Attached files
| file | filename |
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| EX-31.1 - SECTION 302 CERTIFICATION OF CHIEF EXECUTIVE OFFICER - Terra Nova Financial Group Inc | terra10q063010ex311.htm |
| EX-32.1 - SECTION 906 CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER - Terra Nova Financial Group Inc | terra10q063010ex321.htm |
| EX-31.2 - SECTION 302 CERTIFICATION OF CHIEF FINANCIAL OFFICER - Terra Nova Financial Group Inc | terra10q063010ex312.htm |
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
___________________
FORM 10-Q
___________________
For the quarterly period ended June 30, 2010
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 August 1, 2010.
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Item 1. Unaudited Condensed Consolidated Financial Statements
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TERRA NOVA FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Note 1 - Nature of Operations and Basis of Presentation
Nature of Operations
Terra Nova Financial Group, Inc. (collectively, the "Company," "Parent", "firm," "we," "us," or "our") is a holding company of businesses providing a range of products and services to trading professionals. We have one primary subsidiary: Terra Nova Financial, LLC ("Terra Nova"), an Illinois limited liability company, a broker-dealer registered with the SEC and a member of Financial Industry Regulatory Authority, Inc. which provides execution, clearing and prime brokerage services to professional traders, hedge funds and money managers. We have ceased operations at our other subsidiary, SC QuantNova Research SRL ("QuantNova"), which was based in Bucharest, Romania and provided software development, architecture and engineering for back office clearing systems. Terra Nova Financial Group, Inc. trades under the stock symbol "TNFG" and is quoted on the OTC Bulletin Board.
On June 16, 2010, Terra Nova Financial Group, Inc. entered into a Purchase Agreement (the "Purchase Agreement") with Lightspeed Financial, Inc., a Delaware corporation ("Lightspeed"). Pursuant to the Purchase Agreement, Lightspeed will acquire substantially all of the Company's assets relating to its brokerage business, including without limitation, the membership interests of Terra Nova Financial, LLC, for $27.6 million in cash (the "Transaction"). $22.6 million is to be paid at closing and $5 million is to be paid pursuant to an unsecured promissory note no later than six months from closing. The promissory note will accrue interest at 8% per annum. Assets excluded from the Transaction include the Company's cash, cash-equivalents, its subsidiary QuantNova, and certain other non-operating assets.
In addition to customary closing conditions, the Transaction is subject to the approval of the Company's shareholders and certain regulators, including the Financial Industry Regulatory Authority, Inc. The affirmative vote of the holders of two-thirds of the outstanding shares of the Company's common stock is required to approve the Transaction.
The Company has made customary representations, warranties and covenants in the Purchase Agreement, including, among others, covenants to conduct its business in the ordinary course during the interim period between the execution of the Purchase Agreement and the consummation of the Transaction. The representations and warranties do not survive the consummation of the Transaction.
The Purchase Agreement contains certain termination rights for both the Company and Lightspeed. Upon termination of the Purchase Agreement by the Company to pursue a superior proposal, the Company may be obligated to pay a termination fee of $1,100,000 to Lightspeed.
If the Transaction is consummated, the Company will have no remaining operating assets and, subject to the approval of its shareholders, expects to wind up its business and effect a liquidation and dissolution pursuant to the plan of dissolution approved by our board of directors on July 2, 2010, which we refer to as the plan of dissolution.
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:
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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.
QuantNova, a wholly-owned subsidiary of the Company which is currently inactive, previously provided consulting, software development, electronic data processing, software architecture and engineering for backoffice clearing software. QuantNova is based in Bucharest, Romania.
Basis of Presentation
The accompanying unaudited 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, 2009.
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 June 30, 2010 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.
During the first quarter of 2010, the Company discontinued the operations of its subsidiary, Tradient Technologies, Inc. ("Tradient"). In accordance with the provisions of FASB ASC Subtopic 205-20, the results of Tradient are presented as discontinued operations for all periods in the consolidated financial statements. See footnote 6 for additional details.
During the second quarter of 2010, the Company determined that the capital required to operate QuantNova could be better deployed in other Company operations. As a result, effective June 30, 2010, QuantNova is an inactive subsidiary and the process of dissolving QuantNova has been initiated.
(a) Consolidation Policy
The accompanying unaudited 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 brokerage customers, payables to brokers, dealers and clearing organizations, payables to brokerage customers and accounts payable and accrued expenses approximate their fair value due to their short term nature.
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(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) 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.
(e) 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, as amended ("Exchange Act"). 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.
Cash segregated in compliance with federal regulations also includes Proprietary Accounts of Introducing Brokers ("PAIB") in accordance with the customer reserve computation set forth in Rule 15c3-3 ("customer reserve formula") of the Exchange Act. 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.
(f) Impairment of 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.
(g) 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.
(h) Receivables from Brokerage Customers
Receivables from brokerage 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 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 decline 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.
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(i) Payables to Brokerage Customers
Customer funds are maintained in brokerage customer segregated accounts and relate to item cash segregated in compliance with federal regulations as discussed in item (f) above. Payables to brokerage 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 Exchange Act. The customer funds have been segregated in special reserve accounts earning interest. This payable to brokerage customers does not include customer securities positions as customer owned securities represent an off-balance sheet item.
(j) Revenue Recognition
Commissions and fees: Commission revenue on trading products including equities, options, futures and futures options, ETFs, fixed income and mutual funds transactions are recorded on a settlement date basis.
Net interest income: 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 interest expense on brokerage accounts are recorded on an accrual basis as earned or incurred.
Other revenue: Other revenue consists of account and transaction fees and is recorded on a settlement date basis as transactions occur.
(k) Lines of Credit
From time to time Terra Nova may obtain short-term bank loans to facilitate its broker-dealer settlement and clearing operations due to customer margin debits. These short-term bank loans are fully secured by customer marginable positions.
(l) 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 on a more likely than not basis. Income tax expense or benefit is the income tax payable or refundable for the period plus or minus the change during the period in deferred tax assets and liabilities.
Uncertain tax positions are initially recognized in the financial statements when they are more likely than not to be sustained upon examination by the respective tax authorities.
(m) Reclassifications
Certain reclassifications have been made to prior period amounts to conform to current period classifications.
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 six months ended June 30, 2010 and June 30, 2009 the components of basic and diluted weighted average shares outstanding are as follows:
Common
stock equivalents totaling 17,260,336 and 17,934,724 for the three and six months
ended June 30, 2010 and 2009, respectively, were 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 June 30, 2010.
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(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 allowed 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 granted discretion to the Company's management to execute the repurchase program and there was no requirement to purchase any minimum number of shares. The repurchase program ended as of April 30, 2010. The Company did not repurchase shares of common stock during the six months ended June 30, 2010.
(c) Non-employee Warrants
Non-employee warrants outstanding as of June 30, 2010 totaled 13,713,836 with a weighted average exercise price of $2.81.
Note 5 - Risks and Uncertainties
In the ordinary course of business there are certain contingencies which are not reflected in the consolidated financial statements. These activities may expose Terra Nova 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 Terra Nova, in effect, loans money to clients. In margin transactions, Terra Nova 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 Terra Nova 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 Terra Nova would be required to purchase or sell financial instruments at prevailing market prices to fulfill the clients' obligations.
Terra Nova 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.
Terra Nova 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. Terra Nova'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 6 - Discontinued Operations
During November 2009 the Company determined that the capital required to operate Tradient Technologies, Inc. ("Tradient") could be better deployed in other Company operations. Therefore, the Company decided to close Tradient effective February 1, 2010. Tradient operated the Company's proprietary technology development activities, building applications for electronic trade execution, order routing and clearing. Tradient offered three proprietary trading platforms to clients, Tradient Pro, Tradient Plus, and Tradient Web that were alternatives to other third party platforms offered by the Company. Tradient was located in Chicago, Illinois and was included in software services segment. As a result of the closure of Tradient, the Company has a single reporting segment, brokerage services, and therefore, segment reporting is no longer applicable. Primary sources of revenue for Tradient included software licensing and routing fees.
The following table summarizes certain operating data for discontinued operations for the three and six months ended June 30, 2010 and June 30, 2009:
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Note 7 - Commitments and Contingencies
Litigation and Claims
We accrue for litigation matters and regulatory claims when losses become probable and reasonably estimable. We have recorded an aggregate accrual of approximately $390,000 relating to our outstanding legal matters and regulatory claims as of June 30, 2010. As of the end of each applicable reporting period, we review each outstanding matter and, where it is probable that a liability has been incurred, we accrue for all probable and reasonably estimable losses. Where we are able to reasonably estimate a range of losses we may incur with respect to such a matter, we record an accrual for the amount within the range that constitutes our best estimate. If we are able to reasonably estimate a range but no amount within the range appears to be a better estimate than any other, we use the amount that is the low end of such range. If we determine that an additional loss is probable but not estimable, we provide footnote disclosure to that effect.
In December 2009, Terra Nova received a Wells Letter from NYSE Regulation ("NYSE") stating that NYSE was formally investigating whether Terra Nova had violated NYSE rules by failing to maintain adequate policies or procedures relating to four separate matters. The first relates to an incident on September 30, 2008 in which a large volume of erroneous trades were placed through an automated trading program by a Terra Nova client. NYSE alleges that Terra Nova's processes should have prevented such erroneous orders from reaching the market. The second involves a matter relating to whether Terra Nova maintained adequate policies and procedures to ensure proper marking, execution and handling of short sale orders. The third matter involves the maintenance of adequate policies and procedures to restrict wash sales and pre-arranged trades. The fourth matter involves maintaining adequate policies and procedures to prevent possibly manipulative order cancellations made by a customer. Terra Nova has submitted a written response to NYSE and is prepared to vigorously defend this matter. NYSE has proposed to settle all matters for a fine of $400,000. Settlement discussions are continuing. We have accrued a reserve for this matter.
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 as compared to certain other industries. 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. These investigations include but are not limited to a May 26, 2010 Wells Letter from FINRA alleging rules violations relating to OATS reporting during the period from January 1, 2006 through December 31, 2007. Additionally, a Wells Letter dated March 9, 2010 from FINRA alleging rules violations relating to short sales during the period from October 1, 2007 through December 31, 2007. The Company has to date responded to such investigations as required. We are unable to predict the outcome of these matters. Although the range of reasonably possible loss cannot be estimated with respect to such matters, based on the information currently available to us, we do not believe that these matters will have a material impact on our consolidated financial positions, results of operations or cash flows.
On April 29, 2009, the Company 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 sought to recover $500,000. The complaint alleged that Terra Nova allowed the transfer of $60,443 from Andali's account without proper authorization. The Claimant sought to recover a total of $500,000 from several defendants. Terra Nova and the Claimant settled this matter on June 4, 2010 pursuant to a Settlement Release Agreement under which Terra Nova paid a settlement amount, which amount had been previously accrued for resolution of this matter.
Note 8 - Income Taxes
The Company recorded no income tax benefit for the three and six months ended June 30, 2010 compared to a deferred income tax benefit of $135,000 and $345,000 for the same periods in 2009. The 2009 deferred income tax benefit is a result of the increase in the Company's net deferred tax asset. During 2010, the Company has not increased its net deferred tax asset as any increases are not believed to be more likely than not realizable.
At June 30, 2010 and December 31, 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 quarter's returns of approximately $150,000.
Note 9 - Regulatory Requirements
Terra Nova is subject to the U.S. Securities and Exchange Commission Uniform Net Capital Rule ("Rule 15c3-1") under the Exchange Act which requires the maintenance of minimum net capital. Terra Nova calculates its net capital using the ''alternative method,'' which requires maintaining 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.
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Terra Nova is also subject to the CFTC financial requirement ("Regulation 1.17") under the Commodity Exchange Act, administered by the CFTC and the NFA, which also requires maintaining minimum net capital. Terra Nova is a futures commission merchant and is required to maintain minimum net capital the sum of 8% of the total risk margin requirements for all positions carried in customer accounts, as defined in Regulation 1.17 and 8% of the total risk margin requirements for all positions carried in non-customer accounts with a minimum adjusted net capital of $1,000,000.
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. A summary of net capital requirements as of June 30, 2010 are as follows:
Note 10 - 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; estimated expected life based on historical employee exercise behavior for similar awards giving consideration to the award's contractual terms vesting schedules; 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.
During the three and six months ended June 30, 2010 and June 30, 2009 no stock options were granted.
Effective May 19, 2006, the Company adopted the 2006 Warrant Incentive Plan (the "2006 WIP"). The purpose of the 2006 WIP is to (a) to encourage certain employees and directors of the Company, as well as employees and directors of any current or after-acquired subsidiary corporation, to acquire a proprietary interest in the Company and thus share in the future success of the Company; and (b) to enable the Company, by offering comparable incentives, to attract and retain outstanding management personnel and directors who are in a position to make important and direct contributions to the success of the Company; and (c) to promote a closer identity of interests between the Company's employees, directors and consultants and its stockholders. The Company reserved 3,500,000 shares of voting common stock for sale upon the exercise of warrants granted under the 2006 WIP. If a warrant expires or terminates for any reason without having been fully exercised, the unpurchased shares will be available for other warrant grants under the 2006 WIP. Unless the 2006 WIP is terminated earlier, it shall terminate five years from its effective date.
The table below summarizes the Company's employee stock option and warrant plans as of June 30, 2010:
A
summary of employee stock option activity, under the Company's Long Term Incentive
Plan, for the six months ended June 30, 2010 is presented below:
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The aggregate intrinsic value of stock options outstanding and stock options exercisable at June 30, 2010 is calculated as the number of in-the-money options times the difference between exercise price of the underlying awards and the quoted closing market price of common stock at June 30, 2010. The aggregate intrinsic value of stock options exercised is calculated as the number of in-the-money options on the exercise date times the difference between the exercise price of the underlying awards and the quoted closing market price on the exercise date.
As of June 30, 2010 there was $59,978 of total unrecognized compensation cost related to unvested share-based compensation arrangements granted under stock option plans. The cost is expected to be recognized over a weighted-average period of approximately two and one-half years. During the six months ended June 30, 2010 and June 30, 2009 compensation expense of $20,602 and $26,515, respectively, was recognized related to options vesting under option plans.
A summary of employee warrant activity under the 2006 Warrant Incentive Plan for the six months ended June 30, 2010 is presented below:
As of June 30, 2010 and June 30, 2009 there was no unrecognized compensation cost
related to employee warrant grants.
Note 11 - 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 June 30, 2010 and December 31, 2009:
Depreciation and amortization related to property and equipment
for six months ended June 30, 2010 and 2009 was $225,298 and $183,361, respectively.
Amortization related to capitalized software development costs for the six months
ended June 30, 2010 and 2009 was $89,232 and $263,819, respectively.
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Note 12 - Intangible Assets
Intangible assets consist of the following as of June 30, 2010 and December 31, 2009:
The customer list and trade name are being amortized on a straight-line basis
over their estimated useful lives. Amortization expense related to intangible
assets was approximately $685,000 for the six months ended June 30, 2010 and 2009.
Note 13 - Fair Value of Financial Instruments
FASB issued ASC Topic 820, "Fair Value Measurements", ("Topic 820") which defines fair value, establishes a framework for measuring fair value 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) and not the price that would be paid to acquire the asset or received to assume the liability (an entry price).
Financial Assets and Liabilities
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 June 30, 2010 and December 31, 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 inputs used to measure the Company's financial instruments owned at fair value as of June 30, 2010.
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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 June 30, 2010 and December 31, 2009:
The
cash held for securities borrowed represents 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 June 30, 2010 and
December 31, 2009. 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.
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 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. Examples of such forward-looking statements include, but are not limited to, the statements concerning trends in revenue, costs and expenses; our pending asset sale with Lightspeed, including related uncertainties and risks and the impact on our business if the asset sale is not completed; our accounting estimates, assumptions and judgments; our business plans relating to our products and services; our ability to scale our operations in response to changing demands and expectations of our customers; and the level of demand for our products and services. 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, 2009 and below in Part II, Item 1A of this Report, and in other securities filings by the Company with the SEC.
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, 2009 and below in Part II, Item 1A of this Report.
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Overview
Terra Nova Financial Group, Inc. (collectively, the "Company," "Parent", "firm," "we," "us," or "our") is a holding company of businesses providing a range of products and services to trading professionals. We have one operating subsidiary: Terra Nova Financial, LLC, ("Terra Nova"), an Illinois limited liability company, a broker-dealer registered with the SEC and a member of FINRA which provides execution, clearing and prime brokerage services to professional traders, hedge funds and money managers. Our other subsidiary, QuantNova, based in Bucharest, Romania, is now inactive but formerly provided software development, architecture and engineering for back office clearing systems. Terra Nova Financial Group, Inc. trades under the stock symbol "TNFG" and is quoted on the OTC Bulletin Board.
Professional traders, hedge funds, money managers and others come to Terra Nova 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 second quarter of 2010, primary sources of revenue for Terra Nova include 89% from commissions and fees, 5% from net interest income and 6% from other income. During the second quarter of 2009, the primary sources of revenue for Terra Nova included 93% from commissions and fees, 6% from net interest income and 1% from other income.
On June 16, 2010, we entered into a Purchase Agreement (the "Purchase Agreement") with Lightspeed Financial, Inc., a Delaware corporation ("Lightspeed"). Pursuant to the Purchase Agreement, Lightspeed will acquire substantially all of the Company's assets relating to its brokerage business, including without limitation, the membership interests of Terra Nova Financial, LLC, for $27.6 million in cash (the "Transaction"). $22.6 million is to be paid at closing and $5 million is to be paid pursuant to an unsecured promissory note no later than six months from closing. Assets excluded from the Transaction include the Company's cash, cash-equivalents, its subsidiary QuantNova, which the Company intends to close, and certain other non-operating assets.
In addition to customary closing conditions, the Transaction is subject to the approval of our shareholders and certain regulators, including FINRA. The affirmative vote of the holders of two-thirds of the outstanding shares of our common stock is required to approve the Transaction.
The information in this Quarterly Report on Form 10-Q does not give effect to the Transaction.
If the Transaction is consummated, we will have no remaining operating assets and, subject to the approval of our shareholders, expect to wind up our business and effect a liquidation and dissolution pursuant to the plan of dissolution approved by our board of directors on July 2, 2010.
Due to the economic climate and after a thorough review of the Company's operations we initiated a program in November 2009 to refocus on our core customer base and to align financial resources appropriately. As part of this effort we closed our subsidiary Tradient Technologies, Inc. ("Tradient") on February 1, 2010. Tradient operated proprietary trading platforms offered to customers as an alternative to other third party platforms. We determined that the capital required to operate Tradient could be better deployed in our other operations. The results of Tradient are presented as discontinued operations for all periods presented.
The initiatives resulted in the elimination of approximately 23% of our full time workforce and we believe will reduce employee costs by approximately $2.1 million annually. Additionally, cost savings of approximately $750,000 are anticipated from reduced capital expenditures and infrastructure costs associated with operating Tradient. The benefits from these initiatives materialized in the second quarter and helped offset declines in revenue compared to the same period in 2009.
We also have had several significant executive management changes. Our former Chief Executive Officer, Michael Nolan, left the Company and was replaced as Chief Executive Officer by our Chairman, Bernay Box, as of December 1, 2009. In addition, our former Chief Technology Officer, Cristian Doloc, left the Company effective January 28, 2010 and our Managing Director of Sales, Gerald G. Kallas, resigned effective February 26, 2010.
We depend on the performance of our executive officers and managers. Our operational effectiveness depends, in large part, on the contributions from key individuals as well as our ability to motivate and retain capable personnel. We do not believe that the recent loss of the above mentioned senior executives will materially adversely impact our ability to execute our current business plan though future loss of other key personnel may impact our operations.
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The overall slowdown in trading volumes that began in 2008 and continued into the first six months of 2010 has been partially mitigated by cost containment strategies. The Company will continue to review headcount and other business operations throughout 2010. Since the federal funds rate declined to a range of 0% to 0.25% in December 2008 we continue to see a reduction in net interest income resulting from low federal funds rates, which is our base rate to determine client debit and credit rates and earnings on our reserve deposits. Terra Nova relies on net interest income as significant revenue source and, as a result, the decrease in federal funds rate impacts our profitability. We are attempting to incorporate cost saving measures to offset declining revenues while also seeking ways to increase revenues.
Commencing in July, 2010 we began the process to exit our self-clearing operations. After analyzing the potential risks and benefits, we have determined to eliminate Terra Nova's self-clearing operations. We determined that the benefits of being a self-clearing firm do not outweigh the costs of maintaining the significant capital required to support the self-clearing operations. We expect the elimination of the self-clearing operations to provide a two-fold benefit to the Company. First, the self-clearing operation requires significant overhead, and we expect that we will be able to make significant overhead reductions once the process is completed. Second, the capital required to be maintained by Terra Nova for its self-clearing operations will be released once the self-clearing operations are ended and can then be used for other purposes. We believe that in the current interest rate environment the returns on that capital are not sufficient to warrant the continuation of Terra Nova's self-clearing operations. Terra Nova currently utilizes third party clearing relationships for larger and more complex trading customers. We expect to be out of our self-clearing operations by the fourth quarter of 2010.
2010 Initiatives
Pursue targeted segments of brokerage industry
Increase emphasis on sales and marketing
Reduce costs to increase working capital
Close self-clearing operations to increase working capital
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.
Impairment of 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.
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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 on a more likely than not basis. 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.
Revenue Recognition
Commissions and fees: Commission revenue on trading products including equities, options, futures and futures options, ETFs, fixed income and mutual funds transactions are recorded on a settlement date basis.
Net interest income: 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 interest expense on brokerage accounts are recorded on an accrual basis as earned or incurred.
Other revenue: Other revenue consists of account and transaction fees and is recorded on a settlement date basis as transactions occur.
Results of Operations
The following table below represents net revenues and total expenses from the condensed consolidated statements of loss for the three and six months ended June 30, 2010 and 2009. The financial information below is derived from the condensed consolidated financial statements and related notes in the Quarterly Report on 10-Q.
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Three and Six Months ended June 30, 2010 and 2009
Our 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. We 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.
In the first and second quarter of 2010, lower stock market volatility led to reduced trading by our clients resulting in fewer stock, option and futures transactions compared to the same time period in 2009. Total trades executed declined 729,000 to 1.45 million for the six months ended June 30, 2010 compared to six months ended June 30, 2009. Total equity trades decreased 359,000 to 1.19 million for the six months ended June 30, 2010 compared to the six months ended June 30, 2009. Total option trades declined 359,000 to 179,000 for the six months ended June 30, 2010 compared to the six months ended June 30, 2009. Total equity shares and futures and option contracts declined 866.1 million to 2.06 billion for the six months ended June 30, 2010 compared to six months ended June 30, 2009. Both the three and six months ended June 30, 2010 showed a decline in Commissions and Fees revenue compared to the three and six months ended June 30, 2009. These declines are due in large part to the shutdown of our subsidiary Tradient in February 2010. The closing of Tradient resulted in a reduction in active clients and therefore reduced trading volumes.
Our net interest income decreased $387,000 for the six months ended June 30, 2010 compared to June 30, 2009 primarily due to the persistently low federal funds interest rate. We monitor the federal funds rate daily and adjust our client's credit and debit interest rates accordingly to maintain an acceptable spread. During 2009 through the second quarter of 2010 the federal funds rate has stayed consistently within a range of 0% to .25%. Our interest rate spread has narrowed considerably from our historical interest rate spread and will continue to be constricted until we see an increase in the federal funds rate.
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Our results for the six months ended June 30, 2010 reflect the following important factors:
Revenues
Commissions and fees
Our commissions and fees revenue is dependent on the overall trading activity in the United States equity, futures and option markets by our clients. Commissions revenue consists of executing NYSE and NASDAQ listed securities and OTC securities transactions along with exchange listed option transactions, futures and futures options, ETFs, fixed income and mutual funds. Commission revenue is recorded on a settlement date basis. Fee revenue is generated from clients accessing stock exchanges and various account maintenance fees.
Our commissions and fees decreased from $6.8 million in the second quarter of 2009 to $4.3 million in the second quarter of 2010-a decrease of 36.9% due primarily to lower trading activity. For the second quarter of 2010 compared to the second quarter of 2009 the firm showed a decrease in equity commissions of 47.6%, decrease in option commissions of 18.5% and an increase in futures commissions of 47.1%. For the six months ended June 30, 2010 commissions and fees decreased from $13.5 million to $8 million-a decrease of 40.3% compared to the six months ended June 30, 2009.
The total equity shares and futures and option contracts traded declined 866.1 million to 2.06 billion in the first six months of 2010 compared to the first six months of 2009. The total trades executed decreased 729,000 to 1.45 billion during the six months ended June 30, 2010 compared to the six months ended June 30, 2009. Total equity trades decreased 359,000 to 1.19 million for the six months ended June 30, 2010 compared to six months ended June 30, 2009. Option trades executed during the six months ended June 30, 2010 decreased by 359,000 to 179,000 compared to the six months ended June 30, 2009.
Net interest income
As a self-clearing broker-dealer we receive 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 $440,000 for three months ended June 30, 2009 to $247,000 for three months ended June 30, 2010-a decrease of 43.86%. For the six months ended June 30, 2010 interest decreased from $861,000 to $473,000 - a decrease of 45%. Interest income was impacted by a decline in federal fund rates from the same period in the prior year. The interest earned on segregated cash balances was also impacted by the historically low federal funds rate which is our base rate to determine client debit and credit rates and earnings on our reserve deposits.
During 2009 and through June 2010 the Federal Reserve did not materially change the federal funds rate which remains in a range of 0% to .25%. All client credit and margin debit rates are based off the federal funds rate. We also borrow securities resulting from clients who have short securities and we receive interest on cash we have deposited with broker-dealers as collateral in return for borrowing the securities.
As a self-clearing broker-dealer we pay interest to clients on cash credit balances as well as interest to banks for short-term client related loans. Interest expense on brokerage accounts was zero for both the three and six months ended June 30, 2010 and 2009 as we do not credit client's interest for credit cash balances due to the low federal funds rate.
Expenses
Commissions and clearing
A percentage of commissions that we earn are paid to registered representatives and multiple clearing correspondent arrangements with other broker-dealers. We have access to multiple Electronic Communication Networks ("ECNs") and other execution venues and we pay a fee (or receive rebate payment for order flow) to these venues for executing equity and option transactions on or through their systems. We are a member of multiple exchange and regulatory organizations and are paid or rebated 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 we pay clearing fees associated with those futures transactions. Lastly, included in commissions and clearing are soft dollar and sales commission expenses.
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Our commissions and clearing expense decreased from $2.4 million for three months ended June 30, 2009 to $1.58 million for three months ended June 30, 2010-a decrease of 33.6%. For the six months ended June 30, 2010 the Company's commissions and clearing expense decreased $2.11 million to $2.97 million-a decrease of 41.6%. The decreases for the three and six months ended June 30,2010 compared to the three and six months ended June 30, 2009 are attributable to lower ECN transaction fees as well as reduced payments to registered representatives.
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 $482,000 to $1.44 million for the three months ended June 30, 2010 compared to the three months ended June 30, 2009. The decrease is attributable to a reduction in headcount and decline in incentive compensation. For the six months ended June 30, 2010 the Company's compensation and benefits expense decreased $723,000 to $3.24 million-a decrease of 18.24%. The number of our full-time employees was fifty-two as of June 30, 2010 and eighty as of June 30, 2009.
Software and market data
The software and market data expense consists of payments to multiple third-party trading platform providers for data and trading platform access for our clients and is a variable cost based on the number of clients, licenses and order routing execution. The remaining fees include payments to vendors for access to market data including option and equity prices and news information. Our software and market data expenses decreased $406,000 from $869,000 for three months ended June 30, 2009 to $463,000 for three months ended June 30, 2010-a decrease of 46.7%. For the six months ended June 30, 2010 the Company's software and market data expense decreased $825,000 to $991,000-a decrease of 45.4%-compared to the six months ended June 30, 2009.
The declines in software and market data expense for the three and six months ended June 30, 2010 compared to the same periods in 2009 were due to decreased costs associated with a reduction in a third party vendor's software and order routing execution fees along with reduced payments for exchange data relating to our Tradient proprietary trading platform.
Tradient produced proprietary trading platforms which were alternatives to third party provided offerings. We closed Tradient in February 2010.
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 $207,000 for the three months ended June 30, 2009 to $5,000 for three months ended June 30, 2010-a decrease of 97.5%. For the six months ended June 30, 2010 the Company's advertising and promotional expense compared to the six months ended June 30, 2009 decreased $269,000 to $25,000-a decrease of 91.4%. Throughout 2010 we have implemented strategies to reduce costs associated with traditional methods of advertising and promotion, and therefore we are instead focusing on targeted partnerships with leading programs focused on highly active traders.
Professional fees
Professional fees relate to legal and consulting fees incurred for such things as our defense against litigation, compliance with Sarbanes-Oxley requirements, shareholders meeting, multiple regulatory filings, tax and audit expenses and regulatory compliance. Professional fees increased from $692,000 for the three months ended June 30, 2009 to $753,000 for the three months ended June 30, 2010-an increase of 8.8%. Professional fees decreased from $1.38 million for the six months ended June 30, 2009 to $1.28 million for the six months ended June 30, 2010-a decrease of 7.08%. The legal expenses are largely associated with multiple securities filings, various litigation defense costs, and the Transaction. Consulting expenses included multiple technology consultants used for ongoing technology support. Professional fees can vary as new legal issues arise and there will also be ongoing costs associated with the Transaction.
Communications and information technology
Our communications and information technology expenses decreased from $201,000 for the three months ended June 30, 2009 to $153,000 for the three months ended June 30, 2010-a decrease of 24%. We incur expenses associated with multiple vendors providing communications and network connectivity. The decrease for the three months ended June 30, 2010 compared to three months ended June 30, 2009 is mainly due to fewer hardware expenses. For the six months ended June 30, 2010 communications and information technology expense increased $51,000 to $449,000 compared to $398,000 for the six months ended June 30, 2009. The increase in the six months ended June 30, 2010 compared to June 30, 2009 is due to increased hardware expenses.
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Depreciation and amortization
Depreciation and amortization expenses decreased from $493,000 for the three months ended June 30, 2009 to $471,000 for the three months ended June 30, 2010-a decrease of 4.6%. For the six months ended June 30, 2010 depreciation and amortization expense increased $17,000 to $1 million compared to $982,000 for the six months ended June 30, 2009. Intangible assets are comprised of the acquired customer list and trade name of Terra Nova in connection with the acquisition of Terra Nova in the amounts of $4.7 million and $1.8 million, respectively.
Other general and administrative expenses
Our general and administrative expenses increased from $757,000 for the three months ended June 30, 2009 to $781,000 for the three months ended June 30, 2010-an increase of 3.2%. Our general and administrative expenses increased from $1.2 million for the six months ended June 30, 2009 to $1.4 million for the six months ended June 30, 2010-an increase of 14.1%. General and administrative expenses include certain clearing related expenses, office rent, shareholder relations, travel and entertainment, franchise taxes, director compensation, employee severance and other miscellaneous expenses that we incur. The expenses for the six months ended June 30, 2010 include $164,500 in severance expenses, $30,000 in arbitration settlements and $260,000 in expenses related to various regulatory fines.
Income tax benefit
The Company recorded no income tax benefit for the three and six months ended June 30, 2010 compared to a deferred income tax benefit of $135,000 and $345,000 for the same periods in 2009. The 2009 deferred income tax benefit is a result of the increase in the Company's net deferred tax asset. During 2010, the Company has not increased its net deferred tax asset as any increases are not believed to be more likely than net realizable.
At June 30, 2010 and December 31, 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 quarter' returns of approximately $150,000.
Liquidity and Capital Resources
Cash and cash equivalents
As reflected on the accompanying condensed consolidated statements of cash flows, cash and cash equivalents increased $2.4 million to $4.2 million at June 30, 2010 compared to December 31, 2009. Cash provided by operating activities was $2.4 million for three months ended June 30, 2010 which included net loss of $2.4 million. Adjustments to reconcile net loss to net cash provided by operating activities for three months ended in 2010 included depreciation and amortization totaling $1 million. Changes in cash segregated in compliance with federal regulations and receivables and payables from brokerage customers increased cash flow from operations by $16.1 million. The increase in receivables from brokers, dealers and clearing organizations from December 31, 2009 is primarily attributable to an increase in our OCC margin requirement driven by more activity by our clients in the options market. Liquidity needs relating to client trading and margin borrowing activities are met through cash balances in client brokerage accounts which totaled approximately $133.2 million as of June 30, 2010 and bank lending facilities that in aggregate amount to $40 million in secured borrowing capacity.
Cash used in investing activities for the quarter ended June 30, 2010 was $48,000 due to the purchases of property and equipment.
Cash and cash equivalents on the statement of consolidated balance sheets consists primarily of cash held in liquid commercial bank accounts or clearing organization accounts paying a "money market" rate of interest. We also have a sweep account which deposits excess operating bank balances overnight into a money market account. We review all money market funds in which it invests to ensure, to the extent possible, that our funds are not at risk.
Net capital requirement
Our broker-dealer subsidiary is subject to capital and other requirements of the SEC, FINRA, and CFTC. In addition to mandatory capital requirements (See Note 9 - Regulatory Requirements to our financial statements included in this Form 10-Q), as a self-clearing broker-dealer, Terra Nova is required to deposit funds with clearing organizations, such as DTCC and OCC, which may be large in relation to Terra Nova's total liquid assets and may vary significantly based on client trading activity. Currently, the Company believes it has sufficient capital 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.
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Cash segregated in compliance with federal regulations
Cash segregated in compliance with federal regulations was $119.9 million at June 30, 2010 versus $136 million at December 31, 2009. Such funds have been segregated in special reserve accounts for the exclusive benefit of customers under Rule 15c3-3 of the Exchange Act and other regulations. We are 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 next business day.
Due to the banking crisis that began in 2008 we now maintain special reserve accounts for the exclusive benefit of customers under Rule 15c3-3 of the Exchange Act with multiple qualified banking institutions to mitigate credit risk. We have 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 we maintain 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 us.
Lines of credit
Terra Nova maintains credit lines in the aggregate amount of $40 million secured by customer securities to facilitate its self-clearing broker-dealer operations. The rate on the lines of credits are determined daily by the banks and are 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 us in the future. At June 30, 2010 and December 31, 2009, we did not have any outstanding balances drawn on the credit lines.
Liquidity
To the extent that business or transactional opportunities are presented we 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 us to obtain capital for short-term financing of our self-clearing operations and customer margin lending. Management believes that cash balances in client brokerage accounts and operating earnings will continue to be our primary source of liquidity for the Company in the future.
Based on our historical results, management's experience, our current business strategy, including the sale of our operating subsidiary and the closing of our self-clearing operations, and current cash flows, we believe that our existing cash resources will be sufficient to meet our anticipated working capital and capital expenditure requirements for the next 12 months. Even if the Transaction were not to occur and if we did not close our self-clearing operations, we believe our cash flows from operations and existing cash resources are sufficient to meet our anticipated working capital and capital expenditure requirements for the next 12 months.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Not applicable for Smaller Reporting Companies.
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.
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Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures will prevent or detect all errors and fraud. Disclosure controls and procedures, no matter how well designed, operated and managed, can provide only reasonable assurance that the objectives of the disclosure controls and procedures are met. Because of the inherent limitations of disclosure controls and procedures, no evaluation of such disclosure controls and procedures can provide absolute assurance that all control issues and instances of fraud, if any, have been detected.
(b) Changes in Internal Control Over Financial Reporting
There were no changes in internal controls over financial reporting during the quarter ended June 30, 2010 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.
Item 1. Legal Proceedings
We accrue for litigation matters and regulatory claims when losses become probable and reasonably estimable. We have recorded an aggregate accrual of approximately $390,000 relating to our outstanding legal matters and regulatory claims as of June 30, 2010. As of the end of each applicable reporting period, we review each outstanding matter and, where it is probable that a liability has been incurred, we accrue for all probable and reasonably estimable losses. Where we are able to reasonably estimate a range of losses we may incur with respect to such a matter, we record an accrual for the amount within the range that constitutes our best estimate. If we are able to reasonably estimate a range but no amount within the range appears to be a better estimate than any other, we use the amount that is the low end of such range. If we determine that an additional loss is probable but not estimable, we provide footnote disclosure to that effect.
In December 2009, Terra Nova received a Wells Letter from NYSE Regulation ("NYSE") stating that NYSE was formally investigating whether Terra Nova had violated NYSE rules by failing to maintain adequate policies or procedures relating to four separate matters. The first relates to an incident on September 30, 2008 in which a large volume of erroneous trades were placed through an automated trading program by a Terra Nova client. NYSE alleges that Terra Nova's processes should have prevented such erroneous orders from reaching the market. The second involves a matter relating to whether Terra Nova maintained adequate policies and procedures to ensure proper marking, execution and handling of short sale orders. The third matter involves the maintenance of adequate policies and procedures to restrict wash sales and pre-arranged trades. The fourth matter involves maintaining adequate policies and procedures to prevent possibly manipulative order cancellations made by a customer. Terra Nova has submitted a written response to NYSE and is prepared to vigorously defend this matter. NYSE has proposed to settle all matters for a fine of $400,000. Settlement discussions are continuing. We have accrued a reserve for this matter.
In addition to the foregoing, many aspects of our business involve substantial risk of liability and from time to time we 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 as compared to certain other industries. We also are subject to periodic regulatory audits, inquiries and inspections. In this regard, we have been notified by regulatory authorities of various ongoing investigations. These investigations include but are not limited to a May 26, 2010 Wells Letter from FINRA alleging rules violations relating to OATS reporting during the period from January 1, 2006 through December 31, 2007. Additionally, a Wells Letter dated March 9, 2010 from FINRA alleging rules violations relating to short sales during the period from October 1, 2007 through December 31, 2007. We have to date responded to such investigations as required. We are unable to predict the outcome of these matters. Although the range of reasonably possible loss cannot be estimated with respect to such matters, based on the information currently available to us, we do not believe that these matters will have a material impact on our consolidated financial positions, results of operations or cash flows.
On April 29, 2009, the Company 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 sought to recover $500,000. The complaint alleged that Terra Nova allowed the transfer of $60,443 from Andali's account without proper authorization. The Claimant sought to recover a total of $500,000 from several defendants. Terra Nova and the Claimant settled this matter on June 4, 2010 pursuant to a Settlement Release Agreement under which Terra Nova paid a settlement amount, which amount had been previously accrued for resolution of this matter.
Item 1A. Risk Factors
Since the date of the filing of our Annual Report on Form 10-K for the year ended December 31, 2009, there have been no material changes to the risk factors described in Item 1A - "Risk Factors" of the Annual Report on Form 10-K for the year ended December 31, 2009, except we have added the following risk factors to address the Transaction and the plan of dissolution.
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Risks Relating to the Pending Transaction
Uncertainty about the Transaction and diversions of management could harm us, whether or not the Transaction is completed.
In response to the announcement of the Transaction, existing or prospective customers and counterparties of ours may delay or defer decisions concerning us or they may seek to change their existing business relationships with us. In addition, as a result of the Transaction, current and prospective employees could experience uncertainty about their future with us. These uncertainties may impair our ability to retain, recruit or motivate key personnel. Completion of the Transaction will also require a significant amount of time and attention from management. The diversion of management attention away from ongoing operations could adversely affect our business relationships. If the Transaction is not completed as anticipated, the adverse effects of these uncertainties and the diversion of management could be exacerbated by the delay.
Failure to complete the Transaction for regulatory or other reasons could adversely affect the price of our shares and our future business and financial results.
Completion of the Transaction is conditioned upon, among other things, the receipt of certain regulatory approvals, including from FINRA, and approval of our shareholders. There is no assurance that we will receive the necessary approvals or satisfy the other conditions necessary for completion of the Transaction. In addition, the current market price of our common shares may reflect a market assumption that the Transaction will occur, and a failure to complete the Transaction could result in a negative perception by the market of us generally and a resulting decline in the market price of our common shares.
We have incurred and will continue to incur significant costs in connection with the Transaction, whether or not we complete it.
We have incurred and expect to continue to incur significant costs related to the Transaction. These expenses include financial advisory, legal and accounting fees and expenses, employee expenses, filing fees, printing expenses, and other related charges. If we fail to complete the Transaction, we will remain liable for these transaction costs, and may be required, in certain circumstances, to pay a termination fee of $1.1 million. We may also incur additional unanticipated expenses in connection with the Transaction.
Risks Related to Proposed Plan of Dissolution
If our expectations regarding operating and liquidation expenses are inaccurate, the amount we distribute to our shareholders may be reduced.
The amount of cash ultimately distributed to shareholders pursuant to the plan of dissolution depends on the amount of our liabilities, obligations and expenses and claims against us, and contingency reserves that we establish during the liquidation process. We have attempted to estimate the amount of and reasonable reserves for such liabilities, obligations, expenses and claims against us. However, those estimates may be inaccurate. Factors that could impact our estimates include the following:
We may continue to incur the expenses of complying with public company reporting requirements, which may be economically burdensome. Whether or not the plan of dissolution is approved, we have an obligation to continue to comply with the applicable reporting requirements of the Securities and Exchange Act of 1934, as amended, which we refer to as the Exchange Act, even though compliance with such reporting requirements may be economically burdensome and of minimal value to our shareholders. If our shareholders approve the plan of dissolution, in order to curtail expenses, we may, following the date our articles of dissolution become effective with the Illinois Secretary of State, which we refer to as the effective date, to seek relief from the SEC to suspend our reporting obligations under the Exchange Act, and ultimately to terminate the registration of our common shares. If we are unable to suspend our obligation to file periodic reports with the SEC, we will be obligated to continue complying with the applicable reporting requirements of the Exchange Act and, as a result, will be required to continue to incur the expenses associated with these reporting requirements, which will reduce the cash available for distribution to our shareholders. These expenses include, among others, those costs relating to:
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Distributions to our shareholders could be delayed.
All or a portion of the distributions could be delayed, depending on many factors, including without limitation:
Any of the foregoing could delay or substantially diminish the amount available for distribution to our shareholders.
We may delay the distribution of some or all of the estimated amounts that we expect to distribute to shareholders to satisfy claims against and obligations of the Company that may arise during the five-year period following the effective date.
Under the Illinois Business Corporation Act, or IBCA, unbarred claims and demands may be asserted against us at any time during the five years following the effective date. Accordingly, the board of directors may obtain and maintain insurance coverage or establish and set aside a reasonable amount of cash or other assets as a contingency reserve to satisfy claims against and obligations of the Company that may arise during the five-year period following the effective date. As a result of these factors, we may retain for distribution at a later date some or all of the estimated amounts that we expect to distribute to shareholders.
If we fail to retain sufficient funds to pay our creditors, our shareholders could be held responsible for these liabilities up to the amount of any liquidating distributions they have received.
If we fail to obtain insurance or to retain or reserve sufficient funds to pay our creditors or claimants, including for contingent claims or claims that are not known to us by the time we make final liquidating distribution to shareholders, our shareholders could be held responsible for these liabilities up to the amount distributed to them as liquidating distributions under the plan of dissolution. The potential for shareholder liability continues for unbarred claims made within five years after our articles of dissolution are filed. In this event, a shareholder could be required to return all amounts received as liquidating distributions and ultimately could receive nothing under the plan of dissolution. Furthermore, an aggrieved claimant could seek to enjoin any proposed liquidating distributions to preserve assets pending resolution of the claimant's claim. For U.S. federal income tax purposes, payments made by a shareholder in satisfaction of our liabilities not covered by our cash or reserves or otherwise satisfied through insurance or other reasonable means generally would produce a capital loss for such shareholder in the year the liabilities are paid. The deductibility of any such capital loss generally would be subject to limitations under the Internal Revenue Code.
Shareholders may not be able to recognize a loss for United States federal income tax purposes until they receive a final distribution from us.
As a result of our dissolution and liquidation, for United States federal income tax purposes, our shareholders generally will recognize gain or loss equal to the difference between (1) the sum of the amount of cash and the fair market value (at the time of distribution) of property, if any, distributed to them, and (2) their tax basis for their common shares of the Company. Liquidating distributions pursuant to the plan of dissolution may occur at various times and in more than one tax year. Any loss generally will be recognized by a shareholder only when the shareholder receives our final liquidating distribution to shareholders, and then only if the aggregate value of all liquidating distributions with respect to a share is less than the shareholder's tax basis for that share. Shareholders are urged to consult their own tax advisors as to the specific tax consequences to them of our dissolution and liquidation pursuant to the plan of dissolution.
We expect to close our transfer books if the plan of distribution is approved and implemented, which may prevent our shareholders from liquidating their holdings in our shares.
The plan of distribution provides that we may close our share transfer books at any time after we file our articles of dissolution. Upon the closing of our transfer books, share certificates evidencing our common stock will not be assignable or transferable on our books except by will, intestate succession or operation of law, and we will not issue any new stock certificates, other than replacement certificates. Accordingly, if the plan of dissolution is approved and implemented, shareholders may not be able to liquidate their investment in the Company or otherwise receive value for their shares of our common stock other than through receipt of liquidating distributions pursuant to the plan of dissolution. No assurance can be given that our shareholders will receive notice of the date our transfer books closed in sufficient time, if at all, to effect a sale of their shares of our common stock.
Our shareholders could approve the Transaction but vote against the plan of dissolution.
After the Transaction, we will have no business, operations or assets with which to generate revenue, and will have retained only those employees required to wind up our business and affairs. We do not intend to invest in another operating business or otherwise invest the proceeds other than in money market funds or similar short-term investments. If the plan of dissolution is not approved, we will proceed with the sale of substantially all of our assets, pay all of our liabilities, and, as a result of the plan of dissolution not being approved, use some of the cash received from the Transaction to pay ongoing operating expenses instead of distributing it to our shareholders pursuant to the plan of dissolution, which would decrease the distribution to be made to our shareholders. If the plan of dissolution is not approved, we may make a second attempt to solicit a vote of the shareholders to approve the plan of dissolution.
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At this time, our board of directors has considered numerous options and has determined that it is in the best interests of our shareholders to dissolve the Company and return the net cash to our shareholders. The board of directors, however, retains the right to consider other alternatives should a more attractive opportunity arise before or after the effective date. If shareholders do not approve the plan of dissolution, we expect that our cash resources will continue to diminish and would likely adversely affect our financial condition and the value of your common shares. Such a result would increase the risk that you would lose all of your investment. Moreover, any alternative selected by the board of directors may have unanticipated negative consequences.
If we fail to retain the services of certain key personnel, the plan of dissolution may not succeed.
The success of the plan of dissolution depends in large part upon our ability to retain the services of Bernay Box, our Chairman and Chief Executive Officer and Murrey Wanstrath, our Chief Financial Officer. We expect them to remain as employees to assist in our liquidation. Failure to retain these personnel could harm the implementation of the plan of dissolution. If we fail to retain the services of these personnel, we will need to hire others to oversee our liquidation and dissolution, which could involve additional compensation expenses, if such other personnel are available at all.
The board of directors may abandon the Transaction and suspend implementation of the plan of dissolution even if they are approved by the shareholders.
Even if the shareholders approve the Transaction and the plan of dissolution at the special meeting, if for any reason, the board of directors determines that such action would be in our best interests and the best interests of the shareholders, the board of directors may, in its sole discretion and without requiring advance shareholder approval, abandon the Transaction and terminate the purchase agreement and suspend the plan of dissolution or revoke the articles of dissolution of the Company, to the extent permitted by the IBCA. A revocation of the dissolution would result in the shareholders not receiving any liquidating distributions pursuant to the plan of dissolution.
If our shareholders do not approve the plan of dissolution, our stock price may be adversely affected.
If our shareholders do not approve the plan of dissolution, our stock price may be adversely affected due to market perception about our ability to restart and operate successfully or to successfully pursue other strategic alternatives.
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 were made in the open market, in block transactions, or in privately negotiated transactions and were allowed to 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 conducted the repurchases in compliance with Securities and Exchange Commission Rule 10b-18. The program commenced on May 1, 2009 and expired on April 30, 2010. In the second quarter of 2010 the Company made no common stock repurchases.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Reserved
Item 5. Other Information
(a) None.
(b) Not Applicable.
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Item 6. Exhibits
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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 June 30, 2010
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 August 1, 2010.
TERRA NOVA FINANCIAL GROUP, INC.
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2
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PART I FINANCIAL INFORMATION
Item 1. Unaudited Condensed Consolidated Financial Statements
|
TERRA NOVA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) |
|||||||
|
June 30,
2010 |
December 31,
2009 |
||||||
|
ASSETS
|
|||||||
| Cash and cash equivalents | $ |
4,218,881
|
$ |
1,857,671
|
|||
| Cash segregated in compliance with federal regulations |
119,901,388
|
136,042,376
|
|||||
| Receivables from brokers, dealers and clearing organizations |
25,765,001
|
23,001,389
|
|||||
| Receivables from brokerage customers |
9,306,155
|
12,022,905
|
|||||
| Property and equipment, net of accumulated depreciation and amortization |
858,432
|
1,045,707
|
|||||
| Capitalized software development costs, net of accumulated amortization |
157,604
|
246,835
|
|||||
| Intangible assets, net of accumulated amortization |
2,056,289
|
2,741,364
|
|||||
| Income tax receivable |
738,285
|
738,285
|
|||||
| Deferred income taxes, net |
1,499,761
|
1,499,761
|
|||||
| Other assets |
910,208
|
657,361
|
|||||
| Total assets | $ |
165,412,004
|
$ |
179,853,654
|
|||
|
LIABILITIES AND SHAREHOLDERS'
EQUITY
|
|||||||
| Payables to brokerage customers | $ |
147,086,127
|
$ |
159,825,033
|
|||
| Payables to brokers, dealers and clearing organizations |
502,829
|
490,911
|
|||||
| Accounts payable and accrued expenses |
2,039,635
|
1,355,905
|
|||||
| Total liabilities |
149,628,591
|
161,671,849
|
|||||
| 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 June 30, 2010 and December 31, 2009 |
254,829
|
254,829
|
|||||
| Treasury stock, common, at cost; 428,434 shares at June 30, 2010 and December 31, 2009 |
(272,056
|
) |
(272,056
|
) | |||
| Additional paid-in capital |
52,153,438
|
52,132,836
|
|||||
| Accumulated deficit |
(36,352,798
|
) |
(33,933,804
|
) | |||
| Total shareholders' equity |
15,783,413
|
18,181,805
|
|||||
| Total liabilities and shareholders' equity | $ |
165,412,004
|
$ |
179,853,654
|
|||
|
See accompanying notes to unaudited
condensed consolidated financial statements.
|
|||||||
3
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|
TERRA NOVA FINANCIAL GROUP, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF LOSS (UNAUDITED) |
|||||||||||||||
|
Three Months Ended June 30,
|
Six Months Ended June 30,
|
||||||||||||||
|
2010
|
2009
|
2010
|
2009
|
||||||||||||
| REVENUES | |||||||||||||||
| Commissions and fees | $ |
4,290,348
|
$ |
6,796,714
|
$ |
8,039,098
|
$ |
13,473,134
|
|||||||
|
|
|||||||||||||||
| Interest income |
247,583
|
440,307
|
473,485
|
860,583
|
|||||||||||
| Interest expense on brokerage accounts |
458
|
86
|
458
|
370
|
|||||||||||
| Net interest income |
247,125
|
440,221
|
473,027
|
860,213
|
|||||||||||
|
|
|||||||||||||||
| Other revenues |
266,481
|
63,283
|
438,726
|
107,560
|
|||||||||||
|
|
|||||||||||||||
| Net revenues |
4,803,954
|
7,300,218
|
8,950,851
|
14,440,907
|
|||||||||||
|
|
|||||||||||||||
| EXPENSES |
|
||||||||||||||
| Commissions and clearing |
1,584,498
|
2,387,170
|
2,967,625
|
5,080,447
|
|||||||||||
| Compensation and benefits |
1,443,312
|
1,925,683
|
3,237,932
|
3,960,468
|
|||||||||||
| Software and market data |
463,238
|
869,415
|
990,951
|
1,816,134
|
|||||||||||
| Advertising and promotional |
5,102
|
207,111
|
25,258
|
294,123
|
|||||||||||
| Professional fees |
753,261
|
692,257
|
1,281,218
|
1,378,836
|
|||||||||||
| Communications and information technology |
153,125
|
201,353
|
449,103
|
397,975
|
|||||||||||
| Depreciation and amortization |
470,527
|
493,049
|
999,606
|
982,199
|
|||||||||||
| Other general and administrative expenses |
781,055
|
757,149
|
1,398,367
|
1,225,536
|
|||||||||||
|
|
|||||||||||||||
| Total expenses |
5,654,118
|
7,533,187
|
11,350,060
|
15,135,718
|
|||||||||||
|
|
|||||||||||||||
| Loss from continuing operations before income taxes |
(850,164
|
) |
(232,969
|
) |
(2,399,209
|
) |
(694,811
|
) | |||||||
|
|
|||||||||||||||
| Income tax benefit |
-
|
89,000
|
-
|
269,000
|
|||||||||||
|
|
|||||||||||||||
| Net loss from continuing operations |
(850,164
|
) |
(143,969
|
) |
(2,399,209
|
) |
(425,811
|
) | |||||||
|
|
|||||||||||||||
| Discontinued operations: |
|
|
|||||||||||||
| Loss from discontinued operations before income taxes |
-
|
(117,417
|
) |
(19,785
|
) |
(195,384
|
) | ||||||||
| Income tax benefit |
-
|
46,000
|
-
|
76,000
|
|||||||||||
| Loss from discontinued operations |
-
|
(71,417
|
) |
(19,785
|
) |
(119,384
|
) | ||||||||
| Net loss | $ |
(850,164
|
) | $ |
(215,386
|
) | $ |
(2,418,994
|
) | $ |
(545,195
|
) | |||
| Net loss per common share: | |||||||||||||||
| Basic and Diluted |
|
|
|||||||||||||
| Continuing operations | $ |
(0.03
|
) | $ |
(0.01
|
) | $ |
(0.10
|
) | $ |
(0.02
|
) | |||
| Discontinued operations | $ |
-
|
$ |
-
|
$ |
-
|
$ |
-
|
|||||||
| $ |
(0.03
|
) | $ |
(0.01
|
) | $ |
(0.10
|
) | $ |
(0.02
|
) | ||||
| Weighted average common shares outstanding: | |||||||||||||||
| Basic |
25,054,508
|
25,453,124
|
25,054,508
|
25,467,950
|
|||||||||||
| Diluted |
25,054,508
|
25,453,124
|
25,054,508
|
25,467,950
|
|||||||||||
|
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) |
|||||||
|
Six Months Ended June 30,
|
|||||||
|
2010
|
2009
|
||||||
| Cash flows from operating activities | |||||||
| Net loss | $ |
(2,418,994
|
) | $ |
(545,195
|
) | |
| Adjustments to reconcile net loss to net cash provided by operating activities: | |||||||
| Share-based compensation |
20,602
|
56,515
|
|||||
| Depreciation and amortization |
999,606
|
1,132,255
|
|||||
| Deferred income taxes |
-
|
(345,000
|
) | ||||
| Gain (loss) on write-off of other assets |
10,231
|
(60,626
|
) | ||||
| Changes in operating assets and liabilities: | |||||||
| Decrease in cash segregated in compliance with federal regulations |
16,140,988
|
20,969,046
|
|||||
| Increase in receivables from brokers, dealers and clearing organizations |
(2,763,612
|
) |
(5,042,835
|
) | |||
| Decrease (increase) in receivables from brokerage customers |
2,716,750
|
(3,991,979
|
) | ||||
| Decrease in income tax receivable |
-
|
730,000
|
|||||
| Decrease (increase) in other assets |
(252,847
|
) |
214,954
|
||||
| Increase (decrease) in payables to brokers, dealers and clearing organizations |
11,918
|
(101,626
|
) | ||||
| Decrease in payables to brokerage customers |
(12,738,906
|
) |
(11,246,283
|
) | |||
| Increase in accounts payable and accrued expenses |
683,730
|
139,992
|
|||||
| Net cash provided by operating activities |
2,409,466
|
1,909,218
|
|||||
| Cash flows from investing activities | |||||||
| Purchases of property and equipment |
(48,256
|
) |
(216,286
|
) | |||
| Capitalization of software development costs |
-
|
(116,857
|
) | ||||
| Net cash used in investing activities |
(48,256
|
) |
(333,143
|
) | |||
| Cash flows from financing activities | |||||||
| Purchase of treasury stock |
-
|
(272,056
|
) | ||||
| Net cash used in financing activities |
-
|
(272,056
|
) | ||||
| Net increase in cash and cash equivalents |
2,361,210
|
1,304,019
|
|||||
| Cash and cash equivalents at beginning of period |
1,857,671
|
7,889,553
|
|||||
| Cash and cash equivalents at end of period | $ |
4,218,881
|
$ |
9,193,572
|
|||
| Supplemental cash flow information: | |||||||
| Cash paid for interest | $ |
-
|
$ |
-
|
|||
| Cash paid (received) for income taxes | $ |
-
|
$ |
(696,322
|
) | ||
|
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)
Note 1 - Nature of Operations and Basis of Presentation
Nature of Operations
Terra Nova Financial Group, Inc. (collectively, the "Company," "Parent", "firm," "we," "us," or "our") is a holding company of businesses providing a range of products and services to trading professionals. We have one primary subsidiary: Terra Nova Financial, LLC ("Terra Nova"), an Illinois limited liability company, a broker-dealer registered with the SEC and a member of Financial Industry Regulatory Authority, Inc. which provides execution, clearing and prime brokerage services to professional traders, hedge funds and money managers. We have ceased operations at our other subsidiary, SC QuantNova Research SRL ("QuantNova"), which was based in Bucharest, Romania and provided software development, architecture and engineering for back office clearing systems. Terra Nova Financial Group, Inc. trades under the stock symbol "TNFG" and is quoted on the OTC Bulletin Board.
On June 16, 2010, Terra Nova Financial Group, Inc. entered into a Purchase Agreement (the "Purchase Agreement") with Lightspeed Financial, Inc., a Delaware corporation ("Lightspeed"). Pursuant to the Purchase Agreement, Lightspeed will acquire substantially all of the Company's assets relating to its brokerage business, including without limitation, the membership interests of Terra Nova Financial, LLC, for $27.6 million in cash (the "Transaction"). $22.6 million is to be paid at closing and $5 million is to be paid pursuant to an unsecured promissory note no later than six months from closing. The promissory note will accrue interest at 8% per annum. Assets excluded from the Transaction include the Company's cash, cash-equivalents, its subsidiary QuantNova, and certain other non-operating assets.
In addition to customary closing conditions, the Transaction is subject to the approval of the Company's shareholders and certain regulators, including the Financial Industry Regulatory Authority, Inc. The affirmative vote of the holders of two-thirds of the outstanding shares of the Company's common stock is required to approve the Transaction.
The Company has made customary representations, warranties and covenants in the Purchase Agreement, including, among others, covenants to conduct its business in the ordinary course during the interim period between the execution of the Purchase Agreement and the consummation of the Transaction. The representations and warranties do not survive the consummation of the Transaction.
The Purchase Agreement contains certain termination rights for both the Company and Lightspeed. Upon termination of the Purchase Agreement by the Company to pursue a superior proposal, the Company may be obligated to pay a termination fee of $1,100,000 to Lightspeed.
If the Transaction is consummated, the Company will have no remaining operating assets and, subject to the approval of its shareholders, expects to wind up its business and effect a liquidation and dissolution pursuant to the plan of dissolution approved by our board of directors on July 2, 2010, which we refer to as the plan of dissolution.
Terra Nova is registered with the following exchanges, registered clearing agencies, and regulatory organizations:
Regulatory and Self-Regulatory Organizations:
|
•
|
U.S. Securities and Exchange Commission ("SEC") as a broker-dealer |
|
•
|
Financial Industry Regulatory Authority, Inc. ("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 & Clearing Corporation ("DTCC") |
|
•
|
National Securities Clearing Corporation ("NSCC") |
|
•
|
The Options Clearing Corporation ("OCC") |
U.S. Equity Exchanges:
|
•
|
ISE Stock Exchange |
|
•
|
National Stock Exchange |
|
•
|
NYSE Arca Equities |
|
•
|
NYSE Amex Equities |
|
•
|
NYSE Euronext |
|
•
|
NASDAQ Stock Market |
|
•
|
NASDAQ OMX BX |
|
•
|
BATS Exchange, Inc. |
|
•
|
EDGX Exchange, Inc. |
|
•
|
EDGA Exchange, Inc. |
6
Table of Contents
U.S. Option Exchanges:
|
•
|
Boston Options Exchange |
|
•
|
NYSE Arca Options |
|
•
|
NYSE Amex Options |
|
•
|
NASDAQ OMX PHLX |
|
•
|
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.
QuantNova, a wholly-owned subsidiary of the Company which is currently inactive, previously provided consulting, software development, electronic data processing, software architecture and engineering for backoffice clearing software. QuantNova is based in Bucharest, Romania.
Basis of Presentation
The accompanying unaudited 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, 2009.
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 June 30, 2010 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.
During the first quarter of 2010, the Company discontinued the operations of its subsidiary, Tradient Technologies, Inc. ("Tradient"). In accordance with the provisions of FASB ASC Subtopic 205-20, the results of Tradient are presented as discontinued operations for all periods in the consolidated financial statements. See footnote 6 for additional details.
During the second quarter of 2010, the Company determined that the capital required to operate QuantNova could be better deployed in other Company operations. As a result, effective June 30, 2010, QuantNova is an inactive subsidiary and the process of dissolving QuantNova has been initiated.
(a) Consolidation Policy
The accompanying unaudited 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 brokerage customers, payables to brokers, dealers and clearing organizations, payables to brokerage customers and accounts payable and accrued expenses approximate their fair value due to their short term nature.
7
Table of Contents
(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) 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.
(e) 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, as amended ("Exchange Act"). 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.
Cash segregated in compliance with federal regulations also includes Proprietary Accounts of Introducing Brokers ("PAIB") in accordance with the customer reserve computation set forth in Rule 15c3-3 ("customer reserve formula") of the Exchange Act. 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.
(f) Impairment of 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.
(g) 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.
(h) Receivables from Brokerage Customers
Receivables from brokerage 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 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 decline 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.
8
Table of Contents
(i) Payables to Brokerage Customers
Customer funds are maintained in brokerage customer segregated accounts and relate to item cash segregated in compliance with federal regulations as discussed in item (f) above. Payables to brokerage 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 Exchange Act. The customer funds have been segregated in special reserve accounts earning interest. This payable to brokerage customers does not include customer securities positions as customer owned securities represent an off-balance sheet item.
(j) Revenue Recognition
Commissions and fees: Commission revenue on trading products including equities, options, futures and futures options, ETFs, fixed income and mutual funds transactions are recorded on a settlement date basis.
Net interest income: 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 interest expense on brokerage accounts are recorded on an accrual basis as earned or incurred.
Other revenue: Other revenue consists of account and transaction fees and is recorded on a settlement date basis as transactions occur.
(k) Lines of Credit
From time to time Terra Nova may obtain short-term bank loans to facilitate its broker-dealer settlement and clearing operations due to customer margin debits. These short-term bank loans are fully secured by customer marginable positions.
(l) 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 on a more likely than not basis. Income tax expense or benefit is the income tax payable or refundable for the period plus or minus the change during the period in deferred tax assets and liabilities.
Uncertain tax positions are initially recognized in the financial statements when they are more likely than not to be sustained upon examination by the respective tax authorities.
(m) Reclassifications
Certain reclassifications have been made to prior period amounts to conform to current period classifications.
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 six months ended June 30, 2010 and June 30, 2009 the components of basic and diluted weighted average shares outstanding are as follows:
|
For Three Months Ended June 30,
|
For Six Months Ended June 30,
|
||||||||||||
|
2010
|
2009
|
2010
|
2009
|
||||||||||
| Weighted average shares outstanding - Basic |
25,054,508
|
25,453,124
|
25,054,508
|
25,467,950
|
|||||||||
| Weighted average shares outstanding - Diluted |
25,054,508
|
25,453,124
|
25,054,508
|
25,467,950
|
|||||||||
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 June 30, 2010.
9
Table of Contents
(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 allowed 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 granted discretion to the Company's management to execute the repurchase program and there was no requirement to purchase any minimum number of shares. The repurchase program ended as of April 30, 2010. The Company did not repurchase shares of common stock during the six months ended June 30, 2010.
(c) Non-employee Warrants
Non-employee warrants outstanding as of June 30, 2010 totaled 13,713,836 with a weighted average exercise price of $2.81.
Note 5 - Risks and Uncertainties
In the ordinary course of business there are certain contingencies which are not reflected in the consolidated financial statements. These activities may expose Terra Nova 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 Terra Nova, in effect, loans money to clients. In margin transactions, Terra Nova 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 Terra Nova 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 Terra Nova would be required to purchase or sell financial instruments at prevailing market prices to fulfill the clients' obligations.
Terra Nova 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.
Terra Nova 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. Terra Nova'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 6 - Discontinued Operations
During November 2009 the Company determined that the capital required to operate Tradient Technologies, Inc. ("Tradient") could be better deployed in other Company operations. Therefore, the Company decided to close Tradient effective February 1, 2010. Tradient operated the Company's proprietary technology development activities, building applications for electronic trade execution, order routing and clearing. Tradient offered three proprietary trading platforms to clients, Tradient Pro, Tradient Plus, and Tradient Web that were alternatives to other third party platforms offered by the Company. Tradient was located in Chicago, Illinois and was included in software services segment. As a result of the closure of Tradient, the Company has a single reporting segment, brokerage services, and therefore, segment reporting is no longer applicable. Primary sources of revenue for Tradient included software licensing and routing fees.
The following table summarizes certain operating data for discontinued operations for the three and six months ended June 30, 2010 and June 30, 2009:
|
Three Months Ended June 30,
|
Six Months Ended June 30,
|
|||||||||||||||
|
2010
|
2009
|
2010
|
2009
|
|||||||||||||
| Total revenues | $ |
-
|
$ |
491,352
|
$ |
108,842
|
$ |
1,059,706
|
||||||||
| Total expenses |
-
|
(608,769
|
) |
(128,627
|
) |
(1,255,090
|
) | |||||||||
| Income tax benefit |
-
|
46,000
|
-
|
76,000
|
||||||||||||
| Loss from discontinued operations | $ |
-
|
$ |
(71,417
|
) | $ |
$(19,785
|
) | $ |
(119,384
|
) | |||||
10
Table of Contents
Note 7 - Commitments and Contingencies
Litigation and Claims
We accrue for litigation matters and regulatory claims when losses become probable and reasonably estimable. We have recorded an aggregate accrual of approximately $390,000 relating to our outstanding legal matters and regulatory claims as of June 30, 2010. As of the end of each applicable reporting period, we review each outstanding matter and, where it is probable that a liability has been incurred, we accrue for all probable and reasonably estimable losses. Where we are able to reasonably estimate a range of losses we may incur with respect to such a matter, we record an accrual for the amount within the range that constitutes our best estimate. If we are able to reasonably estimate a range but no amount within the range appears to be a better estimate than any other, we use the amount that is the low end of such range. If we determine that an additional loss is probable but not estimable, we provide footnote disclosure to that effect.
In December 2009, Terra Nova received a Wells Letter from NYSE Regulation ("NYSE") stating that NYSE was formally investigating whether Terra Nova had violated NYSE rules by failing to maintain adequate policies or procedures relating to four separate matters. The first relates to an incident on September 30, 2008 in which a large volume of erroneous trades were placed through an automated trading program by a Terra Nova client. NYSE alleges that Terra Nova's processes should have prevented such erroneous orders from reaching the market. The second involves a matter relating to whether Terra Nova maintained adequate policies and procedures to ensure proper marking, execution and handling of short sale orders. The third matter involves the maintenance of adequate policies and procedures to restrict wash sales and pre-arranged trades. The fourth matter involves maintaining adequate policies and procedures to prevent possibly manipulative order cancellations made by a customer. Terra Nova has submitted a written response to NYSE and is prepared to vigorously defend this matter. NYSE has proposed to settle all matters for a fine of $400,000. Settlement discussions are continuing. We have accrued a reserve for this matter.
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 as compared to certain other industries. 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. These investigations include but are not limited to a May 26, 2010 Wells Letter from FINRA alleging rules violations relating to OATS reporting during the period from January 1, 2006 through December 31, 2007. Additionally, a Wells Letter dated March 9, 2010 from FINRA alleging rules violations relating to short sales during the period from October 1, 2007 through December 31, 2007. The Company has to date responded to such investigations as required. We are unable to predict the outcome of these matters. Although the range of reasonably possible loss cannot be estimated with respect to such matters, based on the information currently available to us, we do not believe that these matters will have a material impact on our consolidated financial positions, results of operations or cash flows.
On April 29, 2009, the Company 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 sought to recover $500,000. The complaint alleged that Terra Nova allowed the transfer of $60,443 from Andali's account without proper authorization. The Claimant sought to recover a total of $500,000 from several defendants. Terra Nova and the Claimant settled this matter on June 4, 2010 pursuant to a Settlement Release Agreement under which Terra Nova paid a settlement amount, which amount had been previously accrued for resolution of this matter.
Note 8 - Income Taxes
The Company recorded no income tax benefit for the three and six months ended June 30, 2010 compared to a deferred income tax benefit of $135,000 and $345,000 for the same periods in 2009. The 2009 deferred income tax benefit is a result of the increase in the Company's net deferred tax asset. During 2010, the Company has not increased its net deferred tax asset as any increases are not believed to be more likely than not realizable.
At June 30, 2010 and December 31, 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 quarter's returns of approximately $150,000.
Note 9 - Regulatory Requirements
Terra Nova is subject to the U.S. Securities and Exchange Commission Uniform Net Capital Rule ("Rule 15c3-1") under the Exchange Act which requires the maintenance of minimum net capital. Terra Nova calculates its net capital using the ''alternative method,'' which requires maintaining 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.
11
Table of Contents
Terra Nova is also subject to the CFTC financial requirement ("Regulation 1.17") under the Commodity Exchange Act, administered by the CFTC and the NFA, which also requires maintaining minimum net capital. Terra Nova is a futures commission merchant and is required to maintain minimum net capital the sum of 8% of the total risk margin requirements for all positions carried in customer accounts, as defined in Regulation 1.17 and 8% of the total risk margin requirements for all positions carried in non-customer accounts with a minimum adjusted net capital of $1,000,000.
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. A summary of net capital requirements as of June 30, 2010 are as follows:
|
Minimum Net Capital Requirement
|
Excess Net Capital
|
||||||||||||||||
|
Net Capital
|
SEC
|
CFTC
|
SEC
|
CFTC
|
|||||||||||||
| Terra Nova Financial, LLC | $ |
9,974,251
|
$ |
1,500,000
|
$ |
1,000,000
|
$ |
8,474,251
|
$ |
8,974,251
|
|||||||
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; estimated expected life based on historical employee exercise behavior for similar awards giving consideration to the award's contractual terms vesting schedules; 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.
During the three and six months ended June 30, 2010 and June 30, 2009 no stock options were granted.
Effective May 19, 2006, the Company adopted the 2006 Warrant Incentive Plan (the "2006 WIP"). The purpose of the 2006 WIP is to (a) to encourage certain employees and directors of the Company, as well as employees and directors of any current or after-acquired subsidiary corporation, to acquire a proprietary interest in the Company and thus share in the future success of the Company; and (b) to enable the Company, by offering comparable incentives, to attract and retain outstanding management personnel and directors who are in a position to make important and direct contributions to the success of the Company; and (c) to promote a closer identity of interests between the Company's employees, directors and consultants and its stockholders. The Company reserved 3,500,000 shares of voting common stock for sale upon the exercise of warrants granted under the 2006 WIP. If a warrant expires or terminates for any reason without having been fully exercised, the unpurchased shares will be available for other warrant grants under the 2006 WIP. Unless the 2006 WIP is terminated earlier, it shall terminate five years from its effective date.
The table below summarizes the Company's employee stock option and warrant plans as of June 30, 2010:
| Employee Stock Option and Warrant Plans |
Authorized
|
Outstanding
|
Available
|
|||||
| 2005 Long-Term Incentive Plan ("LTIP") |
4,231,484
|
524,000
|
3,707,484
|
|||||
| 2006 Warrant Incentive Plan ("2006 WIP") |
3,500,000
|
3,027,500
|
472,500
|
|||||
| Balance at June 30, 2010 |
7,731,484
|
3,551,500
|
4,179,984
|
|||||
| 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, 2009 |
992,774
|
$ |
1.25
|
3.64
|
-
|
|||||||
| Granted |
-
|
-
|
-
|
-
|
||||||||
| Exercised |
-
|
-
|
-
|
-
|
||||||||
| Cancelled |
(468,774
|
) |
1.42
|
0.47
|
-
|
|||||||
| Balance at June 30, 2010 |
524,000
|
$ |
1.09
|
3.46
|
$ |
-
|
||||||
| Options exercisable at June 30, 2010 |
139,000
|
$ |
1.68
|
2.18
|
$ |
-
|
||||||
12
Table of Contents
The aggregate intrinsic value of stock options outstanding and stock options exercisable at June 30, 2010 is calculated as the number of in-the-money options times the difference between exercise price of the underlying awards and the quoted closing market price of common stock at June 30, 2010. The aggregate intrinsic value of stock options exercised is calculated as the number of in-the-money options on the exercise date times the difference between the exercise price of the underlying awards and the quoted closing market price on the exercise date.
As of June 30, 2010 there was $59,978 of total unrecognized compensation cost related to unvested share-based compensation arrangements granted under stock option plans. The cost is expected to be recognized over a weighted-average period of approximately two and one-half years. During the six months ended June 30, 2010 and June 30, 2009 compensation expense of $20,602 and $26,515, respectively, was recognized related to options vesting under option plans.
A summary of employee warrant activity under the 2006 Warrant Incentive Plan for the six months ended June 30, 2010 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, 2009 |
3,027,500
|
$ |
2.56
|
1.55
|
-
|
|||||||||||
| Granted |
-
|
-
|
-
|
-
|
||||||||||||
| Exercised |
-
|
-
|
-
|
-
|
||||||||||||
| Cancelled |
-
|
-
|
-
|
-
|
||||||||||||
| Balance at June 30, 2010 |
3,027,500
|
$ |
2.56
|
1.06
|
$ |
-
|
||||||||||
| Warrants exercisable at June 30, 2010 |
3,027,500
|
$ |
2.56
|
1.06
|
$ |
-
|
||||||||||
Note 11 - 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 June 30, 2010 and December 31, 2009:
|
June 30, 2010
|
December 31, 2009
|
||||||||||||||||
|
Estimated
Useful Life in Years |
Property and
equipment |
Capitalized
software development costs |
Property and
equipment |
Capitalized
software development costs |
|||||||||||||
| Capitalized software development |
3-5
|
$ |
-
|
$ |
332,284
|
$ |
-
|
$ |
428,332
|
||||||||
| Computer and hardware |
3-5
|
863,879
|
-
|
1,013,879
|
-
|
||||||||||||
| Furniture, fixtures and equipment |
3-7
|
272,534
|
-
|
352,141
|
-
|
||||||||||||
| Leasehold improvements |
5-10
|
119,588
|
-
|
119,589
|
-
|
||||||||||||
|
1,256,001
|
332,284
|
1,485,609
|
428,332
|
||||||||||||||
| Accumulated depreciation
and amortization |
(397,569
|
) |
(174,680
|
) |
(439,902
|
) |
(181,497
|
) | |||||||||
| Net balance |
$ |
858,432
|
$ |
157,604
|
$ |
1,045,707
|
$ |
246,835
|
|||||||||
13
Table of Contents
Note 12 - Intangible Assets
Intangible assets consist of the following as of June 30, 2010 and December 31, 2009:
|
June 30, 2010
|
December 31, 2009
|
|||||||||
| Customer list | $ |
4,749,000
|
$ |
4,749,000
|
||||||
| Trade name |
1,829,000
|
1,829,000
|
||||||||
|
6,578,000
|
6,578,000
|
|||||||||
| Accumulated amortization |
(4,521,711
|
) |
(3,836,636
|
) | ||||||
| Net balance | $ |
2,056,289
|
$ |
2,741,364
|
||||||
Note 13 - Fair Value of Financial Instruments
FASB issued ASC Topic 820, "Fair Value Measurements", ("Topic 820") which defines fair value, establishes a framework for measuring fair value 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) and not the price that would be paid to acquire the asset or received to assume the liability (an entry price).
Financial Assets and Liabilities
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 June 30, 2010 and December 31, 2009.
| Financial instruments owned, at fair value: |
June 30, 2010
|
December 31, 2009
|
||||||||
| Commercial Paper | $ |
3,400,000
|
$ |
2,337,655
|
||||||
| U.S. Treasury securities held as clearing deposits |
18,994,233
|
12,998,592
|
||||||||
| Total | $ |
22,394,233
|
$ |
15,336,247
|
||||||
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 inputs used to measure the Company's financial instruments owned at fair value as of June 30, 2010.
|
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
|
Fair Value
|
||||||||||||
| Commercial Paper | $ |
3,400,000
|
$ |
-
|
$ |
-
|
$ |
3,400,000
|
||||||||
| U.S. Treasury securities held as clearing deposits |
18,994,233
|
-
|
-
|
18,994,233
|
||||||||||||
| Total | $ |
22,394,233
|
$ |
-
|
$ |
-
|
$ |
22,394,233
|
||||||||
14
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 June 30, 2010 and December 31, 2009:
|
June 30, 2010
|
December 31, 2009
|
||||||||||||
|
Receivables
|
Payables
|
Receivables
|
Payables
|
||||||||||
| Cash held for securities borrowed $ | $ |
5,291,525
|
$ |
-
|
$ |
7,988,525
|
$ |
-
|
|||||
| Clearing deposits & receivables/payables |
20,473,476
|
502,829
|
15,012,864
|
490,911
|
|||||||||
| Total | $ |
25,765,001
|
$ |
502,829
|
$ |
23,001,389
|
$ |
490,911
|
|||||
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.
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 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. Examples of such forward-looking statements include, but are not limited to, the statements concerning trends in revenue, costs and expenses; our pending asset sale with Lightspeed, including related uncertainties and risks and the impact on our business if the asset sale is not completed; our accounting estimates, assumptions and judgments; our business plans relating to our products and services; our ability to scale our operations in response to changing demands and expectations of our customers; and the level of demand for our products and services. 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, 2009 and below in Part II, Item 1A of this Report, and in other securities filings by the Company with the SEC.
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, 2009 and below in Part II, Item 1A of this Report.
15
Table of Contents
Overview
Terra Nova Financial Group, Inc. (collectively, the "Company," "Parent", "firm," "we," "us," or "our") is a holding company of businesses providing a range of products and services to trading professionals. We have one operating subsidiary: Terra Nova Financial, LLC, ("Terra Nova"), an Illinois limited liability company, a broker-dealer registered with the SEC and a member of FINRA which provides execution, clearing and prime brokerage services to professional traders, hedge funds and money managers. Our other subsidiary, QuantNova, based in Bucharest, Romania, is now inactive but formerly provided software development, architecture and engineering for back office clearing systems. Terra Nova Financial Group, Inc. trades under the stock symbol "TNFG" and is quoted on the OTC Bulletin Board.
Professional traders, hedge funds, money managers and others come to Terra Nova 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 second quarter of 2010, primary sources of revenue for Terra Nova include 89% from commissions and fees, 5% from net interest income and 6% from other income. During the second quarter of 2009, the primary sources of revenue for Terra Nova included 93% from commissions and fees, 6% from net interest income and 1% from other income.
On June 16, 2010, we entered into a Purchase Agreement (the "Purchase Agreement") with Lightspeed Financial, Inc., a Delaware corporation ("Lightspeed"). Pursuant to the Purchase Agreement, Lightspeed will acquire substantially all of the Company's assets relating to its brokerage business, including without limitation, the membership interests of Terra Nova Financial, LLC, for $27.6 million in cash (the "Transaction"). $22.6 million is to be paid at closing and $5 million is to be paid pursuant to an unsecured promissory note no later than six months from closing. Assets excluded from the Transaction include the Company's cash, cash-equivalents, its subsidiary QuantNova, which the Company intends to close, and certain other non-operating assets.
In addition to customary closing conditions, the Transaction is subject to the approval of our shareholders and certain regulators, including FINRA. The affirmative vote of the holders of two-thirds of the outstanding shares of our common stock is required to approve the Transaction.
The information in this Quarterly Report on Form 10-Q does not give effect to the Transaction.
If the Transaction is consummated, we will have no remaining operating assets and, subject to the approval of our shareholders, expect to wind up our business and effect a liquidation and dissolution pursuant to the plan of dissolution approved by our board of directors on July 2, 2010.
Due to the economic climate and after a thorough review of the Company's operations we initiated a program in November 2009 to refocus on our core customer base and to align financial resources appropriately. As part of this effort we closed our subsidiary Tradient Technologies, Inc. ("Tradient") on February 1, 2010. Tradient operated proprietary trading platforms offered to customers as an alternative to other third party platforms. We determined that the capital required to operate Tradient could be better deployed in our other operations. The results of Tradient are presented as discontinued operations for all periods presented.
The initiatives resulted in the elimination of approximately 23% of our full time workforce and we believe will reduce employee costs by approximately $2.1 million annually. Additionally, cost savings of approximately $750,000 are anticipated from reduced capital expenditures and infrastructure costs associated with operating Tradient. The benefits from these initiatives materialized in the second quarter and helped offset declines in revenue compared to the same period in 2009.
We also have had several significant executive management changes. Our former Chief Executive Officer, Michael Nolan, left the Company and was replaced as Chief Executive Officer by our Chairman, Bernay Box, as of December 1, 2009. In addition, our former Chief Technology Officer, Cristian Doloc, left the Company effective January 28, 2010 and our Managing Director of Sales, Gerald G. Kallas, resigned effective February 26, 2010.
We depend on the performance of our executive officers and managers. Our operational effectiveness depends, in large part, on the contributions from key individuals as well as our ability to motivate and retain capable personnel. We do not believe that the recent loss of the above mentioned senior executives will materially adversely impact our ability to execute our current business plan though future loss of other key personnel may impact our operations.
16
Table of Contents
The overall slowdown in trading volumes that began in 2008 and continued into the first six months of 2010 has been partially mitigated by cost containment strategies. The Company will continue to review headcount and other business operations throughout 2010. Since the federal funds rate declined to a range of 0% to 0.25% in December 2008 we continue to see a reduction in net interest income resulting from low federal funds rates, which is our base rate to determine client debit and credit rates and earnings on our reserve deposits. Terra Nova relies on net interest income as significant revenue source and, as a result, the decrease in federal funds rate impacts our profitability. We are attempting to incorporate cost saving measures to offset declining revenues while also seeking ways to increase revenues.
Commencing in July, 2010 we began the process to exit our self-clearing operations. After analyzing the potential risks and benefits, we have determined to eliminate Terra Nova's self-clearing operations. We determined that the benefits of being a self-clearing firm do not outweigh the costs of maintaining the significant capital required to support the self-clearing operations. We expect the elimination of the self-clearing operations to provide a two-fold benefit to the Company. First, the self-clearing operation requires significant overhead, and we expect that we will be able to make significant overhead reductions once the process is completed. Second, the capital required to be maintained by Terra Nova for its self-clearing operations will be released once the self-clearing operations are ended and can then be used for other purposes. We believe that in the current interest rate environment the returns on that capital are not sufficient to warrant the continuation of Terra Nova's self-clearing operations. Terra Nova currently utilizes third party clearing relationships for larger and more complex trading customers. We expect to be out of our self-clearing operations by the fourth quarter of 2010.
2010 Initiatives
Pursue targeted segments of brokerage industry
|
•
|
Pursue high-growth segment by capturing sponsored access and high frequency traders; |
|
•
|
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. |
Increase emphasis on sales and marketing
|
•
|
Enhance the lead pipeline through targeted partnerships with leading programs focused on highly active traders; and |
|
•
|
Enable the sales team with additional tools and support. |
Reduce costs to increase working capital
|
•
|
Optimize order-flow costs; |
|
•
|
Continue to align costs of routing with third-party platforms; and |
|
•
|
Continue to reduce cost structure by optimizing a variety of management and IT systems processes. |
Close self-clearing operations to increase working capital
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.
Impairment of 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.
17
Table of Contents
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 on a more likely than not basis. 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.
Revenue Recognition
Commissions and fees: Commission revenue on trading products including equities, options, futures and futures options, ETFs, fixed income and mutual funds transactions are recorded on a settlement date basis.
Net interest income: 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 interest expense on brokerage accounts are recorded on an accrual basis as earned or incurred.
Other revenue: Other revenue consists of account and transaction fees and is recorded on a settlement date basis as transactions occur.
Results of Operations
The following table below represents net revenues and total expenses from the condensed consolidated statements of loss for the three and six months ended June 30, 2010 and 2009. The financial information below is derived from the condensed consolidated financial statements and related notes in the Quarterly Report on 10-Q.
18
Table of Contents
|
Three Months Ended June 30,
|
Six Months Ended June 30,
|
||||||||||||||
|
2010
|
2009
|
2010
|
2009
|
||||||||||||
| REVENUES | |||||||||||||||
| Commissions and fees | $ |
4,290,348
|
$ |
6,796,714
|
$ |
8,039,098
|
$ |
13,473,134
|
|||||||
|
|
|||||||||||||||
| Interest income |
247,583
|
440,307
|
473,485
|
860,583
|
|||||||||||
| Interest expense on brokerage accounts |
458
|
86
|
458
|
370
|
|||||||||||
| Net interest income |
247,125
|
440,221
|
473,027
|
860,213
|
|||||||||||
|
|
|||||||||||||||
| Other revenues |
266,481
|
63,283
|
438,726
|
107,560
|
|||||||||||
|
|
|||||||||||||||
| Net revenues |
4,803,954
|
7,300,218
|
8,950,851
|
14,440,907
|
|||||||||||
|
|
|||||||||||||||
| EXPENSES |
|
||||||||||||||
| Commissions and clearing |
1,584,498
|
2,387,170
|
2,967,625
|
5,080,447
|
|||||||||||
| Compensation and benefits |
1,443,312
|
1,925,683
|
3,237,932
|
3,960,468
|
|||||||||||
| Software and market data |
463,238
|
869,415
|
990,951
|
1,816,134
|
|||||||||||
| Advertising and promotional |
5,102
|
207,111
|
25,258
|
294,123
|
|||||||||||
| Professional fees |
753,261
|
692,257
|
1,281,218
|
1,378,836
|
|||||||||||
| Communications and information technology |
153,125
|
201,353
|
449,103
|
397,975
|
|||||||||||
| Depreciation and amortization |
470,527
|
493,049
|
999,606
|
982,199
|
|||||||||||
| Other general and administrative expenses |
781,055
|
757,149
|
1,398,367
|
1,225,536
|
|||||||||||
|
|
|||||||||||||||
| Total expenses |
5,654,118
|
7,533,187
|
11,350,060
|
15,135,718
|
|||||||||||
|
|
|||||||||||||||
| Loss from continuing operations before income taxes |
(850,164
|
) |
(232,969
|
) |
(2,399,209
|
) |
(694,811
|
) | |||||||
|
|
|||||||||||||||
| Income tax benefit |
-
|
89,000
|
-
|
269,000
|
|||||||||||
|
|
|||||||||||||||
| Net loss from continuing operations |
(850,164
|
) |
(143,969
|
) |
(2,399,209
|
) |
(425,811
|
) | |||||||
|
|
|||||||||||||||
| Discontinued operations: |
|
|
|||||||||||||
| Loss from discontinued operations before income taxes |
-
|
(117,417
|
) |
(19,785
|
) |
(195,384
|
) | ||||||||
| Income tax benefit |
-
|
46,000
|
-
|
76,000
|
|||||||||||
| Loss from discontinued operations |
-
|
(71,417
|
) |
(19,785
|
) |
(119,384
|
) | ||||||||
| Net loss | $ |
(850,164
|
) | $ |
(215,386
|
) | $ |
(2,418,994
|
) | $ |
(545,195
|
) | |||
Three and Six Months ended June 30, 2010 and 2009
Our 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. We 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.
In the first and second quarter of 2010, lower stock market volatility led to reduced trading by our clients resulting in fewer stock, option and futures transactions compared to the same time period in 2009. Total trades executed declined 729,000 to 1.45 million for the six months ended June 30, 2010 compared to six months ended June 30, 2009. Total equity trades decreased 359,000 to 1.19 million for the six months ended June 30, 2010 compared to the six months ended June 30, 2009. Total option trades declined 359,000 to 179,000 for the six months ended June 30, 2010 compared to the six months ended June 30, 2009. Total equity shares and futures and option contracts declined 866.1 million to 2.06 billion for the six months ended June 30, 2010 compared to six months ended June 30, 2009. Both the three and six months ended June 30, 2010 showed a decline in Commissions and Fees revenue compared to the three and six months ended June 30, 2009. These declines are due in large part to the shutdown of our subsidiary Tradient in February 2010. The closing of Tradient resulted in a reduction in active clients and therefore reduced trading volumes.
Our net interest income decreased $387,000 for the six months ended June 30, 2010 compared to June 30, 2009 primarily due to the persistently low federal funds interest rate. We monitor the federal funds rate daily and adjust our client's credit and debit interest rates accordingly to maintain an acceptable spread. During 2009 through the second quarter of 2010 the federal funds rate has stayed consistently within a range of 0% to .25%. Our interest rate spread has narrowed considerably from our historical interest rate spread and will continue to be constricted until we see an increase in the federal funds rate.
19
Table of Contents
Our results for the six months ended June 30, 2010 reflect the following important factors:
|
•
|
Net loss from continuing operations for the six months ended June 30, 2010 of $2,399,209 includes the following non-cash expenses among other non-cash items: |
|
°
|
Depreciation expense on property and equipment of $225,298 | |
|
°
|
Amortization expense on capitalized software of $89,232 | |
|
°
|
Amortization expense on intangible assets of $685,000 | |
|
°
|
Share-based compensation of $20,602 |
|
•
|
Posted average revenue per employee of approximately $172,100 based on fifty-two full-time employees as of June 30, 2010 compared to $180,500 based on eighty full-time employees as of June 30, 2009. |
|
•
|
Net interest income was down $387,000 to $473,000 for the six months ended June 30, 2010 compared to $860,000 for the six months ended June 30, 2009. |
Revenues
Commissions and fees
Our commissions and fees revenue is dependent on the overall trading activity in the United States equity, futures and option markets by our clients. Commissions revenue consists of executing NYSE and NASDAQ listed securities and OTC securities transactions along with exchange listed option transactions, futures and futures options, ETFs, fixed income and mutual funds. Commission revenue is recorded on a settlement date basis. Fee revenue is generated from clients accessing stock exchanges and various account maintenance fees.
Our commissions and fees decreased from $6.8 million in the second quarter of 2009 to $4.3 million in the second quarter of 2010-a decrease of 36.9% due primarily to lower trading activity. For the second quarter of 2010 compared to the second quarter of 2009 the firm showed a decrease in equity commissions of 47.6%, decrease in option commissions of 18.5% and an increase in futures commissions of 47.1%. For the six months ended June 30, 2010 commissions and fees decreased from $13.5 million to $8 million-a decrease of 40.3% compared to the six months ended June 30, 2009.
The total equity shares and futures and option contracts traded declined 866.1 million to 2.06 billion in the first six months of 2010 compared to the first six months of 2009. The total trades executed decreased 729,000 to 1.45 billion during the six months ended June 30, 2010 compared to the six months ended June 30, 2009. Total equity trades decreased 359,000 to 1.19 million for the six months ended June 30, 2010 compared to six months ended June 30, 2009. Option trades executed during the six months ended June 30, 2010 decreased by 359,000 to 179,000 compared to the six months ended June 30, 2009.
Net interest income
As a self-clearing broker-dealer we receive 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 $440,000 for three months ended June 30, 2009 to $247,000 for three months ended June 30, 2010-a decrease of 43.86%. For the six months ended June 30, 2010 interest decreased from $861,000 to $473,000 - a decrease of 45%. Interest income was impacted by a decline in federal fund rates from the same period in the prior year. The interest earned on segregated cash balances was also impacted by the historically low federal funds rate which is our base rate to determine client debit and credit rates and earnings on our reserve deposits.
During 2009 and through June 2010 the Federal Reserve did not materially change the federal funds rate which remains in a range of 0% to .25%. All client credit and margin debit rates are based off the federal funds rate. We also borrow securities resulting from clients who have short securities and we receive interest on cash we have deposited with broker-dealers as collateral in return for borrowing the securities.
As a self-clearing broker-dealer we pay interest to clients on cash credit balances as well as interest to banks for short-term client related loans. Interest expense on brokerage accounts was zero for both the three and six months ended June 30, 2010 and 2009 as we do not credit client's interest for credit cash balances due to the low federal funds rate.
Expenses
Commissions and clearing
A percentage of commissions that we earn are paid to registered representatives and multiple clearing correspondent arrangements with other broker-dealers. We have access to multiple Electronic Communication Networks ("ECNs") and other execution venues and we pay a fee (or receive rebate payment for order flow) to these venues for executing equity and option transactions on or through their systems. We are a member of multiple exchange and regulatory organizations and are paid or rebated 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 we pay clearing fees associated with those futures transactions. Lastly, included in commissions and clearing are soft dollar and sales commission expenses.
20
Table of Contents
Our commissions and clearing expense decreased from $2.4 million for three months ended June 30, 2009 to $1.58 million for three months ended June 30, 2010-a decrease of 33.6%. For the six months ended June 30, 2010 the Company's commissions and clearing expense decreased $2.11 million to $2.97 million-a decrease of 41.6%. The decreases for the three and six months ended June 30,2010 compared to the three and six months ended June 30, 2009 are attributable to lower ECN transaction fees as well as reduced payments to registered representatives.
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 $482,000 to $1.44 million for the three months ended June 30, 2010 compared to the three months ended June 30, 2009. The decrease is attributable to a reduction in headcount and decline in incentive compensation. For the six months ended June 30, 2010 the Company's compensation and benefits expense decreased $723,000 to $3.24 million-a decrease of 18.24%. The number of our full-time employees was fifty-two as of June 30, 2010 and eighty as of June 30, 2009.
Software and market data
The software and market data expense consists of payments to multiple third-party trading platform providers for data and trading platform access for our clients and is a variable cost based on the number of clients, licenses and order routing execution. The remaining fees include payments to vendors for access to market data including option and equity prices and news information. Our software and market data expenses decreased $406,000 from $869,000 for three months ended June 30, 2009 to $463,000 for three months ended June 30, 2010-a decrease of 46.7%. For the six months ended June 30, 2010 the Company's software and market data expense decreased $825,000 to $991,000-a decrease of 45.4%-compared to the six months ended June 30, 2009.
The declines in software and market data expense for the three and six months ended June 30, 2010 compared to the same periods in 2009 were due to decreased costs associated with a reduction in a third party vendor's software and order routing execution fees along with reduced payments for exchange data relating to our Tradient proprietary trading platform.
Tradient produced proprietary trading platforms which were alternatives to third party provided offerings. We closed Tradient in February 2010.
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 $207,000 for the three months ended June 30, 2009 to $5,000 for three months ended June 30, 2010-a decrease of 97.5%. For the six months ended June 30, 2010 the Company's advertising and promotional expense compared to the six months ended June 30, 2009 decreased $269,000 to $25,000-a decrease of 91.4%. Throughout 2010 we have implemented strategies to reduce costs associated with traditional methods of advertising and promotion, and therefore we are instead focusing on targeted partnerships with leading programs focused on highly active traders.
Professional fees
Professional fees relate to legal and consulting fees incurred for such things as our defense against litigation, compliance with Sarbanes-Oxley requirements, shareholders meeting, multiple regulatory filings, tax and audit expenses and regulatory compliance. Professional fees increased from $692,000 for the three months ended June 30, 2009 to $753,000 for the three months ended June 30, 2010-an increase of 8.8%. Professional fees decreased from $1.38 million for the six months ended June 30, 2009 to $1.28 million for the six months ended June 30, 2010-a decrease of 7.08%. The legal expenses are largely associated with multiple securities filings, various litigation defense costs, and the Transaction. Consulting expenses included multiple technology consultants used for ongoing technology support. Professional fees can vary as new legal issues arise and there will also be ongoing costs associated with the Transaction.
Communications and information technology
Our communications and information technology expenses decreased from $201,000 for the three months ended June 30, 2009 to $153,000 for the three months ended June 30, 2010-a decrease of 24%. We incur expenses associated with multiple vendors providing communications and network connectivity. The decrease for the three months ended June 30, 2010 compared to three months ended June 30, 2009 is mainly due to fewer hardware expenses. For the six months ended June 30, 2010 communications and information technology expense increased $51,000 to $449,000 compared to $398,000 for the six months ended June 30, 2009. The increase in the six months ended June 30, 2010 compared to June 30, 2009 is due to increased hardware expenses.
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Depreciation and amortization
Depreciation and amortization expenses decreased from $493,000 for the three months ended June 30, 2009 to $471,000 for the three months ended June 30, 2010-a decrease of 4.6%. For the six months ended June 30, 2010 depreciation and amortization expense increased $17,000 to $1 million compared to $982,000 for the six months ended June 30, 2009. Intangible assets are comprised of the acquired customer list and trade name of Terra Nova in connection with the acquisition of Terra Nova in the amounts of $4.7 million and $1.8 million, respectively.
Other general and administrative expenses
Our general and administrative expenses increased from $757,000 for the three months ended June 30, 2009 to $781,000 for the three months ended June 30, 2010-an increase of 3.2%. Our general and administrative expenses increased from $1.2 million for the six months ended June 30, 2009 to $1.4 million for the six months ended June 30, 2010-an increase of 14.1%. General and administrative expenses include certain clearing related expenses, office rent, shareholder relations, travel and entertainment, franchise taxes, director compensation, employee severance and other miscellaneous expenses that we incur. The expenses for the six months ended June 30, 2010 include $164,500 in severance expenses, $30,000 in arbitration settlements and $260,000 in expenses related to various regulatory fines.
Income tax benefit
The Company recorded no income tax benefit for the three and six months ended June 30, 2010 compared to a deferred income tax benefit of $135,000 and $345,000 for the same periods in 2009. The 2009 deferred income tax benefit is a result of the increase in the Company's net deferred tax asset. During 2010, the Company has not increased its net deferred tax asset as any increases are not believed to be more likely than net realizable.
At June 30, 2010 and December 31, 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 quarter' returns of approximately $150,000.
Liquidity and Capital Resources
Cash and cash equivalents
As reflected on the accompanying condensed consolidated statements of cash flows, cash and cash equivalents increased $2.4 million to $4.2 million at June 30, 2010 compared to December 31, 2009. Cash provided by operating activities was $2.4 million for three months ended June 30, 2010 which included net loss of $2.4 million. Adjustments to reconcile net loss to net cash provided by operating activities for three months ended in 2010 included depreciation and amortization totaling $1 million. Changes in cash segregated in compliance with federal regulations and receivables and payables from brokerage customers increased cash flow from operations by $16.1 million. The increase in receivables from brokers, dealers and clearing organizations from December 31, 2009 is primarily attributable to an increase in our OCC margin requirement driven by more activity by our clients in the options market. Liquidity needs relating to client trading and margin borrowing activities are met through cash balances in client brokerage accounts which totaled approximately $133.2 million as of June 30, 2010 and bank lending facilities that in aggregate amount to $40 million in secured borrowing capacity.
Cash used in investing activities for the quarter ended June 30, 2010 was $48,000 due to the purchases of property and equipment.
Cash and cash equivalents on the statement of consolidated balance sheets consists primarily of cash held in liquid commercial bank accounts or clearing organization accounts paying a "money market" rate of interest. We also have a sweep account which deposits excess operating bank balances overnight into a money market account. We review all money market funds in which it invests to ensure, to the extent possible, that our funds are not at risk.
Net capital requirement
Our broker-dealer subsidiary is subject to capital and other requirements of the SEC, FINRA, and CFTC. In addition to mandatory capital requirements (See Note 9 - Regulatory Requirements to our financial statements included in this Form 10-Q), as a self-clearing broker-dealer, Terra Nova is required to deposit funds with clearing organizations, such as DTCC and OCC, which may be large in relation to Terra Nova's total liquid assets and may vary significantly based on client trading activity. Currently, the Company believes it has sufficient capital 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.
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Cash segregated in compliance with federal regulations
Cash segregated in compliance with federal regulations was $119.9 million at June 30, 2010 versus $136 million at December 31, 2009. Such funds have been segregated in special reserve accounts for the exclusive benefit of customers under Rule 15c3-3 of the Exchange Act and other regulations. We are 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 next business day.
Due to the banking crisis that began in 2008 we now maintain special reserve accounts for the exclusive benefit of customers under Rule 15c3-3 of the Exchange Act with multiple qualified banking institutions to mitigate credit risk. We have 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 we maintain 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 us.
Lines of credit
Terra Nova maintains credit lines in the aggregate amount of $40 million secured by customer securities to facilitate its self-clearing broker-dealer operations. The rate on the lines of credits are determined daily by the banks and are 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 us in the future. At June 30, 2010 and December 31, 2009, we did not have any outstanding balances drawn on the credit lines.
Liquidity
To the extent that business or transactional opportunities are presented we 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 us to obtain capital for short-term financing of our self-clearing operations and customer margin lending. Management believes that cash balances in client brokerage accounts and operating earnings will continue to be our primary source of liquidity for the Company in the future.
Based on our historical results, management's experience, our current business strategy, including the sale of our operating subsidiary and the closing of our self-clearing operations, and current cash flows, we believe that our existing cash resources will be sufficient to meet our anticipated working capital and capital expenditure requirements for the next 12 months. Even if the Transaction were not to occur and if we did not close our self-clearing operations, we believe our cash flows from operations and existing cash resources are sufficient to meet our anticipated working capital and capital expenditure requirements for the next 12 months.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Not applicable for Smaller Reporting Companies.
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.
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Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures will prevent or detect all errors and fraud. Disclosure controls and procedures, no matter how well designed, operated and managed, can provide only reasonable assurance that the objectives of the disclosure controls and procedures are met. Because of the inherent limitations of disclosure controls and procedures, no evaluation of such disclosure controls and procedures can provide absolute assurance that all control issues and instances of fraud, if any, have been detected.
(b) Changes in Internal Control Over Financial Reporting
There were no changes in internal controls over financial reporting during the quarter ended June 30, 2010 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
We accrue for litigation matters and regulatory claims when losses become probable and reasonably estimable. We have recorded an aggregate accrual of approximately $390,000 relating to our outstanding legal matters and regulatory claims as of June 30, 2010. As of the end of each applicable reporting period, we review each outstanding matter and, where it is probable that a liability has been incurred, we accrue for all probable and reasonably estimable losses. Where we are able to reasonably estimate a range of losses we may incur with respect to such a matter, we record an accrual for the amount within the range that constitutes our best estimate. If we are able to reasonably estimate a range but no amount within the range appears to be a better estimate than any other, we use the amount that is the low end of such range. If we determine that an additional loss is probable but not estimable, we provide footnote disclosure to that effect.
In December 2009, Terra Nova received a Wells Letter from NYSE Regulation ("NYSE") stating that NYSE was formally investigating whether Terra Nova had violated NYSE rules by failing to maintain adequate policies or procedures relating to four separate matters. The first relates to an incident on September 30, 2008 in which a large volume of erroneous trades were placed through an automated trading program by a Terra Nova client. NYSE alleges that Terra Nova's processes should have prevented such erroneous orders from reaching the market. The second involves a matter relating to whether Terra Nova maintained adequate policies and procedures to ensure proper marking, execution and handling of short sale orders. The third matter involves the maintenance of adequate policies and procedures to restrict wash sales and pre-arranged trades. The fourth matter involves maintaining adequate policies and procedures to prevent possibly manipulative order cancellations made by a customer. Terra Nova has submitted a written response to NYSE and is prepared to vigorously defend this matter. NYSE has proposed to settle all matters for a fine of $400,000. Settlement discussions are continuing. We have accrued a reserve for this matter.
In addition to the foregoing, many aspects of our business involve substantial risk of liability and from time to time we 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 as compared to certain other industries. We also are subject to periodic regulatory audits, inquiries and inspections. In this regard, we have been notified by regulatory authorities of various ongoing investigations. These investigations include but are not limited to a May 26, 2010 Wells Letter from FINRA alleging rules violations relating to OATS reporting during the period from January 1, 2006 through December 31, 2007. Additionally, a Wells Letter dated March 9, 2010 from FINRA alleging rules violations relating to short sales during the period from October 1, 2007 through December 31, 2007. We have to date responded to such investigations as required. We are unable to predict the outcome of these matters. Although the range of reasonably possible loss cannot be estimated with respect to such matters, based on the information currently available to us, we do not believe that these matters will have a material impact on our consolidated financial positions, results of operations or cash flows.
On April 29, 2009, the Company 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 sought to recover $500,000. The complaint alleged that Terra Nova allowed the transfer of $60,443 from Andali's account without proper authorization. The Claimant sought to recover a total of $500,000 from several defendants. Terra Nova and the Claimant settled this matter on June 4, 2010 pursuant to a Settlement Release Agreement under which Terra Nova paid a settlement amount, which amount had been previously accrued for resolution of this matter.
Item 1A. Risk Factors
Since the date of the filing of our Annual Report on Form 10-K for the year ended December 31, 2009, there have been no material changes to the risk factors described in Item 1A - "Risk Factors" of the Annual Report on Form 10-K for the year ended December 31, 2009, except we have added the following risk factors to address the Transaction and the plan of dissolution.
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Risks Relating to the Pending Transaction
Uncertainty about the Transaction and diversions of management could harm us, whether or not the Transaction is completed.
In response to the announcement of the Transaction, existing or prospective customers and counterparties of ours may delay or defer decisions concerning us or they may seek to change their existing business relationships with us. In addition, as a result of the Transaction, current and prospective employees could experience uncertainty about their future with us. These uncertainties may impair our ability to retain, recruit or motivate key personnel. Completion of the Transaction will also require a significant amount of time and attention from management. The diversion of management attention away from ongoing operations could adversely affect our business relationships. If the Transaction is not completed as anticipated, the adverse effects of these uncertainties and the diversion of management could be exacerbated by the delay.
Failure to complete the Transaction for regulatory or other reasons could adversely affect the price of our shares and our future business and financial results.
Completion of the Transaction is conditioned upon, among other things, the receipt of certain regulatory approvals, including from FINRA, and approval of our shareholders. There is no assurance that we will receive the necessary approvals or satisfy the other conditions necessary for completion of the Transaction. In addition, the current market price of our common shares may reflect a market assumption that the Transaction will occur, and a failure to complete the Transaction could result in a negative perception by the market of us generally and a resulting decline in the market price of our common shares.
We have incurred and will continue to incur significant costs in connection with the Transaction, whether or not we complete it.
We have incurred and expect to continue to incur significant costs related to the Transaction. These expenses include financial advisory, legal and accounting fees and expenses, employee expenses, filing fees, printing expenses, and other related charges. If we fail to complete the Transaction, we will remain liable for these transaction costs, and may be required, in certain circumstances, to pay a termination fee of $1.1 million. We may also incur additional unanticipated expenses in connection with the Transaction.
Risks Related to Proposed Plan of Dissolution
If our expectations regarding operating and liquidation expenses are inaccurate, the amount we distribute to our shareholders may be reduced.
The amount of cash ultimately distributed to shareholders pursuant to the plan of dissolution depends on the amount of our liabilities, obligations and expenses and claims against us, and contingency reserves that we establish during the liquidation process. We have attempted to estimate the amount of and reasonable reserves for such liabilities, obligations, expenses and claims against us. However, those estimates may be inaccurate. Factors that could impact our estimates include the following:
| • If currently unknown or unanticipated
claims are asserted against us, we will have to defend, resolve or reserve
for such claims before making distributions to shareholders, which will
reduce amounts otherwise available for distribution. • We have made estimates regarding the expense of personnel required and other operating expenses (including legal, accounting and other professional fees) necessary to dissolve the Company and wind up our business and affairs. Our actual expenses could vary significantly. If the closing of the Transaction takes longer than we expect or the time it takes to wind up of our business takes longer than anticipated, we may incur additional expenses above our current estimates, which could substantially reduce funds available for distribution to our shareholders. |
We may continue to incur the expenses of complying with public company reporting requirements, which may be economically burdensome. Whether or not the plan of dissolution is approved, we have an obligation to continue to comply with the applicable reporting requirements of the Securities and Exchange Act of 1934, as amended, which we refer to as the Exchange Act, even though compliance with such reporting requirements may be economically burdensome and of minimal value to our shareholders. If our shareholders approve the plan of dissolution, in order to curtail expenses, we may, following the date our articles of dissolution become effective with the Illinois Secretary of State, which we refer to as the effective date, to seek relief from the SEC to suspend our reporting obligations under the Exchange Act, and ultimately to terminate the registration of our common shares. If we are unable to suspend our obligation to file periodic reports with the SEC, we will be obligated to continue complying with the applicable reporting requirements of the Exchange Act and, as a result, will be required to continue to incur the expenses associated with these reporting requirements, which will reduce the cash available for distribution to our shareholders. These expenses include, among others, those costs relating to:
| • The preparation, review, filing and dissemination of SEC filings. | |
| • Maintenance of effective internal controls over financial reporting. | |
| • Audits and reviews conducted by our independent registered public accountants. |
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Distributions to our shareholders could be delayed.
All or a portion of the distributions could be delayed, depending on many factors, including without limitation:
| • If a creditor or other third
party seeks an injunction against the making of distributions to our shareholders
on the ground that the amounts to be distributed are needed to provide for
the satisfaction of our liabilities or other obligations. • If we become a party to lawsuits or other claims asserted by or against us, including any claims or litigation arising in connection with our decision effect the Transaction or to liquidate and dissolve. • If we are unable to resolve claims with creditors or other third parties, or if such resolutions take longer than expected. |
Any of the foregoing could delay or substantially diminish the amount available for distribution to our shareholders.
We may delay the distribution of some or all of the estimated amounts that we expect to distribute to shareholders to satisfy claims against and obligations of the Company that may arise during the five-year period following the effective date.
Under the Illinois Business Corporation Act, or IBCA, unbarred claims and demands may be asserted against us at any time during the five years following the effective date. Accordingly, the board of directors may obtain and maintain insurance coverage or establish and set aside a reasonable amount of cash or other assets as a contingency reserve to satisfy claims against and obligations of the Company that may arise during the five-year period following the effective date. As a result of these factors, we may retain for distribution at a later date some or all of the estimated amounts that we expect to distribute to shareholders.
If we fail to retain sufficient funds to pay our creditors, our shareholders could be held responsible for these liabilities up to the amount of any liquidating distributions they have received.
If we fail to obtain insurance or to retain or reserve sufficient funds to pay our creditors or claimants, including for contingent claims or claims that are not known to us by the time we make final liquidating distribution to shareholders, our shareholders could be held responsible for these liabilities up to the amount distributed to them as liquidating distributions under the plan of dissolution. The potential for shareholder liability continues for unbarred claims made within five years after our articles of dissolution are filed. In this event, a shareholder could be required to return all amounts received as liquidating distributions and ultimately could receive nothing under the plan of dissolution. Furthermore, an aggrieved claimant could seek to enjoin any proposed liquidating distributions to preserve assets pending resolution of the claimant's claim. For U.S. federal income tax purposes, payments made by a shareholder in satisfaction of our liabilities not covered by our cash or reserves or otherwise satisfied through insurance or other reasonable means generally would produce a capital loss for such shareholder in the year the liabilities are paid. The deductibility of any such capital loss generally would be subject to limitations under the Internal Revenue Code.
Shareholders may not be able to recognize a loss for United States federal income tax purposes until they receive a final distribution from us.
As a result of our dissolution and liquidation, for United States federal income tax purposes, our shareholders generally will recognize gain or loss equal to the difference between (1) the sum of the amount of cash and the fair market value (at the time of distribution) of property, if any, distributed to them, and (2) their tax basis for their common shares of the Company. Liquidating distributions pursuant to the plan of dissolution may occur at various times and in more than one tax year. Any loss generally will be recognized by a shareholder only when the shareholder receives our final liquidating distribution to shareholders, and then only if the aggregate value of all liquidating distributions with respect to a share is less than the shareholder's tax basis for that share. Shareholders are urged to consult their own tax advisors as to the specific tax consequences to them of our dissolution and liquidation pursuant to the plan of dissolution.
We expect to close our transfer books if the plan of distribution is approved and implemented, which may prevent our shareholders from liquidating their holdings in our shares.
The plan of distribution provides that we may close our share transfer books at any time after we file our articles of dissolution. Upon the closing of our transfer books, share certificates evidencing our common stock will not be assignable or transferable on our books except by will, intestate succession or operation of law, and we will not issue any new stock certificates, other than replacement certificates. Accordingly, if the plan of dissolution is approved and implemented, shareholders may not be able to liquidate their investment in the Company or otherwise receive value for their shares of our common stock other than through receipt of liquidating distributions pursuant to the plan of dissolution. No assurance can be given that our shareholders will receive notice of the date our transfer books closed in sufficient time, if at all, to effect a sale of their shares of our common stock.
Our shareholders could approve the Transaction but vote against the plan of dissolution.
After the Transaction, we will have no business, operations or assets with which to generate revenue, and will have retained only those employees required to wind up our business and affairs. We do not intend to invest in another operating business or otherwise invest the proceeds other than in money market funds or similar short-term investments. If the plan of dissolution is not approved, we will proceed with the sale of substantially all of our assets, pay all of our liabilities, and, as a result of the plan of dissolution not being approved, use some of the cash received from the Transaction to pay ongoing operating expenses instead of distributing it to our shareholders pursuant to the plan of dissolution, which would decrease the distribution to be made to our shareholders. If the plan of dissolution is not approved, we may make a second attempt to solicit a vote of the shareholders to approve the plan of dissolution.
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At this time, our board of directors has considered numerous options and has determined that it is in the best interests of our shareholders to dissolve the Company and return the net cash to our shareholders. The board of directors, however, retains the right to consider other alternatives should a more attractive opportunity arise before or after the effective date. If shareholders do not approve the plan of dissolution, we expect that our cash resources will continue to diminish and would likely adversely affect our financial condition and the value of your common shares. Such a result would increase the risk that you would lose all of your investment. Moreover, any alternative selected by the board of directors may have unanticipated negative consequences.
If we fail to retain the services of certain key personnel, the plan of dissolution may not succeed.
The success of the plan of dissolution depends in large part upon our ability to retain the services of Bernay Box, our Chairman and Chief Executive Officer and Murrey Wanstrath, our Chief Financial Officer. We expect them to remain as employees to assist in our liquidation. Failure to retain these personnel could harm the implementation of the plan of dissolution. If we fail to retain the services of these personnel, we will need to hire others to oversee our liquidation and dissolution, which could involve additional compensation expenses, if such other personnel are available at all.
The board of directors may abandon the Transaction and suspend implementation of the plan of dissolution even if they are approved by the shareholders.
Even if the shareholders approve the Transaction and the plan of dissolution at the special meeting, if for any reason, the board of directors determines that such action would be in our best interests and the best interests of the shareholders, the board of directors may, in its sole discretion and without requiring advance shareholder approval, abandon the Transaction and terminate the purchase agreement and suspend the plan of dissolution or revoke the articles of dissolution of the Company, to the extent permitted by the IBCA. A revocation of the dissolution would result in the shareholders not receiving any liquidating distributions pursuant to the plan of dissolution.
If our shareholders do not approve the plan of dissolution, our stock price may be adversely affected.
If our shareholders do not approve the plan of dissolution, our stock price may be adversely affected due to market perception about our ability to restart and operate successfully or to successfully pursue other strategic alternatives.
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 were made in the open market, in block transactions, or in privately negotiated transactions and were allowed to 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 conducted the repurchases in compliance with Securities and Exchange Commission Rule 10b-18. The program commenced on May 1, 2009 and expired on April 30, 2010. In the second quarter of 2010 the Company made no common stock repurchases.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Reserved
Item 5. Other Information
(a) None.
(b) Not Applicable.
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Item 6. Exhibits
| Exhibit No. | Description |
| Exhibit 2.1 | Purchase Agreement between Terra Nova Financial Group, Inc. and Lightspeed Financial, Inc. dated June 16, 2010 (incorporated herein by reference to Exhibit 2.1 or Terra Nova Financial Group, Inc. Current Report on Form 8-K dated June 16, 2010). |
| Exhibit 2.2 | Plan of Dissolution (incorporated herein by reference to Annex B of Terra Nova Financial Group, Inc. definitive proxy statement on schedule 14A filed with the SEC on August 9, 2010). |
| Exhibit 31.1 | Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) or Rule 15d-14(a) |
| Exhibit 31.2 | Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) or Rule 15d-14(a) |
| Exhibit 32.1 | Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Rule 13a-14(b) or Rule 15d-14(b) and 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
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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: August 13, 2010 | By: /s/ Bernay Box | |
| Bernay Box | ||
| Chief Executive Officer (Principal Executive Officer) |
||
| Date: August 13, 2010 | By: /s/ Murrey Wanstrath | |
| Murrey Wanstrath Chief Financial Officer (Principal Financial Officer and Accounting Officer) |
||
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