Notes To Consolidated Financial Statements
December 31, 2012
NOTE 1. ORGANIZATION AND RECENT DEVELOPMENTS
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Halo Companies, Inc. (“Halo”, “HCI” or the “Company”) was incorporated under the laws of the State of Delaware on December 9, 1986. Its principal executive offices are located at One Allen Center, Suite 500, 700 Central Expy South, Allen, Texas 75013 and its telephone number is 214-644-0065.
Unless otherwise provided in footnotes, all references from this point forward in this Report to “we,” “us,” “our company,” “our,” or the “Company” refer to the combined Halo Companies, Inc. entity, together with its subsidiaries.
Halo has multiple wholly-owned subsidiaries including Halo Group Inc. (“HGI”), Halo Asset Management, LLC (“HAM”), Halo Portfolio Advisors, LLC (“HPA”), Halo Select Insurance Services, LLC (“HSIS”), Halo Group Mortgage, LLC (“HGM”), Halo Benefits, Inc. (“HBI”), and Equitas Housing Fund, LLC (“EHF”). HGI is the management and shared services operating company. HAM provides asset management and mortgage servicing services to investor and asset owners including all aspects of buying and managing distressed REO and non-performing loans. HPA exists to market all of the Company’s operations into turnkey solutions for strategic business to business opportunities with HAM’s investors and asset owners, major debt servicers, lenders, and mortgage backed securities holders. The remaining subsidiaries provide insurance brokerage, mortgage services, and association benefit services to customers throughout the United States. EHF is the Company’s investment in non-performing loans as discussed below in Note 7.
In January 2012, based on management’s assessment of the Halo Group Realty, LLC (“HGR”) operating segment performance along with the Company’s continued focus and financial capitalization efforts on growing the asset management and portfolio advisor subsidiaries, the Company committed to a plan to sell the subsidiary entity. On January 31, 2012, the Company sold HGR for $30,000. Included in the sale was some of the HGR’s intellectual property, which excluded the primary technology platform. The business sale includes the purchaser retaining the HGR name and legal entity. The Company recorded a loss on the sale of HGR of $7,500. On August 31, 2012, the Company sold the primary technology platform, including the source code, of HGR for $50,000. This sale included a cash payment of $10,000 and a $40,000 promissory note to the Company, payable on August 31, 2013. In December 2012, the Company received $40,000 payment in full on the promissory note.
In November 2012, the Company entered into a stock/unit purchase agreement for the sale of the Company’s subsidiaries Halo Debt Solutions, Inc. (“HDS”), Halo Financial Services, LLC (“HFS”), and Halo Credit Solutions (“HCS”). The purchase agreement was for $350,000, which includes a $25,000 down payment at closing and promissory note financing for the remainder of the purchase price. The note receivable does not accrue interest. Any purchaser default on the promissory note not properly cured would immediately declare the note due and payable. The purchaser has a prepayment option that allows for the buyer to pay a cumulative total of $250,000 by April 20, 2013 as full satisfaction of the $350,000. The Company recorded a gain on the sale of HDS, HFS and HCS of $134,731. The gain calculation was based on the $250,000 prepayment option as the Company expects the purchaser to pay in full by April 20, 2013. If the purchaser does not pay in full on April 20, 2013, the Company would recognize the additional consideration, less any broker fees, as additional net gain on the sale of the subsidiaries. As of December 31, 2012, the buyer has paid (including the down payment) the Company $85,000. The promissory note receivable is included in current assets on the consolidated balance sheet for the period ended December 31, 2012.
NOTE 2. SIGNIFICANT ACCOUNTING POLICIES
The accompanying Consolidated Financial Statements as of December 31, 2012 and 2011 include the accounts of the Company and have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim information. Certain balances have been reclassified in prior period to be consistent with current year presentation.
Revenue Recognition, Accounts Receivable and Deferred Revenue
The Company recognizes revenue in the period in which services are earned and realizable. To further understand the Company’s business, HAM earns fees from its clients for its boarding and initial asset management fee, success fees, and its monthly servicing fee. The boarding and initial asset management services are performed in the first 30-60 days of assets being boarded and include; IRR analysis of loans boarded, detailed asset level workout exit strategy analysis, boarding the assets onto HAM’s proprietary software platform and the integrated servicing platform, identification and oversight of custodial files, oversight of mortgage/deed assignment from previous servicer, oversight of title policy administration work, and delinquent property tax research and exposure review. HAM’s monthly success fees are earned for completing its default and asset disposition services including loan modification, notes sales, obtaining a deed in lieu of foreclosure, originating owner finance agreements, and cash sales of REO properties owned by the client. HAM’s servicing fees are earned monthly and are calculated on a monthly unit price for assets under management.
Prior to the subsidiary sale in November 2012, with respect to any enrolled debt account, HFS recognized its revenue once a client made at least one payment to a creditor pursuant to a settlement agreement, debt management plan, or other valid contractual agreement between the client and the creditor. The revenue recognized on any enrolled account bared the same proportional relationship to the total revenue that would be recognized for renegotiating, settling, reducing, or altering the terms of the debt balance on all of a particular client’s enrolled accounts as the individual debt amount bears to the entire debt amount. Settlements were in the form of a lump sum creditor settlement payment or via contractual payment plans. Effective October 27, 2010, there were no new sales in HDS (until the subsidiary sale in November 2012 the servicing of existing customers was active, including collecting of fees already earned and owed on all existing customers). Any new debt settlement business to the Company after October 27, 2010 was transacted in the HFS entity. Cash receipts from customers (including boarding and initial asset management fees from clients of HAM) in advance of revenue recognized are originally recorded as deferred revenue and recognized into revenue over the period services are provided.
HAM and HPA receivables are typically paid the month following services performed. As of December 31, 2012, the Company’s accounts receivable are made up of the following percentages; HAM at 81%, HPA at 17%, all other at 2%.
The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. Management considers the following factors when determining the collectability of specific customer accounts: past transaction history with the customer, current economic and industry trends, and changes in customer payment terms. The Company provides for estimated uncollectible amounts through an increase to the allowance for doubtful accounts and a charge to earnings based on actual historical trends and individual account analysis. Balances that remain outstanding after the Company has used reasonable collection efforts are written off through a charge to the allowance for doubtful accounts. The below table summarizes the Company’s allowance for doubtful accounts as of December 31, 2012 and December 31, 2011, respectively;
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|
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Balance at
Beginning of
Period
|
|
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Increase in the
Provision
|
|
|
Account
Receivable
Write-offs
|
|
|
Balance at
End of Period
|
|
|
Year ended December 31, 2012
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for doubtful accounts
|
|
$
|
446,722
|
|
|
$
|
35,259
|
|
|
$
|
106,316
|
|
|
$
|
375,665
|
|
|
Year ended December 31, 2011
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for doubtful accounts
|
|
$
|
331,085
|
|
|
$
|
931,719
|
|
|
$
|
816,082
|
|
|
$
|
446,722
|
|
As of December 31, 2012, the Company’s allowance for doubtful accounts is made up of the following percentages; HAM at 96% and HPA at 4%. The HAM and HPA allowance is related to one client for whom the Company has fully reserved all outstanding accounts receivables as of December 31, 2012.
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Net Income (Loss) Per Common Share
Basic net income (loss) per share is computed by dividing (i) net income (loss) available to common shareholders (numerator), by (ii) the weighted average number of common shares outstanding during the period (denominator). Diluted net income (loss) per share is computed using the weighted average number of common shares and dilutive potential common shares outstanding during the period. At December 31, 2012 and 2011, there were 5,563,777 and 2,310,977 shares, respectively, underlying potentially dilutive convertible preferred stock and stock options outstanding. These shares were not included in dilutive weighted average shares outstanding for the periods ended December 31, 2012 and 2011 because their effect is anti-dilutive due to the Company’s reported net loss.
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Use of Estimates and Assumptions
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 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 reported period. Actual results could differ from those estimates. Significant estimates include the Company’s revenue recognition method, valuation of equity based compensation and derivative liabilities.
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Principles of Consolidation
The consolidated financial statements of the Company for the year ended December 31, 2012 include the financial results of HCI, HGI, HGM, HBI, HSIS, HCIS (defined below), HPA, HAM, and EHF. The financial results of HGR are included for the one month period ended January 31, 2012. The financial results of HDS, HFS, and HCS are included for period beginning January 1, 2012 thru November 9, 2012. All significant intercompany transactions and balances have been eliminated in consolidation.
The consolidated financial statements of the Company for the year ended December 31, 2011, include the financial results of HCI, HGI, HCS, HDS, HGM, HGR, HBI, HLMS, HSIS, HCIS (defined below), HFS, HPA, HAM, and EHF. All significant intercompany transactions and balances have been eliminated in consolidation.
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Cash and Cash Equivalents
The Company considers all liquid investments with a maturity of 90 days or less to be cash equivalents.
Note Receivable
In November 2012, the Company entered into a stock/unit purchase agreement for the sale of the Company’s subsidiaries HDS, HFS, and HCS for consideration of $250,000 (sale discussed in further detail above). As of December 31, 2012, the buyer has paid (including the down payment) the Company $85,000. The remaining $165,000 note receivable is included in current assets on the consolidated balance sheet for the period ended December 31, 2012. The note receivable does not bear interest.
On August 31, 2012, the Company sold the primary technology platform, including the source code, of HGR for $50,000. This sale included a cash payment of $10,000 and a $40,000 promissory note to the Company bearing interest of .25%, payable on August 31, 2013. In December 2012, the Company received $40,000 payment in full on the promissory note.
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Deposits and Other Assets
At December 31, 2011, deposits and other assets included $10,000 in funds held as a deposit by a merchant bank to cover potential losses by the bank from customer cancellations. The remaining balance as of December 31, 2011, includes $50,000 related to the fiscal year 2010 purchase of certain intellectual property (IP) (offset by $11,667 in accumulated amortization of the IP). The IP purchase consisted primarily of multiple web domains for which Halo held the right, title, and interest. The IP was to be amortized into earnings over a 60 month term effective November 2010 through October 2015. The IP was sold in the HGR sale, discussed above, on January 31, 2012. The $10,000 in funds kept by a merchant bank was reclassified to cash and cash equivalents. During the year ended December 31, 2012, the Company established a $45,000 deposit held with the Company’s office lessor. As such, Deposits and Other Assets balance was $45,000 at December 31, 2012.
Property and Equipment
Property and equipment are stated at cost. Depreciation is provided in amounts sufficient to relate the cost of the depreciable assets to operations over their estimated service lives, ranging from three to seven years. Provisions for depreciation are made using the straight-line method.
Major additions and improvements are capitalized, while expenditures for maintenance and repairs are charged to expense as incurred. Upon sale or retirement, the cost of the property and equipment and the related accumulated depreciation are removed from the respective accounts, and any resulting gains or losses are credited or charged to other general and administrative expenses.
Investment in Portfolio Assets Valuation and Income Recognition
The Company adopted FASB ASC 820, “Fair Value Measurements and Disclosures”, at inception, which among other matters, requires enhanced disclosures about investments that are measured and reported at fair value. ASC 820 establishes a hierarchal disclosure framework which prioritizes and ranks the level of market price versatility used in measuring investments at fair value. Market price versatility is affected by a number of factors, including the type of investment and the characteristics specific to the investment. Investments with readily available active quoted prices or for which fair value can be measured from actively quoted prices generally will have a higher degree of market price versatility and a lesser degree of judgment used in measuring fair value.
Investments measured and reported at fair value are classified and disclosed in one of the following categories:
Level I – Quoted prices are available in active markets for identical investments as of the reporting date. The type of investments included in Level 1 includes listed equities and listed derivatives.
Level II – Pricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the reporting date, and fair value is determined through the use of models or other valuation methodologies. Investments which are generally included in this category include corporate bonds and loans, less liquid and restricted equity securities and certain over-the-counter derivatives.
Level III – Pricing inputs are unobservable for the investment and includes situations where there is little, if any, market activity for the investment. The inputs into the determination of fair value require significant management judgment or estimation. Investments that are included in this category generally include general and limited partnership interests in corporate private equity and real estate funds, mezzanine funds, funds of hedge funds, distressed debt and non-investment grade residual interests in securitizations and collateralized debt obligations.
The Company has adopted FASB ASC 310-30, “Loans and Debt Securities Acquired with Deteriorated Credit Quality”, which addresses accounting for differences between contractual cash flows and cash flows expected to be collected from the Company’s initial investment in the loans if those differences are attributable to credit quality. ASC 310-30 requires that acquired impaired loans be recorded at fair value which at acquisition is purchase price plus any fees. The Company determines the excess of the loan’s or pool’s scheduled contractual principal and contractual interest payments over all cash flows expected at acquisition as an amount that should not be accreted (non accretable difference). The remaining amount, representing the excess of the loan’s cash flows expected to be collected over the amount paid, is accreted into interest income over the remaining life of the loan or pool (accretable yield). Over the life of the loan or pool, we evaluate at the balance sheet date whether the present value of such loans determined using the effective interest rates has decreased and if so, recognize a loss. For increases in cash flows expected to be collected, we adjust the amount of accretable yield recognized on a prospective basis over the loan’s or pool’s remaining life. If the Company cannot reasonably estimate the timing and amount of future cash flows from acquired loans, the Company applies the cost recovery method as described in AICPA Practice Bulletin No. 6 whereby cash payments received are applied to the investment in mortgages up to the cost of the investment. Accordingly, the cost recovery method has been applied. Payments received in excess of the investment are recognized as revenue as received. The Company’s investment in portfolio assets has been classified as a Level III investment according to ASC 820.
Gains (Losses) on Investments
Gains (losses) on investments are reported as realized upon disposition of investments and are calculated based upon the difference between the proceeds and the cost basis determined. Costs of investments that in management’s judgment have become permanently impaired, in whole or in part, are written off and reported as realized losses. All other changes in the valuation of portfolio investments are included as changes in the unrealized appreciation or depreciation of investments in the consolidated statements of operations. For the year ended December 31, 2012 and 2011, there was $0 and $279,241 loss on investment in portfolio assets.
Fair Value of Financial Instruments
The carrying value of trade accounts receivable, note receivable, accounts payable, accrued and other liabilities approximate fair value due to the short maturity of these items. The estimated fair value of the notes payable and subordinated debt approximates the carrying amounts as they bear market interest rates.
The Company considers the warrants related to its Subordinated Debt to be derivatives, and the Company records the fair value of the derivative liabilities in our consolidated balance sheets. Changes in fair value of the derivative liabilities are included in gain (loss) on change in fair value of derivative in the consolidated statements of operations. The Company’s derivative liability has been classified as a Level III valuation according to ASC 820.
Internally Developed Software
Internally developed legacy application software consisting of database, customer relations management, process management and internal reporting modules are used in each of the Company’s subsidiaries. The Company accounts for computer software used in the business in accordance with ASC 350 “Intangibles-Goodwill and Other”. ASC 350 requires computer software costs associated with internal use software to be charged to operations as incurred until certain capitalization criteria are met. Costs incurred during the preliminary project stage and the post-implementation stages are expensed as incurred. Certain qualifying costs incurred during the application development stage are capitalized as property, equipment and software. These costs generally consist of internal labor during configuration, coding, and testing activities. Capitalization begins when (i) the preliminary project stage is complete, (ii) management with the relevant authority authorizes and commits to the funding of the software project, and (iii) it is probable both that the project will be completed and that the software will be used to perform the function intended. Management has determined that a significant portion of costs incurred for internally developed software came from the preliminary project and post-implementation stages; as such, no costs for internally developed software were capitalized.
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Long-Lived Assets
Long-lived assets are reviewed on an annual basis or whenever events or changes in circumstance indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets held and used is generally measured by a comparison of the carrying amount of an asset to undiscounted future net cash flows expected to be generated by that asset. If it is determined that the carrying amount of an asset may not be recoverable, an impairment loss is recognized for the amount by which the carrying amount of the asset exceeds the fair value of the asset. Fair value is the estimated value at which the asset could be bought or sold in a transaction between willing parties. There were no impairment charges for the year ended December 31, 2012 and 2011.
Identifiable Intangible Assets
During 2010, the Company purchased an intangible asset consisting of certain trade secrets and methods relating to HAM. See further discussion regarding the purchase in Note 17 Shareholders’ Equity. The intangible asset will be amortized over its useful life, determined by management to be two years.
This is the period over which the asset is expected to contribute to the future cash flows of that entity. An intangible asset that is subject to amortization shall be reviewed for impairment in accordance with ASC 350. In accordance with that statement, an impairment loss shall be recognized if the carrying amount of an intangible asset is not recoverable and its carrying amount exceeds its fair value.
As of December 31, 2012, in line with the fact the Company received no additional cash flows into the Company related to the Assignment and Contribution Agreement (discussed in detail in Note 17 below), the Company has not recorded in its consolidated balance sheets an intangible asset of any value and therefore there has been no amortization or impairment of the identifiable intangible asset. As it relates to the intangible asset, the trade secrets purchased on the contract date will in no case be forfeited by the Company regardless of the shares conveyance as discussed in Note 17.
Equity-Based Compensation
The Company accounts for equity instruments issued to employees in accordance with ASC 718 “Compensation-Stock Compensation”. Under ASC 718, the fair value of stock options at the date of grant is recognized in earnings over the vesting period of the options beginning when the specified events become probable of occurrence. For the year ended December 31, 2012, there were 20,000 shares of stock options awarded as discussed in Note 16. All transactions in which goods or services are the consideration received for the issuance of equity instruments are accounted for based on the fair value of the consideration received or the fair value of the equity instrument issued, whichever is more reliably measurable. The measurement date of the fair value of the equity instrument issued is the earlier of (i) the date on which the counterparty’s performance is complete, or (ii) the date on which it is probable that performance will occur.
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Income Taxes
The Company accounts for income taxes in accordance with ASC 740 “Income Taxes”. ASC 740 requires the use of the asset and liability method whereby deferred tax assets and liability account balances are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. These differences result in deferred tax assets and liabilities, which are included in the Company’s consolidated balance sheets.
The Company then assesses the likelihood of realizing benefits related to such assets by considering factors such as historical taxable income and the Company’s ability to generate sufficient taxable income of the appropriate character within the relevant jurisdictions in future years. Based on the aforementioned factors, if the realization of these assets is not likely a valuation allowance is established against the deferred tax assets.
The Company accounts for its position in tax uncertainties under ASC 740-10. ASC 740-10 establishes standards for accounting for uncertainty in income taxes. ASC 740-10 provides several clarifications related to uncertain tax positions. Most notably, a “more likely-than-not” standard for initial recognition of tax positions, a presumption of audit detection and a measurement of recognized tax benefits based on the largest amount that has a greater than 50 percent likelihood of realization. ASC 740-10 applies a two-step process to determine the amount of tax benefit to be recognized in the financial statements. First, the Company must determine whether any amount of the tax benefit may be recognized. Second, the Company determines how much of the tax benefit should be recognized (this would only apply to tax positions that qualify for recognition.) No additional liabilities have been recognized as a result of the implementation. The Company has not taken a tax position that, if challenged, would have a material effect on the financial statements or the effective tax rate during the years ended December 31, 2012 or 2011.
The Company incurred no penalties or interest for taxes for the years ended December 31, 2012 or 2011. At December 31, 2012, the Company is subject to a three year statute of limitations by major tax jurisdictions for the fiscal years ended December 31, 2009, 2010, and 2011. The Company files income tax returns in the U.S. federal jurisdiction.
Deferred Rent
Deferred rent of the Company is comprised of two balances. First, the Company’s operating leases for its office facilities contain free rent periods during the lease term. For these types of leases the Company recognizes rent expense on a straight line basis over the minimum lease term and records the difference between the amounts charged to expense and the amount paid as deferred rent. As the free rent periods have expired on the existing office facility leases the Company expects the deferred rent balance to decrease over the remaining rental period until the maturity date at which time the deferred rent balance will have been reduced to $0. This balance is included within the consolidated balance sheets in both the current and long term portion of deferred rent. The second portion of the deferred rent balance is comprised of a $257,012 reduction fee for a contractually agreed decrease in the Company’s office facilities as discussed fully in Note 15. This balance is reduced evenly over the remaining lease term beginning in August 2012. This balance is included within the consolidated balance sheets in both the current and long term portion of deferred rent.
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Non-controlling Interest
On January 1, 2009, HSIS entered into a joint venture with another entity to form Halo Choice Insurance Services, LLC (“HCIS”). HSIS contributed 49% of the opening equity balance. Under a qualitative analysis performed in accordance with ASC 810 “Consolidation”, HCIS is a variable interest entity and HSIS is the primary beneficiary as HSIS’s parent company, HGI, acts as the sole manager of the entity. Based on this analysis, HSIS has consolidated HCIS with the non-controlling 51% interest included in non-controlling interest on the consolidated balance sheets and consolidated statements of operations.
NOTE 3. CONCENTRATIONS OF CREDIT RISK
The Company maintains aggregate cash balances, at times, with financial institutions, which are in excess of amounts insured by the Federal Deposit Insurance Corporation (“FDIC”). During the year ended December 31, 2012, the FDIC insured deposit accounts up to $250,000. Further, all funds in noninterest-bearing transaction accounts are insured in full by the FDIC from December 31, 2010 through December 31, 2012. At December 31, 2012, the Company’s cash accounts in interest bearing accounts were all less than the $250,000 FDIC insured amount or were in noninterest bearing transaction accounts and as such were insured in full.
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of accounts receivable and note receivable.
In the normal course of business, the Company extends unsecured credit to its customers. Because of the credit risk involved, management has provided an allowance for doubtful accounts which reflects its estimate of amounts which will eventually become uncollectible. In the event of complete non-performance by the Company’s customers, the maximum exposure to the Company is the outstanding accounts receivable balance at the date of non-performance as well as the remaining note receivable balance held with one entity.
NOTE 4. OPERATING SEGMENTS
The Company has several operating segments as listed below and as defined in Note 1. The results for these operating segments are based on our internal management structure and review process. We define our operating segments by service industry. If the management structure and/or allocation process changes, allocations may change. See the following summary of operating segment reporting;
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Operating Segments
|
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For the Year Ended
|
|
|
|
|
December 31,
|
|
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|
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2012
|
|
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2011
|
|
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Revenue:
|
|
|
|
|
|
|
|
Halo Asset Management
|
|
$
|
2,863,944
|
|
|
$
|
2,929,027
|
|
|
Halo Portfolio Advisors
|
|
|
1,440,183
|
|
|
|
1,131,312
|
|
|
Halo Group Realty
|
|
|
116,008
|
|
|
|
1,145,835
|
|
|
Halo Debt Solutions/Halo Financial Solutions
|
|
|
110,972
|
|
|
|
652,383
|
|
|
Other
|
|
|
279,487
|
|
|
|
421,757
|
|
|
Net Revenue
|
|
$
|
4,810,594
|
|
|
$
|
6,280,314
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss):
|
|
|
|
|
|
|
|
|
|
Halo Asset Management
|
|
$
|
1,248,448
|
|
|
$
|
1,816,521
|
|
|
Halo Portfolio Advisors
|
|
|
350,968
|
|
|
|
266,236
|
|
|
Halo Group Realty
|
|
|
832
|
|
|
|
(21,771
|
)
|
|
Halo Debt Solutions/Halo Financial Services
|
|
|
(39,660
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)
|
|
|
(607,254
|
)
|
|
Other
|
|
|
(103,330
|
)
|
|
|
(676,498
|
)
|
|
Less: Corporate expenses (a)
|
|
|
(2,456,544
|
)
|
|
|
(3,280,262
|
)
|
|
Operating income (loss):
|
|
$
|
(999,286
|
)
|
|
$
|
(2,503,028
|
)
|
|
|
|
|
|
|
|
|
|
|
|
a.
|
Corporate expenses include salaries, benefits and other expenses, including rent and general & administrative expenses, related to corporate office overhead and functions that benefit all operating segments. Corporate expenses are expenses that the Company does not directly allocate to any segment above. Allocating these indirect expenses to operating segments would require an imprecise allocation methodology. Further, there are no material amounts that are the elimination or reversal of transactions between the above reportable operating segments.
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The assets of the Company consist primarily of cash, trade accounts receivable, note receivable, and property/equipment/software. Cash is managed at the corporate level of the Company and not at the segment level. Each of the remaining primary assets has been discussed in detail, including the applicable operating segment for which the assets and liabilities reside, in the consolidated notes to the financial statements. As such, the duplication is not warranted in this footnote.
All debt of the Company is on the books of the corporate parent companies HCI and HGI with the exception of the $1,200,000 secured asset promissory note of EHF. This note is discussed in detail in Note 12. Interest expense related to the secured asset promissory note totaled $327,000 for the year ended December 31, 2012, included above in other and in other income (expense) in the consolidated statements of operations. The remaining $104,487 of the $431,487 interest expense in the consolidated statements of operations for the year ended December 31, 2012 is included in corporate expenses above.
Both the gain on sale of HDS, HFS and HCS of $134,731 and the gain on sale of HGR software of $50,000 is included in “other” above (offset to the $327,000 in interest expense on the secured asset promissory note).
For the year ended December 31, 2012 and 2011, there have been no material transactions between reportable units that would materially affect an operating segment profit or loss. Intercompany transactions are eliminated in the consolidated financial statements.
NOTE 5. GOING CONCERN
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates the Company will need additional financing to fully implement its business plan including continued growth and establishment of a stronger brand name of HAM’s asset management in the distressed asset sector.
There are no assurances that additional financing will be available on favorable terms, or at all. If additional financing is not available, the Company will need to reduce, defer or cancel development programs, planned initiatives and overhead expenditures. The failure to adequately fund its capital requirements could have a material adverse effect on the Company’s business, financial condition and results of operations. Moreover, the sale of additional equity securities to raise financing will result in additional dilution to the Company’s stockholders, and incurring additional indebtedness could involve an increased debt service cash obligation, the imposition of covenants that restrict the Company operations or the Company’s ability to perform on its current debt service requirements. The Company has incurred an accumulated deficit of $10,678,986 as of December 31, 2012. However, of the accumulated deficit, $2,110,748 of expense was incurred as stock-based compensation, $434,463 in depreciation expense, and $279,241 in impairment loss on investment in portfolio assets, all of which are non-cash expenses. Further, $906,278 of the accumulated deficit is related to the issuance of stock dividends, also non cash reductions. The $3,730,730 total of these non-cash retained earnings reductions represents 35% of the total deficit balance. Management, in the ordinary course of business, is trying to raise additional capital through sales of common stock as well as seeking financing via equity or debt, or both from third parties. The consolidated financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.
NOTE 6. PROPERTY, EQUIPMENT AND SOFTWARE
Property, equipment and software consist of the following as of December 31, 2012 and December 31, 2011, respectively:
|
Computers and purchased software
|
|
$
|
159,159
|
|
|
$
|
162,518
|
|
|
Furniture and equipment
|
|
|
352,800
|
|
|
|
352,800
|
|
|
|
|
|
511,959
|
|
|
|
515,318
|
|
|
Less: accumulated depreciation
|
|
|
(365,262
|
)
|
|
|
(316,224
|
)
|
|
|
|
$
|
146,697
|
|
|
$
|
199,094
|
|
Depreciation totaled $70,603 and $95,331 for the year ended December 31, 2012 and 2011, respectively. The Company retired $21,565 of fully depreciated assets for year ended December 31, 2012.
NOTE 7. INVESTMENTS IN PORTFOLIO ASSETS
In December 2010, EHF entered into an agreement to purchase non-performing mortgage notes secured by the property, across the United States, for 6.6% of unpaid principal balance. Total purchase price of the investment was $300,000. Payments of $20,759 were received during 2011 and applied to the investment. During 2011, the seller’s estate, including the above mentioned non-performing mortgage notes purchased for $300,000 was placed into receivership with a court appointed receiver of the seller. The receiver has asserted ownership of the assets in receivership, including the referenced mortgage notes. As the Company’s right to these assets had been impaired, the Company assessed its ability to reclaim the assets as remote and an impairment of the investment in portfolio assets was warranted. Accordingly, the Company recognized impairment of the assets of $279,241 as of December 31, 2011. For the year ended December 31, 2012, the Company still deems the investments in portfolio assets as impaired and as such the value remains $0.
NOTE 8. ACCRUED AND OTHER LIABILITIES
The Company had $601,742 in accrued liabilities at December 31, 2012. Included in this accrual was $77,296 in salaries and wages payable, $211,936 in deferred compensation to multiple senior management personnel, $311,365 in accrued interest ($252,000 of this balance is discussed in more detail in Note 12), and $1,145 in other. The Company had $332,713 in accrued liabilities at December 31, 2011. Included in this accrual was $155,656 in salaries and wages payable (including payroll tax and accrued penalties of $70,466), $88,145 in deferred compensation to multiple senior management personnel, $55,412 in accrued interest, and $33,500 in other.
NOTE 9. NOTES PAYABLE DUE TO RELATED PARTIES
The notes payable due to related parties reside with five related parties as follows;
During March 2011, the Company entered into one unsecured promissory note with a related party (a company director) in the amount of $250,000 (the “2011 Related Party Note”). The 2011 Related Party Note had a fixed interest amount of $50,000 and a maturity date of July 31, 2011. On September 20, 2011, the 2011 Related Party Note was amended to include the 2011 Related Party Note plus $52,426 of accrued interest for a total note balance of $302,426. The 2011 Related Party Note has a 6% interest rate and is a monthly installment note with final maturity of October 2013. Interest and principal is due upon maturity. As of December 31, 2012, the 2011 Related Party Note was $206,292, all of which is included in current portion of notes payable to related parties. As of December 31, 2011, the balance of the 2011 Related Party Note was $246,436, of which $40,143 is included in current portion of notes payable to related parties.
On September 1, 2011, several previous related party notes totaling $370,639 were amended and consolidated (“the 2011 Consolidated Related Party Note”). This note bears interest of 6% and has a maturity date of September 15, 2016. As of December 31, 2012, the 2011 Consolidated Related Party Note balance was $291,969, of which $49,837 is included in current portion of notes payable to related parties. As of December 31, 2011, the 2011 Consolidated Related Party Note balance was $315,672, of which $23,704 is included in current portion of notes payable to related parties.
During the six months ended December 31, 2012, a company director advanced $150,000 to the Company for short term capital. The Company repaid $50,000 of the advance back to the director during the same time period. At the time of the filing of these financial statements, the Company and the director had not finalized a maturity date for the advance repayment. The note does not accrue interest. As such, as of December 31, 2012, the advance balance was $100,000, all of which is included in current portion of notes payable to related parties.
In December 2012, the Company’s President and Chief Legal Officer advanced $28,000 to the Company for short term capital. At the time of the filing of these financial statements, the Company and the officer had not finalized a maturity date for the advance repayment. The note does not accrue interest. As such, as of December 31, 2012, the advance balance was $28,000, all of which is included in current portion of notes payable to related parties.
In December 2012, the Company’s CEO and Director of the Board advanced $12,000 to the Company for short term capital. At the time of the filing of these financial statements, the Company and the officer/director had not finalized a maturity date for the advance repayment. The note does not accrue interest. As such, as of December 31, 2012, the advance balance was $12,000, all of which is included in current portion of notes payable to related parties.
As of December 31, 2012, the notes payable to related party balance totaled $638,261, of which $396,129 is included in current portion of notes payable to related parties in the consolidated financial statements.
The Company incurred $36,633 and $86,892 of interest expense to directors, officers, and other related parties during the year ended December 31, 2012 and 2011, respectively. Accrued interest due to directors and other related parties totaled $90,579 at December 31, 2012, of which $55,927 is included in accrued and other current liabilities. Accrued interest due to directors and other related parties totaled $105,098 at December 31, 2011, of which $55,030 in included in accrued and other current liabilities.
NOTE 10. NOTES PAYABLE
On August 15, 2011, the Company entered into an agreement with LegacyTexas Bank (“LTB”) to consolidate two outstanding notes (“LTB Consolidated Note”) into a 15 month note. As such, effective August 15, 2011, the LTB Consolidated Note had a balance of $155,000. The note bears fixed interest of 3% and had a maturity date of November 15, 2012. As of December 31, 2012 and December 31, 2011, the note payable balance was $0 (paid in full) and $114,244, respectively, included in current portion of notes payable.
On August 15, 2011, the Company entered into an agreement with LTB to term out a previously outstanding $75,001 line of credit into an 18 month note. The terms of the new note include an interest rate of 3% with a maturity date of February 15, 2013. As of December 31, 2012, the note payable balance was $8,509, included in current portion of notes payable. As of December 31, 2011, the note payable balance was $58,630, of which $50,174 was included in current portion of notes payable.
The remaining note is current and collateralized by all of the Company’s assets.
NOTE 11. SUBORDINATED DEBT
During January 2010, the Company authorized a $750,000 subordinated debt offering (“Subordinated Offering”), which consists of the issuance of notes paying a 16% coupon with a 1% origination fee at the time of closing. The maturity date of the notes was originally January 31, 2013, however, subsequent to December 31, 2012, the Company and the subordinated debt holders agreed to an extended maturity date of April 30, 2013. Repayment terms of the notes included interest only payments through July 31, 2010. Thereafter, level monthly payments of principal and interest are made as calculated on a 60 month payment amortization schedule with final balloon payment due at maturity. The rights of holders of notes issued in the Subordinated Offering are subordinated to any and all liens granted by the Company to a commercial bank or other qualified financial institution in connection with lines of credit or other loans extended to the Company in an amount not to exceed $2,000,000, and liens granted by the Company in connection with the purchase of furniture, fixtures or equipment. This includes the LTB debt disclosed in Note 10. Since inception of the offering, the Company has raised $420,000 in the Subordinated Offering. As of December 31, 2012, the remaining balance of this offering, less debt discount (discussed below), totals $222,546.
As part of the Subordinated Offering, the Company granted to investors common stock purchase warrants (the “Warrants”) to purchase an aggregate of 200,000 shares of common stock of the Company at an exercise price of $0.01 per share. The 200,000 shares of common stock contemplated to be issued upon exercise of the Warrants are based on an anticipated cumulative debt raise of $750,000. The investors are granted the Warrants pro rata based on their percentage of investment relative to the $750,000 aggregate principal amount of notes contemplated to be issued in the Subordinated Offering. The Warrants shall have a term of seven years, exercisable from January 31, 2015 to January 31, 2017. The Company will have a call option any time prior to maturity, so long as the principal and interest on the notes are fully paid, to purchase the Warrants for an aggregate of $150,000. After the date of maturity until the date the Warrants are exercisable, the Company will have a call option to purchase the Warrants for $200,000. The call option purchase prices assume a cumulative debt raise of $750,000.
The Company adopted the provisions of ASC 815, “Derivatives and Hedging”. ASC 815 requires freestanding contracts that are settled in a company’s own stock to be designated as an equity instrument, assets or liability. Under the provisions of ASC 815, a contract designated as an asset or liability must be initially recorded and carried at fair value until the contract meets the requirements for classification as equity, until the contract is exercised or until the contract expires. Accordingly, the Company determined that the warrants should be accounted for as derivative liabilities and has recorded the initial value as a debt discount which will be amortized into interest expense using the effective interest method. As of December 31, 2012, the balance of debt discount was $1,454, included in current portion of subordinated debt. As of December 31, 2011, the balance of debt discount was $18,898, of which $17,444 was included in current portion of subordinated debt, with the remaining $1,454 included in subordinated debt, less current portion. Subsequent changes to the marked-to-market value of the derivative liability will be recorded in earnings as derivative gains and losses. As of December 31, 2012, there were 112,000 warrants outstanding with a derivative liability of $29,351. As of December 31, 2011, there were 112,000 warrants outstanding with a derivative liability of $24,970. The $4,381 increase in fair value is included in the consolidated statements of operations as loss on change in fair value of derivative
.
The Warrants were valued using the Black-Scholes model, which resulted in the fair value of the warrants at $0.26 per share using the following assumptions:
|
|
|
December 31, 2012
|
|
|
|
|
|
|
%
|
|
|
|
|
|
%
|
Expected remaining life (in years)
|
|
|
|
|
|
|
|
|
|
%
|
During August 2012, the Company entered into an additional $25,000 subordinated term note with a current holder of the Company’s subordinated debt. The note pays an 18% coupon rate with a maturity date of August 31, 2015. There are no warrants associated with this subordinated term note. Repayment terms of the note include interest only payments through February 28, 2013. Thereafter, level monthly payments of principal and interest are made as calculated on a 60 month payment amortization schedule with final balloon payment due at maturity. The rights of the holder of this note is subordinated to any and all liens granted by the Company to a commercial bank or other qualified financial institution in connection with lines of credit or other loans extended to the Company in an amount not to exceed $2,000,000, and liens granted by the Company in connection with the purchase of furniture, fixtures or equipment. As of December 31, 2012, the remaining balance of this note totals $25,000.
As of December 31, 2012, the subordinated debt balance (including the $22,546 and $25,000 noted above) was $247,546, of which $226,713 was included in current portion of subordinated debt. As of December 31, 2011, the subordinated debt balance was $282,102, of which $66,556 was included in current portion of subordinated debt.
NOTE 12. SECURED ASSET PROMISSORY NOTE
During December 2010, the Company authorized a debt offering to be secured by real estate assets purchased in connection with Equitas Housing Fund, LLC, (“Equitas Offering”). The Equitas Offering, which is now closed, generated $1,200,000 in proceeds. Of the $1,200,000 in proceeds received in December 2010, $300,000 was used to acquire non-performing, residential mortgage notes and the balance was used for mortgage note workout expenses and operational expenses of Halo Asset Management. The Secured Asset Promissory Notes consist of a 25% coupon with a maturity date of December 31, 2012. Accrued interest is to be paid quarterly at the end of each fiscal quarter beginning March 31, 2011 through maturity date and continuing until the promissory note has been paid in full. The rights of the holders of the Secured Asset Promissory Notes include a security interest in the collateral of the above mentioned securities of real estate properties. As of December 31, 2012, the Secured Asset Promissory Note balance was $1,200,000. For the year ended December 31, 2012 and 2011, the Company incurred $327,000 and $300,000, respectively, in interest expense on the note. As of December 31, 2012, the accrued interest balance was $252,000. The unpaid interest has triggered a default interest rate of 28%, effective April 1, 2012. As of December 31, 2011, the Secured Asset Promissory Note balance was $1,200,000, with an accrued interest balance of $0.
NOTE 13. RELATED PARTY TRANSACTIONS
For the year ended December 31, 2012, HAM recognized monthly servicing fee revenue totaling $20,783 from an entity that is an affiliate of the Company. For the year ended December 31, 2011, HPA and HAM recognized revenue totaling $986,162, respectively, from an entity owned by a significant shareholder in the Company. The shareholder became a significant shareholder in December 2010 as part of the Assignment and Contribution Agreement (defined in Note 17 below).
For the years ended December 31, 2012 and 2011, the Company incurred consulting costs totaling $0 and $74,750, respectively, to a former director of the Company. The former director remains a significant shareholder in the Company.
For the years ended December 31, 2012 and 2011, the Company incurred interest expense to related parties (See Note 9).
NOTE 14. INCOME TAXES
For the year ended December 31, 2012, the annual effective federal tax rate of (2.5%) varies from the U.S. federal statutory rate primarily due to statutory state tax, certain non-deductible expenses and an increase in the valuation allowance associated with the net operating loss carry-forwards. For the year ended December 31, 2012 and 2011, the $24,172 and $12,895 income tax provision is for statutory state tax. Our deferred tax assets related primarily to net operating loss carry-forwards remain fully reserved due to uncertainty of utilization of those assets. The following table summarizes the difference between the actual tax provision and the amounts obtained by applying the statutory tax rates to the income or loss before income taxes for the years ended December 31, 2012 and 2011:
|
|
|
Years Ended December 31,
|
|
|
|
2012
|
|
2011
|
|
Tax benefit calculated at statutory rate
|
|
|
34.0
|
%
|
|
|
34.0
|
%
|
|
Permanent Differences
|
|
|
(0.6
|
)
|
|
|
(0.5
|
)
|
|
State Income Tax
|
|
|
(1.6
|
)
|
|
|
(0.9
|
)
|
|
Other
|
|
|
(0.0
|
)
|
|
|
(0.0
|
)
|
|
Total
|
|
|
31.8
|
|
|
|
32.6
|
|
|
|
|
|
|
|
|
|
|
|
|
Increase to Valuation Allowance
|
|
|
(34.3
|
)
|
|
|
(34.0
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Provision for income taxes
|
|
|
(2.5
|
%)
|
|
|
(1.4
|
%)
|
Deferred tax assets and liabilities are computed by applying the effective U.S. federal and state income tax rate to the gross amounts of temporary differences and other tax attributes. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. At December 31, 2012, the Company believed it was more likely than not that future tax benefits from net operating loss carry-forwards and other deferred tax assets would not be realizable through generation of future taxable income and are fully reserved.
The Company has net operating loss (“NOL”) carry-forwards of approximately $4,800,000 available for federal income tax purposes, which expire from 2026 to 2033. The current year operating loss resulted in an increase in the NOL, however, the overall cumulative NOL decreased in 2012 due to the disposition of HDS further discussed in Note 1. Separately, because of the changes in ownership that occurred on June 30, 2004 and September 30, 2009, prior to GVC merging with HCI, and based on the Section 382 Limitation calculation, the Company will be allowed approximately $6,500 per year of GVC Venture Corp.’s federal NOLs generated prior to June 30, 2004 until they would otherwise expire. The Company would also be allowed approximately $159,000 per year of GVC Venture Corp.’s federal NOLs generated between June 30, 2004 and September 30, 2009 until they would otherwise expire.
Significant components of the Company’s deferred income tax assets and liabilities as of December 31, 2012 and 2011 are as follows:
|
|
|
At December 31, 2012
|
|
|
At December 31, 2011
|
|
|
Net current deferred tax asset:
|
|
|
|
|
|
|
|
Accrual to cash adjustment
|
|
$
|
0
|
|
|
$
|
337,698
|
|
|
Bad Debt Allowance
|
|
|
127,726
|
|
|
|
0
|
|
|
Installment Sale of HDS
|
|
|
(47,465
|
)
|
|
|
0
|
|
|
Net
|
|
|
80,261
|
|
|
|
337,698
|
|
|
Net non-current deferred tax assets:
|
|
|
|
|
|
|
|
|
|
Property and equipment
|
|
|
0
|
|
|
|
(12,221
|
)
|
|
Capital Loss Carryover
|
|
|
94,942
|
|
|
|
0
|
|
|
Deferred rent
|
|
|
104,157
|
|
|
|
143,023
|
|
|
Stock compensation
|
|
|
279,111
|
|
|
|
276,799
|
|
|
Other
|
|
|
9,356
|
|
|
|
2,821
|
|
|
Net operating loss carry-forward
|
|
|
1,634,374
|
|
|
|
1,961,629
|
|
|
Net
|
|
|
2,202,201
|
|
|
|
2,709,749
|
|
|
Less valuation allowance
|
|
|
(2,202,201
|
)
|
|
|
(2,709,749
|
)
|
|
Net deferred taxes
|
|
$
|
–
|
|
|
$
|
–
|
|
NOTE 15. COMMITMENTS AND CONTINGENCIES
The Company leases its office facilities and various office equipment under non-cancelable operating leases which provide for minimum monthly rental payments. Pursuant to an office lease amendment dated September 2, 2011, the Company amended its office facilities agreement to reduce its leased office facilities and make monthly cash payments of $43,552. In amending the agreement, the Company and lessor also agreed to a reduction fee of $257,012, originally due by February 1, 2012, and subsequently agreed to be paid in equal installments over the remaining lease term. The first payment was payable on August 1, 2012. The lease expires on August 28, 2014. This balance is included in deferred rent.
Future minimum rental obligations, including the reduction fee, under leases as of December 31, 2012 are as follows:
Years Ending December 31:
|
|
|
|
|
2013
|
|
$
|
679,966
|
|
|
2014
|
|
|
431,692
|
|
|
2015
|
|
|
1,218
|
|
|
2016 and thereafter
|
|
|
0
|
|
|
Total minimum lease commitments
|
|
$
|
1,112,876
|
|
For the year ended December 31, 2012 and 2011, the Company incurred facilities rent expense totaling $408,850 and $755,572, respectively. The $755,572 includes the $257,012 reduction fee noted above.
In the ordinary course of conducting its business, the Company may be subject to loss contingencies including possible disputes or lawsuits. The Company notes the following;
The Company and certain of its affiliates, officers and directors have been named as defendants in an action filed on December 12, 2011 in the 191
st
District Court of Dallas County, Texas. The Plaintiffs alledge that the Company has misappropriated funds in connection with offerings of securities during 2010 and 2011. The complaint further alleges that Defendants engaged in fraudulent inducement, negligent misrepresentation, fraud, breach of fiduciary duty, negligence, breach of contract, unjust enrichment, conversion, violation of the Texas Securities Act, and civil conspiracy. The Plaintiff’s amended their Petition on April 24, 2012 and dropped the conversion and civil conspiracy claims. The action seeks an injunction and a demand for accounting along with damages in the amount of $4,898,157. The Company has taken the position that the Plaintiff’s claims have no merit, and accordingly is defending the matter vigorously. Defendants have filed a general denial of the claims as well as a Motion to Designate Responsible Third Parties whom Defendants believe are responsible for any damages Plaintiffs may have incurred. Defendants have also filed a Motion for Sanctions against the Plaintiffs and their counsel arguing, among other things, that (i) Plaintiffs’ claims are “judicially stopped” from moving forward by virtue of the fact that the same Plaintiffs previously filed suit against separate entities and parties with dramatically opposed and contradicting views and facts; (ii) Plaintiffs have asserted claims against Defendants without any basis in law or fact; and (iii) Plaintiffs have made accusations against Defendants that Plaintiffs know to be false. Additionally, Defendants have filed a no evidence Motion for Summary Judgment which was scheduled to be heard in October of 2012. The Plaintiff’s requested and were granted a six month continuance on the hearing of that motion. The Plaintiff’s have also filed a Motion to Stay the case pending the outcome of the Company’s lawsuit with the insurance companies which the Company has opposed. Initially the motion to stay was granted and Defendants moved for reconsideration. The parties were alerted that the court had reversed the Stay on appeal but to date, the order reversing the Stay has not been entered.
As noted above, the Company, in conjunction with its Directors and Officers insurance carrier, is defending the matter vigorously. Based on the facts alleged and the proceedings to date, the Company believes that the Plaintiffs’ allegations will prove to be false, and that accordingly, it is not probable or reasonably possible that a negative outcome for the Company or the remaining Defendants will occur. As with any action of this type the timing and degree of any effect upon the Company are uncertain. If the outcome of the action is adverse to the Company, it could have a material adverse effect on our business prospects, financial position, and results of operation.
The Company and certain of its affiliates, officers and directors named as defendants in an insurance action filed on April 27, 2012 in the United States District Court for the Northern District of Texas. The Plaintiffs allege that it had no duty to indemnify the Company, its affiliates, officers or directors because the claims set forth in the lawsuit mentioned herein above were not covered by the insurance policy issued by Plaintiff in favor of Defendants. The action sought declaratory judgment that the Plaintiff had no duty to indemnify the Defendants pursuant to the insurance policy that Defendants purchased from Plaintiff. The Company took the position that Plaintiff’s claim had no merit, and defended the matter vigorously. Additionally, Defendants filed a counterclaim against the insurer alleging breach of contract, violation of the Texas Insurance Code and violation of the duty of good faith and fair dealing. On March 12, 2013, Plaintiff and Defendants entered into an agreement whereby Plaintiff’s and Defendant’s claims, are to be dismissed without prejudice while the underlying liability suit in the 191
st
District Court of Dallas County proceeds. An Agreed Motion to Dismiss Without Prejudice was filed on March 12, 2013, and the parties are awaiting the court’s entry of the Agreed Order of Dismissal Without Prejudice.
As noted above, the Company has defended this matter vigorously. Based on the status of the litigation, it is not probable or reasonably possible that a negative outcome for the Company or the remaining Defendants will occur. As with any action of this type the timing and degree of any effect upon the Company are uncertain. If the outcome of the action is adverse to the Company, it could have a material adverse effect on our financial position.
The Company and certain of its affiliates, officers and directors have been named as defendants in an action filed on July 19, 2012 in the United States District Court for the Northern District of Texas. The Plaintiff alleges that it has no duty to defend or indemnify the Company, its affiliates, officers or directors because the claims set forth in the lawsuit mentioned herein above are not covered by the insurance policy written by Plaintiff in favor or Defendants. The action seeks declaratory judgment that the Plaintiff has no duty to defend or indemnify the Defendants pursuant to the insurance policy that Defendants purchased from Plaintiff. Initially, the Company took the position that Plaintiff’s claims had no merit, and defended the matter vigorously. Additionally, Defendants filed a counterclaim against the insurer alleging breach of contract, violation of the Texas Insurance Code and violation of the duty of good faith and fair dealing. Plaintiff has filed a Motion for Summary Judgment seeking a judgment that it owes no duty to defend or indemnify Defendants. After careful consideration, Defendants decided not to oppose the Motion for Summary Judgment and a response in opposition was not filed. The parties are currently awaiting the court’s ruling.
Based on the current status of the litigation, the Company believes it is not probable or reasonably possible that a negative outcome for the Company or the remaining Defendants will occur. As with any action of this type the timing and degree of any effect upon the Company are uncertain. If the outcome of the action is adverse to the Company, it could have a material adverse effect on our financial position.
The Company granted stock options to certain employees under the HGI 2007 Stock Plan, as amended (the “Plan”). The Company was authorized to issue 2,950,000 shares subject to options, or stock purchase rights under the Plan. These options (i) vest over a period no greater than two years, (ii) are contingently exercisable upon the occurrence of a specified event as defined by the option agreements, and (iii) expire three months following termination of employment or five years from the date of grant depending on whether or not the options were granted as incentive options or non-qualified options. At September 30, 2009, pursuant to the terms of the merger, all options granted prior to the merger were assumed by the Company and any options available for issuance under the Plan but unissued, have been forfeited and consequently the Company has no additional shares subject to options or stock purchase rights available for issuance under the Plan. As of December 31, 2012, 438,300 option shares have been exercised. Total stock options outstanding through December 31, 2012 total 1,215,150. The weighted average remaining contractual life of the outstanding options at December 31, 2012 is approximately 1.34 years.
A summary of stock option activity in the Plan is as follows:
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
Exercise
|
|
|
Average
|
|
|
|
|
Number of
|
|
|
Price
|
|
|
Exercise
|
|
|
|
|
Options
|
|
|
Per Option
|
|
|
Price
|
|
|
Outstanding at December 31, 2010
|
|
|
2,194,070
|
|
|
$
|
0.01 – 1.59
|
|
|
$
|
0.47
|
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Exercised
|
|
|
(64,800
|
)
|
|
|
0.01
|
|
|
|
0.01
|
|
|
Canceled
|
|
|
(666,920
|
)
|
|
|
0.01 – 1.59
|
|
|
|
0.31
|
|
|
Outstanding at December 31, 2011
|
|
|
1,462,350
|
|
|
$
|
0.01 – 1.59
|
|
|
$
|
0.81
|
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Exercised
|
|
|
10,000
|
|
|
|
0.01
|
|
|
|
0.01
|
|
|
Canceled
|
|
|
237,200
|
|
|
|
0.01
|
|
|
|
0.01
|
|
|
Outstanding at December 31, 2012
|
|
|
1,215,150
|
|
|
$
|
0.01 – 1.59
|
|
|
$
|
0.97
|
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All stock options granted under the Plan and as of December 31, 2012 became exercisable upon the occurrence of the merger that occurred on September 30, 2009. As such, equity-based compensation for the options is recognized in earnings from issuance date of the options over the vesting period of the options effective September 30, 2009. Total compensation cost expensed over the vesting period of stock options was $2,103,948, all of which was expensed as of September 30, 2011.
On July 19, 2010, the board of directors approved the Company’s 2010 Incentive Stock Plan (“2010 Stock Plan”). The 2010 Stock Plan allows for the reservation of 7,000,000 shares of the Company’s common stock for issuance under the plan. The 2010 Stock Plan became effective July 19, 2010 and terminates July 18, 2020. During the year ended December 31, 2012, 20,000 shares were granted under the 2010 Stock Plan with an exercise price of $0.34 per option. These are the only shares that have been issued under the 2010 Stock Plan. The shares granted vested immediately and can become exercisable for so long as the Company remains a reporting company under the Securities Exchange Act of 1934. Total compensation cost expensed over the vesting period of the stock options was $6,800. As of December 31, 2012, none of the shares issued under the 2010 Stock Plan have been exercised.
NOTE 17. SHAREHOLDERS’ (DEFICIT) EQUITY
Common Stock
On December 31, 2011 the Company’s Board of Directors declared a stock dividend of Halo Companies Inc. common stock to all holders of HGI Series A Preferred, Series B Preferred, and Series C Preferred (all defined below) for all accrued dividends from June 30, 2010 up through December 31, 2011. This resulted in the board declaring 780,031 shares of common stock valued at $171,602. The common stock was valued using the Black-Scholes model, which resulted in the fair value of the common stock at $0.22 per share. The declaration of these shares resulted in an increase in the accumulated deficit of $171,602. The 780,031 shares were issued by the Company during the year ended December 31, 2012.
On December 13, 2010 (“the Closing”), the Company was party to an Assignment and Contribution Agreement (the “Agreement”). Pursuant to the terms of Agreement, the members of Equitas Asset Management, LLC, (“EAM”), a non Halo entity, which owned 100% of the interests of Equitas Housing Fund, LLC (“EHF”), assigned and contributed 100% of the interests of EAM to HAM (a Halo subsidiary) in exchange for shares of 21,200,000 shares of the Company’s Common Stock, $0.001 par value, of the Company. The Agreement did not constitute a business combination.
The Company issued 7,500,000 shares of Halo common stock in exchange for $3,000,000 in debt or equity capital. The aggregate of 7,500,000 shares of Halo common stock will be subject to clawback (and cancellation) by Halo in the event that EAM does not generate at least three million dollars ($3,000,000) in new capital to Halo within twelve months following the closing. Halo shall have the right to claw back 2.5 shares of Halo common stock for every dollar not raised within the twelve months. Any cash generated by EAM will need to be designated for use in Halo’s general operations and not that of the EHF business to release the clawback rights.
The Company issued 13,700,000 shares of Halo common stock for the purchase of intangible assets owned by EAM which included trade secrets and business processes used in the EHF business. The aggregate 13,700,000 shares of Halo common stock shall be subject to clawback (and cancellation) by Halo in the event that EAM fails to generate at least $10,000,000 of net operating cash flows from the EHF business within twenty-four months following the closing. Halo shall have the right to claw back 1.37 shares of Halo common for every dollar not generated from the net operating cash flows of the EHF business. Once the $10,000,000 in net operating cash flows from the EHF business is generated, the clawback rights will be released.
In applying the guidance of ASC 505 “Equity” to the above transactions, the clawback provisions create a performance commitment that has not been met. As such, although the transaction did provide for a grant date at which time the equity shares are issued and outstanding, the equity shares have not met the measurement date requirements required by ASC 505. Accordingly, the par value of the shares issued and outstanding have been recorded at the grant date and as the clawback rights are released and the measurement dates established, the fair value of the transactions will be determined and recorded. The pro-rata fair value of equity issued in connection with fund raising efforts at each measurement date will be recorded as debt issuance costs or a reduction in the equity proceeds raised by the counter party. The pro-rata fair value of equity issued in connection with the purchase of intangible assets at the measurement date will be recorded as amortization expense because the amortization period of the underlining asset purchase and the clawback release rights are commensurate.
As mentioned above, the Agreement provides for “clawback” provisions, pursuant to which all of the shares of Halo Common Stock issued to the member of EAM are subject to forfeiture in the event certain financial metrics are not timely achieved. The financial metrics call for significant cash generation by EHF within the first 12 months, and within the first 24 months following the closing date. We refer you to Section 2(b)(i) and (ii) of the Agreement, for the specifics of the clawback provisions. As of December 31, 2012, no cash has been generated by EHF. The times to meet both the 12 month and 24 month financial metrics have lapsed and the metrics have not been met. Based upon the events that have transpired, and the lack of progress toward the financial metrics, the Company demanded that the recipients of the shares of Halo Common Stock give effect to both clawback provisions and immediately forfeit back all of the Halo shares issued to such recipients – an aggregate of 21,200,000 shares. Additionally, the Company has instructed the Company’s transfer agent to cancel all of the shares of Company Common Stock issued pursuant to the Agreement. To date, the Company’s transfer agent has refused to cancel the shares without either (i) presentation of the physical certificates to the transfer agent, or (ii) a court order requiring the transfer agent to cancel. At the time of issuing these consolidated financial statements, the Company has been unsuccessful in its attempts to procure the physical certificates for presentment to the transfer agent, and the Company has yet to secure a court order requiring the transfer agent to cancel the certificates. Accordingly, the 21,200,000 shares issued are still outstanding at December 31, 2012.
The Company’s total common shares outstanding totaled 66,364,083 at December 31, 2012.
Preferred Stock
In connection with the merger, the Company authorized 1,000,000 shares of Series Z Convertible Preferred Stock with a par value of $0.01 per share (the “Series Z Convertible Preferred”). The number of shares of Series Z Preferred Stock may be decreased by resolution of the Board; provided, however, that no decrease shall reduce the number of Series Z Preferred Shares to less than the number of shares then issued and outstanding. In the event any Series Z Preferred Shares shall be converted, (i) the Series Z Preferred Shares so converted shall be retired and cancelled and shall not be reissued and (ii) the authorized number of Series Z Preferred Shares set forth in this section shall be automatically reduced by the number of Series Z Preferred Shares so converted and the number of shares of the Corporation’s undesignated Preferred Stock shall be deemed increased by such number. The Series Z Convertible Preferred is convertible into common shares at the rate of 45 shares of common per one share of Series Z Convertible Preferred. The Series Z Convertible Preferred has liquidation and other rights in preference to all other equity instruments. Simultaneously upon conversion of the remaining Series A Preferred, Series B Preferred, and Series C Preferred and exercise of any outstanding stock options issued under the HGI 2007 Stock Plan into Series Z Convertible Preferred, they will automatically, without any action on the part of the holders, be converted into common shares of the Company. Since the merger, in connection with the exercise of stock options into common stock and converted Series A Preferred, Series B Preferred and Series C Preferred as noted above, 82,508 shares of Series Z Convertible Preferred were automatically authorized and converted into shares of the Company’s common stock leaving 917,492 shares of authorized undesignated Preferred Stock in the Company in accordance with the Series Z Convertible Preferred certificate of designation. As of December 31, 2012, there were 82,508 shares of Series Z Preferred authorized with zero shares issued and outstanding.
The Company authorized 175,000 shares of Series X Convertible Preferred Stock with a par value of $0.01 per share (the “Series X Preferred”). The number of shares of Series X Preferred may be decreased by resolution of the Board; provided, however, that no decrease shall reduce the number of Series X Preferred to less than the number of shares then issued and outstanding. In the event any Series X Preferred Shares shall be redeemed, (i) the Series X Preferred so redeemed shall be retired and cancelled and shall not be reissued and (ii) the authorized number of Series X Preferred Shares set forth in this section shall be automatically reduced by the number of Series X Preferred Shares so redeemed and the number of shares of the Corporation's undesignated Preferred Stock shall be deemed increased by such number. The Series X Preferred Shares rank senior to the Company’s common stock to the extent of $10.00 per Series X Preferred Shares and on a parity with the Company’s common stock as to amounts in excess thereof. The holders of Series X Preferred shall not have voting rights. Holders of the Series X Preferred shall be entitled to receive, when and as declared by the board of directors, dividends at an annual rate of 9% payable in cash when declared by the board. Holders of Series X Preferred have a liquidation preference per share equal to $10.00. The liquidation preference was $1,436,770 as of December 31, 2012. During the year ended December 31, 2012, 8,500 Series X Preferred shares have been redeemed through a Halo selective discretionary redemption. As such, as of December 31, 2012, there were 143,677 shares authorized with 143,677 shares issued and outstanding. Of the 143,677 shares issued and outstanding, 53,677 shares were related to the 2010 conversion from notes payable due to related parties. The remaining 90,000 shares were issued for cash consideration.
In April 2012, the Company authorized 100,000 shares of Series E Convertible Preferred Stock (the “Series E Preferred”) with a par value of $0.001 per share, at ten dollars ($10.00) per share with a conversion rate of fifty (50) shares of the Company’s common stock for one share of Series E Preferred. The number of shares of Series E Preferred may be decreased by resolution of the Board; provided, however, that no decrease shall reduce the number of Series E Preferred to less than the number of shares then issued and outstanding. In the event any Series E Preferred Shares shall be converted, (i) the Series E Preferred so converted shall be retired and cancelled and shall not be reissued and (ii) the authorized number of Series E Preferred Shares set forth shall be automatically reduced by the number of Series E Preferred Shares so converted and the number of shares of the Corporation's undesignated Preferred Stock shall be deemed increased by such number. The Series E Preferred Shares rank senior to the Company’s common stock to the extent of $10.00 per Series E Preferred Shares and on a parity with the Company’s common stock as to amounts in excess thereof. The holders of Series E Preferred shall not have voting rights. Holders of the Series E Preferred shall be entitled to receive, when and as declared by the board of directors, dividends at an annual rate of 9% payable in cash or common stock when declared by the board. Holders of Series E Preferred have a liquidation preference per share equal to $10.00. The liquidation preference was $700,000 as of December 31, 2012. Each share of Series E Preferred, if not previously converted by the holder, will automatically be converted into common stock at the then applicable conversion rate after thirty six months from the date of purchase. As of December 31, 2012, there were 70,000 shares issued and outstanding with total cash consideration of $700,000, convertible into 3,500,000 shares of the Company’s common stock.
The HGI Series A Convertible Preferred Stock (the “Series A Preferred”) has a par value of $0.001 per share and has a liquidation preference of the greater of (a) the consideration paid to the Company for such shares plus all accrued but unpaid dividends, if any or (b) the per share amount the holders of the Series A Preferred would be entitled to upon conversion, as defined in the Series A Preferred certificate of designation. The liquidation preference was $605,451, of which $45,953 is an accrued dividend for the year ended December 31, 2012. Holders of the Series A Preferred are entitled to receive, if declared by the board of directors, dividends at a rate of 8% payable in cash or common stock of the Company. The Series A Preferred is convertible into the Company’s common stock at a conversion price of $1.25 per share. The Series A Preferred is convertible, either at the option of the holder or the Company, into shares of the Company’s Series Z Convertible Preferred Stock, and immediately, without any action on the part of the holder, converted into common stock of the Company. The Series A Preferred is redeemable at the option of the Company at $1.80 per share prior to conversion. As of December 31, 2012, there have been 127,001 shares of Series A Preferred converted or redeemed. The Series A Preferred does not have voting rights. The Series A Preferred ranks senior to the following capital stock of the Company: (a) Series B Preferred, and (b) Series C Preferred.
The HGI Series B Convertible Preferred Stock (the “Series B Preferred”) has a par value of $0.001 per share and has a liquidation preference of the greater of (a) the consideration paid to the Company for such shares plus all accrued but unpaid dividends, if any or (b) the per share amount the holders of the Series B Preferred would be entitled to upon conversion. The liquidation preference was $497,789, of which $37,877 is an accrued dividend for the year ended December 31, 2012. Holders of the Series B Preferred are entitled to receive, if declared by the board of directors, dividends at a rate of 8% payable in cash or common stock of the Company. The Series B Preferred is convertible into the Company’s common stock at a conversion price of $1.74 per share. The Series B Preferred is convertible, either at the option of the holder or the Company, into shares of the Company’s Series Z Convertible Preferred Stock, and immediately, without any action on the part of the holder, converted into common stock of the Company. The Series B Preferred is redeemable at the option of the Company at $2.30 per share prior to conversion. As of December 31, 2012, there have been 270,044 shares of Series B Preferred converted or redeemed. The Series B Preferred does not have voting rights. Series B Preferred ranks senior to the following capital stock of the Company: the Series C Preferred.
The HGI Series C Convertible Preferred Stock (the “Series C Preferred”) has a par value of $0.001 per share and has a liquidation preference of the greater of (a) the consideration paid to the Company for such shares plus all accrued but unpaid dividends, if any or (b) the per share amount the holders of the Series C Preferred would be entitled to upon conversion. The liquidation preference was $335,4925, of which $25,492 is an accrued dividend for the year ended December 31, 2012. Holders of the Series C Preferred are entitled to receive, if declared by the board of directors, dividends at a rate of 8% payable in cash or common stock of the Company. The Series C Preferred is convertible into the Company’s common stock at an initial conversion price of $2.27 per share. The Series C Preferred is convertible, either at the option of the holder or the Company, into shares of the Company’s Series Z Convertible Preferred Stock, and immediately, without any action on the part of the holder, converted into common stock of the Company. The Series C Preferred is redeemable at the option of the Company at $2.75 per share prior to conversion. As of December 31, 2012, there have been 28,000 shares of Series C Preferred converted or redeemed. The Series C Preferred does not have voting rights. Series C Preferred ranks senior to the following capital stock of the Company: None.
The Company had issued and outstanding at December 31, 2012, 372,999 shares of Series A Preferred, 229,956 shares of Series B Preferred, and 124,000 shares of Series C Preferred, all with a par value of $0.001.
NOTE 18. SUBSEQUENT EVENTS
Subsequent to December 31, 2012, the CEO and Director of the Board advanced $40,000 for working capital. The advance does not accrue interest. At the time of the filing of these financial statements, a maturity date had not been set.
Subsequent to December 31, 2012, a Director advanced $100,000 for working capital. The advance does not accrue interest. At the time of the filing of these financial statements, a maturity date had not been set.
Subsequent to December 31, 2012, the President of the Company advanced $15,000 for working capital. The advance does not accrue interest. At the time of the filing of these financial statements, a maturity date had not been set.
There were no other subsequent events to disclose.