PINX:SOHL Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q
(Mark One)
þ
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended June 30, 2012
 
 o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ______ to ___________
Commission file number: 000-52618

SOUTHERN TRUST SECURITIES HOLDING CORP.
(Exact name of registrant as specified in its charter)

Florida
 
651001593
(State or other jurisdiction of Incorporation or organization)
 
(I.R.S Employer Identification No.)
 
145 Almeria Ave., Coral Gables, Florida
 
33134
(Address of principal executive offices)
 
(Zip Code)

(305) 446-4800
(Registrant’s telephone area, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes  þ No  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer o Accelerated filer o
Non-accelerated filer o Smaller reporting company þ
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o No þ

State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date:

The registrant had 19,177,826 shares of common stock issued and outstanding on July 18, 2012.

Introductory Note:  The Registrant qualifies as a “smaller reporting company” and has elected to comply with the requirements applicable to smaller reporting companies set forth in Regulation S-K and Form 10-Q.

 
 

 
 
INDEX
 
 Item 1.
Consolidated Interim Financial Statements
     
         
 
Consolidated Statements of Financial Condition as of June 30, 2012 and December 31, 2011
    3  
           
 
Consolidated Statements of Operations and Comprehensive Income (Loss) for the three and six months ended June 30, 2012 and 2011
    4  
           
 
Consolidated Statements of Changes in Stockholders’ Equity
    5  
           
 
Consolidated Statements of Cash Flows for the six months ended June 30, 2012 and 2011
    6  
           
 
Notes to Consolidated Financial Statements
    7  
           
 Item 2.  
Management’s Discussion and Analysis
    30  
           
 Item 3.  
Quantitative and Qualitative Disclosures About Market Risk
    41  
           
 Item 4.  
Controls and Procedures
    41  
           
 PART II        
           
 Item 1.  
Legal Proceedings
    43  
           
 Item 1A.  
Risk Factors
    45  
           
 Item 2.  
Unregistered Sale of Equity Securities and Use of Proceeds
    45  
           
 Item 3.  
Default Upon Senior Securities
    45  
           
 Item 4.  
None.
    45  
           
 Item 5.  
Other Information
    45  
           
 Item 6.  
Exhibits
    45  
           
Signature Page     46  

 
2

 
 
PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS
 
SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
 
   
June 30,
   
December 31,
 
   
2012
   
2011
 
   
(Unaudited)
       
ASSETS
           
             
Cash and cash equivalents
  $ 298,779     $ 339,445  
                 
Securities owned at fair value
  $ 1,006,642       957,953  
                 
Receivable from ProBenefit, S.A.
  $ 1,100,000       -  
                 
Due from clearing brokers
  $ 5,966,648       4,480,177  
                 
Commissions receivable
  $ 76,774       76,566  
                 
Investment in AR Growth
  $ 22,370       22,370  
                 
Investment in Nexo Emprendimientos, S.A. (see Note 16)
  $ 1,524,704       1,763,855  
                 
Other assets
  $ 27,734       17,322  
                 
Property and equipment, net
  $ 1,552,722       1,555,628  
                 
Total assets
  $ 11,576,373     $ 9,213,316  
                 
                 
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
                 
Liabilities
               
Accounts payable and accrued expenses
  $ 432,712     $ 290,805  
Payable to customers
    6,077,764       4,715,566  
Notes payable
    671,032       700,739  
                 
Total liabilities
  $ 7,181,508       5,707,110  
                 
Commitments and contingencies (notes 15 and 16)
               
                 
Stockholders' equity
               
Series C 8% convertible preferred stock, no par value, 2.5 million shares authorized,
         
520,000 issued and outstanding
    5,200,000       5,200,000  
Common stock, no par value, 100 million shares authorized; 19,177,826 and 19,177,826
         
shares issued and outstanding at June 30, 2012 and December 31, 2011, respectively
    10,474,760       10,474,760  
   Additional paid-in capital
    1,866,515       1,729,538  
Accumulated deficit
    (13,240,187 )     (13,992,111 )
Accumulated other comprehensive loss
    (24,531 )     (18,154 )
                 
Total Southern Trust Securities Holding Corp. and Subsidiaries stockholders' equity
    4,276,557       3,394,033  
Noncontrolling interest
    118,308       112,173  
Total stockholders' equity
    4,394,865       3,506,206  
                 
Total liabilities and stockholders' equity
  $ 11,576,373     $ 9,213,316  
 
See accompanying notes to consolidated financial statements.
 
 
3

 
SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
 
   
Three Months
   
Three Months
   
Six Months
   
Six Months
 
   
Ended
   
Ended
   
Ended
   
Ended
 
   
June 30,
   
June 30,
   
June 30,
   
June 30,
 
   
2012
   
2011
   
2012
   
2011
 
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
 
Revenues
                       
Trading income
  $ 387,486     $ 532,207     $ 970,063     $ 897,010  
Commissions
  $ 278,300     $ 177,853     $ 370,287     $ 558,189  
Investment banking fees
  $ -     $ -     $ -     $ 3,704  
Managed account fees
  $ 25,027     $ 19,027     $ 47,627     $ 38,742  
Interest and dividend income
  $ 12,989     $ 12,346     $ 47,375     $ 22,292  
Other income
  $ 180,844     $ 75,000     $ 196,167     $ 75,000  
                                 
      884,646     $ 816,433     $ 1,631,519     $ 1,594,937  
                                 
Expenses
                               
Commissions and clearing fees
    379,758     $ 420,551     $ 769,012     $ 853,971  
Employee compensation and benefits
    225,627     $ 186,751     $ 430,066     $ 373,572  
Occupancy
    12,021     $ 16,506     $ 33,397     $ 33,309  
Communications and market data
    70,449     $ 49,379     $ 121,648     $ 80,259  
Professional fees
    145,284     $ 107,394     $ 271,546     $ 224,609  
Travel and entertainment
    18,060     $ 22,851     $ 33,144     $ 31,539  
Depreciation and amortization
    17,088     $ 15,814     $ 32,047     $ 31,627  
Interest expense
    12,711     $ 3,945     $ 25,618     $ 27,925  
Other operational expenses
    59,350     $ 63,524     $ 117,831     $ 101,233  
                                 
      940,348     $ 886,715     $ 1,834,309     $ 1,758,044  
                                 
                                 
Loss from operations
    (55,702 )     (70,282 )     (202,790 )     (163,107 )
                                 
Gain on exercise of put option
    750,242     $ -     $ 750,242     $ -  
                                 
Income (loss) before equity income (loss) of NEXO Emprendimientos SA
    694,540       (70,282 )     547,452       (163,107 )
                                 
Equity in income (loss) of NEXO Emprendimientos SA
    351,427     $ (106,725 )   $ 210,607     $ (262,502 )
                                 
Net income (loss)
    1,045,967     $ (177,007 )   $ 758,059     $ (425,609 )
                                 
Net income attributable to noncontrolling interest
    5,541     $ 24     $ 6,135     $ 915  
                                 
Net income (loss) attributable to Southern Trust Securities Holding Corp.
                         
and Subsidiaries
  $ 1,040,426     $ (177,031 )   $ 751,924     $ (426,524 )
Preferred Stock Dividends
  $ -     $ (52,000 )   $ -     $ (52,000 )
                                 
                                 
Net income (loss) applicable to common stockholders
  $ 1,040,426     $ (229,031 )   $ 751,924     $ (478,524 )
                                 
                                 
Comprehensive income (loss):
                               
Net income (loss)
  $ 1,045,967     $ (177,007 )   $ 758,059     $ (425,609 )
Foreign currency translation adjustment
    (12,654 )   $ 4,659     $ (6,377 )   $ 16,002  
 
                               
Total Comprehensive income (loss)
    1,033,313     $ (172,348 )   $ 751,682     $ (409,607 )
Comprehensive income (loss) attributable to noncontrolling interest
    5,541     $ 24     $ 6,135     $ 915  
                                 
Comprehensive income (loss) attributable to Southern Trust Securities Holding Corp. and subsidiaries
  $ 1,027,772     $ (172,372 )   $ 745,547     $ (410,522 )
                                 
                                 
Weighted average common shares outstanding
                               
Basic
    19,177,826       15,451,328     $ 19,177,826     $ 14,895,441  
                                 
Diluted
    21,257,826       15,451,328       21,257,826       14,895,441  
                                 
Net income (loss) per common share
                               
Basic
  $ 0.05     $ (0.01 )   $ 0.04     $ (0.03 )
                                 
Diluted
  $ 0.05     $ (0.01 )   $ 0.04     $ (0.03 )
 
See accompanying notes to consolidated financial statements.
 
4

 
 
SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLERS' EQUITY
 
                                                     
                                  Total Southern Trust Securities Holding              
                                               
                                               
                            Accumulated     Corp. and              
               
Additional
         
Other
    Subsidiaries           Total  
   
Preferred Stock
   
Common Stock
   
Paid-In
   
Accumulated
   
Comprehensive
   
Stockholders'
   
Noncontrolling
   
Stockholders'
 
   
Shares
   
Amount
   
Shares
   
Amount
   
Capital
   
Deficit
   
(loss)
   
Equity
   
Interest
   
Equity
 
                                                             
Balance, December 31, 2011
    520,000     $ 5,200,000       19,177,826     $ 10,474,760     $ 1,729,538     $ (13,992,111 )   $ (18,154 )   $ 3,394,033     $ 112,173     $ 3,506,206  
                                                                                 
                                                                                 
Stock based compensation
                              136,977                       136,977               136,977  
                                                                                 
Comprehensive loss:
                                                                               
                                                                                 
         Net income
                                            751,924               751,924       6,135       758,059  
Foreign currency
                                                                               
currency adjustment
                                              (6,377 )     (6,377 )             (6,377 )
                                                                                 
Balance, June 30, 2012
    520,000     $ 5,200,000       19,177,826     $ 10,474,760     $ 1,866,515     $ (13,240,187 )   $ (24,531 )   $ 4,276,557     $ 118,308     $ 4,394,865  
 
See accompanying notes to consolidated financial statements.

 
5

 
 
SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
   
Six Months
   
Six Months
 
   
Ended
   
Ended
 
   
June 30,
   
June 30,
 
   
2012
   
2011
 
   
(Unaudited)
   
(Unaudited)
 
Cash flows from operating activities
           
             
Net income (loss )
  $ 758,059     $ (425,609 )
Adjustments to reconcile net income (loss) to net cash (used in) provided by
         
operating activities:
               
Stock-based compensation - employees
  $ 136,977       95,947  
Depreciation and amortization
  $ 32,047       31,627  
(Gain) Loss in equity of affiliate
  $ (210,607 )     262,502  
Gain on exercise of put option   $ (750,242 )     -  
Changes in operating assets and liabilities:
               
Securities owned
  $ (48,689 )     (8,073 )
Due from clearing broker
  $ (1,486,471 )     (2,134,059 )
Commissions receivable
  $ (208 )     51,968  
Other assets
  $ (10,412 )     3,351  
Accounts payable and accrued expenses   $ 141,907       76,376  
Payable to customers
  $ 1,362,198       2,230,468  
                 
Net cash (used in) provided by operating activities
  $ (75,441 )     184,498  
                 
Cash Flows from investing activities
               
                 
  Purchases of equipment
  $ (29,141 )     -  
  Purchases of equity investment
  $ -       (1,000,000 )
  Proceeds from exercise of put option
  $ 100,000       -  
                 
Net cash provided by (used in) investing activities
  $ 70,859       (1,000,000 )
                 
Cash flows from financing activities
               
                 
   Proceeds from sale of common stock
  $ -       1,042,857  
   Dividends paid to preferred stockholders
  $ -       (52,000 )
   Principal payments on notes payable and capital lease obligations
  $ (29,707 )     (30,198 )
                 
Net cash flows (used in) provided by financing activities
  $ (29,707 )     960,659  
                 
Effect of foreign exchange rate changes
               
on cash and cash equivalents
  $ (6,377 )     16,002  
                 
Net (decrease) increase in cash and cash equivalents
  $ (40,666 )     161,159  
                 
Cash and cash equivalents, beginning of period
  $ 339,445       281,878  
                 
Cash and cash equivalents, end of period
  $ 298,779     $ 443,037  
                 
Supplementary disclosure of cash flow information:
               
                 
Cash paid during the years for interest
  $ 25,618     $ 27,925  
                 
Noncash investing and financing activities
               
Receivable from ProBenefit, S.A. in connection with exercise of put   $ 1,100,000     $ -  
 
See accompanying notes to consolidated financial statements.

 
6

 
 
SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
1.  Basis of Presentation

The following (a) condensed consolidated statement of financial condition as of June 30, 2012, which has been derived from audited financial statements, and (b) the unaudited condensed consolidated interim financial statements included herein have been prepared by Southern Trust Securities Holding Corp. and subsidiaries  (collectively, the “Company”) in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and the instructions to the quarterly report on Form 10-Q and Rule 8-03 of Regulation S-X. We are providing herein the consolidated interim statements of financial condition of Southern Trust Securities Holding Corp. and subsidiaries (collectively the "Company") as of June 30, 2012 and December 31, 2011, and the related consolidated interim statements of operations and comprehensive income (loss) for the three and six months ended June 30, 2012 and 2011, and cash flows for the six months ended June 30, 2012 and 2011 and the consolidated interim statements of changes in stockholders equity and comprehensive income (loss) for the six months ended June 30, 2012.  Certain information and footnote disclosures normally included in the financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. The consolidated interim financial statements should be read in conjunction with the Company's consolidated financial statements and related notes contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2011 as filed with the SEC.

The information furnished in this report reflects all adjustments consisting of only normal recurring adjustments, which are in the opinion of management necessary for a fair presentation of the results for the interim periods. The results of operations for the three and six months ended June 30, 2012 are not necessarily indicative of results that may be expected for the fiscal year ending December 31, 2012

2.  Nature of operations
 
Southern Trust Securities Holding Corp. (the "Company”) owns Southern Trust Securities, Inc. ("STS"), Southern Trust Metals, Inc. (“STM”), Southern Trust Securities Asset Management, Inc. ("STSAM"), and Loreley Overseas Corporation (“LOR”). Additionally, on October 23, 2006, the Company formed Kiernan Investment Corp. (“KIC”) as an international business company in Belize.  KIC has had very limited operations since inception.

The Company contributed $105,653 in cash to form a new company, IPWM, España S.A. ("IPWM Spain") under a partnership agreement with a Swiss Financial Group, International Private Wealth Management, SA (“IPWM, SA”), in exchange for a 50.01% interest and control of the newly created company.  During July 2008, IPWM Spain commenced operations and opened offices in the cities of Barcelona, Spain, San Sebastian, Spain and Marbella, Spain.  IPWM Spain had limited operations for the six months ended June 30, 2012 and the year ended December 31, 2011.

The Company is a Florida corporation and was organized on January 25, 2000.  STS, a Florida corporation, was organized on June 10, 1999 and is registered as an introducing broker/dealer with the Securities and Exchange Commission (“SEC”).  STS is a member of the Financial Industry Regulatory Authority (“FINRA”) and National Futures Association (“NFA”). STS operates as an introducing broker clearing customer trades on a fully disclosed basis through clearing firms.  Under this basis, it forwards all customers transactions to another broker who carries all customers’ accounts and maintains and preserves books and records.  Pershing, LLC currently performs certain of the transaction clearing functions and related services for STS.   STSAM, a Florida corporation formed on November 22, 2005, is a fee-based investment advisory company which offers its services to retail customers. STM, a Florida corporation formed on October 29, 2009, to capitalize on investor interest in the trading of precious metals such as gold, silver, platinum, and palladium.  LOR, a British Virgin Islands corporation, was formed on May 19, 2004, and acts as an international intermediary for STM’s international trading transactions; the corporation had been inactive until 2010.
 
 
7

 
 
SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


3.  Summary of significant accounting policies
 
Basis of Presentation and Principles of Consolidation
 
The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”).
 
The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, STS, STM, STSAM, LOR, and KIC.  IPWM Spain’s assets and liabilities are consolidated with those of the Company and the outside investor’s 49.99% interest in IPWM Spain is included in the accompanying consolidated financial statements as a noncontrolling interest.  All intercompany balances and transactions have been eliminated in consolidation.

Use of Estimates
 
The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect certain reported amounts of assets and liabilities at the date of the consolidated financial statements, as well as their related disclosures.  Such estimates and assumptions also affect the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.

Cash and Cash Equivalents
 
The Company considers short-term interest bearing investments with initial maturities of three months or less to be cash equivalents. Cash and cash equivalents consist of cash in banks, free credit on investment accounts and money market accounts.

Government and Other Regulation
 
The business of STS is subject to significant regulation by various governmental agencies and self-regulatory organizations. Such regulation includes, among other things, periodic examinations by these regulatory bodies to determine whether the Company is conducting and reporting its operations in accordance with the applicable requirements of these organizations.
 
 
8

 
 
SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
3.   Summary of significant accounting policies (continued)
 
Property and Equipment
 
Property and equipment is stated at cost less accumulated depreciation and amortization.  Improvements are amortized using the straight-line method over the shorter of the estimated useful lives of the respective assets or the lease term. Depreciation is computed using the straight-line method over the estimated useful lives of the assets.  Repairs and maintenance are expensed as incurred while betterments and improvements are capitalized. When property and equipment are retired, sold, or otherwise disposed of, the asset’s carrying amount and related accumulated depreciation are removed from the accounts and any gain or loss is included in operations.

Long-Lived Assets

In accordance with Financial Accounting Standard Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 360 “Property, Plant, and Equipment,” the Company records impairment losses on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets’ carrying amounts.  There were no impairment charges during the six months ended June 30, 2012 and 2011.

Fair Value of Financial Instruments – Definition and Hierarchy

In accordance with GAAP, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., the “exit price”) in an orderly transaction between market participants at the measurement date.

In determining fair value, the Company uses various valuation approaches.  In accordance with GAAP, a fair value hierarchy for inputs is used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available.  Observable inputs are those that market participants would use in pricing the asset or liability based on market data obtained from sources independent of the Company.  Unobservable inputs reflect the Company’s assumptions about the inputs market participants would use in pricing the asset or liability developed based on the best information available in the circumstances.
 
 
9

 

SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
3.  Summary of significant accounting policies (continued)

Fair Value of Financial Instruments – Definition and Hierarchy (continued)

The fair value hierarchy is categorized into three levels based on the inputs as follows:
 
Level 1 – Inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities the Company has the ability to access.
Level 2 - Valuations based on quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly. 
Level 3 - Valuations based on inputs that are unobservable and significant to the overall fair value measurement.
 
The availability of valuation techniques and observable inputs can vary from security to security and is affected by a wide variety of factors including, the type of security, whether the security is new and not yet established in the marketplace, and other characteristics particular to the transaction.  To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment.  Those estimated values do not necessarily represent the amounts that may be ultimately realized due to the occurrence of future circumstances that cannot be reasonably determined.
 
Because of the inherent uncertainty of valuation, those estimated values may be materially higher or lower than the values that would have been used had a ready market for the securities existed. Accordingly, the degree of judgment exercised by the Company in determining fair value is greatest for securities categorized in Level 3. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes, the level in the fair value hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement.
 
Fair value is a market-based measure considered from the perspective of a market participant rather than an entity-specific measure.  Therefore, even when market assumptions are not readily available, the Company’s own assumptions are set to reflect those that market participants would use in pricing the asset or liability at the measurement date.  The Company uses prices and inputs that are current as of the measurement date, including periods of market dislocation.  In periods of market dislocation, the observability of prices and inputs may be reduced for many securities.  This condition could cause a security to be reclassified to a lower level within the fair value hierarchy.

Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in Note 5. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular instruments. Changes in assumptions or in market conditions could significantly affect the estimates.
 
 
10

 
 
SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
3.  Summary of significant accounting policies (continued)

Valuation Techniques

The Company values investments in securities that are freely tradable and are listed on a national securities exchange or reported on the NASDAQ national market at their last sales price as of the last business day of the year.

Derivative Contracts

The Company records its derivative activities at fair value. Gains and losses from derivative contracts are included in trading income in the consolidated statements of operations.  Derivative contracts include future and option contracts related to foreign currencies, government bonds and other securities.

The fair value of the derivative contracts traded by the Company is generally based on quoted prices in active markets on national exchanges. The derivative contracts, such as options and futures, which are listed on a national securities exchange or reported on the NASDAQ national market, are generally categorized in Level 1 of the fair value hierarchy.
 
Offsetting of Amounts Related to Certain Contracts

The Company has elected to offset fair value amounts recognized for cash collateral receivables and payables against fair value amounts recognized for net derivative positions executed with the same counterparty under the same master netting arrangement. At June 30, 2012 and December 31, 2011, the Company offset cash collateral receivables of approximately $20,000 and $9,000 against its net derivative positions, respectively.

Broker Receivable and Payable to Customers

As part of its operations STM collects funds from customers and remits the amounts to the respective clearing broker.  The receivable and payable amounts are stated at the amounts transferred.  Upon liquidation of customer positions, STM typically remits the proceeds back to the customer after deducting commission and other fees. As further discussed in Note 14, the Company is dependent upon clearing brokers to satisfy its obligations to the Company in order for the Company to liquidate its payable to the customers.
 
Securities Transactions
 
Revenues for executing customer securities transactions and associated expenses are recorded as earned and incurred, on a trade date basis. Securities owned are valued at fair value. Unrealized appreciation or depreciation is reflected in income currently.

Commissions

Commissions and related clearing expenses are recorded on a trade-date basis as securities transactions occur.
 
 
11

 
 
SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
3.  Summary of significant accounting policies (continued)

Investment Banking Fees
 
Investment banking fees include fees, net of syndication expenses, arising from securities offerings in which the Company acts as an underwriter or agent.  Investment banking revenues also include fees earned in providing financial advisory services.  These revenues are recorded in accordance with the terms of the investment banking agreements.
 
Managed Account Fees

Managed account fees are primarily earned based on a percentage of assets under management.  Fees are computed and due at specified intervals, generally quarterly and recorded when earned.

Investments-Equity Method to Cost Method

Investee companies that are not consolidated, but over which the Company exercises significant influence, are accounted for under the equity method of accounting. Whether or not the Company exercises significant influence with respect to an Investee depends on an evaluation of several factors including, among others, representation on the Investee company’s board of directors and ownership level, which is generally a 20% to 50% interest in the voting securities of the Investee company. Under the equity method of accounting, an Investee company’s accounts are not reflected within the Company’s Consolidated Statements of Financial Condition and Statements of Operations; however, the Company’s share of the earnings or losses of the Investee company, Nexo Emprendimientos S.A., is reflected in the caption ‘‘Equity in loss of NEXO Emprendimientos SA” in the Consolidated statements of Operations. The Company’s carrying value in an equity method Investee company is reflected in the caption ‘‘Investment in Nexo Emprendimientos, S.A.” in the Company’s Consolidated Statements of Financial Condition.

The Company purchased an additional 12.2% interest on May 26, 2011, raising its overall interest in Nexo to 29.5%.  This required the Company to change its method of accounting for this investment from the cost method to the equity method. According to ASC 323-10-35-33, the investment, results of operations (current and prior periods presented), and retained earnings of the investor shall be adjusted retroactively as if the equity method had been in effect during all previous periods in which the investment was held. 

As a result of the method change noted in the prior paragraph, the 2010 investment accumulated deficit was adjusted to give effect to equity method accounting. The change to equity method affected the net loss for the first six months of 2011 through retrospective application of the equity method.  

 
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SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
3.   Summary of significant accounting policies (continued)

Investments-Equity Method to Cost Method (continued)
 
               
Three Months Ended
 
         
Effect of
   
June 30, 2011
 
   
Three Months
   
Correction of
   
Giving Effect to
 
   
Ended
   
Error in
   
Correction of
 
   
June 30, 2011
   
Retrospective
   
Error in Retrospective
 
   
As originally
   
Application of
   
Application of
 
   
Reported
   
Equity Method
   
Equity Method
 
                   
Equity in income of NEXO Emprendimientos SA
    (76,962 )   $ (29,763 )   $ (106,725 )
 
               
Six Months Ended
 
         
Effect of
   
June 30, 2011
 
   
Six Months
   
Correction of
   
Giving Effect to
 
   
Ended
   
Error in
   
Correction of
 
   
June 30, 2011
   
Retrospective
   
Error in Retrospective
 
   
As originally
   
Application of
   
Application of
 
   
Reported
   
Equity Method
   
Equity Method
 
                   
Equity in income of NEXO Emprendimientos SA
    (133,311 )   $ (129,191 )   $ (262,502 )

On March 21, 2012, Nexo executed a debt for equity exchange which resulted in the issuance of new shares by Nexo, reducing the Company’s level of ownership in Nexo from 29.5% to 25.13%.  On May 10, 2012, the Company exercised a put option to sell 2,184,250 of its 9,621,582 shares of Nexo to ProBenefit, S.A., thereby reducing its ownership to 19.42%.  At this point, the Company began recording its investment in Nexo under the cost method of accounting.

The fair value of our cost-method investment is not estimated if there are no identified events or changes in circumstances that may have a significant adverse effect on the fair value of the investment.  The Company does not believe there are any events which occurred in the three months ended June 30, 2012 that would indicate impairment.  Additionally, the Company believes that it is not practicable to estimate the fair value of this investment without incurring excessive costs.
 
 
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SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


3.  Summary of significant accounting policies (continued)

Income Taxes

The Company files a consolidated income tax return with its subsidiaries.  The Company accounts for income taxes in accordance with FASB ASC Topic 740 “Income Taxes”, which requires accounting for deferred income taxes under the asset and liability method.  Deferred income tax asset and liabilities are computed for difference between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on the enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income.  Valuation allowances are established, when necessary, to reduce the deferred income tax assets to the amount expected to be realized.

The determination of the Company’s provision for income taxes requires significant judgment, the use of estimates, and the interpretation and application of complex tax laws.  Significant judgment is required in assessing the timing and amounts of deductible and taxable items and the probability of sustaining uncertain tax positions.  The benefits of uncertain tax positions are recorded in the Company’s consolidated financial statements only after determining a more-likely-than-not probability that the uncertain tax positions will withstand challenge, if any, from tax authorities.  When facts and circumstances change, the Company reassesses these probabilities and records any changes in the consolidated financial statements as appropriate.

In accordance with GAAP, the Company is required to determine whether a tax position of the Company is more likely than not to be sustained upon examination by the applicable taxing authority, including resolution of any related appeals or litigation processes, based on the technical merits of the position.  The tax benefit to be recognized is measured as the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement.  De-recognition of a tax benefit previously recognized could result in the Company recording a tax liability that would reduce stockholders’ equity.  This policy also provides guidance on thresholds, measurement, de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition that is intended to provide better consolidated financial statement comparability among different entities.  Management’s conclusions regarding this policy may be subject to review and adjustment at a later date based on factors including, but not limited to, on-going analyses of and changes to tax laws, regulations and interpretations thereof.  Generally, the tax filings are no longer subject to income tax examinations by major taxing authorities for years before 2008. Any potential examinations may include questioning the timing and amount of deductions, the nexus of income among various tax jurisdictions and compliance with U.S. federal, state and local tax laws.  The Company's management does not expect that the total amount of unrecognized tax benefits will materially change over the next twelve months.

Interest and Penalty Recognition on Unrecognized Tax Benefits

The Company recognizes interest accrued related to unrecognized tax benefits in interest expense and penalties in other operational expenses. No interest expense or penalties have been recognized as of and for the six month periods ended June 30, 2012 and 2011 and the year ended December 31, 2011.
 
 
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SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


3.   Summary of significant accounting policies (continued)

Foreign Currency Adjustments

The financial position and results of operations of the Company’s foreign subsidiary is measured using the foreign subsidiary’s local currency as the functional currency in accordance with FASB ASC Topic 830, “Foreign Currency Matters.” Revenues and expenses of such subsidiary have been translated into U.S. dollars at average exchange rates prevailing during the period. Assets and liabilities have been translated at the rates of exchange as of the balance sheet date. The resulting translation gain and loss adjustments are recorded directly as a separate component of stockholders’ equity.  Foreign currency translation adjustments resulted in a loss of $12,654 and $6,377 for the three and six months ended June 30, 2012, respectively, and a gain of $4,659 and $16,002 for the three and six months ended June 30, 2011.
 
Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the consolidated results of operations as incurred.
 
Comprehensive Income (Loss)

The Company complies with FASB ASC Topic 220, “Comprehensive Income,” which establishes rules for the reporting and display of comprehensive income (loss) and its components.  FASB ASC Topic 220 requires the Company’s change in foreign currency translation adjustments to be included in other comprehensive income (loss), and is reflected as a separate component of stockholders’ equity.
 
Fair Value of Financial Instruments
 
The approximate fair value of the mortgage loan as of June 30, 2012 and December 31, 2011 was $888,000 and $944,000, respectively. The carrying amount of all other financial assets and liabilities that qualify as financial instruments under FASB ASC Topic 825, “Financial Instruments,” approximate their carrying amounts presented in the accompanying consolidated statements of financial condition at June 30, 2012 and December 31, 2011.
 
Income (Loss) Per Common Share
 
The Company complies with the accounting and disclosure requirements of FASB ASC 260, “Earnings Per Share.” Basic income (loss) per common share is computed by dividing net loss available to common stockholders by the weighted average number of common shares outstanding during the period.  Diluted earnings per common share is computed by dividing net income attributable to the Company by the combination of dilutive common share equivalents, comprised of shares issuable under the Company’s share-based compensation plans, stock warrants and shares of common stock issuable upon the conversion of the Series C 8% convertible preferred stock and the weighted average number of common shares outstanding during the reporting period.

Employee stock options to purchase approximately 8,360,000 shares of common stock during the three months and six months ended June 30, 2012, were outstanding but not included in the computation of diluted earnings per common share because the stock option’s exercise prices were less than the average market price of the common stock while they were outstanding.  For the three and six months ended June 30, 2012 the 2,080,000 shares of common stock issuable upon the conversion of the Series C 8% convertible preferred stock were outstanding and included in the computation of diluted earnings per share.  Employee stock options to purchase approximately
 
 
15

 
 
SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
3.   Summary of significant accounting policies (continued)

5,010,000 shares of common stock, 4,500 warrants and 2,080,000 shares of common stock issuable upon the conversion of the Series C 8% convertible preferred stock during the three and six months ended June 30, 2011, were outstanding but not included in the computation of diluted earnings per common share because the effect would be anti-dilutive.

Loss Contingencies

The Company recognizes contingent losses that are both probable and estimable.  In this context, the Company defines probability as circumstances under which events are likely to occur.  In regards to legal cost, we record such costs as incurred.

Funds received from court awarded legal settlements
 
The Company accounts for funds received from court awarded legal settlements on the cash basis.  These funds are reported as miscellaneous income on the consolidated statements of operations and comprehensive income (loss).

Investment
 
The Company classifies its common stock investment in AR Growth Finance Corp. (“AR Growth”) as available-for-sale in accordance with FASB ASC Topic 320, “Investments-Debt and Equity securities.” Available-for-sale investments are carried on the consolidated statements of financial condition at their fair value with the current period adjustments to the carrying value recorded in accumulated other comprehensive income (loss).

Stock-Based Compensation

The Company complies with FASB ASC Topic 718 “Compensation – Stock Compensation,” which establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services.  It also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. FASB ASC Topic 718 focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions.  FASB ASC Topic 718 requires an entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award (with limited exceptions).  That cost will be recognized over theperiod during which an employee is required to provide service in exchange for the award, the requisite service period (usually the vesting period).  No compensation costs are recognized for equity instruments for which employees do not render the requisite service.  The grant-date fair value of employee share options and similar instruments will be estimated using option-pricing models adjusted for the unique characteristics of those
 
 
16

 
 
SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
3.    Summary of significant accounting policies (continued)

Stock-Based Compensation (continued)

instruments (unless observable market prices for the same or similar instruments are available).  If an equity award is modified after the grant date, incremental compensation cost will be recognized in an amount equal to the excess of the fair value of the modified award over the fair value of the original award immediately before the modification.  Based on stock options and stock awards that vested during the three and six months ended June 30, 2012, the Company recorded approximately $76,000 and $128,000, respectively, as compensation expense under FASB ASC 718 and $48,000 and $96,000, respectively, during the three and six months ended June 30, 2011.
 
Nonemployee awards     

The fair value of equity instruments issued to a nonemployee is measured by using the stock price and other measurement assumptions as of the date of either: (i) a commitment for performance by the nonemployee has been reached; or (ii) the counterparty’s performance is complete.  Expenses related to nonemployee awards are generally recognized in the same period as the Company incurs the related liability for goods and services received.  The Company recorded stock compensation of approximately $4,600 and $9,200 for the three and six months ended June 30, 2012, respectively, and $-0- and $-0- for the three and six months ended June 30, 2011, related to consulting services.
 
Recently Adopted Accounting Pronouncements
 
On June 16, 2011, the FASB issued ASU No. 2011-05, “Presentation of Comprehensive Income (Topic 220),” which requires companies to report total net income, each component of comprehensive income, and total comprehensive income on the face of the income statement, or as two consecutive statements. The components of comprehensive income will not be changed, nor does the ASU affect how earnings per share is calculated or reported. These amendments will be reported retrospectively upon adoption. The adoption of the ASU had no material impact on the Company’s consolidated financial statements.
 
In May 2011, the FASB issued an accounting standard update which works to achieve common fair value measurement and disclosure requirements in GAAP and International Financial Reporting Standards. The update both clarifies the FASB’s intent about the application of existing fair value guidance, and also changes certain principles regarding measurement and disclosure.  The update is effective prospectively and is effective for annual periods beginning after December 15, 2011. The adoption of the ASU had no material impact on the Company’s consolidated financial statements.
 
 
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SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 
4.   Clearing Arrangements

STS, the Company’s broker-dealer subsidiary, has clearing agreements with clearing brokers to provide execution and clearing services on behalf of its customers on a fully disclosed basis. All customer records and accounts are maintained by the clearing brokers. STS maintains a deposit with one of the clearing brokers. A termination fee may apply if the Company were to terminate its relationship with the respective clearing broker.
 
5.  Fair value measurements

The Company's assets and liabilities recorded at fair value have been categorized based upon a fair value hierarchy in accordance with GAAP guidance for fair value measurement.  See Note 3 for a discussion of the Company's policies regarding this hierarchy.
 
Cash and cash equivalents, receivables, as well as accounts payable and accrued expenses, and other current liabilities, as reflected in the consolidated financial statements, approximate fair value because of the short-term maturity of these instruments.

Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
 
     
June 30, 2012
   
December 31, 2011
 
 
Fair Value
 
Carrying
   
Fair
   
Carrying
   
Fair
 
 
Hierarchy
 
Amount
   
Value
   
Amount
   
Value
 
Liabilities:
                         
Mortgage payable at  7.28% due 2020
Level 3
  $ 671,032     $ 888,187     $ 700,739     $ 943,735  
 
The fair value estimates of these financial instruments were based upon a discounted cash flow analysis taking into consideration current rates.

The Company's financial assets and liabilities measured at fair value on a recurring basis include those securities classified as securities owned on the consolidated statements of financial condition.
 
 
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SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

5.  Fair value measurements (continued)
 
   
Quoted Prices
                         
   
in Active
   
Significant
                   
   
Markets
   
Other
   
Significant
         
Balance
 
   
for Identical
   
Observable
   
Unobservable
   
Collateral
   
as of
 
   
Assets
   
Inputs
   
Inputs
   
Held
   
June 30,
 
   
(Level 1)
   
(level 2)
   
(Level 3)
   
at Broker
   
2012
 
Assets
                             
Securities owned, at fair value:
                             
Money market
  $ 259,521     $ -     $ -     $ -     $ 259,521  
Options and futures
    -       -       -       20,290       20,290  
Corporate bonds
    509,211       -       -               509,211  
Equity securities
    217,620       -       -       -       217,620  
                                         
    $ 986,352     $ -     $ -     $ 20,290     $ 1,006,642  
                                         
Investment in A/R Growth common stock
  $ -     $ -     $ 22,370     $ -     $ 22,370  


   
Quoted
                         
   
Prices in Active
   
Significant
                   
   
Markets
   
Other
   
Significant
         
Balance
 
   
For Identical
   
Observable
   
Unobservable
   
Collateral
   
as of
 
   
Assets
   
Inputs
   
Inputs
   
Held
   
December 31,
 
   
(Level 1)
   
(level 2)
   
(Level 3)
   
at Broker
   
2011
 
Assets
                             
Securities owned, at fair value:
                             
Money market
  $ 250,766     $ -     $ -     $ -     $ 250,766  
Options and futures
    -       -       -       8,744       8,744  
Corporate bonds
    501,064       -       -               501,064  
Equity securities
    197,379       -       -       -       197,379  
                                         
    $ 949,209     $ -     $ -     $ 8,744     $ 957,953  
                                         
Investment in A/R Growth common stock
  $ -     $ -     $ 22,370     $ -     $ 22,370  
 
 
19

 
 
SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 
5.  Fair value measurements (continued)

Derivatives

In the normal course of business, the Company utilizes derivative contracts in connection with its proprietary trading activities.  Investments in derivative contracts are subject to additional risks that can result in a loss of all or part of an investment.  The Company’s derivative activities and exposure to derivative contracts are classified by the following primary underlying risks: interest rate, credit, foreign currency exchange rate, commodity price, and equity price risks.  In addition to its primary underlying risks, the Company is also subject to additional counterparty risk due to inability of  its counterparties to meet the terms of their contracts.

Options

The Company is subject to equity price risk in the normal course of pursuing its investment objectives.  Option contracts give the Company the right, but not the obligation, to buy or sell within a limited time, a financial instrument, commodity or currency at a contracted price that may also be settled in cash, based on differentials between specified indices or prices.

The Company is exposed to counterparty risk from the potential that a seller of an option contract does not sell or purchase the underlying asset as agreed under the terms of the option contract.  The maximum risk of loss from counterparty risk to the Company is the fair value of the contracts and the premiums paid to purchase its open option contracts.  The Company considers the credit risk of the intermediary counterparty to its option transactions in evaluating potential credit risk.

Futures Contracts

The Company is subject to equity price risk in the normal course of pursuing its investment objectives. The Company may use futures contracts to gain exposure to, or hedge against, changes in the value of equities. A futures contract represents a commitment for the future purchase or sale of an asset at a specified price on a specified date. At June 30, 2012, there are two futures contracts held and are classified by commodity price risk, the fair value of which amounted to approximately ($2,300). At December 31, 2011, the fair value of open contracts amounted to approximately ($500) and is reflected in the Securities Owned at fair value caption of the accompanying consolidated statements of financial condition.
 
 
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SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
6.  Property and equipment, net

Property and equipment, net consisted of the following at June 30, 2012 and December 31:

   
June 30,
   
December 31,
 
   
2012
   
2011
 
             
Building  and improvements
  $ 1,075,942     $ 1,075,942  
                 
Land
    725,000       725,000  
                 
Furniture and fixtures
    75,042       72,178  
                 
Office equipment
    95,929       69,652  
                 
      1,971,913       1,942,772  
                 
Less:  accumulated depreciation and amortization
    (419,191 )     (387,144 )
                 
    $ 1,552,722     $ 1,555,628  

Depreciation and amortization expense for the three months ended June 30, 2012 and 2011 was $17,088 and $15,814, respectively.  Depreciation for the six months ending June 30, 2012 and June 30, 2011 was $32,047 and $31,627, respectively.
 
7.  Notes Payable

Notes payable consisted of the following at June 30, 2012:
 
Mortgage payable to a bank, secured by the
     
building, monthly payments of $9,207, including
     
interest at 7.28% per annum, due July 20, 2020.
  $ 671,032  
 
Maturities of notes payable are approximately as follows at June 30, 2012:
 
2012
  $ 31,000  
2013
    65,000  
2014
    70,000  
2015
    76,000  
2016
    81,000  
Thereafter
    348,000  
         
    $ 671,000  

 
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SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
8.  Income taxes

The Company files a consolidated income tax return with its subsidiaries.  Income taxes are charged by the Company based on the amount of income taxes the subsidiaries would have paid had they filed their own income tax returns.  In accordance with FASB ASC Topic 740, “Accounting for Income Taxes,” allocation of the consolidated income tax expense is necessary when separate financial statements are prepared for the affiliates.  As a result, the Company uses a method that allocates current and deferred taxes to members of the consolidated group by applying the liability method to each member as if it were a separate taxpayer.

The Company had no income tax expense (benefit) for the six month periods ended June 30, 2012 and 2011. At December 31, 2011, the Company had approximately $5.5 million of net operating losses (“NOL”) carry-forwards for federal and state income purposes.  These losses are available for future years and expire through 2031.  Utilization of these losses may be severely or completely limited if the Company undergoes an ownership change pursuant to Internal Revenue Code Section 382.  The Company has taken a full valuation allowance against the other timing differences and the deferred asset attributable to the NOL carry-forwards at June 30, 2012 and December 31, 2011, respectively, due to the uncertainty of realizing the future tax benefits.
 
9.  Common stock
 
The Company is authorized to issue 100 million shares of common stock, no par value and 10 million shares of preferred stock of which 2.5 million shares have been designated as Series C 8% convertible preferred stock, no par value.

In June 2011, the Company issued 2,979,591 shares of its no par value common stock for $1,042,857 cash.  These shares were deemed to have been issued pursuant to an exemption provided by Section 4(2) of the Act, which exempts from registration “transactions by an issuer not involving any public offering.”

In June 2011, the Company issued 1,864,857 shares of its no par value common stock at an agreed value of $0.23 per share, in connection with its purchase of an additional 12.2% equity investment in Nexo Emprendimientos S.A. (“Nexo”), a credit card and consumer loan financing company based in Sunchales, Argentina.  These shares were deemed to have been issued pursuant to an exemption provided by Section 4(2) of the Act, which exempts from registration “transactions by an issuer not involving any public offering.”
 
 
22

 

SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

10.  Preferred stock

No Series C preferred stock was sold during the six months ended June 30, 2012 and 2011. The Series C 8% Convertible Preferred Stock provides for non-cumulative dividends at the rate of 8% per year.  Subject to certain restrictions, the Series C 8% Convertible Preferred Stock shall automatically convert into shares of the Company’s Common Stock upon any of the following events: (i) the sale by the Corporation of all or substantially all of its assets; (ii) the consummation of a merger or a consolidation in which the Corporation is not the survivor or (iii) the sale or exchange of all or substantially all of the outstanding shares of the Corporation’s common stock.  The Series C 8% Convertible Preferred Stock is redeemable, at the option of the Company, for cash in the amount of $11.00 per share of Series C Convertible Preferred Stock or for shares of the Company’s Common Stock in accordance with a conversion rate.

The holders of preferred stock have liquidation preferences over the holders of the Company’s common stock.
 
11.  Stock options

The Company accounts for its stock option awards under FASB ASC Topic 718 “Compensation—Stock Compensation.” The fair value of each option is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions used for each grant for the six months ended June 30, 2012; risk free interest rate between 1.95% and 2.22%, no dividend yield, expected lives of ten years and volatility between 140.32% and 157.01%. The expected term of stock option awards granted is generally based up the “simplified” method for “plain vanilla” options discussed in SEC Staff Accounting Bulletin (“SAB”) No. 107, as amended by SAB No. 110. The expected volatility is derived from historical volaltility of the Company’s stock on the OTCBB for a period that matches the expected term of the option.  The risk free interest rate is the yield from a Treasury bond or note corresponding to the expected term of the option.
 
Options vest ratably between one and ten years and are exercisable over ten years. The Company granted 3,350,000 options to employees during the six month period ended June 30, 2012.
 
During the three and six months ended June 30, 2012, the Company recognized stock-based compensation expense of approximately $76,000 and $128,000, respectively, and $48,000 and $96,000, respectively, during the three and six months ended June 30, 2011.  This expense is reported within Employee compensation and benefits in the accompanying consolidated statements of operations.
 
The Company has not paid cash dividends and does not expect to pay cash dividends in the future.  Forfeiture rates are based on management’s estimates.
 
 
23

 
 
SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


11.   Stock options (continued)
 
Options Outstanding
               
Options Exercisable
 
                                 
     
Number
   
Weighted
         
Number
       
     
Outstanding
   
Average
   
Weighted
   
Exercisable
   
Weighted
 
     
at
   
Remaining
   
Average
   
at
   
Average
 
Exercise
   
June 30,
   
Contractual
   
Exercise
   
June 30,
   
Exercise
 
Price
   
2012
   
Life
   
Price
   
2012
   
Price
 
                                 
$ 0.25       4,250,000       8.3     $ 0.25       1,131,250     $ 0.25  
                                             
$ 0.35       3,350,000       9.7     $ 0.35       -     $ 0.35  
                                             
$ 0.50       200,000       4.5     $ 0.50       200,000     $ 0.50  
                                             
$ 0.75       100,000       6.5     $ 0.75       70,000     $ 0.75  
                                             
$ 1.00       400,000       4.7     $ 1.00       400,000     $ 1.00  
                                             
$ 1.50       60,000       6.3     $ 1.50       51,000     $ 1.50  
                               
\
         
          8,360,000       8.5     $ 0.35       1,852,250     $ 0.49  

 
24

 
 
SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


 
11.     Stock options (continued)

The following is a summary of all option activity through June 30, 2012:
 
   
Number of
   
Weighted
   
Remaining
   
Aggregate
 
   
Shares
   
Average
   
Term
   
Instrinsic
 
   
Outstanding
   
Price
   
(in years)
   
Value
 
                         
                         
Options outsanding at December 31, 2011
    5,010,000     $ 0.34       8.3     $ -  
                                 
Granted in 2012
    3,350,000     $ 0.35                  
Canceled in 2012
    -       -                  
                                 
Options outstanding at June 30, 2012
    8,360,000     $ 0.35                  
                                 
Excercisable at June 30, 2012
    1,852,250     $ 0.49       7.2     $ -  


         
Weighted Average
 
   
Stock
   
Grant Date
 
   
Options
   
Fair Value
 
             
Options unvested, December 31, 2011
    3,491,667     $ 0.25  
                 
Options granted
    3,350,000     $ 0.11  
                 
Options vested
    (333,917 )   $ 0.26  
                 
Options unvested, June 30, 2012
    6,507,750     $ 0.18  
 
 
25

 

SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
11.   Stock options (continued)

Cash flows resulting from excess tax benefits are to classified as part of cash flows from financing activities.  Excess tax benefits are realized tax benefits from tax deductions of exercised options in excess of the deferred tax asset attributable to the compensation cost for such options.  There were no options exercised during the six months ended June 30, 2012 and 2011; therefore, the Company did not receive any cash payments or recognize any tax benefits from options exercised during the six month periods ended June 30, 2012 and 2011.

12.  Net capital requirement

STS is a member of FINRA and is subject to the SEC Uniform Net Capital Rule 15c3-1.  This Rule requires the maintenance of minimum net capital and requires that the ratio of aggregate indebtedness to net capital, both as defined, shall not exceed 15 to 1 and that equity capital may not be withdrawn or dividends paid if the resulting net capital ratio would exceed 10 to 1.  STS is also subject to the Commodity Futures Trading Commission’s minimum financial requirements which require that STS maintain net capital, as defined for securities brokers and dealers, equal to or in excess of the greater of $45,000 or the amount of net capital required by the SEC Rule 15c3-1. At June 30, 2012, STS’s net capital was approximately $691,000 which was approximately $591,000 in excess of its minimum requirement of $100,000. STS’s ratio of aggregate indebtedness to net capital was 0.27 to 1 as of June 30, 2012.

13.  Exemption from Rule 15c3-3

The Company is exempt from the SEC Rule 15c3-3 pursuant to the exemptive provision under sub-paragraph (k) (2) (ii) and, therefore, is not required to maintain a “Special Reserve Bank Account for the Exclusive Benefit of Customers.”
 
 
26

 

SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


14.  Concentration of risk

Off-balance Sheet Risk

Pursuant to a clearance agreement, certain of the Company’s subsidiaries introduce all of its securities transactions to a clearing broker on a fully-disclosed basis.  All of the customers' money balances and long and short security positions are carried on the books of the clearing broker. In addition, STM has entered into several clearance agreements with clearing brokers. In accordance with the clearance agreements, certain of the Company’s subsidiaries have agreed to indemnify the clearing broker for losses, if any, which the clearing brokers may sustain from carrying securities transactions introduced by the Company.

In accordance with industry practice and regulatory requirements, certain of the Company’s subsidiaries and the clearing broker monitor collateral on the customers' accounts. In addition, the receivable from clearing broker is pursuant to the clearance agreement.

The maximum potential amount of future payments that certain of the Company’s subsidiaries could be required to make under these indemnifications cannot be estimated.  However, the Company believes that it is unlikely it will have to make material payments under these arrangements and has not recorded any contingent liability in the consolidated financial statements for these indemnifications.

In the normal course of business, the Company’s customer activities involve the execution, settlement and financing of various customer securities transactions.  These activities may expose the Company to off-balance sheet risk in the event the customer or other broker is unable to fulfill its contracted obligations and the Company has to purchase or sell the financial instrument underlying the contract at a loss.

Credit Risk

The Company maintains its cash in financial institutions, which at times, may exceed federally insured limits.  The Company has not experienced any losses in such accounts and believes it is not subject to any significant credit risk on cash.
 
15.  Commitments and contingencies

Legal Claims

In the ordinary course of business, incidental to the Company’s operations, the Company retains outside counsel to address claims with which the Company is involved. As of June 30, 2012, the Company was not aware of any legal proceedings, which management has determined to be material to its business operations; however, the Company has been named in the following two actions which it is vigorously defending and which actions, based on management's assessment in coordination with outside litigation counsel, the Company believes to be frivolous and without merit:

On December 7, 2010, the Company filed a FINRA arbitration against Joseph Meuse, Rosewood Securities, LLC, BP Capital, LLC, and China Values Technology, Inc.  The FINRA filing was amended on January 18, 2011, before FINRA commenced serving the respondents.  The Company seeks to recover compensation it was entitled to receive for acting as placement agent under an agreement involving an offering of securities in a reverse merger into a publicly traded company, Respondent China Valves, which closed on May 18, 2009.
 
 
27

 

SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


15.  Commitments and contingencies  (continued)

Legal Claims (continued)

The Agreement provided that the Company would receive 23,490 warrant shares of China Valves, but it only received 5,739 warrant shares.  Thus, the Company has sued the respondents to recover the additional 17,751 warrant shares that it should have received on May 18, 2009, their value, lost profits, and lost opportunity costs caused by the failure to timely deliver the shares as required. The respondents, in response to the Company’s pre-filing demands for payment, each blamed the other for the claimed failures to timely deliver the missing warrant shares.

On April 7, 2011, the Company entered into a Settlement Agreement (“Agreement”) with BP Capital, LLC, for which Joseph Meuse as managing member (“BP Capital”) and Joseph Meuse (“Meuse”) an individual.  The Agreement provides that Meuse will make a payment to the Company in the amount of $125,000, in full settlement with Meuse and BP Capital.  The payment will be made by Meuse to the Company in five (5) installments, with the first payment of $25,000 due on the date of the signing of the Agreement and four successive payments of $25,000 due thirty (30) days following each prior payment until the full payment has been made.  On April 2, 2012, the Company received payment of the remaining balance in accordance in satisfaction of the Agreement. These amounts were included in the applicable consolidated statement of operations as other miscellaneous income.

Employment Agreements
 
During the six months ended June 30, 2012, the Company entered into employment agreements with certain employees, which provides that they will be paid on a profit sharing and/or commission basis, based on the results of the business unit managed by these employees.  In connection with the agreement, the Company granted stock options to the two employees totaling 950,000 shares of its common stock with an option price of $0.35 per shares vesting equally over three years.
 
On January 4, 2007, the Company entered into employment agreements with several of its key executives.  The agreements are for two to three-year duration and renew automatically for one year unless either party provides notice of non-renewal 30 days prior to the anniversary date of the agreement or the agreement is earlier terminated in accordance with its terms.  Two of the agreements are for two-year duration with total compensation of $247,000 per year. The third agreement is for three-year duration with total compensation of $150,000 per year.  In July 2009, two of our executive officers, Robert Escobio, CEO, and Kevin Fitzgerald, President, agreed to take a reduction in salary, commencing in July 2009, with the right to request payment pursuant to the terms of their employment agreements, when the Company’s financial condition will allow it to do so.

As part of the agreements, the Company granted 4,500,000 shares of common stock vesting over five years to one of the executives, reduced to 3,500,000 shares pursuant to a stock waiver agreement entered into on November 18, 2009; on August 4, 2010, the executive waived his right, title, and interest to vest the remaining 3,000,000 shares, the balance after 500,000 were vested and issued in December 2009. Also, as part of the

 
28

 
 
SOUTHERN TRUST SECURITIES HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

15.  Commitments and contingencies  (continued)

Employment Agreements (continued)

employment agreements, the Company  granted 922,389 shares vesting equally over eighteen months to another executive, and 200,000 options to the third executive exercisable on December 31, 2007 for a period of ten years.

One of the key executive’s agreements provides for a lump-sum payment of $5 million and the repurchase of all shares based on their fair market value, if his employment is terminated as a result of a change of control.  Should the executive’s employment be terminated for any other reason, the Company would have to pay him $2 million and repurchase all of his shares based on their fair market value.  Lastly, another agreement provides for a lump-sum payment of $1 million to one of the executives if his employment is terminated due to change of control.

16.  Investment in AR Growth Finance Corp. and Nexo Emprendimientos S.A.

The following presents statements of operations for Nexo Emprendimientos S.A. (“Nexo”).  Such summary information has been provided herein based upon the individual significance of the unconsolidated equity investments to the consolidated information of the Company.  The three months and six months ended June 30, 2012 shows the financial results through May 10, 2012, the exercise date of the put option for the Nexo investment.  On this date, the Company’s interest in Nexo decreased from 25.13% to 19.42% resulting in a change from the equity method to the cost method of accounting for the investment prospectively.

   
For the Period
   
For the Period
 
   
April 1 through
   
January 1 through
 
   
May 10, 2012
   
June 30, 2011
   
May 10, 2012
   
June 30, 2011
 
                         
Revenues
  $ 307,811     $ 1,198,419     $ 885,684     $ 2,070,023  
                                 
Cost of services
    (278,999 )     (1,824,709 )     (1,417,297 )     (3,588,707 )
                                 
Operating income (loss)
    28,812       (626,290 )     (531,612 )     (1,518,684 )
                                 
Net income (loss)
    28,580       (185,108 )     (531,785 )     (1,077,595 )

On May 10, 2012, the Company exercised a put option which required ProBenefit, S.A., an Argentine financial services holding company to repurchase 2,184,250 shares of Nexo Emprendimientos S.A. for $1,200,000 which resulted in a gain on those shares of approximately $750,000.  At June 30, 2012, $1,100,000 was outstanding from ProBenefit, S.A.
 
The impact of any dilution to the Company's ownership in equity method investments is recorded in Equity in income (loss) of NEXO Emprendimientos S.A. in the Statement of Operations and Comprehensive Income(loss), in accordance with ASC 323-10.
 
17.  Subsequent events

On May 2, 2012, plaintiffs of the Pope Investments, et. al. matter re-filed the previously dismissed case in the Supreme Court of the State of New York.  On July 25,2012, STSHC responded accordingly and filed a motion to dismiss with the Supreme Court of the State of New York, based upon lack of jurisdiction, failure to state a valid cause of action against STSHC and the previous dismissal of the case.  The Company does not anticipate any material losses.

The Company received two payments related to its exercise of the option to sell 2,184,250 shares of Nexo to ProBenefit, S.A. for the purchase price of $1,200,000.  Specifically, the Company received payments of $150,000 on July 3, 2012 and $450,000 on July 17, 2012.   The remaining balance is due to be paid on or before October 15, 2012.

 
29

 
ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations contain “forward-looking statements” including statements about our beliefs and expectations. There are many risks and uncertainties that could cause actual results to differ materially from those discussed in the forward-looking statements.
All forward-looking statements are based on information available to us on the date of this filing, and we assume no obligation to update such statements. The following discussion should be read in conjunction with the consolidated financial statements and the related notes included in this Annual Report on Form 10-K.

We were formed as a Florida corporation on January 14, 1998. We are the holding company for STS, which is registered as an introducing broker-dealer with the SEC and is a member of, or subject to regulations of, the SEC, FINRA, the NFA, the CFTC, SIPC and the MSRB. We are also the holding company for both: (i) STSAM a fee-based investment advisory service registered with the State of Florida, which offers its services to retail customers, (ii) Southern Trust Metals, a trader of primarily gold, silver, platinum and palladium, and (iii) Loreley Overseas Corporation (“LOR”), which acts as an international intermediary for STM’s international trading transactions.

Our principal business is the business of STS. We offer clients access to all major domestic and international securities and options exchanges, as well as trading in fixed income products, corporate, government, agencies, municipals, and emerging market debt. We also offer fixed and variable annuities and life insurance. We currently offer hundreds of domestic and international mutual funds, as well as retirement plans. We manage portfolios for individuals, pension funds, retirement plans, foundations, trusts and corporations. Our corporate services facilitate restricted stock dispositions and employee stock option exercises. Our offshore services give clients access to foreign trusts and corporations, which they can use to structure their financial planning.
 
Our investment banking group provides traditional as well as innovative securities transaction structures. Our focus is on merger and acquisition services, private placements convertible into publicly-traded shares, and private placements bridging to public offerings through reverse mergers into publicly-traded shell corporations.
 
Southern Trust Metals, Inc. (STM) was formed to capitalize on investor interest in the trading of precious metals such as gold, silver, platinum, and palladium.  STS is a separate subsidiary of STSHC and separately managed.  STM will work with its own clients to generate new business through the innovative trading of metals.
 
Critical Accounting Policies and Estimates

Our 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 we believe 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.

 
30

 
 
Valuation of Investments in Securities at Fair Value – Definition and Hierarchy

FASB ASC Topic 820 “Fair Value Measurements and Disclosures” provides a framework for measuring fair value under generally accepted accounting principles in the United States and requires expanded disclosures regarding fair value measurements.  ASC 820 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (i.e., the “exit price”) in an orderly transaction between market participants at the measurement date. 
 
In determining fair value, the Company uses various valuation approaches.  In accordance with generally accepted accounting principles (“GAAP”), a fair value hierarchy for inputs is used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available.  Observable inputs are those that market participants would use in pricing the asset or liability based on market data obtained from sources independent of the Company.  Unobservable inputs reflect the Company’s assumptions about the inputs market participants would use in pricing the asset or liability developed based on the best information available in the circumstances.

The fair value hierarchy is categorized into three levels based on the inputs as follows:
 
Level 1 – Inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities the Company has the ability to access.
Level 2 - Valuations based on quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly.
Level 3 - Valuations based on inputs that are unobservable and significant to the overall fair value measurement.
 
The availability of valuation techniques and observable inputs can vary from security to security and is affected by a wide variety of factors including, the type of security, whether the security is new and not yet established in the marketplace, and other characteristics particular to the transaction.  To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment.  Those estimated values do not necessarily represent the amounts that may be ultimately realized due to the occurrence of future circumstances that cannot be reasonably determined.
 
Because of the inherent uncertainty of valuation, those estimated values may be materially higher or lower than the values that would have been used had a ready market for the securities existed. Accordingly, the degree of judgment exercised by the Company in determining fair value is greatest for securities categorized in Level 3. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes, the level in the fair value hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement.

Fair value is a market-based measure considered from the perspective of a market participant rather than an entity-specific measure.  Therefore, even when market assumptions are not readily available, the Company’s own assumptions are set to reflect those that market participants would use in pricing the asset or liability at the measurement date.  The Company uses prices and inputs that are current as of the measurement date, including periods of market dislocation.  In periods of market dislocation, the observability of prices and inputs may be reduced for many securities.  This condition could cause a security to be reclassified to a lower level within the fair value hierarchy.

 
31

 
 
Valuation Techniques

The Company values investments in securities that are freely tradable and are listed on a national securities exchange or reported on the NASDAQ national market at their last sales price as of the last business day of the year. At June 30, 2012, all of the Company’s investments classified as securities owned on the consolidated statements of financial condition are classified as Level 1 investments on the fair value hierarchy table in Note 6, Fair value measurements. The Company’s investment in A/R Growth’s common stock is classified as Level 3.

Clearing Arrangements.

STS does not carry accounts for customers or perform custodial functions related to customers’ securities. STS introduces all of its customer transactions, which are not reflected in these financial statements, to its primary clearing broker, which maintains the customers’ accounts and clears such transactions. These activities may expose us to off-balance-sheet risk in the event that customers do not fulfill their obligations with the primary clearing broker, as we have agreed to indemnify our primary clearing broker for any resulting losses. We continually assess risk associated with each customer who is on margin credit and record an estimated loss when we believe collection from the customer is unlikely. Our losses incurred from these arrangements were not significant for the six month periods ended June 30, 2012 and 2011.

Stock-Based Compensation
The Company complies with FASB ASC Topic 718 “Compensation – Stock Compensation,” which establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services.  It also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. FASB ASC Topic 718 focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions.  FASB ASC Topic 718 requires an entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award (with limited exceptions).  That cost will be recognized over the period during which an employee is required to provide service in exchange for the award the requisite service period (usually the vesting period).  No compensation costs are recognized for equity instruments for which employees do not render the requisite service.  The grant-date fair value of employee share options and similar instruments will be estimated using option-pricing models adjusted for the unique characteristics of those instruments (unless observable market prices for the same or similar instruments are available).  If an equity award is modified after the grant date, incremental compensation cost will be recognized in an amount equal to the excess of the fair value of the modified award over the fair value of the original award immediately before the modification.  Based on stock options and stock awards that vested during the three and six months ended June 30, 2012, the Company recorded approximately $76,000 and $128,000, respectively, as compensation expense under FASB ASC 718 and $48,000 and $96,000, respectively, during the three and six months ended June 30, 2011.
 
Revenue Recognition.

Commissions and related clearing expenses are recorded on a trade-date basis as security transactions occur. Riskless principal transactions in regular-way trades are recorded on the trade date, as if they had settled.