10-K 1 cpfh_10k.htm ANNUAL REPORT cpfh_10k.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

Form 10-K
 
þ ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2011

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period of ___________ to___________
 
Commission File Number 000-25958

CAPITAL FINANCIAL HOLDINGS, INC.
(Exact name of registrant as specified in its charter)

North Dakota
 
45-0404061
(State or other jurisdiction of
incorporation or organization)
 
(IRS Employer
Identification No.)
 
1 Main Street North
Minot, North Dakota 58703
(Address of principal executive offices)

701.837.9600
(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:
None

Securities registered pursuant to Section 12(g) of the Act:
Common Stock; $.0001 par value
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the 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 þ 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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ

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.

Large accelerated filer
o
Accelerated filer
o
Non-accelerated filer
o
Smaller reporting company
þ

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Act). Yes o No þ

The aggregate market value of voting and non-voting common equity held by non-affiliates of the Registrant as of February 24, 2012 was $484,135, based on the last reported sale price.  For purposes of this calculation, the Registrant has assumed that its board of directors, executive officers and holders of greater than five percent of the Registrant’s shares are affiliates.

On February 29, 2012, there were 14,455,943 shares of the issuer’s common equity outstanding.

References in this Annual Report on Form 10-K to the “Company”, “CFH”, “we”, “us”, “its” or “our” includes the subsidiary, unless the context indicates otherwise.

Documents Incorporated by Reference: Portions of the Company’s definitive Proxy Statement for the Annual Meeting of Shareholders to be held on June 12, 2012, are incorporated by reference in certain sections of Part III.
 


 
 

 
 
10-K

CAPITAL FINANCIAL HOLDINGS, INC.

INDEX

     
Page
#
 
PART I
         
Item 1.
Business
    4  
Item 1A.
Risk Factors
    7  
Item 1B.
Unresolved Staff Comments
    7  
Item 2.
Properties
    7  
Item 3.
Legal Proceedings
    7  
Item 4.
(Removed and Reserved)
    7  
PART II
           
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
    8  
Item 6.
Selected Financial Data
    9  
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
    9  
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
    15  
Item 8.
Financial Statements and Supplementary Data
    15  
Item 9.
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
    15  
Item 9A.
Controls and Procedures
    15  
Item 9B.
Other Information
    16  
PART III
           
Item 10.
Directors, Executive Officers and Corporate Governance
    17  
Item 11.
Executive Compensation
    17  
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
    17  
Item 13.
Certain Relationships and Related Transactions, and Director Independence
    17  
Item 14.
Principal Accounting Fees and Services
    17  
           
PART IV
           
Item 15.
Exhibits, Financial Statement Schedules
    18  
           
  SIGNATURES     19  

 
2

 
 
Special Note Regarding Forward Looking Statements

When used herein, in future filings by the Company with the Securities and Exchange Commission (“SEC”), in the Company's press releases, and in other Company-authorized written or oral statements, the words and phrases "can be," "expects," "anticipates," "may affect," "may depend," "believes," "estimate," or similar expressions are intended to identify "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. The Company cautions readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made.  Such statements are subject to certain risks and uncertainties, including those set forth in this "Forward-Looking Statements" section, which could cause actual results for future periods to differ materially from those presently anticipated or projected.  The Company does not undertake and specifically disclaims any obligation to update any forward-looking statement to reflect events or circumstances after the date of such statements.
Forward-looking statements include, but are not limited to, statements about the Company’s:

  
Business strategies and investment policies,
  
Possible or assumed future results of operations and operating cash flows,
  
Financing plans and the availability of short-term borrowing,
  
Competitive position,
  
Potential growth opportunities,
  
Recruitment and retention of the Company’s key employees,
  
Potential operating performance, achievements, productivity improvements, efficiency and cost reduction efforts,
  
Likelihood of success and impact of litigation,
  
Expected tax rates,
  
Expectations with respect to the economy, securities markets, the market for merger and acquisition activity, the market for asset management activity, and other industry trends,
  
Competition, and
  
Effect from the impact of future legislation and regulation on the Company.

The following factors, among others, could cause actual results to differ materially from forward-looking statements, and future results could differ materially from historical performance:

  
General political and economic conditions which may be less favorable than expected;
  
The effect of changes in interest rates, inflation rates, the stock markets, or other financial markets;
  
Unfavorable legislative, regulatory, or judicial developments;
  
Adverse findings or rulings in arbitrations, litigation or regulatory proceedings;
  
Incidence and severity of catastrophes, both natural and man-made;
  
Changes in accounting rules, policies, practices, and procedures which may adversely affect the business;
  
Terrorist activities or other hostilities which may adversely affect the general economy.
 
The Company is a financial services holding company that, through its broker dealer subsidiary, Capital Financial Services, Inc., provides brokerage, investment advisory, insurance and related services.  The Company operates in a highly regulated and competitive industry that is influenced by numerous external factors such as economic conditions, marketplace liquidity and volatility, monetary policy, global and national political events, regulatory developments, competition, and investor preferences. The Company’s revenues and net earnings may be either enhanced or diminished from period to period by such external factors. The Company remains focused on continuing to reduce redundant operating costs, upgrade operating efficiency, recruit quality representatives and grow our revenue base.  The Company provides broker-dealer services in support of trading and investment by its representatives’ customers in corporate equity and debt securities, U.S. Government securities, municipal securities, mutual funds, private placement alternative investments, variable annuities and variable life insurance.  The Company also provides investment advisory services for its representative’s customers
 
A key component of the broker-dealer subsidiary’s business strategy is to recruit well-established, productive representatives who generate substantial revenues from an array of investment products and services. Additionally, the broker-dealer subsidiary assists its representatives in developing and expanding their business by providing a variety of support services and a diversified range of investment products for their clients.
 
 
3

 
 
PART I

ITEM 1. BUSINESS

OVERVIEW

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.

The Company has been engaged in the financial services business since 1987. The Company was incorporated September 22, 1987, as a North Dakota corporation. The Company’s principal offices are located at 1 Main Street North, Minot, North Dakota 58703. As of December 31, 2011, the Company had 16 full-time employees consisting of officers, securities distribution, data processing, compliance, accounting, and clerical support staff.

BUSINESS DEVELOPMENT

On April 22, 2005, the Company acquired the management rights to the IPS Millennium Fund and the IPS New Frontier Fund from IPS Advisory, Inc. (“IPS Advisory”), and merged them into a new Integrity Fund called the Integrity Growth & Income Fund. The two funds had combined assets of approximately $57 million at the time of acquisition. The purchase agreement called for total consideration of approximately 656,000 common shares of the Company. The Company provided IPS Advisory with 250,000 common shares upon closing. The remaining consideration of approximately 406,000 common shares, which was subject to adjustment based on retention of assets in the fund, was to be issued as follows: 203,000 common shares at the one-year anniversary of the closing date, and 203,000 common shares at the two-year anniversary of the closing date. The shares are subject to a put option, which allows the holders of the shares to put them back to the Company at a price equal to the market price of the Company’s shares as of the closing date, which was $.36 per share. The put option is exercisable with respect to one-third of the shares per year starting on the third anniversary of the closing date. The Company will also provide IPS Advisory with a stock option incentive bonus based on growth in assets in the Fund based on the following schedule: 150,000 options on the Company’s common shares if assets of the Fund reach $100 million and 150,000 options on the Company’s common shares if the assets of the Fund reach $200 million. The options will have a strike price of $.65 per share and mature 10 years from the closing date. The securities issued in connection with this transaction were issued on a private placement basis. In April of 2006, the one-year anniversary payment of 158,603 common shares was made, which reflected the assets of the acquired funds at the one-year anniversary. In June of 2007, the two-year anniversary payment of 138,797 common shares was made, which reflected the assets of the acquired funds at the two-year anniversary. In April 2010 the put option mentioned above expired, which resulted in the liability of this acquisition to be reduced to $0.

On March 7, 2007, the Company acquired certain assets of United Heritage Financial Services, Inc. (UHFS), a wholly owned subsidiary of United Heritage Financial Group, Inc., of Meridian, Idaho. UHFS had approximately 120 independent registered representatives who became part of Capital Financial Services, Inc. (CFS), the retail brokerage division of the Company. Pursuant to the agreement, in exchange for the assets of UHFS set forth above, the Company agreed to
issue 500,000 restricted CFH shares and pay a deferred cash earn out payment totaling a maximum of $900,000, to be paid in 21 quarterly installments. On March 7, 2007, the Company issued 500,000 options to purchase shares of the Company, to UHFS. As a result of this issuance of shares, $175,000 was recorded by the Company as goodwill relating to the purchase of the assets. As of December 31, 2011, the Company had made nineteen quarterly installment payments totaling $411,766. The liability relating to this acquisition is valued at approximately $61,590 as of December 31, 2011.  Due to the goodwill impairment charge that was recorded for the year ended December 31, 2010, as of December 31, 2011, the total goodwill recorded relating to this acquisition was $554,911.

THE COMPANY’S SUBSIDIARY

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.
 
 
4

 
 
Capital Financial Services, Inc.

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 over 240 investment representatives and investment advisors.

DESCRIPTION OF BUSINESS

Brokerage Commissions

CFS’s primary source of revenue is commission revenue in connection with sales of shares of mutual funds, insurance products, and various other securities. CFS receives commission and Rule 12b-1 servicing revenue generated from the sale of investment products originated by its registered representatives. CFS also receives investment advisory revenue as a registered investment advisor. CFS pays a portion of the revenue generated to its registered representatives and retains the balance.

REGULATION

Virtually all aspects of the Company’s businesses are subject to various complex and extensive federal and state laws and regulations. Regulated areas include, but are not limited to, the effecting of securities transactions, the financial condition of the Company’s subsidiaries, record-keeping and reporting procedures, relationships with clients, and experience and training requirements for certain employees. The Company’s subsidiary is registered with various federal and state government agencies, including the SEC, as well as FINRA, a self-regulatory industry organization, as described below.

CFS is a registered broker-dealer, subject to extensive regulation and periodic examinations by the SEC, FINRA, and state agencies in those states in which CFS conducts business. As a broker-dealer, CFS is subject to the Net Capital Rule promulgated by the SEC under the Exchange Act. This rule requires that a broker-dealer must maintain certain minimum net capital and that its aggregate indebtedness may not exceed specified limitations.

Federal and state laws and regulations, and the rules of FINRA, grant broad powers to such regulatory agencies and organizations. These include the power to limit, restrict, or prevent the Company from carrying on its business if it fails to comply with such laws, regulations and rules. Other possible sanctions that may be imposed include the suspension of individual employees, restrictions on the Company expanding its business or paying cash dividends, the revocation of the investment advisor or broker dealer expulsions, censures, and/or fines.

Since 1993, FINRA rules have limited the amount of aggregate sales charges which may be paid in connection with the purchase and holding of investment company shares sold through broker-dealers. Congress and the SEC presently are considering amendments to Rule 12b-1 and other statutory provisions and rules that regulate the distribution of mutual fund shares. The effect of the rule amendments and other legislative or regulatory actions might be to limit the amount of fees that could be paid pursuant to a fund’s 12b-1 Plan in a situation where a fund has no, or limited, new sales for a prolonged period of time, as well as the imposition of other limits on the use of fund assets to pay for distribution.
 
 
5

 

COMPETITION

The Company derives substantially all of its revenues from commission revenue earned in connection with sales of shares of mutual funds, insurance products and various other securities, and also receives investment advisory revenue.

The Company participates in retail brokerage, a highly competitive related sector of the financial services industry. The Company competes directly with full-service stock brokerage firms, insurance companies, banks, regional broker-dealers, other independent broker-dealers, and other financial institutions, as well as investment advisory firms. Each of these competitors offer to the public many of the same investment products and services offered by the Company. Further, other broker-dealers providing the same services heavily recruit the representatives and advisors transacting business through the Company. This competition forces the Company to maintain high levels of support services and commission payouts for these representatives and advisors. These high levels of services and payouts could have a materially adverse effect on the Company’s earnings.
 
RECENT DEVELOPMENTS

On February 22, 2012, the Company entered into an agreement to sell its headquarters building, located at 1 Main Street North, Minot North Dakota, to Corridor Investors, LLC., at a sales price of $990,000.  The sale is scheduled to close on March 30, 2012, however, there is no assurance that this sale will be completed.  Upon the sale, the proceeds will be paid to PawnMart, Inc. as payment on the $1,300,000 promissory note, which is secured by the building, to reduce the balance due on that note.  The holder of the title will release the title for this sale and has agreed to issue an unsecured note for the remaining balance due.  The new note has not yet been finalized as of the filing date of this report.
 
On October 21, 2011, the Company repurchased 3,050,000 of its preferred shares, owned by PawnMart, Inc., in exchange for a Promissory Note for $1,300,000.  This note carries an interest rate of 7%, is payable in 24 quarterly payments of approximately $66,801, and is secured by the building owned by the Company.  The note matures on October 1, 2017.  The shares are reported in the stockholders’ equity section of the Company’s balance sheet as treasury stock, and are deducted from the total stockholders’ equity.

On July 1, 2011, the Board of Directors of the Company voted to close its oil and gas subsidiary, Capital Energy Resources, Inc.  The Company continues to operate as a Broker-Dealer through its wholly owned subsidiary Capital Financial Services, Inc.  The impact on the consolidated statement of operation, with regard to closing this subsidiary, was not considered significant for the year-ended December 31, 2011.

AVAILABILITY OF SEC REPORTS

All SEC reports may be viewed and copied at the SEC’s Public Reference Room at 100 F Street NE, Washington, DC 20549, on official business days during the hours of 10 a.m. to 3 p.m. local time. Information on the operation of the Public Reference Room may be obtained by calling the Commission at 1-800-SEC-0330. The Commission maintains an Internet site (http://www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the Commission.

All SEC reports are also made available on the Company’s website at http://capitalfinancialholdings.com. These reports, including annual reports on Form 10-K and 10-KSB, quarterly reports of Form 10-Q and 10-QSB, and current reports on Form 8-K, are available on the same day they are filed with the SEC.
 
 
6

 
 
ITEM 1A. RISK FACTORS

Not Applicable as a Smaller Reporting Company.

ITEM 1B. UNRESOLVED STAFF COMMENTS

Not Applicable as a Smaller Reporting Company.

ITEM 2. PROPERTIES

The Company operates the majority of its business out of its location at 1 Main Street North, Minot, North Dakota, which the Company owned as of December 31, 2011.   On February 22, 2012, the Company entered into an agreement to sell this property to Corridor Investors, LLC, and the scheduled closing date of this sale is March 30, 2012.

ITEM 3. LEGAL PROCEEDINGS

The Company, through its subsidiary Capital Financial Services, Inc., operates in a legal and regulatory environment that exposes it to potentially significant litigation risks.  As a result, the Company is involved in various disputes and legal proceedings, including litigation and arbitration, including a number of legal proceedings arising out of customer allegations related to past commissioned sales of alternative investment products.  In 2007 through the first quarter of 2009 a substantial amount (approximately 10% to 20%) of the Company’s sales of commissioned products were in private placements of alternative products, three of which were placed in receivership by action of the United States Securities and Exchange Commission and issuers of certain other alternative products sold by the Company are in Chapter 11 Bankruptcy or may have financial difficulties.  Additionally, difficult economic conditions in general and the stock market decline have contributed to decline in broker-dealer subsidiary client portfolio values.  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 several FINRA arbitration claims, and two trustee actions, one in Delaware Federal Court and one in Delaware Bankruptcy Court.  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.  The current proceedings are subject to uncertainties and as such, the Company is unable to estimate the possible loss or a range of loss that may result from each individual matter. 

ITEM 4. (REMOVED AND RESERVED)
 
 
7

 

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Information about the Company’s Common Stock

The Company’s Common Shares are traded on the OTC Bulletin Board under the symbol CPFH. The Company’s common shares began trading on the OTC Bulletin Board on November 7, 1997. On May 31, 2002, the shareholders of the Company approved a two for one (2:1) share split of the issued and outstanding common shares of the Company, which took effect on July 1, 2002. On December 31, 2011, the closing price of the Company’s Common Shares on the OTC Bulletin Board was $.06 per share. At February 29, 2012, there were approximately 665 shareholders of record.

The following table sets forth the high and low closing prices for the Company’s common stock. The quotations reflect inter-dealer prices, without retail mark-up, mark-down, or commission, and may not represent actual transactions.

   
2011
   
2010
 
   
Fiscal Year
   
Fiscal Year
 
Quarter
 
High
   
Low
   
High
   
Low
 
                         
First Quarter
    .130       .050       .190       .130  
Second Quarter
    .070       .040       .190       .110  
Third Quarter
    .080       .040       .200       .090  
Fourth Quarter
    .070       .040       .130       .050  

The Company has not paid a dividend with respect to its common stock, nor does the Company anticipate paying dividends in the foreseeable future.

The Company has issued the following securities in the past quarter without registering the securities under the Securities Act:

None
 
 
8

 

Smaller Reporting Company Repurchases of Equity Securities:

In November of 1997, the Board of Directors of the Company authorized the repurchase of up to $2,000,000 of its outstanding common stock from time to time in the open market.  The table below displays the dollar value of shares that may yet be purchased under this plan.
 
Period
 
Total Number of Shares Purchased
   
Average Price Per Share
   
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
   
Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs
 
October 2011
    -     -     -     $ 597,754  
November 2011
    -     -     -     $ 597,754  
December 2011
    -     -     -     $ 597,754  
Total
    -     -     -     $ 597,754  

ITEM 6. SELECTED FINANCIAL DATA

Not Applicable as a Smaller Reporting Company.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following information is provided in connection with, and should be read in conjunction with, the consolidated financial statements and notes included in this Annual Report on Form 10-K.

GENERAL

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.
 
 
9

 
 
RESULTS OF OPERATIONS

The following table sets forth, for the periods indicated, amounts included in the Company’s Consolidated Statements of Operations and the percentage change in those amounts from period to period.
 
                      Variance 2011 to     Variance 2010 to  
   
2011
   
2010
   
2009
   
2010
   
2009
 
OPERATING REVENUES
                             
Fee income
  $ 1,031,083     $ 975,010     $ 1,062,492       6 %     (8 )%
Commission income
    16,180,938       17,746,472       16,096,513       (9 )%     10 %
Other income
    778,453       670,325       743,769       16 %     (10 )%
Total revenue
  $ 17,990,474     $ 19,391,807     $ 17,902,774       (7 )%     8 %
                                         
OPERATING EXPENSES
                                       
Compensation and benefits
  $ 1,067,439     $ 1,350,094     $ 1,786,179       (21 )%     (24 )%
Commission expense
    15,111,206       16,566,033       15,223,613       (9 )%     9 %
Goodwill impairment expense
    -       753,518       -       (100 )%     100 %
General and administrative expenses
    1,487,384       1,489,663       1,036,490       (.01 )%     44 %
Depreciation and amortization
    67,837       75,381       100,369       (10 )%     (25 )%
Total operating expenses
  $ 17,733,866     $ 20,234,689     $ 18,146,651       (12 )%     12 %
                                         
OPERATING INCOME (LOSS)
  $ 256,608     $ (842,882 )   $ (243,877 )     130 %     246 %
                                         
OTHER EXPENSES
                                       
Loss on investment
  $ -     $ -     $ (31,876 )     -       (100 )%
Interest expense
    (63,480 )     (80,880 )     (212,552 )     (22 )%     (62 )%
Total other expenses
  $ (63,480 )   $ (80,880 )   $ (244,428 )     (22 )%     (67 )%
                                         
INCOME (LOSS) OF CONTINUING OPERATIONS BEFORE INCOME TAX BENEFIT (EXPENSE)
  $ 193,128     $ (923,762 )   $ (488,305 )     (121 )%     89 %
                                         
INCOME TAX BENEFIT (EXPENSE)
  $ (58,813 )   $ 40,581     $ 191,416       (245 )%     (79 )%
                                         
NET INCOME (LOSS) BEFORE DISCONTINUED OPERATIONS
  $ 134,315     $ (883,181 )   $ (296,889 )     (115 )%     197 %
                                         
DISCONTINUED OPERATIONS
                                       
Loss from operations of discontinued operations (net of tax)
  $ -     $ -     $ (125,211 )     -       100 %
Gain (Loss) on disposal of discontinued operations
    (76,663 )     (111,601 )     228,402       (31 )%     (149 )%
Net discontinued operations
  $ (76,663 )   $ (111,601 )   $ 103,191       (31 )%     (208 )%
                                         
NET INCOME (LOSS)
  $ 57,652     $ (994,782 )   $ (193,698 )     106 %     (414 )%
NET INCOME (LOSS) OF CONTINUING OPERATIONS PER COMMON SHARE:
            .01       (.07 )     (.03 )                
NET INCOME (LOSS) PER COMMON SHARE:
    .00       (.07 )     (.02 )                
 
 
10

 
 
Year Ended December 31, 2011, compared with Year Ended December 31, 2010:

Operating Revenues—Total operating revenues for 2011 were $17,990,474, a decrease of 7% from $19,391,807 in 2010. The decrease resulted from decreased commission income earned by CFS, the Company’s broker-dealer division.

Fee Income—Fee income for 2011 was $1,031,083, a 6% increase from $975,010 in 2010. The increase was due to an increase in fees received by CFS as a result of an increase in assets under management in CFS’ registered investment advisor.

The Company earns investment advisory fees in connection with CFS’ registered investment advisor. The Company pays the registered representatives a portion of this fee income as a commission expense and retains the balance. These fees constituted 6% of the Company’s consolidated revenues in 2011.

Commission Income—Commission income includes CFS. The Company pays the registered representatives a percentage of this income as commission expense and retains the balance. Commission income for 2011 was $16,180,938, a 9% decrease from $17,746,472 in 2010. The decrease was due primarily to a decrease in commissions received by CFS as a result of market conditions. Future market conditions will continue to impact commission levels. Commission revenues constituted 90% of the Company’s consolidated revenues in 2011.

Other Income—Other income for 2011 was $778,453 a 16% increase from $670,325 in 2010. The increase was due primarily to the gain of $235,000, recognized in the second quarter, from the prepayment of a $950,000 convertible promissory note due to PawnMart, Inc.  Other income constituted 4% of the Company’s consolidated revenues in 2011.

Operating Expenses—Total operating expenses for 2011 were $17,733,866 a 12% decrease from $20,234,689 in 2010. The decrease resulted from the net decreases in the expense categories described in the paragraphs below.

Compensation and Benefits—Compensation and benefits expense for 2011 was $1,067,439, a 21% decrease from $1,350,094 in 2010. The decrease resulted primarily from a reduction in the number of persons employed by the Company over the past twelve months.

Commission Expense—Commission expense for 2011 was $15,111,206, a 9% decrease from $16,566,033 in 2010. The decrease corresponds with the decrease in commission income.

Goodwill Impairment Expense— Goodwill impairment expense for 2011 was $0, a 100% decrease from $753,518 in 2009.

The Company’s goodwill represents the excess of purchase prices over the fair value of the identifiable net assets of previously acquired broker/dealer businesses.  The goodwill is not amortized; instead it is tested for impairment annually or more frequently if the fair value of a reporting unit is below its carrying value. Absent any impairment indicators, the Company performs its annual goodwill impairment testing as of June 30 of each year.

The Company’s policy is to test goodwill for impairment using a fair value approach at the reporting unit level.  The Company performs its goodwill impairment test in two steps.  Step one compares the fair value of the reporting unit to its carrying value, including goodwill.  If the fair value of the unit determined in step one is lower than its carrying value, the Company proceeds to step two, which then compares the carrying value of goodwill to its implied fair value.  Any excess of carrying value of goodwill over its implied fair value at a reporting unit is recorded as impairment.
 
 
11

 

The valuation methodology the Company utilizes in testing the Company’s goodwill for impairment is based on the income approach.  The income approach is based on a discounted cash flow methodology in which expected future net cash flows are discounted to present value, using a discounted rate that compensates for the risk in attaining the projected cash flows.  This approach is dependent upon a number of significant management estimates about future performance including but not limited to, market performance, income taxes, capital spending and working capital changes.
 
As of December 31, 2011, there were no impairment indicators, so further testing of goodwill was not deemed necessary.

In December of 2010, as a result of ongoing volatility in the financial industry and a reduction in the estimated fair market value of the Company’s wholly owned subsidiary Capital Financial Services, Inc., the Company determined it was necessary to perform an interim goodwill impairment test.  In step one of the impairment test it was determined that the fair value of the reporting unit had decreased below its carrying value.  The Company then proceeded to step two of its impairment testing and compared the carrying value of goodwill to its implied fair value and determined that an impairment charge of $753,518 was necessary to reduce the carrying value of goodwill to its implied fair value.

General and Administrative Expenses—Total general and administrative expenses for 2011 were $1,487,384, a decrease of .01% from $1,489,663 in 2010.

Depreciation and Amortization—Depreciation and amortization for 2011 was $67,837, a 10% decrease from $75,381 in 2010.

Interest Expense—Interest expense was $63,480 for 2011, a 22% decrease from $80,880 in 2010. The decrease was due to the fact that we prepaid a convertible promissory note in the amount of $715,000 in the second quarter of 2011.

Year Ended December 31, 2010, compared with Year Ended December 31, 2009:

Operating Revenues—Total operating revenues for 2010 were $19,391,807, an increase of 8% from $17,902,774 in 2009. The increase resulted from increased commission income earned by CFS, the Company’s broker-dealer division.

Fee Income—Fee income for 2010 was $975,010, an 8% decrease from $1,062,492 in 2009. The decrease was due to a reduction in fees received by CFS due to a reduction in assets under management in CFS’ registered investment advisor.

The Company earns investment advisory fees in connection with CFS’ registered investment advisor. The Company pays the registered representatives a portion of this fee income as commission expense and retains the balance. These fees constituted 5% of the Company’s consolidated revenues in 2010.

Commission Income—Commission income earned by CFS. The Company pays the registered representatives a percentage of this income as commission expense and retains the balance. Commission income for 2010 was $17,746,472, a 10% increase from $16,096,513 in 2009. The increase was due primarily to an increase in commissions received by CFS due to market conditions. Future market conditions will continue to impact commission levels. Commission revenues constituted 92% of the Company’s consolidated revenues in 2010.

Other Income—Other income for 2010 was $670,325 a 10% decrease from $743,769 in 2009. Other income is comprised primarily of due diligence and marketing allowances received by CFS. Other income constituted 4% of the Company’s consolidated revenues in 2010.
 
 
12

 

Operating Expenses—Total operating expenses for 2010 were $20,234,689 a 12% increase from $18,146,651 in 2009. The increase resulted from the net increases in the expense categories described in the paragraphs below.

Compensation and Benefits—Compensation and benefits expense for 2010 was $1,350,094, a 24% decrease from $1,786,179 in 2009. The decrease resulted primarily from a reduction in incentive overrides paid to certain employees for the recruitment of new registered representatives in CFS, as well as a reduction in the number of employees over the past twelve months.

Commission Expense—Commission expense for 2010 was $16,566,033, an 8% increase from $15,223,613 in 2009. The increase corresponds with the increase in commission income.

Goodwill Impairment Expense— Goodwill impairment expense for 2010 was $753,518, a 100% increase from $0 in 2009.
 
The Company’s goodwill represents the excess of purchase prices over the fair value of the identifiable net assets of previously acquired broker/dealer businesses.  The goodwill is not amortized; instead it is tested for impairment annually or more frequently if the fair value of a reporting unit is below its carrying value. Absent any impairment indicators, the Company performs its annual goodwill impairment testing as of June 30 of each year.

The Company’s policy is to test goodwill for impairment using a fair value approach at the reporting unit level.  The Company performs its goodwill impairment test in two steps.  Step one compares the fair value of the reporting unit to its carrying value, including goodwill.  If the fair value of the unit determined in step one is lower than its carrying value, the Company proceeds to step two, which then compares the carrying value of goodwill to its implied fair value.  Any excess of carrying value of goodwill over its implied fair value at a reporting unit is recorded as impairment.

The valuation methodology the Company utilizes in testing the Company’s goodwill for impairment is based on the income approach.  The income approach is based on a discounted cash flow methodology in which expected future net cash flows are discounted to present value, using a discounted rate that compensates for the risk in attaining the projected cash flows.  This approach is dependent upon a number of significant management estimates about future performance including but not limited to, market performance, income taxes, capital spending and working capital changes.

In December of 2010, as a result of ongoing volatility in the financial industry and a reduction in the estimated fair market value of the Company’s wholly owned subsidiary Capital Financial Services, Inc., the Company determined it was necessary to perform an interim goodwill impairment test.  In step one of the impairment test it was determined that the fair value of the reporting unit had decreased below its carrying value.  The Company then proceeded to step two of its impairment testing and compared the carrying value of goodwill to its implied fair value and determined that an impairment charge of $753,518 was necessary to reduce the carrying value of goodwill to its implied fair value.

General and Administrative Expenses—Total general and administrative expenses for 2010 were $1,489,663, an increase of 44% from $1,036,490 in 2009. The increase was due primarily to an increase in licensing fees and legal expenses paid by CFS.

Depreciation and Amortization—Depreciation and amortization for 2010 was $75,381, a 25% decrease from $100,369 in 2009. The decrease was due to the disposal of assets associated with the mutual fund division sale.

Interest Expense—Interest expense was $80,880 for 2010, a 62% decrease from $212,552 in 2009. The decrease was due primarily to a reduction in outstanding debt due to redemptions of the company’s subordinated corporate notes processed on June 23rd and July 31st, totaling $500,000, and also the company’s decision to call the remaining notes, totaling $1,500,000, processed on September 30, 2009.
 
 
13

 

FINANCIAL CONDITION

On December 31, 2011, the Company’s assets aggregated $6,923,067, a decrease of 20% from $8,707,621 in 2010, due to increases in income tax receivables, the employee sponsored severance escrow and other assets, offset by decreases in cash and cash equivalents, accounts receivable, deferred tax asset, long-term receivable, goodwill, and net property and equipment. Stockholder’s equity was $4,146,756 on December 31, 2011, compared to $5,457,729 on December 31, 2010.

On December 31, 2010, the Company’s assets aggregated $8,707,621, a decrease of 8% from $9,500,728 in 2009, due to increases in cash and cash equivalents, accounts receivable, prepaids, deferred tax asset and other assets, offset by decreases in income tax receivables, long-term assets, goodwill, and net property and equipment.  Stockholder’s equity was $5,457,729 on December 31, 2010, compared to $6,494,044 on December 31, 2009.
 
Cash used by operating activities was $219,164 for the year ended December 31, 2011, as compared to net cash provided by operating activities of $204,833 for the year ended December 31, 2010 and net cash used by operating activities of $162,907 for the year ended December 31, 2009.

Net cash provided by investing activities was $333,989 for the year ended December 31, 2011, as compared to net cash provided by investing activities of $211,125 for the year ended December 31, 2010 and net cash provided by investing activities of $1,424,096 for the year ended December 31, 2009. During the year ended December 31, 2011, the cash provided by investing activities were from the final payment being received from the sale of the mutual fund division (See Note 17-Discontinued Operations), minus office and computer equipment purchased during this time frame.

Net cash used by financing activities was $1,142,428 for the year ended December 31, 2011, as compared to net cash used by financing activities of $198,495 for the year ended December 31, 2010, and net cash used by financing activities of $2,132,559 for the year ended December 31, 2009. During the year ended December 31, 2011, the Company paid out $68,625 in preferred stock dividends, repaid $277,772 of bank debt, prepaid the $950,000 convertible promissory note at a $235,000 discount and paid $81,030 relating to the acquisition of certain assets of United Heritage Financial Services in 2007.
 
LIQUIDITY AND CAPITAL RESOURCES

On December 31, 2011, the Company held $1,158,598 in cash and cash equivalents, as compared to $2,186,201 on December 31, 2010, and $1,968,738 on December 31, 2009. Liquid assets, which consist of cash and cash equivalents, totaled $1,158,598 at December 31, 2011, as compared to $2,186,201 on December 31, 2010, and $1,968,738 on December 31, 2009. The Company is required to maintain certain levels of cash and liquid securities in its broker-dealer subsidiary to meet regulatory net capital requirements.

The Company currently has no lines of credit available.

The Company has historically relied upon sales of its equity securities and debt instruments, as well as bank loans, for liquidity and growth. Management believes that the Company’s existing liquid assets, along with cash flow from operations, will provide the Company with sufficient resources to meet its ordinary operating expenses during the next twelve months. Significant, unforeseen or extraordinary expenses may require the Company to seek alternative financing sources, including common or preferred share issuance or additional debt financing.

In addition to the liabilities coming due in the next twelve months, management expects that the principal needs for cash may be to acquire additional financial services firms, broker recruitment, and repurchase shares of the Company’s common stock, and service debt. Management also expects to realize increases in consultant expenses as well as increased compliance and legal costs with respect to its broker dealer subsidiary related to regulatory and litigation matters.
 
 
14

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not Applicable as a Smaller Reporting Company.
 
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
The financial statements required by this item, the accompanying notes thereto, and the reports of independent registered public accounting firm are included as part of this Form 10-K immediately following the signatures page, beginning on page F-1.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

ITEM 9A. CONTROLS AND PROCEDURES

The Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-14(c) and Rule 15c-14(c) under the Exchange Act) as of the end of the period covered by this report, pursuant to Rule 13a-15(b) of the Exchange Act. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures are effective as of December 31, 2011, and that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed and summarized, and reported within the time periods specified by the SEC’s rules and forms.

Disclosure controls and procedures are the controls and other procedures that are designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

There were no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies or material weaknesses.
 
 
15

 
 
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Management of Capital Financial Holdings, Inc. (together with its consolidated subsidiary, the “Company”), is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control over financial reporting is a process designed under the supervision of the Company’s principal executive and principal financial officers to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external reporting purposes in accordance with United States generally accepted accounting principles.

As of December 31, 2011, management conducted an assessment of the effectiveness of the Company’s internal control over financial reporting, based on the framework established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, management has determined that the Company’s internal control over financial reporting as of December 31, 2011, is effective.

The Company’s internal control over financial reporting includes policies and procedures that pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect transactions and acquisitions and dispositions of assets; provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with United States generally accepted accounting principles, and that receipts and expenditures are being made only in accordance with authorizations of management and the directors of the Company; and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of Company assets that could have a material effect on the Company’s financial statements.

This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to final rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.

ITEM 9B. OTHER INFORMATION

None.
 
 
16

 

PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

The information required by this Item will be contained in our definitive Proxy Statement for our 2012 Annual Meeting of Shareholders and such information is incorporated herein by reference.

ITEM 11. EXECUTIVE COMPENSATION

The information required by this Item will be contained in our definitive Proxy Statement for our 2012 Annual Meeting of Shareholders and such information is incorporated herein by reference.
 
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information required by this Item will be contained in our definitive Proxy Statement for our 2012 Annual Meeting of Shareholders and such information is incorporated herein by reference.
 
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

The information required by this Item will be contained in our definitive Proxy Statement for our 2012 Annual Meeting of Shareholders and such information is incorporated herein by reference.

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

The information required by this Item will be contained in our definitive Proxy Statement for our 2012 Annual Meeting of Shareholders and such information is incorporated herein by reference.
 
 
17

 

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES

The following exhibits are filed herewith or incorporated herein by reference as set forth below:
   
Share Purchase Agreement and Change of Advisor between Capital Financial Holdings, Inc. and Corridor Investors, LLC.
   
3.1
Restated Articles of Incorporation of the Company (incorporated by reference to Exhibit 3.1 contained in the Company’s Quarterly Report on Form 10-QSB, (File No. 0-25958), filed with the Commission on November 10, 2004 and amended on June 5, 2009).
   
3.2
Amended Bylaws of the Company (incorporated by reference to Exhibit 3.2 contained in the Company’s Quarterly Report on Form 10-QSB, as amended (File No. 0-25958), filed with the Commission on August 11, 2006).
   
4.1
Specimen form of Common Stock Certificate (incorporated by reference to Exhibit 4.1 contained in the Company’s Registration Statement on Form S-1, as amended (File No.33-96824), filed with the Commission on September 12, 1995).
   
4.2
Certificate of designation of Series A Convertible Preferred Shares (incorporated by reference to Exhibit 4.1 contained in the Company’s Quarterly Report on Form 10-QSB, (File No. 0-25958), filed with the Commission on November 10, 2004).
   
4.3
Instruments defining rights of holders of securities: (See Exhibit 3.1 & 3.2)
   
14.1
Code of Ethics (incorporated by reference to Exhibit 14.1 contained in the Company’s Annual Report on Form 10-KSB, filed with the Commission on March 28, 2006).
   
21.1
Subsidiaries of the Company (incorporated by reference to Exhibit 21.1 contained in the Company’s Annual Report on Form 10-KSB, filed with the Commission on March 28, 2005).
   
CEO Certification Pursuant to Section 302 of the Sarbanes-Oxley Act and Rules 13a-14(a) and 15d-14(a) of the Exchange Act.
   
CFO Certification Pursuant to Section 302 of the Sarbanes-Oxley Act and Rules 13a-14(a) and 15d-14(a) of the Exchange Act.
   
CEO Certification Pursuant to Section 906 of the Sarbanes-Oxley Act and 18 U.S.C. Section 1350.
   
CFO Certification Pursuant to Section 906 of the Sarbanes-Oxley Act and 18 U.S.C. Section 1350.
   
Management Rights Agreement to the IPS Millennium Fund and the IPS New Frontier Fund entered into between Capital Financial Holdings, Inc. (formerly known as Integrity Mutual Funds, Inc.) and IPS Advisory, Inc.
   
Asset Purchase Agreement between Capital Financial Holdings, Inc. and United Heritage Financial Group, Inc.

 
18

 

SIGNATURES
 
In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 
  CAPITAL FINANCIAL HOLDINGS, INC.  
       
Date: March 20, 2012
By:
 /s/ John Carlson
 
   
John Carlson,
 
   
Chief Executive Officer & President
(Principal Executive Officer)
 
 
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
 
 
Date Signature & Title  
       
Date: March 20, 2012
By:
/s/ John R. Carlson  
   
John R. Carlson,
 
   
President & Executive Officer
 
   
(Principal Executive Officer)
 
       
Date: March 20, 2012
By:
 /s/ Valarie A. Hoskin
 
   
Valarie A. Hoskin,
 
   
Chief Financial Officer & Corporate Secretary
 
   
(Principal Financial & Accounting Officer)
 
       
Date: March 20, 2012 By:
 /s/ Jeffrey A. Cummer
 
   
Jeffrey A. Cummer,
 
   
Chairman
 
       
Date: March 20, 2012
By:
 /s/ Vance A. Castleman
 
   
Vance A. Castleman,
 
   
Director
 
       
Date: March 20, 2012
By:
/s/ Myron D. Thompson
 
   
Myron D. Thompson,
 
   
Director
 
       
Date: March 20, 2012
By:
 /s/ Gregory G. Philipps
 
   
Gregory G. Philipps,
 
   
Director
 
       
Date: March 20, 2012
By:
/s/ Vaune M. Cripe
 
   
Vaune M. Cripe,
 
   
Director
 
 
 
19

 
 
 
 
 
 
 
 
 
 
 
CAPITAL FINANCIAL HOLDINGS, INC., AND SUBSIDIARY

MINOT, NORTH DAKOTA

CONSOLIDATED FINANCIAL STATEMENTS

AS OF

DECEMBER 31, 2011, 2010 AND 2009

AND

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
 
 
 
 
 
 
 
 
 
 
F-1

 
 
CAPITAL FINANCIAL HOLDINGS, INC., AND SUBSIDIARY
 
TABLE OF CONTENTS
 
   
Pages
 
       
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
    F-3  
         
CONSOLIDATED FINANCIAL STATEMENTS
       
         
Consolidated Balance Sheets
    F-4 - F-5  
         
Consolidated Statements of Operations
    F-6 – F-7  
 
       
Consolidated Statements of Stockholders’ Equity
    F-8  
 
       
Consolidated Statements of Cash Flows
    F-9 – F-10  
         
Notes to Consolidated Financial Statements
    F-11 – F-25  
         
ADDITIONAL INFORMATION
       
         
Report of Independent Registered Public Accounting Firm
    F-26  
         
Selected Financial Data
    F-27  
         
Quarterly Results of Consolidated Operations (Unaudited)
    F-28  

 
F-2

 
 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Stockholders and Directors of
Capital Financial Holdings, Inc. and Subsidiary
Minot, North Dakota

We have audited the accompanying consolidated balance sheets of Capital Financial Holdings, Inc. and Subsidiary as of December 31, 2011 and 2010 and the related consolidated statements of operations, stockholders’ equity and cash flows for the years ended December 31, 2011, 2010 and 2009. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Capital Financial Holdings, Inc. and Subsidiary as of December 31, 2011 and 2010, and the results of their consolidated operations and their consolidated cash flows for the years ended December 31, 2011, 2010 and 2009 in conformity with accounting principles generally accepted in the United States of America.


BRADY, MARTZ & ASSOCIATES, P.C.
Minot, North Dakota USA


March 20, 2012
 
 
F-3

 
 
CAPITAL FINANCIAL HOLDINGS, INC., AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2011 AND 2010
 
ASSETS
 
   
2011
   
2010
 
             
CURRENT ASSETS
           
Cash and cash equivalents
  $ 929,030     $ 1,973,938  
Accounts receivable (net of allowance for doubtful accounts of $24,000 for 2011 and 2010)
    1,294,930       1,432,575  
Income taxes receivable
    58,354       57,900  
Deferred tax asset – current
    81,287       68,683  
Current portion of long-term receivable
    -       211,969  
Prepaids
    44,063       38,809  
                 
Total current assets
  $ 2,407,664     $ 3,783,874  
                 
                 
LONG-TERM ASSETS
               
LT receivable-MF Division Sale
  $ -     $ 423,938  
Less: current portion shown above
    -       (211,969 )
                 
      Total long-term assets
  $ -     $ 211,969  
                 
PROPERTY AND EQUIPMENT
  $ 1,740,606     $ 1,727,320  
Less accumulated depreciation
    (674,590 )     (606,753 )
                 
Net property and equipment
  $ 1,066,016     $ 1,120,567  
                 
OTHER ASSETS
               
Goodwill
  $ 2,472,419     $ 2,574,413  
Severance escrow
    229,568       212,263  
Deferred tax asset – non-current
    521,897       579,084  
  Other assets (net of accumulated amortization                
     of $214,444 for 2011 and 2010)     225,503       225,451  
                 
Total other assets
  $ 3,449,387     $ 3,591,211  
                 
TOTAL ASSETS
  $ 6,923,067     $ 8,707,621  
 
SEE NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 
 
F-4

 
 
CONSOLIDATED BALANCE SHEETS (CONTINUED)

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
   
2011
   
2010
 
CURRENT LIABILITIES
           
Accounts payable
  $ 85,094     $ 331,895  
Commissions payable
    1,184,745       1,298,078  
Other current liabilities
    144,882       147,532  
Current portion of long-term debt
    242,475       229,522  
                 
Total current liabilities
  $ 1,657,196     $ 2,007,027  
                 
LONG-TERM LIABILITIES
               
Note payable
  $ -     $ 277,772  
Convertible promissory note
    -       950,000  
Promissory note
    1,300,000       -  
Other long-term liabilities
    61,590       244,615  
Less current portion of long-term debt
    (242,475 )     (229,522 )
                 
Total long-term liabilities
  $ 1,119,115     $ 1,242,865  
                 
TOTAL LIABILITIES
  $ 2,776,311     $ 3,249,892  
                 
STOCKHOLDERS’ EQUITY
               
Series A Preferred stock – 5,000,000 shares authorized, $.0001 par value;                
3,050,000 shares issued and 0 outstanding   $ 305     $ 305  
Additional paid in capital – series A preferred stock
    1,524,695       1,524,695  
Common stock – 1,000,000,000 shares authorized, $.0001 par value;                
14,455,943 and 14,455,943 shares issued and outstanding, respectively     1,446       1,446  
Additional paid in capital – common stock
    10,446,302       10,446,302  
Accumulated deficit
    (6,525,992 )     (6,515,019 )
Less Treasury stock, 3,050,000 preferred shares at $0.4262
    (1,300,000 )     -  
                 
TOTAL STOCKHOLDERS’ EQUITY
  $ 4,146,756     $ 5,457,729  
                 
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
  $ 6,923,067     $ 8,707,621  
 
SEE NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 
 
F-5

 
 
CAPITAL FINANCIAL HOLDINGS, INC., AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2011, 2010 AND 2009
 
   
2011
   
2010
   
2009
 
OPERATING REVENUES
                 
Fee income
  $ 1,031,083     $ 975,010     $ 1,062,492  
Commission income
    16,180,938       17,746,472       16,096,513  
Other income
    778,453       670,325       743,769  
Total revenue
  $ 17,990,474     $ 19,391,807     $ 17,902,774  
                         
OPERATING EXPENSES
                       
Compensation and benefits
  $ 1,067,439     $ 1,350,094     $ 1,786,179  
Commission expense
    15,111,206       16,566,033       15,223,613  
Goodwill impairment expense
    -       753,518       -  
General and administrative expenses
    1,487,384       1,489,663       1,036,490  
Depreciation and amortization
    67,837       75,381       100,369  
Total operating expenses
  $ 17,733,866     $ 20,234,689     $ 18,146,651  
                         
OPERATING INCOME (LOSS)
  $ 256,608     $ (842,882 )   $ (243,877 )
                         
OTHER EXPENSES
                       
Loss on investment
  $ -     $ -     $ (31,876 )
Interest expense
    (63,480 )     (80,880 )     (212,552 )
Total other expenses
  $ (63,480 )   $ (80,880 )   $ (244,428 )
                         
INCOME (LOSS) OF CONTINUING OPERATIONS BEFORE INCOME TAX BENEFIT (EXPENSE)
  $ 193,128     $ (923,762 )   $ (488,305 )
                         
INCOME TAX BENEFIT (EXPENSE)
    (58,813 )     40,581       191,416  
                         
NET INCOME (LOSS) BEFORE DISCONTINUED OPERATIONS
  $ 134,315     $ (883,181 )   $ (296,889 )
                         
DISCONTINUED OPERATIONS
                       
Loss from operation of discontinued mutual fund segment (net of tax)
  $ -     $ -     $ (125,211 )
Gain (Loss) on disposal of mutual fund segment
    (76,663 )     (111,601 )     228,402  
Total discontinued operations (net of tax)
  $ (76,663 )   $ (111,601 )   $ 103,191  
                         
NET INCOME (LOSS)
  $ 57,652     $ (994,782 )   $ (193,698 )
 
SEE NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 
 
F-6

 
 
CONSOLIDATED STATEMENTS OF OPERATIONS (CONTINUED)

NET INCOME (LOSS) OF CONTINUING OPERATIONS PER COMMON SHARE:
                 
Basic
  $ .01     $ (.07 )   $ (.03 )
Diluted
  $ .01     $ (.07 )   $ (.03 )
                         
SHARES USED IN COMPUTING NET INCOME (LOSS) OF CONTINUING OPERATIONS PER COMMON SHARE:
                       
Basic
    14,638,937       14,638,937       14,541,585  
Diluted
    14,638,937       14,638,937       14,541,585  
                         
NET INCOME (LOSS) OF DISCONTINUED OPERATIONS PER COMMON SHARE:
                       
Basic
  $ (.01 )   $ (.01 )   $ .01  
Diluted
  $ (.01 )   $ (.01 )   $ .01  
                         
SHARES USED IN COMPUTING NET INCOME (LOSS) OF DISCONTINUED OPERATIONS PER COMMON SHARE:
                       
Basic
    14,638,937       14,638,937       14,541,585  
Diluted
    14,638,937       14,638,937       14,541,585  
                         
NET INCOME (LOSS) PER COMMON SHARE:
                       
Basic
  $ .00     $ (.07 )   $ (.02 )
Diluted
  $ .00     $ (.07 )   $ (.02 )
                         
SHARES USED IN COMPUTING NET INCOME (LOSS) PER COMMON SHARE:
                       
Basic
    14,638,937       14,638,937       14,541,585  
Diluted
    14,638,937       14,638,937       14,541,585  
 
SEE NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 
 
F-7

 
 
CAPITAL FINANCIAL HOLDINGS, INC., AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2011, 2010 AND 2009

   
Amounts
   
Shares
 
   
2011
   
2010
   
2009
   
2011
   
2010
   
2009
 
Preferred stock and additional paid-in capital
                                   
Balance, beginning of year
  $ 1,525,000     $ 1,525,000     $ 1,525,000       3,050,000       3,050,000       3,050,000  
Preferred stock issued
    -       -       -       -       -       -  
Balance, end of year
  $ 1,525,000     $ 1,525,000     $ 1,525,000       3,050,000       3,050,000       3,050,000  
                                                 
Common stock and additional paid-in capital
                                               
                                               
Balance, beginning of year
  $ 10,447,748     $ 10,397,780     $ 10,375,474       14,455,943       14,455,943       14,455,943  
Common stock issued
    -       49,968       57,097       -       -       -  
Purchase of common stock
    -       -       (34,791 )     -       -       -  
Balance, end of year
  $ 10,447,748     $ 10,447,748     $ 10,397,780       14,455,943       14,455,943       14,455,943  
                                                 
Accumulated deficit
                                               
Balance, beginning of year
  $ (6,515,019 )   $ (5,428,737 )   $ (5,143,539 )                        
Net income (loss)
    57,652       (994,782 )     (193,698 )                        
Preferred dividends
    (68,625 )     (91,500 )     (91,500 )                        
Balance, end of year
  $ (6,525,992 )   $ (6,515,019 )   $ (5,428,737 )                        
                                                 
ESOP activity
                                               
Balance, beginning of year
  $ -     $ -     $ (48,685 )                        
Repayments from ESOP
    -       -       48,685                          
Balance, end of year
  $ -     $ -     $ -                          
                                                 
Treasury stock and additional paid-in capital
                                               
Balance, beginning of year
  $ -     $ -     $ -                          
Purchase of preferred stock
    (1,300,000 )     -       -                          
Balance, end of year
  $ (1,300,000 )   $ -     $ -                          
                                                 
                                                 
Total stockholders’ equity
  $ 4,146,756     $ 5,457,729     $ 6,494,043                          
 
SEE NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 
 
F-8

 
 
CAPITAL FINANCIAL HOLDINGS, INC., AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2011, 2010 AND 2009
 
   
2011
   
2010
   
2009
 
CASH FLOWS FROM OPERATING ACTIVITIES
                 
                   
Net income (loss)
  $ 57,652     $ (994,782 )   $ (193,698 )
Adjustments to reconcile net income (loss) to net cash provided (used) by operating activities:                        
Depreciation
    67,837       70,357       85,302  
Amortization
    -       5,022       15,067  
Goodwill impairment expense
    -       753,518       -  
Loss on investment
    -       -       31,876  
Gain on prepayment of convertible promissory note
    (235,000 )     -       -  
Gain on allocation of ESOP shares
    -       -       (34,791 )
(Gain) loss on disposal of discontinued operations
    76,663       111,601       (228,402 )
Loss on disposal of assets
    -       -       67,860  
Effects on operating cash flows due to changes in:
                       
Accounts receivable
    137,645       (189,945 )     316,543  
Income taxes receivable
    (454 )     115,602       (145,321 )
Prepaids
    (5,254 )     (10,960 )     46,975  
Deferred tax asset
    44,583       (127,979 )     405,541  
Other assets
    (52 )     (31,482 )     31,657  
Commissions Payable
    (113,333 )     182,944       (98,056 )
Accounts payable
    (246,801 )     228,169       (266,772 )
Other liabilities
    (2,650 )     92,768       (196,688 )
                         
Net cash provided (used) by operating activities
  $ (219,164 )   $ 204,833     $ (162,907 )
                         
CASH FLOWS FROM INVESTING ACTIVITIES
                       
                         
Purchase of investment
  $ -     $ -     $ (76,876 )
Purchase of property and equipment
    (13,286 )     (16,075 )     (24,508 )
Proceeds on sale of mutual fund division
    -       -       1,525,480  
Long-term receivable
    347,275       227,200       -  
                         
Net cash provided by investing activities
  $ 333,989     $ 211,125     $ 1,424,096  
 
SEE NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 
 
F-9

 
 
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
 
   
2011
   
2010
   
2009
 
CASH FLOWS FROM FINANCING ACTIVITIES
                 
                   
Repayments from ESOP
  $ -     $ -     $ 48,685  
Reduction of long-term liability
    (81,031 )     (76,865 )     (63,450 )
Dividends paid
    (68,625 )     (91,500 )     (91,500 )
Reduction of notes payable
    (277,772 )     (30,130 )     (26,294 )
Prepayment of convertible promissory note
    (715,000 )     -       -  
Reduction of subordinate corporate notes
    -       -       (2,000,000 )
                         
Net cash used by financing activities
  $ (1,142,428 )   $ (198,495 )   $ (2,132,559 )
                         
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
  $ (1,027,603 )   $ 217,463     $ (871,370 )
CASH AND CASH EQUIVALENTS  AT BEGINNING OF YEAR
    2,186,201       1,968,738       2,840,108  
CASH AND CASH EQUIVALENTS AT END OF YEAR
  $ 1,158,598     $ 2,186,201     $ 1,968,738  
                         
SUPPLEMENTARY DISCLOSURE OF CASH FLOW INFORMATION
                       
Cash paid during the year for:
                       
Interest
  $ 63,480     $ 80,880     $ 382,135  
Income taxes
  $ 16,921     $ 31,929     $ 276,768  
                         
RECONCILIATION OF CASH AND CASH EQUIVALENTS
                       
Cash
  $ 929,030     $ 1,973,938     $ 1,986,738  
Severance escrow
    229,568       212,263       -  
Net Cash
  $ 1,158,598     $ 2,186,201     $ 1,986,738  
                         
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES
                       
Increase in long-term receivable
  $ -     $ -     $ 762,740  
Decrease in goodwill
  $ 101,994     $ 103,710     $ 109,140  
Decrease in other long-term liabilities
  $ 101,994     $ 153,677     $ 166,237  
Increase in common stock
  $ -     $ 49,967     $ 57,097  
Preferred stock dividends declared
  $ -     $ 22,875     $ 22,875  
Goodwill impairment expense
  $ -     $ 753,518     $ -  
 
SEE NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 
 
F-10

 
 
CAPITAL FINANCIAL HOLDINGS, INC., AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011, 2010 AND 2009

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., and its Subsidiary (the “Company”) was established in September 1987 as a North Dakota corporation. The Company derives its revenue from investment advisory fees as well as commissions earned from sales of mutual funds, insurance products, and various other securities through it’s Subsidiary Capital Financial Services, Inc. Headquartered in Minot, North Dakota, the Company is marketing its services throughout the United States.

Principles of consolidation—The consolidated financial statements include the accounts of Capital Financial Holdings, Inc., and its wholly owned 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 the majority 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.

Revenue recognition—Commission income and the related clearing expenses are recorded on a trade-date basis as securities transactions occur. The revenue earned from 12b-1 and advisory fees is recognized in the period earned.

Stock-based compensation—In December of 2005, the Company adopted the Financial Accounting Standards Board (“FASB”) accounting and reporting standards for share-based payment which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors, including employee stock options, based on estimated fair values.

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.

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.
 
 
F-11

 

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.
 
Property and equipment—Property and equipment is stated at cost less accumulated depreciation computed on straight-line and accelerated methods over estimated useful lives as follows:

Equipment
5-7 years
Building
40 years

Other assets—Other assets include debt issue costs, clearing deposits and other miscellaneous assets. Debt issue costs are amortized over the life of the corresponding debt.

Advertising—Costs of advertising and promotion are expensed as incurred. Advertising and promotion costs aggregated $45 in 2011, $11,252 in 2010 and $27,903 in 2009.

Earnings per common share—Basic earnings per common share was computed using the weighted average number of shares outstanding of 14,638,937 in 2011 and 2010 and 14,541,585 in 2009. 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.  The weighted average shares outstanding used in computing diluted earnings per common share were 14,638,937 in 2011 and 2010 and 14,541,585 in 2009.

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 has put into place a contingent Severance Benefit Package for its employees. The package has an annual expiration date of August 1st, and can be renewed by the board of the Company. The funds for this package have been placed into an account specifically designated for these funds.

Reclassification—Certain amounts from 2010 and 2009 have been reclassified to conform to the 2011 presentation. These reclassifications had no effect on the Company’s net income.

Recent Accounting Developments—In July 2009, the FASB launched the FASB Accounting Standards Codification (the Codification) as the single source of Generally Accepted Accounting Principals (“GAAP”). While the Codification did not change GAAP, it introduced a new structure to the accounting literature and changed references to accounting standards and other authoritative accounting guidance. The Codification was effective for the firm for the third quarter of fiscal 2009 and did not have an effect on the Company’s financial condition, results of operations or cash flows.

In January 2010, the FASB issued ASU No. 2010-06, “Fair Value Measurements and Disclosures (Topic 820) — Improving Disclosures about Fair Value Measurements.” ASU No. 2010-06 provides amended disclosure requirements related to fair value measurements. ASU No. 2010-06 is effective for financial statements issued for reporting periods beginning after December 15, 2009 for certain disclosures and for reporting periods beginning after December 15, 2010 for other disclosures. Since these amended principles require only additional disclosures concerning fair value measurements, adoption did not affect the Company’s financial condition, results of operations or cash flows.
 
 
F-12

 
 
In January 2011, the Financial Accounting Standards Board (“FASB”) issued an update to the guidance contained in Accounting Standards Codification (“ASC”) 310, Receivables.  The new guidance requires companies to provide more information about the credit quality of their financing receivables in the disclosures to financial statements including, but not limited to, significant purchases and sales of financing receivables, aging information and credit quality indicators.  The adoption of this accounting guidance did not have a significant impact on the Company’s consolidated financial statements.

In September 2011, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2011-08, “Intangibles—Goodwill and Other (Topic 350) Testing Goodwill for Impairment.”  Under ASU No. 2011-08, an entity has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount.  If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary.  However, if an entity concludes otherwise, then it is required to perform the first step of the two-step impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying amount of the reporting unit, as described in paragraph 350-20-35-4.  If the carrying amount of a reporting unit exceeds its fair value, then the entity is required to perform the second step of the goodwill impairment test to measure the amount of the impairment loss, if any, as described in paragraph 350-20-35-9.  Under the amendments in this update, an entity has the option to bypass the qualitative assessment for any reporting unit in any period and proceed directly to performing the first step of the two-step goodwill impairment test.  An entity may resume performing the qualitative assessment in any subsequent period.  ASU No. 2011-08 is effective for annual and interim goodwill impairment tests performed beginning after December 15, 2011.  The adoption of this update is not expected to have a significant impact on the Company’s consolidated financial statements.

NOTE 2—CASH AND CASH EQUIVALENTS

Cash and cash equivalents at December 31, 2011 and 2010 consist of the following:
 
  Current   Current    
Amount
 
  Maturity   Interest Rate    
2011
   
2010
 
Cash in checking
Demand
    -     $ 803,290     $ 1,006,858  
Cash in escrow
Demand
    0.05 %     229,568       212,263  
Cash in savings
Demand
    0.25 %     125,740       967,080  
              $ 1,158,598     $ 2,186,201  

NOTE 3—PROPERTY AND EQUIPMENT

Property and equipment at December 31, 2011 and 2010, consists of the following:

   
2011
   
2010
 
Office furniture and equipment
  $ 325,201     $ 314,615  
Building and land
    1,415,405       1,412,705  
    $ 1,740,606     $ 1,727,320  
Accumulated depreciation and amortization
    (674,590 )     (606,753 )
    $ 1,066,016     $ 1,120,567  

Depreciation expense totaled $67,837, $75,381 and $85,302 in 2011, 2010 and 2009, respectively.
 
 
F-13

 
 
NOTE 4—BUSINESS ACQUISITIONS
 
Purchase Combinations—

On April 22, 2005, the Company acquired the management rights to the IPS Millennium Fund and the IPS New Frontier Fund from IPS Advisory, Inc. (“IPS Advisory”), and merged them into a new Integrity Fund called the Integrity Growth & Income Fund. The two funds had combined assets of approximately $57 million at the time of acquisition. The purchase agreement called for total consideration of approximately 656,000 common shares of the Company. The Company provided IPS Advisory with 250,000 common shares upon closing. The remaining consideration of approximately 406,000 common shares, which was subject to adjustment based on retention of assets in the fund, was to be issued as follows: 203,000 common shares at the one-year anniversary of the closing date, and 203,000 common shares at the two-year anniversary of the closing date. The shares are subject to a put option, which allows the holders of the shares to put them back to the Company at a price equal to the market price of the Company’s shares as of the closing date, which was $.36 per share. The put option is exercisable with respect to one-third of the shares per year starting on the third anniversary of the closing date. The Company will also provide IPS Advisory with a stock option incentive bonus based on growth in assets in the Fund based on the following schedule: 150,000 options on the Company’s common shares if assets of the Fund reach $100 million and 150,000 options on the Company’s common shares if the assets of the Fund reach $200 million. The options will have a strike price of $.65 per share and mature 10 years from the closing date. The securities issued in connection with this transaction were issued on a private placement basis. In April of 2006, the one-year anniversary payment of 158,603 common shares was made, which reflected the assets of the acquired funds at the one-year anniversary. In June of 2007, the two-year anniversary payment of 138,797 common shares was made, which reflected the assets of the acquired funds at the two-year anniversary. In April 2010 the put option mentioned above expired, which resulted in the liability of this acquisition to be reduced to $0.

On March 7, 2007, the Company acquired certain assets of United Heritage Financial Services, Inc. (UHFS), a wholly owned subsidiary of United Heritage Financial Group, Inc., of Meridian, Idaho. UHFS had approximately 120 independent registered representatives who became part of Capital Financial Services, Inc. (CFS), the retail brokerage division of the Company. Pursuant to the agreement, in exchange for the assets of UHFS set forth above, the Company agreed to issue 500,000 restricted CFH shares and pay a deferred cash earn out payment totaling a maximum of $900,000, to be paid in 21 quarterly installments. On March 7, 2007, the Company issued 500,000 options to purchase common shares of the Company, to UHFS. As a result of this issuance of shares, $175,000 was recorded by the Company as goodwill relating to the purchase of the assets. As of December 31, 2011, the Company had made nineteen quarterly installment payments totaling $411,766. The liability relating to this acquisition is valued at approximately $61,590 as of December 31, 2011.  Due to the goodwill impairment charge that was recorded for the year ended December 31, 2010, as of December 31, 2011, the total goodwill recorded relating to this acquisition was $554,911.

NOTE 5—LONG-TERM DEBT

Long-term debt at December 31, 2011 and 2010 was as follows:
 
    Rate     Current Portion     2011     2010  
Long-term debt:
                       
First Western Bank
    6.50 %   $ -     $ -     $ 277,772  
Convertible promissory note
    6.50 %     -       -       950,000  
Promissory note
    7.00 %     180,885       1,300,000       -  
Future payments on acquisitions
            61,590       61,590       244,615  
                                 
Totals
          $ 242,475     $ 1,361,590     $ 1,472,387  
 
 
F-14

 
 
Summaries of the terms of the current long-term debt agreements follow:

First Western Bank— In June of 1999, the Company converted its outstanding balance of $500,000 borrowed on its bank line-of-credit to long-term debt.  The debt was refinanced in September of 2009 and carried an interest rate of 6.50%, with monthly payments of $4,105.  On August 18, 2011, the Company paid the remaining balance due to First Western Bank.

Subordinate Corporate Notes—The Company approved a $2 million intra-state subordinate corporate note offering limiting the sale in North Dakota, to North Dakota residents only. The subordinate corporate notes did not represent ownership in the Company. On June 23, 2009 and July 30, 2009 redemptions were processed, totaling $200,000 and $300,000 respectively. On September 30, 2009 the Company elected pursuant to the terms of its Corporate Note obligations to call and prepay its remaining $1,500,000 Corporate Note obligation. This amount consists of all of outstanding Corporate Notes originally due January 1, 2011. By prepaying the Corporate Notes from available cash, the current asset position of the Company was reduced by $1,591,613 and the Corporate Note liability of the same amount was eliminated. There was no prepayment charge or other cost to the Company associated with the prepayment.

Convertible Promissory Note— In October of 2006, the Company issued a $950,000 convertible promissory note in a private placement to PawnMart, Inc., which is a wholly owned subsidiary of Xponential, Inc.  The unsecured note carried an interest rate of 6.50% per annum, payable semi-annually, and was scheduled to mature on October 15, 2016.  The company negotiated with PawnMart, Inc. to prepay the note at a discounted rate of $715,000, as of June 6, 2011.  A payment of $640,000 was sent to PawnMart, Inc., and a $75,000 promissory note was signed for the remaining balance due.  This promissory note carried an interest rate of 6.50%, per annum, payable at the maturity date of the note, which was May 26, 2012.  On September 19, 2011, the Company paid the promissory note in full plus accrued interest, for a total payment of $76,523.

Promissory Note- On October 21, 2011, the Company issued a promissory note to PawnMart, Inc. in exchange for the repurchase of the 3,050,000 shares of preferred stock.  The note carries an interest rate of 7%, with quarterly payments of $66,801.  On October 1, 2017, the remaining balance will be due in full.

Future Payments On Acquisitions-See Note 4 Business Acquisitions.

The aggregate amount of required future payments on the above long-term debt at December 31, 2011, is as follows:

Year ending December 31,
 
2012
  $ 242,475  
2013
    193,884  
2014
    207,815  
Thereafter
    717,416  
         
Total due
  $ 1,361,590  

 
F-15

 
 
NOTE 6—INCOME TAXES

The provision for income taxes is based on earnings before income taxes reported for financial statement purposes and consisted of the following:

   
2011
   
2010
   
2009
 
Current income tax benefit (expense):
                 
Federal
  $ -     $ -     $ -  
State
    (14,183 )     (17,358 )     (13,096 )
Total current tax benefit (expense)
  $ (14,183 )   $ (17,358 )   $ (13,096 )
Deferred tax benefit (expense):
                       
Federal
  $ (39,542 )   $ 51,334     $ 181,198  
State
    (5,088 )     6,605       23,314  
Total deferred tax benefit (expense)
  $ (44,630 )   $ 57,939     $ 204,512  
                         
Total provision for income tax
                       
benefit (expense)
  $ (58,813 )   $ 40,581     $ 191,416  
 
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:
 
   
2011
   
2010
   
2009
 
Deferred tax asset:
                 
Net operating and capital loss carry forwards
  $ 81,292     $ 68,687     $ 52,139  
Goodwill impairment adjustment
    -       75,371       -  
Stock option compensation
    583,374       583,374       583,374  
                         
Total deferred tax assets
  $ 664,666     $ 727,432     $ 635,513  
                         
Deferred tax liabilities:
                       
Accumulated depreciation
  $ 16,015     $ 25,723     $ 37,502  
Accumulated amortization