NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2018 AND 2017
NOTE
1—
NATURE OF OPERATIONS AND
SIGNIFICANT ACCOUNTING POLICIES
The
nature of operations and significant accounting policies of Capital
Financial Holdings, Inc. and its Subsidiary are presented to assist
in understanding the Company’s consolidated financial
statements.
Nature of operations
—Capital Financial Holdings, Inc.,
(the “Company”) is the parent company of Capital
Financial Services, Inc. Capital Financial Holdings, Inc. was
established in September 1987 as a North Dakota corporation.
Headquartered in Minot, North Dakota, the Company is marketing its
services throughout the United States. The Company currently has
two reporting segments:
Broker-Dealer Services
The
Company derives all of its operating revenues from Capital
Financial Services, Inc. through investment advisory fees as well
as commissions earned from sales of mutual funds, insurance
products, and various other securities. CFS is a full-service
brokerage firm. CFS is registered with the SEC as an investment
advisor and broker-dealer and also with FINRA as a broker-dealer.
CFS specializes in providing investment products and services to
independent investment representatives, financial planners, and
investment advisors and currently supports approximately 130
investment representatives and investment advisors.
The
Company operates under the provision of Paragraph (k)(2)(ii) of
Rule 15c3-3 of the Securities and Exchange Commission and,
accordingly, is exempt from the remaining provisions of that rule.
To the best of management’s knowledge and belief the Company
met the identified exemption provisions from January 1, 2018 to
December 31, 2018 without exception.
Holding Company
The
Company encompasses cost associated with ownership of its office
building, business development and acquisitions, dispositions of
subsidiary entities and results of discontinued operations,
dividend income and recognized gains or losses.
Principles of consolidation
—The consolidated financial
statements include the accounts of Capital Financial Holdings,
Inc., and its subsidiary Capital Financial Services, Inc.
(“CFS”). All significant inter-company transactions and
balances have been eliminated in the accompanying consolidated
financial statements.
Concentrations
—Capital Financial Holdings, Inc.
derives all of its revenues and net income from sales of mutual
funds, insurance products, and various other securities through
CFS, the Company’s broker-dealer subsidiary. The
Company’s revenues are largely dependent on the sales
activity of registered representatives operating as independent
contractors. Accordingly, fluctuations in financial markets and the
composition of assets under management impact revenues and results
of operations.
Use of estimates
—The preparation of consolidated
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 amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the consolidated
financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ
from those estimates.
Fair Value of Financial Instruments
– The
Company’s financial instruments consist of cash, accounts
receivables, accounts payable and accrued expense obligations. The
carrying value of the Company’s financial instruments
approximate their fair value due to the short-term nature of their
underlying terms.
Revenue recognition
—Commission income and the related
clearing expenses are recorded based on the trade date. The revenue
earned from 12b-1 is recognized ratably over the period received.
Investment advisory fees are derived from account management and
investment advisory services. These fees are determined based on a
percentage of the customer’s assets under sponsor management
or a flat fee, may be billed monthly or quarterly and recognized
ratably over the period received.
Cash and cash equivalents
—The Company’s policy
is to record all liquid investments with original maturities of
three months or less as cash equivalents. Liquid investments with
maturities greater than three months are recorded as
investments.
Clearing Deposits
—The Company has “Deposit
Accounts” with each of its Clearing Firms, as set forth in
each of the Clearing Agreements. Upon termination or expiration of
these agreements, the Clearing Firms would deliver the balance of
these accounts to the Company. As of December 31, 2018, the balance
in the Company’s Dain account, Pershing account and NSCC was
$50,000, $25,392 and $40,279, respectively. These deposits are
included in Cash and cash equivalents.
Accounts Receivable
—The Company’s receivables
consist primarily of concessions related to registered
representative activity. Management evaluates the need for an
allowance for doubtful accounts by identifying troubled accounts
and using historical experience. Accounts receivable are written
off when management deems them uncollectible. Recoveries of
accounts receivable previously written off are recorded when
received. The Company does not charge interest on its
receivables.
Goodwill
—The Company accounts for goodwill under the
FASB accounting and reporting standards for goodwill and other
intangible assets, which requires that goodwill and
indefinite-lived other intangible assets deemed to have an
indefinite useful life be assessed annually for impairment using
fair value measurement techniques. As of December 31, 2018, the
Company no longer has a value for goodwill.
Property and equipment
—Property and equipment is
stated at cost less accumulated depreciation computed on
straight-line and accelerated methods over estimated useful lives
of 5-7 years. The office building is stated at cost less
accumulated depreciation computed on a straight line method over an
estimated useful life of 39 years.
Other assets
—Other assets include other miscellaneous
assets.
Advertising
—Costs of advertising and promotion are
expensed as incurred. There were no advertising and promotion costs
in 2018 or 2017.
Earnings per common share
—Basic earnings per common
share was computed using the weighted average number of shares
outstanding of 1,241 in 2017 and 2018. Diluted earnings per common
share is computed using the weighted average number of shares
outstanding adjusted for share equivalents arising from unexercised
stock warrants, stock options, written put options, and preferred
shares.
Income taxes
—The Company files a consolidated income
tax return with its wholly owned subsidiary. The amount of deferred
tax benefit or expense is recognized as of the date of the
consolidated financial statements, utilizing currently enacted tax
laws and rates. Deferred tax benefits or expenses are recognized in
the financial statements for the changes in deferred tax assets
between years. The Company’s policy is to evaluate the
likelihood that its uncertain tax positions will prevail upon
examination based on the extent to which those positions have
substantial support within the Internal Revenue Code and
Regulations, Revenue Rulings, court decisions, and other evidence.
It is the opinion of management that the Company has no significant
uncertain tax positions that would be subject to change upon
examination. The federal income tax returns of the Company are
subject to examination by the IRS, generally for three years after
they were filed.
Severance Escrow
—The Company’s severance escrow
accounts are restricted cash held in third-party administered
escrow accounts for the sole purpose of funding certain employee
severance plans established in 2010 by the Company’s Board of
Directors for the benefit of and with the purpose of retaining its
employees. These funds are held in escrow accounts pursuant to
several Involuntary Termination Severance Pay Plans and are not
available to the Company for use other than the Involuntary
Termination Severance Plan purposes nor is it accessible to
creditors of the Company. These restricted cash accounts, totaling
$157,911 in 2017 and $157,927 in 2018 are included in Cash and cash
equivalents.
Concentration of Credit Risk
—The Company has a
concentration of credit risk for cash deposits at various financial
institutions. These deposits may at times exceed amounts covered by
insurance provided by the U.S. Federal Deposit Insurance
Corporation (FDIC). The Company has not experienced any losses in
such accounts.
Recent Accounting Developments
ASU
2014-15—
Presentation of
Financial Statements—Going Concern (Subtopic 205-40):
Disclosure of Uncertainties about an Entity’s Ability to
Continue as a Going Concern.
The amendment requires that in
connection with preparing financial statements for each annual and
interim reporting period, an entity’s management should
evaluate whether there are conditions or events, considered in the
aggregate, that raise substantial doubt about the entity’s
ability to continue as a going concern within one year after the
date that the financial statements are issued.
ASU
2016-02 —
Leases (Topic
842):
In February 2016, the FASB issued ASU 2016-02,
Leases
. Under the new
guidance, lessees will be required to recognize a lease liability
and a right-of-use asset for all leases (with the exception of
short-term leases) at the commencement date. ASU 2016-02 is
effective for annual and interim periods beginning on or after
December 15, 2018 and early adoption is permitted. Under ASU
2016-02, lessees (for capital and operating leases) and lessors
(for sales-type, direct financing, and operating leases) must apply
a modified retrospective transition approach for leases existing
at, or entered into after, the beginning of the earliest
comparative period presented in the financial statements. Lessees
and lessors may not apply a full retrospective transition approach.
The Company is currently in the process of evaluating the impact of
the pending adoption of ASU 2016-02 on its consolidated financial
statements beginning January 1, 2019.
ASU
2016-12—
Revenue from
Contracts with Customers (Topic 606): Narrow-Scope Improvements and
Practical Expedients.
The amendments in this update affect
the guidance in ASU 2014-09,
Revenue from Contracts with Customers (Topic
606)
.
ASU
2014-09
- In May 2014, the FASB issued ASU
2014-09,
Revenue from Contracts with
Customers
, to clarify the
principles of recognizing revenue from contracts with customers and
to improve financial reporting by creating common revenue
recognition guidance for U.S. GAAP and International Financial
Reporting Standards. This ASU will supersede the revenue
recognition requirements in ASC Topic 605,
Revenue Recognition,
and most industry-specific guidance.
Entities are required to apply the following steps when recognizing
revenue under ASU 2014-09: (1) identify the contract(s) with a
customer; (2) identify the performance obligations in the contract;
(3) determine the transaction price; (4) allocate the transaction
price to the performance obligations in the contract; and (5)
recognize revenue when (or as) the entity satisfies a performance
obligation. This ASU also requires additional disclosures related
to the nature, amount, timing and uncertainty of revenue and cash
flows arising from customer contracts. An entity may apply the
amendments by using one of the following two methods: (1)
retrospective application to each prior reporting period presented,
or (2) a modified retrospective approach, requiring the standard be
applied only to the most current period presented, with the
cumulative effect of initially applying the standard recognized at
the date of initial application. ASU 2014-09 is effective for
annual reporting periods beginning after December 15, 2017,
including interim periods within that reporting period, with early
adoption permitted. Subsequent to issuing ASU 2014-09, the FASB has
issued additional standards for the purpose of clarifying certain
aspects of ASU 2014-09. Adopting this new guidance has not had a
reporting impact on the Company.
ASU
2016-15—
Statement of Cash
Flows (Topic 230): Classification of Certain Cash Receipts and Cash
Payments.
This amendment becomes effective for public
companies for fiscal years beginning after December 15, 2017. The
pronouncement would impact the presentation of certain items on the
statement of cash flows including debt prepayment or debt
extinguishment costs, settlement of zero coupon debt instruments,
contingent consideration payments made after a business
combination, proceeds from the settlement of insurance claims
and/or corporate-owned life insurance policies, distributions
received from equity method investees, beneficial interests in
securitization transactions, and separately identifiable cash flows
and application of the predominance principle. Should the Company
have any of the aforementioned items, they would be presented on
the statement of cash flows in accordance to ASU 2016-15. This
guidance has not had a reporting impact on the
Company.
ASU
2016-17—
Consolidation (Topic
810): Interests Held through Related Parties That Are under Common
Control.
The amendments in this Update do not change the
characteristics of a primary beneficiary in current generally
accepted accounting principles (GAAP). Therefore, a primary
beneficiary of a VIE has both of the following characteristics: (1)
the power to direct the activities of a VIE that most significantly
impact the VIE’s economic performance and (2) the obligation
to absorb losses of the VIE that could potentially be significant
to the VIE or the right to receive benefits from the VIE that could
potentially be significant to the VIE. If a reporting entity
satisfies the first characteristic of a primary beneficiary (such
that it is the single decision maker of a VIE), the amendments in
this Update require that reporting entity, in determining whether
it satisfies the second characteristic of a primary beneficiary, to
include all of its direct variable interests in a VIE and, on a
proportionate basis, its indirect variable interests in a VIE held
through related parties, including related parties that are under
common control with the reporting entity. The amendments in this
Update are effective for public business entities for fiscal years
beginning after December 15, 2016, including interim periods within
those fiscal years. The Company has determined that there is no
reporting impact.
ASU
2016-18—
Statement of Cash
Flows (Topic 230): Restricted Cash (a consensus of the FASB
Emerging Issues Task Force).
The amendments in this Update
require that a statement of cash flows explain the change during
the period in the total of cash, cash equivalents, and amounts
generally described as restricted cash or restricted cash
equivalents. Therefore, amounts generally described as restricted
cash and restricted cash equivalents should be included with cash
and cash equivalents when reconciling the beginning-of-period and
end-of-period total amounts shown on the statement of cash flows.
The amendments in this Update do not provide a definition of
restricted cash or restricted cash equivalents. The amendments in
this Update are effective for public business entities for fiscal
years beginning after December 15, 2017, and interim periods within
those fiscal years. The Company has determined that there is no
reporting impact.
ASU
2017-01—
Business
Combinations (Topic 805): Clarifying the Definition of a
Business.
Under the current implementation guidance in Topic
805, there are three elements of a business—inputs,
processes, and outputs. While an integrated set of assets and
activities (collectively referred to as a “set”) that
is a business usually has outputs, outputs are not required to be
present. In addition, all the inputs and processes that a seller
uses in operating a set are not required if market participants can
acquire the set and continue to produce outputs, for example, by
integrating the acquired set with their own inputs and processes.
Public business entities should apply the amendments in this Update
to annual periods beginning after December 15, 2017, including
interim periods within those periods. The Company has determined
that there is no reporting impact.
NOTE
2—
CASH AND CASH
EQUIVALENTS
Cash
and cash equivalents at December 31, 2018 and 2017 consist of
checking and savings accounts of $1,559,482 and $1,461,706,
respectively. At December 31, 2018 and 2017, the Company had
severance escrow balances of $157,926 and $157,911, respectively.
The Company’s severance escrow accounts are restricted cash
held in third-party administered escrow accounts for the sole
purpose of funding certain employee severance plans which are
included in Cash and cash equivalents. The Company had deposit
accounts with clearing firms of $25,392, $50,000 and $40,279 with
Pershing, Dain and NSCC, respectively on December 31, 2018 and
$100,000, $50,000 and $40,279, respectively on December 31, 2017
which are included in Cash and cash equivalents.
NOTE
3—
PROPERTY AND
EQUIPMENT
Property
and equipment at December 31, 2018 and 2017, consists of the
following:
|
|
|
|
|
|
|
|
|
Office furniture
and equipment
|
$
350,429
|
$
348,363
|
|
Land
|
98,409
|
98,409
|
|
Building
|
1,102,148
|
1,096,946
|
|
Accumulated
depreciation
|
(343,800
)
|
(271,747
)
|
|
|
$
1,207,196
|
$
1,271,971
|
Depreciation
expense for continuing operations totaled $72,053 and $62,705 in
2018 and 2017, respectively.
NOTE
4—
INCOME
TAXES
The
provision for income taxes is based on earnings before income taxes
reported for financial statement purposes and consisted of the
following:
|
|
|
|
|
|
|
|
|
Current income tax
expense:
|
|
|
|
Federal
|
$
–
|
$
–
|
|
State
|
–
|
10,859
|
|
Total current tax
expense
|
$
–
|
$
10,859
|
|
Deferred tax
expense:
|
|
|
|
Federal
|
$
(123,124
)
|
$
(123,124
)
|
|
State
|
(18,468
)
|
(18,468
)
|
|
Total deferred tax
expense
|
$
(141,592
)
|
$
(141,592
)
|
|
|
|
|
|
Total provision
(benefit) for income tax expense
|
$
(141,592
)
|
$
(141,592
)
|
Deferred
taxes arise because of different tax treatment between financial
statement accounting and tax accounting, known as “temporary
differences.” The Company records the tax effect of these
temporary differences as “deferred tax assets”
(generally items that can be used as a tax deduction or credit in
future periods) and “deferred tax liabilities”
(generally items for which the Company has received a tax deduction
and has not yet been recorded in the consolidated statement of
operations).
Deferred
tax assets (liabilities) were comprised of the
following:
|
|
|
|
|
|
|
|
|
Deferred
tax asset:
|
|
|
|
Net
operating loss carryforward
|
$
131,827
|
$
49,344
|
|
Intangibles
|
–
|
–
|
|
Stock
option compensation
|
152,895
|
152,895
|
|
Other
assets
|
–
|
–
|
|
|
|
|
|
Total
deferred tax assets
|
$
284,722
|
$
202,239
|
|
|
|
|
|
Deferred
tax liabilities:
|
|
|
|
Plant,
property and equipment
|
$
(14,308
)
|
$
(14,308
)
|
|
Total
deferred tax liabilities
|
$
(14,308
)
|
$
(14,308
)
|
|
|
|
|
|
Net
deferred tax asset
|
|
|
|
Net
deferred tax asset – non-current
|
$
270,414
|
$
187,391
|
|
Net
deferred tax asset
|
$
270,414
|
$
187,391
|
Management
reviews and adjusts those estimates annually based upon the most
current information available. However, because the recoverability
of deferred taxes is directly dependent upon the future operating
results of the Company, actual recoverability of deferred taxes may
differ materially from management’s estimates. The Company is
aware of the risk that the recorded deferred tax assets may not be
realizable. The capital loss generated on the sale of Omega shares
is unlikely to be recognized and therefore has not been included in
deferred assets. However, management believes that the Company will
obtain the full benefit of any net operating loss and other
deferred tax assets on the basis of its evaluation of the
Company’s anticipated profitability over the period of years
that the temporary differences are expected to become tax
deductions. It believes that sufficient book and taxable income
will be generated to realize the benefit of any net operating loss
and other deferred tax assets.
ASC 740
guidance requires that the Company evaluate all monetary tax
positions taken, and recognize a liability for any uncertain tax
positions that are more likely than not to be sustained by the tax
authorities. The Company has not recorded any liabilities, or
interest and penalties, as of December 31, 2018 related to
uncertain tax positions.
The
Company files income tax returns in the U.S. and various state
jurisdictions. There are currently no federal or state income tax
examinations underway for these jurisdictions. The tax years
2015-2018 remain open to examination by taxing jurisdictions to
which the Company is subject.
At
December 31, 2018, the Company has approximately $1,084,128 in
federal net operation loss carryforward which begins to expire in
2036.
A
reconciliation of the difference between the expected federal tax
rate computed at the U.S. statutory income tax rate of 35% and the
Company’s effective tax rate for the years ended December 31,
2018 and 2017 is shown in the following table:
|
|
|
|
|
|
|
|
|
Expected federal
tax rate
|
21
%
|
21
%
|
|
State income
taxes
|
5
%
|
5
%
|
|
Effect of permanent
differences
|
0
%
|
0
%
|
|
Change in tax rate
and other
|
0
%
|
0
%
|
|
|
|
|
|
Effective tax
rate
|
26
%
|
26
%
|
Income
tax payable for period ended December 31, 2017 was $10,859 compared
to income tax payable of $0 during the same period in
2018.
NOTE
5—
STOCK WARRANTS, STOCK
SPLITS, AND STOCK OPTIONS
In
December of 2003 the Company issued 3,050,000 shares of Series A
preferred Stock for total cash of $1,525,000 ($305 par value and
$1,524,695 paid in Capital). By agreement dated November 14, 2011,
the Company bought back the 3,050,000 shares of Series A Preferred
Stock as treasury stock for a payment of $1,300,000. There are no
outstanding shares of Series A Preferred Stock.
The
Company has authorized 210 perpetual warrants to certain
organizers, directors, officers, employees and shareholders of the
Company. All of these warrants were issued between 1987 and 1990
and were accounted for in accordance with the provisions of
Accounting Principles Board (“APB”) Opinion No. 25,
Accounting for Stock Issued to Employees. No compensation expense
was recorded for these warrants as the exercise price exceeded the
market price of the stock at the date of issue. The Company plans
to continue to apply APB Opinion No. 25 in accounting for these
warrants. These warrants, at the date of issue, allowed for the
purchase of shares of stock at $2.00 per share. The exercise prices
of these warrants were adjusted to reflect stock splits of 1 for
10,000 in 2013, 2 for 1 in 2002, and 11 for 10 in 1990 and 1989.
0.2 warrants (adjusted for the 1 for 10,000 stock split in 2013 and
the 2 for 1 stock split in 2002) were exercised in 1997, leaving an
outstanding balance of 210 warrants as of December 31,
2018.
The
Company had entered into employment agreements with past employees
of the Company. Upon execution of these employment agreements, a
one-time granting of stock options took effect. These options are
fully vested and have a perpetual life. Each employment contract
stated the strike price for which options were granted. In
addition, the contracts granted options when the employees reach
specified performance goals.
The
Company has also issued options to directors as well as various
other employees and past employees. The options granted to
employees were granted in connection with reaching certain
performance goals. These options are considered to be fully vested
and have a contractual life of ten years.
The
Company plans to issue additional common shares if any of its
outstanding options are exercised. There have been no options
exercised to date.
The
Company has adopted the FASB accounting and standards for fair
value recognition provisions for stock-based employee compensation.
There were no compensation costs or deferred tax benefits
recognized for stock-based compensation awards for the twelve
months ended December 31, 2018. As of December 31, 2018, 421 stock
options totaling $1,103,600 had been cancelled.
In June
of 2013, shareholders approved by a majority vote a 10,000 to 1
reverse stock split during the annual meeting of shareholders. The
reverse stock split became effective on August 14,
2013.
Option
activity for the last three years was as follows:
|
|
|
Weighted Average
Exercise Price per Share
|
Weighted Average
Grant Date Fair Value
|
Aggregate
Intrinsic Value
|
|
Outstanding on
December 31, 2015
|
207
|
$
8,692
|
$
4,435
|
$
–
|
|
Granted
|
–
|
–
|
–
|
–
|
|
Exercised
|
–
|
–
|
–
|
–
|
|
Canceled
|
39
|
–
|
–
|
–
|
|
Outstanding on
December 31, 2016
|
168
|
$
5,000
|
$
3,844
|
$
–
|
|
Granted
|
–
|
–
|
–
|
–
|
|
Exercised
|
–
|
–
|
–
|
–
|
|
Canceled
|
–
|
–
|
–
|
–
|
|
Outstanding on
December 31, 2017
|
168
|
$
5,000
|
$
3,844
|
$
–
|
|
Granted
|
–
|
–
|
–
|
–
|
|
Exercised
|
–
|
–
|
–
|
–
|
|
Cancelled
|
–
|
–
|
–
|
–
|
|
Outstanding on
December 31, 2018
|
168
|
$
5,000
|
$
3,844
|
$
–
|
Exercisable
options at the end of 2018 were 168, 168 in 2017, and 168 in 2016.
The following table summarizes information concerning options
outstanding and exercisable as of December 31, 2018:
|
|
|
Weighted Average
Remaining Contractual Life (Years)
|
Weighted Average
Exercise Price
|
|
Weighted Average
Exercise Price
|
|
$
0 to $4,900
|
138
|
|
$
4,200
|
138
|
$
4,200
|
|
$
5,000 to $9,900
|
27
|
1*
|
$
5,200
|
27
|
$
5,200
|
|
$
10,000 to $15,000
|
3
|
|
$
10,100
|
3
|
$
10,100
|
|
$
0 to $15,000
|
168
|
1*
|
$
8,692
|
168
|
$
8,692
|
*
Excludes options with a perpetual life
NOTE
6—
EMPLOYEE BENEFIT
PLANS
The
Company sponsors a 401(K) plan for all its employees. Effective
January 1, 2005, the Company implemented a match of up to 4% of
employee deferrals. Plan expenses paid for by the Company
were $1,678 and $2,858 for the years ended December 31, 2018
and 2017, respectively. The matching contributions paid by the
Company were $49,591 and $54,826 for the years ended December 31,
2018 and 2017, respectively. Effective January 1, 2016, the Company
implemented a match of up to 6% of employee deferrals.
NOTE
7—
RULE 4110
(c)(1)
The
Company operates under the provision of FINRA Rule 4410 (c)(1) and,
accordingly, the member is restricted from withdrawing equity
capital for a period of one year from the date such equity capital
is contributed, unless otherwise permitted by FINRA in writing.
Subject to the requirements of paragraph (c)(2) of this Rule, this
paragraph shall not preclude a member from withdrawing profits
earned.
NOTE
8—
NET CAPITAL
REQUIREMENTS
The
Company’s broker-dealer subsidiary, Capital Financial
Services, Inc., is a member firm of the Financial Industry
Regulatory Authority (FINRA) and is registered with the Securities
and Exchange Commission (SEC) as a broker-dealer. Under the Uniform
Net Capital Rule (Rule 15c3-1 under the Securities Exchange Act of
1934), the subsidiary is required to maintain a minimum net capital
and a ratio of aggregate indebtedness to net capital, as defined,
of not more than 15 to 1. At December 31, 2018, this subsidiary had
net capital of $386,231 compared to $626,409 during the same period
ended in 2017; a minimum net capital requirement of $194,380 in
2018 compared to $171,851 during the same period ended in 2017;
excess net capital of $191,851 in 2018 compared to $454,355 during
the same period ended in 2017 and a ratio of aggregate indebtedness
to net capital of 7.5 to 1 in 2018 compared to a ratio of aggregate
indebtedness to net capital of 4.1 to 1 during the same period
ended in 2017.
The
subsidiary claims exemption from Rule 15c3-3 under Section
15c3-3(k)(2)(ii), which states that all customer transactions are
cleared through another broker-dealer on a fully disclosed basis.
The subsidiary promptly transmits customer funds or securities to
its clearing firm. Therefore, a schedule showing the Computation
for Determination of Reserve Requirements under Rule 15c3-3 of the
Securities and Exchange Commission and the Schedule of Information
Relating to Possession or Control Requirements under Rule 15c3-3 of
the Securities and Exchange Commission, are not
required.
We, as
members of management of Capital Financial Services, Inc. (the
subsidiary) are responsible for complying with 17 C.F.R
§240.17a-5, “Reports to be made by certain brokers and
dealers” and complying with 17 C.F.R §240.15c3-3:
((k)(2)(ii)) (the “exemption provisions”). To the best
of our knowledge and belief we state the following:
(1) We
identified the following provisions of 17 C.F.R §15c3-3(k)
under which the subsidiary claimed an exemption from 17C.F.R
§240.15c3-3: ((k)(2)(ii)) (the “exemption
provisions”), and (2) we met the identified exemption
provisions from January 1, 2018 to December 31, 2018 without
exception.
NOTE
9—
REGULATORY
MATTERS
The
broker dealer (“BD”) segment of Capital Financial
Services, Inc. is subject to periodic examinations by its
regulator, the Securities Exchange Commission (“SEC”).
During 2016, the SEC conducted a routine examination of the CFS BD.
At the conclusion of its examination, the SEC issued an Examination
Report with certain findings, asking the Company’s regulated
entity to improve its anti-money laundering program, record
additional information on the Company’s transaction blotters,
and record transactions on the Company’s transaction blotters
that are performed at other companies. On November 28, 2016 the
broker dealer made its latest response to the routine examination
report.
NOTE
10—
BUILDING
PURCHASE
On November 16, 2016, the Company closed on the acquisition of a
commercial office building and associated property (the
“Office Building”) located at 1801 Burdick Expressway
West, Minot, North Dakota from Evanmark Enterprises, LLC, an entity
unrelated to the Company. The contract purchase price for the
Office Building was $975,000, exclusive of closing costs of $9,091,
with all built-in fixtures and other furniture, fixtures and
equipment in the building remaining with the property. The Company
paid $509,091 at closing toward the purchase price of the Office
Building with the remaining $475,000 of the purchase price financed
by a commercial real estate loan from American Bank Center
(“American Bank”) in the principal amount of $675,000,
$475,000 of which is being applied to the purchase price of the
Office Building and $200,000 of which was utilized for renovations
to the building. Renovations to the building at cost of $221,264
were made in 2017 to bring the total cost of the land building to
$1,195,355, and additional renovation cost of $5,202 were made in
2018 to bring the total cost of the land and building to
$1,200,557. The loan carries a fixed interest rate of 4.879% per
annum for five (5) years with the rate to be adjusted at the end of
the five (5) year period based on the Wall Street Journal Prime
interest rate plus 1.759%. American Bank has a first priority
mortgage on the Office Building.
NOTE
11—
OPERATING
LEASES
The
Company has various leases for office equipment and office space
that are set to expire over the next several years through 2018.
The total rent expense for these leases was $14,197 and $94,224 for
December 31, 2018 and 2017, respectively.
The
following is a schedule by years of future minimum rental payments
on operating leases as of December 31, 2018.
|
Years
ending December 31,
|
|
|
2019
|
$
13,203
|
|
2020
|
13,203
|
|
2021
|
13,203
|
|
2022
|
13,203
|
|
2023
|
13,203
|
|
Total minimum
future rental payments
|
$
66,016
|
NOTE
12—
GOODWILL
The
Company had no Goodwill recorded as of December 31, 2018 or
December 31, 2017.
NOTE
13—
FAIR VALUE
DISCLOSURES
FASB
ASC 820 defines fair value, establishes a framework for measuring
fair value, and establishes a fair value hierarchy which
prioritizes the inputs to valuation techniques. Fair value is the
price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at
the measurement date. A fair value measurement assumes that the
transaction to sell the asset or transfer the liability occurs in
the principal market for the asset or liability or, in the absence
of a principal market, the most advantageous market. Valuation
techniques that are consistent with the market, income or cost
approach, as specified by FASB ASC 820, are used to measure fair
value.
The
fair value hierarchy prioritizes the inputs to valuation techniques
used to measure fair value in three broad levels:
●
Level 1 inputs are quoted prices (unadjusted) in active markets for
identical assets or liabilities the Company have the ability to
access.
●
Level 2 inputs are inputs (other than quoted prices included within
level 1) that are observable for the asset or liability, either
directly or indirectly.
●
Level 3 are unobservable inputs for the asset or liability and rely
on management’s own assumptions about the assumptions that
market participants would use in pricing the asset or liability.
(The unobservable inputs should be developed based on the best
information available in the circumstances and may include the
Company’s own data.)
The
Company had no assets subject to Fair Value Disclosure measurement
calculations at December 31, 2018 or December 31,
2017.
NOTE
14—
EARNINGS PER
SHARE
Basic
earnings per share are computed by dividing earnings available to
common stockholders by the weighted average number of common shares
outstanding during the period. Diluted earnings per share reflect
per share amounts that would have resulted if dilutive potential
common stock had been converted to common stock. The following
reconciles amounts reported in the financial
statements:
Options
and warrants to purchase 378 common shares at exercise prices
between $3,500 and $14,300 were outstanding at December 31, 2018,
but were not included in the computation of earnings per share for
the year ended December 31, 2017.
|
|
For the Year
Ended December 31, 2018
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (Loss) from
continuing operations
|
$
(295,437
)
|
1,241
|
$
(238
)
|
|
Less: preferred
stock dividends
|
–
|
|
|
|
Income(Loss)
available to common stockholders –
Basic earnings per
share
|
$
(295,437
)
|
1,241
|
$
(238
)
|
|
Effect of dilutive
securities:
|
|
|
|
|
Options and
warrants
|
–
|
–
|
|
|
Diluted earnings
per share
|
$
(295,437
)
|
1,241
|
$
(238
)
|
|
|
For the Year
Ended December 31, 2017
|
|
|
|
|
|
|
|
|
|
|
|
Income (Loss) from
continuing operations
|
$
(117,298
)
|
1,241
|
$
(95
)
|
|
Less: preferred
stock dividends
|
–
|
|
|
|
Income (Loss)
available to common stockholders –
Basic earnings per
share
|
$
(117,298
)
|
1,241
|
$
(95
)
|
|
Effect of dilutive
securities:
|
|
|
|
|
Options and
warrants
|
–
|
–
|
–
|
|
Income (Loss)
available to common stockholders –
Diluted earnings
per share
|
$
(117,298
)
|
1,241
|
$
(95
)
|
NOTE
15—
COMPREHENSIVE INCOME
(LOSS)
There
were no differences between net income (loss) and comprehensive
income (loss).
NOTE
16—
RELATED PARTY
TRANSACTIONS
There
were no related party transactions during the years ended December
31, 2018 or December 31, 2017.
NOTE
17—
LITIGATION
The
Company operates in a legal and regulatory environment that exposes
it to potentially significant litigation risks. Issuers of certain
alternative products sold by the Company are in Bankruptcy or may
have other financial difficulties. As a result of such alleged
failings of alternative products and the uncertainty of client
recovery from the various product issuers, the Company is subject
to multiple FINRA arbitration proceedings by customers. These
proceedings include customer suits, investments alleged to be
unsuitable, and bankruptcies and other issues brought by claimants.
The Company vigorously contests the allegations of the various
proceedings and believes that there are multiple meritorious legal
and fact based defenses in these matters. Such cases are subject to
many uncertainties, and their outcome is often difficult to
predict, including the impact on operations or on the financial
statements, particularly in the earlier stages of a case. The
Company makes provisions for cases brought against it when, in the
opinion of management after seeking legal advice, it is probable
that a liability exists, and the amount can be reasonably
estimated. Collectively these legal proceedings, when resolved are
expected to be material to the Company’s financial
statements.
To protect against the
currently known legal risks, including suitable expenses for
defense and legal advice related to the legal proceedings, existing
information and assessments at the time indicated the need to
generate provisions for the contingency. For the year ended
December 31, 2018, a sum of $555,000 has been reported for
contingent liabilities, insofar as these can be adequately measured
at this stage. The provisions recognized, the contingent
liabilities disclosed and the other latent legal risks are
partially subject to substantial estimation risks given the
complexity of the individual factors and the fact that the
independent and exhaustive investigations have not yet been
completed.
The current individual proceedings evaluated
separately are subject to uncertainties and, as such, the Company
is unable to estimate the possible loss or range of loss that may
result from the outcome of these cases; however, results in these
cases that are against the interests of the Company could have a
severe negative impact on the financial position of the Company. As
of December 31, 2018, the Company is a defendant in eleven on-going
suits or arbitrations as discussed above. Ten of these arbitrations
relate to allegations of unsuitable investments attributed to a
single registered representative no longer associated with the
Company. The Company expects to vigorously defend itself in these
cases.
NOTE
18
—
COMMITMENTS AND
CONTINGENCIES.
If a contingent liability is probable and
the
amount of loss that could be sustained is reasonably estimated, the
loss is shown on the financial statements by reducing net income
and increasing liabilities.
As of December 31, 2018, the
Company is a defendant in eleven customer arbitrations through
FINRA Arbitration which are legal proceedings considered to be in
the normal course of business. Collectively these legal
proceedings, when resolved are expected to be material to the
Company’s financial statements.
To protect against the currently known legal
risks, including suitable expenses for defense and legal advice
related to the legal proceedings, existing information and
assessments at the time indicated the need to generate provisions
for the contingency. For the year ended 12/31/18 a sum of
$555,000 has been reported for contingent liabilities, insofar
as these can be adequately measured at this stage. The provisions
recognized, the contingent liabilities disclosed and the other
latent legal risks are partially subject to substantial estimation
risks given the complexity of the individual factors and the fact
that the independent and exhaustive investigations have not yet
been completed.
In evaluating liabilities associated with
its various legal proceedings, the Company has accrued $555,000 for
probable liabilities associated with these matters for the year
ended 12/31/18. Reasonably possible losses for any of the
individual legal proceedings which have not been accrued were not
material to the Company’s consolidated financial
statements
NOTE
19—
OPERATING
SEGMENTS
The
Company organizes its business units into two reportable segments:
Broker-Dealer Services and Holding Company. The broker-dealer
services segment distributes securities and insurance products to
retail investors through a network of registered representatives
through its wholly-owned subsidiary, Capital Financial Services,
Inc. (“CFS”), a Wisconsin corporation. The Holding
Company encompasses cost associated with ownership of the
Company’s office building, business development and
acquisitions, dispositions of subsidiary entities and results of
discontinued operations, dividend income and recognized gains or
losses.
The
Company's reportable segments are strategic business units that
offer different products and services. They are managed separately
because each business requires different technology and marketing
strategies.
Capital
Financial Holdings, Inc. derives the majority of its revenues and
net income from sales of mutual funds, insurance products, and
various other securities through Capital Financial Services, Inc.
(“CFS”), the Company’s broker-dealer
subsidiary.
As of,
and for the year ended, December 31, 2018:
|
|
|
|
|
|
|
|
|
|
|
Revenues from
external customers$
|
$
3,200
|
$
15,068,191
|
$
15,071,391
|
|
Interest
expense
|
(34,564
)
|
–
|
(34,564
)
|
|
Depreciation
|
34,972
|
37,081
|
72,053
|
|
Income (loss)
before income tax benefit (expense)
|
(219,075
)
|
(105,251
)
|
(324,326
)
|
|
Income tax benefit
(expense)
|
5,015
|
23,874
|
28,889
|
|
Net income (loss)
of continued operations
|
(214,060
)
|
(81,377
)
|
(295,437
)
|
|
Segment assets of
continued operations
|
|
|
|
As of,
and for the year ended, December 31, 2017:
|
Revenues from
external customers$
|
$
–
|
$
15,569,191
|
$
15,569,191
|
|
Interest
expense
|
(29,039
)
|
–
|
(29,039
)
|
|
Depreciation
|
21,357
|
41,349
|
62,705
|
|
Income (loss)
before income tax benefit (expense)
|
(336,728
)
|
305,363
|
(31,365
)
|
|
Income tax benefit
(expense)
|
16,409
|
(102,342
)
|
(85,933
)
|
|
Net income (loss)
of continued operations
|
(320,319
)
|
203,021
|
(117,298
)
|
|
Segment assets of
continued operations
|
1,638,344
|
3,496,915
|
5,135,259
|
Reconciliation of Segment Information
|
|
|
|
|
|
|
|
|
Assets for the
Holding Company segment
|
$
1,622,065
|
$
1,638,344
|
|
Assets for the
Broker-Dealer Services segment
|
$
3,519,905
|
$
3,496,915
|
|
Elimination for the
Holding Company segment receivables
|
$
–
|
$
–
|
|
Elimination for the
Broker-Dealer Services segment receivables
|
$
–
|
$
–
|
|
Consolidated assets
of continued operations
|
$
5,141,970
|
$
5,135,259
|
NOTE
20—
SUBSEQUENT
EVENTS
The Company has evaluated subsequent events through the date the
financial statements were available to be issued on April 12, 2019,
and have identified the following events.
January 28, 2019, the Company’s subsidiary executed a
tentative Asset Purchase and Assignment Agreement with another
FINRA member broker dealer ("Assignee") wherein, subject to
approval of FINRA and any other securities regulatory authorities,
Assignee may be entitled to purchase certain retail customer
accounts of the Company’s subsidiary. The agreement will
become effective only upon approval of FINRA (the Effective Date).
Pursuant to the terms of the tentative agreement, Assignee will pay
to the Company’s subsidiary a total of Three Hundred Thousand
Dollars for all retail accounts accepted by Assignee that choose to
transfer to Assignee, to be paid in installments as follows:
Seventy Five Thousand Dollars upon the Effective Date of the
Assignment Agreement, Seventy Five Thousand Dollars three months
from the Effective Date and assuming the Effective Date has
occurred, One Hundred Fifty Thousand Dollars on or before December
31, 2019. The Company has no knowledge of or control over when the
agreement will be effective if ever.
Since December 31, 2018, the Company’s subsidiary has been
named as a Respondent in an additional three customer arbitration
claims, bringing the outstanding arbitration claims to fourteen.
These claims relate to the same former registered representative
and with similar allegations to the arbitration claims described in
Note 17.