MERRIMAN CURHAN FORD GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

1. Significant Accounting Policies

 

Basis of Presentation

 

The interim financial statements included herein for Merriman Curhan Ford Group, Inc. (formerly MCF Corporation), or the Company, have been prepared, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. In the opinion of management, the financial statements included in this report reflect all normal recurring adjustments that the Company considers necessary for the fair presentation of the results of operations for the interim periods covered and the financial position of the Company at the date of the interim statement of financial condition. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations. However, the Company believes that the disclosures are adequate to understand the information presented. The operating results for interim periods are not necessarily indicative of the operating results for the entire year. These financial statements should be read in conjunction with the Company’s 2007 audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007.

Securities Owned

 

“Securities owned” and “Securities sold, but not yet purchased” are reflected in the consolidated statements of financial condition on a trade-date basis. Related unrealized gains or losses are generally recognized in “Principal transactions revenue” in the consolidated statements of operations. The fair value of a financial instrument is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (the exit price). Instruments that the Company owns (long positions) are marked to bid prices, and instruments that the Company has sold, but not yet purchased (short positions), are marked to offer prices. Fair value measurements are not adjusted for transaction costs.

Investment Banking Revenue

 

Investment banking revenue includes underwriting and private placement agency fees earned through the Company’s participation in public offerings and private placements of equity and convertible debt securities and fees earned as financial advisor in mergers and acquisitions and similar transactions. Underwriting revenue is earned in securities offerings in which the Company acts as an underwriter and includes management fees, selling concessions and underwriting fees. Fee revenue relating to underwriting commitments is recorded when all significant items relating to the underwriting cycle have been completed and the amount of the underwriting revenue has been determined. This generally is the point at which all of the following have occurred: (i) the issuer’s registration statement has become effective with the SEC, or other offering documents are finalized, (ii) the Company has made a firm commitment for the purchase of the shares or debt from the issuer, and (iii) the Company has been informed of the exact number of shares or the principal amount of debt that it has been allotted.

 

Syndicate expenses related to securities offerings in which the Company acts as underwriter or agent are deferred until the related revenue is recognized or we determine that it is more likely than not that the securities offerings will not ultimately be completed. Underwriting revenue is presented net of related expenses. As co-manager for registered equity underwriting transactions, management must estimate the Company’s share of transaction related expenses incurred by the lead manager in order to recognize revenue. Transaction related expenses are deducted from the underwriting fee and therefore reduces the revenue that is recognized as co-manager. Such amounts are adjusted to reflect actual expenses in the period in which the Company receives the final settlement, typically 90 days following the closing of the transaction.

 

Merger and acquisition fees and other advisory service revenue are generally earned and recognized only upon successful completion of the engagement. Unreimbursed expenses associated with private placement and advisory transactions are recorded as expenses as incurred

 

6

---

 

MERRIMAN CURHAN FORD GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—CONTINUED

(unaudited)

 

1. Significant Accounting Policies - Continued

 

Commissions and Principal Transactions Revenue

 

Commissions revenue includes revenue resulting from executing stock exchange-listed securities, over-the counter securities and other transactions as agent for the Company’s clients. Principal transactions consist of a portion of dealer spreads attributed to the Company’s securities trading activities as principal in NASDAQ-listed and other securities, and include transactions derived from activities as a market-maker. Additionally, principal transactions include gains and losses resulting from market price fluctuations that occur while holding positions in trading security inventory. Commissions revenue and related clearing expenses are recorded on a trade-date basis as security transactions occur. Principal transactions in regular-way trades are recorded on the trade date, as if they had settled. Profit and loss arising from all securities and commodities transactions entered into for the account and risk of the Company are recorded on a trade-date basis.

 

Share-Based Compensation Expense

 

The Company measures and recognizes compensation expense based on estimated fair values for all share-based awards made to employees and directors, including stock options, non-vested stock, and participation in the Company’s employee stock purchase plan. The Company estimates fair value of share-based awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense in the Company’s consolidated statements of operations over the requisite service periods. Share-based compensation expense recognized in the Company’s consolidated statement of operations includes compensation expense for share-based awards granted (i) prior to, but not yet vested as of December 31, 2005, based on the grant date fair value, and (ii) subsequent to December 31, 2005. Compensation expense for all share-based awards subsequent to December 31, 2005 is recognized using the straight-line single-option method. Because share-based compensation expense is based on awards that are ultimately expected to vest, share-based compensation expense has been reduced to account for estimated forfeitures. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

 

To calculate option-based compensation, the Company uses the Black-Scholes option pricing model, which is affected by the Company’s stock price as well as assumptions regarding a number of subjective variables. These variables include, but are not limited to the Company’s expected stock price volatility over the term of the awards, and actual and projected employee stock option exercise behaviors. No tax benefits were attributed to the share-based compensation expense because a valuation allowance was maintained for all net deferred tax assets.

 

Income Taxes

 

The Company uses the asset and liability method of accounting for income taxes. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. A valuation allowance is recorded to reduce deferred tax assets to an amount whose realization is more likely than not. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the consolidated statements of operations in the period that includes the enactment date. Merriman Curhan Ford Group, Inc. adopted FIN No. 48 on January 1, 2007.

 

Segment Reporting

 

The Company organizes its operations into three operating segments for the purpose of making operating decisions and assessing performance. These operating segments are organized along operating subsidiaries, Merriman Curhan Ford & Co., MCF Asset Management, LLC and Panel Intelligence, LLC. Accordingly, the Company operated in three reportable operating segments in the United States during 2008.

Use of Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses. Actual results could differ from those estimates.

 

7

---

 

MERRIMAN CURHAN FORD GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—CONTINUED

(unaudited)

 

1. Significant Accounting Policies - Continued 

 

New Accounting Pronouncements

 

SFAS 141(R). In December 2007, the FASB issued SFAS No. 141(R), Business Combinations. SFAS 141(R) expands the definition of transactions and events that qualify as business combinations; requires that the acquired assets and liabilities, including contingencies, be recorded at the fair value determined on the acquisition date and changes thereafter reflected in revenue, not goodwill; changes the recognition timing for restructuring costs; and requires acquisition costs to be expensed as incurred. Adoption of SFAS 141(R) is required for combinations after December 15, 2008. Early adoption and retroactive application of SFAS 141(R) to fiscal years preceding the effective date are not permitted. The Company is evaluating the impact of adoption on its consolidated financial statements.

 

2. Fair Value of Assets and Liabilities

 

Securities owned, and securities sold but not yet purchased, are presented at fair value. Fair value is defined as the price at which an asset would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (the exit price). Where available, fair value is based on observable market prices or parameters or derived from such prices or parameters. Where observable prices or inputs are not available, valuation models are applied. These valuation techniques involve some level of management estimation and judgment, the degree of which is dependent on the price transparency for the instruments or market and the instruments’ complexity. Assets and liabilities recorded at fair value in the consolidated statement of financial condition are categorized based upon the level of judgment associated with the inputs used to measure their fair value. Hierarchical levels, defined by SFAS 157 and directly related to the amount of subjectivity associated with the inputs to fair valuation of these assets and liabilities, are as follows:

 

Level 1 — Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date. The types of assets and liabilities carried at Level 1 fair value generally are G-7 government and agency securities, equities listed in active markets, investments in publicly traded mutual funds with quoted market prices and listed derivatives.

 

Level 2 — Inputs (other than quoted prices included in Level 1) are either directly or indirectly observable for the asset or liability through correlation with market data at the measurement date and for the duration of the instrument’s anticipated life. Fair valued assets that are generally included in this category are stock warrants for which there are market-based implied volatilities, unregistered common stock and thinly-traded common stock.

 

Level 3 — Inputs reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model. Generally, assets carried at fair value and included in this category include stock warrants for which market-based implied volatilities are not available.

Assets measured at fair value on a recurring basis are categorized in the table below based upon the lowest level of significant input to the valuations.

 

8

---

 

MERRIMAN CURHAN FORD GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—CONTINUED

(unaudited)

 

 2. Fair Value of Assets and Liabilities (continued)

 

		Assets at Fair Value at June 30, 2008
		Level 1			Level 2			Level 3			Total
Corporate equities		$	11,372,856		$	25,000		$	712,811		$	12,110,667
Stock warrants			—			—			5,441,043			5,441,043
Underwriters’ purchase option			—			—			283,714			283,714
Preferred stock			3,000			—			—			3,000
		$	11,375,856		$	25,000		$	6,437,568		$	17,838,424

 

		Assets at Fair Value at December 31, 2007
		Level 1			Level 2			Level 3			Total
Corporate equities		$	13,696,019		$	—		$	489,453		$	14,185,472
Stock warrants			—			—			1,756,580			1,756,580
Underwriters’ purchase option			—			—			194,957			194,957
Convertible notes			228,456			—			—			228,456
Preferred stock			225			—			—			225
		$	13,924,700		$	—		$	2,440,990		$	16,365,690

 

Liabilities measured at fair value on a recurring basis consisted of Securities sold, not yet purchased which are categorized as Level 1. The fair value of Securities sold, not yet purchased as of June 30, 2008 and December 31, 2007 was approximately $1,513,000 and $3,805,000, respectively.

 

The following summarizes the change in carrying values associated with Level 3 financial instruments for the six months ended June 30, 2008:

 

		Corporate Equities			Stock Warrants			Underwriters’ Purchase Option			Total
Balance at December 31, 2007		$	489,453		$	1,756,580		$	194,957		$	2,440,990
Purchases, issuances and settlements			551,809			1,110,586			—			1,662,395
Net transfers in / (out)			(339,453	)		—			—			(339,453	)
Gains / (losses)
Realized			—			—			—			—
Unrealized			11,002			2,573,877			88,757			2,673,636
Balance at June 30, 2008		$	712,811		$	5,441,043		$	283,714		$	6,437,568

 

Gains/(losses) (both realized and unrealized) for Level 3 financial instruments are a component of Principal transactions in the consolidated statements of operations.

 

9

---

 

MERRIMAN CURHAN FORD GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—CONTINUED

(unaudited)

 

 3. Goodwill and Intangible Assets

 

Goodwill is related to the acquisition of MedPanel, Inc. Goodwill, totaling $3,130,000, was allocated to the Primary Research segment pursuant to SFAS No. 142, “Goodwill and Other Intangible Assets”. Goodwill represents the excess cost of a business acquisition over the fair value of the net assets acquired at the acquisition date. Identifiable intangible assets capitalized in connection with the acquisition of MedPanel included customer relationships, customer backlog, technology platform and the database of registered panelists. The estimated fair market value of these amortizable intangible assets at the date of acquisition amounting to $1,990,000 is being amortized over periods ranging from 8 months to 56 months. In addition, an indefinite lived intangible asset was recorded for the acquired tradename in the amount of $710,000.

In accordance with SFAS No. 142, indefinite-life intangible assets and goodwill are not amortized. Rather, they are subject to impairment testing on an annual basis, or more often if events or circumstances indicate there may be impairment. This test involves assigning tangible assets and liabilities, identified intangible assets and goodwill to reporting units and comparing the fair value of each reporting unit to its carrying amount. If the fair value is less than the carrying amount, a further test is required to measure the amount of the impairment.

 

When available, the Company uses recent, comparable transactions to estimate the fair value of the respective reporting unit. The Company calculates an estimated fair value based on multiples of revenue, earnings, and book value of comparable transactions. However, when such comparable transactions are not available or have become outdated, the Company uses discounted cash flow scenarios to estimate the fair value of the reporting units. As of April 30, 2008, the Company performed its annual impairment testing and recorded an impairment loss of $2,602,000 in its consolidated statement of operations for the three and six months ended June 30, 2008 related to goodwill and tradename.

 

4. Share-Based Compensation Expense

Stock Options

 

As of June 30, 2008, there were 6,961,430 shares authorized for issuance under the Option Plans, and 612,858 shares authorized for issuance outside of the Option Plans. As of June 30, 2008, 1,302,108 shares were available for future option grants under the Option Plans. There were no shares available for future option grants outside of the Options Plans. Compensation expense for stock options during the three months and six months ended June 30, 2008 was $402,000 and $784,000, respectively. Compensation expense for stock options during the three months and six months ended June 30, 2007 was $329,000 and $649,000, respectively.

 

The following table is a summary of the Company’s stock option activity for the six months ended June 30, 2008:  

 

			Options Outstanding			Weighted Average Exercise Price
Balance as of December 31, 2007			4,066,259		$	6.00
Granted			608,385			3.75
Exercised			(64,628	)		(2.36	)
Canceled			(300,119	)		(6.87	)
Balance as of June 30, 2008			4,309,897		$	5.68
Exercisable as of June 30, 2008			3,069,672		$	6. 17

 

10

---

MERRIMAN CURHAN FORD GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED

(unaudited)

 

 4. Share Based Compensation Expense (continued)

The following table summarizes information with respect to stock options outstanding at June 30, 2008:

 

		Options Outstanding												Vested Options
Range of Exercise Price		Number			Weighted Average Remaining Contractual Life (Years)			Weighted Average Exercise Price			Aggregate Intrinsic Value			Number			Weighted Average Exercise Price			Aggregate Intrinsic Value
$ 0.00 - $ 3.50			2,007,309			4.86		$	2.98		$	─			1,909,777		$	3.02		$	─
$ 3.51 - $ 7.00			1,592,700			8.11		$	4.45			─			506,212			4.43			─
$ 7.01 - $14.00			414,220			6.06		$	9.24			─			358,015			9.37			─
$14.01 - $28.00			256,381			2.35		$	22.04			─			256,381			22.04			─
$28.01 - $49.00			39,287			1.66		$	49.00			─			39,287			49.00			─
			4,309,897			6.00		$	5.68		$	─			3,069,672		$	6.17		$	─

 

As of June 30, 2008, total unrecognized compensation expense related to unvested stock options was $3,461,340. This amount is expected to be recognized as expense over a weighted-average period of 1.48 years.

Non-Vested Stock

 

At the date of grant, the recipients of non-vested stock have most of the rights of a stockholder other than voting rights, subject to certain restrictions on transferability and a risk of forfeiture. Non-vested shares typically vest over a two to four year period beginning on the date of grant. The fair value of non-vested stock is equal to the market value of the shares on the date of grant. The Company recognizes the compensation expense for non-vested stock on a straight-line basis over the requisite service period. Compensation expense for non-vested stock during the three months and six months ended June 30, 2008 was $251,000 and $533,000, respectively. Compensation expense for non-vested stock during the three months and six months ended June 30, 2007 was $327,000 and $688,000, respectively.

The following table is a summary of the Company's non-vested stock activity for the six months ended June 30, 2007: 

		Non-Vested Stock Outstanding			Weighted Average Grant Date Fair Value			Intrinsic Value at June 30, 2007
Balance as of December 31, 2007			180,620		$	7.51
Granted			30,346			1.92
Vested			(85,307	)		(6.86	)
Canceled			(670	)		(10.97	)
Balance as of June 30, 2008			124,989		$	7.41		$	158,736

 

As of June 30, 2008, total unrecognized compensation expense related to non-vested stock was $539,000. This expense is expected to be recognized over a weighted-average period of 0.78 year.

 

11

---

MERRIMAN CURHAN FORD GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—CONTINUED

(unaudited)

 

4. Share-Based Compensation Expense (continued)

 

2002 Employee Stock Purchase Plan

 

The Company issued all shares previously available under the Employee Stock Purchase Plan, or ESPP, to its employees through August 15, 2007. As of June 30, 2008, there are no shares available under the ESPP plan and the Company has no plan to request additional shares from the stockholders for this program. Compensation expense for ESPP during each of the three months and six months ended June 30, 2008 was $0. Compensation expense for the ESPP during the three months and six months ended June 30, 2007 were $58,000 and $115,700, respectively.

Fair Value and Assumptions Used to Calculate Fair Value

 

The weighted average fair value of each stock option granted for the three months and six months ended June 30, 2008 was $2.31 and $2.49, respectively. The weighted average fair value of each stock option granted for the three months and six months ended June 30, 2007 was $2.53 and $2.56, respectively. The fair value of each option award is estimated on the date of grant using the Black-Scholes stock option pricing model, with the following assumptions for the six months ended June 30, 2008 and 2007: 

 

		Six months Ended June 30,
		2008			2007
Expected volatility			70.42	%		65.83	%
Expected life (years)			6.43			4.17
Risk-free interest rate			3.11	%		4.75	%
Expected dividend yield			0	%		0	%

  The weighted average fair value of the non-vested stock granted under the Company's stock option plans for the three months and six months ended June 30, 2008 was $3.84 and $4.50 per share, respectively. The weighted average fair value of the non-vested stock granted under the Company's stock option plans for the three months and six months ended June 30, 2007 was $4.44 and 4.80 per share, respectively. The fair value of the non-vested stock award is estimated on the date of grant using the intrinsic value method.

5. Income Taxes

 

Income tax expense is a result of applying the estimated annual effective tax rate to cumulative income before taxes adjusted for certain discrete items which are fully recognized in the period they occur.  For the three months and six months ended June 30, 2008, the Company recorded an income tax benefit of ($1,839,000).  The Company’s tax rate is affected by recurring items, which it expects to be fairly consistent in the near term, and by discrete items that are not consistent from year to year.  The effective tax rate for the six months ended June 30, 2008 is (12.64)%, which is mainly attributable to the release of the FIN 48 liability due to the approval of an accounting method change for federal tax purposes.

 

Historically and currently, the Company has recorded a valuation allowance on the deferred tax assets, a significant component of which relates to net operating loss carryforwards.  Management continually evaluates the realizability of its deferred tax assets based upon negative and positive evidence available.  Based on the evidence available at this time, the Company continues to conclude that it is not “more likely than not” that we will be able to realize the benefit of our deferred tax assets in the future.

 

The Company adopted Interpretation No. 48 on January 1, 2007.  Upon the adoption of FIN 48, the Company recognized no adjustment in the liability for unrecognized income tax benefits and no corresponding change in retained earnings.  At the end of the fiscal year 2007, the Company recorded a liability for an uncertain tax position related to certain investments in the amount of $1,839,000.  This entire amount has been derecognized as of June 30, 2008 due to an Internal Revenue service approved accounting method change. 

 

12

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MERRIMAN CURHAN FORD GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED

(unaudited)

5. Income Taxes (continued)

 The Company’s tax years 2005-2007 will remain open for three years for examination by the Internal Revenue Service from the date the federal corporation tax returns were filed.  The Company’s tax years 2003-2007 will remain open for three to four years for examination by state tax authorities from the date the state corporation tax returns were filed.  Net operating losses deducted are subject to review and adjustment for three to four years after the net operating losses are deducted on the U.S. and state returns filed.

6. (Loss)/Earnings per Share

 

The following is a reconciliation of the basic and diluted net (loss) income available to common stockholders and the number of shares used in the basic and diluted net (loss) income per common share computations for the periods presented:

		Three Months Ended June 30,						Six Months Ended June 30,
		2008			2007			2008			2007
Net (loss) income available to stockholders - basic		$	(5,113,845	)	$	2,320,373		$	(12,163,818	)	$	2,389,629
Interest on dilutive securities			500			4,084			4,584			8,168
Net (loss) income available to stockholders - diluted		$	(5,113,345	)	$	2,324,457		$	(12,159,234	)	$	2,397,797
Weighted-average number of common shares - basic			12,562,120			11,657,775			12,425,851			11,000,702
Weighted-average number of common shares - diluted			12,562,120			12,856,306			12,425,851			12,208,965
Basic net income (loss) per common share:		$	(0.41	)	$	0.20		$	(0.98	)	$	0.22
Diluted net loss per common share:		$	(0.41	)	$	0.18		$	(0.98	)	$	0.20

Basic (loss) earnings per share is computed by dividing net (loss) income by the weighted average number of common shares outstanding, excluding shares of non-vested stock. Diluted earnings per share is calculated by dividing net income, plus interest and dividends on dilutive securities, by the weighted average number of common shares used in the basic earnings per share calculation plus the number of common shares that would be issued assuming exercise or conversion of all potentially dilutive common shares outstanding, including non-vested stock. Diluted loss per share is unchanged from basic loss per share for the three months and six months ended June 30, 2008 because the addition of common shares that would be issued assuming exercise or conversion would be anti-dilutive.

  

13

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MERRIMAN CURHAN FORD GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED

(unaudited)

6. (Loss)/Earnings per Share (continued)

Shares used in the diluted net income per share computation include the dilutive impact of the Company's stock options and warrants. The impact of the Company's stock options and warrants on shares used for the diluted earnings per share computation is calculated based on the average share price of the Company's common stock for each period using the treasury stock method. Under the treasury stock method, the tax-effected proceeds that would be hypothetically received from the exercise of all stock options and warrants with exercise prices below the average share price of the Company's common stock are assumed to be used to repurchase shares of the Company's common stock. Because the Company reported a net loss during the three months and six months ended June 30, 2008, the Company excluded the impact of all stock options and warrants in the computation of dilutive earnings per share, as their effect would be anti-dilutive.

The Company excludes all potentially dilutive securities from its diluted net (loss) income per share computation when their effect would be anti-dilutive. The following common stock equivalents were excluded from the earnings per share computation, as their inclusion would have been anti-dilutive:

		Three Months Ended June 30,						Six Months Ended June 30,
		2008			2007			2008			2007
Stock options and warrants excluded due to the exercise price exceeding the average fair value of the Company's common stock during the period			4,198,770			1,682,257			2,226,464			1,637,949
Weighted average non-vested stock, stock options and stock warrants, calculated using the treasury stock method, that were excluded due to the Company reporting a net loss during the period			348,754			─			740,477			─
Weighted average shares issuable for the period prior to the conversion of the convertible notes payable			45,526			─			94,192			─
Total common stock equivalents excluded from diluted net (loss) income per share			4,593,050			1,682,257			3,061,133			1,637,949

7. Regulatory Requirements

 

Merriman Curhan Ford & Co. is a broker-dealer subject to Rule 15c3-1 of the Securities and Exchange Commission, which specifies uniform minimum net capital requirements, as defined, for their registrants. As of June 30, 2008, Merriman Curhan Ford & Co. had regulatory net capital, as defined, of $6,398,982, which exceeded the amount required by $5,398,982. Merriman Curhan Ford & Co. is exempt from Rules 15c3-3 and 17a-13 under the Securities Exchange Act of 1934 because it does not carry customer accounts, nor does it hold customer securities or cash.

 

14

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MERRIMAN CURHAN FORD GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—CONTINUED

(unaudited)

 

8. Business Segments

 

The Company’s business results are categorized into the following three segments: investment bank / broker-dealer, primary research and asset management. The investment bank / broker-dealer segment includes a broad range of services, such as capital raising and financial advisory services for corporate clients, and brokerage and equity research services for our institutional investor clients. Our primary research segment offers custom, independent primary research services to health care and CleanTech companies, as well as financial services firms that invest in these companies. Our asset management segment manages investment products for investors.

 

The accounting policies of the segments are consistent with those described in the Significant Accounting Policies in Note 2. Revenue generating activities between segments are eliminated from the segments results for reporting purposes. These activities include fees paid by the Asset Management segment to the Primary Research segment for the management of its investment portfolio.

 

·

Capital Raising - Capital raising includes private placements of equity and debt instruments and underwritten public offerings.

 

·

Financial Advisory - Financial advisory includes advisory assignments with respect to mergers and acquisitions, divestures, restructurings and spin-offs.

 

The following table sets forth our revenue and transaction volumes from our investment banking activities for the three months and six months ended June 30, 2008 and 2007:

 

		Three Months Ended						Six Months Ended
		June 30, 2008			June 30, 2007			June 30, 2008			June 30, 2007
Revenue:
Capital raising		$	4,252,495		$	5,126,556		$	7,482,685		$	9,146,527
Financial advisory and other			194,500			505,000			340,721			717,500
Total investment banking revenue		$	4,446,995		$	5,631,556		$	7,823,406		$	9,864,027
Transaction Volumes:
Public offerings:
Capital underwritten participations		$	8,153,000		$	72,750,000		$	8,153,000		$	105,250,000
Number of transactions			2			4			2			7
Private placements:
Capital raised		$	43,276,000		$	22,985,000		$	75,700,000		$	86,585,000
Number of transactions			6			3			10			6

 

Our investment banking revenue was $4,447,000 or 28% of our revenue during second quarter 2008, representing a 21% decrease from the similar quarter in 2007. Second quarter of 2008 represented a different operating environment where the ability to execute larger transactions was more difficult than what we have experienced in the same period in 2007. However, banking revenue for the three months ended June 30, 2008 has rebounded versus the first quarter 2008 up 32% sequentially driven by an increased number of deals. We participated in two secondary public offerings during the latest quarter and acted as placement agent for five private placements during the quarter.

 

During the six months ended June 30, 2008, we had one investment banking client that accounted for 18% of our revenue, while no single investment banking client accounted for more than 10% of our revenue during the first half of 2007.

Commissions and Principal Transactions Revenue

 

Our broker-dealer activity includes the following:

 

·

Commissions - Commissions include revenue resulting from executing stock trades for exchange-listed securities, over-the-counter securities and other transactions as agent.

 

·

Principal Transactions - Principal transactions consist of a portion of dealer spreads attributed to our securities trading activities as principal in NASDAQ-listed and other securities, and include transactions derived from our activities as a market-maker. Additionally, principal transactions include gains and losses resulting from market price fluctuations that occur while holding positions in our trading security inventory.

 

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The following table sets forth our revenue and several operating metrics which we utilize in measuring and evaluating performance and the results of our trading activity operations:

		Three Months Ended						Six Months Ended
		June 30, 2008			June 30, 2007			June 30, 2008			June 30, 2007
Revenue:
Commissions		$	7,892,372		$	7,717,573		$	16,361,082		$	14,883,280
Principal transactions:
Customer principal transactions, proprietary trading and market making		$	112,637		$	4,669,144		$	(3,672,105	)	$	7,354,753
Investment portfolio			1,306,192			1,043,508			3,775,858			971,023
Total principal transactions revenue		$	1,418,829		$	5,712,652		$	103,753		$	8,325,776
Transaction Volumes:
Number of shares traded			329,419,357			247,476,532			561,535,539			477,147,878
Number of active clients			343			408			444			488

Commissions amounted to $7,892,000, or 50%, of our revenue during the second quarter 2008, representing a 2% increase from the similar period in 2007. Lower brokerage commissions were offset by higher revenue for brokering institutional money funds by our Institutional Cash Distributors division.

 

Principal transactions produced modest gains of $112,637 during the second quarter 2008 versus our record gains experienced in 2007. The 2008 gain included increased profitability in our market making activities, as well as realized and unrealized gains in our investment portfolio. As of June 30, 2008, we made markets in 1,361 stocks, which has increased from 1,100 stocks as of June 30, 2007. We view “intelligent market making” in small cap stocks as a key element to differentiating ourselves from our competition. Principal transactions revenue consists of four different activities - customer principal trades, market making, trading for our proprietary account, and realized and unrealized gains and losses in our investment portfolio. As a broker-dealer, we account for all of our marketable security positions on a trading basis and as a result, all security positions are marked to fair market value each day. Returns from market making and proprietary trading activities tend to be more volatile than acting as agent or principal for customers.

 

During 2008 and 2007, no single brokerage customer accounted for more than 10% of our revenue from continuing operations.

Primary Research Revenue

 

Panel Intelligence provides primary market research to corporate and financial clients in the healthcare and CleanTech industries. The predecessor business which was called MedPanel was acquired April 17, 2007. For the quarter ended June 30, 2008, Panel revenues were up 58% to $1,498,000 versus the same period in 2007. The growth has been primarily driven by increased business in the healthcare industry. However, we have not seen the acceleration in the financial services industry that was originally estimated when we acquired the business. We believe this is more related to the current challenging market environment and not a reduction in opportunity. That said, the current revised outlook for this segment of the business was a contributing factor in our impairment analysis of the balance sheet assets for Panel Intelligence. See Other Operating Expenses below for further information.

 

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Compensation and Benefits Expenses

 

Compensation and benefits expense represents the largest component of our operating expenses and includes incentive compensation paid to sales, trading, research and investment banking professionals, as well as discretionary bonuses, salaries and wages, and stock-based compensation. Incentive compensation varies primarily based on revenue production. Discretionary bonuses paid to research analysts also vary with commissions revenue production, but includes other qualitative factors as well. Salaries, payroll taxes and employee benefits vary based on overall headcount.

The following table sets forth the major components of our compensation and benefits for the three months ended June 30, 2008 and 2007:

		Three Months Ended						Six Months Ended
		June 30, 2008			June 30, 2007			June 30, 2008			June 30, 2007
Incentive compensation and discretionary bonuses		$	6,139,517		$	7,708,451		$	12,355,067		$	13,383,686
Salaries and wages			4,242,553			3,559,646			8,552,376			6,599,791
Stock-based compensation			653,821			714,159			1,316,606			1,451,862
Payroll taxes, benefits and other			1,066,677			784,831			3,049,161			2,142,035
Total compensation and benefits		$	12,102,568		$	12,767,087		$	25,273,210		$	23,577,374
Total compensation and benefits as a percentage of revenue			77	%		63	%		92	%		68	%
Cash compensation and benefits as a percentage of revenue			72	%		59	%		87	%		64	%

The decrease in compensation and benefits expense of $664,519 or 5%, from the second quarter 2007 to the second quarter 2008 represents lower incentive compensation, which is directly correlated to revenue production. Cash compensation is equal to total compensation and benefits expense excluding stock-based compensation, which is a non-cash expense. Cash compensation and benefits expense as a percentage of revenue increased to 77% during the three months ended June 30, 2008 as compared to 63% during the similar period in 2007. The increase was largely attributed to lower than anticipated revenues especially in our proprietary trading account during the three months ended June 30, 2008 versus same period in 2007. We do not historically pay commissions on gains in this account, driving higher gross profits. During the second quarter of 2007 proprietary trading contributed $3,709,000 in trading gains versus a loss of $436,378 in the same period in 2008. In addition, as revenues decrease, the fixed portion of the compensation base becomes a larger impact on the percentage of total revenues.

 

No single sales professional accounted for more than 10% of our revenue during the six months ended June 30, 2008 and 2007.

 

Stock-based compensation expense decreased by $60,000 during the second quarter 2008, as compared to the similar quarter in 2007. The decline in stock-based compensation expense was due in part to fewer non-vested restricted shares outstanding in 2008.

Other Operating Expenses

 

Brokerage and clearing fees include trade processing expenses that we pay to our clearing broker and execution fees that we pay to floor brokers and electronic communication networks. Merriman Curhan Ford & Co. is a fully-disclosed broker-dealer, which has engaged a third party clearing broker to perform all of the clearance functions. The clearing broker-dealer processes and settles the customer transactions for Merriman Curhan Ford & Co. and maintains the detailed customer records. Additionally, security trades are executed by third-party broker-dealers and electronic trading systems. These expenses are almost entirely variable with commission revenue and the volume of brokerage transactions. Our brokerage and clearing fees increased by $47,000, or 7%, during the second quarter of 2008 as compared to the second quarter of 2007. This increase reflected higher costs associated with execution of foreign securities for our clients during second quarter 2008 as compared to second quarter 2007. Execution fees for foreign securities are higher than they are for domestic securities.

 

Cost of primary research revenue principally consists of panelist honorarium and recruitment costs. Technical experts (mostly in the medical field but including those in the CleanTech and technology fields) receive cash honoraria for participating in qualitative panels and quantitative surveys. We pay the honoraria to the panelists when the panel or survey has been completed and record this expense as incurred. We closed the acquisition of MedPanel on April 17, 2007 and began recognizing primary research revenue and related expenses since that date.

 

Professional services expense includes legal, audit, consulting fees, as well as expenses related to investment banking transactions. The increase of $1,771,000 or 252%, from the second quarter of 2007 to the second quarter of 2008 was primarily attributed to higher legal fees associated with defending the Company in the litigations in which it is involved and with various projects, as well as higher business development costs associated with investment banking transactions.

 

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Occupancy and equipment includes rental costs for our office facilities and equipment, as well as equipment, software and leasehold improvement expenses. These expenses are largely fixed in nature. The increase of $236,000 or 52%, from the second quarter of 2007 to the second quarter of 2008 was in part due to inclusion of expenses from Panel Intelligence and a subsequent move to a new office location in August of 2007, as well as higher costs associated with a new lease for our New York office, which commenced in March 2008.

 

Communications and technology expense includes market data and quote services, voice, data and Internet service fees, and data processing costs. Historically, these costs have increased as we hire additional employees. The increase of $127,000, or 14%, from the second quarter of 2007 to the second quarter of 2008 was primarily due to the new lease in New York and Boston as well as increased investment in data services for the Asset Management business.

 

Depreciation and amortization expense primarily relate to the depreciation of our computer equipment and leasehold improvements. The decrease of $19,000, or 10%, from the second quarter of 2007 to the second quarter of 2008 was due to a decrease in book value of computer equipment and furniture as they become fully depreciated.

As of April 30, 2008, the Company determined there was an impairment to the goodwill and intangible assets related to the acquisition of MedPanel, Inc. (currently its subsidiary Panel Intelligence, LLC). The Company calculates an estimated fair value based on multiples of revenue, earnings, and book value of comparable transactions. However, when such comparable transactions are not available or have become outdated, the Company uses discounted cash flow scenarios to estimate the fair value of the reporting units. As of April 30, 2008, the Company performed its annual impairment testing and recorded an impairment loss of $2,600,000 in its consolidated statement of operations for the three months and six months ended June 30, 2008 related to the goodwill and tradename. This is a non-cash expense item.

 

Travel and entertainment expense results from business development activities across our various businesses. The increase of $327,000 or 48%, from the second quarter of 2007 to the second quarter of 2008 was due mostly to increased costs associated with non-deal related roadshows, client visits, and business development.

Other operating expense includes company events, recruiting fees, professional liability and property insurance, marketing, business licenses and taxes, office supplies and other miscellaneous office expenses. The increase of approximately $153,000 or 14%, from the second quarter of 2007 to the second quarter of 2008 was partly due to increased marketing expenses somewhat offset by lower recruiting fees.

 

Income Tax Expense

 

At the end of each interim reporting period the Company calculates an effective tax rate based on the Company’s estimate of the tax provision (benefit) that will be provided for the full year, stated as a percentage of estimated annual pre-tax income (loss). The tax provision (benefit) for the interim period is determined using this estimated annual effective tax rate. For the three months and six months ended June 30, 2008, the Company recorded $0 and $1,839,000 of income tax benefit, respectively. The effective tax rate for the six months ended June 30, 2008 is (12.64)%, which is mainly attributable to the release of the FIN 48 liability due to the approval of an accounting method change for federal tax purposes.

 

Historically and currently, the Company has recorded a valuation allowance on the deferred tax assets, the significant component of which relates to net operating loss tax carryforwards. Management continually evaluates the realizability of its deferred tax assets based upon negative and positive evidence available. Based on the evidence available at this time, the Company continues to conclude that it is not “more likely than not” that we will be able to realize the benefit of our deferred tax assets in the future.

The Company adopted Interpretation No. 48 on January 1, 2007. Upon the adoption of FIN 48, the Company recognized no adjustment in the liability for unrecognized income tax benefits and no corresponding change in retained earnings. At the end of the fiscal year 2007, the Company recorded a liability for an uncertain tax position related to certain investments in the amount of $1,839,000. This entire amount has been derecognized as of June 30, 2008 due to an Internal Revenue service approved accounting method change. 

The Company’s tax years 2005-2007 will remain open for three years for examination by the Internal Revenue Service from the date the federal corporation tax returns were filed. The Company’s tax years 2003-2007 will remain open for three to four years for examination by state tax authorities from the date the state corporation tax returns were filed. Net operating losses deducted are subject to review and adjustment for three to four years after the net operating losses are deducted on the U.S. and state returns filed.

 

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Off-Balance Sheet Arrangements

We were not a party to any off-balance sheet arrangements during the six months ended June 30, 2008 and 2007. In particular, we do not have any interest in so-called limited purpose entities, which include special purpose entities and structured finance entities.

 

Commitments

The following table summarizes our significant commitments as of June 30, 2008, consisting of debt payments related to convertible notes payable, non-convertible notes payable, capital leases and future minimum lease payments under all non-cancelable operating leases with initial or remaining terms in excess of one year.

 

		Operating Leases			Capital Leases
2008		$	1,377,663		$	280,338
2009			2,624,011			407,369
2010			2,019,930			268,853
2011			1,923,516			146,647
2012			1,174,323			—
Thereafter			572,000			—
Total commitments		$	9,691,443		$	1,103,207

 

Critical Accounting Policies and Estimates

 

The consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States, which require us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to the valuation of securities owned and deferred tax assets. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.

 

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