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

Show all filings for SUMMIT FINANCIAL SERVICES GROUP INC | Request a Trial to NEW EDGAR Online Pro



Annual Report

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

Critical Accounting Policies

General. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses. Actual results could differ from those estimates.

Clearing Arrangements. Summit Brokerage does not carry accounts for clients or perform custodial functions related to clients' securities. Summit Brokerage introduces certain of its client transactions to its Clearing Brokers, which maintain the clients' accounts and clears such transactions. These activities may expose us to significant risk in the event that clients do not fulfill their obligations with the Clearing Brokers since Summit Brokerage has agreed to indemnify the Clearing Brokers for any resulting losses. Any such client-related losses are typically charged to the client's financial advisor, as a result of such financial advisor agreeing to indemnify Summit Brokerage against such losses. In the event the financial advisor is unable or unwilling to fulfill their indemnification obligation, Summit Brokerage will bear the loss. Losses related to these types of activity have historically not been material.

Customer Claims, Litigation and Regulatory Matters. In the normal course of business as a broker-dealer, investment advisor, and insurance agent, we are subject to client-related complaints relating to the manner in which client accounts are handled by our financial advisors. When the complaint relates to the sale of securities, both Summit Brokerage and the client are typically obligated to seek resolution through arbitration. When the complaint is not client-related, or does not relate to the sale of securities, such matters will be resolved pursuant to the terms of the governing agreement or contract or, if no such agreement or contract exists, through an otherwise appropriate forum. The Company maintains various types of insurance to reduce exposure relating to possible claims, including errors and omissions insurance, directors' and officers' liability insurance and employment practices liability insurance. Due to the uncertain nature of litigation in general, we are unable to estimate with a high degree of precision a range of possible loss related to arbitration or litigation filed against us, but based on our historical experience and consultation with counsel, we reserve an amount we believe will be sufficient to cover any damages assessed against us. However, it is possible that the actual amounts required to be paid by us will exceed the reserved amount. If we misjudged the amount of damages that may be assessed against us from pending or threatened claims, or if we are unable to adequately estimate the amount of damages that will be assessed against us from claims that arise in the future and our reserves are inadequate, our income would be reduced. Furthermore, our ability to reasonably estimate the amount of damages that may be assessed may be hampered by the introduction of all lay-person arbitration panels. Industry studies have shown that such panels tend to award larger amounts to clients than those panels upon which at least one industry-associated person sits. Such costs may have a material adverse effect on our future financial position, results of operations or liquidity.

Valuation of Deferred Tax Assets. We account for income taxes in accordance with U.S. generally accepted accounting principles, which requires the recognition of tax benefits or expense on the timing differences between the tax basis and book basis of assets and liabilities. Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those timing differences are expected to be recovered or settled. Deferred tax assets as of December 31, 2012, which consisted principally of unrecognized stock-based compensation, the amortization of client list and goodwill and the net effect of timing differences, amounted to approximately $1.88 million. We have determined that a valuation allowance at December 31, 2012 was necessary to fully offset such deferred tax asset based on the likelihood of future realization.

Expense Recognition of Employee Stock Options, Warrants and Deferred Stock Units. We account for all option, warrant and deferred stock unit (including those issued to both employees and non-employees of Summit Brokerage) issuances using a fair market value method. In connection therewith, we record, upon the issuance of each option, warrant and deferred stock unit, unearned stock-based compensation in an amount equal to the number of shares covered by the option, warrant and deferred stock unit multiplied by the fair value per option, warrant or deferred stock unit. The amount recorded as unearned stock-based compensation is then amortized over the vesting period of the option, warrant or deferred stock unit. Consequently, the total expense recognized in the current period represents the amortized portion, if any, of the fair value of all outstanding options, warrants and deferred stock units (net of recaptures, if any).

See the notes to our Consolidated Financial Statements included elsewhere in this Annual Report for additional information concerning our accounting policies.

The following discussion and analysis of our financial condition and results of its operation for the fiscal years ended December 31, 2012 and 2011 should be read in conjunction with our Consolidated Financial Statements included elsewhere in this Annual Report.

When used in the following discussions, the words "believes," "anticipates," "intends," "expects," and similar expressions are intended to identify forward-looking statements. Such statements are subject to certain risks and uncertainties, which could cause results to differ materially from those anticipated or projected, including, but not limited to, those set forth in "Factors That May Affect Future Results and Market Price of Our Stock" set forth below.

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Certain amounts from the prior periods have been reclassified to conform to the current year's presentation.


Summit Financial Services Group, Inc., through its primary operating subsidiary, Summit Brokerage Services, Inc., provides full-service securities brokerage through a network of approximately 300 producing financial advisors serving retail and, to a much lesser extent, institutional client accounts. With the exception of our Boca Branch, which we acquired from Wachovia Securities Financial Network in January 2003, our approximately 225 other branch offices are owned and operated by independent owners, who maintain appropriate licenses and are responsible for all office overhead and expenses. This arrangement allows us to operate with a reduced amount of fixed costs and lowers the risk of operational losses for non-production. Because these independent operators, many of whom are financial planners, are required to pay their own expenses, we generally pay them a much greater percentage of the commissions and fee income they generate, typically 80%-90%.

Summit Brokerage is registered as a broker-dealer with the SEC, is a member of FINRA, the MSRB, the NFA and SIPC, and is licensed to conduct its brokerage activities in all 50 states, plus the District of Columbia. SFG, our investment advisory firm, is registered or eligible to conduct business as an investment advisor in 37 states and the District of Columbia. SBSIA, our subsidiary insurance agency, directly or through its subsidiary entities, is licensed to sell insurance, or is not required to be so licensed, in all jurisdictions where the Company conducts its brokerage activities.

Our financial advisors offer a broad range of investment products and services. These products and services allow us to generate both commissions (from the purchase and sale of securities and other investment transactions) and fee income (for providing investment advisory services, namely managing a client's account). The investment products and services offered include mutual funds, annuities, insurance, individual stocks and bonds, and managed money accounts. The following table reflects the various sources of revenue and the percentage of total revenues for each of the last two fiscal years:

                                             2012                        2011
       Insurance related products   $ 24,666,110        34 %    $ 22,730,678        33 %
       Investment advisory fees       14,101,056        19        13,068,786        19
       Mutual funds                   12,300,777        17        10,628,791        16
       Equities                        9,703,751        13        10,305,219        15
       Other commission revenue        7,436,453        10         6,617,827        10
       Other revenue                   4,029,863         6         3,647,486         5
       Interest and dividends            998,490         1         1,117,219         2

       Total                        $ 73,236,500       100 %    $ 68,116,006       100 %

Summit Brokerage is a fully disclosed broker-dealer, and therefore relies on its Clearing Brokers to provide the back office support and transaction processing services necessary to effect transactions on all principal national and international securities exchanges. Additionally, because the Clearing Brokers provide us with access to many other financial products and services that we would not otherwise be able to offer, we are able to provide our clients with products and services comparable to much larger brokerage firms. In exchange for providing these services, the Clearing Brokers typically charge us a fee every time they effect a transaction on behalf of the firm or its clients.

In 2012 and 2011, we reported gross revenues and net income of $73.2 million and $1.59 million and $68.1 million and $1.46 million, respectively. During 2012, our revenues and earnings grew as a result of the ability to successfully recruit financial advisors during 2012 and the latter part of 2011, as well as due to an increase in the average production of those financial advisors that had been with us for at least 18 months prior to the end of 2012. Prospectively, we continue to believe that events that trigger the loss of investor confidence, including as a result of economic problems and uncertainty within the European Union (including Greece, Italy and Cyprus), the geopolitical uncertainty of the Middle East and the increase in oil prices, continued political instability in North Korea, and concerns of a faltering domestic economy, including the sequester, will negatively impact our results of operations. We may also be unable to sustain the same level of growth in financial advisors as we experienced in prior years, especially if the factors that permitted such growth are in any way diminished.

In addition to the factors described above, our operating results in 2013 and beyond may be negatively impacted by several other factors, including, but not limited to, increased costs required to become compliant with the extensive regulatory reforms recently enacted (as well as proposed reforms), the potential loss of revenue sources related to such regulatory reforms, Summit Brokerage's decision to focus on expanding its marketing and recruiting efforts, and an overall reduction of margins on an industry-wide basis.

Although we expect our results, in general, to be impacted by macroscopic forces, such as the state of the economy, as well as overall market conditions and investor confidence, we may experience fluctuations in our revenue that do not follow such trends, or mirror trends experienced by the financial services industry as a whole. This is because, given our size, we may add, or lose, financial

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advisors who generate a significant amount of commissions from the sale of a particular type of investment product. As we grow larger, we anticipate that the ability of any branch office to impact the overall revenue mix will be diminished. However, due to our size, it is possible that the addition or loss of financial advisors (and their clients), who focus on certain products over other products, will be a factor in causing fluctuations in our revenue and/or revenue mix from period to period, which may not be representative of results in other periods or reflective of general market conditions or economic trends.

Our business plan is focused primarily on increasing our network of affiliated financial advisors, which permits us to expand our base of revenue and our network for the retail brokerage of securities without the capital expenditures that would be required to open Company-owned offices and the additional administrative and other costs of hiring financial advisors as in-house employees. As was the case with the Boca Branch, however, we may evaluate potential acquisitions, including those that would result in acquired financial advisors becoming employees of Summit Brokerage. Typically, Summit Brokerage has recruited offices comprised of between one and three financial advisors. Prospectively, we expect to continue to recruit smaller offices, although we may target larger offices comprised of many financial advisors. Because of the size of larger offices, we may be required to pay a greater percentage of the offices' commissions than we would pay to a smaller office. As a result, if we are successful in acquiring a larger office, of which no assurance can be given, we may experience a potential decline in our gross margin percentage.

By their nature, our business activities are highly competitive and are subject to, among other things, general market conditions, including the volatility of the trading markets and the attractiveness of various forms of investment products. Although the markets have recently enjoyed all-time highs, our revenues and net income are subject to substantial positive and negative fluctuations due to a variety of factors that cannot be predicted with great certainty and may result in revenues and net income (or losses) in any particular period that may not be representative of future results and may vary significantly from period to period. Furthermore, we have determined that our long-term growth strategy can best be maximized through the reinvestment of a portion of our earnings into the development of our infrastructure and recruiting and business development efforts, including through the payment of upfront amounts to advisors. As a result, our future earnings may be significantly less than in prior years.

Results of Operation

The following discussion relates to the results of operations for the fiscal year ended December 31, 2012 ("2012"), compared to the results of operations for the fiscal year ended December 31, 2011 ("2011"). All amounts are rounded.

Comparison of Fiscal Years Ended December 31, 2012 and 2011


Commission revenue of $68.21 million for 2012 represents an increase of $4.86 million, or 8%, over the $63.35 million of commission revenue reported for 2011. During 2012, our revenues and earnings grew as a result of the ability to successfully recruit financial advisors during 2012 and the latter part of 2011, as well as due to an increase in the average production of those financial advisors that had been with us for at least 18 months prior to the end of 2012.

In any period, our mix of business will be impacted by several factors, including, among other things, investor confidence, as reflected by the movements of the equities markets, and the attractiveness of non-equity-related investment products, such as fixed income securities. Additionally, during any period, we may add, or lose, a significant number of financial advisors who focus only on the sale of a particular type or types of investment product(s) (e.g., insurance, equities, fixed income, etc.).

Interest and dividend income decreased by $120,000, or 11%, from $1.12 million in 2011 to $998,000 in 2012. Interest and dividend income is comprised primarily of that portion of the interest income earned from, and the interest expense charged to, clients of Summit Brokerage that are received from our Clearing Brokers. As interest rates and yields have declined, so has the amount that Summit Brokerage received. During 2012, the percentage paid to Summit by one of its Clearing Brokers was reduced from prior year levels. That same Clearing Broker has advised the Company of an additional reduction for 2013. Going forward, we believe that the likelihood of additional reductions is great should interest rates remain at their low levels. Unless Summit Brokerage is able to offset these decreases with proportionate increases in the balances upon which such amounts are earned, our earnings will continue to be negatively impacted, as was the case in each of 2011 and 2012. A significant reduction in such overall compensation may have a material, adverse impact on the Company's operating results.

Other revenue increased by approximately $380,000, or 10%, from $3.65 million in 2011 to $4.03 million in 2012. Other revenue represents fees generated by the Company primarily from providing services and administration and acting as a principal in certain fixed income transactions.

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Commissions and related costs increased to $58.14 million in 2012, representing an increase of $4.09 million, or 8%, over the $54.05 million reported in 2011. In general, commissions and related costs are directly related to commission revenue, and will typically increase or decrease proportionately as commission revenue rises or falls. Commissions and related costs, as a percentage of commission revenue, decreased slightly in 2012 to 85.2% from 85.3% in 2011. Prospectively, this amount may increase as we recruit more independent financial advisors. Because our independent financial advisors are responsible for the payment of all costs associated with operating their offices, we must pay them a higher percentage of the commissions they generate (typically 80% to 90%), than we pay to those financial advisors working from the Boca Branch, where Summit pays the costs associated with operating the Boca Branch. In addition to the commission expense we pay to our financial advisors, we also include certain costs that are either billed, or credited, to Summit Brokerage by its Clearing Brokers, other than those related to clearance and execution.

Employee compensation and benefits increased to $6.50 million in 2012, which represents an increase of $.26 million, or 4%, over the $6.24 million reported for 2011. This increase is due primarily to an increase in salaries, as well as non-discretionary bonus payments. Also included with employee compensation and benefits is the cost we recognize related to the issuance of common stock and equivalents (e.g., options) to our employees. For 2012 and 2011, a total of $584,000 and $577,000, respectively, was expensed (net of recaptured amortization), all of which related to the amortization of unearned stock-based compensation.

Occupancy and equipment costs increased to $778,000 in 2012, which represents an increase of $45,000, or 6%, from the $733,000 reported for 2011. This increase was due primarily to the annual increase in common area maintenance costs passed through by our landlord, as well as to costs that we incurred in connection with our efforts to create a paperless office environment.

Communications costs decreased by $70,000, or 13%, to $457,000 during 2012 from $527,000 during 2011. This decrease in costs was due primarily to enhancements to the Company's technology infrastructure during 2011, including its website.

Depreciation and amortization expense increased to $203,000 in 2012, which represents an increase of $20,000, or 10%, from the $183,000 reported for 2011. This increase was due primarily to the addition of software during 2012 and the second half of 2011.

Other operating expenses include the general and administrative costs incurred by us, to the extent such costs are not included elsewhere. Other operating expenses increased by $260,000, or 7%, to $3.83 million during 2012 from $3.57 million for 2011. During 2012, professional fees and other costs increased, by $244,000, or 72%, from $337,000 in 2011 to $581,000 in 2012. This increase was due primarily to an increase in legal fees and accrued litigation/settlement costs. The costs that we pay for insurance also increased, to $659,000 in 2012 versus $582,000 in 2011, representing an increase of 13%. These increases in costs were only partially offset by a decrease in certain costs that we pay to acquire and retain financial advisors. During 2012, these costs decreased by $70,000, or 4%, from $1.71 million in 2011 to $1.64 million in 2012. We also include within other operating expenses the costs related to the issuance of common stock and equivalents to our independent financial advisors. For 2012 and 2011, a total of approximately $149,000 and $133,000, respectively, was expensed (net of recaptured amortization) for such issuances, all of which related to the amortization of unearned stock-based compensation.

Net Income:

For 2012, we reported net income of $1.59 million, or $0.06 per basic share and $0.05 per diluted share. For 2011, we reported net income of $1.46 million, or $0.05 per basic share and diluted share. Our performance in 2012 was positively impacted by an increase in commission revenues resulting primarily from an increase in the average production per financial advisor.

Liquidity and Capital Resources

Net cash provided by operating activities totaled $2.34 million in 2012, compared to $1.71 million during 2011. Net cash provided by operating activities represents net income adjusted for certain non-cash expenses such as depreciation and amortization. Net cash provided by operations is also impacted by changes in the balances of current assets and liabilities (exclusive of cash and equivalents). Although non-cash expenses were approximately the same in both 2012 and 2011, the net change in the balances of current assets and liabilities was significantly different in 2012 compared to 2011. For 2012, the net change in current asset and liability accounts resulted in a reduction of $380,000 when computing net cash provided by operations, compared with a net reduction of $857,000 for 2011. Cash and cash equivalents decreased during 2012 by $2.82 million to $7.97 million.

During 2012, we purchased $68,000 of property and equipment, compared to $192,000 purchased during 2011. For 2013, the Company does not anticipate incurring significant capital expenditures for furniture, equipment and leasehold improvements.

Financing activities resulted in a net use of cash of approximately $5.10 million during 2012. During 2011, financing activities used net cash of $170,000. The primary reason for the decrease in cash provided by financing activities was the purchase and retirement (as well as the termination of certain rights held by Antares, including Stock Purchase Rights, Registration Rights, Co-Sale and Voting Rights and Board Participation Rights), during 2012, in privately negotiated transactions, of 6.56 million shares of our common stock from shareholders for $5.15 million. During 2012, options were exercised for aggregate consideration of $162,000, which proceeds were partially offset by the payment and accrual of $15,000 in Preferred Stock dividends. This compares with aggregate proceeds from the exercise of options and warrants of $257,000 during 2011, which was partially offset by the payment and accrual of $15,000 in Preferred Stock dividends.

In the normal course of business, we evaluate acquisitions of businesses that complement our business. In connection with any acquisitions, we may issue additional securities, which could result in dilution for existing shareholders.

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Inflation. Inflation has not been a major factor in our business since inception. There can be no assurances that this will continue.

Significant Business Relationships

Since 1994, we have had a clearing agreement with First Clearing Corporation, an affiliate of Wells Fargo & Company, to execute securities orders and maintain accounts for clients on behalf of Summit Brokerage and its clients. On March 19, 2008, we entered into a clearing agreement with Pershing LCC (a division of the BNY Mellon) to provide clearing services in addition to First Clearing Corporation. In the event a Clearing Broker were to cease doing business with us, our ability to execute transactions on behalf of, and provide a full range of services to, our clients could be negatively impacted, which could, in turn, have a material adverse effect on both our revenues and earnings.

Factors That May Affect Future Results and Market Price of Our Stock

We operate in a rapidly changing environment that involves numerous risks, some of which are beyond our control. The following discussion highlights some of these risks.

There can be no assurance that we will continue to operate profitably in the future. Although the Company has reported an after-tax profit in every year but one since 2004, we cannot assure you that we will continue to sustain profitability, or that, even if we generate net income, that our cash flow from operations will be sufficient to allow us to fully execute our strategy for the reasons further described in this Annual Report on Form 10-K.

Our business could be harmed by market volatility, declining investor confidence, declines in general economic conditions and other securities industry risks. As a provider of financial products and services, we are affected by economic and political conditions over which we have no control. These conditions may directly and indirectly impact a number of factors that may be detrimental to our operating results, including reduced investor confidence, a slowdown in economic activity, declining or volatility in interest rates, and changes in volume and price levels of the securities markets. Although the markets have recently enjoyed all-time highs, these types of conditions have historically resulted in a reduction in the value and attractiveness of certain types of investments, which will negatively impact our operating results. In periods during major stock market declines, many firms in the securities industry suffer financial losses, and the level of individual investor confidence (and trading activity) decreases after these events as many investors leave the equity market for real estate or other investments. When investor confidence and trading volume is low, our profitability is adversely affected because a portion of our costs do not vary with revenue. For these reasons, severe market fluctuations can have a material adverse effect on our business, financial condition and operating results. Some of our competitors with more diversified business lines and/or greater financial resources might withstand a downturn in the securities industry better than we could.

In addition, declines in the market value of securities generally result in a decline in revenues from fees based on the asset values of client portfolios, and in the failure of Summit Brokerage's clients to fulfill their credit and settlement obligations. Summit Brokerage permits its clients to purchase securities on margin. During periods of steep declines in securities prices, the value of the collateral securing client accounts margin purchases may drop below the amount of the purchaser's indebtedness. If the clients are unable or unwilling to provide additional collateral for these loans, Summit Brokerage may lose money on these margin transactions because it is required to indemnify its Clearing Brokers. This may cause Summit Brokerage to incur additional expenses . . .

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