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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
(Mark One)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
/ / 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 0-23587
CHAPMAN HOLDINGS, INC.
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(Name of Small Business Issuer in Its Charter)
MARYLAND 52-2069777
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
401 EAST PRATT STREET, 28TH FLOOR, BALTIMORE, MARYLAND 21202
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(Address of Principal Executive Offices) (Zip Code)
Issuer's telephone number, including area code: (410) 625-9656
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Securities registered pursuant to Section 12(b) of the Exchange Act: None
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Securities registered pursuant to Section 12(g) of the Exchange Act:
COMMON STOCK, PAR VALUE $0.001 PER SHARE
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(Title of Class)
Check whether the Issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 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 /X/ No / /
--- ---
Check if disclosure of delinquent filers pursuant to Item 405 of Regulation S-B
is not contained herein, and no disclosure will be contained, to the best of
registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. /X/
The issuer's revenues for its most recent fiscal year were: $2,935,069.
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The aggregate market value of the voting stock and non-voting common equity held
by non-affiliates computed by reference to the average bid and asked price of
such common equity on March 10, 1999 was $5,129,691.
APPLICABLE ONLY TO CORPORATE REGISTRANTS
The number of outstanding shares of Common Stock of the registrant as of
March 10, 1999 was 2,953,622. Transitional Small Business Disclosure Format
(check one). Yes [ ] No [ X ]
DOCUMENTS INCORPORATED BY REFERENCE
Selected portions of the Registrant's Annual Report to Stockholders for the
year ended December 31, 1998 and selected portions of the Proxy Statement
pertaining to the Annual Meeting are incorporated herein by reference into
Parts II and III.
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TABLE OF CONTENTS
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PAGE
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PART I 3
ITEM 1. DESCRIPTION OF BUSINESS 3
ITEM 2. DESCRIPTION OF PROPERTY 8
ITEM 3. LEGAL PROCEEDINGS 8
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 8
PART II 9
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS 9
ITEM 5A. RISK FACTORS 10
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 17
ITEM 7. FINANCIAL STATEMENTS 17
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 17
PART III 17
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT 17
ITEM 10. EXECUTIVE COMPENSATION 17
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT 18
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 18
ITEM 13. EXHIBIT, LIST AND REPORTS ON FORM 8-K 18
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Domestic Emerging Markets-Registered Trademark-and DEM-Registered
Trademark-are registered trademarks and DEM Profile--TM--, DEM
Universe--TM--, DEM Company--TM--, DEM Index--TM--and the stylized C-Eagle
logo are trademarks of Nathan A. Chapman, Jr.
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
Chapman Holdings, Inc. (the "Company") is an African-American owned and
controlled holding company. The Company's full service securities brokerage and
investment banking subsidiary, The Chapman Co., is registered as a broker-dealer
with the Commission and in 34 states and the District of Columbia, and is a
member firm of the National Association of Securities Dealers, Inc. (the
"NASD"). (Unless the context otherwise indicates, the Company and The Chapman
Co. are hereinafter referred to collectively as the "Company")
The Company is headquartered at the World Trade Center--Baltimore, 401
East Pratt Street, 28th Floor, Baltimore, Maryland and its telephone number is
(410) 625-9656. The Company was incorporated in Maryland on December 12, 1997.
The Chapman Co. was incorporated in Maryland in 1986.
The Company is headquartered in Baltimore, Maryland with sales offices
in Alabama, California, Colorado, Illinois, Mississippi, Pennsylvania, Tennessee
and Texas.
The Company's primary sources of revenue are derived from brokerage
services, corporate finance, and government finance activities. These activities
are supported by the Company's research capabilities.
BROKERAGE SERVICES
The Company provides brokerage services to institutional and retail
clients. Commissions are charged to these clients for executing buy and sell
orders for securities on national and regional exchanges and in the
over-the-counter market. The Company's primary source of revenue for its
brokerage business has historically been commissions generated from
institutional brokerage. The Company's institutional clients include investment
managers, corporate retirement plans and municipal retirement plan sponsors. The
Company maintains floor broker relationships on the New York, American and
Chicago Stock Exchanges and executes buy and sell orders in the over-the-counter
markets. Approximately 46% and 40% of the Company's revenue during 1998 and
1997, respectively, was derived from its brokerage business.
The Company also participates in fixed income secondary market trading
in government securities primarily for fixed income investment managers,
municipal treasurers and other investment professionals. This business is done
on a competitive basis where the Company acts as a broker. Approximately 4% and
29% of the Company's revenue during 1998 and 1997, respectively, was derived
from secondary market trading.
As of December 31, 1998, the Company employed 12 brokers.
The Company is a market-maker with respect to the securities of five
companies.
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CORPORATE FINANCE
To date, the Company's corporate finance activities have been limited
primarily to participation in syndicates. The Company has been a member of over
200 underwriting syndicates for corporate issues, substantially all of which
were equity offerings. During 1998 and 1997, approximately 20% and 16%,
respectively, of the Company's revenue was derived from corporate finance
transactions. In 1998, over half of the Company's corporate finance revenue was
derived from the sale of the stock of Chapman Capital Management Holdings, Inc.,
an affiliate and former subsidiary of the Company for whom the Company acted as
sole underwriter. In 1997, over half of the Company's corporate finance revenue
was derived from the sale of the stock of DEM, Inc. for which the Company was
the sole underwriter. DEM, Inc. was a publicly-traded closed-end company managed
by Chapman Capital Management, Inc., a former subsidiary of the Company.
GOVERNMENT FINANCE
The Company participates in the tax-exempt public finance market and
has managed, primarily as co-manager, over 250 transactions in 22 states and the
District of Columbia, including approximately 59 transactions in the past two
years. Over half of the total dollar amount of these transactions has been with
jurisdictions located in Alabama, California, Pennsylvania and Tennessee.
During 1998 and 1997, approximately 17% and 13%, respectively, of the
Company's revenue was derived from management fees, financial advisory fees and
selling concessions in public finance transactions. The Company currently
employs four investment bankers whose primary responsibility is the development
of the Company's public finance business.
STRATEGY
The Company intends to utilize its available resources to both exploit
its DEM strategic initiative and to expand its existing business activities.
DOMESTIC EMERGING MARKETS
The Company has implemented its Domestic Emerging Markets, or DEM,
strategy pursuant to which the Company markets financial services, primarily
investment banking services to domestic companies that are owned or controlled
by African-Americans, Asian-Americans, Hispanic Americans or women. As part of
the DEM strategy, the Company makes markets in the stocks of selected DEM
companies. The Company believes that the DEM market is underserved and its DEM
strategy will permit the Company to develop a market niche for its corporate
finance business.
The Company has identified approximately 180 DEM companies and seeks to
establish relationships with such companies that intend to raise additional
equity or debt financing. The Company's target clients are small capitalization
companies traded in the over-the-counter market and privately-held companies
undertaking an initial public offering. While the size of any particular
offering may vary, the Company anticipates that most such transactions would
range from $2 million to $15 million. The Company seeks to manage or co-manage a
substantial portion of these underwritings in which it participates.
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The Company's ability to exploit its DEM strategy in the context of
corporate underwritings is dependent upon its ability to identify potential
clients fitting the DEM company profile and convincing such potential clients
that the Company is the right investment banking firm for their needs. The
Company has not conducted any independent research to test the marketability of
the DEM strategy, nor has the Company engaged in any significant marketing of
the strategy. Therefore, while the Company believes the concept to be viable,
the level of market acceptance is largely unknown. The Company intends to devote
a substantial amount of its resources to the execution of the DEM strategy.
EXPANSION OF EXISTING BUSINESS
The Company is expanding its existing business as follows:
The Company is expanding its research capabilities, focusing primarily
on DEM companies, hiring additional brokers and marketing specialized products
to retail and institutional clients.
In addition to the DEM corporate finance strategy discussed above, the
Company is aggressively seeking larger allocations in corporate underwriting
syndicates managed by other investment banking firms.
The Company is seeking larger positions in state and local public
finance transactions. As a result of its ability to undertake larger
participations, the Company believes it is better positioned to seek manager
roles in these transactions, entitling the Company to receive management fees
in addition to selling concessions. The Company intends to expand its
participation in the state and local public finance market by establishing a
presence in states with major issuers of negotiated tax-exempt bonds and by
seeking more assignments as manager of such transactions. The Company has
identified California, New York, Texas, Illinois, Pennsylvania, Michigan,
Ohio and Florida as representing over 45% of the dollar amount of aggregate
tax-exempt bonds issued in the U.S. in 1997. In addition to its other
offices, the Company currently has offices in Texas, Illinois and
Pennsylvania and has recently opened an office in California. The Company
intends to use its increased capital to expand its participation in federal
agency debt transactions as a member of selling groups in direct offerings
and syndicates, as well as aggressively seeking management roles in these
offerings.
RESEARCH
The Company currently employs four research analysts and provides
research primarily on selected DEM companies. The Company intends to
substantially increase the number of DEM companies covered by its research.
The Company has created the DEM Index which tracks the results of
certain of those companies meeting the DEM profile. The Company believes that
inclusion of a DEM company in the DEM Index offers certain advantages such as
facilitating identification by fund managers and other institutions seeking to
invest in minority or women controlled businesses. The Company will seek to earn
fees from subscriptions to the DEM Index and the sale of limited information
regarding the companies included in the DEM Index.
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CLEARING AGENT AND CUSTOMER CREDIT
The Company utilizes the services of RPR Clearing Services, Inc. as
its clearing agent on a fully disclosed basis (the "Clearing Agent"). The
Clearing Agent processes all securities transactions and maintains the
accounts of customers. Customer accounts are protected through the Securities
Investor Protection Corporation for up to $500,000, of which coverage for
cash balances is limited to $100,000. The Company has selected the Pershing
Division of Donaldson, Lufkin & Jenrette Securities Corporation to replace
RPR Clearing Services, Inc. as the Clearing Agent. The Company expects that
Pershing will commence operations as the Company's clearing agent in
mid-Summer 1999.
The services of the Clearing Agent include billing, credit control,
receipt and custody and delivery of securities. The Clearing Agent provides the
operational support necessary to process, record and maintain securities
transactions for the Company's brokerage and distribution activities. The total
cost of the Clearing Agent's services to the Company is less than the cost the
Company would incur to provide these services itself.
The Clearing Agent lends funds to the Company's customers through the
use of margin credit. These loans are made to customers on a secured basis, with
the Clearing Agent maintaining collateral in the form of salable securities,
cash or cash equivalents. Under the terms of the Company's clearing agreement,
the Company indemnifies the Clearing Agent for any loss on these credit
arrangements. As of December 31, 1998, the Company had approximately $2,559,189
of margin credit outstanding to its customers through its Clearing Agent. There
have been no defaults on margin loans in the last two years. The net interest
income to the Company from margin activities for the years ending December 31,
1997 and 1998 was not material.
GOVERNMENT REGULATION
The securities business is subject to extensive and frequently changing
federal and state laws and substantial regulation under such laws by the
Commission and various state agencies and self-regulatory organizations, such as
the NASD. The Company is registered as a broker-dealer with the Commission and
is a member firm of the NASD. Much of the regulation of broker-dealers has been
delegated to self-regulatory organizations, principally the NASD, which has been
designated by the Commission as the Company's primary regulator. The NASD adopts
rules (which are subject to approval by the Commission) that govern its members
and conducts periodic examinations of member firms' operations. Securities firms
are also subject to regulation by state securities administrators in those
states in which they conduct business. The Company is registered as a
broker-dealer in 34 states and the District of Columbia.
Broker-dealers are subject to regulations which cover all aspects of
the securities business, including sales methods and supervision, trading
practices among broker-dealers, use and safekeeping of customers' funds and
securities, capital structure of securities firms, record keeping and the
conduct of directors, officers and employees. Additional legislation, changes in
rules promulgated by the Commission and self-regulatory organizations, or
changes in the interpretation or enforcement of existing laws and rules, may
directly affect the mode of operation and profitability of broker-dealers.
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The Commission, self-regulatory organizations and state securities
commissions may conduct administrative proceedings which can result in censure,
fine, the issuance of cease-and-desist orders or the suspension or expulsion of
a broker-dealer, its officers or employees. The principal purpose of regulation
and discipline of broker-dealers is the protection of customers and the
integrity of the securities markets.
The Company's mutual fund distribution business is subject to extensive
regulation as to its duties, affiliations, conduct and limitations on fees under
the Securities Exchange Act of 1934, as amended (the "Exchange Act"), the
Investment Company Act of 1940, as amended (the "1940 Act"), and the regulations
of the NASD. As discussed above, the Company is an NASD member. The NASD has
prescribed rules (Rule 2830 of the NASD Conduct Rules) with respect to maximum
commissions, charges and fees related to investment in any open-end investment
company registered under the 1940 Act.
NET CAPITAL REQUIREMENTS
As a registered broker-dealer and a member firm of the NASD, the
Company is subject to the net capital rule of the Commission. The net capital
rule, which specifies minimum net capital requirements for registered brokers
and dealers, is designed to measure the general financial integrity and
liquidity of a broker-dealer and requires that at least a minimum part of its
assets be kept in relatively liquid form. Net capital is essentially defined as
net worth (assets minus liabilities), plus qualifying subordinated borrowings
and less certain mandatory deductions that result from excluding assets not
readily convertible into cash and from valuing certain other assets, such as a
firm's positions in securities, conservatively. Among these deductions are
adjustments in the market value of securities to reflect the possibility of a
market decline prior to disposition. The Company has elected to compute its net
capital under the standard aggregate indebtedness method permitted by the net
capital rule, which requires that the ratio of aggregate indebtedness to net
capital, both as defined, shall not exceed a 15-to-1 ratio. At December 31,
1998, the Company had net capital and a net capital requirement of $797,382 and
$100,000, respectively. The Company's ratio of aggregate indebtedness to net
capital was .7 to 1.
Failure to maintain the required net capital may subject a firm to
suspension or expulsion by the NASD, the Commission and other regulatory bodies
and ultimately may require its liquidation. The Company entered into a consent
agreement with the NASD regarding alleged violations of the net capital rules in
late 1993 and early 1994. Pursuant to such agreement, the Company and Mr.
Chapman were jointly fined $30,000 and Mr. Chapman was suspended from
association with the Company for 10 days. The Company has exceeded all net
capital requirements since such alleged violations. The net capital rule also
prohibits payments of dividends, redemption of stock and the prepayment or
payment in respect of principal of subordinated indebtedness if net capital,
after giving effect to the payment, redemption or repayment, would be less than
a specified percentage (currently 120%) of the minimum net capital requirement.
Compliance with the net capital rule could limit those operations of the
Company's brokerage subsidiary that require the intensive use of capital, such
as underwriting and trading activities, and also could restrict the Company's
ability to withdraw capital from its operating subsidiary, which in turn, could
limit the Company's ability to pay dividends, repay debt and redeem or purchase
shares of its outstanding capital stock.
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COMPETITION
The Company encounters intense competition in all aspects of its
securities business and competes directly with other securities firms, a
significant number of which have greater capital and other resources. In
addition to competition from firms currently in the securities business, there
has recently been increasing competition from other sources, such as commercial
banks and insurance companies offering financial services, and from other
investment alternatives. The Company believes that the principal factors
affecting competition in the securities industry are the quality and abilities
of professional personnel, including their ability to effectuate a firm's
commitments, and the quality, range and relative prices of services and products
offered.
Although the Company may expand the financial services it can offer to
its customers, it does not now offer as broad a range of financial services as
national stock exchange member firms, commercial banks, insurance companies and
others.
PERSONNEL
At December 31, 1998, the Company had 35 full-time employees, including
25 registered representatives. None of the Company's personnel is covered by a
collective bargaining agreement. The Company considers its relationships with
its employees to be good.
ITEM 2. DESCRIPTION OF PROPERTY
The principal executive offices of the Company are located at The World
Trade Center--Baltimore, 401 East Pratt Street, 28th Floor, Baltimore, Maryland
21202 where the Company leases approximately 10,000 square feet of office space.
The lease for these premises expires in 2000. The Company leases furniture and
equipment from an affiliated entity.
ITEM 3. LEGAL PROCEEDINGS
Many aspects of the Company's business involve substantial risks of
liability, including exposure under federal and state securities laws in
connection with the underwriting and distribution of securities. The Company
does not presently maintain an errors and omissions insurance policy insuring it
against these risks. In recent years, there has been an increasing incidence of
litigation involving the securities industry, including class actions which
generally seek rescission and substantial damages. Additionally, securities
brokerage firms become parties to arbitrations brought by dissatisfied customers
in the general course of business. The Company has been and is currently a party
to such proceedings, none of which has resulted or is expected to result in any
material liability.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
RECENT SALES OF UNREGISTERED SECURITIES
Since its organization, the following securities were issued by the
Company without registration under the Securities Act:
On December 12, 1997, in connection with the organization of the
Company, the Company issued one share of Common Stock, to Nathan A. Chapman, Jr.
for an aggregate price of $8.00. This transaction was exempt from registration
under the Securities Act under Section 4(2) because it did not involve a public
offering. Such transaction was completed without an underwriter.
On December 22, 1997, the Company issued 196,594 shares of Common Stock
to Mr. Chapman in consideration for which Mr. Chapman contributed a warrant for
1,048,500 shares of The Chapman Co., currently the Company's wholly-owned
subsidiary, then exercisable at a price of $0.10 per share. This transaction was
exempt from registration under the Securities Act under Section 4(2) because it
did not involve a public offering. Such transaction was completed without an
underwriter.
On December 29, 1997, the Company issued 1,792,640 shares of Common
Stock to 19 former stockholders of The Chapman Co. in a statutory merger
pursuant to a vote of the security holders of The Chapman Co. Specifically, a
wholly-owned subsidiary of the Company was organized and merged into The Chapman
Co. with The Chapman Co. surviving the merger as a wholly-owned subsidiary of
the Company. All shares of Common Stock, Preferred Stock and Preferred
Stock--Series B of The Chapman Co. that were outstanding prior to the merger
automatically converted at the effective time of the merger into shares of
Common Stock of the Company. This transaction was exempt from registration under
the Securities Act under Section 4(2) because it did not involve a public
offering. Such transaction was completed without an underwriter.
PROCEEDS OF THE OFFERING
On February 23, 1998, the Company's Registration Statement on Form SB-2
(File No. 333-43487) pertaining to its initial public offering of shares of the
Company's common stock, par value $0.001 (the "Offering") was declared
effective.
The Company has applied Offering proceeds in the amount of
approximately $3 million to expand net capital to participate in corporate and
government finance transactions, $200,000 to expand market-making and research
capabilities, $150,000 to implement the DEM strategy, $400,000 to expand sales
and marketing efforts, $400,000 to hire sales personnel to staff additional
sales offices and corporate finance staff to implement the DEM strategy and $1
million for working capital and general corporate purposes. The remaining
Offering proceeds
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have been invested by the Company in The Chapman U.S. Treasury Money Fund, an
affiliate, pending final application of such proceeds.
The remainder of the information required by Item 5 is incorporated by
reference from the information set forth under the heading "Stockholder
Information" in the selected portions of the 1998 Annual Report filed as Exhibit
13.01 to this Form 10-KSB.
ITEM 5A. RISK FACTORS
The words "believes," "intends," "anticipates," and "expects," and
similar expressions are intended to identify forward-looking statements. These
forward-looking statements are based on our current expectations and are subject
to a number of risks and uncertainties. In light of these risks and
uncertainties, many of which are described in detail in the risk factors set
forth below, actual results could differ materially from the forward-looking
statements contained in this document.
NET LOSS; RISK OF INABILITY TO MANAGE GROWTH
We have experienced and expect to continue to experience significant
growth in our business activities and the number of our employees. This
growth requires increased investment in personnel, financial and management
systems and controls and facilities. Unless we achieve revenue growth in line
with our growth in expenses, we will continue to incur losses. During 1998,
we had a net loss of $1,130,758. Furthermore, our inability to manage such
growth could have a material adverse effect on our continued operations.
In addition, as is common in the securities industry, we continue to be
highly dependent on the effective and reliable operation of its communications
and information systems. We believe that our future growth will require
implementation of new and enhanced communications and information systems and
training of its personnel to operate such systems. Any difficulty or significant
delay in the implementation or operation of existing or new systems or the
training of personnel could adversely affect the our ability to manage growth.
RISKY NATURE OF SECURITIES BUSINESS
Our business is concentrated in the securities industry which is
subject to numerous and substantial risks, particularly in volatile or illiquid
markets and in markets influenced by sustained periods of low or negative
economic growth. Such risks include the risk of losses resulting from:
o underwriting or ownership of securities
o trading and principal activities
o counterparty failure to meet commitments
o customer fraud
o employee errors
o misconduct and fraud (including unauthorized transactions by traders)
o failures in connection with the processing of securities transactions
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In addition, our revenue may decline in periods of reduced demand for public
offerings or reduced activity in the secondary markets and when there is reduced
spreads on the trading of securities.
RISKS OF MAKING A MARKET IN THINLY-TRADED ISSUES
A key element of our strategy is to make a market in selected
securities of small capitalization, emerging U.S. companies. We currently make a
market in the securities of 5 small capitalization companies and we are
currently in the process of obtaining approval to make a market in up to 100
small capitalization securities. Market-making activities typically require us
to maintain an inventory of the securities in which we make a market. Our
inventory is subject to the same risks as those faced by investors in such
securities and, since we make a market in securities of small capitalization
companies, our risk is typically greater than that customarily associated with
investments in securities of larger, more established companies. Small emerging
companies may be subject to greater earnings fluctuation, lack of established
markets for products or services, more limited financial resources and less
depth of experienced management. Securities of small emerging companies
generally have more limited marketability and may be subject to greater price
volatility than securities of larger companies. They may be dependent for
management on one or a few key persons, and can be more susceptible to losses
and risks of bankruptcy.
The companies in which we make a market are traded on the Nasdaq
SmallCap Market, and, in the future, may be on the OTC Bulletin Board or the
Pink Sheets, where the trading market is thinner and the spread between bid and
offer prices is often larger than on the major exchanges or Nasdaq National
Market. The nature of these trading markets subjects us to the risk that should
the need arise to liquidate our inventories in such securities, our activities
could adversely affect the market price of such securities, resulting in a
requirement that we sell our inventory below the price that we deem to be
representative of their value. As of December 31, 1998, our inventory of
market-making securities was $2,080,355. In 1998, we experienced a loss on
trading of $637,957.
HIGHLY COMPETITIVE INDUSTRY
The investment banking and brokerage industry is extremely
competitive. We encounter intense competition in all aspects of the
securities business and compete directly with other securities firms, a
significant number of which have greater capital, experience and resources
than us. Competition also exists for experienced personnel including
technical personnel and account executives. In addition to competition from
firms currently in the securities business, recently there has been
increasing competition from other sources, such as commercial banks and
insurance companies offering financial services. See "Description of
Business--Competition" for more information about the nature and extent of
the competition we face.
UNPROVEN NATURE OF DOMESTIC EMERGING MARKET STRATEGY
Our business plan emphasizes the DEM strategy which targets U.S.
companies controlled by African-Americans, Asian-Americans,
Hispanic-Americans and women as candidates for investment banking services.
See "Description of Business--Strategy" for a discussion of the DEM strategy.
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We will seek to expand our investment banking business through the
implementation of its DEM strategy, by:
- -- earning fees from the distribution of DEM products such as investment
companies with DEM-driven portfolios
- -- providing financial advisory and investment banking services to DEM
companies
- -- making markets in the securities of DEM companies
Although we have identified approximately 180 publicly-traded companies
with DEM characteristics, there can be no assurance that companies meeting the
DEM profile will select us for investment banking or other services.
We have had limited corporate finance experience in a management role.
Therefore our ability to provide DEM companies with investment banking services,
such as management of underwriting syndicates, will require adding personnel
with investment banking expertise and development of a track record in the
management of underwriting syndicates. There can be no assurance that we will be
able to attract, hire and retain such personnel.
Furthermore, because a substantial number of companies meeting the DEM
profile are expected to trade in the over-the-counter markets, the formation of
underwriting syndicates for and the distribution of securities of such companies
as well as making markets in the stocks of such companies may be more difficult
than for companies having larger capitalizations and greater market liquidity.
ONGOING EXPANSION OF OPERATIONS
We have increased our net capital in order to participate in corporate
and government finance transactions. There can be no assurance that we will
continue to be invited to participate in such transactions or that the number of
such transactions in which we are invited to participate will grow.
In an effort to obtain new government finance business, we have opened
offices in those states with the most tax-exempt bond offerings. The addition of
personnel to staff such offices together with corporate finance staff added to
implement the DEM strategy has significantly increased our operating expenses.
There can be no assurance that we will be able to increase our revenue in an
amount sufficient to offset such increased expenses.
DEPENDENCE ON KEY PERSONNEL
For the foreseeable future, we will place substantial reliance upon the
personal efforts and abilities of Nathan A. Chapman, Jr., our President, who
will not devote his full time to our activities. The loss of the services of Mr.
Chapman may have a material adverse effect on our business, operations, revenue
and/or business prospects. We maintain key man life insurance on Mr. Chapman in
the amount of $11 million.
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CERTAIN TRANSACTIONS; RELATIONSHIPS WITH OTHER CHAPMAN ENTITIES;
CONFLICTS OF INTEREST
Mr. Chapman, our majority stockholder, is also the majority stockholder
of the parent companies of Chapman Capital Management, Inc. ("CCM") and The
Chapman Insurance Agency, Inc. Several of our executive officers, including Mr.
Chapman are also executive officers of such companies and The Chapman Funds,
Inc., a CCM-sponsored and - managed registered investment company that includes
multiple investment portfolios including The Chapman US Treasury Money Fund, DEM
Equity Fund and DEM Index Fund. The common management and/or ownership among the
Company and these other companies may involve potential conflicts of interest
with respect to the terms of business transactions, the allocation of shared
expenses and the allocation of business opportunities between the Company and
such other companies. See "Certain Transactions."
Further, because our key executives are also senior executives of other
companies, our management will not be able to devote all of its time to our
business affairs. Although there is no written agreement, we expect that Mr.
Chapman will devote no less than 33% of his time to our operations and entities
that he serves at the our request. All business transactions and allocations of
overhead between us and such other companies is approved by at least a majority
of the independent, outside members of the Board of Directors. Furthermore, the
compensation of our President will be approved by the Compensation Committee of
the Board of Directors, a majority of the members of which are independent,
outside directors.
EFFECT ON MARKET PRICE OF SHARES ELIGIBLE FOR FUTURE SALE/CONTROL BY PRINCIPAL
STOCKHOLDER
Nathan A. Chapman, Jr. holds 61.9% of the shares of our outstanding
Common Stock. All of the shares held by Mr. Chapman are currently available for
resale in the public market under Rule 144, promulgated pursuant to the
Securities Act. As of February 28, 1998, an additional 118,047 shares, or
approximately 4% of the outstanding Common Stock, where held in inventory by our
subsidiary, The Chapman Co., in its capacity as market-maker for the Common
Stock. All of the shares held by The Chapman Co. are available for immediate
resale. Sales of a significant number of shares of Common Stock in the public
market could have a material adverse effect on the market price of the Common
Stock. Because Mr. Chapman controls a majority of the outstanding shares of
Common Stock, he controls the outcome of all matters submitted to the
stockholders for approval, including the election of all members of the Board of
Directors. See "Principal Stockholders" for a table showing the amount of shares
owned by Mr. Chapman and other stockholders.
SIGNIFICANT FLUCTUATIONS IN QUARTERLY OPERATING RESULTS
Our revenue and operating results may fluctuate from quarter to quarter
and from year to year due to a combination of factors, including:
- -- the number of underwriting transactions in which we participate
- -- access to public markets for companies in which we have invested as a
principal
13
<PAGE>
- -- the valuations of our principal investments
- -- the level of institutional and retail brokerage transactions,
- -- variations in expenditures for personnel, litigation expenses and
expenses of establishing new business units
Our revenue from an underwriting transaction is recorded only when the
underwritten security commences trading. Therefore, the timing of our
recognition of revenue from a significant transaction can materially affect our
quarterly operating results. In addition, we could experience losses if demand
for these transactions declines more quickly than our ability to change our cost
structure.
REGULATORY RISKS
Our business, and the securities industry generally, are subject to
extensive regulation at both the federal and state levels. In addition,
self-regulatory organizations, such as the NASD, require strict compliance with
their rules and regulations. Among other things, these regulatory authorities
impose restrictions on sales methods, trading practices, use and safekeeping of
customer funds and securities, record keeping and the conduct of principals and
employees.
The purpose of the extensive regulation of broker-dealers is to protect
customers and the integrity of the securities markets. However, this regulation
imposes significant compliance requirements on us. Failure to comply with any of
the laws, rules or regulations of any independent, state or federal regulatory
authority could result in a fine, injunction, suspension or expulsion from the
industry, which could have a material adverse effect on our business. Although
we have implemented procedures designed to achieve compliance with such laws,
rules and regulations, there can be no assurance that such compliance procedures
will prevent violations. Furthermore, amendments to existing statutes and
regulations or the adoption of new statutes and regulations could require us to
alter our methods of operation at costs which could be substantial.
NET CAPITAL REQUIREMENTS
The Commission and the NASD have stringent provisions with respect to
net capital requirements of securities firms. A significant operating loss or
any charge against the net capital of our brokerage subsidiary, The Chapman Co.,
could adversely affect its ability to operate, expand or, depending upon the
magnitude of the loss or charge, maintain its present level of business. These
rules could also restrict our ability to withdraw capital from The Chapman Co.,
even in circumstances where The Chapman Co. has more than the minimum amount of
required capital, which could limit our ability to implement our strategies.
14
<PAGE>
EFFECT ON COMMON STOCK TRADING OF LIMITATIONS ON MARKET-MAKING ACTIVITIES
Because our brokerage subsidiary, The Chapman Co., makes a market in
the Common Stock, we are subject to Commission and NASD regulations that require
The Chapman Co. to deliver a current market-making prospectus to purchasers when
engaging in market-making transactions in the Common Stock. A "market-making"
prospectus is a continuously updated prospectus that is part of an effective
registration statement filed with the Commission that must be delivered to
purchasers of securities from the issuer of such securities or a broker-dealer
affiliate of such issuer in market-making transactions. Therefore, in the
absence of a current market-making prospectus, The Chapman Co. will not be able
to engage in market-making activities relating to the Common Stock. The costs of
maintaining a current prospectus and the prospectus delivery requirements can
increase the cost of making a market in securities to both the issuer and the
broker-dealer.
We believe that there will be sufficient market-makers for the
Common Stock to maintain its Nasdaq SmallCap Market quotation. However, no
firms are under any obligation to make a market in the Common Stock and any
firm which commences market-making activities may cease such activities at
any time. Further, other rules, including those relating to the use of
"insider information," may prevent our registered representatives from
recommending the Common Stock to their customers. To the extent that The
Chapman Co. is unable to make a market in, or make recommendations regarding,
the Common Stock, your ability to sell the Common Stock in the secondary
market may be limited, our Nasdaq SmallCap Market quotation may be threatened
and the price of the Common Stock may be adversely affected.
CREDIT RISKS
We clear all transactions for our brokerage customers on a fully
disclosed basis with our clearing agent, which carries and clears all customer
securities accounts. The clearing agent also lends funds to our brokerage
customers through the use of margin credit. These loans are made to customers on
a secured basis, with the clearing agent maintaining collateral in the form of
salable securities, cash or cash equivalents. Pursuant to the terms of our
agreement with the clearing agent, in the event our customers fail to pay for
their purchases, to supply the securities that they have sold, or to repay funds
they have borrowed, and the clearing agent satisfies any customer obligations,
we would be obligated to indemnify the clearing agent for any resulting losses.
YEAR 2000 SOFTWARE ISSUE
As the year 2000 approaches, an issue has emerged regarding how
existing application software programs and operating systems can accommodate
information that employs dates after December 31, 1999. We are working with our
software vendors to prepare our systems for the year 2000. Based on information
currently available, we do not anticipate that we will incur significant
operating expenses or be required to incur material costs to be year 2000
compliant. We are, however, still analyzing and modifying our systems and
requirements. In addition, we have relationships with third parties that have
computer systems that may not be year 2000 compliant. To the extent that their
systems are not fully year 2000 compliant, we can not be sure that potential
systems interruptions or the cost necessary to update software would not have a
material adverse effect on our business, financial condition, results of
operations, or business prospects. See
15
<PAGE>
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Year 2000 Software Issue."
LEGAL PROCEEDINGS AND ARBITRATION RISKS
Many aspects of our business involve substantial risks of liability and
regulatory enforcement by state and federal regulators. Additionally, in recent
years, there has been increased litigation involving participants in the
securities industry. Underwriters and agents are subject to substantial
potential liability for material misstatements and omissions in prospectuses and
other communications with respect to underwritten offerings of securities.
Claims by dissatisfied customers for fraud, unauthorized trading, churning,
mismanagement and breach of fiduciary duty are regularly made against
broker-dealers. Customer claims may be made in arbitration proceedings, which
claims could result in awards of compensatory and/or punitive damages against
us.
CURRENT AND POTENTIAL REFORMS IN THE NASDAQ STOCK MARKET
The Nasdaq Stock Market has come under intense scrutiny in the media
and Congress during the past few years and has been the subject of Commission
investigations into its operations. Concerns have been raised with respect to
the size of the spreads between the price paid by investors purchasing
Nasdaq-quoted securities and the dealers who process the transactions. Concerns
also have been raised with respect to whether Nasdaq's listing requirements are
sufficiently stringent and whether the NASD, the trade organization controlling
the Nasdaq market, carefully polices Nasdaq-quoted companies. In response, the
NASD has begun to boost its internal compliance and monitoring programs,
including establishing a separate regulatory unit, National Association of
Securities Dealers Regulation, Inc. ("NASDR"). NASDR has taken numerous steps to
better monitor trading activities among dealers and to scrutinize companies'
compliance with applicable standards for quotation, and has heightened its
overall monitoring of small capitalization companies.
The effects of current and proposed Nasdaq reform on the operations of
brokerage firms, especially those specializing in the securities of small
capitalization companies, like us, cannot be fully anticipated. The cost of
compliance with any new rules, regulations and procedures instituted by the
NASDR could be significant. Additionally, the implementation of stricter
standards for initial and continued inclusion of companies on Nasdaq could
adversely affect the prospects of small capitalization companies, the stock
performance of such companies, and the liquidity of investors' investments in
such companies. Increased compliance costs or the inability to attain or
maintain the quotation of underwriting clients on the Nasdaq system could
adversely affect our financial performance.
NO DIVIDENDS
We have not paid any cash dividends on the Common Stock and we do
not expect to declare or pay any cash dividends in the foreseeable future. We
intend to retain any earnings for the foreseeable future for our continued
growth. Moreover, our ability to pay dividends in the future may be
restricted by our obligation to comply with the net capital rules applicable
to broker-dealers. See "Description of Business--Government Regulation--Net
Capital Requirements" for a discussion of the net capital rules.
16
<PAGE>
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Information required by Item 6 is incorporated by reference from the
information set forth under the heading "Management's Discussion and Analysis of
Financial Condition and Results of Operations" in the selected portions of the
1998 Annual Report filed as Exhibit 13.01 to this Form 10-KSB.
ITEM 7. FINANCIAL STATEMENTS
Information required by Item 7 is incorporated by reference from the
information set forth under the heading "Financial Statements" in the selected
portions of the 1998 Annual Report filed as Exhibit 13.01 to this Form 10-KSB.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
The information regarding directors and executive officers required by
Item 9 is incorporated by reference from the information set forth under the
heading "Proposal 1--Election of Directors--Directors and Executive Officers"
and "--Section 16(a) Beneficial Ownership Reporting Compliance" in the Company's
definitive proxy statement for its annual meeting of stockholders to be held on
May 25, 1999.
ITEM 10. EXECUTIVE COMPENSATION
The information required by Item 10 is incorporated by reference from
the information set forth under the heading "Executive Compensation" in the
Company's definitive proxy statement for its annual meeting of stockholders to
be held of May 25, 1999.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
17
<PAGE>
The information required by Item 11 is incorporated by reference from
the information set forth under the heading "Principal Stockholders" in the
Company's definitive proxy statement for its annual meeting of stockholders to
be held on May 25, 1999.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 12 is incorporated by reference from
the information set forth under the heading "Certain Relationships and Related
Transactions" in the Company's definitive proxy statement for its annual meeting
of stockholders to be held on May 25, 1999.
ITEM 13. EXHIBITS LIST AND REPORTS ON FORM 8-K
(a) Exhibits
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- ------- -----------
<S> <C>
1.1 Underwriting Agreement between the Company and The Chapman Co.(2)
1.2 Qualified Independent Underwriter Agreement between the Company and
Ferris Baker Watts, Incorporated.(2)
1.3 Escrow Agreement between the Company and UMB Bank, N.A.(2)
3.1 Articles of Incorporation of the Company.(1)
3.2 By-laws of the Company.(4)
4 Form of Common Stock Certificate.(1)
10.1 $106,922.68 Promissory Note to The Chapman Co. from Nathan A. Chapman,
Jr. dated December 31, 1996.(1)
10.2 Chapman Holdings, Inc. 1998 Omnibus Stock Plan.(1)
10.3 Fully Disclosed Clearing Agreement between RPR Clearing Services and
The Chapman Co. dated April 1, 1993, as amended June 16, 1993 and
February 4, 1997.(1)
10.4 [Reserved]
10.5 Placement Agency Agreement between DEM, Inc. and The Chapman Co. dated
May 30, 1997(1)
10.6 Distribution Agreement between The Chapman Co. and The Chapman Funds,
Inc. on behalf of The Chapman U.S. Treasury Money Fund and The Chapman
Institutional Cash Management Fund dated April 30, 1997.(1)
</TABLE>
18
<PAGE>
<TABLE>
<S> <C>
10.7 Distribution Agreement between The Chapman Co. and The Chapman Funds,
Inc. on behalf of the DEM Equity Fund dated October 28, 1997.(1)
10.8 Equipment Lease Agreement between The Chapman Co. and Chapman Limited
Partnership I dated October 1, 1993.(1)
10.9 Trademark Assignment from The Chapman Co. to Nathan A. Chapman, Jr.
dated December 24, 1997.(1)
10.10 Trademark Assignment from The Chapman Co. to Nathan A. Chapman, Jr.
dated December 24, 1997.(1)
10.11 License Agreement between The Chapman Co. and Nathan A. Chapman, Jr.
dated December 26, 1997.(1)
10.12 $763,367 Promissory Note to The Chapman Co. from Chapman Capital
Management, Inc. dated December 28, 1997.(2)
10.13 Lock-up Agreement between the Company and Nathan A. Chapman, Jr. dated
December 28, 1997.(2)
10.14 $176,250 Promissory Note to The Chapman Co. from Nathan A. Chapman, Jr.
dated February 11, 1998.(2)
10.15 $285,587 Promissory Note to the Company from Nathan A. Chapman, Jr.
dated March 11, 1998.(3)
10.16 $100,000 Promissory Note to The Chapman Co. from Nathan A. Chapman, Jr.
dated May 1, 1998.(3)
10.17 $51,690 Promissory Note to the Company from Nathan A. Chapman, Jr.
dated December 31, 1998.(4)
23.1 Consent of Arthur Andersen LLP(5)
21 Subsidiaries of the Company.(4)
24 Power of Attorney.(5)
27 Financial Data Schedule(5)
</TABLE>
(1) Incorporated by reference to the Company's Registration Statement on Form
SB-2 (File No. 333-43487) as filed with the Securities and Exchange
Commission on December 30, 1997.
(2) Incorporated by reference to Pre-Effective Amendment 1 to the Company's
Registration Statement on Form SB-2 (File No. 333-43487) as filed with the
Securities and Exchange Commission on February 17, 1998.
19
<PAGE>
(3) Incorporated by reference to the Company's Quarterly Report on Form
10-QSB (File No. 0-23587) as filed with the Securities and Exchange
Commission on November 16, 1998.
(4) Incorporated by reference to Post-Effective Amendment 2 to the Company's
Registration Statement on Form SB-2 (File No. 333-48419) as filed with the
Securities and Exchange Commission on March 19, 1999.
(5) Filed herewith.
(b) Reports on Form 8-K:
The Company has filed no reports on Form 8-K during the Fourth Quarter
of 1998.
20
<PAGE>
SIGNATURES
In accordance with the requirements of Section 13 or 15(d) of the Exchange Act,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
CHAPMAN HOLDINGS, INC.
Dated: March 30,1999 /S/ NATHAN A. CHAPMAN, JR.
-------------------------------
Nathan A. Chapman
Chairman of the Board of Directors,
President and Chief Executive Officer
In accordance with the requirements of the Exchange Act, this report is signed
below by the following persons on behalf of the Registrant in the capacities and
on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURES TITLE AND CAPACITY DATE
- ---------- ------------------ ----
<S> <C> <C>
/S/ NATHAN A. CHAPMAN, JR. President and Director March 30, 1999
- ------------------------------- (Principal Executive Officer)
Nathan A. Chapman, Jr.
Treasurer and Controller March 30, 1999
/S/ M. LYNN BALLARD (Principal Financial
- ------------------------------ Officer andP rincipal
M. Lynn Ballard Accounting Officer)
The Entire Board of Directors
Nathan A. Chapman, Jr.
Donald V. Watkins
Earl U. Bravo, Sr.
Lottie Shackelford
By: /S/ NATHAN A. CHAPMAN, JR. March 30,1999
---------------------------
Nathan A. Chapman, Jr.
Attorney-in-Fact
</TABLE>
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION PAGE NO.
---------- ----------- --------
<S> <C> <C>
13.1 Certain information from Registrant's
Annual Report to Stockholders for the
year ended December 31, 1998 which is
incorporated by reference in this
Form 10-KSB.
23.1 Consent of Arthur Andersen LLP
24 Power of Attorney
27 Financial Data Schedule
</TABLE>
<PAGE>
Exhibit 13.01
Certain information from the Annual Report to Stockholders of CHAPMAN HOLDINGS,
INC. for the year ended December 31, 1998 which is incorporated by reference in
this Form 10-KSB
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION AND ANALYSIS SHOULD BE READ IN CONJUNCTION
WITH THE CHAPMAN HOLDINGS, INC. CONSOLIDATED FINANCIAL STATEMENTS AND THE NOTES
THERETO INCLUDED ELSEWHERE IN THIS DOCUMENT. THE DISCUSSION OF RESULTS, CAUSES
AND TRENDS SHOULD NOT BE CONSTRUED TO IMPLY ANY CONCLUSION THAT SUCH RESULTS OR
TRENDS WILL NECESSARILY CONTINUE IN THE FUTURE. WHEN USED IN THIS DOCUMENT, THE
WORDS "BELIEVES," "INTENDS," "EXPECTS," "ANTICIPATES" AND SIMILAR EXPRESSIONS
ARE INTENDED TO IDENTIFY FORWARD-LOOKING STATEMENTS. THESE FORWARD-LOOKING
STATEMENTS ARE LARGELY BASED ON THE CURRENT EXPECTATIONS OF MANAGEMENT AND ARE
SUBJECT TO A NUMBER OF RISKS AND UNCERTAINTIES. IN LIGHT OF THESE RISKS AND
UNCERTAINTIES, MANY OF WHICH ARE DESCRIBED IN THE "RISK FACTORS" SECTION OF THIS
DOCUMENT, ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THE FORWARD-LOOKING
STATEMENTS CONTAINED HEREIN.
OVERVIEW AND GENERAL INDUSTRY CONDITIONS
The primary sources of revenue of Chapman Holdings, Inc. (the
"Company") are commissions earned from brokerage services and management fees.
The Company's principal business activities are, by their nature, affected by
many factors, including general economic and financial conditions, movement of
interest rates, security valuations in the marketplace, competitive conditions,
transaction volume and market liquidity. Consequently, brokerage commission
revenue and investment banking fees can be volatile. While the Company seeks to
maintain cost controls, a significant portion of the Company's expenses are
fixed and do not vary with market activity. As a result, substantial
fluctuations can occur in the Company's revenue and net income from period to
period. Unless otherwise indicated, in this section, references to years are to
fiscal years.
RESULTS OF OPERATIONS
The following table reflects items in the Statements of Operations as
dollar amounts and as percentages of total revenue.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------------------------------
1998 1997
-------------------------- -----------------------------
PERCENTAGE OF PERCENTAGE OF
AMOUNTS TOTAL REVENUE AMOUNTS TOTAL REVENUE
<S> <C> <C> <C> <C>
REVENUE:
Commissions $2,538,436 86.5% $2,612,251 87.3%
Underwriting and
management fees 699,797 23.8 324,826 10.9
Interest and dividends 334,793 11.4 54,724 1.8
Loss on Trading (637,957) (21.7) - -
------------ ------------- ------------ ------------
Total revenue 2,935,069 100.0 2,991,801 100.0
------------ ------------- ------------ ------------
EXPENSE:
Compensation and benefits 2,185,396 74.5 1,120,753 37.4
</TABLE>
<TABLE>
2
<PAGE>
<S> <C> <C> <C> <C>
Brokerage and clearing 430,989 14.7 286,505 9.6
fees
Communications 192,408 6.5 154,364 5.2
Occupancy and equipment 460,079 15.7 355,542 11.9
Travel and business
development 255,017 8.7 210,881 7.0
Professional fees 416,267 14.2 103,431 3.5
Other operating expense 610,671 20.8 269,797 9.0
------------ ------------- ------------ ------------
Total expense 4,550,827 155.1 2,501,273 83.6
------------ ------------- ------------ ------------
(Loss) income from
continuing operations (1,615,758) (55.1) 490,528 16.4
Income tax (benefit)
provision (485,000) (16.6) 205,000 6.9
----------- --------- ---------- ------
(Loss) income from
continuing operations (1,130,758) (38.5) 285,528 9.5
Income from discontinued
operations - - 51,459 1.7
------------ ------------- ------------ ------------
Net (loss) income $(1,130,758) (38.5%) $336,987 11.2%
------------ ------------- ------------ ------------
------------ ------------- ------------ ------------
</TABLE>
FISCAL YEAR ENDED DECEMBER 31, 1998 COMPARED TO FISCAL YEAR ENDED
DECEMBER 31, 1997.
Total Revenue decreased by $56,732, or 1.9%, to $2,935,069 for 1998
from $2,991,801 for 1997. Revenue increased by $581,225 or 19.4% in 1998 before
the loss related to the Company's inventory of trading stock of $637,957.
Commission revenue decreased $73,815, or 2.8% to $2,538,436 for 1998
from $2,612,251 for 1997. This decrease was primarily due to an 88% decrease in
commissions for government securities primarily related to the volume of such
transactions. Increases in equities, institutional and fixed income commission
of 73.2%, 19.5% and 53%, respectively, partially offset this decrease.
Underwriting and management fees, increased by $374,971, or 115.4%, to
$699,797 for 1998 from $324,826 for 1997. The increase was primarily due to an
increase in management fees from municipal transactions and underwriting fees of
$334,005, or 120.1%, to $612,039 for 1998 from $278,034 for 1997.
Interest and dividend revenue increased by $280,069 to $334,793 for
1998 from $54,724 for 1997. This increase is due to higher cash balances
associated with the net proceeds from the Company's public offering of common
stock.
The loss on trading accounts was $637,957 for 1998. The Company's loss
on trading accounts is attributable to an unrealized loss of value on its
market-making securities inventory of $404,509 and a realized loss of $74,325. A
realized loss of $159,123 was recognized on sales related to trading stock of
DEM, Inc.
Total expense for 1998 increased by $2,049,554, or 81.9%, to $4,550,827
for 1998 from $2,501,273 for 1997. Total expense increased to 155.1% of total
revenue for
3
<PAGE>
1998 as compared to 83.6% of total revenue for 1997. Expenses increased in all
areas due to increased staffing, the opening of new offices and other expansions
of operations.
Compensation and benefits increased by $1,064,643 or 95.0%, to
$2,185,396 for 1998 from $1,120,753 for 1997. As a percentage of total revenue,
these expenses increased to 74.5% in 1998 from 37.4% in 1997. This increase is
largely due to the addition of 19 employees in connection with the Company's
ongoing business expansion efforts. Compensation expense includes sales
commissions paid to brokers and varies in relation to changes in commission
revenue. Notwithstanding that commission revenue decreased in 1998, commissions
paid to brokers increased primarily due to an increased municipal sales volume.
Floor brokerage and clearing fees increased by $144,484, or 50.4%, to
$430,989 for 1998 from $286,505 for 1997. This increase is attributable to an
increase in the number of transactions and a decrease in the average dollar
amount of such transactions.
Communication expense increased by $38,044, or 24.6%, to $192,408 for
1998 from $154,364 for 1997. This increase was primarily attributable to
increased usage associated with opening new offices and the Company's ongoing
business expansion efforts.
Occupancy and equipment expense increased by $104,537, or 29.4%, to
$460,079 for 1998 from $355,542 for 1997 due to the opening of additional
offices.
Travel and business development expense increased by $44,136, or 20.9%,
to $255,017 for 1998 from $210,881 for 1997 due to increased travel related to
business development activities.
Professional fees increased by $312,836, or 302.5%, to $416,267 for
1998 from $103,431 for 1997. The Company's increased use of legal services,
professional recruiters and marketing consultants related to the growth and
expansion of the Company.
Other operating expense increased by $340,874, or 126.3%, to $610,671
for 1998 from $269,797 for 1997. This increase was attributable to increased
advertising, supplies, postage and filing fees due to the growth and expansion
of the Company.
Income taxes from continuing operations decreased by $690,000 to a tax
benefit of $485,000 in 1998 from a tax provision of $205,000 for 1997. This
decrease was due to the loss from continuing operations.
The Company had no income from discontinued operations in 1998 verses
$51,459 for 1997.
The Company had a net loss of $1,130,758 for 1998 verses net income of
$336,987 for 1997. This change was a result of items discussed above.
4
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
The Company's assets are reasonably liquid with a substantial majority
consisting of cash and cash equivalents, investment securities, and receivables
from other broker-dealers and the Company's clearing agent, all of which
fluctuate depending upon the levels of customer business and trading activity.
Receivables from broker-dealers and the Company's clearing agent turnover
rapidly. Both the Company's total assets as well as the individual components as
a percentage of total assets may vary significantly from period to period
because of changes relating to customer demand, economic and market conditions,
and proprietary trading strategies. The Company's total assets as of December
31, 1998 was $10,205,138.
As a broker-dealer, the Company is subject to the net capital rules of
the NASD. As such, the Company is subject to certain restrictions on the use of
capital and its related liquidity. The net capital position of The Chapman Co.
as of December 31, 1998 was $797,382, which was $697,382 in excess of its
minimum net capital requirement.
The Company's cash and cash equivalents was $3,089,683 as of December
31, 1998.
Historically, the Company has financed its operations through the
private placement of equity securities and cash flow from operations. The
Company has not employed any significant leverage or debt. The Company intends
to use debt prudently in the future and may seek to arrange for lines of credit.
On February 26, 1998, the Company consummated an initial public
offering, the Offering, of its Common Stock pursuant to which the Company
received net proceeds of approximately $6,812,000.
The Company's overall capital and funding needs are continually
reviewed to ensure that its capital base can support the estimated needs of its
business. These reviews take into account business needs as well as the
Company's regulatory capital requirements. The Company believes that its capital
structure is adequate for current operations.
EFFECTS OF INFLATION
The Company's assets are to a large extent liquid in nature and,
accordingly, may be significantly affected by inflation. Market prices of
securities that the Company may hold in inventory are also influenced by changes
in inflation. Moreover, the rate of inflation affects the Company's expenses,
such as employee compensation, occupancy expenses and communications costs,
which may not be readily recoverable in the prices of services offered to the
Company's customers. To the extent inflation results in rising interest rates or
has adverse effects upon the securities markets, it may adversely affect the
Company's financial condition and results of operations.
5
<PAGE>
YEAR 2000 SOFTWARE ISSUE
As the Year 2000 approaches, existing software programs and operating
systems must be reviewed to determine if they can accommodate information
that employs dates after December 31, 1999. As of February 28, 1999, the
Company has incurred Year 2000 compliance costs of approximately $10,000, to
cover assessment of systems, internal testing, point-to-point testing,
training, and replacement and modification of existing systems. A portion of
the Company's Year 2000 compliance costs consisting primarily of expenses for
upgraded computers, software, and communication systems will be allocated to
Chapman Capital Management, Inc., ("CCM"), an affiliate of the Company,
through increased charges for administrative support under its expense
allocation agreement with the Company. See "Certain Transactions."
During 1999, the Company's Year 2000 compliance costs are estimated at
approximately $120,000, of which approximately $32,000 will be allocated to
CCM. The Company estimates that over the next three years its total Year 2000
compliance costs, will be approximately $300,000, of which approximately
$95,000 will be allocated to CCM.
Management has prepared a written plan detailing the Company's software
and operating systems' compliance issues for the year 2000. The plan identifies
critical and non-critical operating systems of the Company and addresses
external interfaces with third-party computer systems. The Company is currently
working with its hardware and software vendors and other third parties to
prepare for the year 2000. The Company anticipates that most of the necessary
hardware and software renovations needed to render the Company year 2000
compliant have been or will be completed by the first quarter of 1999.
Management plans to test its systems during the second quarter of 1999 to
determine the effect of its compliance efforts. According to the Company's plan,
the testing phase is scheduled to be completed by approximately June 30, 1999.
The table below summarizes the status of key elements of the Company's
Year 2000 compliance plan:
<TABLE>
<CAPTION>
PHASE PERCENTAGE OF COMPLETION
- -------------------------------- -----------------------------------------------------
<S> <C>
Assessment...................... 90%
Remediation and Renovation...... 90%
Testing......................... 25%
Contingency Planning............ 33%
</TABLE>
The Company has relationships with third parties that may have computer
systems that are not year 2000 compliant. The Company has identified the third
parties upon which it relies for mission-critical systems and has contacted or
is contacting such
<PAGE>
third parties to confirm that their systems are in compliance with the year 2000
requirements.
While the Company believes that it is taking prudent and necessary
action to comply with year 2000 requirements, there can be no assurance that the
year 2000 issue will not result in information or communications systems
interruptions. Any such interruptions could be expected to have a material
adverse effect on the Company's business, financial condition, results of
operations and business prospects and may subject the Company to liability to
its clients. The Company is currently building upon its existing contingency
plan in the event that the Company or third parties do not successfully complete
their compliance efforts, or if vendors or third parties controlling systems
critical to the Company are unable to confirm that their systems will be year
2000 compliant. These efforts may result in additional costs in excess of
current allocations and estimates.
6
<PAGE>
STOCKHOLDER INFORMATION
The Common Stock is quoted on the SmallCap Market under the symbol
"CMAN." As of March 17, 1999, there were approximately 28 holders of record and
approximately 500 beneficial owners of the Common Stock.
PRICE RANGE PER SHARE
Set forth below is the range of high and low bid information on the
Nasdaq SmallCap Market for the Company's Common Stock for each quarter since the
Company's initial public offering. These quotations reflect inter-dealer prices,
without retail mark-up, mark-down or commission, and may not represent actual
transactions.
<TABLE>
<CAPTION>
----------------------------------------------- ---------------------------------------
QUARTER 1998
----------------------------------------------- ------------------- -------------------
HIGH LOW
----------------------------------------------- ------------------- -------------------
<S> <C> <C>
January to March* 10 93/4
----------------------------------------------- ------------------- -------------------
April to June 11 10
----------------------------------------------- ------------------- -------------------
July to September 10 1/8 10
----------------------------------------------- ------------------- -------------------
October to December 93/4 41/2
----------------------------------------------- ------------------- -------------------
</TABLE>
* The Common Stock commenced trading on the Nasdaq SmallCap Market in
February 1998.
DIVIDENDS
The Company has never declared or paid cash or other dividends on its
Common Stock and does not anticipate doing so in the foreseeable future.
The payment of dividends, if any, in the future is within the discretion of
the Board of Directors and will depend upon the Company's earnings, if any,
its financial condition, and other relevant factors. The Company intends to
retain any earnings in the foreseeable future for the Company's continued
growth.
7
<PAGE>
FINANCIAL STATEMENTS
<PAGE>
CHAPMAN HOLDINGS, INC. AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
Report of Independent Public Accountants................................................................... F-2
Financial Statements
Consolidated Balance Sheet as of December 31, 1998....................................................... F-3
Consolidated Statements of Operations for the Years Ended December 31, 1998 and 1997..................... F-4
Consolidated Statements of Changes in Stockholders' Equity for the Years Ended December 31, 1998 and
1997................................................................................................... F-5
Consolidated Statements of Cash Flows for the Years Ended December 31, 1998 and 1997..................... F-6
Notes to Consolidated Financial Statements............................................................... F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of
Chapman Holdings, Inc:
We have audited the accompanying consolidated balance sheet of Chapman Holdings,
Inc. and Subsidiaries (a Maryland corporation) as of December 31, 1998, and the
related consolidated statements of operations, changes in stockholders' equity
and cash flows for the two years ended December 31, 1998. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Chapman Holdings,
Inc. and Subsidiaries as of December 31, 1998, and the results of their
operations and their cash flows for the two years ended December 31, 1998, in
conformity with generally accepted accounting principles.
/S/ARTHUR ANDERSEN LLP
Baltimore, Maryland,
February 22, 1999
F-2
<PAGE>
CHAPMAN HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
AS OF DECEMBER 31, 1998
<TABLE>
<CAPTION>
ASSETS:
Cash and cash equivalents.................................................... $3,089,683
<S> <C>
Cash deposits with clearing organization..................................... 2,388,600
Investments.................................................................. 203,750
Securities owned............................................................. 2,080,355
Receivables from brokers and dealers......................................... 331,428
Receivables from discontinued operations..................................... --
Receivables from affiliates.................................................. 379,832
Income taxes receivable...................................................... 294,000
Advances to officer/employee................................................. 657,198
Office equipment, net........................................................ 37,653
Prepaids and other assets.................................................... 583,172
Intangible assets............................................................ 145,000
Deferred tax asset........................................................... 14,467
Net assets from discontinued operations...................................... --
----------
Total assets............................................................. $10,205,138
----------
----------
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY:
<S> <C>
Accounts payable and accrued expenses........................................ $ 261,457
Margin loan payable.......................................................... 2,559,189
Accrued compensation......................................................... 242,807
Deferred rent................................................................ 78,143
Payable to affiliated partnership............................................ --
Income taxes payable......................................................... --
Deferred tax liability....................................................... --
Net liabilities from discontinued operations................................. --
----------
Total liabilities........................................................ 3,141,596
----------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock, $.001 par value, 20,000,000 shares authorized, 2,953,622 shares
issued and outstanding..................................................... 2,954
Additional paid-in capital................................................... 7,902,561
Accumulated deficit.......................................................... (841,973)
----------
Total stockholders' equity............................................... 7,063,542
----------
Total liabilities and stockholders' equity............................... $10,205,138
----------
----------
</TABLE>
The accompanying notes are an integral part of this consolidated balance sheet.
F-3
<PAGE>
CHAPMAN HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
------------- ------------
<S> <C> <C>
REVENUE:
Commissions........................................................................ $ 2,538,436 $ 2,612,251
Underwriting and management fees................................................... 699,797 324,826
Interest and dividends............................................................. 334,793 54,724
Loss on trading.................................................................... (637,957) --
------------- ------------
Total revenue.................................................................. 2,935,069 2,991,801
------------- ------------
EXPENSE:
Compensation and benefits.......................................................... 2,185,396 1,120,753
Floor brokerage and clearing fees.................................................. 430,989 286,505
Communications..................................................................... 192,408 154,364
Occupancy, equipment rental, and depreciation...................................... 460,079 355,542
Travel and business development.................................................... 255,017 210,881
Professional fees.................................................................. 416,267 103,431
Other operating expense............................................................ 610,671 269,797
------------- ------------
Total expense.................................................................. 4,550,827 2,501,273
------------- ------------
(Loss) income from continuing operations before income tax (benefit)
provision.................................................................... (1,615,758) 490,528
INCOME TAX (BENEFIT) PROVISION....................................................... (485,000) 205,000
------------- ------------
(Loss) income from continuing operations....................................... (1,130,758) 285,528
INCOME FROM DISCONTINUED OPERATIONS, net of income taxes of $40,000.................. -- 51,459
------------- ------------
Net (loss) income.............................................................. $ (1,130,758) $ 336,987
------------- ------------
------------- ------------
BASIC EARNINGS PER SHARE DATA:
Income from continuing operations.................................................. $ (.40) $ 0.14
Income from discontinued operations................................................ -- 0.03
------------- ------------
Net (loss) income.............................................................. $ (.40) $ 0.17
------------- ------------
------------- ------------
Weighted average shares outstanding................................................ 2,792,891 2,001,914
------------- ------------
------------- ------------
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-4
<PAGE>
CHAPMAN HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
RETAINED
ADDITIONAL EARNINGS TOTAL
COMMON PAID-IN (ACCUMULATED STOCKHOLDERS'
STOCK CAPITAL DEFICIT) EQUITY
----------- ------------ ------------ ------------
<S> <C> <C> <C> <C>
BALANCE, December 31, 1996.................................. $ 1,945 $ 1,309,005 $ (181,743) $1,129,207
Net income................................................ -- -- 336,987 336,987
Purchase of 152,250 shares of stock....................... (152) (217,348) -- (217,500)
Issuance of 196,594 shares of stock in exchange for a
stock warrant........................................... 196 (196) -- --
----------- ------------ ------------ ------------
BALANCE, December 31, 1997.................................. 1,989 1,091,461 155,244 1,248,694
Net loss.................................................. -- -- (1,130,758) (1,130,758)
Accumulated deficit from discontinued operations.......... -- -- 133,541 133,541
Net proceeds from issuance of common stock................ 965 6,811,100 -- 6,812,065
----------- ------------ ------------ ------------
BALANCE, December 31, 1998.................................. $ 2,954 $ 7,902,561 $ (841,973) $7,063,542
----------- ------------ ------------ ------------
----------- ------------ ------------ ------------
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-5
<PAGE>
CHAPMAN HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
-------------- ----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income................................................................... $ (1,130,758) $ 336,987
Adjustments to reconcile net (loss) income to net cash used in operating activities:
Depreciation expense.............................................................. 7,500 --
Unrealized/realized loss on securities owned...................................... 637,957 --
Deferred taxes.................................................................... (122,467) 108,000
Effect from changes in assets and liabilities--
Deposits with clearing organization............................................. (2,348,484) (5,116)
Receivables from brokers and dealers............................................ 53,722 (228,743)
Receivables from discontinued operations........................................ 800,672 (118,029)
Receivables from affiliates..................................................... (379,587) (45)
Income tax receivable........................................................... (294,000) --
Advances to officer/employee.................................................... (481,147) (66,378)
Prepaids and other assets....................................................... (494,764) (24,330)
Net assets from discontinued operations......................................... 5,934 83,628
Accounts payable and accrued expenses........................................... 192,593 (24,104)
Accrued compensation............................................................ 173,897 (7,461)
Deferred rent................................................................... (10,905) --
Payable to affiliated partnership............................................... (9,846) (49,230)
Income taxes payable............................................................ (97,837) (52,504)
-------------- ----------
Net cash used in operating activities......................................... (3,497,520) (47,325)
-------------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of office equipment........................................................ (22,810) (9,785)
Purchase of Bell.................................................................... (219,827) --
Purchase of investments............................................................. (1,207,444) (11,806)
Proceeds from sale of investments................................................... 1,013,877 --
-------------- ----------
Net cash used in investing activities......................................... (436,204) (21,591)
-------------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of common stock.......................................... 7,715,096 --
Issuance costs...................................................................... (903,031) --
Purchase of stock................................................................... -- (217,500)
-------------- ----------
Net cash provided by (used in) financing activities........................... 6,812,065 (217,500)
-------------- ----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS.................................. 2,878,341 (286,416)
CASH AND CASH EQUIVALENTS, beginning of year.......................................... 211,342 497,758
-------------- ----------
CASH AND CASH EQUIVALENTS, end of year................................................ $ 3,089,683 $ 211,342
-------------- ----------
-------------- ----------
</TABLE>
>The accompanying notes are an integral part of these consolidated statements.
F-6
<PAGE>
CHAPMAN HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
ORGANIZATION AND BUSINESS
Chapman Holdings, Inc. (the "Company") provides securities brokerage and
investment banking services. The Company, during December 1997, became the
parent of a wholly-owned subsidiary, The Chapman Co. ("Chapman") and its two
subsidiaries, Chapman Capital Management, Inc. ("CCM") and Chapman Insurance
Agency, Incorporated ("CIA") pursuant to the merger of a newly formed wholly-
owned subsidiary of the Company into Chapman. CCM and CIA were spun off from
Chapman as part of the initial public offering ("IPO") on February 26, 1998.
The Company allocates compensation, benefits and other costs to CCM and CIA
on a proportional allocation cost method which management believes is
reasonable. Compensation and benefits are allocated based on management's
estimate of the percentage of time employees spend performing services for CCM
and CIA. Other costs, consisting of communications, occupancy and administrative
support, are allocated based on estimated usage by CCM and CIA.
BASIS OF PRESENTATION
The accompanying consolidated financial statements are presented on the
accrual basis of accounting in accordance with generally accepted accounting
principles. All significant intercompany balances have been eliminated in
consolidation. The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities as of the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
ACQUISITION
The Company acquired all of the outstanding stock of Charles A. Bell (Bell),
a securities brokerage firm located in San Francisco, California, on December
29, 1998, for approximately $391,200. The acquisition resulted in recording
approximately $145,000 of intangible assets from the purchase price being in
excess of the book value of Bell. The assets acquired consist of cash, current
assets, property and intangibles.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents primarily consists of cash invested in the U.S.
Treasury Money Fund, a fund managed by Chapman Capital Management, Inc., an
affiliate.
INVESTMENTS
Investments as of December 31, 1998 and 1997, consist primarily of
certificates of deposit in which cost approximates market.
SECURITIES OWNED AND NOT YET PURCHASED
Securities owned consist of trading proprietary stock, which is carried at
market. The proprietary stock is primarily stock of Chapman Capital Management
Holdings, Inc. (CCMH), a company whose majority
F-7
<PAGE>
CHAPMAN HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
stockholder is also the majority stockholder of the Company. Chapman is the
market maker for the Company and CCMH and, thus, holds their stock in inventory.
As of December 31, 1998, Chapman held 115,997 shares of common stock of the
Company, with a market value of $579,985. The proprietary stock was purchased on
margin.
FINANCIAL INSTRUMENTS
The carrying amounts reported in the consolidated balance sheet for cash and
cash equivalents, receivables, investments, securities owned, advances, accounts
payable, accrued expenses and margin loan payable approximate fair value.
EARNINGS PER SHARE
As of December 31, 1997, the Company adopted Financial Accounting Standards
Board Statement No. 128, "Earnings Per Share" (SFAS No. 128). Under SFAS No.
128, a company must disclose basic earnings per share (the principal difference
being that common stock equivalence would not be considered in the compilation
of basic earnings per share) and diluted earnings per share. The Company adopted
this pronouncement which required restatement of all prior periods presented.
Earnings per share are based on the weighted average number of common and
dilutive common equivalent shares outstanding during the period the calculation
is made. Common equivalent shares consist of shares issuable upon the exercise
of stock warrants, using the treasury stock method. The weighted average shares
outstanding as of December 31, 1998 and 1997, are the weighted average common
shares outstanding of 2,792,891 and 2,001,914, respectively. The options granted
during 1998 would be antidilutive and, thus, are not required in the earnings
per share calculation.
INTANGIBLE ASSETS
Intangible assets consist of a non-compete agreement of $75,000 being
amortized over 2 years and goodwill of $70,000 being amortized over 15 years.
These intangibles are related to the Bell acquisition.
SEGMENT REPORTING
The Company has adopted SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information" as of December 31, 1998, and has determined
that the Company has only one segment, securities brokerage and investment
banking services. The Company came to this conclusion because the Company
operates in one regulatory environment and has only one management group that
manages the entire Company. Information on the Company's results are provided as
one segment to the key decision-maker to make decisions.
COMPREHENSIVE INCOME
The Company has adopted SFAS, No. 130, "Reporting Comprehensive Income" and
has determined that the Company does not have any comprehensive income
adjustments for the periods presented, and therefore, comprehensive income
equals net income.
F-8
<PAGE>
CHAPMAN HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
REVENUE RECOGNITION
The Company records commission revenue, underwriting and management fees,
and related expenses on a trade date basis.
VOLATILITY OF BUSINESS
The Company's revenues and operating results may fluctuate from month to
month, quarter to quarter and year to year due to a combination of factors,
including the number of underwriting transactions in which the Company
participates, access to public markets for companies in which the Company has
invested as a principal, the level of institutional and retail brokerage
transactions, and expenses of establishing new business units. The Company's
revenues from an underwriting transaction are recorded only when the
underwritten security commences trading; accordingly, the timing of the
Company's recognition of revenue from a significant transaction can materially
affect the Company's operating results. As a result, the Company could
experience losses if demand for the above transactions declines faster than the
Company's ability to change its cost structure.
OFFICE EQUIPMENT
Office equipment is depreciated using the straight-line method over the
estimated useful life of 3 to 5 years. As of December 31, 1998, accumulated
depreciation was $7,500.
TRANSACTIONS WITH CLEARING ORGANIZATION
The Company is required to have cash on deposit with its clearing agent for
general trading purposes. In addition, receivables from and payables to the
clearing organization arise from cash settlements on ordinary trading activity
and clearing expenses.
INCOME TAXES
The Company accounts for income taxes under the separate company liability
method, whereby deferred income taxes are recognized for the tax consequences of
temporary differences by applying enacted statutory tax rates applicable to
future years to differences between the financial statement carrying amounts and
the tax bases of existing assets and liabilities.
2. INITIAL PUBLIC OFFERING AND SPIN-OFF OF OPERATIONS:
On February 26, 1998, the Company consummated an initial public offering
(the Offering) of its Common Stock pursuant to which the Company received net
proceeds, after the offering costs, of approximately $6,812,000.
Effective February 26, 1998, concurrent with the Company's completed initial
public offering, the Company spun off two of its wholly owned subsidiaries,
Chapman Capital Management, Inc. and the Chapman Insurance Agency, Inc. For the
year ended December 31, 1997, the results of operations of CCM and CIA are
reflected on the accompanying consolidated statement of operations as income
from discontinued operations, respectively.
F-9
<PAGE>
CHAPMAN HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
3. CAPITAL STOCK:
The common stock activity included in the accompanying consolidated
financial statements has been restated to reflect the one-for-five share
exchange of stock related to the merger of Chapman into the Company during 1998.
As such, all share data related to Chapman prior to the merger has been restated
at the Company's stock conversion amounts.
4. COMMITMENTS AND CONTINGENCIES:
The Company has entered into an operating lease agreement for office
facilities which expires on October 15, 2000. Rent expense under this agreement
was $209,052 in 1998 and 1997. The aggregate minimum future annual rental for
the following fiscal years ending December 31 is as follows:
<TABLE>
<CAPTION>
<S> <C>
1999.............................................................................. $ 252,660
2000.............................................................................. 200,022
</TABLE>
In addition, a proportionate share of real estate taxes and building
expenses in excess of base year amounts are charged to the Company. This lease
agreement includes scheduled rent increases which are recognized on a
straight-line basis. As of December 31, 1998, the Company recorded $78,143 in
deferred rent relating to this straight-line basis of rent expense recognition.
The Company leases furniture and equipment from the Chapman Limited
Partnership I (the Partnership), an entity in which certain officers and
stockholders of the Company are partners. The lease requires monthly payments of
$9,846 and contains one year renewable terms, at the option of the Company,
through September 2000, at which time the Company can purchase the furniture and
equipment at fair value. Rent expense under this lease agreement was $118,152 in
1998 and 1997.
The Company clears all transactions for its brokerage customers through its
clearing agent, which carries and clears all customer securities accounts. The
clearing agent also lends funds to the Company's brokerage customers through the
use of margin credit. These loans are made to customers on a secured basis, with
the clearing agent maintaining collateral in the form of saleable securities,
cash or cash equivalents. Pursuant to the terms of the agreement between the
Company and the clearing agent, in the event that customers fail to pay for
their purchases, to supply the securities that they have sold, or to repay funds
they have borrowed, and the clearing agent satisfies any customer obligations,
the Company would be obligated to indemnify the clearing agent for any resulting
losses. For the years ended December 31, 1998 and 1997, the Company did not
incur such losses.
Securities brokerage firms become parties to arbitrations brought by
dissatisfied customers in the general course of business. The Company has been
and is currently a party to such proceedings, none of which has resulted or
which management believes will result in any material liability.
F-10
<PAGE>
CHAPMAN HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
5. INCOME TAXES:
A reconciliation of the statutory income taxes to the recorded income tax
(benefit) provision for the years ended December 31, 1998 and 1997, are as
follows:
<TABLE>
<CAPTION>
1998 1997
----------- ----------
<S> <C> <C>
Statutory tax (at 35% rate).................................................... $ (566,000) $ 167,000
Effect of state income taxes................................................... (79,000) 24,000
Effect of graduated tax rate................................................... 120,000 --
Effect of permanent book to tax differences.................................... 40,000 14,000
----------- ----------
Income tax (benefit) provision................................................. $ (485,000) $ 205,000
----------- ----------
----------- ----------
</TABLE>
The components of the income tax (benefit) provision for the years ended
December 31, 1998 and 1997, are as follows:
<TABLE>
<CAPTION>
1998 1997
----------- ----------
<S> <C> <C>
Current........................................................................ $ (362,533) $ 57,000
Deferred....................................................................... (122,467) 108,000
Discontinued operations........................................................ -- 40,000
----------- ----------
Income tax (benefit) provision................................................. $ (485,000) $ 205,000
----------- ----------
----------- ----------
</TABLE>
The Company's deferred income tax asset and liability as of December 31,
1998, consist of the following:
<TABLE>
<CAPTION>
<S> <C>
Deferred tax asset:
NOL carryforward.......................................................................... $ 64,999
Deferred tax liability:
Other..................................................................................... (50,532)
----------
Net deferred tax asset recorded on the consolidated balance sheet........................... $ 14,467
----------
----------
</TABLE>
6. REGULATORY REQUIREMENTS:
Pursuant to the requirements of the Securities and Exchange Commission's
(SEC) Uniform Net Capital Rule (Rule 15c3-1), the Company is required to
maintain net capital, as defined, of not less than $100,000 and a ratio of
aggregate indebtedness to net capital, as defined, not to exceed 15 to 1. As of
December 31, 1998, the Company had excess net capital of $697,382 and a ratio of
aggregate indebtedness to net capital of .7 to 1. As of December 31, 1997, the
Company had excess net capital of $169,509 and a ratio of aggregate indebtedness
to net capital of .9 to 1.
The Company is subject to compliance with various SEC and National
Association of Securities Dealers, Inc. (NASD) regulations. Also, the NASD
periodically reviews the Company's records and procedures for compliance with
its requirements. Any acts of noncompliance may subject the Company to fines and
other punitive remedies and may significantly effect the Company's ability to
operate.
F-11
<PAGE>
CHAPMAN HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
7. STATEMENTS OF CASH FLOWS-SUPPLEMENTAL DISCLOSURE:
Supplemental cash flow disclosure for the years ended December 31, 1998 and
1997 were as follows:
<TABLE>
<CAPTION>
1998 1997
--------- ---------
<S> <C> <C>
Cash paid-
Interest........................................................................ $ 9,686 $ 9,341
Income taxes.................................................................... 29,000 182,232
</TABLE>
8. EMPLOYEE SAVINGS PLAN:
The Company's Retirement Savings Plan, a 401(k) plan, provides participants
a mechanism for making contributions for retirement savings. Each participant
may make pre-tax and after-tax contributions based upon eligible compensation.
The Company may make discretionary contributions based on the participants'
compensation for the plan year. The Company elected not to contribute to the
plan for the years ended December 31, 1998 and 1997.
9. OMNIBUS STOCK PLAN:
In March 1998, Chapman started an Omnibus Stock Plan (the Plan) to enable
selected management, employees, consultants and directors to acquire interest in
Chapman through ownership of common stock. The Plan has 150,000 shares of common
stock registered. On September 28, 1998, Chapman granted options for 43,900
shares of common stock at fair market value at the date of grant, which was
$9.50. The options vested on the grant date and have a three-year term. None of
those options had been exercised, expired or canceled as of December 31, 1998.
The Company accounts for its stock-based compensation plans as permitted by
FASB Statement No. 123, "Accounting for Stock-Based Compensation," which allows
the Company to follow Accounting Principles Board Opinion No. 25 ("APB No. 25"),
"Accounting for Stock Issued to Employees" and recognize no compensation cost
for options granted at fair market prices. The Company has computed, for pro
forma disclosure purposes, the value of all compensatory options granted during
1998, using the Black-Scholes option pricing model. The following assumptions
were used for grants for the year ended December 31, 1998:
<TABLE>
<S> <C>
Risk free interest rate.................................................... 4.51%
Expected dividend yield.................................................... 0.0%
Expected lives............................................................. 2 years
Expected volatility........................................................ 59%
</TABLE>
Options were assumed to be exercised upon vesting for the purposes of this
valuation. Had compensation costs for compensatory options been determined
consistent with SFAS No. 123, the Company's pro forma net loss and earnings per
share information reflected on the accompanying consolidated statements
F-12
<PAGE>
CHAPMAN HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
9. OMNIBUS STOCK PLAN: (CONTINUED)
of operations would have been increased to the following "as adjusted" amount
for the year ended December 31, 1998:
<TABLE>
<S> <C>
Net loss:
As reported........................................................... $1,130,758
As adjusted........................................................... 1,234,639
Basic earnings:
Per share-
As reported......................................................... (.40)
As adjusted......................................................... (.44)
</TABLE>
Weighted average fair value of options granted for the year ended December
31, 1998, was $3.37. The value was calculated using the Black-Scholes option
pricing model.
10. RELATED PARTY TRANSACTIONS:
The Company served as the underwriter for DEM, Inc. (DEM), a registered
non-diversified closed-ended management investment company. CCM provides
investment advisory and administrative services to DEM under an investment
advisory and administrative services agreement which sets forth the services to
be provided and the fees to be charged. The Company purchased 69,000 shares of
DEM stock during 1998. During the fourth quarter of 1998, DEM was dissolved. The
Company recognized a $159,123 loss on trading due to this dissolution.
Listed below are fees and commissions earned from DEM for the year ended
December 31, 1997.
<TABLE>
<S> <C>
Included in continuing operations (underwriting fees)..................... $ 432,008
Included in discontinued operations....................................... 138,614
---------
$ 570,622
---------
---------
</TABLE>
As of December 31, 1998, the Company had outstanding advances to its
majority stockholder and other employees of $657,198. The advances to the
majority stockholder are reflected in demand notes, which accrue interest at
5.5% per annum.
F-13
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the use of our
reports in this Form 10-KSB. It should be noted that we have not audited any
financial statements of the Company subsequent to December 31, 1998, or
performed any audit procedures subsequent to the date of our report.
/S/ ARTHUR ANDERSEN LLP
Baltimore, Maryland
March 30, 1999
<PAGE>
Exhibit 24
CHAPMAN HOLDINGS, INC.
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS that the undersigned Directors and
Executive Officers of Chapman Holdings, Inc., incorporated in the State of
Maryland, hereby constitute and appoint Nathan A. Chapman, Jr. and Earl U.
Bravo, Sr., and either of them, the true and lawful agents and attorney-in-fact
of the undersigned with full power and authority in either said agent and
attorney-in-fact, to sign for the undersigned and in their respective names as
Directors and/or Executive Officers of Chapman Holdings, Inc., the Annual Report
on Form 10-KSB, and any and all further amendments to said report, hereby
ratifying and confirming all acts taken by such agent and attorney-in-fact, as
herein authorized.
Dated as of: March 5, 1999
/S/ NATHAN A. CHAPMAN, JR. /S/ DONALD V. WATKINS
- ---------------------------------------------- ------------------------------
Nathan A. Chapman, Jr., President, Chairman Donald V. Watkins, Director
of the Board and Director (Principal Executive
Officer)
/S/ EARL U. BRAVO, SR. /S/ LOTTIE H. SHACKELFORD
- ---------------------------------------------- ------------------------------
Earl U. Bravo, Sr., Director Lottie H. Shackelford, Director
/S/ M. LYNN BALLARD
- --------------------------
M. Lynn Ballard, Treasurer
(Principal Financial Officer and Principal
Accounting Officer)
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
The schedule contains summary financial information extracted from the financial
statements of the Company for the fiscal years ended December 31, 1998 and
1997, and is qualified in its entirety by reference to such financial
statements.
</LEGEND>
<S> <C> <C>
<PERIOD-TYPE> 12-MOS 12-MOS
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1997
<PERIOD-START> JAN-01-1998 JAN-01-1997
<PERIOD-END> DEC-31-1998 DEC-31-1997
<CASH> 3,089,683 0
<SECURITIES> 2,284,105 0
<RECEIVABLES> 1,662,458 0
<ALLOWANCES> 0 0
<INVENTORY> 0 0
<CURRENT-ASSETS> 10,045,671 0
<PP&E> 45,153 0
<DEPRECIATION> 7,500 0
<TOTAL-ASSETS> 10,205,138 0
<CURRENT-LIABILITIES> 3,141,696 0
<BONDS> 0 0
0 0
0 0
<COMMON> 2,954 0
<OTHER-SE> 7,060,588 0
<TOTAL-LIABILITY-AND-EQUITY> 10,205,138 0
<SALES> 2,935,069 2,991,801
<TOTAL-REVENUES> 2,935,069 2,991,801
<CGS> 4,550,827 2,501,273
<TOTAL-COSTS> 4,550,827 2,501,273
<OTHER-EXPENSES> 0 0
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 9,686 0
<INCOME-PRETAX> (1,615,758) 490,528
<INCOME-TAX> (165,00) 205,000
<INCOME-CONTINUING> (1,130,758) 285,528
<DISCONTINUED> 0 51,459
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (1,130,758) 336,987
<EPS-PRIMARY> 0.40 0.17
<EPS-DILUTED> 0 0
</TABLE>