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SFNS > SEC Filings for SFNS > Form 10-Q on 15-May-2013All Recent SEC Filings

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Form 10-Q for SUMMIT FINANCIAL SERVICES GROUP INC


15-May-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of the Company's financial condition and results of its operations for the three-month periods ended March 31, 2013 and 2012 should be read in conjunction with the Company's condensed consolidated financial statements included as Item 1 herein. When used in the following discussions, the words "believes," "anticipates," "intends," "expects," and similar expressions are intended to identify forward-looking statements. As further explained in the section entitled "Forward Looking Statements" on page 2 herein, such statements are subject to certain risks and uncertainties, which could cause results to differ materially from those projected.

Overview

The Company is a Florida-based financial services holding company that provides, through its Summit Brokerage Services, Inc. ("Summit Brokerage") operating subsidiary, a broad range of securities brokerage and investment services primarily to individual investors. Summit Brokerage also sells insurance products, predominantly fixed and variable annuities and life insurance, under licenses held by its SBS Insurance Agency of Florida, Inc. ("SBSIA") subsidiary (or by SBSIA's subsidiary entities). Summit Brokerage also provides, through its SEC-registered investment advisor subsidiary, Summit Financial Group, Inc. ("SFG"), asset management and investment advisory services. SFSG was incorporated under the laws of the State of Florida in 2003.

Summit Brokerage is registered as a broker-dealer with the SEC, is a member of the Financial Industry Regulatory Authority ("FINRA") (f/k/a National Association of Securities Dealers, Inc. ("NASD")), the Municipal Securities Rule Making Board ("MSRB"), the National Futures Association ("NFA") and the Securities Investor Protection Corporation ("SIPC"), and is licensed to conduct its brokerage activities in all 50 states, plus the District of Columbia. SFG is registered or eligible to conduct business as an investment advisor in 37 states and the District of Columbia. SBSIA, 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.

As of April 30, 2013, we had approximately 300 financial advisors operating from approximately 225 offices located throughout the United States. Our financial advisors service retail, and to a much lesser extent, institutional clients. The number of financial advisors in each affiliate office typically ranges from one to five, although the number of financial advisors in certain offices may exceed this amount. With the exception of our Boca Raton, Florida branch (the "Boca Branch"), all of our branch offices and satellite locations are owned and operated by independent owners, whom we refer to as affiliates, who maintain all appropriate licenses and are responsible for all of their respective office overhead and expenses. Our financial advisors offer a broad range of investment products and services. These products and services allow us to generate both commissions (from transactions in securities and other investment products) 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. Historically, many of our affiliates have also provided financial planning services to their clients, wherein the financial advisor evaluates a client's financial needs and objectives, develops a detailed plan, and then implements the plan with the client's approval. When the implementation of such objectives involves the purchase or sale of securities (including the placement of assets within a managed account) such transactions are effected through Summit Brokerage, for which we earn either a commission or a fee. The following table reflects the various sources of revenue and the percentage of total revenues for the three-month periods ended March 31, 2013 and 2012:

                                           For The Three Months Ended March 31,
                                             2013                        2012
       Insurance-related products   $  6,368,097        30 %    $  6,103,307        34 %
       Investment advisory fees        4,132,907        19         3,380,013        19
       Equities                        3,112,124        14         2,553,734        14
       Mutual funds                    2,920,118        13         2,459,287        13
       Other commission income         3,852,742        18         2,553,359        14
       Miscellaneous                   1,293,402         6         1,109,653         6


       Total                        $ 21,679,390       100 %    $ 18,159,353       100 %

We do not hold any funds or securities of our customers, but instead utilize, on a fully disclosed basis, the services of First Clearing, LLC (an affiliate of Wells Fargo & Company) and Pershing, LLC (an affiliate of the Bank of New York Mellon) as our clearing brokers (the "Clearing Brokers"). Our clearing arrangements provide us with back-office support, transaction processing services on all principal national and international securities exchanges, and access to many other financial services and products. These arrangements allow us to offer a range of products and services that are generally offered only by firms that are larger and have more capital than Summit Brokerage.

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. Consequently, our revenues and net income or loss are subject to substantial positive and negative fluctuations due to a variety of factors that cannot be determined from period to period. Furthermore, our mix of business in any particular period will be impacted by several factors, including the attractiveness of any particular type of investment when compared with other types of investments, and the types of investments sold by newly added financial advisors to our Company, many of whom specialize in the sale of specific types of investment products.

In general, our financial results can be impacted by a number of factors, including general market conditions and volatility, as well as our ability to recruit and retain financial advisors. During the three-month period ended March 31, 2013, our revenues were positively impacted by an increase in the average production per financial advisor when compared with the comparable 2012 period. This increase in average production per financial advisor was due primarily to an improvement in investor confidence (as evidenced by the significant increase in the major market indices during that period to near or at all-time highs) and the related increase in investing activity, which served to increase our commission and fee revenue. Alternatively, in periods of general market declines, our commission and fee revenue may be lower, thereby negatively impacting our operating results.

Although we expect our results, in general, to be impacted by macroeconomic 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 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.


Table of Contents

Broker-dealers, and their affiliated registered representatives, operate in a highly regulated industry. For 2013 and beyond, we expect our operating results to be impacted by the continued increase in the rules and regulations that govern how we and our advisors are required to conduct business. Many of these new rules, which were designed in response to the factors leading up to the market turmoil of 2008, as well as the Madoff scandal and other instances of corporate fraud, will require Summit Brokerage to devote considerable resources to their implementation, and subsequent monitoring. Significant new rules and regulations have and are being implemented under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act"), which was enacted in July 2011. Compliance with these provisions, as well as other regulatory initiatives, has resulted in, and is likely to continue to result in, increased costs. Moreover, to the extent the Dodd-Frank Act and other regulations impact the operations, financial condition, liquidity and capital requirements of financial institutions with which we do business, those institutions may seek to pass on increased costs, reduce their capacity to transact, or otherwise present inefficiencies in their interactions with us. In addition, changes in regulations may have the effect of reducing certain types of compensation received by Summit Brokerage, such as the SEC's consideration of a rule that would limit the amount of 12b-1 fees that could be paid to a broker-dealer.

For the balance of 2013, we expect to continue to focus our business plan on increasing our network of affiliated financial advisors, primarily through recruiting efforts. Although we will continue to attempt to recruit those financial advisors who serve as financial planners (who sell primarily annuities, insurance, mutual funds and fee-based products), we also intend to pursue the addition of financial advisors who focus on the sale of different types of products and securities, namely investment advisory services and equity and fixed income products. Because of the numerous factors influencing a financial advisor's decision to affiliate with us, there can be no assurance that we will be successful in our recruiting efforts. We may also pursue mergers with, or the acquisition of the assets of, other brokerage firms. Our ability to realize growth through acquisitions, however, will depend on the availability of suitable broker-dealer candidates and our ability to successfully negotiate favorable terms (from both sellers, as well as financing sources, if necessary), and there can be no assurance that we will be able to consummate any such acquisitions. Further, there are costs associated with the integration of new businesses and personnel, which may be more than we anticipate at that time. Thus, there is no assurance that we will be able to successfully execute such growth strategy.

As we continue to grow, we may also incur increases in expenses related to, among other things, commission expense (for financial advisors receiving accelerated payouts), marketing and recruiting, personnel, office space, compliance, and the amortization of forgivable loans provided to newly recruited financial advisors. There can also be no assurance that any increase in the Company's overall gross margin from revenue growth will be sufficient to offset any increased expenses, or that the Company's current gross margin (as both a percentage of total revenues, as well as in absolute dollars) will not otherwise be adversely affected by factors beyond the control of the Company. For example, recent legislation, as well as initiatives undertaken by the regulatory agencies charged with overseeing the financial services industry, will have the effect of not only reducing sources of revenue to the Company, but also increasing the cost of compliance. Furthermore, the Company's strategy of reinvesting a portion of its earnings into the development of its infrastructure and its recruiting and business development efforts, including through the payment of upfront amounts to financial advisors, may negatively impact our future earnings should our future revenue growth be less than anticipated.

To a large extent, the Company is subject to the same types of risks inherent within the retail financial services industry as a whole. For example, clients that purchased fixed income securities such as bonds through their financial advisors may find that the value of these bonds may decrease substantially in the event of a significant rise in interest rates. Despite suitability determinations and extensive disclosure to clients about the risks and rewards of such investments, the resulting declines in value could have negative consequences to the Company.

Based on our anticipated level of operating activities, we believe that our operations and current capital resources will be sufficient to fund our working capital needs through 2013. However, depending on the size and terms of any transaction, our strategy of growth through acquisitions may necessitate additional debt and/or equity financing, although there can be no assurance that this will happen. Our failure to obtain sufficient financing for this purpose could have a material adverse effect on our ability to execute our growth strategy to the extent desired.

Results of Operations

The following discussion relates to the results of operations for the three months ended March 31, 2013 (the "2013 Quarter") and the comparable period in the prior year (the "2012 Quarter"). All amounts are approximate unless otherwise indicated.

Comparison of Three Months Ended March 31, 2013 and March 31, 2012

Revenue:

Commission revenue of $20.4 million for the 2013 Quarter represents an increase of $3.4 million, or 20%, over the $17.0 million of commission revenue reported for the 2012 Quarter. For the 2013 Quarter, our revenues were positively impacted by an increase in the average production per financial advisor affiliated with the Company during the 2013 Quarter compared with the 2012 Quarter. This increase in average production per financial advisor was due primarily to an improvement in investor confidence (as evidenced by the significant increase in the major market indices during that period to near or at all-time highs) and the related increase in investing activity, which served to increase our commission and fee revenue.

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 dividends decreased by $66,000, or 24%, from $272,000 in the 2012 Quarter to $206,000 in the 2013 Quarter. 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. This decline is due to an overall reduction in the interest income earned by our Clearing Brokers resulting from the overall decline in interest rates. As a result, the amounts received by Summit Brokerage have declined over amounts received in prior periods. 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 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 $250,000, or 30%, from $837,000 in the 2012 Quarter to approximately $1.1 million in the 2013 Quarter. This increase is due primarily to an increase in certain non-commission related income, as well as in the reimbursements we receive from our financial advisors related to transaction costs, various technology products and certain types of insurance.


Table of Contents

Expenses:

Commissions and related costs increased to $17.1 million in the 2013 Quarter, which represents an increase of $2.6 million, or 18%, from the $14.5 million reported for the 2012 Quarter. 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 in the 2013 Quarter to 84.1% from 85.1% in the 2012 Quarter. Commissions and related costs as a percentage of commission revenues can also be impacted by several other factors. For example, commissions and related costs as a percentage of commission revenue may increase as a result of certain newly recruited advisors electing to take a greater payout for a limited period of time in lieu of upfront, forgivable loans. Conversely, commissions and related costs as a percentage of commission revenues would decline upon the expiration of such limited periods. The Company also includes within commissions and related costs the amortization related to the issuance of forgivable notes receivable, which amounts increased by $14,000 during the 2013 Quarter when compared to the 2012 Quarter. Prospectively, we would expect our commission expense, as a whole, to increase over the long term as we recruit more independent financial advisors, although the actual percentage in any period may be more or less than the prior period. 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 we pay the costs associated with operating the Boca Branch.

Employee compensation and benefits increased to $1.9 million in the 2013 Quarter, which represents an increase of approximately $175,000, or 11%, from the $1.7 million reported for the 2012 Quarter. Additionally, we include within employee compensation and benefits the amortization of unearned stock-based compensation related to the issuance of common stock equivalents, such as options and warrants, to our employees. For the 2013 and 2012 Quarters, a total of $179,000 and $259,000, respectively, was expensed (net of recaptured amortization).

Occupancy and equipment costs increased by 2%, or $4,400, to $195,000 in the 2013 Quarter from $190,000 in the 2012 Quarter. This increase was due primarily to rent and common area maintenance costs associated with the Company's home office.

Communications expense decreased by $3,000, or 3%, to $111,000 in the 2013 Quarter from $114,000 in the 2012 Quarter, due primarily to decreased telecommunications and website development and maintenance costs.

Depreciation and amortization expense decreased by $7,000, or 14%, to $44,000 for the 2013 Quarter from $50,000 in the 2012 Quarter.

Other operating expenses include the general and administrative costs incurred by the Company, to the extent such costs are not included elsewhere. Other operating expenses increased by $145,000, or 18%, to $937,000 during the 2013 Quarter from $792,000 for the 2012 Quarter. During the 2013 Quarter, increases in legal and litigations costs of $200,000 and the reserve for certain amounts due from advisors of $65,000 were only partially offset by decreases in advertising and other promotional costs of $54,000 and the costs we pay to consultants of $40,000. Additionally, we include within other operating expenses the amortization of unearned stock-based compensation related to the issuance of common stock equivalents, such as options and warrants, to non-employees. For the 2013 and 2012 Quarters, a total of $40,000 and $53,000, respectively, was expensed (net of recaptured amortization).

Provision for income taxes was $651,000 and $340,000 for the 2013 and 2012 Quarters, respectively, representing an effective tax rate of 49% and 45%, respectively. Our provision for income taxes in any period will be affected by, among other things, permanent, as well as temporary differences in the deductibility of certain items, including stock-based compensation and the amortization of intangible assets.

Net Income:

For the 2013 Quarter, we generated net income of $674,000, or $0.03 per basic and diluted share, as compared to net income for the 2012 Quarter of $417,000, or $0.02 per basic and $0.01 per diluted share. Earnings per share increased not only as a result of an increase in the Company's net income, but also as a result of the repurchase and retirement, during 2012, of 6.56 million shares of the Company's common stock.

Liquidity and Capital Resources

Cash provided by, or used in, operating activities for any period includes the net income for that period adjusted for non-cash items and the effects of changes in working capital. Net cash provided by operating activities during the 2013 Quarter totaled $1.3 million compared to $592,000 for the 2012 Quarter. This increase was primarily due to higher net income of $674,000 for the 2013 Quarter increased by non-cash adjustments of $219,000 related to net stock-based compensation, $50,000 related to the amortization of advisor notes, $44,000 related to depreciation and amortization and $361,000 as a result of the net changes in certain balance sheet accounts.

Net cash used in investing activities during the 2013 Quarter was $22,000 compared to $9,000 for the 2012 Quarter. This represented the purchase of property and equipment.

Net cash provided by financing activities during the 2013 Quarter was $21,000, resulting from the receipt of $25,000 from the exercise of stock options. The receipts were partially offset by the payment of $4,000 in dividends on our Series A Preferred Stock. For 2012 Quarter, net cash provided by financing activities totalled $51,000, resulting from the receipt of $55,000 from the exercise of stock options and warrants, less $4,000 for the payment of dividends on our Series A Preferred Stock.

Overall, cash and cash equivalents increased during the 2013 Quarter by approximately $1.3 million to approximately $9.3 million at March 31, 2013 from approximately $8.0 million at December 31, 2012. This increase was due primarily to cash provided by operations, as described above.

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