $530,000 net loss in proprietary trading and market making, partially offset by a $719,000 gain from customer principal transactions.

For the years ended December 31, 2012 and 2011, one customer accounted for more than 10% of total revenues.

Compensation and Benefit Expenses

Compensation and benefits expenses represent the majority of our operating expenses and include commissions, base salaries, discretionary bonuses and stock-based compensation. Sales professionals are paid commissions based on their production. Incentive compensation varies primarily based on revenue production. Investment banking, research and support staff and executives are paid base salaries and may participate in the discretionary bonus plans. Discretionary bonuses paid to investment bankers and research analysts vary with revenue production, but also include other qualitative factors and are determined by management. Salaries, payroll taxes and employee benefits vary based primarily on overall headcount.

The following table sets forth the major components of our compensation and benefits for the years ended December 31, 2012 and 2011:

                                                                 2012             2011

Incentive compensation and discretionary bonuses             $  6,215,340     $  9,871,572
Salaries and wages                                              2,739,579        5,888,225
Stock-based compensation                                        2,224,693          725,179
Payroll taxes, benefits and other                                 904,979        1,404,424

Total compensation and benefits                              $ 12,084,591     $ 17,889,400

Total compensation and benefits as a percentage of revenue             94 %             82 %
Cash compensation and benefits as a percentage of revenue              76 %             78 %

Total compensation and benefits were approximately $12,084,000 and $17,889,000 for the years ended December 31, 2012 and 2011, respectively, a decrease of approximately $5,805,000 or 32%. The decrease consisted of (i) a $3,656,000 (37%) decrease in incentive compensation and discretionary bonuses directly relating to the decrease in revenue, (ii) a $3,149,000 (53%) and $499,000 (36%) decrease in salaries and wages, and payroll taxes, benefits and other, respectively, as a direct result of headcount reduction, (iii) partially offset by a $1,499,000 (207%) increase in stock-based compensation which was primarily due to option forfeiture.

Of the total compensation and benefits for the year ended December 31, 2012, $1,355,000 was for FEP personnel.

During the third quarter of 2011, the Company began the process of eliminating non-profitable revenue activities and certain discretionary spending. The Company significantly reduced its operating expenses by eliminating certain non-revenue generating personnel, administrative positions and technology related costs. We continue to focus on decreasing the ratio of total cash compensation and benefits as a percentage of revenue and anticipate a lower metric in 2013.

Incentive compensation directly correlates to commission revenue earned and discretionary bonuses primarily correlate to investment banking revenues earned. Cash compensation and benefits exclude stock-based compensation which is a non-cash expense.

In 2012, two sales professionals accounted for more than 10% of total revenues. One sales professional accounted for more than 10% of total revenue in 2011.

Other Operating Expenses

Brokerage and clearing fees include trade processing expenses paid to our clearing broker, and execution fees paid to floor brokers and electronic communication networks. MC is a fully-disclosed broker-dealer which contracts a third party clearing broker to perform all of the clearance functions. The clearing broker-dealer processes and settles all of MC's customer transactions and maintains the detailed customer records. These expenses are almost entirely variable, and are based on commission revenue and trade volume. Brokerage and clearing fees decreased approximately $802,000 or 57% compared to 2011 as a direct result of decreases in trading volume and commission revenue.

Professional services expense includes audit and accounting fees, expenses related to investment banking transactions, and various consulting fees. Professional services expense decreased $760,000 or 56% compared to 2011 primarily due to the fact that a number of consulting agreements expiring in 4th quarter of 2011 and 1st quarter of 2012 were not renewed.

Occupancy and equipment include rents and related costs of our office premises, equipment, software and leasehold improvements. Occupancy expense is largely fixed in nature while equipment expense can vary somewhat in relation to our business operations. Occupancy and equipment expenses decreased $239,000 or 12% compared to 2011 as a result of certain subleases that took effect in 2012.

Communications and technology expense includes market data and quote services, voice, data and internet service fees, and data processing costs. Communications and technology expense decreased $870,000 or 45% compared to 2011 due to headcount reduction and cancellation of certain services.

Depreciation and amortization relate to the depreciation of our fixed assets and amortization of leasehold improvements. Depreciation and amortization are mostly fixed in nature. The decrease of approximately $105,000, or 83% compared to 2011 resulted from minimal fixed asset additions and the full depreciation of certain assets, reducing the depreciable base of assets.

Travel and business development expenses include business development costs by our sales professionals, investment bankers and non-deal road show expenses. Non-deal road shows are meetings in which management teams of our corporate clients present directly to our institutional investors. The decrease of approximately $493,000 or 55% on a year over year basis was due to lower headcount, fewer deals closed and continued cost reduction measures.

Legal services and litigation settlement expenses relate to our ongoing litigations. The decrease of $284,000 or 40% from prior year was mostly due to the fact that there was no settlement payment in 2012.

Cost of underwriting capital represents borrowing cost of capital to supplement MC's net capital to enable it to underwrite banking deals. Costs of underwriting capital increased $100,000 or 102% compared to 2011 due to certain temporary borrowings remain outstanding longer than anticipated.

The following expenses are included in other operating expenses for the years ended December 31, 2012 and 2011:

                                                         2012            2011

    Insurance                                         $   504,229     $   807,228
    Regulatory & filing fees                              220,216         320,571
    Provision for uncollectible accounts receivable       337,436          53,332
    Investor conference                                   210,317               -
    Other                                                 (10,781 )       717,753

    Total other operating expenses                    $ 1,261,417     $ 1,898,884

Other operating expenses include insurance, regulatory & filing fees, provision for uncollectible accounts receivable, investor conference and other miscellaneous expenses. The decrease of approximately $637,000 or 33% on a year over year basis was due to (i) a decrease of $303,000 in insurance due to lower coverage and higher deductibles of insurance policies, (ii) a decrease of $100,000 in regulatory & filing fees due to lower number of registered employees and lower revenue resulting in lower regulatory fee assessment, (iii) an increase of $284,000 in provision for uncollectible accounts receivable due to write-off of certain banking receivables, (iv) an increase of $210,000 in investor conference due to the fact that no investor conference was held in 2011, (v) and a decrease of $728,000 in other miscellaneous expenses primarily due to reduction in recruiting and commercial rent tax expenses.

Interest Income

Interest income represents interest earned on our cash balances maintained at financial institutions.

Amortization of Debt Discounts

In 2011 we issued various debts with stocks or warrants, for which total proceeds were allocated to individual instruments based on the relative fair values of each instrument at the time of issuance. The value of the stocks or warrants was recorded as discount on the debt and amortized over the term of the respective debt using the effective interest method.

In November and December 2011, certain debt and related warrants were exchanged for common shares and new warrants to purchase common shares. The discounts related to the debt being exchanged were written off as part of the loss recognized as a result of the transaction.

For the year ended December 31, 2012, amortization of debt discounts for the remaining debt and related warrants was $122,742.

Income Tax Expense

Income tax expenses of $0 and $6,100 were recorded in 2012 and 2011 resulting in zero effective tax rates. The effective tax rate differs from the statutory rate primarily due to the net operating loss carry-forwards offset by a 100% valuation allowance resulting in a tax provision equal to our expected current benefit for the year.

The Company accounts for income taxes under the provisions of Accounting Standards Codification ("ASC") 740 - Income Taxes. ASC 740 requires the recognition of deferred tax assets and liabilities for both the expected impact of differences between the financial statements and tax basis of assets and liabilities and the expected future tax benefit to be derived from tax loss and tax credit carry-forwards. ASC 740 additionally requires the establishment of a valuation allowance to reflect the likelihood of realization of deferred tax assets.

Critical Accounting Policies and Estimates

The consolidated financial statements are prepared in accordance with U. S. GAAP 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 are believed 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.

Revenue Recognition

Investment banking revenue includes underwriting and private placement agency fees earned through the Company's participation in public offerings and private placements of equity and convertible debt securities and fees earned as financial advisor in mergers and acquisitions and similar transactions. Underwriting revenue is earned in securities offerings in which the Company acts as an underwriter and includes management fees, underwriting fees and selling concessions. Fee revenue relating to underwriting commitments is recorded when all significant items relating to the underwriting cycle have been completed and the amount of the underwriting revenue has been determined.

Syndicate expenses related to securities offerings in which the Company acts as underwriter or agent are deferred until the related revenue is recognized or we determine that it is more likely than not that the securities offerings will not ultimately be completed. Underwriting revenue is recorded net of related expenses. As co-manager for registered equity underwriting transactions, management must estimate the Company's share of transaction related expenses incurred by the lead manager in order to recognize revenue. Transaction-related expenses are deducted from the underwriting fee and therefore reduce the revenue that is recognized as co-manager. Such amounts are adjusted to reflect actual expenses in the period in which the Company receives the final settlement, typically 90 days following the closing of the transaction.

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.

Commission revenues and related clearing expenses are recorded on a trade-date basis as security transactions occur. Principal transactions in regular-way trades are recorded on the trade date, as if they had settled. Profit and loss arising from all securities transactions entered into for the account and risk of our Company are recorded on a trade-date basis.

Fair Value of Financial Instruments

Substantially all of the Company's financial instruments are recorded at fair value or contract amounts that approximate fair value. The carrying amounts of the Company's financial instruments, which include cash and cash equivalents, securities owned, restricted cash, due from clearing broker, accounts receivable, accounts payable, commissions and bonus payable, accrued expenses and other, securities sold, not yet purchased, deferred revenue, and capital lease obligation, approximate their fair values.

Fair Value Measurement-Definition and Hierarchy

The Company follows the provisions of Accounting Standards Codification (ASC) 820, Fair Value Measurement and Disclosures, for its financial assets and liabilities. Under ASC 820, 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.

Where available, fair value is based on observable market prices or parameters, or derived from such prices or parameters. Where observable prices or inputs are not available, valuation models are applied. These valuation techniques involve some level of management estimation and judgment, the degree of which is dependent on the price transparency for the instruments or market and the instruments' complexity. Assets and liabilities recorded at fair value in the consolidated statement of financial condition are categorized based upon the level of judgment associated with the inputs used to measure their fair value. . . .

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