Attached files
| file | filename |
|---|---|
| EX-31.2 - SECTION 302 CERTIFICATION OF CHIEF FINANCIAL OFFICER - Terra Nova Financial Group Inc | terra10q093009ex312.htm |
| EX-31.1 - SECTION 302 CERTIFICATION OF CHIEF EXECUTIVE OFFICER - Terra Nova Financial Group Inc | terra10q093009ex311.htm |
| EX-32.1 - SECTION 906 CERTIFICATION OF CHIEF EXECUTIVE AND FINANCIAL OFFICER - Terra Nova Financial Group Inc | terra10q093009ex321.htm |
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
___________________
FORM 10-Q
___________________
For the quarterly period ended September 30, 2009
OR
For the transition period from _____ to _____
Commission file number 000-24057
Terra Nova Financial Group, Inc.
(Exact name of registrant as specified in its charter)
100 South Wacker Drive, Suite 1550
Chicago, Illinois 60606
(Address of principal executive offices, including zip code)
(312) 827-3600
(Registrant's telephone number)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 under the Act). Yes o No x
The number of shares of common stock, $0.01 par value per share, outstanding was 25,054,508 as of November 1, 2009.
Table of Contents
Item 1. Unaudited Condensed Consolidated Financial Statements
3
Table of Contents
4
Table of Contents
5
Table of Contents
Note 1 - Nature of Operations and Basis of Presentation
Nature of Operations
Terra Nova Financial Group, Inc., an Illinois corporation, ("Parent", and collectively with its wholly-owned subsidiaries, the "Company," "firm," "we," "us," or "our"), is a holding company of businesses providing a range of products and services to the professional trading community. The Company has three primary subsidiaries: Terra Nova Financial, LLC ("Terra Nova"), a broker-dealer registered with the Securities and Exchange Commission and a member of Financial Industry Regulatory Authority, provides execution, clearing and prime brokerage services to professional traders, hedge funds and money managers; Tradient Technologies, Inc. ("Tradient"), a financial technology development business, provides proprietary applications for electronic trade execution, order routing and clearing; SC QuantNova Research SRL ("QuantNova"), based in Bucharest, Romania, provides software development, architecture and engineering for Tradient and back office clearing systems. Terra Nova Financial Group, Inc. trades under the stock symbol "TNFG" and is listed on the OTC Bulletin Board.
Terra Nova is registered with the following exchanges, registered clearing agencies, and regulatory organizations:
Regulatory and Self Regulatory Organizations:
Registered Clearing Agencies:
U.S. Equity Exchanges:
U.S. Option Exchanges:
Investor Protection:
Terra Nova offers a broad array of services for the execution and clearing of trading products including equities, options, futures and commodity options, ETFs, fixed income and mutual funds as well as prime brokerage, clearing and back office services for institutions. Terra Nova serves a diverse client base of professional traders, hedge funds, money managers, correspondent introducing brokers, registered representatives, registered investment advisors and foreign brokers located in the United States and in certain foreign countries. Primary sources of revenue for Terra Nova include commissions, account fees and interest.
Tradient, a wholly-owned subsidiary of the Parent, is a technology development entity that builds applications for electronic trade execution, order routing and clearing. Tradient applications are marketed to broker-dealers, institutional portfolio managers and traders. Primary sources of revenue for Tradient include software licensing and order routing fees.
Table of Contents
QuantNova, a wholly-owned subsidiary of the Parent, provides consulting, software development, electronic data processing, software architecture and engineering for the Tradient trading platforms and backoffice clearing software. QuantNova is based in Bucharest, Romania and as of September 30, 2009 has eight full-time employees.
The Parent also maintains the following wholly-owned subsidiaries:
Basis of Presentation
The accompanying condensed consolidated financial statements should be read in conjunction with the consolidated financial statements of Terra Nova Financial Group, Inc. and notes to the consolidated financial statements included in the Annual Report on Form 10-K of Terra Nova Financial Group, Inc. for the year ended December 31, 2008.
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and in accordance with the instructions to Form 10-Q and Articles 8 and 10 of Regulation S-X. Accordingly, certain notes and other information normally included in financial statements prepared in accordance with United States generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, all adjustments (consisting only of normal recurring adjustments), necessary to present fairly the condensed consolidated financial position of Terra Nova Financial Group, Inc. and subsidiaries as of September 30, 2009 and the consolidated results of their operations and cash flows for each of the periods presented have been recorded. The results of operations and cash flows for an interim period are not necessarily indicative of the results of operations or cash flows that may be reported for the year or any subsequent period.
Note 2 - Summary of Significant Accounting Policies
(a) Consolidation Policy
The accompanying condensed consolidated financial statements include the accounts of the Parent and its wholly-owned subsidiaries. All significant intercompany transactions have been eliminated in consolidation.
(b) Fair Value of Financial Instruments
The carrying amounts of the Company's short term financial instruments, which consist of cash and cash equivalents, cash segregated in compliance with federal regulations, receivables from brokers, dealers and clearing organizations, receivables from customers and non-customers, payables to brokers, dealers and clearing organizations, payables to customers and non-customers and accounts payable and accrued expenses approximate their fair value due to their short term nature.
(c) Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported financial statement amounts and disclosures. Actual amounts could differ from those estimates.
(d) Foreign Currency Translation
The local currency of the Company's foreign operations, QuantNova, is considered to be its functional currency. Assets and liabilities of foreign operations are translated using quarter-end exchange rates and revenues and expenses are translated using average exchange rates in effect during the month with the resulting adjustment, if material, included in other comprehensive income (loss). To date, foreign currency translation adjustments have been immaterial.
(e) Cash and Cash Equivalents
The Company classifies all highly liquid investments with an original maturity of three months or less as cash equivalents. Cash and cash equivalents consist primarily of cash held in liquid commercial bank accounts or clearing organization accounts paying a "money market" rate of interest. The Company also has a sweep account which deposits excess operating bank balances overnight into a money market account.
7
Table of Contents
(f) Cash Segregated in Compliance with Federal Regulations
Cash segregated in compliance with federal regulations is in special reserve accounts for the exclusive benefit of customers under Rule 15c3-3 of the Securities Exchange Act of 1934. We maintain special reserve accounts with multiple qualified banking institutions to mitigate credit risk. In the special reserve accounts we invest in a combination of qualified securities including short-term U.S. government securities, reverse repurchase agreements collateralized by U.S. government securities, qualified trust products, and interest bearing cash accounts. These special reserve accounts are in full compliance with all regulatory requirements.
(g) Long-Lived Assets
Long-lived assets, primarily consisting of definite lived intangible assets, property and equipment and capitalized software development costs, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. Recoverability of assets held and used is generally measured by a comparison of the carrying amount of the asset to undiscounted future net cash flows expected to be generated by that asset. If it is determined that the carrying amount of an asset may not be recoverable, an impairment loss is recognized for the amount by which the carrying amount of the asset exceeds the fair value of the asset. Fair value is the estimated value at which the asset could be bought or sold in a transaction between willing parties.
(h) Intangible Assets
The Company acquired $6,578,000 of intangible assets as part of the acquisition of Terra Nova on May 17, 2006. The acquired intangible assets comprised the values prescribed to the acquired customer list and trade name of $4,749,000 and $1,829,000, respectively. Amortization expense related to intangible assets for the nine months ended September 30, 2009 and 2008 was $1,027,613 and $1,015,281, respectively. The accumulated amortization of intangible assets as of September 30, 2009 and December 31, 2008 was $3,494,099 and $2,466,486, respectively.
(i) Receivables from Brokers, Dealers and Clearing Organizations
Receivables from brokers, dealers and clearing organizations consist primarily of securities borrowed, commissions receivable, and deposits with clearing organizations. Transactions involving borrowed securities require the Company to provide the counterparty with collateral in the form of cash. The Company adjusts this amount on a daily basis as the value of the securities borrowed may change. The Company utilizes various third-party clearing brokers for institutional, prime brokerage, equity and option clearing business and fully-disclosed futures business.
(j) Receivables from Customers and Non-Customers
Receivables from customers consist of margin loans to brokerage customers. Margin loans are secured by securities in brokerage customers accounts. Such collateral is not reflected in the condensed consolidated financial statements. Terra Nova charges interest on debit balances in brokerage customer accounts. Margin requirements determine the amount of equity required to be held in an account relative to the purchase and sale of equity transactions. Margin lending is subject to the rules and regulations of the Federal Reserve System, FINRA, exchanges, various clearing firms and the internal policies of Terra Nova. Terra Nova assumes risk that the collateral securing margin debits may reduce in value to an amount that renders the margin loan unsecured. Margin requirements are amended by Terra Nova as deemed necessary for certain accounts and securities. Terra Nova also reserves the right to close-out any and all positions in an account should it be deemed necessary to protect itself from loss. Although Terra Nova monitors risk and margin of trading accounts, there is no assurance that a customer will satisfy a margin call or pay unsecured indebtedness owed to Terra Nova. The Company has an allowance for potential credit losses based upon its assessment of specifically identified unsecured receivables and other factors. At September 30, 2009 and December 31, 2008, allowance for doubtful accounts totaled $13,500 and $15,000, respectively.
(k) Payables to Customers and Non-Customers
Customers funds are maintained in customer segregated accounts and relate to item (f) discussed above. Payables to customers are free credit balances on deposit with the Company related to its self-clearing business which, are subject to Rule 15c3-3 of the Securities Exchange Act of 1934. The customer funds have been segregated in special reserve accounts earning interest. This payable to customers does not include customer securities positions as customer owned securities represent an off-balance sheet item.
Payables to non-customers are Proprietary Accounts of Introducing Brokers ("PAIB") in accordance with the customer reserve computation set forth in Rule 15c3-3 of the Securities Exchange Act of 1934 ("customer reserve formula"). The Company has established and maintains a separate "Special Reserve Account for the Exclusive Benefit of Customers" with a bank in conformity with the standards of Rule 15c3-3 ("PAIB Reserve Account"). Cash and/or qualified securities as defined in the customer reserve formula are maintained in the PAIB Reserve Account in an amount equal to the PAIB reserve requirement.
Table of Contents
(l) Revenue Recognition
Revenues primarily consist of commission and fees, interest income and software related licensing fees. Commission revenue and related expenses on securities transactions are recorded on a settlement date basis. Other revenue consists of account and transaction fees and is recorded on a settlement date basis as security transactions occur. Software fees are charges for the use of the Company's software execution platform. Revenues from software fees are recognized on a monthly basis as services are provided to clients. Interest income is primarily generated by charges to clients on margin balances and revenue from client cash held and invested by Terra Nova as a clearing firm offset by interest paid to clients on their credit balances. Interest income and brokerage interest expense are recorded on an accrual basis as earned or incurred.
(m) Goodwill
Goodwill is tested for impairment annually on December 31 or more frequently if impairment indicators arise. The first step of this process is to identify potential goodwill impairment by comparing the fair value of the reporting unit to its carrying value. The Company estimates fair value using a combination of the market price of the Company's common equity and discounted cash flows. If the carrying value is less than fair value, the Company would complete step two in the impairment review process which measures the amount of goodwill impairment. Management tests the reasonableness of the inputs and outcomes of the discounted future cash flow analysis and the evaluation of the market price of its common equity against other available comparable market data. The entire amount of goodwill at September 30, 2009 and December 31, 2008 of $7,501,408 was created from the Terra Nova, Market Wise Stock Trading School, LLC and MW Securities acquisition in May 2006 and has been assigned to the Terra Nova reporting unit within the Brokerages Services Segment. The Company performed its annual impairment test of goodwill on December 31, 2008 and determined that there was no impairment.
(n) Line of Credit
From time to time, Terra Nova may obtain a short-term bank loan to facilitate its broker-dealer settlement and clearing operations due to customer margin debits. This short-term bank loan is fully secured with customer marginable positions.
(o) Income Taxes
The Company files a consolidated federal income tax return with its subsidiaries. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense or benefit is the tax payable or refundable for the period, plus or minus the change during the period in deferred tax assets and liabilities.
(p) Reclassifications
Certain reclassifications have been made to prior period amounts to conform to current period classifications.
(q) Recently Adopted Accounting Standards
In June 2009, the FASB established the FASB Accounting Standards Codification ("ASC") as the sole source of authoritative generally accepted accounting principles in the United States ("GAAP"). Rules and interpretive releases of the Securities and Exchange Commission ("SEC") under federal securities laws are also sources of authoritative GAAP for SEC registrants. The ASC is effective for financial statements issued for interim and annual periods ending after September 15, 2009. Accordingly, the Company has updated references to GAAP in its financial statements issued for the period ended September 30, 2009. The adoption of the ASC did not impact the Company's financial condition, results of operations or cash flows.
On May, 2009, the FASB established general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. The Company adopted this new standard during the quarter ended June 30, 2009. The adoption of this standard did not impact the Company's financial condition, results of operations or cash flows.
In December 2007, the FASB amended the business combinations accounting guidance. The amended guidance retains the underlying concepts that all business combinations are still required to be accounted for at fair value under the acquisition method of accounting, but changes the method of applying the acquisition method in a number of aspects. The amended guidance on business combinations is effective prospectively for business combinations for which the acquisition date is on or after January 1, 2009.
In April 2009, the FASB amended disclosure guidance about fair value of financial statements to require fair value disclosures for interim reporting periods. Such disclosures were previously required only in annual financial statements. The Company adopted the provisions of the amended disclosure guidance during the quarter ended June 30, 2009.
Table of Contents
Note 3 - Net Income (Loss) Per Common Share
Basic net income (loss) per common share ("EPS") is computed by dividing net income (loss) attributable to common shareholders by the weighted average common shares outstanding for the period. Diluted EPS is computed by dividing net income (loss) attributable to common shareholders by the weighted average common shares outstanding plus the additional shares that would have been outstanding if potentially dilutive shares, such as shares that would satisfy outstanding warrants and options, had been issued applying the treasury stock method.
For the three and nine months ended September 30, 2009 and September 30, 2008 the components of basic and diluted weighted average shares outstanding are as follows:
Common
stock equivalents totaling 18,132,694 and 18,004,724 for both the three and nine
months ended September 30, 2009 and September 30, 2008, respectively, are excluded
from the calculation of diluted EPS as their effect would have been anti-dilutive.
Note 4 - Capitalization
(a) Common Stock
The Company had 150,000,000 shares of common stock authorized, 25,482,942 shares issued and 25,054,508 shares outstanding as of September 30, 2009.
(b) Stock Repurchase Program
On May 1, 2009 the Company's Board of Directors authorized the Company's management to pursue repurchases of the Company's stock at the discretion of the management. This authorization allows management to purchase up to $3,000,000 of stock under the safe harbor guidelines of and pursuant to the requirements of SEC Rule 10b-18. This authorization grants discretion to the Company's management to execute the repurchase program and there is no requirement to purchase any minimum number of shares. The repurchase program is intended to continue until April 30, 2010 but may be modified or terminated by the Company's Board of Directors prior to that date. The Company repurchased a total of 428,434 shares of common stock for $272,056 during the nine months ended September 30, 2009. All such repurchased shares are included in treasury stock. The Company intends to retain the common shares repurchased under the stock repurchase program as treasury stock rather than retire the repurchased shares.
(c) Non-employee Warrants
Non-employee warrants outstanding as of September 30, 2009 totaled 14,002,170 with a weighted average exercise price of $2.79. During the nine months ended September 30, 2009 and 2008 no non-employee warrants were granted or exercised.
(d) Restricted Stock
As of September 30, 2009 and December 31, 2008, the Company had no outstanding non-vested shares related to equity incentive plans.
Note 5 - Segment Information
The Company organizes its operations into two operating segments for the purpose of making operating decisions and assessing performance. Segments have been identified based on products and services offered as well as risks assumed in a manner consistent with the data utilized by management in evaluating operations. The Company's broker-dealer related services have been included in the Brokerage Services Segment which includes Terra Nova and MW Securities. The Software Services Segment is comprised of Tradient and QuantNova, which are the Company's technology development subsidiaries. Corporate and Unallocated is not an operating segment and is comprised mainly of corporate expenses.
The assets of the Company are used primarily to support the operations of the two primary subsidiaries, Terra Nova and Tradient. The following summarizes the Company's segment information.
Table of Contents
Note 6 - Contingencies
Litigation and Claims
On September 25, 2009, a FINRA arbitration panel in the matter of Friedman v. Riverside Securities, Jordan Zaro and Terra Nova found in favor of the claimant and awarded damages together with attorneys' fees, costs and interest against the defendants who were held jointly and severally liable. The matter involved a dispute under which claimant contended that Zaro engaged in improper trades in her account. The Company accrued $285,000 in satisfaction of the judgment and is seeking indemnification and contribution from the co-defendants.
On or about September 25, 2009, Terra Nova was notified that it had been joined as a defendant in FINRA Arbitration Number 09-05462, the case of Beatriz Santana and the Estate of Guillermo Zuniga v. Southwest Securities, Carlos Manuel Garcia and Terra Nova in which the plaintiff seeks to recover up to $500,000. The complaint alleges that Terra Nova negligently or knowingly allowed co-defendant Garcia to improperly manage the account of Santana and Zuniga. Terra Nova maintains that it has acted properly and will vigorously defend this matter. The Company believes the potential for liability in this matter is limited. Accordingly, no liability has been recorded related to this claim.
On April 29, 2009, Terra Nova was notified that it had been joined as a defendant in FINRA Arbitration Number 09-02166, the case of Andali Investments v. Southwest Securities, Tradestation Securities, Terra Nova and Carlos Manuel Garcia in which the plaintiff seeks to recover $500,000. The complaint alleges that Terra Nova allowed the transfer of $60,443 from Andali's account without proper authorization. Terra Nova maintains that it has acted properly and will vigorously defend this matter. The Company believes the potential for liability in this matter is limited, as its involvement compared to the other respondents was for a short period of time and it was involved in only a very limited number of trades involving less than the $500,000 the claimant seeks to recover. Accordingly, no liability has been recorded related to this claim.
Table of Contents
On December 19, 2008, FINRA notified Terra Nova that it had made a preliminary determination to recommend disciplinary action against Terra Nova as well as one current and two former employees based on alleged rule violations primarily related to soft dollar accounts, including without limitation alleged improper soft dollar payments, failure to adequately supervise soft dollar payments, failure to maintain adequate written supervisory procedures and improper record keeping. The charges mainly relate to activities that occurred in 2004 and 2005. Terra Nova signed an Acceptance, Waiver and Consent document to settle this proceeding in October of 2009. The amount of the settlement has been reserved as of September 30, 2009.
In September 2008, an automated program used by Hsu-Tung Lee ("Lee"), a client of the Terra Nova, resulted in erroneous trades far exceeding the buying power in Lee's account with Terra Nova. While the exchange canceled a large number of these trades Terra Nova was forced to cover Lee's short positions, resulting in a large debit position in Lee's account with Terra Nova. Terra Nova brought a collection action against Lee by filing arbitration Case Number 08-4728 before FINRA. On February 13, 2009, Lee filed a counterclaim against Terra Nova alleging that Terra Nova's supervisory procedures should have prevented the mistaken trades from being sent to the market. This counterclaim seeks actual damages of no less than $62,000 and punitive damages of approximately $2,800,000, the amount of punitive damages being the same amount as Terra Nova is seeking as damages against Lee in this matter. Terra Nova believes that it has strong defenses and intends to vigorously defend against this claim. Terra Nova further believes that even if Lee were to prevail in his counterclaim that any imposition of punitive damages would be unwarranted. Accordingly, no liability has been recorded related to this claim.
On May 1, 2009 Terra Nova was informed that the mistaken Lee trades have become the subject of an inquiry by NYSE Arca for the trades placed on that exchange.
In addition to the foregoing, many aspects of the Company's business involve substantial risk of liability and from time to time the Company may become involved in additional lawsuits, arbitrations, claims and other legal proceedings. There is a relatively high incidence of litigation involving the securities brokerage industry. The Company also is subject to periodic regulatory audits, inquiries and inspections. In this regard, the Company has been notified by regulatory authorities of various ongoing investigations. The Company has responded to all requests related to such investigations. At this time, management is unable to predict with certainty the outcome of these matters.
Note 7 - General Contingencies
In the ordinary course of business, there are certain contingencies which are not reflected in the condensed consolidated financial statements. These activities may expose the Company to credit risk in the event that broker-dealer clients are unable to fulfill their contractual obligations.
Many client accounts are margin accounts in which the Company, in effect, loans money to clients. In margin transactions, the Company may be obligated for client losses when credit is extended to clients directly that is not fully collateralized by cash and securities in the clients' accounts. In connection with securities activities, Terra Nova executes client transactions involving the sale of securities not yet purchased ("short sales"), all of which are transacted on a margin basis subject to federal, self-regulatory organizations, individual exchange regulations and Terra Nova's internal risk management policies. In all cases, such transactions may expose the Company to significant off-balance sheet credit risk in the event that client collateral is not sufficient to fully cover losses that clients may incur. In the event that clients fail to satisfy their obligations, the Company would be required to purchase or sell financial instruments at prevailing market prices to fulfill the clients' obligations.
The Company seeks to control the risks associated with its clients' activities by requiring clients to maintain collateral in their margin accounts in compliance with various regulatory requirements and internal risk management requirements. Terra Nova monitors required margin levels on an intra-day basis and, pursuant to such guidelines, requires the clients to deposit additional collateral or to reduce positions when necessary.
The Company provides guarantees to clearing organizations and exchanges under their standard membership agreements, which require members to guarantee the performance of other members. Under these agreements, if a member becomes unable to satisfy its obligations to the clearing organization and exchanges, other members may be called upon to meet such shortfalls. The Company's liability under these arrangements is not quantifiable and may exceed the cash and securities it has posted as collateral. However, management believes the possibility of being required to make payments under these arrangements is remote. Accordingly, no liability has been recorded for these potential events.
Note 8 - Reversal of Liabilities
During the nine months ended September 30, 2009 the Company determined the statute of limitations had expired on various debts totaling approximately $61,000. Accordingly, the Company reversed these liabilities from the condensed consolidated balance sheet upon the expiration of the statute of limitations. The gains on the reversal of liabilities are reflected under the category "Other general and administrative expenses" on the accompanying condensed consolidated statements of loss.
Table of Contents
Note 9 - Income Taxes
The Company recorded an income tax benefit for the three and nine months ended September 30, 2009 of $392,021 and $737,021, respectively, based on an estimated annual effective tax rate of 39%. At September 30, 2009, the Company had income tax receivables totaling $738,285 which are comprised of an overpayment in estimated federal and state tax payments for 2008 of approximately $400,000, State of Illinois refunds from amendments from filing on a unitary basis of approximately $190,000, and State of Illinois refund receivables from amendments to prior years' returns of approximately $150,000.
Note 10 - Regulatory Requirements
Terra Nova and MW Securities are subject to the Securities and Exchange Commission Uniform Net Capital Rule ("Rule 15c3-1") under the Securities Exchange Act of 1934 which requires the maintenance of minimum net capital. Terra Nova calculates its net capital using the ''alternative method,'' which requires the maintenance of minimum net capital, as defined by the rules, equal to the greater of (i) $1,500,000 or (ii) 2.0% of aggregate debit items.
Terra Nova is also subject to the Commodity Futures Trading Commission's ("CFTC") financial requirement ("Regulation 1.17") under the Commodity Exchange Act, administered by the CFTC and the NFA, which also requires the maintenance of minimum net capital. Terra Nova is a futures commission merchant and is required to maintain minimum net capital equal to the greater of its net capital requirement under Rule 15c3-1, (i) $1,500,000 or (ii) 2.0% of aggregate debit items, or the sum of 8% of the total risk margin requirements for all positions carried in customer accounts, as defined in Regulation 1.17 and 4% of the total risk margin requirements for all positions carried in non-customer accounts with a required net capital minimum of $500,000.
MW Securities is an inactive broker-dealer and is subject to a minimum capital requirement of $5,000 as a FINRA broker-dealer.
Excess net capital of one broker-dealer subsidiary may not be used to offset a net capital deficiency of another broker-dealer subsidiary. Net capital and the related net capital requirement may fluctuate on a daily basis. The net capital requirements for the Company's broker-dealer subsidiaries as of September 30, 2009 are as follows:
Note 11 - Share-Based Compensation
Stock Options and Warrants
The fair value of each share-based award is estimated on the date of grant using the Black-Scholes option pricing model. Assumptions used in the Black-Scholes model include: expected volatility of the Company's common stock estimated based on historical volatility and management's estimate of future volatility; expected life estimated based on historical employee exercise behavior for similar awards, giving consideration to the award's contractual terms vesting schedules and expectations of future employee behavior; risk-free interest rate; and expected dividend yield. Share-based compensation is recorded based on the grant date fair value of awards over their respective requisite service periods, net of estimated forfeitures based on historical employee termination behavior.
The table below summarizes the Company's employee stock option and warrant plans as of September 30, 2009:
Table of Contents
A summary of employee stock option activity, under the Company's LTIP, as of September 30, 2009, is presented below:
On
May 14, 2009 the Board of Directors approved the granting of 600,000 employee
stock options under the LTIP. On August 3, 2009 the 600,000 stock options were
granted to various employees with an exercise price of $0.80 which was also the
closing market price of the Company's common stock. The fair value of the stock
options granted in August 2009 was approximately $0.34 per share using the Black-Scholes
option pricing model. The fair value of these awards was estimated based on the
following assumptions: expected volatility of 40%; risk-free interest rate of
4.28%, and a dividend yield of 0%. These stock options were issued with a term
of five years and vest 33% after 12 months, an additional 33% after 24 months
and the remaining 34% after 36 months. The resultant share-based compensation
expense of $201,000 will be recognized over the requisite service period.
The aggregate intrinsic value of stock options outstanding and stock options exercisable at September 30, 2009 was calculated as the number of in-the-money options times the difference between the exercise price of the underlying awards and the quoted closing market price of the Company's common stock at September 30, 2009. The aggregate intrinsic value of stock options exercised is determined by the number of options times the difference between the exercise price of the underlying awards and the quoted closing market price of the Company's common stock on the exercise date.
As of September 30, 2009 the aggregate unrecognized compensation cost related to share-based compensation arrangements granted under stock option plans was approximately $228,000. The cost is expected to be recognized over a weighted average period of approximately three years. During the nine months ended September 30, 2009 and 2008 compensation expense of $91,000 and $107,000, respectively, was recognized related to options vesting under option plans.
A summary of employee warrant activity under the 2006 WIP as of September 30, 2009 is presented below:
As
of September 30, 2009, there was no unrecognized compensation cost related to
warrants granted under the 2006 WIP. During the nine months ended September 30,
2009 and 2008, there was no compensation expense related to warrants.
During the nine months ended September 30, 2009 and 2008 no employee warrants were granted.
Note 12 - Property and Equipment and Capitalized Software Development Costs
The following table represents the different classes of property and equipment and capitalized software development costs as of September 30, 2009 and December 31, 2008:
Table of Contents
Depreciation
and amortization related to property and equipment for three months ended September
30, 2009 and 2008 was $100,666 and $88,928, respectively. Depreciation and amortization
related to property and equipment for nine months ended September 30, 2009 and
2008 was $284,026 and $277,633, respectively. Amortization related to capitalized
software development costs for the three months ended September 30, 2009 and 2008
was $140,458 and $168,568, respectively. Amortization related to capitalized software
development costs for the nine months ended September 30, 2009 and 2008 was $404,277
and $428,940, respectively.
Note 13 - Fair Value Measurements
In September 2006, the FASB issued ASC Topic 820, "Fair Value Measurements", ("Topic 820") which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. The definition of fair value retains the exchange price notion in earlier definitions of fair value and focuses on the price that would be received to sell the asset or paid to transfer the liability (an exit price), not the price that would be paid to acquire the asset or received to assume the liability (an entry price).
The following table sets forth the Company's financial instruments that are recognized or disclosed at fair value in the financial statements on a recurring basis as of September 30, 2009.
Topic
820 establishes a fair value hierarchy that prioritizes the inputs to valuation
techniques used to measure fair value. The hierarchy gives the highest priority
to unadjusted quoted prices in active markets for identical assets or liabilities
(Level 1 measurements) and the lowest priority to unobservable inputs (Level 3
measurements). Assets and liabilities are classified in their entirety based on
the lowest level of input that is significant to the fair value measurement.
The fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value into three broad levels, as follows:
The following table sets forth by level within the fair value hierarchy the Company's financials instruments owned at fair value as of September 30, 2009.
Table of Contents
Note 14 - Receivables From and Payables to Brokers, Dealers,
and Clearing Organizations
The components of receivables from and payables to brokers, dealers and clearing organizations are as follows at September 30, 2009 and December 31, 2008:
The
securities borrowed/loaned represent Terra Nova's temporary borrowing of securities
from broker-dealers which have been collateralized with cash in return for borrowing
the security. Terra Nova borrows securities as a result of clients who have sold
securities not yet purchased ("short sales") in their trading accounts. At times,
Terra Nova loans securities temporarily to other broker-dealers in connection
with its broker-dealer business. The Company receives cash as collateral for the
securities loaned. There were no loaned securities at September 30, 2009 and December
31, 2008. Credit approval is required for all broker-dealers from which securities
are borrowed and loaned. Terra Nova monitors the collateral value daily and requires
additional collateral if warranted.
Self-clearing related clearing deposits and receivables/payables include transactions and deposits required by various clearing and exchange organizations. Generally, the Company is obligated to meet deposit requirements on a daily basis.
Note 15 - Subsequent Events
Management has evaluated subsequent events through November 13, 2009, the date of issuance of our condensed consolidated financial statements included in this Quarterly Report on Form 10-Q.
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Cautionary Note Regarding Forward-Looking Statements
Certain statements in this Quarterly Report on Form 10-Q may constitute "forward-looking" statements as defined in Section 27A of the Securities Act of 1933 (the "Securities Act"), Section 21E of the Securities Exchange Act of 1934 (the "Exchange Act"), the Private Securities Litigation Reform Act of 1995 (the "PSLRA") or in releases made by the Securities and Exchange Commission ("SEC"), all as may be amended from time to time. Such forward-looking statements involve known and unknown risks, uncertainties and other important factors that could cause the actual results, performance or achievements of Terra Nova Financial Group, Inc. and its subsidiaries, to differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements. Statements that are not historical fact are forward-looking statements. Forward-looking statements can be identified by, among other things, the use of forward-looking language, such as the words "plan," "believe," "expect," "anticipate," "intend," "estimate," "project," "may," "will," "would," "could," "should," "seeks," or "scheduled to," or other similar words, or the negative of these terms or other variations of these terms or comparable language, or by discussion of strategy or intentions. These cautionary statements are being made pursuant to the Securities Act, the Exchange Act and the PSLRA with the intention of obtaining the benefits of the "safe harbor" provisions of such laws. The Company cautions investors that any forward-looking statements made by the Company are not guarantees or indicative of future performance. Important assumptions and other important factors that could cause actual results to differ materially from those forward-looking statements with respect to the Company, include, but are not limited to, risks and uncertainties that are described in Item 1A - "Risk Factors" of the Annual Report on Form 10-K for the year ended December 31, 2008 and in Item 1A - "Risk Factors" of this Quarterly Report, and in other securities filings by the Company with the SEC.
Table of Contents
Although the Company believes that its plans, intentions and expectations reflected in or suggested by such forward-looking statements are reasonable, actual results could differ materially from a projection or assumption in any forward-looking statements.
The Company's future financial condition and results of operations, as well as any forward-looking statements, are subject to change and inherent risks and uncertainties. The forward-looking statements contained in this Quarterly Report on Form 10-Q are made only as of the date hereof and the Company does not have or undertake any obligation to update or revise any forward-looking statements whether as a result of new information, subsequent events or otherwise, unless otherwise required by law.
Variability of Quarterly Results
The operating results for any quarter are not necessarily indicative of results for any future period or for the full year. Quarterly revenues and operating results have varied in the past and are likely to vary in the future. Such fluctuations may result in volatility in the price of the Company's common stock. For information regarding the risks related to the variability of quarterly results, see Item 1A - "Risk Factors" of the Annual Report on Form 10-K of the Company for the year ended December 31, 2008 and Item 1A - "Risk Factors" of this Quarterly Report.
Overview
Terra Nova Financial Group, Inc. ("Parent", and collectively with its wholly-owned subsidiaries, the "Company," "firm," "we," "us," or "our") is a holding company of businesses providing a range of products and services to the professional trading community. The Company has three primary subsidiaries: Terra Nova Financial, LLC ("Terra Nova"), Tradient Technologies, Inc. ("Tradient") and SC QuantNova Research SRL ("QuantNova"). Terra Nova, Tradient and QuantNova are wholly-owned subsidiaries of the Parent, a public company trading on the OTC Bulletin Board under the symbol TNFG.
Professional traders, hedge funds, money managers and others come to Terra Nova, a broker-dealer registered with the Securities and Exchange Commission and a member of Financial Industry Regulatory Authority, for what we believe to be good value in execution, clearing and prime brokerage services. The firm offers highly active traders what we believe are effective solutions for direct access trading in domestic and global markets across many product classes including equities, options, ETFs, commodity futures and options, fixed income securities and mutual funds. Clients can make unbiased executions on an agency-only basis through Terra Nova's 24-hour trading desk staffed with licensed brokers or through any of a range of different trading platforms suited to different trading styles. The firm also provides customizable, turn-key clearing solutions for broker-dealers and introducing brokers; and prime brokerage services well suited for small and mid-sized hedge funds. Terra Nova is located in Chicago, Illinois. During the third quarter of 2009, primary sources of revenue for Terra Nova include 90% from commissions and fees, 5% from net interest income and 3% from software fees. During the third quarter of 2008, the primary sources of revenue for Terra Nova included 84% from commissions and fees, 12% from net interest income and 2% from software fees.
Tradient is the Company's financial technology development business providing proprietary applications for electronic trade execution, order routing and clearing. Tradient platforms for real-time market data and direct access trading are intended to be designed for efficiency, consistency and value. Tradient platforms include its flagship product Tradient Pro, a fully customizable Level II trading platform; Tradient Plus, an easy-to-use, customizable trading platform offering essential equity and options trading features economically; and Tradient Web, a browser-based trading system with streaming Level I data. Tradient is located in Chicago, Illinois. Primary sources of revenue for Tradient include software licensing and order routing fees.
QuantNova provides consulting, software development, electronic data processing, software architecture and engineering for Tradient trading platforms and backoffice clearing software. QuantNova is based in Bucharest, Romania and as of September 30, 2009 had eight full-time employees.
Plan of Operation
2009 Initiatives
In 2009, our current goals are to increase revenue growth through strategic initiatives involving marketing and sales operations, technology innovation and cost control, such as:
Pursue targeted segments:
Table of Contents
Broaden product offering:
Increase emphasis on sales and marketing:
Reduce costs to increase working capital:
Terra Nova, the Company's broker-dealer subsidiary, while reliant upon the Tradient platforms, continues to improve its ability to operate as a technology neutral clearing agent for different front-end trading platforms. Our control over the back office processes allows the firm to accommodate business opportunities which revolve around non-traditional front-end trading platforms. We offer three proprietary trading platforms, Tradient Pro, Tradient Plus, and Tradient Web, along with RealTick, a real-time, Level II cross-asset trading platform developed by Townsend Analytics. Another platform offered is Sterling Trader Pro, developed by Sterling Financial, a customizable direct access trading platform. We also accommodate alternative order routing solutions including algorithmic trading with financial information eXchange ("FIX") protocol and API capability.
We intend to continue to focus on improving its capital structure, technology and business processes. We expect to continue to increase our systems and backoffice clearing capacity for anticipated growth in the number of transactions and executions that it processes in the future. We plan to invest resources in back office technology to lower operating costs.
The brokerage industry is a highly competitive industry with ongoing compression in commission pricing. In an effort to mitigate any impact from lower pricing we intend to continue to invest resources in our back office technology to lower the man-hours required to manage our systems and processing costs and attract high frequency trading clients.
A slow down in our business which began towards the end of 2008 has continued through the first nine months of 2009 and is reflected in lower commission and fee revenues. We reduced our workforce in January 2009 based on these continuing adverse economic conditions and intends to continue to review headcount throughout 2009. We continue to see a reduction in net interest income resulting from low federal funds rates, our base rate to determine client debit and credit rates and earnings on our reserve deposits. Terra Nova relies on net interest income as a significant revenue source, thus the decrease in federal funds rate impacts our profitability. We are attempting to incorporate cost saving measures to offset declining revenues.
Critical Accounting Policies
The condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States, which require the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the condensed consolidated financial statements, and revenues and expenses during the periods reported. Actual results could differ from those estimates. The following are believed to be the critical accounting policies, which could have the most significant effect on reported results and require the most difficult, subjective or complex judgments by management.
Table of Contents
Goodwill
Goodwill is tested for impairment annually on December 31 or more frequently if impairment indicators arise. The first step of this process is to identify potential goodwill impairment by comparing the fair value of the reporting unit to its carrying value. The Company estimates fair value using a combination of the market price of the Company's common equity and discounted cash flows. If the carrying value is less than fair value the Company would complete step two in the impairment review process which measures the amount of goodwill impairment. Management tests the reasonableness of the inputs and outcomes of the discounted future cash flow analysis and the evaluation of the market price of its common equity against other available comparable market data. The entire amount of goodwill was created from the Terra Nova, Market Wise Stock Trading School, LLC and Market Wise Securities acquisition in May 2006 and has been assigned to Terra Nova within the Brokerage Services Segment. The Company performed its annual impairment test of goodwill on December 31, 2008 and determined that there was no impairment as of that date.
Capitalization of Software Development Costs
Internally generated software development costs associated with new products and significant enhancements to existing software products are expensed as incurred until technological feasibility has been established. Software development costs that qualify for capitalization include the salaries and benefits of the software engineers assigned to the products, internal and external quality assurance testing costs, overhead allocations primarily associated with rent and facilities costs and the costs of outsourced development activities. Software development costs not qualifying for capitalization are recorded as product development expenses. Capitalized software development costs, including purchased software, if any, are amortized using the straight-line method over the estimated useful life of the software. At each balance sheet date the Company evaluates the estimated net realizable value of each software product and when required, records write-downs of net carrying value to net realizable value of any products for which the net carrying value is in excess of net realizable value. The net realizable value is the estimated future gross revenue of each product reduced by the estimated future costs of completing and disposing of that product, including the costs of completing in process development and client support.
Internally used software includes software that is acquired, internally developed or modified to meet the Company's internal needs and the Company has no substantive plans to market the software externally. Application development and modifications resulting in additional functionality are capitalized. Costs associated with preliminary project stage where business requirements are defined, internal and external training costs and ongoing maintenance are expensed as incurred. Capitalization of appropriate costs occurs when the preliminary project stage is complete and management authorizes and commits to the completion of the project. Capitalization ceases when the project is ready for its intended use. The capitalized costs are amortized on a straight-line basis over the estimated useful life of the software.
Share-Based Compensation
Share-based payments, including grants of employee stock options, are recognized in the condensed consolidated statements of loss based on their grant date fair values over their requisite service periods, less estimated forfeitures.
Long-Lived Assets
Long-lived assets, consisting primarily of definite lived intangible assets, property and equipment and capitalized software development costs, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. Recoverability of assets held and used is generally measured by a comparison of the carrying amount the asset to undiscounted future net cash flows expected to be generated by that asset. If it is determined that the carrying amount of an asset may not be recoverable, an impairment loss is recognized for the amount by which the carrying amount of the asset exceeds the fair value of the asset. Fair value is the estimated value at which the asset could be bought or sold in a transaction between willing parties.
Income Taxes
Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense or benefit is the tax payable or refundable for the period, plus or minus the change during the period in deferred tax assets and liabilities.
Table of Contents
Revenue Recognition
Revenues primarily consist of commission and fees, interest income and software related licensing fees. Commission revenue and related expenses on securities transactions are recorded on a settlement date basis. Other revenue consists of account and transaction fees and is recorded on a settlement date basis as security transactions occur. Software fees are charges for the use of the Company's software execution platform. Revenues from software fees are recognized on a monthly basis as services are provided to clients. Interest income is primarily generated by interest charges to clients on margin balances and revenue from clients cash held and invested by Terra Nova as a clearing firm offset by interest paid to clients on their credit balances. Interest income and interest expense on brokerage accounts is recorded on an accrual basis as earned or incurred.
Results of Operations
The following table below represents net revenues and total expenses from the condensed consolidated statements of loss for the three and nine months ended September 30, 2009 and 2008. The financial information below is derived from the condensed consolidated financial statements and related notes in the Quarterly Report on Form 10-Q.
Three and Nine Months ended September 30, 2009 and 2008
The Company's clients mainly trade in the United States equity, futures and options markets. There is a direct correlation between the volume of our clients' trading activity and our profitability. The Company cannot predict future trading volumes in the United States equity, futures and options markets but if client trading activity increases we expect that it would have a positive impact on our profitability. If client trading activity declines we also expect that it would have a negative impact on our profitability.
The reduced level of trading in stock and futures by our clients in the early part of the first quarter of 2009 continued into the third quarter providing the Company with reduced volumes of stock and futures transactions offset by an increase in option transactions. The total equity shares traded declined 2.2 billion shares to 4.3 billion shares during the first nine months of 2009 compared to the first nine months of 2008. In addition, we experienced a decline of 0.7 million futures contracts to 1.8 million futures contracts during the first nine months of 2009 versus the same period last year. This reduction in activity is primarily due to a decline in our number of clients. The total option contracts traded increased 2.0 million option contracts to 8.2 million option contracts during the first nine months of 2009 versus the same period last year. This increase is due to both an increase in the number of clients trading only options as well as increased trading activity within those existing accounts that trade equities and options.
The changes in client debit and credit cash balances may significantly impact our profitability along with changes in interest rates. The Company seeks to mitigate interest rate risk by aligning the average duration of our interest-earning assets with that of our interest-bearing liabilities. We cannot predict the direction of interest rates or the levels of client debit and credit cash balances. If interest rates rise the Company generally expects to earn a larger net interest spread. Conversely, a falling interest rate environment generally would result in our earning a smaller net interest spread.
Table of Contents
The decline in the federal funds interest rates has reduced the Company's net interest income which declined $2.6 million during the nine months ended in 2009 compared to the same period in 2008. We monitor the federal funds rate daily on invested client funds and adjust our client's credit and debit interest rates accordingly to maintain an acceptable spread. We have also experienced a decline in both credit and debit client cash balances which also caused a decline in overall net interest income.
Our results for the nine months ended September 30, 2009 reflect the following important factors:
Revenues
Commissions and fees
The Company's commissions and fees revenue is dependent on the overall trading activity in the United States equity, futures and options markets by our clients. Commissions revenues consist of executing NYSE and NASDAQ listed securities and OTC securities along with exchange listed options transactions, futures and futures options, ETFs, fixed income and mutual funds. Commissions revenues are recorded on a settlement date basis. Fee revenue is generated from clients accessing market data through proprietary software platforms and various account maintenance fees.
The Company's commissions and fees decreased from $8.1 million in the third quarter of 2008 to $6.3 million in the third quarter of 2009-a decrease of 22.8% due primarily to lower trading activity offset by an increase in the average commission rate. For the nine months ended September 30, 2009 commissions and fees decreased from $23.4 million to $19.7 million-a decrease of 15.7% which is also due to lower trading activity offset by an increase in the average commission rate. For the nine months ended September 30, 2009 compared to same period ending September 30, 2008 the firm showed a decrease in equity commissions of 16.1%, a 1.5% increase in options commissions, and a 50.4% decline in futures commissions.
The Company's total trade tickets declined 1.3 million to 3.1 million during the nine months ending September 30, 2009 from the same period in 2008.
Net interest income
As a self-clearing broker-dealer the Company receives interest income on client credit and debit balances through interest bearing accounts, U.S. government securities and correspondent clearing interest sharing arrangements. Interest income decreased from $1.4 million for the three months ended September 30, 2008 to $329,000 for the same period in 2009 and for nine months ended September 30, 2009 declined $3.7 million to $1.2 million-a decrease of 75%. Interest income was impacted both by a decline in client debit and credit cash balances and lower federal fund rates from the year earlier. The interest earned on segregated cash balances was also impacted by the low federal funds rate.
During the first nine months of 2009 the Federal Reserve did not change the federal funds rate which remains in a range of 0% to 0.25%. During 2008 the Federal Reserve Open Market Committee lowered the federal funds 400 basis points. All client credit and margin debit rates are based off the federal funds rate. The Company also borrows securities resulting from clients who have short securities and receives interest from broker-dealers who have collateralized with cash in return for borrowing the securities.
Table of Contents
Interest expense on brokerage accounts was $187,000 during the three months ended September 30, 2008 compared to zero during the three months ended September 30, 2009 and for the nine months ended September 30, 2009 declined $1 million to zero-a decrease of 100%. As a self-clearing broker-dealer the Company pays interest to clients on cash credit balances as well as interest to banks for short-term client related loans.
Software fees, net
The Company's net software fees are generated from software subscription fees and exchange charges. Net software fees increased 9% to $230,000 during the three months ended September 30, 2009 from $211,000 during the same period in 2008. For nine months ended September 30, 2009, net software fees increased $154,000 to $717,000-an increase of 27.3%. The number of Tradient platform users declined from 2,804 users as of September 30, 2008 to 2,070 users as of September 30, 2009. The net increase for both the three month and nine months ended September 30, 2009 was primarily due to fewer users qualifying for a software rebate during 2009. The software rebate is based on users achieving certain trading levels each month. Additionally, a strategic relationship was terminated in January 2009 that accounted for a majority of the decline in users as well as the change in software rebates earned.
Expenses
Commissions and clearing
A percentage of the commissions the Company earns are paid to registered representatives and multiple clearing correspondent arrangements with other broker-dealers. The Company has access to multiple Electronic Communication Networks ("ECNs") and other execution venues and the Company pays a fee (or rebate payment for order flow) to these venues for executing equity and option transactions on or through their systems. The Company is a member of multiple exchange and regulatory organizations and must pay them fees when executing transactions through them. These exchange and regulatory costs are typically based on the number and size of transactions executed. Futures are cleared through an established futures commission merchant and the Company pays execution fees associated with those futures transactions. Lastly, included in commissions and clearing are soft dollar and sales commission expenses.
The Company's commissions and clearing expense increased from $2.5 million for three months ended September 30, 2008 to $2.6 million for three months ended September 30, 2009-an increase of 3.5%. The increase is attributable to higher ECN transaction fees. Additionally, the Company experienced a slight shift in the mix of revenue to more correspondent clearing relationships which have higher percentage commission payouts. For the nine months ended September 30, 2009 the Company's commissions and clearing expense decreased $604,000 to $7.7 million-a decrease of 7.3%.
Compensation and benefits
Compensation and benefits consists mainly of wages, payroll taxes, employee benefits, and discretionary bonuses, along with non-cash share-based compensation expense. Compensation and benefits decreased $100,000 to $2.2 million for the three months ended September 30, 2009-a decrease of 4.3%. The decrease during the third quarter of 2009 compared to the same period in 2008 was due primarily to a reduction in bonuses accrued. For the nine months ended September 30, 2009 the Company's compensation and benefits expense decreased $508,000 to $6.6 million-a decrease of 7.1%. The decline is attributable to lower bonus accrual offset by less capitalized salaries software development. The overall number of full-time employees was eighty-nine as of September 30, 2009 and ninety as September 30, 2008, which includes a reduction in workforce in January 2009, offset by an increase in headcount at our Romanian subsidiary, QuantNova. The total headcount numbers include employees of our foreign subsidiary QuantNova which had eight full-time employees at September 30, 2009 and six employees at September 30, 2008.
Software and market data
The software and market data expense consists of payments to multiple third-parties for data and trading platform access for the Company's clients and is a variable cost based on the number of clients, licenses and order routing execution services. The remaining fees include payments to vendors for access to market data including option and equity prices and news information. The Company's software and market data expenses decreased $589,000 from $1.3 million during the quarter ending September 30, 2008 to $741,000 for the same period in 2009- a decrease of 44.3%. For the nine months ended September 30, 2009 the Company's software and market data expense decreased $4.6 million to $2.5 million-a decrease of 45.4%.
The majority of the decrease in software and market data expense for the three and nine months ended September 30, 2009 compared to the same period in 2008 was due to decreased costs associated with a reduction in a third party vendor's software and order routing execution fees. The Company, during the second half of 2008 and to a lesser extent in 2009, had many of its clients convert to Tradient, its proprietary trading platform, to balance costs and fulfill client trading software needs.
Table of Contents
Advertising and promotional
Advertising and promotional expenses include trade shows, targeted marketing in financial publications, online advertising, and various sales force marketing related expenses. Advertising and promotional expenses decreased from $215,000 during the quarter ended September 30, 2008 to $162,000 for the same period in 2009-a decrease of 24.7%. For the nine months ended September 30, 2009 the Company's advertising and promotional expense decreased $14,000 to $456,000-a decrease of 3%.
Professional fees
Professional fees relate to legal and consulting fees incurred for such things as the Company's defense against litigation, compliance with Sarbanes-Oxley requirements, shareholders meeting, multiple regulatory filings, tax and audit expenses and regulatory compliance. Professional fees decreased from $737,000 during the third quarter of 2008 to $654,000 during the same period in 2009-a decrease of 11.3%. For the nine months ended September 30, 2009 the Company's professional fees expenses decreased $16,000 to $2 million-a decrease of 0.8%.
Communications and information technology
The Company's communications and information technology expenses increased from $190,000 during the three months ended September 30, 2008 to $247,000 for the same period in 2009-an increase of 30.2%. For the nine months ended September 30, 2009 the Company's communications and information technology expenses increased $76,000 from the same 2008 period to $713,000-an increase of 11.9%. The Company incurs expenses associated with multiple vendors providing communications and network connectivity. To enhance capacity and reliability as a self-clearing broker-dealer financial services technology provider, the Company maintains two co-location data centers in Chicago, Illinois. The firm continues to transfer services from third-party providers to internally based solutions and is enhancing various facilities to better meet the needs of the organization, reduce expenses and lower reliance on third-party providers.
Depreciation and amortization
For the nine months ended September 30, 2009 the Company's depreciation and amortization expense remained consistent with the nine months ended September 30, 2008 at approximately $1.7 million.
Bad debt expense
Bad debt expense decreased from $3.5 million for the three and nine months ended September 30, 2008 to zero for the three and nine months ended September 30, 2009. The bad debt expense in 2008 resulted from two isolated customer trading losses.
Other general and administrative expenses
Other general and administrative expenses of the Company increased from $464,000 during the third quarter of 2008 to $826,000 for the same period in 2009. For the nine months ended September 30, 2009 the Company's other general and administrative expenses increased $1.2 million to $2.1 million-an increase of 118%. General and administrative expenses include certain clearing related expenses, office rent, shareholder relations, travel and entertainment, franchise taxes, director compensation and other miscellaneous expenses incurred by the Company. The increase for both the three and nine month periods is due to an increase in our legal fine accrual of $530,000 in the nine months ended September 30, 2009. In addition, there was a gain from the reversal of liabilities for which the statute of limitations expired totaling approximately $540,000 during the nine months ended September 30, 2008 and a $300,142 gain on the sale of a seat on the Boston Stock Exchange during the third quarter of 2008.
Income tax benefit (provision)
The Company recorded an income tax benefit for the three and nine months ended September 30, 2009 of $392,021 and $737,021, respectively, based on an estimated annual effective tax rate of 39%. At September 30, 2009, the Company had income tax receivables totaling $738,285 which are comprised of an overpayment in estimated federal and state tax payments for 2008 of approximately $400,000, State of Illinois refunds from amendments from filing on a unitary basis of approximately $190,000, and State of Illinois refund receivables from amendments to prior years' returns of approximately $150,000.
Liquidity and Capital Resources
The Company's broker-dealer subsidiaries are subject to capital and other requirements of the SEC, FINRA, and CFTC. In addition to mandatory capital requirements (See Note 10 - Regulatory Requirements), as a self-clearing broker-dealer, the Company is required to deposit funds with clearing organizations, such as DTCC and OCC, which may be large in relation to the Company's total liquid assets and may vary significantly based on client trading activity. At the present, the Company believes it has sufficient capital on hand to meet all such capital requirements. These capital requirements are subject to change from time to time. Unforeseen increases in regulatory capital requirements may impact the Company's growth and operational plans depending on the amount of the increase.
Table of Contents
Cash Flow
As reflected on the accompanying condensed consolidated statements of cash flows, cash and cash equivalents declined $1.4 million to $6.5 million at September 30, 2009 compared to December 31, 2008. Cash used in operating activities was $623,000 for the nine months ended September 30, 2009 which included net loss of $1.2 million. Adjustments to reconcile net loss to net cash used in operating activities for nine months ended September 30, 2009 included depreciation and amortization totaling $1.7 million. This was offset by a change in deferred taxes totaling $715,000 and $60,626 of gains related to extinguishment of liabilities. Changes in cash segregated in compliance with federal regulations, receivables from customers and non-customers, and payables to customers and non-customers, aggregately, decreased cash flow from operations by $17.7 million. Receivables from customers and non-customers are primarily client margin loans secured by marketable securities. Receivables from and payables to brokers, dealers and clearing organizations consist primarily of securities borrowed, commissions receivable, securities related to the clearance of transactions and deposits with clearing organizations. Liquidity needs relating to client trading and margin borrowing activities are met through cash balances in client brokerage accounts which totaled approximately $183.4 million as of September 30, 2009.
Cash used in investing activities for the nine months ended September 30, 2009 was $514,000 due to the purchases of property and equipment of $371,000 and capitalization of software development costs of $143,000.
Cash used in financing activities for the nine months ended September 30, 2009 was $272,000 due to the purchases of treasury stock.
Cash and cash equivalents on the statement of condensed consolidated balance sheets consists primarily of cash held in liquid commercial bank accounts or clearing organization accounts paying a "money market" rate of interest. The Company also has a sweep account which deposits excess operating bank balances overnight into a money market account. The Company reviews all money market funds in which it invests to ensure, to the extent possible, that the Company's funds are not at risk.
Cash segregated in compliance with federal regulations
Cash segregated in compliance with federal regulations was $149.4 million at September 30, 2009 versus $141.2 million at December 31, 2008. Such funds have been segregated in special reserve accounts for the exclusive benefit of customers under Rule 15c3-3 of the Securities Exchange Act of 1934, as amended and other regulations. The Company is required to determine the amount required to be deposited weekly, as of the close of the last business day of the week, and if necessary, to deposit additional funds by the opening of banking business on the second following business day.
The cash segregated in compliance with federal regulations had historically been in a special reserve account at one banking institution invested in an interest bearing cash account for the exclusive benefit of customers under Rule 15c3-3 of the Securities Exchange Act of 1934. Due to the continuing banking crisis that began in 2008, the Company now maintains special reserve accounts with multiple qualified banking institutions to mitigate credit risk. The Company has taken measures to diversify the banks in which it maintains customer and corporate accounts and monitors their bank performance ratios on a regular basis to help mitigate insolvency risk. All banks in which the Company maintains customer and corporate deposits are "Well Capitalized" in accordance with the FDIC's Regulatory "Prompt Corrective Action" risk capital rating system. In the special reserve accounts we invest in a combination of qualified securities including short-term U.S. government securities, reverse repurchase agreements collateralized by U.S. government securities, qualified trust products, and interest bearing cash accounts. These changes are in full compliance with all regulatory requirements while providing customer protection of their funds held with the Company.
Line of Credit
We maintain a credit line secured by customer securities used to facilitate its self-clearing broker-dealer operations. The rate on the line of credit is determined daily by the bank and is based on the daily rate at which banking institutions are able to borrow from each other plus a predetermined spread. Management believes that cash balances in client brokerage accounts and operating earnings will continue to be the primary source of liquidity for the Company in the future. At September 30, 2009, we did not have any outstanding balance drawn on our credit line. In the fourth quarter of 2009 the Company added a second credit line secured by customer securities with a qualified banking institution which will also be used occasionally to facilitate timing issues to meet daily cashflow needs.
Table of Contents
Liquidity
To the extent that business or transactional opportunities are presented the Company may need to raise additional capital or issue additional equity. Current alternatives include, but are not limited to subordinated debt, term loans, and collateralized bank loans with multiple banking institutions, however, the current credit environment makes it difficult to raise capital through these means. The tighter credit market has made it more difficult for the Company to obtain capital for short-term financing of the Company's self-clearing operations and customer margin lending. Management believes that cash balances in client brokerage accounts and operating earnings will continue to be the primary source of liquidity for the Company in the future.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Not Applicable.
Item 4T. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
The Company maintains disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act") that are designed to ensure that information required to be disclosed by the Company in the reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms and that such information is accumulated and communicated to management, including the Company's principal executive officer and principal financial officer, to allow timely decisions regarding required disclosure.
The Company's management, with the participation of its Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of its disclosure controls and procedures as of the end of the period covered in this Quarterly Report on Form 10-Q.
Based on this evaluation, the Company's Chief Executive Officer and Chief Financial Officer have concluded that its disclosure controls and procedures were effective as of the end of the period covered in this Quarterly Report on Form 10-Q.
(b) Changes in Internal Control Over Financial Reporting
There were no changes in internal controls over financial reporting during the quarter ended September 30, 2009 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.
Item 1. Legal Proceedings
On September 25, 2009, a FINRA arbitration panel in the matter of Friedman v. Riverside Securities, Jordan Zaro and Terra Nova found in favor of the claimant and awarded damages together with attorneys' fees, costs and interest against the defendants who were held jointly and severally liable. The matter involved a dispute under which claimant contended that Zaro engaged in improper trades in her account. The Company accrued $285,000 in satisfaction of the judgment and is seeking indemnification and contribution from the co-defendants.
On or about September 25, 2009, Terra Nova was notified that it had been joined as a defendant in FINRA Arbitration Number 09-05462, the case of Beatriz Santana and the Estate of Guillermo Zuniga v. Southwest Securities, Carlos Manuel Garcia and Terra Nova in which the plaintiff seeks to recover up to $500,000. The complaint alleges that Terra Nova negligently or knowingly allowed co-defendant Garcia to improperly manage the account of Santana and Zuniga. Terra Nova maintains that it has acted properly and will vigorously defend this matter. The Company believes the potential for liability in this matter is limited. Accordingly, no liability has been recorded related to this claim.
On April 29, 2009, Terra Nova was notified that it had been joined as a defendant in FINRA Arbitration Number 09-02166, the case of Andali Investments v. Southwest Securities, Tradestation Securities, Terra Nova and Carlos Manuel Garcia in which the plaintiff seeks to recover $500,000. The complaint alleges that Terra Nova allowed the transfer of $60,443 from Andali's account without proper authorization. Terra Nova maintains that it has acted properly and will vigorously defend this matter. The Company believes the potential for liability in this matter is limited, as its involvement compared to the other respondents was for a short period of time and it was involved in only a very limited number of trades involving less than the $500,000 the claimant seeks to recover. Accordingly, no liability has been recorded related to this claim.
On December 19, 2008, FINRA notified Terra Nova that it had made a preliminary determination to recommend disciplinary action against Terra Nova as well as one current and two former employees based on alleged rule violations primarily related to soft dollar accounts, including without limitation alleged improper soft dollar payments, failure to adequately supervise soft dollar payments, failure to maintain adequate written supervisory procedures and improper record keeping. The charges mainly relate to activities that occurred in 2004 and 2005. Terra Nova signed an Acceptance, Waiver and Consent document to settle this proceeding during October of 2009. The amount of the settlement has been reserved as of September 30, 2009.
Table of Contents
In September 2008, an automated program used by Hsu-Tung Lee ("Lee"), a client of the Terra Nova, resulted in erroneous trades far exceeding the buying power in Lee's account with Terra Nova. While the exchange canceled a large number of these trades Terra Nova was forced to cover Lee's short positions, resulting in a large debit position in Lee's account with Terra Nova. Terra Nova brought a collection action against Lee by filing arbitration Case Number 08-4728 before FINRA. On February 13, 2009, Lee filed a counterclaim against Terra Nova alleging that Terra Nova's supervisory procedures should have prevented the mistaken trades from being sent to the market. This counterclaim seeks actual damages of no less than $62,000 and punitive damages of approximately $2,800,000, the amount of punitive damages being the same amount as Terra Nova is seeking as damages against Lee in this matter. Terra Nova believes that it has strong defenses and intends to vigorously defend against this claim. Terra Nova further believes that even if Lee were to prevail in his counterclaim that any imposition of punitive damages would be unwarranted. Accordingly, no liability has been recorded related to this claim.
On May 1, 2009 Terra Nova was informed that the mistaken Lee trades have become the subject of an inquiry by NYSE Arca for the trades placed on that exchange.
In addition to the foregoing, many aspects of the Company's business involve substantial risk of liability and from time to time the Company may become involved in additional lawsuits, arbitrations, claims and other legal proceedings. There is a relatively high incidence of litigation involving the securities brokerage industry. The Company also is subject to periodic regulatory audits, inquiries and inspections. In this regard, the Company has been notified by regulatory authorities of various ongoing investigations. The Company has responded to all requests related to such investigations. At this time, management is unable to predict with certainty the outcome of these matters.
Item 1A. Risk Factors
Our Annual Report on Form 10-K for the fiscal year ended December 31, 2008 lists in more detail various important risk factors facing our business in Item 1A - "Risk Factors" for the year ended December 31, 2008, and in other securities filings by the Company with the SEC. Except as set forth below, there have been no material changes from the risk factors disclosed in that section of our Annual Report on Form 10-K. We encourage you to review that information and to review our other reports filed periodically with the Securities and Exchange Commission for any further information regarding risks facing our business.
We are subject to litigation and legal compliance risks.
Because of the extent and complexity of our regulatory environment and the products we offer, many aspects of our business involve substantial risks of liability. In recent years, there has been an increasing incidence of litigation involving the securities brokerage industry, including class action and other suits that generally seek substantial damages, including in some cases punitive damages. Any such litigation brought in the future could have a material adverse effect on our business, financial condition and operating results. We also face potential indirect liability for claims of defamation, negligence, copyright, patent or trademark infringement, violation of the securities laws and other claims based upon the third-party content that we distribute online. Computer failures may also result in our widely publishing and distributing incorrect data. Our insurance may not necessarily cover any of these claims or may not be adequate to protect us against all liability that may be imposed. Any such litigation brought in the future could have a material adverse effect on our business, financial condition and operating results.
In addition, we and our subsidiaries, our business and the industries in which we operate are at times being reviewed or investigated by regulators, which could lead to enforcement actions, fines and penalties or the assertion of private litigation claims and damages. While we believe that we have adopted appropriate risk management and compliance programs, the nature of our operations means that legal compliance risk will continue to exist and additional legal proceedings and other contingencies, the outcome of which cannot be predicted with certainty, will arise from time to time.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
(a) None.
(b) Not Applicable.
(c) On May 1, 2009 the Company's Board of Directors authorized the use of up to $3,000,000 to repurchase the Company's outstanding common stock. Stock repurchases are made in the open market, in block transactions, or in privately negotiated transactions and may be made from time to time or in one or more larger repurchases, all as determined by the officers of the Company at their discretion. The Company conducts the repurchases in compliance with Securities and Exchange Commission Rule 10b-18. The program commenced on May 1, 2009 and will expire on April 30, 2010. The program does not obligate the Company to acquire any particular amount of common stock and the program may be modified, suspended or terminated at any time at the Company's discretion. In the third quarter of 2009 the Company made no common stock repurchases. As of September 30, 2009, $2,727,944 of authorized funds remain available for share repurchases under this program.
Table of Contents
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
(a) None.
(b) Not Applicable.
Item 6. Exhibits
In accordance with requirements of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
___________________
FORM 10-Q
___________________
| x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2009
OR
| o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from _____ to _____
Commission file number 000-24057
Terra Nova Financial Group, Inc.
(Exact name of registrant as specified in its charter)
|
Illinois
|
75-2375969
|
|
(State of incorporation)
|
(I.R.S. employer identification no.)
|
100 South Wacker Drive, Suite 1550
Chicago, Illinois 60606
(Address of principal executive offices, including zip code)
(312) 827-3600
(Registrant's telephone number)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
|
Large accelerated filer o
|
Accelerated filer o
|
|||
|
Non-accelerated filer o
|
Smaller reporting company x
|
|||
|
(Do not check if a smaller reporting
company)
|
||||
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 under the Act). Yes o No x
The number of shares of common stock, $0.01 par value per share, outstanding was 25,054,508 as of November 1, 2009.
TERRA NOVA FINANCIAL GROUP, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
TABLE OF CONTENTS
2
Table of Contents
PART I FINANCIAL INFORMATION
Item 1. Unaudited Condensed Consolidated Financial Statements
|
TERRA NOVA FINANCIAL GROUP, INC. AND
SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) |
|||||||
|
September 30,
2009 |
|
December 31,
2008 |
|||||
|
ASSETS
|
|||||||
| Cash and cash equivalents | $ |
6,481,304
|
$ |
7,889,553
|
|||
| Cash segregated in compliance with federal regulations |
149,390,045
|
141,159,364
|
|||||
| Receivables from brokers, dealers and clearing organizations |
32,907,231
|
13,568,459
|
|||||
| Receivables from customers and non-customers, net of allowance for doubtful accounts |
10,295,347
|
4,858,360
|
|||||
| Property and equipment, net of accumulated depreciation and amortization |
1,307,758
|
1,221,066
|
|||||
| Capitalized software development costs, net of accumulated amortization |
1,798,575
|
2,060,015
|
|||||
| Intangible assets, net of accumulated amortization |
3,083,901
|
4,111,514
|
|||||
| Income tax receivables |
738,285
|
1,446,264
|
|||||
| Goodwill |
7,501,408
|
7,501,408
|
|||||
| Deferred income taxes |
2,499,761
|
1,784,761
|
|||||
| Other assets |
1,193,435
|
1,346,764
|
|||||
| Total assets | $ |
217,197,050
|
$ |
186,947,528
|
|||
|
LIABILITIES AND SHAREHOLDERS' EQUITY
|
|||||||
|
|
|
||||||
| Payables to brokers, dealers and clearing organizations | $ |
1,191,819
|
$ |
913,621
|
|||
| Payables to customers and non-customers |
183,377,532
|
151,970,566
|
|||||
| Accounts payable and accrued expenses |
2,426,404
|
2,525,692
|
|||||
| Total liabilities |
186,995,755
|
155,409,879
|
|||||
| Commitments and contingencies | |||||||
| Shareholders' equity | |||||||
| Preferred stock - $10 par value; 5,000,000 shares authorized; none issued |
-
|
-
|
|||||
| Common stock; $0.01 par value;
150,000,000 shares authorized; 25,482,942 shares issued and 25,054,508 shares outstanding at September 30, 2009 and 25,482,942 shares issued and outstanding at December 31, 2008 |
254,829
|
254,829
|
|||||
| Treasury stock, common, at cost; 428,434 shares
at September 30, 2009 and no shares at December 31, 2008 |
(272,056
|
) |
-
|
||||
| Additional paid-in capital |
52,096,682
|
52,005,418
|
|||||
| Accumulated deficit |
(21,878,160
|
) |
(20,722,598
|
) | |||
| Total shareholders' equity |
30,201,295
|
31,537,649
|
|||||
| Total liabilities and shareholders' equity | $ |
217,197,050
|
$ |
186,947,528
|
|||
|
See accompanying notes to unaudited condensed
consolidated financial statements.
|
|||||||
3
Table of Contents
|
TERRA NOVA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF LOSS (UNAUDITED) |
|||||||||||||||
|
Three Months Ended September
30,
|
Nine
Months Ended September 30,
|
||||||||||||||
|
2009
|
2008
|
2009
|
2008
|
||||||||||||
| REVENUES: |
|
|
|||||||||||||
| Commissions and fees | $ |
6,288,807
|
$ |
8,147,071
|
$ |
19,761,940
|
$ |
23,438,687
|
|||||||
| Interest income |
329,017
|
1,376,672
|
1,189,231
|
4,848,101
|
|||||||||||
| Interest expense on brokerage accounts |
-
|
187,260
|
-
|
1,009,689
|
|||||||||||
| Net interest income |
329,017
|
1,189,412
|
1,189,231
|
3,838,412
|
|||||||||||
|
|
|||||||||||||||
| Software fees, net |
229,778
|
210,821
|
716,978
|
563,157
|
|||||||||||
| Other revenues |
154,833
|
163,243
|
262,192
|
359,731
|
|||||||||||
|
|
|||||||||||||||
| Net revenues |
7,002,435
|
9,710,547
|
21,930,341
|
28,199,987
|
|||||||||||
|
|
|||||||||||||||
| EXPENSES: |
|
|
|||||||||||||
| Commissions and clearing |
2,575,546
|
2,488,600
|
7,663,804
|
8,267,603
|
|||||||||||
| Compensation and benefits |
2,216,306
|
2,315,995
|
6,616,982
|
7,125,321
|
|||||||||||
| Software and market data |
741,207
|
1,330,087
|
2,494,848
|
4,580,196
|
|||||||||||
| Advertising and promotional |
161,798
|
214,906
|
456,139
|
470,091
|
|||||||||||
| Professional fees |
653,566
|
736,876
|
2,032,802
|
2,048,807
|
|||||||||||
| Communications and information technology |
246,875
|
189,618
|
713,341
|
637,712
|
|||||||||||
| Depreciation and amortization |
583,662
|
595,923
|
1,715,916
|
1,721,854
|
|||||||||||
| Bad debt expense |
-
|
3,553,296
|
-
|
3,470,890
|
|||||||||||
| Other general and administrative expenses |
825,863
|
464,310
|
2,129,092
|
977,102
|
|||||||||||
|
|
|
||||||||||||||
| Total expenses |
8,004,823
|
11,889,611
|
23,822,924
|
29,299,576
|
|||||||||||
|
|
|
||||||||||||||
| Loss before income taxes |
(1,002,388
|
) |
(2,179,064
|
) |
(1,892,583
|
) |
(1,099,589
|
) | |||||||
|
|
|
||||||||||||||
| Income tax benefit |
392,021
|
785,814
|
737,021
|
277,696
|
|||||||||||
|
|
|
||||||||||||||
| Net loss |
(610,367
|
) |
(1,393,250
|
) |
(1,155,562
|
) |
(821,893
|
) | |||||||
|
|
|
||||||||||||||
| Dividends on preferred stock |
-
|
-
|
-
|
(20,113
|
) | ||||||||||
|
|
|
||||||||||||||
| Loss attributable to common shareholders | $ |
(610,367
|
) | $ |
(1,393,250
|
) | $ |
(1,155,562
|
) | $ |
(842,006
|
) | |||
| Loss per common share: | |||||||||||||||
| Basic | $ |
(0.02
|
) | $ |
(0.05
|
) | $ |
(0.05
|
) | $ |
(0.03
|
) | |||
| Diluted | $ |
(0.02
|
) | $ |
(0.05
|
) | $ |
(0.05
|
) | $ |
(0.03
|
) | |||
| Weighted average common shares outstanding: | |||||||||||||||
| Basic |
25,054,508
|
25,520,694
|
25,328,622
|
25,987,771
|
|||||||||||
| Diluted |
25,054,508
|
25,520,694
|
25,328,622
|
25,987,771
|
|||||||||||
|
See accompanying notes to unaudited
condensed consolidated financial statements.
|
|||||||||||||||
4
Table of Contents
|
TERRA NOVA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) |
|||||||
|
Nine Months Ended September 30,
|
|||||||
|
2009
|
2008
|
||||||
| Cash flows from operating activities: |
|
|
|||||
| Net loss | $ |
(1,155,562
|
) | $ |
(821,893
|
) | |
| Adjustments to reconcile net loss to net cash provided by (used in) operating activities: | |||||||
| Share-based compensation |
91,264
|
107,094
|
|||||
| Bad debt expense |
-
|
3,470,890
|
|||||
| Depreciation and amortization |
1,715,916
|
1,721,854
|
|||||
| Gain on sale of seat on exchange |
-
|
(300,142
|
) | ||||
| Deferred income taxes |
(715,000
|
) |
(392,630
|
) | |||
| Reversal of legal reserve |
-
|
(140,000
|
) | ||||
| Gain on extinguishment of liabilities |
(60,626
|
) |
(540,000
|
) | |||
| Loss on write-off of assets |
50,000
|
32,127
|
|||||
| Change in operating assets and liabilities: |
|
|
|||||
| (Increase) decrease in assets: |
|
|
|||||
| Cash segregated in compliance with federal regulations |
(8,230,681
|
) |
(31,593,762
|
) | |||
| Receivables from brokers, dealers and clearing organizations |
(19,338,772
|
) |
(21,192,697
|
) | |||
| Receivables from customers and non-customers |
(5,436,987
|
) |
25,888,918
|
||||
| Income tax receivables |
707,979
|
(1,225,464
|
) | ||||
| Other assets |
103,329
|
(29,763
|
) | ||||
| Increase (decrease) in liabilities: |
|
|
|||||
| Payables to brokers, dealers and clearing organizations |
278,198
|
20,077
|
|||||
| Payables to customers and non-customers |
31,406,966
|
29,811,231
|
|||||
| Accounts payable and accrued expenses |
(38,662
|
) |
(1,247,711
|
) | |||
| Income tax liability |
-
|
(592,918
|
) | ||||
| Net cash provided by (used in) operating activities |
(622,638
|
) |
2,975,211
|
||||
| Cash flows from investing activities: | |||||||
| Proceeds from sale of seat on exchange |
-
|
309,642
|
|||||
| Purchases of property and equipment |
(370,718
|
) |
(263,460
|
) | |||
| Capitalization of software development costs |
(142,837
|
) |
(722,394
|
) | |||
| Net cash used in investing activities |
(513,555
|
) |
(676,212
|
) | |||
| Cash flows from financing activities: | |||||||
| Repurchase and retirement of common stock |
-
|
(1,314,378
|
) | ||||
| Purchase of treasury stock |
(272,056
|
) |
-
|
||||
| Preferred dividends paid |
-
|
(50,063
|
) | ||||
| Redemption of preferred stock |
-
|
(781,100
|
) | ||||
| Net payments on line of credit |
-
|
(7,222,179
|
) | ||||
| Net cash used in financing activities |
(272,056
|
) |
(9,367,720
|
) | |||
| Net decrease in cash and cash equivalents |
(1,408,249
|
) |
(7,068,721
|
) | |||
| Cash and cash equivalents at beginning of period |
7,889,553
|
7,937,880
|
|||||
| Cash and cash equivalents at end of period | $ |
6,481,304
|
$ |
869,159
|
|||
| Supplemental cash flow information: | |||||||
| Cash paid for interest | $ |
-
|
$ |
1,009,689
|
|||
| Cash (received) paid for income taxes | $ |
(696,322
|
) | $ |
1,933,316
|
||
|
See accompanying notes to unaudited
condensed consolidated financial statements.
|
|||||||
5
Table of Contents
TERRA NOVA FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Note 1 - Nature of Operations and Basis of Presentation
Nature of Operations
Terra Nova Financial Group, Inc., an Illinois corporation, ("Parent", and collectively with its wholly-owned subsidiaries, the "Company," "firm," "we," "us," or "our"), is a holding company of businesses providing a range of products and services to the professional trading community. The Company has three primary subsidiaries: Terra Nova Financial, LLC ("Terra Nova"), a broker-dealer registered with the Securities and Exchange Commission and a member of Financial Industry Regulatory Authority, provides execution, clearing and prime brokerage services to professional traders, hedge funds and money managers; Tradient Technologies, Inc. ("Tradient"), a financial technology development business, provides proprietary applications for electronic trade execution, order routing and clearing; SC QuantNova Research SRL ("QuantNova"), based in Bucharest, Romania, provides software development, architecture and engineering for Tradient and back office clearing systems. Terra Nova Financial Group, Inc. trades under the stock symbol "TNFG" and is listed on the OTC Bulletin Board.
Terra Nova is registered with the following exchanges, registered clearing agencies, and regulatory organizations:
Regulatory and Self Regulatory Organizations:
|
•
|
Securities and Exchange Commission ("SEC") as a broker-dealer |
|
•
|
Financial Industry Regulatory Authority ("FINRA") as a broker-dealer |
|
•
|
National Futures Association ("NFA") as a futures commission merchant |
|
•
|
Commodity Futures Trading Commission ("CFTC") as a futures commission merchant |
Registered Clearing Agencies:
|
•
|
The Depository Trust Company |
|
•
|
National Securities Clearing Corporation |
|
•
|
The Options Clearing Corporation |
U.S. Equity Exchanges:
|
•
|
Chicago Stock Exchange |
|
•
|
ISE Stock Exchange |
|
•
|
National Stock Exchange |
|
•
|
NYSE Arca Equities |
|
•
|
NYSE Amex Equities |
|
•
|
NYSE Euronext |
|
•
|
NASDAQ Stock Market |
|
•
|
NASDAQ OMX BX |
U.S. Option Exchanges:
|
•
|
Boston Options Exchange |
|
•
|
NYSE Arca Options |
|
•
|
NASDAQ OMX PHLX |
|
•
|
NYSE Amex Options |
|
•
|
International Securities Exchange |
Investor Protection:
|
•
|
Securities Investor Protection Corporation |
Terra Nova offers a broad array of services for the execution and clearing of trading products including equities, options, futures and commodity options, ETFs, fixed income and mutual funds as well as prime brokerage, clearing and back office services for institutions. Terra Nova serves a diverse client base of professional traders, hedge funds, money managers, correspondent introducing brokers, registered representatives, registered investment advisors and foreign brokers located in the United States and in certain foreign countries. Primary sources of revenue for Terra Nova include commissions, account fees and interest.
Tradient, a wholly-owned subsidiary of the Parent, is a technology development entity that builds applications for electronic trade execution, order routing and clearing. Tradient applications are marketed to broker-dealers, institutional portfolio managers and traders. Primary sources of revenue for Tradient include software licensing and order routing fees.
6
Table of Contents
QuantNova, a wholly-owned subsidiary of the Parent, provides consulting, software development, electronic data processing, software architecture and engineering for the Tradient trading platforms and backoffice clearing software. QuantNova is based in Bucharest, Romania and as of September 30, 2009 has eight full-time employees.
The Parent also maintains the following wholly-owned subsidiaries:
|
•
|
Market Wise Securities, LLC ("MW Securities"), a FINRA broker-dealer |
|
•
|
QNT, LLC, a new subsidiary, formed on July 27, 2009 |
Basis of Presentation
The accompanying condensed consolidated financial statements should be read in conjunction with the consolidated financial statements of Terra Nova Financial Group, Inc. and notes to the consolidated financial statements included in the Annual Report on Form 10-K of Terra Nova Financial Group, Inc. for the year ended December 31, 2008.
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and in accordance with the instructions to Form 10-Q and Articles 8 and 10 of Regulation S-X. Accordingly, certain notes and other information normally included in financial statements prepared in accordance with United States generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, all adjustments (consisting only of normal recurring adjustments), necessary to present fairly the condensed consolidated financial position of Terra Nova Financial Group, Inc. and subsidiaries as of September 30, 2009 and the consolidated results of their operations and cash flows for each of the periods presented have been recorded. The results of operations and cash flows for an interim period are not necessarily indicative of the results of operations or cash flows that may be reported for the year or any subsequent period.
Note 2 - Summary of Significant Accounting Policies
(a) Consolidation Policy
The accompanying condensed consolidated financial statements include the accounts of the Parent and its wholly-owned subsidiaries. All significant intercompany transactions have been eliminated in consolidation.
(b) Fair Value of Financial Instruments
The carrying amounts of the Company's short term financial instruments, which consist of cash and cash equivalents, cash segregated in compliance with federal regulations, receivables from brokers, dealers and clearing organizations, receivables from customers and non-customers, payables to brokers, dealers and clearing organizations, payables to customers and non-customers and accounts payable and accrued expenses approximate their fair value due to their short term nature.
(c) Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported financial statement amounts and disclosures. Actual amounts could differ from those estimates.
(d) Foreign Currency Translation
The local currency of the Company's foreign operations, QuantNova, is considered to be its functional currency. Assets and liabilities of foreign operations are translated using quarter-end exchange rates and revenues and expenses are translated using average exchange rates in effect during the month with the resulting adjustment, if material, included in other comprehensive income (loss). To date, foreign currency translation adjustments have been immaterial.
(e) Cash and Cash Equivalents
The Company classifies all highly liquid investments with an original maturity of three months or less as cash equivalents. Cash and cash equivalents consist primarily of cash held in liquid commercial bank accounts or clearing organization accounts paying a "money market" rate of interest. The Company also has a sweep account which deposits excess operating bank balances overnight into a money market account.
7
Table of Contents
(f) Cash Segregated in Compliance with Federal Regulations
Cash segregated in compliance with federal regulations is in special reserve accounts for the exclusive benefit of customers under Rule 15c3-3 of the Securities Exchange Act of 1934. We maintain special reserve accounts with multiple qualified banking institutions to mitigate credit risk. In the special reserve accounts we invest in a combination of qualified securities including short-term U.S. government securities, reverse repurchase agreements collateralized by U.S. government securities, qualified trust products, and interest bearing cash accounts. These special reserve accounts are in full compliance with all regulatory requirements.
(g) Long-Lived Assets
Long-lived assets, primarily consisting of definite lived intangible assets, property and equipment and capitalized software development costs, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. Recoverability of assets held and used is generally measured by a comparison of the carrying amount of the asset to undiscounted future net cash flows expected to be generated by that asset. If it is determined that the carrying amount of an asset may not be recoverable, an impairment loss is recognized for the amount by which the carrying amount of the asset exceeds the fair value of the asset. Fair value is the estimated value at which the asset could be bought or sold in a transaction between willing parties.
(h) Intangible Assets
The Company acquired $6,578,000 of intangible assets as part of the acquisition of Terra Nova on May 17, 2006. The acquired intangible assets comprised the values prescribed to the acquired customer list and trade name of $4,749,000 and $1,829,000, respectively. Amortization expense related to intangible assets for the nine months ended September 30, 2009 and 2008 was $1,027,613 and $1,015,281, respectively. The accumulated amortization of intangible assets as of September 30, 2009 and December 31, 2008 was $3,494,099 and $2,466,486, respectively.
(i) Receivables from Brokers, Dealers and Clearing Organizations
Receivables from brokers, dealers and clearing organizations consist primarily of securities borrowed, commissions receivable, and deposits with clearing organizations. Transactions involving borrowed securities require the Company to provide the counterparty with collateral in the form of cash. The Company adjusts this amount on a daily basis as the value of the securities borrowed may change. The Company utilizes various third-party clearing brokers for institutional, prime brokerage, equity and option clearing business and fully-disclosed futures business.
(j) Receivables from Customers and Non-Customers
Receivables from customers consist of margin loans to brokerage customers. Margin loans are secured by securities in brokerage customers accounts. Such collateral is not reflected in the condensed consolidated financial statements. Terra Nova charges interest on debit balances in brokerage customer accounts. Margin requirements determine the amount of equity required to be held in an account relative to the purchase and sale of equity transactions. Margin lending is subject to the rules and regulations of the Federal Reserve System, FINRA, exchanges, various clearing firms and the internal policies of Terra Nova. Terra Nova assumes risk that the collateral securing margin debits may reduce in value to an amount that renders the margin loan unsecured. Margin requirements are amended by Terra Nova as deemed necessary for certain accounts and securities. Terra Nova also reserves the right to close-out any and all positions in an account should it be deemed necessary to protect itself from loss. Although Terra Nova monitors risk and margin of trading accounts, there is no assurance that a customer will satisfy a margin call or pay unsecured indebtedness owed to Terra Nova. The Company has an allowance for potential credit losses based upon its assessment of specifically identified unsecured receivables and other factors. At September 30, 2009 and December 31, 2008, allowance for doubtful accounts totaled $13,500 and $15,000, respectively.
(k) Payables to Customers and Non-Customers
Customers funds are maintained in customer segregated accounts and relate to item (f) discussed above. Payables to customers are free credit balances on deposit with the Company related to its self-clearing business which, are subject to Rule 15c3-3 of the Securities Exchange Act of 1934. The customer funds have been segregated in special reserve accounts earning interest. This payable to customers does not include customer securities positions as customer owned securities represent an off-balance sheet item.
Payables to non-customers are Proprietary Accounts of Introducing Brokers ("PAIB") in accordance with the customer reserve computation set forth in Rule 15c3-3 of the Securities Exchange Act of 1934 ("customer reserve formula"). The Company has established and maintains a separate "Special Reserve Account for the Exclusive Benefit of Customers" with a bank in conformity with the standards of Rule 15c3-3 ("PAIB Reserve Account"). Cash and/or qualified securities as defined in the customer reserve formula are maintained in the PAIB Reserve Account in an amount equal to the PAIB reserve requirement.
8
Table of Contents
(l) Revenue Recognition
Revenues primarily consist of commission and fees, interest income and software related licensing fees. Commission revenue and related expenses on securities transactions are recorded on a settlement date basis. Other revenue consists of account and transaction fees and is recorded on a settlement date basis as security transactions occur. Software fees are charges for the use of the Company's software execution platform. Revenues from software fees are recognized on a monthly basis as services are provided to clients. Interest income is primarily generated by charges to clients on margin balances and revenue from client cash held and invested by Terra Nova as a clearing firm offset by interest paid to clients on their credit balances. Interest income and brokerage interest expense are recorded on an accrual basis as earned or incurred.
(m) Goodwill
Goodwill is tested for impairment annually on December 31 or more frequently if impairment indicators arise. The first step of this process is to identify potential goodwill impairment by comparing the fair value of the reporting unit to its carrying value. The Company estimates fair value using a combination of the market price of the Company's common equity and discounted cash flows. If the carrying value is less than fair value, the Company would complete step two in the impairment review process which measures the amount of goodwill impairment. Management tests the reasonableness of the inputs and outcomes of the discounted future cash flow analysis and the evaluation of the market price of its common equity against other available comparable market data. The entire amount of goodwill at September 30, 2009 and December 31, 2008 of $7,501,408 was created from the Terra Nova, Market Wise Stock Trading School, LLC and MW Securities acquisition in May 2006 and has been assigned to the Terra Nova reporting unit within the Brokerages Services Segment. The Company performed its annual impairment test of goodwill on December 31, 2008 and determined that there was no impairment.
(n) Line of Credit
From time to time, Terra Nova may obtain a short-term bank loan to facilitate its broker-dealer settlement and clearing operations due to customer margin debits. This short-term bank loan is fully secured with customer marginable positions.
(o) Income Taxes
The Company files a consolidated federal income tax return with its subsidiaries. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense or benefit is the tax payable or refundable for the period, plus or minus the change during the period in deferred tax assets and liabilities.
(p) Reclassifications
Certain reclassifications have been made to prior period amounts to conform to current period classifications.
(q) Recently Adopted Accounting Standards
In June 2009, the FASB established the FASB Accounting Standards Codification ("ASC") as the sole source of authoritative generally accepted accounting principles in the United States ("GAAP"). Rules and interpretive releases of the Securities and Exchange Commission ("SEC") under federal securities laws are also sources of authoritative GAAP for SEC registrants. The ASC is effective for financial statements issued for interim and annual periods ending after September 15, 2009. Accordingly, the Company has updated references to GAAP in its financial statements issued for the period ended September 30, 2009. The adoption of the ASC did not impact the Company's financial condition, results of operations or cash flows.
On May, 2009, the FASB established general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. The Company adopted this new standard during the quarter ended June 30, 2009. The adoption of this standard did not impact the Company's financial condition, results of operations or cash flows.
In December 2007, the FASB amended the business combinations accounting guidance. The amended guidance retains the underlying concepts that all business combinations are still required to be accounted for at fair value under the acquisition method of accounting, but changes the method of applying the acquisition method in a number of aspects. The amended guidance on business combinations is effective prospectively for business combinations for which the acquisition date is on or after January 1, 2009.
In April 2009, the FASB amended disclosure guidance about fair value of financial statements to require fair value disclosures for interim reporting periods. Such disclosures were previously required only in annual financial statements. The Company adopted the provisions of the amended disclosure guidance during the quarter ended June 30, 2009.
9
Table of Contents
Note 3 - Net Income (Loss) Per Common Share
Basic net income (loss) per common share ("EPS") is computed by dividing net income (loss) attributable to common shareholders by the weighted average common shares outstanding for the period. Diluted EPS is computed by dividing net income (loss) attributable to common shareholders by the weighted average common shares outstanding plus the additional shares that would have been outstanding if potentially dilutive shares, such as shares that would satisfy outstanding warrants and options, had been issued applying the treasury stock method.
For the three and nine months ended September 30, 2009 and September 30, 2008 the components of basic and diluted weighted average shares outstanding are as follows:
|
For Three Months Ended September 30,
|
For Nine Months Ended September 30,
|
||||||||||||||
|
2009
|
2008
|
2009
|
2008
|
||||||||||||
| Weighted average shares outstanding - Basic |
25,054,508
|
25,520,694
|
25,328,622
|
25,987,771
|
|||||||||||
| Weighted average shares outstanding - Diluted |
25,054,508
|
25,520,694
|
25,328,622
|
25,987,771
|
|||||||||||
Note 4 - Capitalization
(a) Common Stock
The Company had 150,000,000 shares of common stock authorized, 25,482,942 shares issued and 25,054,508 shares outstanding as of September 30, 2009.
(b) Stock Repurchase Program
On May 1, 2009 the Company's Board of Directors authorized the Company's management to pursue repurchases of the Company's stock at the discretion of the management. This authorization allows management to purchase up to $3,000,000 of stock under the safe harbor guidelines of and pursuant to the requirements of SEC Rule 10b-18. This authorization grants discretion to the Company's management to execute the repurchase program and there is no requirement to purchase any minimum number of shares. The repurchase program is intended to continue until April 30, 2010 but may be modified or terminated by the Company's Board of Directors prior to that date. The Company repurchased a total of 428,434 shares of common stock for $272,056 during the nine months ended September 30, 2009. All such repurchased shares are included in treasury stock. The Company intends to retain the common shares repurchased under the stock repurchase program as treasury stock rather than retire the repurchased shares.
(c) Non-employee Warrants
Non-employee warrants outstanding as of September 30, 2009 totaled 14,002,170 with a weighted average exercise price of $2.79. During the nine months ended September 30, 2009 and 2008 no non-employee warrants were granted or exercised.
(d) Restricted Stock
As of September 30, 2009 and December 31, 2008, the Company had no outstanding non-vested shares related to equity incentive plans.
Note 5 - Segment Information
The Company organizes its operations into two operating segments for the purpose of making operating decisions and assessing performance. Segments have been identified based on products and services offered as well as risks assumed in a manner consistent with the data utilized by management in evaluating operations. The Company's broker-dealer related services have been included in the Brokerage Services Segment which includes Terra Nova and MW Securities. The Software Services Segment is comprised of Tradient and QuantNova, which are the Company's technology development subsidiaries. Corporate and Unallocated is not an operating segment and is comprised mainly of corporate expenses.
The assets of the Company are used primarily to support the operations of the two primary subsidiaries, Terra Nova and Tradient. The following summarizes the Company's segment information.
10
Table of Contents
|
Three Months Ended September 30,
|
Nine Months Ended September 30,
|
||||||||||||||
|
2009
|
2008
|
2009
|
2008
|
||||||||||||
| Revenues: |
(Unaudited)
|
(Unaudited)
|
(Unaudited)
|
(Unaudited)
|
|||||||||||
| Brokerage Services Segment | |||||||||||||||
| Revenues, excluding interest | $ |
6,443,640
|
$ |
8,310,314
|
$ |
20,024,132
|
$ |
23,798,418
|
|||||||
| Interest income |
329,017
|
1,376,672
|
1,189,231
|
4,848,101
|
|||||||||||
| Interest expense on brokerage accounts |
-
|
(187,260
|
) |
-
|
(1,009,689
|
) | |||||||||
| Totals |
6,772,657
|
9,499,726
|
21,213,363
|
27,636,830
|
|||||||||||
| Software Services Segment | |||||||||||||||
| Revenues |
447,458
|
821,213
|
1,507,365
|
2,124,879
|
|||||||||||
| Elimination of intercompany charges from the Software segment to Brokerage segment |
(217,680
|
) |
(610,392
|
) |
(790,387
|
) |
(1,561,722
|
) | |||||||
| Totals |
229,778
|
210,821
|
716,978
|
563,157
|
|||||||||||
| Net revenues | $ |
7,002,435
|
$ |
9,710,547
|
$ |
21,930,341
|
$ |
28,199,987
|
|||||||
| Depreciation and amortization | |||||||||||||||
| Brokerage Services Segment | $ |
401,418
|
$ |
385,552
|
$ |
1,185,523
|
$ |
1,156,261
|
|||||||
| Software Services Segment |
83,299
|
111,816
|
235,254
|
269,670
|
|||||||||||
| Corporate and Unallocated |
98,945
|
98,555
|
295,139
|
295,923
|
|||||||||||
| Totals | $ |
583,662
|
$ |
595,923
|
$ |
1,715,916
|
$ |
1,721,854
|
|||||||
| Income (loss) before income taxes | |||||||||||||||
| Brokerage Services Segment | $ |
160,704
|
$ |
(1,704,096
|
) | $ |
1,239,343
|
$ |
164,503
|
||||||
| Software Services Segment |
(196,342
|
) |
268,571
|
(377,050
|
) |
365,925
|
|||||||||
| Corporate and Unallocated |
(966,750
|
) |
(743,539
|
) |
(2,754,876
|
) |
(1,630,017
|
) | |||||||
| Totals | $ |
(1,002,388
|
) | $ |
(2,179,064
|
) | $ |
(1,892,583
|
) | $ |
(1,099,589
|
) | |||
|
September 30,
|
December 31,
|
||||||||||||||
| Total Assets |
2009
|
2008
|
|||||||||||||
| Brokerage Services Segment | $ |
212,465,319
|
$ |
181,868,725
|
|||||||||||
| Software Services Segment |
706,457
|
733,125
|
|||||||||||||
| Corporate and Unallocated |
4,025,274
|
4,345,678
|
|||||||||||||
| Total assets | $ |
217,197,050
|
$ |
186,947,528
|
|||||||||||
Litigation and Claims
On September 25, 2009, a FINRA arbitration panel in the matter of Friedman v. Riverside Securities, Jordan Zaro and Terra Nova found in favor of the claimant and awarded damages together with attorneys' fees, costs and interest against the defendants who were held jointly and severally liable. The matter involved a dispute under which claimant contended that Zaro engaged in improper trades in her account. The Company accrued $285,000 in satisfaction of the judgment and is seeking indemnification and contribution from the co-defendants.
On or about September 25, 2009, Terra Nova was notified that it had been joined as a defendant in FINRA Arbitration Number 09-05462, the case of Beatriz Santana and the Estate of Guillermo Zuniga v. Southwest Securities, Carlos Manuel Garcia and Terra Nova in which the plaintiff seeks to recover up to $500,000. The complaint alleges that Terra Nova negligently or knowingly allowed co-defendant Garcia to improperly manage the account of Santana and Zuniga. Terra Nova maintains that it has acted properly and will vigorously defend this matter. The Company believes the potential for liability in this matter is limited. Accordingly, no liability has been recorded related to this claim.
On April 29, 2009, Terra Nova was notified that it had been joined as a defendant in FINRA Arbitration Number 09-02166, the case of Andali Investments v. Southwest Securities, Tradestation Securities, Terra Nova and Carlos Manuel Garcia in which the plaintiff seeks to recover $500,000. The complaint alleges that Terra Nova allowed the transfer of $60,443 from Andali's account without proper authorization. Terra Nova maintains that it has acted properly and will vigorously defend this matter. The Company believes the potential for liability in this matter is limited, as its involvement compared to the other respondents was for a short period of time and it was involved in only a very limited number of trades involving less than the $500,000 the claimant seeks to recover. Accordingly, no liability has been recorded related to this claim.
11
Table of Contents
On December 19, 2008, FINRA notified Terra Nova that it had made a preliminary determination to recommend disciplinary action against Terra Nova as well as one current and two former employees based on alleged rule violations primarily related to soft dollar accounts, including without limitation alleged improper soft dollar payments, failure to adequately supervise soft dollar payments, failure to maintain adequate written supervisory procedures and improper record keeping. The charges mainly relate to activities that occurred in 2004 and 2005. Terra Nova signed an Acceptance, Waiver and Consent document to settle this proceeding in October of 2009. The amount of the settlement has been reserved as of September 30, 2009.
In September 2008, an automated program used by Hsu-Tung Lee ("Lee"), a client of the Terra Nova, resulted in erroneous trades far exceeding the buying power in Lee's account with Terra Nova. While the exchange canceled a large number of these trades Terra Nova was forced to cover Lee's short positions, resulting in a large debit position in Lee's account with Terra Nova. Terra Nova brought a collection action against Lee by filing arbitration Case Number 08-4728 before FINRA. On February 13, 2009, Lee filed a counterclaim against Terra Nova alleging that Terra Nova's supervisory procedures should have prevented the mistaken trades from being sent to the market. This counterclaim seeks actual damages of no less than $62,000 and punitive damages of approximately $2,800,000, the amount of punitive damages being the same amount as Terra Nova is seeking as damages against Lee in this matter. Terra Nova believes that it has strong defenses and intends to vigorously defend against this claim. Terra Nova further believes that even if Lee were to prevail in his counterclaim that any imposition of punitive damages would be unwarranted. Accordingly, no liability has been recorded related to this claim.
On May 1, 2009 Terra Nova was informed that the mistaken Lee trades have become the subject of an inquiry by NYSE Arca for the trades placed on that exchange.
In addition to the foregoing, many aspects of the Company's business involve substantial risk of liability and from time to time the Company may become involved in additional lawsuits, arbitrations, claims and other legal proceedings. There is a relatively high incidence of litigation involving the securities brokerage industry. The Company also is subject to periodic regulatory audits, inquiries and inspections. In this regard, the Company has been notified by regulatory authorities of various ongoing investigations. The Company has responded to all requests related to such investigations. At this time, management is unable to predict with certainty the outcome of these matters.
Note 7 - General Contingencies
In the ordinary course of business, there are certain contingencies which are not reflected in the condensed consolidated financial statements. These activities may expose the Company to credit risk in the event that broker-dealer clients are unable to fulfill their contractual obligations.
Many client accounts are margin accounts in which the Company, in effect, loans money to clients. In margin transactions, the Company may be obligated for client losses when credit is extended to clients directly that is not fully collateralized by cash and securities in the clients' accounts. In connection with securities activities, Terra Nova executes client transactions involving the sale of securities not yet purchased ("short sales"), all of which are transacted on a margin basis subject to federal, self-regulatory organizations, individual exchange regulations and Terra Nova's internal risk management policies. In all cases, such transactions may expose the Company to significant off-balance sheet credit risk in the event that client collateral is not sufficient to fully cover losses that clients may incur. In the event that clients fail to satisfy their obligations, the Company would be required to purchase or sell financial instruments at prevailing market prices to fulfill the clients' obligations.
The Company seeks to control the risks associated with its clients' activities by requiring clients to maintain collateral in their margin accounts in compliance with various regulatory requirements and internal risk management requirements. Terra Nova monitors required margin levels on an intra-day basis and, pursuant to such guidelines, requires the clients to deposit additional collateral or to reduce positions when necessary.
The Company provides guarantees to clearing organizations and exchanges under their standard membership agreements, which require members to guarantee the performance of other members. Under these agreements, if a member becomes unable to satisfy its obligations to the clearing organization and exchanges, other members may be called upon to meet such shortfalls. The Company's liability under these arrangements is not quantifiable and may exceed the cash and securities it has posted as collateral. However, management believes the possibility of being required to make payments under these arrangements is remote. Accordingly, no liability has been recorded for these potential events.
Note 8 - Reversal of Liabilities
During the nine months ended September 30, 2009 the Company determined the statute of limitations had expired on various debts totaling approximately $61,000. Accordingly, the Company reversed these liabilities from the condensed consolidated balance sheet upon the expiration of the statute of limitations. The gains on the reversal of liabilities are reflected under the category "Other general and administrative expenses" on the accompanying condensed consolidated statements of loss.
12
Table of Contents
Note 9 - Income Taxes
The Company recorded an income tax benefit for the three and nine months ended September 30, 2009 of $392,021 and $737,021, respectively, based on an estimated annual effective tax rate of 39%. At September 30, 2009, the Company had income tax receivables totaling $738,285 which are comprised of an overpayment in estimated federal and state tax payments for 2008 of approximately $400,000, State of Illinois refunds from amendments from filing on a unitary basis of approximately $190,000, and State of Illinois refund receivables from amendments to prior years' returns of approximately $150,000.
Note 10 - Regulatory Requirements
Terra Nova and MW Securities are subject to the Securities and Exchange Commission Uniform Net Capital Rule ("Rule 15c3-1") under the Securities Exchange Act of 1934 which requires the maintenance of minimum net capital. Terra Nova calculates its net capital using the ''alternative method,'' which requires the maintenance of minimum net capital, as defined by the rules, equal to the greater of (i) $1,500,000 or (ii) 2.0% of aggregate debit items.
Terra Nova is also subject to the Commodity Futures Trading Commission's ("CFTC") financial requirement ("Regulation 1.17") under the Commodity Exchange Act, administered by the CFTC and the NFA, which also requires the maintenance of minimum net capital. Terra Nova is a futures commission merchant and is required to maintain minimum net capital equal to the greater of its net capital requirement under Rule 15c3-1, (i) $1,500,000 or (ii) 2.0% of aggregate debit items, or the sum of 8% of the total risk margin requirements for all positions carried in customer accounts, as defined in Regulation 1.17 and 4% of the total risk margin requirements for all positions carried in non-customer accounts with a required net capital minimum of $500,000.
MW Securities is an inactive broker-dealer and is subject to a minimum capital requirement of $5,000 as a FINRA broker-dealer.
Excess net capital of one broker-dealer subsidiary may not be used to offset a net capital deficiency of another broker-dealer subsidiary. Net capital and the related net capital requirement may fluctuate on a daily basis. The net capital requirements for the Company's broker-dealer subsidiaries as of September 30, 2009 are as follows:
|
Minimum Net Capital Requirement
|
Excess Net Capital
|
||||||||||||||||||
|
Net Capital
|
SEC
|
CFTC
|
SEC
|
CFTC
|
|||||||||||||||
| Terra Nova Financial, LLC | $ |
11,301,401
|
$ |
1,500,000
|
$ |
500,000
|
$ |
9,801,401
|
$ |
10,801,401
|
|||||||||
| Market Wise Securities, LLC | $ |
29,598
|
$ |
5,000
|
$ |
-
|
$ |
24,598
|
$ |
-
|
|||||||||
Stock Options and Warrants
The fair value of each share-based award is estimated on the date of grant using the Black-Scholes option pricing model. Assumptions used in the Black-Scholes model include: expected volatility of the Company's common stock estimated based on historical volatility and management's estimate of future volatility; expected life estimated based on historical employee exercise behavior for similar awards, giving consideration to the award's contractual terms vesting schedules and expectations of future employee behavior; risk-free interest rate; and expected dividend yield. Share-based compensation is recorded based on the grant date fair value of awards over their respective requisite service periods, net of estimated forfeitures based on historical employee termination behavior.
The table below summarizes the Company's employee stock option and warrant plans as of September 30, 2009:
| Employee Stock Option and Warrant Plans |
Authorized
|
Outstanding
|
Available
|
||||||||||
| 2005 Long-Term Incentive Plan ("LTIP") |
4,361,564
|
1,103,024
|
3,258,540
|
||||||||||
| 2006 Warrant Incentive Plan ("2006 WIP") |
3,500,000
|
3,027,500
|
472,500
|
||||||||||
| Balance at September 30, 2009 |
7,861,564
|
4,130,524
|
3,731,040
|
||||||||||
13
Table of Contents
A summary of employee stock option activity, under the Company's LTIP, as of September 30, 2009, is presented below:
| Employee Stock Options |
Employee
Stock Options Outstanding |
Weighted
Average Exercise Price |
Weighted
Average Remaining Contract Term (in years) |
Aggregate
Intrinsic Value |
||||||||||||||
| Balance at December 31, 2008 |
589,274
|
$ |
1.71
|
3.7
|
$ |
-
|
||||||||||||
| Granted |
600,000
|
0.80
|
4.8
|
-
|
||||||||||||||
| Exercised |
-
|
-
|
-
|
-
|
||||||||||||||
| Cancelled |
(86,250
|
) |
1.65
|
-
|
-
|
|||||||||||||
| Balance at September 30, 2009 |
1,103,024
|
$ |
1.22
|
4.0
|
$ |
-
|
||||||||||||
| Options exercisable at September 30, 2009 |
286,137
|
$ |
1.80
|
2.8
|
$ |
-
|
||||||||||||
The aggregate intrinsic value of stock options outstanding and stock options exercisable at September 30, 2009 was calculated as the number of in-the-money options times the difference between the exercise price of the underlying awards and the quoted closing market price of the Company's common stock at September 30, 2009. The aggregate intrinsic value of stock options exercised is determined by the number of options times the difference between the exercise price of the underlying awards and the quoted closing market price of the Company's common stock on the exercise date.
As of September 30, 2009 the aggregate unrecognized compensation cost related to share-based compensation arrangements granted under stock option plans was approximately $228,000. The cost is expected to be recognized over a weighted average period of approximately three years. During the nine months ended September 30, 2009 and 2008 compensation expense of $91,000 and $107,000, respectively, was recognized related to options vesting under option plans.
A summary of employee warrant activity under the 2006 WIP as of September 30, 2009 is presented below:
| Employee Warrants |
Employee
Warrants Outstanding |
Weighted
Average Exercise Price |
Weighted
Average Remaining Contract Term (in years) |
Aggregate
Intrinsic Value |
||||||||||||||
| Balance at December 31, 2008 |
3,027,500
|
$ |
2.56
|
2.6
|
$ |
-
|
||||||||||||
| Granted |
-
|
-
|
-
|
-
|
||||||||||||||
| Exercised |
-
|
-
|
-
|
-
|
||||||||||||||
| Cancelled |
-
|
-
|
-
|
-
|
||||||||||||||
| Balance at September 30, 2009 |
3,027,500
|
$ |
2.56
|
1.8
|
$ |
-
|
||||||||||||
| Warrants exercisable at September 30, 2009 |
3,027,500
|
$ |
2.56
|
1.8
|
$ |
-
|
||||||||||||
During the nine months ended September 30, 2009 and 2008 no employee warrants were granted.
Note 12 - Property and Equipment and Capitalized Software Development Costs
The following table represents the different classes of property and equipment and capitalized software development costs as of September 30, 2009 and December 31, 2008:
14
Table of Contents
|
September 30, 2009
|
December 31, 2008
|
|||||||||||||||||
|
Estimated
Useful Life in Years |
Property and
equipment |
Capitalized
software development costs |
Property and
equipment |
Capitalized
software development costs |
||||||||||||||
| Computer and software |
3-5
|
$ |
735,199
|
$ |
2,923,466
|
$ |
668,531
|
$ |
2,780,628
|
|||||||||
| Furniture, fixtures and equipment |
3-7
|
1,193,624
|
-
|
1,185,672
|
-
|
|||||||||||||
| Leasehold improvements |
5-10
|
119,589
|
-
|
119,590
|
-
|
|||||||||||||
|
2,048,412
|
2,923,466
|
1,973,793
|
2,780,628
|
|||||||||||||||
| Accumulated depreciation and amortization |
(740,654
|
) |
(1,124,891
|
) |
(752,727
|
) |
(720,613
|
) | ||||||||||
| Net balance | $ |
1,307,758
|
$ |
1,798,575
|
$ |
1,221,066
|
$ |
2,060,015
|
||||||||||
Note 13 - Fair Value Measurements
In September 2006, the FASB issued ASC Topic 820, "Fair Value Measurements", ("Topic 820") which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. The definition of fair value retains the exchange price notion in earlier definitions of fair value and focuses on the price that would be received to sell the asset or paid to transfer the liability (an exit price), not the price that would be paid to acquire the asset or received to assume the liability (an entry price).
The following table sets forth the Company's financial instruments that are recognized or disclosed at fair value in the financial statements on a recurring basis as of September 30, 2009.
| Financial instruments owned, at fair value: |
September 30, 2009
|
||||
| Money market funds held in cash and cash equivalents | $ |
5,928,557
|
|||
| U.S. Treasury securities held as clearing deposits |
13,895,425
|
||||
| Total | $ |
19,823,982
|
|||
The fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value into three broad levels, as follows:
|
•
|
Level 1- Quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. |
|
•
|
Level 2- Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Such inputs include quoted prices in markets that are not active, quoted prices for similar assets and liabilities in active markets, inputs other than quoted prices that are observable for the asset or liability and inputs that are derived principally from or corroborated by observable market data by correlation or other means. |
|
•
|
Level 3 - Unobservable inputs for the asset or liability, where there is little, if any, observable market activity or data for the asset or liability. |
The following table sets forth by level within the fair value hierarchy the Company's financials instruments owned at fair value as of September 30, 2009.
15
Table of Contents
|
Quoted Prices in
Active Markets for Identical Assets |
Significant
Other Observable Inputs |
Significant
Unobservable Inputs |
||||||||||||||
| Financial instruments owned, at fair value: |
Level 1
|
Level 2
|
Level 3
|
Total
|
||||||||||||
| Money market funds held in cash and cash equivalents | $ |
5,928,557
|
$ |
-
|
$ |
-
|
$ |
5,928,557
|
||||||||
| U.S. Treasury securities held as clearing deposits |
13,895,425
|
-
|
-
|
13,895,425
|
||||||||||||
| Total | $ |
19,823,982
|
$ |
-
|
$ |
-
|
$ |
19,823,982
|
||||||||
The components of receivables from and payables to brokers, dealers and clearing organizations are as follows at September 30, 2009 and December 31, 2008:
|
September 30, 2009
|
December 31, 2008
|
|||||||||||||||||
|
Receivables
|
Payables
|
Receivables
|
Payables
|
|||||||||||||||
| Securities borrowed/loaned | $ |
16,398,975
|
$ |
-
|
$ |
4,332,350
|
$ |
-
|
||||||||||
| Clearing deposits & receivables/payables |
16,508,256
|
1,191,819
|
9,236,109
|
913,621
|
||||||||||||||
| Total | $ |
32,907,231
|
$ |
1,191,819
|
$ |
13,568,459
|
$ |
913,621
|
||||||||||
Self-clearing related clearing deposits and receivables/payables include transactions and deposits required by various clearing and exchange organizations. Generally, the Company is obligated to meet deposit requirements on a daily basis.
Note 15 - Subsequent Events
Management has evaluated subsequent events through November 13, 2009, the date of issuance of our condensed consolidated financial statements included in this Quarterly Report on Form 10-Q.
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Cautionary Note Regarding Forward-Looking Statements
Certain statements in this Quarterly Report on Form 10-Q may constitute "forward-looking" statements as defined in Section 27A of the Securities Act of 1933 (the "Securities Act"), Section 21E of the Securities Exchange Act of 1934 (the "Exchange Act"), the Private Securities Litigation Reform Act of 1995 (the "PSLRA") or in releases made by the Securities and Exchange Commission ("SEC"), all as may be amended from time to time. Such forward-looking statements involve known and unknown risks, uncertainties and other important factors that could cause the actual results, performance or achievements of Terra Nova Financial Group, Inc. and its subsidiaries, to differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements. Statements that are not historical fact are forward-looking statements. Forward-looking statements can be identified by, among other things, the use of forward-looking language, such as the words "plan," "believe," "expect," "anticipate," "intend," "estimate," "project," "may," "will," "would," "could," "should," "seeks," or "scheduled to," or other similar words, or the negative of these terms or other variations of these terms or comparable language, or by discussion of strategy or intentions. These cautionary statements are being made pursuant to the Securities Act, the Exchange Act and the PSLRA with the intention of obtaining the benefits of the "safe harbor" provisions of such laws. The Company cautions investors that any forward-looking statements made by the Company are not guarantees or indicative of future performance. Important assumptions and other important factors that could cause actual results to differ materially from those forward-looking statements with respect to the Company, include, but are not limited to, risks and uncertainties that are described in Item 1A - "Risk Factors" of the Annual Report on Form 10-K for the year ended December 31, 2008 and in Item 1A - "Risk Factors" of this Quarterly Report, and in other securities filings by the Company with the SEC.
16
Table of Contents
Although the Company believes that its plans, intentions and expectations reflected in or suggested by such forward-looking statements are reasonable, actual results could differ materially from a projection or assumption in any forward-looking statements.
The Company's future financial condition and results of operations, as well as any forward-looking statements, are subject to change and inherent risks and uncertainties. The forward-looking statements contained in this Quarterly Report on Form 10-Q are made only as of the date hereof and the Company does not have or undertake any obligation to update or revise any forward-looking statements whether as a result of new information, subsequent events or otherwise, unless otherwise required by law.
Variability of Quarterly Results
The operating results for any quarter are not necessarily indicative of results for any future period or for the full year. Quarterly revenues and operating results have varied in the past and are likely to vary in the future. Such fluctuations may result in volatility in the price of the Company's common stock. For information regarding the risks related to the variability of quarterly results, see Item 1A - "Risk Factors" of the Annual Report on Form 10-K of the Company for the year ended December 31, 2008 and Item 1A - "Risk Factors" of this Quarterly Report.
Overview
Terra Nova Financial Group, Inc. ("Parent", and collectively with its wholly-owned subsidiaries, the "Company," "firm," "we," "us," or "our") is a holding company of businesses providing a range of products and services to the professional trading community. The Company has three primary subsidiaries: Terra Nova Financial, LLC ("Terra Nova"), Tradient Technologies, Inc. ("Tradient") and SC QuantNova Research SRL ("QuantNova"). Terra Nova, Tradient and QuantNova are wholly-owned subsidiaries of the Parent, a public company trading on the OTC Bulletin Board under the symbol TNFG.
Professional traders, hedge funds, money managers and others come to Terra Nova, a broker-dealer registered with the Securities and Exchange Commission and a member of Financial Industry Regulatory Authority, for what we believe to be good value in execution, clearing and prime brokerage services. The firm offers highly active traders what we believe are effective solutions for direct access trading in domestic and global markets across many product classes including equities, options, ETFs, commodity futures and options, fixed income securities and mutual funds. Clients can make unbiased executions on an agency-only basis through Terra Nova's 24-hour trading desk staffed with licensed brokers or through any of a range of different trading platforms suited to different trading styles. The firm also provides customizable, turn-key clearing solutions for broker-dealers and introducing brokers; and prime brokerage services well suited for small and mid-sized hedge funds. Terra Nova is located in Chicago, Illinois. During the third quarter of 2009, primary sources of revenue for Terra Nova include 90% from commissions and fees, 5% from net interest income and 3% from software fees. During the third quarter of 2008, the primary sources of revenue for Terra Nova included 84% from commissions and fees, 12% from net interest income and 2% from software fees.
Tradient is the Company's financial technology development business providing proprietary applications for electronic trade execution, order routing and clearing. Tradient platforms for real-time market data and direct access trading are intended to be designed for efficiency, consistency and value. Tradient platforms include its flagship product Tradient Pro, a fully customizable Level II trading platform; Tradient Plus, an easy-to-use, customizable trading platform offering essential equity and options trading features economically; and Tradient Web, a browser-based trading system with streaming Level I data. Tradient is located in Chicago, Illinois. Primary sources of revenue for Tradient include software licensing and order routing fees.
QuantNova provides consulting, software development, electronic data processing, software architecture and engineering for Tradient trading platforms and backoffice clearing software. QuantNova is based in Bucharest, Romania and as of September 30, 2009 had eight full-time employees.
Plan of Operation
2009 Initiatives
In 2009, our current goals are to increase revenue growth through strategic initiatives involving marketing and sales operations, technology innovation and cost control, such as:
Pursue targeted segments:
|
•
|
Attract sophisticated traders by providing access to algorithmic trading, "black box" and non-click trading strategies; |
|
•
|
Attract international active trading clients who are interested in the U.S. markets; |
|
•
|
Attract displaced institutional trading professionals who may turn to independent trading or trade group participation; and |
|
•
|
Capture new prime brokerage clients by attracting underserved small to mid-sized hedge funds. |
17
Table of Contents
Broaden product offering:
|
•
|
Enhance the Tradient platforms and application program interface ("API"); |
|
•
|
Broaden the set of platforms from which to choose; |
|
•
|
Refine complex options strategy offerings across all trading platforms; |
|
•
|
Accessibility to portfolio margining; and |
|
•
|
Ability to trade futures products on proprietary Tradient trading platforms. |
Increase emphasis on sales and marketing:
|
•
|
Enhance the lead pipeline through increased web-based marketing and advertising programs targeted at highly active traders; |
|
•
|
Increase the sales team personnel; and |
|
•
|
Enable the sales team with improved tools and support. |
Reduce costs to increase working capital:
|
•
|
Optimize order-flow costs; |
|
•
|
Continue to align costs of order routing with third-party platforms; and |
|
•
|
Continue to reduce cost structure by optimizing a variety of management and IT systems processes. |
Terra Nova, the Company's broker-dealer subsidiary, while reliant upon the Tradient platforms, continues to improve its ability to operate as a technology neutral clearing agent for different front-end trading platforms. Our control over the back office processes allows the firm to accommodate business opportunities which revolve around non-traditional front-end trading platforms. We offer three proprietary trading platforms, Tradient Pro, Tradient Plus, and Tradient Web, along with RealTick, a real-time, Level II cross-asset trading platform developed by Townsend Analytics. Another platform offered is Sterling Trader Pro, developed by Sterling Financial, a customizable direct access trading platform. We also accommodate alternative order routing solutions including algorithmic trading with financial information eXchange ("FIX") protocol and API capability.
We intend to continue to focus on improving its capital structure, technology and business processes. We expect to continue to increase our systems and backoffice clearing capacity for anticipated growth in the number of transactions and executions that it processes in the future. We plan to invest resources in back office technology to lower operating costs.
The brokerage industry is a highly competitive industry with ongoing compression in commission pricing. In an effort to mitigate any impact from lower pricing we intend to continue to invest resources in our back office technology to lower the man-hours required to manage our systems and processing costs and attract high frequency trading clients.
A slow down in our business which began towards the end of 2008 has continued through the first nine months of 2009 and is reflected in lower commission and fee revenues. We reduced our workforce in January 2009 based on these continuing adverse economic conditions and intends to continue to review headcount throughout 2009. We continue to see a reduction in net interest income resulting from low federal funds rates, our base rate to determine client debit and credit rates and earnings on our reserve deposits. Terra Nova relies on net interest income as a significant revenue source, thus the decrease in federal funds rate impacts our profitability. We are attempting to incorporate cost saving measures to offset declining revenues.
Critical Accounting Policies
The condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States, which require the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the condensed consolidated financial statements, and revenues and expenses during the periods reported. Actual results could differ from those estimates. The following are believed to be the critical accounting policies, which could have the most significant effect on reported results and require the most difficult, subjective or complex judgments by management.
18
Table of Contents
Goodwill
Goodwill is tested for impairment annually on December 31 or more frequently if impairment indicators arise. The first step of this process is to identify potential goodwill impairment by comparing the fair value of the reporting unit to its carrying value. The Company estimates fair value using a combination of the market price of the Company's common equity and discounted cash flows. If the carrying value is less than fair value the Company would complete step two in the impairment review process which measures the amount of goodwill impairment. Management tests the reasonableness of the inputs and outcomes of the discounted future cash flow analysis and the evaluation of the market price of its common equity against other available comparable market data. The entire amount of goodwill was created from the Terra Nova, Market Wise Stock Trading School, LLC and Market Wise Securities acquisition in May 2006 and has been assigned to Terra Nova within the Brokerage Services Segment. The Company performed its annual impairment test of goodwill on December 31, 2008 and determined that there was no impairment as of that date.
Capitalization of Software Development Costs
Internally generated software development costs associated with new products and significant enhancements to existing software products are expensed as incurred until technological feasibility has been established. Software development costs that qualify for capitalization include the salaries and benefits of the software engineers assigned to the products, internal and external quality assurance testing costs, overhead allocations primarily associated with rent and facilities costs and the costs of outsourced development activities. Software development costs not qualifying for capitalization are recorded as product development expenses. Capitalized software development costs, including purchased software, if any, are amortized using the straight-line method over the estimated useful life of the software. At each balance sheet date the Company evaluates the estimated net realizable value of each software product and when required, records write-downs of net carrying value to net realizable value of any products for which the net carrying value is in excess of net realizable value. The net realizable value is the estimated future gross revenue of each product reduced by the estimated future costs of completing and disposing of that product, including the costs of completing in process development and client support.
Internally used software includes software that is acquired, internally developed or modified to meet the Company's internal needs and the Company has no substantive plans to market the software externally. Application development and modifications resulting in additional functionality are capitalized. Costs associated with preliminary project stage where business requirements are defined, internal and external training costs and ongoing maintenance are expensed as incurred. Capitalization of appropriate costs occurs when the preliminary project stage is complete and management authorizes and commits to the completion of the project. Capitalization ceases when the project is ready for its intended use. The capitalized costs are amortized on a straight-line basis over the estimated useful life of the software.
Share-Based Compensation
Share-based payments, including grants of employee stock options, are recognized in the condensed consolidated statements of loss based on their grant date fair values over their requisite service periods, less estimated forfeitures.
Long-Lived Assets
Long-lived assets, consisting primarily of definite lived intangible assets, property and equipment and capitalized software development costs, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. Recoverability of assets held and used is generally measured by a comparison of the carrying amount the asset to undiscounted future net cash flows expected to be generated by that asset. If it is determined that the carrying amount of an asset may not be recoverable, an impairment loss is recognized for the amount by which the carrying amount of the asset exceeds the fair value of the asset. Fair value is the estimated value at which the asset could be bought or sold in a transaction between willing parties.
Income Taxes
Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense or benefit is the tax payable or refundable for the period, plus or minus the change during the period in deferred tax assets and liabilities.
19
Table of Contents
Revenue Recognition
Revenues primarily consist of commission and fees, interest income and software related licensing fees. Commission revenue and related expenses on securities transactions are recorded on a settlement date basis. Other revenue consists of account and transaction fees and is recorded on a settlement date basis as security transactions occur. Software fees are charges for the use of the Company's software execution platform. Revenues from software fees are recognized on a monthly basis as services are provided to clients. Interest income is primarily generated by interest charges to clients on margin balances and revenue from clients cash held and invested by Terra Nova as a clearing firm offset by interest paid to clients on their credit balances. Interest income and interest expense on brokerage accounts is recorded on an accrual basis as earned or incurred.
Results of Operations
The following table below represents net revenues and total expenses from the condensed consolidated statements of loss for the three and nine months ended September 30, 2009 and 2008. The financial information below is derived from the condensed consolidated financial statements and related notes in the Quarterly Report on Form 10-Q.
|
Three Months Ended September 30,
|
Nine Months Ended Septermber 30,
|
|||||||||||||||||
|
2009
|
2008
|
2009
|
2008
|
|||||||||||||||
|
(Unaudited)
|
(Unaudited)
|
(Unaudited)
|
(Unaudited)
|
|||||||||||||||
| Commissions and fees | $ |
6,288,807
|
8,147,071
|
$ |
19,761,940
|
23,438,687
|
||||||||||||
|
|
||||||||||||||||||
| Interest income |
329,017
|
1,376,672
|
1,189,231
|
4,848,101
|
||||||||||||||
| Interest expense on brokerage accounts |
-
|
187,260
|
-
|
1,009,689
|
||||||||||||||
| Net interest income |
329,017
|
1,189,412
|
1,189,231
|
3,838,412
|
||||||||||||||
|
|
||||||||||||||||||
| Software fees, net |
229,778
|
210,821
|
716,978
|
563,157
|
||||||||||||||
| Other revenue |
154,833
|
163,243
|
262,192
|
359,731
|
||||||||||||||
| Net revenues |
7,002,435
|
9,710,547
|
21,930,341
|
28,199,987
|
||||||||||||||
|
|
||||||||||||||||||
| Commissions and clearing |
2,575,546
|
2,488,600
|
7,663,804
|
8,267,603
|
||||||||||||||
| Compensation and benefits |
2,216,306
|
2,315,995
|
6,616,982
|
7,125,321
|
||||||||||||||
| Software and market data |
741,207
|
1,330,087
|
2,494,848
|
4,580,196
|
||||||||||||||
| Advertising and promotional |
161,798
|
214,906
|
456,139
|
470,091
|
||||||||||||||
| Professional fees |
653,566
|
736,876
|
2,032,802
|
2,048,807
|
||||||||||||||
| Communications and information technology |
246,875
|
189,618
|
713,341
|
637,712
|
||||||||||||||
| Depreciation and amortization |
583,662
|
595,923
|
1,715,916
|
1,721,854
|
||||||||||||||
| Bad debt expense |
-
|
3,553,296
|
-
|
3,470,890
|
||||||||||||||
| Other general and administrative expenses |
825,863
|
464,310
|
2,129,092
|
977,102
|
||||||||||||||
| Total expenses |
8,004,823
|
11,889,611
|
23,822,924
|
29,299,576
|
||||||||||||||
|
|
||||||||||||||||||
| Loss before income taxes |
(1,002,388
|
) |
(2,179,064
|
) |
(1,892,583
|
) |
(1,099,589
|
) | ||||||||||
|
|
||||||||||||||||||
| Income tax benefit |
392,021
|
785,814
|
737,021
|
277,696
|
||||||||||||||
|
|
||||||||||||||||||
| Net loss | $ |
(610,367
|
) | $ |
(1,393,250
|
) | $ |
(1,155,562
|
) | $ |
(821,893
|
) | ||||||
The Company's clients mainly trade in the United States equity, futures and options markets. There is a direct correlation between the volume of our clients' trading activity and our profitability. The Company cannot predict future trading volumes in the United States equity, futures and options markets but if client trading activity increases we expect that it would have a positive impact on our profitability. If client trading activity declines we also expect that it would have a negative impact on our profitability.
The reduced level of trading in stock and futures by our clients in the early part of the first quarter of 2009 continued into the third quarter providing the Company with reduced volumes of stock and futures transactions offset by an increase in option transactions. The total equity shares traded declined 2.2 billion shares to 4.3 billion shares during the first nine months of 2009 compared to the first nine months of 2008. In addition, we experienced a decline of 0.7 million futures contracts to 1.8 million futures contracts during the first nine months of 2009 versus the same period last year. This reduction in activity is primarily due to a decline in our number of clients. The total option contracts traded increased 2.0 million option contracts to 8.2 million option contracts during the first nine months of 2009 versus the same period last year. This increase is due to both an increase in the number of clients trading only options as well as increased trading activity within those existing accounts that trade equities and options.
The changes in client debit and credit cash balances may significantly impact our profitability along with changes in interest rates. The Company seeks to mitigate interest rate risk by aligning the average duration of our interest-earning assets with that of our interest-bearing liabilities. We cannot predict the direction of interest rates or the levels of client debit and credit cash balances. If interest rates rise the Company generally expects to earn a larger net interest spread. Conversely, a falling interest rate environment generally would result in our earning a smaller net interest spread.
20
Table of Contents
The decline in the federal funds interest rates has reduced the Company's net interest income which declined $2.6 million during the nine months ended in 2009 compared to the same period in 2008. We monitor the federal funds rate daily on invested client funds and adjust our client's credit and debit interest rates accordingly to maintain an acceptable spread. We have also experienced a decline in both credit and debit client cash balances which also caused a decline in overall net interest income.
Our results for the nine months ended September 30, 2009 reflect the following important factors:
|
•
|
Net loss for the nine months ended September 30, 2009 of $1,155,562 includes the following non-cash expenses among other non-cash items: |
|
°
|
Depreciation expense on property and equipment of $284,026 | |
|
°
|
Amortization expense on capitalized software of $404,277 | |
|
°
|
Amortization expense on intangible assets of $1,027,613 | |
|
°
|
Share-based compensation of $91,264 |
|
•
|
Overall trading activity based on tickets was down 29% and reflects a 28% decrease in the number of tickets executed on third-party software trading platforms and a 34% decline in the tickets executed on the Tradient proprietary platforms during the nine months ended September 30, 2009 compared to the same period in 2008. |
|
•
|
Higher net software fees of $153,821 from Tradient platform subscriptions for the nine months ended September 30, 2009 versus the same period last year. The number of Tradient platforms users declined from 2,804 as of September 30, 2008 to 2,070 as of September 30, 2009. The net increase in net software fees was primarily due to fewer platform users qualifying for a software rebate for the nine months ended September 30, 2009 compared to the same period last year. The software rebate is based on users achieving certain trading levels each month. |
|
•
|
Posted average revenue per employee of approximately $78,700 based on eighty-nine full-time employees for the three months ended September 30, 2009 compared to $107,900 based on ninety full-time employees for the same period in 2008. Revenue per employee was down for the three months ended September 30, 2009 compared to the same period last year due to lower net interest income and commission revenue. |
Revenues
Commissions and fees
The Company's commissions and fees revenue is dependent on the overall trading activity in the United States equity, futures and options markets by our clients. Commissions revenues consist of executing NYSE and NASDAQ listed securities and OTC securities along with exchange listed options transactions, futures and futures options, ETFs, fixed income and mutual funds. Commissions revenues are recorded on a settlement date basis. Fee revenue is generated from clients accessing market data through proprietary software platforms and various account maintenance fees.
The Company's commissions and fees decreased from $8.1 million in the third quarter of 2008 to $6.3 million in the third quarter of 2009-a decrease of 22.8% due primarily to lower trading activity offset by an increase in the average commission rate. For the nine months ended September 30, 2009 commissions and fees decreased from $23.4 million to $19.7 million-a decrease of 15.7% which is also due to lower trading activity offset by an increase in the average commission rate. For the nine months ended September 30, 2009 compared to same period ending September 30, 2008 the firm showed a decrease in equity commissions of 16.1%, a 1.5% increase in options commissions, and a 50.4% decline in futures commissions.
The Company's total trade tickets declined 1.3 million to 3.1 million during the nine months ending September 30, 2009 from the same period in 2008.
Net interest income
As a self-clearing broker-dealer the Company receives interest income on client credit and debit balances through interest bearing accounts, U.S. government securities and correspondent clearing interest sharing arrangements. Interest income decreased from $1.4 million for the three months ended September 30, 2008 to $329,000 for the same period in 2009 and for nine months ended September 30, 2009 declined $3.7 million to $1.2 million-a decrease of 75%. Interest income was impacted both by a decline in client debit and credit cash balances and lower federal fund rates from the year earlier. The interest earned on segregated cash balances was also impacted by the low federal funds rate.
During the first nine months of 2009 the Federal Reserve did not change the federal funds rate which remains in a range of 0% to 0.25%. During 2008 the Federal Reserve Open Market Committee lowered the federal funds 400 basis points. All client credit and margin debit rates are based off the federal funds rate. The Company also borrows securities resulting from clients who have short securities and receives interest from broker-dealers who have collateralized with cash in return for borrowing the securities.
21
Table of Contents
Interest expense on brokerage accounts was $187,000 during the three months ended September 30, 2008 compared to zero during the three months ended September 30, 2009 and for the nine months ended September 30, 2009 declined $1 million to zero-a decrease of 100%. As a self-clearing broker-dealer the Company pays interest to clients on cash credit balances as well as interest to banks for short-term client related loans.
Software fees, net
The Company's net software fees are generated from software subscription fees and exchange charges. Net software fees increased 9% to $230,000 during the three months ended September 30, 2009 from $211,000 during the same period in 2008. For nine months ended September 30, 2009, net software fees increased $154,000 to $717,000-an increase of 27.3%. The number of Tradient platform users declined from 2,804 users as of September 30, 2008 to 2,070 users as of September 30, 2009. The net increase for both the three month and nine months ended September 30, 2009 was primarily due to fewer users qualifying for a software rebate during 2009. The software rebate is based on users achieving certain trading levels each month. Additionally, a strategic relationship was terminated in January 2009 that accounted for a majority of the decline in users as well as the change in software rebates earned.
Expenses
Commissions and clearing
A percentage of the commissions the Company earns are paid to registered representatives and multiple clearing correspondent arrangements with other broker-dealers. The Company has access to multiple Electronic Communication Networks ("ECNs") and other execution venues and the Company pays a fee (or rebate payment for order flow) to these venues for executing equity and option transactions on or through their systems. The Company is a member of multiple exchange and regulatory organizations and must pay them fees when executing transactions through them. These exchange and regulatory costs are typically based on the number and size of transactions executed. Futures are cleared through an established futures commission merchant and the Company pays execution fees associated with those futures transactions. Lastly, included in commissions and clearing are soft dollar and sales commission expenses.
The Company's commissions and clearing expense increased from $2.5 million for three months ended September 30, 2008 to $2.6 million for three months ended September 30, 2009-an increase of 3.5%. The increase is attributable to higher ECN transaction fees. Additionally, the Company experienced a slight shift in the mix of revenue to more correspondent clearing relationships which have higher percentage commission payouts. For the nine months ended September 30, 2009 the Company's commissions and clearing expense decreased $604,000 to $7.7 million-a decrease of 7.3%.
Compensation and benefits
Compensation and benefits consists mainly of wages, payroll taxes, employee benefits, and discretionary bonuses, along with non-cash share-based compensation expense. Compensation and benefits decreased $100,000 to $2.2 million for the three months ended September 30, 2009-a decrease of 4.3%. The decrease during the third quarter of 2009 compared to the same period in 2008 was due primarily to a reduction in bonuses accrued. For the nine months ended September 30, 2009 the Company's compensation and benefits expense decreased $508,000 to $6.6 million-a decrease of 7.1%. The decline is attributable to lower bonus accrual offset by less capitalized salaries software development. The overall number of full-time employees was eighty-nine as of September 30, 2009 and ninety as September 30, 2008, which includes a reduction in workforce in January 2009, offset by an increase in headcount at our Romanian subsidiary, QuantNova. The total headcount numbers include employees of our foreign subsidiary QuantNova which had eight full-time employees at September 30, 2009 and six employees at September 30, 2008.
Software and market data
The software and market data expense consists of payments to multiple third-parties for data and trading platform access for the Company's clients and is a variable cost based on the number of clients, licenses and order routing execution services. The remaining fees include payments to vendors for access to market data including option and equity prices and news information. The Company's software and market data expenses decreased $589,000 from $1.3 million during the quarter ending September 30, 2008 to $741,000 for the same period in 2009- a decrease of 44.3%. For the nine months ended September 30, 2009 the Company's software and market data expense decreased $4.6 million to $2.5 million-a decrease of 45.4%.
The majority of the decrease in software and market data expense for the three and nine months ended September 30, 2009 compared to the same period in 2008 was due to decreased costs associated with a reduction in a third party vendor's software and order routing execution fees. The Company, during the second half of 2008 and to a lesser extent in 2009, had many of its clients convert to Tradient, its proprietary trading platform, to balance costs and fulfill client trading software needs.
22
Table of Contents
Advertising and promotional
Advertising and promotional expenses include trade shows, targeted marketing in financial publications, online advertising, and various sales force marketing related expenses. Advertising and promotional expenses decreased from $215,000 during the quarter ended September 30, 2008 to $162,000 for the same period in 2009-a decrease of 24.7%. For the nine months ended September 30, 2009 the Company's advertising and promotional expense decreased $14,000 to $456,000-a decrease of 3%.
Professional fees
Professional fees relate to legal and consulting fees incurred for such things as the Company's defense against litigation, compliance with Sarbanes-Oxley requirements, shareholders meeting, multiple regulatory filings, tax and audit expenses and regulatory compliance. Professional fees decreased from $737,000 during the third quarter of 2008 to $654,000 during the same period in 2009-a decrease of 11.3%. For the nine months ended September 30, 2009 the Company's professional fees expenses decreased $16,000 to $2 million-a decrease of 0.8%.
Communications and information technology
The Company's communications and information technology expenses increased from $190,000 during the three months ended September 30, 2008 to $247,000 for the same period in 2009-an increase of 30.2%. For the nine months ended September 30, 2009 the Company's communications and information technology expenses increased $76,000 from the same 2008 period to $713,000-an increase of 11.9%. The Company incurs expenses associated with multiple vendors providing communications and network connectivity. To enhance capacity and reliability as a self-clearing broker-dealer financial services technology provider, the Company maintains two co-location data centers in Chicago, Illinois. The firm continues to transfer services from third-party providers to internally based solutions and is enhancing various facilities to better meet the needs of the organization, reduce expenses and lower reliance on third-party providers.
Depreciation and amortization
For the nine months ended September 30, 2009 the Company's depreciation and amortization expense remained consistent with the nine months ended September 30, 2008 at approximately $1.7 million.
Bad debt expense
Bad debt expense decreased from $3.5 million for the three and nine months ended September 30, 2008 to zero for the three and nine months ended September 30, 2009. The bad debt expense in 2008 resulted from two isolated customer trading losses.
Other general and administrative expenses
Other general and administrative expenses of the Company increased from $464,000 during the third quarter of 2008 to $826,000 for the same period in 2009. For the nine months ended September 30, 2009 the Company's other general and administrative expenses increased $1.2 million to $2.1 million-an increase of 118%. General and administrative expenses include certain clearing related expenses, office rent, shareholder relations, travel and entertainment, franchise taxes, director compensation and other miscellaneous expenses incurred by the Company. The increase for both the three and nine month periods is due to an increase in our legal fine accrual of $530,000 in the nine months ended September 30, 2009. In addition, there was a gain from the reversal of liabilities for which the statute of limitations expired totaling approximately $540,000 during the nine months ended September 30, 2008 and a $300,142 gain on the sale of a seat on the Boston Stock Exchange during the third quarter of 2008.
Income tax benefit (provision)
The Company recorded an income tax benefit for the three and nine months ended September 30, 2009 of $392,021 and $737,021, respectively, based on an estimated annual effective tax rate of 39%. At September 30, 2009, the Company had income tax receivables totaling $738,285 which are comprised of an overpayment in estimated federal and state tax payments for 2008 of approximately $400,000, State of Illinois refunds from amendments from filing on a unitary basis of approximately $190,000, and State of Illinois refund receivables from amendments to prior years' returns of approximately $150,000.
Liquidity and Capital Resources
The Company's broker-dealer subsidiaries are subject to capital and other requirements of the SEC, FINRA, and CFTC. In addition to mandatory capital requirements (See Note 10 - Regulatory Requirements), as a self-clearing broker-dealer, the Company is required to deposit funds with clearing organizations, such as DTCC and OCC, which may be large in relation to the Company's total liquid assets and may vary significantly based on client trading activity. At the present, the Company believes it has sufficient capital on hand to meet all such capital requirements. These capital requirements are subject to change from time to time. Unforeseen increases in regulatory capital requirements may impact the Company's growth and operational plans depending on the amount of the increase.
23
Table of Contents
Cash Flow
As reflected on the accompanying condensed consolidated statements of cash flows, cash and cash equivalents declined $1.4 million to $6.5 million at September 30, 2009 compared to December 31, 2008. Cash used in operating activities was $623,000 for the nine months ended September 30, 2009 which included net loss of $1.2 million. Adjustments to reconcile net loss to net cash used in operating activities for nine months ended September 30, 2009 included depreciation and amortization totaling $1.7 million. This was offset by a change in deferred taxes totaling $715,000 and $60,626 of gains related to extinguishment of liabilities. Changes in cash segregated in compliance with federal regulations, receivables from customers and non-customers, and payables to customers and non-customers, aggregately, decreased cash flow from operations by $17.7 million. Receivables from customers and non-customers are primarily client margin loans secured by marketable securities. Receivables from and payables to brokers, dealers and clearing organizations consist primarily of securities borrowed, commissions receivable, securities related to the clearance of transactions and deposits with clearing organizations. Liquidity needs relating to client trading and margin borrowing activities are met through cash balances in client brokerage accounts which totaled approximately $183.4 million as of September 30, 2009.
Cash used in investing activities for the nine months ended September 30, 2009 was $514,000 due to the purchases of property and equipment of $371,000 and capitalization of software development costs of $143,000.
Cash used in financing activities for the nine months ended September 30, 2009 was $272,000 due to the purchases of treasury stock.
Cash and cash equivalents on the statement of condensed consolidated balance sheets consists primarily of cash held in liquid commercial bank accounts or clearing organization accounts paying a "money market" rate of interest. The Company also has a sweep account which deposits excess operating bank balances overnight into a money market account. The Company reviews all money market funds in which it invests to ensure, to the extent possible, that the Company's funds are not at risk.
Cash segregated in compliance with federal regulations
Cash segregated in compliance with federal regulations was $149.4 million at September 30, 2009 versus $141.2 million at December 31, 2008. Such funds have been segregated in special reserve accounts for the exclusive benefit of customers under Rule 15c3-3 of the Securities Exchange Act of 1934, as amended and other regulations. The Company is required to determine the amount required to be deposited weekly, as of the close of the last business day of the week, and if necessary, to deposit additional funds by the opening of banking business on the second following business day.
The cash segregated in compliance with federal regulations had historically been in a special reserve account at one banking institution invested in an interest bearing cash account for the exclusive benefit of customers under Rule 15c3-3 of the Securities Exchange Act of 1934. Due to the continuing banking crisis that began in 2008, the Company now maintains special reserve accounts with multiple qualified banking institutions to mitigate credit risk. The Company has taken measures to diversify the banks in which it maintains customer and corporate accounts and monitors their bank performance ratios on a regular basis to help mitigate insolvency risk. All banks in which the Company maintains customer and corporate deposits are "Well Capitalized" in accordance with the FDIC's Regulatory "Prompt Corrective Action" risk capital rating system. In the special reserve accounts we invest in a combination of qualified securities including short-term U.S. government securities, reverse repurchase agreements collateralized by U.S. government securities, qualified trust products, and interest bearing cash accounts. These changes are in full compliance with all regulatory requirements while providing customer protection of their funds held with the Company.
Line of Credit
We maintain a credit line secured by customer securities used to facilitate its self-clearing broker-dealer operations. The rate on the line of credit is determined daily by the bank and is based on the daily rate at which banking institutions are able to borrow from each other plus a predetermined spread. Management believes that cash balances in client brokerage accounts and operating earnings will continue to be the primary source of liquidity for the Company in the future. At September 30, 2009, we did not have any outstanding balance drawn on our credit line. In the fourth quarter of 2009 the Company added a second credit line secured by customer securities with a qualified banking institution which will also be used occasionally to facilitate timing issues to meet daily cashflow needs.
24
Table of Contents
Liquidity
To the extent that business or transactional opportunities are presented the Company may need to raise additional capital or issue additional equity. Current alternatives include, but are not limited to subordinated debt, term loans, and collateralized bank loans with multiple banking institutions, however, the current credit environment makes it difficult to raise capital through these means. The tighter credit market has made it more difficult for the Company to obtain capital for short-term financing of the Company's self-clearing operations and customer margin lending. Management believes that cash balances in client brokerage accounts and operating earnings will continue to be the primary source of liquidity for the Company in the future.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Not Applicable.
Item 4T. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
The Company maintains disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act") that are designed to ensure that information required to be disclosed by the Company in the reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms and that such information is accumulated and communicated to management, including the Company's principal executive officer and principal financial officer, to allow timely decisions regarding required disclosure.
The Company's management, with the participation of its Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of its disclosure controls and procedures as of the end of the period covered in this Quarterly Report on Form 10-Q.
Based on this evaluation, the Company's Chief Executive Officer and Chief Financial Officer have concluded that its disclosure controls and procedures were effective as of the end of the period covered in this Quarterly Report on Form 10-Q.
(b) Changes in Internal Control Over Financial Reporting
There were no changes in internal controls over financial reporting during the quarter ended September 30, 2009 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.
PART II OTHER INFORMATION
Item 1. Legal Proceedings
On September 25, 2009, a FINRA arbitration panel in the matter of Friedman v. Riverside Securities, Jordan Zaro and Terra Nova found in favor of the claimant and awarded damages together with attorneys' fees, costs and interest against the defendants who were held jointly and severally liable. The matter involved a dispute under which claimant contended that Zaro engaged in improper trades in her account. The Company accrued $285,000 in satisfaction of the judgment and is seeking indemnification and contribution from the co-defendants.
On or about September 25, 2009, Terra Nova was notified that it had been joined as a defendant in FINRA Arbitration Number 09-05462, the case of Beatriz Santana and the Estate of Guillermo Zuniga v. Southwest Securities, Carlos Manuel Garcia and Terra Nova in which the plaintiff seeks to recover up to $500,000. The complaint alleges that Terra Nova negligently or knowingly allowed co-defendant Garcia to improperly manage the account of Santana and Zuniga. Terra Nova maintains that it has acted properly and will vigorously defend this matter. The Company believes the potential for liability in this matter is limited. Accordingly, no liability has been recorded related to this claim.
On April 29, 2009, Terra Nova was notified that it had been joined as a defendant in FINRA Arbitration Number 09-02166, the case of Andali Investments v. Southwest Securities, Tradestation Securities, Terra Nova and Carlos Manuel Garcia in which the plaintiff seeks to recover $500,000. The complaint alleges that Terra Nova allowed the transfer of $60,443 from Andali's account without proper authorization. Terra Nova maintains that it has acted properly and will vigorously defend this matter. The Company believes the potential for liability in this matter is limited, as its involvement compared to the other respondents was for a short period of time and it was involved in only a very limited number of trades involving less than the $500,000 the claimant seeks to recover. Accordingly, no liability has been recorded related to this claim.
On December 19, 2008, FINRA notified Terra Nova that it had made a preliminary determination to recommend disciplinary action against Terra Nova as well as one current and two former employees based on alleged rule violations primarily related to soft dollar accounts, including without limitation alleged improper soft dollar payments, failure to adequately supervise soft dollar payments, failure to maintain adequate written supervisory procedures and improper record keeping. The charges mainly relate to activities that occurred in 2004 and 2005. Terra Nova signed an Acceptance, Waiver and Consent document to settle this proceeding during October of 2009. The amount of the settlement has been reserved as of September 30, 2009.
25
Table of Contents
In September 2008, an automated program used by Hsu-Tung Lee ("Lee"), a client of the Terra Nova, resulted in erroneous trades far exceeding the buying power in Lee's account with Terra Nova. While the exchange canceled a large number of these trades Terra Nova was forced to cover Lee's short positions, resulting in a large debit position in Lee's account with Terra Nova. Terra Nova brought a collection action against Lee by filing arbitration Case Number 08-4728 before FINRA. On February 13, 2009, Lee filed a counterclaim against Terra Nova alleging that Terra Nova's supervisory procedures should have prevented the mistaken trades from being sent to the market. This counterclaim seeks actual damages of no less than $62,000 and punitive damages of approximately $2,800,000, the amount of punitive damages being the same amount as Terra Nova is seeking as damages against Lee in this matter. Terra Nova believes that it has strong defenses and intends to vigorously defend against this claim. Terra Nova further believes that even if Lee were to prevail in his counterclaim that any imposition of punitive damages would be unwarranted. Accordingly, no liability has been recorded related to this claim.
On May 1, 2009 Terra Nova was informed that the mistaken Lee trades have become the subject of an inquiry by NYSE Arca for the trades placed on that exchange.
In addition to the foregoing, many aspects of the Company's business involve substantial risk of liability and from time to time the Company may become involved in additional lawsuits, arbitrations, claims and other legal proceedings. There is a relatively high incidence of litigation involving the securities brokerage industry. The Company also is subject to periodic regulatory audits, inquiries and inspections. In this regard, the Company has been notified by regulatory authorities of various ongoing investigations. The Company has responded to all requests related to such investigations. At this time, management is unable to predict with certainty the outcome of these matters.
Item 1A. Risk Factors
Our Annual Report on Form 10-K for the fiscal year ended December 31, 2008 lists in more detail various important risk factors facing our business in Item 1A - "Risk Factors" for the year ended December 31, 2008, and in other securities filings by the Company with the SEC. Except as set forth below, there have been no material changes from the risk factors disclosed in that section of our Annual Report on Form 10-K. We encourage you to review that information and to review our other reports filed periodically with the Securities and Exchange Commission for any further information regarding risks facing our business.
We are subject to litigation and legal compliance risks.
Because of the extent and complexity of our regulatory environment and the products we offer, many aspects of our business involve substantial risks of liability. In recent years, there has been an increasing incidence of litigation involving the securities brokerage industry, including class action and other suits that generally seek substantial damages, including in some cases punitive damages. Any such litigation brought in the future could have a material adverse effect on our business, financial condition and operating results. We also face potential indirect liability for claims of defamation, negligence, copyright, patent or trademark infringement, violation of the securities laws and other claims based upon the third-party content that we distribute online. Computer failures may also result in our widely publishing and distributing incorrect data. Our insurance may not necessarily cover any of these claims or may not be adequate to protect us against all liability that may be imposed. Any such litigation brought in the future could have a material adverse effect on our business, financial condition and operating results.
In addition, we and our subsidiaries, our business and the industries in which we operate are at times being reviewed or investigated by regulators, which could lead to enforcement actions, fines and penalties or the assertion of private litigation claims and damages. While we believe that we have adopted appropriate risk management and compliance programs, the nature of our operations means that legal compliance risk will continue to exist and additional legal proceedings and other contingencies, the outcome of which cannot be predicted with certainty, will arise from time to time.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
(a) None.
(b) Not Applicable.
(c) On May 1, 2009 the Company's Board of Directors authorized the use of up to $3,000,000 to repurchase the Company's outstanding common stock. Stock repurchases are made in the open market, in block transactions, or in privately negotiated transactions and may be made from time to time or in one or more larger repurchases, all as determined by the officers of the Company at their discretion. The Company conducts the repurchases in compliance with Securities and Exchange Commission Rule 10b-18. The program commenced on May 1, 2009 and will expire on April 30, 2010. The program does not obligate the Company to acquire any particular amount of common stock and the program may be modified, suspended or terminated at any time at the Company's discretion. In the third quarter of 2009 the Company made no common stock repurchases. As of September 30, 2009, $2,727,944 of authorized funds remain available for share repurchases under this program.
26
Table of Contents
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
(a) None.
(b) Not Applicable.
Item 6. Exhibits
27
SIGNATURES
In accordance with requirements of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| Terra Nova Financial Group, Inc. (Registrant) |
||
| Date: November 13, 2009 | /s/ Michael G. Nolan | |
| Michael G. Nolan | ||
| President and Chief Executive Officer (Principal Executive Officer) |
||
| Date: November 13, 2009 | /s/ Murrey Wanstrath | |
| Murrey Wanstrath Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer) |
||
28