10-Q 1 form10q093002.txt FORM 10Q SEPTEMBER 30, 2002 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-Q (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended SEPTEMBER 30, 2002 ------------------------------------------------------------------------------------ Commission file number 0-22629 -------------------------------------------------------------------------------------------- UNIFIED FINANCIAL SERVICES, INC. ------------------------------------------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) DELAWARE 35-1797759 ---------------------------------------------------------- ----------------------------------------------------- (State or other jurisdiction (I.R.S. Employer Identification No.) of incorporation or organization) 2424 HARRODSBURG ROAD LEXINGTON, KENTUCKY 40503 ------------------------------------------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (859) 296-2016 ------------------------------------------------------------------------------------------------------------------- (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. |X| Yes |_| No Number of shares Title of class outstanding as of November 1, 2002 -------------------------------------------- ------------------------------------------- Common stock, $0.01 par value 2,858,972 UNIFIED FINANCIAL SERVICES, INC. FORM 10-Q INDEX PART I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Statements of Financial Condition - September 30, 2002 (Unaudited) and December 31, 2001...............................................................1 Consolidated Statements of Operations (Unaudited) - Nine and Three Months Ended September 30, 2002 and 2001...............................................................3 Consolidated Statements of Comprehensive Income (Unaudited) - Nine and Three Months Ended September 30, 2002 and 2001..................................................4 Consolidated Statements of Cash Flow (Unaudited) - Nine Months Ended September 30, 2002 and 2001.....................................................................5 Notes to Consolidated Financial Statements......................................................6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations..........16 Cautionary Statement Regarding Forward-Looking Statements......................................16 General........................................................................................16 Comparison of Results for the Nine Months Ended September 30, 2002 and 2001....................17 Comparison of Results for the Three Months Ended September 30, 2002 and 2001...................20 Liquidity and Capital Resources................................................................21 Item 3. Quantitative and Qualitative Disclosure About Market Risk......................................23 Item 4. Controls and Procedures........................................................................27 PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K...............................................................28 SIGNATURES.......................................................................................................29 CERTIFICATION....................................................................................................30 EXHIBIT INDEX....................................................................................................34 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS UNIFIED FINANCIAL SERVICES, INC. CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION ASSETS ------ SEPTEMBER 30, DECEMBER 31, 2002 2001 -------------- ---------------- Current Assets Cash and cash equivalents (see note 14)........................... $ 6,637,890 $ 8,844,482 Due from banks.................................................... 2,581,559 1,357,483 Federal funds sold................................................ -- 4,033,000 Bond investments (see note 14).................................... 16,338,105 11,374,531 Investment in securities and non-affiliated mutual funds.................................................... 599,937 555,013 Note receivable................................................... 800,000 800,000 Loans (net of allowance for loan losses of $520,216 for 2002 and $430,000 for 2001)................................. 60,635,321 43,705,576 Accounts receivable (net of allowance for doubtful accounts of $81,940 for 2002 and $260,299 for 2001).............................................. 5,683,832 5,480,214 Prepaid assets and deposits....................................... 376,608 425,061 Deferred tax asset................................................ 289,676 287,435 -------------- -------------- Total current assets.......................................... 93,942,928 76,862,795 -------------- -------------- Fixed Assets, at cost Equipment and furniture (net of accumulated depreciation of $2,517,104 for 2002 and $2,330,472 for 2001)............................................ 2,114,049 2,277,430 -------------- -------------- Total fixed assets............................................ 2,114,049 2,277,430 -------------- -------------- Non-Current Assets Investment in affiliate (see note 12)............................. 1,010 1,010 Goodwill (net of accumulated amortization of $347,734 for 2002 and 2001) (see note 3)........................ 1,006,061 1,006,061 Other non-current assets.......................................... 62,830 43,696 -------------- -------------- Total non-current assets...................................... 1,069,901 1,050,767 -------------- -------------- TOTAL ASSETS............................................. $ 97,126,878 $ 80,190,992 ============== ============== (CONTINUED ON NEXT PAGE) See accompanying notes. -1- UNIFIED FINANCIAL SERVICES, INC. CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION LIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------ SEPTEMBER 30, DECEMBER 31, 2002 2001 ---------------- ---------------- Current Liabilities: Current portion of capital lease obligations....................... $ -- $ 595 Current portion of bank borrowings................................. -- 3,153 Borrowed funds..................................................... 4,828,246 -- Bank line-of-credit................................................ 1,270,000 1,104,780 Deposits (see note 14)............................................. 70,702,009 55,905,541 Accounts payable and accrued expenses.............................. 695,262 2,448,177 Accrued compensation and benefits.................................. 562,383 570,883 Payable to broker-dealers.......................................... 93,698 142,985 Income taxes payable............................................... 233,461 215,027 Deferred income taxes.............................................. 193,781 55,608 Other liabilities.................................................. 1,822,060 1,382,025 ------------- ------------- Total current liabilities...................................... 80,400,900 61,828,774 ------------- ------------- Long-Term Liabilities Long-term portion of capital lease obligations..................... -- 454 Deferred income taxes.............................................. 25,680 12,853 Other long-term liabilities........................................ 807,475 1,600,000 ------------- ------------- Total long-term liabilities.................................... 833,155 1,613,307 ------------- ------------- Total liabilities......................................... 81,234,055 63,442,081 ------------- ------------- Commitments and Contingencies........................................... -- -- ------------- ------------- Stockholders' Equity Common stock, par value $.01 per share............................. 33,090 33,277 Additional paid-in capital......................................... 16,078,230 16,187,294 Retained earnings.................................................. (772,223) 231,300 Accumulated other comprehensive income............................. 553,726 297,040 ------------- ------------- Total stockholders' equity................................ 15,892,823 16,748,911 ------------- ------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY.............................. $ 97,126,878 $80,190,992 ============= ============== See accompanying notes. -2- UNIFIED FINANCIAL SERVICES, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) NINE MONTHS ENDED THREE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------------- ----------------------------- 2002 2001 2002 2001 ------------- ------------- ------------ ------------ REVENUE: Gross revenue (see note 10)................. $ 13,339,936 $ 12,997,782 $ 4,546,030 $ 4,403,936 ------------- ------------- ------------ ------------ Total gross revenue..................... 13,339,936 12,997,782 4,546,030 4,403,936 ------------- ------------- ------------ ------------ COST OF SALES: Cost of sales (see note 10)................. 2,710,700 2,522,673 904,959 939,771 ------------- ------------- ------------ ------------ Total cost of sales..................... 2,710,700 2,522,673 904,959 939,771 ------------- ------------- ------------ ------------ GROSS PROFIT (see note 10)....................... 10,629,236 10,475,109 3,641,071 3,464,165 ------------- ------------- ------------ ------------ EXPENSES: Employee compensation....................... 6,397,473 7,127,167 2,094,317 2,367,491 Employee insurance and benefits............. 1,029,568 1,023,444 292,942 331,464 Mail and courier............................ 112,336 122,327 36,126 26,391 Telephone................................... 191,492 304,150 49,571 90,291 Equipment rental and maintenance............ 361,171 357,892 118,921 108,629 Occupancy................................... 712,727 676,965 243,105 227,689 Depreciation and amortization............... 281,954 602,480 53,894 218,522 Professional fees........................... 498,283 517,681 197,848 188,701 Interest.................................... (7,489) 67,648 208 8,778 Program administration fees................. 20,855 157,445 67,400 62,635 Provision for bad debt...................... 96,739 255,543 65,332 31,004 Provision for loan losses................... 589,186 90,000 44,783 35,000 Business development costs.................. 41,332 39,207 27,892 19,218 Insurance................................... 167,294 125,055 53,456 80,071 Other operating expenses (see note 12)...... 1,117,788 1,021,954 413,446 580,503 ------------- ------------- ------------ ------------ Total expenses.......................... 11,610,709 12,488,958 3,759,241 4,376,387 ------------- ------------- ------------ ------------ Loss from continuing operations............. (981,473) (2,013,849) (118,170) (912,222) Other loss.................................. (28,338) (51,851) (4,136) (43,566) Income tax benefit (expense)................ (6,919) 635,872 (10,096) 237,633 ------------- ------------- ------------ ------------ Net loss from continuing operations.............................. (1,016,730) (1,429,828) (132,402) (718,155) Income (loss) from discontinued operations (net of income taxes of $8,081, $660,872, $(96) and $237,633, respectively) .................... 13,207 1,039,012 (158) 364,971 ------------- ------------- ------------ ------------ Net loss ........................................ $ (1,003,523) $ (390,816) $ (132,560) $ (353,184) ============= ============= ============ ============ Per share loss Basic common shares outstanding............. 2,858,972 2,880,028 2,858,972 2,880,028 Net loss - basic............................ $ (0.35) $ (0.14) $ (0.05) $ (0.12) Fully diluted common shares outstanding (see note 13).......................... 2,858,972 2,905,564 2,858,972 2,905,564 Net loss - fully diluted.................... $ (0.35) $ (0.13) $ (0.05) $ (0.12) See accompanying notes. -3- UNIFIED FINANCIAL SERVICES, INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED) NINE MONTHS ENDED THREE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------------- ----------------------------- 2002 2001 2002 2001 ------------- ------------- ------------ ------------ Net loss ........................................ $ (1,003,523) $ (390,816) $ (132,560) $ (353,184) Other comprehensive income (loss), net of tax Unrealized gain on securities, net of reclassification adjustment............. 256,686 269,038 105,552 190,109 ------------- ------------- ------------ ------------ Comprehensive loss............................... $ (746,837) $ (121,778) $ (27,008) $ (163,075) ============= ============= ============ ============ See accompanying notes. -4- UNIFIED FINANCIAL SERVICES, INC. CONSOLIDATED STATEMENTS OF CASH FLOW (UNAUDITED) NINE MONTHS ENDED SEPTEMBER 30, ----------------------------------- 2002 2001 CASH FLOW FROM OPERATING ACTIVITIES -------------- -------------- Net loss....................................................... $ (1,003,523) $ (390,816) Adjustments to reconcile net loss to cash provided by (used in) operating activities: Income tax payable.......................................... 18,434 -- Deferred income taxes....................................... 148,759 (48,871) Provision for depreciation and amortization................. 275,417 836,937 Provision for loan losses................................... 589,186 90,000 Provision for bad debt...................................... 375,276 261,943 Write off of bad debt....................................... (276,593) -- Recovery of bad debt........................................ -- 18,980 Amortization of bond discount............................... (20,116) (18,502) Change in market value of securities........................ (373,187) 449,014 Comprehensive income........................................ 256,686 269,039 Loss on disposal of fixed assets............................ (992) (61,868) Loss on sale/disposal of securities......................... 13,599 10,469 (Increase) decrease in operating assets: Receivables.............................................. (302,301) 1,221,647 Loan receivables......................................... (17,518,931) (17,182,385) Prepaid and sundry assets................................ 48,453 (85,759) Other non-current assets................................. (19,134) 292,185 Increase (decrease) in operating liabilities: Deposits................................................. 14,796,468 19,111,337 Accounts payable and accrued expenses.................... (1,802,202) (1,782,763) Accrued compensation and benefits........................ (8,500) (1,669) Other liabilities........................................ (352,489) 89,968 ------------- ------------- Net cash provided by (used in) operating activities......... (5,155,690) 3,078,886 ------------- ------------- CASH FLOW FROM INVESTING ACTIVITIES Purchase of equipment.......................................... (214,983) (598,302) Due from banks................................................. (1,224,076) (220,704) Federal funds sold/purchased................................... 4,033,000 9,203,000 Bond investments............................................... (4,554,540) (10,523,427) Securities sold/purchased under agreement to repurchase........ 24,000 (1,143,000) Borrowed funds................................................. 4,804,246 -- Proceeds from sale of securities............................... 234,556 65,964 Proceeds from sale of fixed assets............................. 103,939 300,000 Investment in affiliated mutual fund........................... -- (100) Investment in affiliate........................................ -- (1,000) Investment in securities and mutual funds...................... (308,810) (93,161) ------------- ------------- Net cash provided by (used in) investing activities......... 2,897,332 (3,010,730) ------------- ------------- CASH FLOW FROM FINANCING ACTIVITIES Repayment of borrowings........................................ (633,154) (2,431,021) Retirement of common stock..................................... (109,251) -- Borrowings on line of credit................................... 795,220 1,125,000 Repayment of capital lease obligations......................... (1,049) (7,750) ------------- ------------- Net cash provided by (used in) financing activities......... 51,766 (1,313,771) ------------- ------------- Net decrease in cash and cash equivalents.......................... (2,206,592) (1,245,615) Cash and cash equivalents - beginning of year...................... 8,844,482 5,582,098 ------------- ------------- Cash and cash equivalents - end of period.......................... $ 6,637,890 $ 4,336,483 ============= ============= See accompanying notes. -5- UNIFIED FINANCIAL SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) SEPTEMBER 30, 2002 AND 2001 --------------------------- Note 1 - NATURE OF OPERATIONS Unified Financial Services, Inc., a Delaware holding company for various financial services companies, was organized on December 7,1989. We distribute our services via the traditional industry channels of our subsidiaries and via the Internet. Through our subsidiaries, all of which are wholly owned, we provide services primarily in five lines of business: trust and retirement services; mutual fund administration services; banking; brokerage; and investment advisory services. Note 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation --------------------- The consolidated financial statements include the accounts of Unified Financial Services, Inc. and our subsidiaries after elimination of all material intercompany accounts and transactions. The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the nine- and three-month periods ended September 30, 2002 are not necessarily indicative of the results that may be expected for the year ending December 31, 2002. On May 31, 2002, we disposed of Fully Armed Productions, Inc., which we acquired on June 1, 1999 in exchange for 18,182 shares of our common stock. In connection with such disposition, and in exchange for all of the outstanding capital stock of Fully Armed Productions, Inc., we received 18,182 shares of our common stock and $37,569 in cash. The results of Fully Armed Productions, Inc. are shown as a non-cash flow transaction in our Consolidated Statements of Cash Flow. Due to the immateriality of the results of Fully Armed Productions, Inc. to the consolidated results of Unified Financial Services, the consolidated financial statements contained herein and in our Annual Report on Form 10-K for the year ended December 31, 2001 have not been restated for the disposition. The balance sheet at December 31, 2001 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. For further information refer to the consolidated financial statements and footnotes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2001. Financial Statement Presentation -------------------------------- Certain amounts in the 2001 financial statements have been reclassified to conform to the 2002 presentation. -6- UNIFIED FINANCIAL SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) SEPTEMBER 30, 2002 AND 2001 --------------------------- Note 3 - NEW ACCOUNTING STANDARDS Statement of Financial Accounting Standards ("SFAS") No. 144,"ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS," is effective for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years, with early application encouraged. SFAS 144 supersedes Statement of Financial Accounting Standards No. 121, "ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF" and amends Accounting Principles Board Opinion No. 30, "REPORTING RESULTS OF OPERATIONS - REPORTING THE EFFECTS OF DISPOSAL OF A SEGMENT OF A BUSINESS." This statement develops one accounting model (based on the model in SFAS 121) for long-lived assets to be disposed of, expands the scope of discontinued operations and modifies the accounting for discontinued operations. This standard did not have a material impact on our consolidated financial position, results of operations or cash flows for the nine- of three- month periods ended September 30, 2002. Statement of Financial Accounting Standards No. 143, "ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS," addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement cost. This statement is effective for fiscal years beginning after June 15, 2002. We have adopted this statement, which did not have a material impact on our consolidated financial position, results of operations or cash flows for the nine- or three-month periods ended September 30, 2002. Statement of Financial Accounting Standards No. 142, "GOODWILL AND OTHER INTANGIBLE ASSETS," addresses the financial accounting and reporting for acquired goodwill and other intangible assets. Amortization of goodwill, including goodwill recorded in past business combinations, will cease upon adoption of this statement. This statement is effective for fiscal years beginning after December 15, 2001. Effective January 1, 2002, we adopted SFAS 142 and ceased the amortization of goodwill (for the nine months ended September 30, 2002, goodwill amortization would have been approximately $78,000 and would be approximately $104,000 for the year ending December 31, 2002). Other provisions of this statement require that goodwill be measured periodically for impairment. We are currently in the process of fair valuing our reporting unit with goodwill in order to determine potential goodwill impairment, but have not yet determined the impact for 2002. Statement of Financial Accounting Standards No. 141, "BUSINESS COMBINATIONS," requires all business combinations initiated after September 30, 2001 to be accounted for under the purchase method of accounting. SFAS No. 141 also sets forth guidelines for applying the purchase method of accounting in the determination of intangible assets, including goodwill acquired in a business combination, and expands financial disclosures concerning business combinations consummated after June 1, 2001. Management does not believe that this statement will have a material effect on our consolidated financial statements. -7- UNIFIED FINANCIAL SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) SEPTEMBER 30, 2002 AND 2001 --------------------------- Note 4 - OPTIONS Under the terms of our stock incentive plan, employees, directors, advisers and consultants of our company and its subsidiaries are eligible to receive the following: (a) incentive stock; options; (b) nonqualified stock options; (c) stock appreciation rights; (d) restricted stock; (e) restricted stock units; and (f) performance awards. Options granted under our plan may be nonqualified or incentive stock options and typically are granted at a price equal to the quoted market price (or valuation made by independent valuation experts) on our common stock on the trading day immediately prior to the date of grant. Generally, options granted will have a term of ten years from the date of the grant, and will vest in increments of 33% per year over a three-year period or be 100% vested on the date of grant. Effective as of December 31, 2001, in conjunction with the sale of our insurance operations, our board of directors extended to December 31, 2006 the exercise period of 13,255 options held by employees of our former insurance operations, irrespective of the date of termination of such employees. All other terms of such options, including the vesting schedules, were unchanged. As of September 30, 2002 and 2001, options to acquire 107,441 and 102,836 shares, respectively, of our common stock were outstanding and issued to certain of our employees, directors and advisers pursuant to our stock incentive plan. In addition, as of such dates, our board had granted options to acquire 54,545 and 60,000 shares, respectively, of our common stock outside of such plan (see note 12). A summary of our outstanding stock options as of September 30,2002 and 2001 is as follows: SEPTEMBER 30, ------------------------------------------------ 2002 2001 --------------------- ---------------------- WEIGHTED WEIGHTED AVERAGE AVERAGE EXERCISE EXERCISE SHARES PRICE SHARES PRICE ------ ----- ------ ----- Options outstanding at beginning of year...... 149,396 $41.94 170,752 $41.94 Granted....................................... 38,150 16.50 -- -- Option to acquire 66,666 shares at $45.00 per share converted into option to acquire 60,000 shares at $50.00 per share........... -- -- (6,666) 45.00 Option to acquire 60,000 shares at $50.00 per share converted into option to acquire 54,545 shares at $55.00 per share........... (5,455) 50.00 -- -- Forfeitures................................... (20,105) 34.92 (1,250) 40.00 Options outstanding at end of period.......... 161,986 38.24 162,836 41.62 Options exercisable at end of period.......... 161,644 38.23 157,458 41.68 Options available for future grants........... 142,559 n/a 147,164 n/a As of September 30, 2002, 85,136 of such options were intended to qualify as incentive stock options pursuant to Section 422 of the Internal Revenue Code of 1986, as amended. -8- UNIFIED FINANCIAL SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) SEPTEMBER 30, 2002 AND 2001 --------------------------- Note 4 - OPTIONS (Continued) We apply Accounting Principles Board Opinion No. 25, "ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES," in accounting for stock-based employee compensation arrangements whereby compensation costs related to stock options generally are not recognized in determining net income. Had we computed compensation costs for our stock options pursuant to Financial Accounting Standard Board Statement of Financial Accounting Standards No. 123, "ACCOUNTING FOR STOCK-BASED COMPENSATION," the effect would have been immaterial for the nine- and three-month periods ended September 30, 2002 (based upon the Black-Scholes option pricing model) and,in fact, would have been anti-dilutive for such periods. Note 5 - BANK LINE OF CREDIT Bank line of credit at September 30, 2002 consisted of the following: MAXIMUM LINE LINE OF CREDIT AT OF CREDIT SEPTEMBER 30, 2002 ------------ ------------------ Secured by assignment of receivables, bears interest at prime...................... $2,500,000 $1,270,000 Effective July 22, 2002, the bank line of credit was renewed. The line of credit bears interest at prime, which is payable monthly, and all amounts outstanding under the line of credit are due June 30, 2003. The line of credit is secured by contracts receivable and guaranteed by Unified Financial Services, Inc. Note 6 - RENTAL AND LEASE INFORMATION We lease certain office facilities and equipment. Rental expense for the nine months ended September 30, 2002 and 2001 were $712,727 and $676,965, respectively. At September 30, 2002, we were committed to minimal rental payments under certain noncancellable operating leases. As of September 30, 2002, the minimum future rental commitments for each of the succeeding five years subsequent to September 30, 2002 were as follows: 2003 ......................................$ 575,333 2004 ....................................... 506,406 2005 ....................................... 464,147 2006 ....................................... 405,513 2007 ....................................... 425,325 Thereafter.................................. 688,271 ---------- Total.................................. $3,064,995 ========== As of September 30, 2002, the leases with respect to the property occupied by our trust and retirement services operation had expired. We currently are negotiating a new lease with the landlord, which we anticipate will be executed during November 2002. It currently is anticipated that the term of such lease will be five years and annual lease payments of approximately $207,720 will be due with respect to such new lease. -9- UNIFIED FINANCIAL SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) SEPTEMBER 30, 2002 AND 2001 --------------------------- Note 7 - COMMITMENTS AND CONTINGENCIES We are a party to various lawsuits, claims and other legal actions arising in the ordinary course of business. In the opinion of management, after consultation with legal counsel, all such matters are without merit or are of such kind, or involve such amounts, that unfavorable disposition would not have a material adverse effect on our consolidated financial position or results of operations. Note 8 - CASH SEGREGATED UNDER FEDERAL REGULATION AND NET CAPITAL REQUIREMENTS Unified Financial Securities is subject to the Securities and Exchange Commission's Uniform Net Capital Rule, which requires the maintenance of minimum net capital, as defined, of the greater of (i) 6-2/3% of aggregate indebtedness or (ii) $50,000, and a ratio of aggregate indebtedness to net capital of not more than 15 to 1. At September 30, 2002, the net capital and ratio of aggregate indebtedness for Unified Financial Securities were $126,474 and 3.34 to 1, respectively. Unified Financial Securities is a fully disclosed broker-dealer. As a result, pursuant to Rule 15c3-3 as promulgated by the Securities and Exchange Commission, Unified Financial Securities is not required to segregate cash and/or securities for the benefit of its customers. Note 9 - FAIR VALUE OF FINANCIAL INSTRUMENTS The following table presents the carrying amounts and estimated fair value of our financial instruments at September 30, 2002 and 2001. Financial Accounting Standards Board Statement No. 107, "DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS," defines the fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties. SEPTEMBER 30, ------------------------------------------------------- 2002 2001 -------------------------- ------------------------ CARRYING FAIR CARRYING FAIR AMOUNT VALUE AMOUNT VALUE -------- ------ -------- ------- (IN THOUSANDS) Financial assets: Cash and cash equivalents............ $ 6,637.9 $ 6,637.9 $ 4,336.5 $ 4,336.5 Due from banks....................... 2,581.6 2,581.6 1,383.3 1,383.3 Bond investments..................... 16,338.1 16,338.1 20,975.7 20,975.7 Securities and mutual funds.......... 599.9 599.9 548.7 548.7 Loans, net of allowance.............. 60,635.3 60,635.3 37,927.1 37,927.1 Receivables (trade), net of allowance 5,683.8 5,683.8 11,583.5 11,583.5 Prepaid and sundry................... 376.6 376.6 383.0 383.0 Financial liabilities: Current liabilities.................. 80,400.9 80,400.9 66,522.3 66,522.3 Capital lease obligation............. -- -- 1.2 1.2 Term debt............................ -- -- 1,604.7 1,604.7 -10- UNIFIED FINANCIAL SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) SEPTEMBER 30, 2002 AND 2001 --------------------------- Note 10 - DISCLOSURES ABOUT REPORTING SEGMENTS We have five reportable operating segments: trust and retirement services; mutual fund administration services; banking; brokerage; and investment advisory services. In addition, we also report corporate as a separate segment. Our banking segment, which includes Unified Banking Company and Commonwealth Premium Finance Company, reports revenue partially in accordance with the AICPA Audit and Accounting Guide for Banks and Savings Institutions, which requires that banking revenue be reported net of interest expense, and partially in accordance with the AICPA Audit and Accounting Guide for Financial Institutions(other than banks and insurance companies), which treats the provision for loan losses as an operating expense. Pursuant to the AICPA guide for banks, banking revenue is presented net of the provision for loan losses. As a result, we report our provision for loan losses as an operating expense on our Statements of Operations. For the nine months and three months ended September 30, 2002 and 2001, our banking operation recorded interest expense of $2,263,119 and $2,691,129, respectively, and $815,730 and $843,781, respectively. Our banking operation's provision for loan losses was $589,186 and $90,000 for the nine months ended September 30, 2002 and 2001, respectively, and $44,783 and $35,000 for the three months ended September 30, 2002 and 2001, respectively. Additionally, pursuant to the AICPA guide for banks,banks typically do not report gross profit. However, for comparability among our operating segments, we have reported banking gross profit, which amount is equal to banking revenue for any given period. The accounting policies of the segments are the same as those described in the summary of significant accounting policies. We evaluate performance based on profit or loss from operations before income taxes, not including recurring gains and losses. Our reportable segments are strategic business units that offer different products and services. They are managed separately because each business requires different technology and marketing strategies. Most of the businesses were acquired as a unit and the management at the time of the acquisition was retained. Reportable segment revenue, gross profit, total assets, depreciation and amortization and capital expenditures were as follows as of or for the nine or three months ended September 30, 2002 and 2001: -11- UNIFIED FINANCIAL SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) SEPTEMBER 30, 2002 AND 2001 --------------------------- AS OF OR FOR THE FOR THE NINE MONTHS ENDED THREE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------------- ----------------------------- 2002 2001 2002 2001 ------------- ------------- ------------ ------------ Revenue: ------- Trust and retirement........................ $ 3,885,920 $ 3,696,935 $ 1,220,518 $ 1,293,164 Mutual fund administration.................. 4,391,201 4,011,885 1,655,321 1,344,586 Banking..................................... 2,067,516 1,509,233 739,341 587,589 Brokerage................................... 1,810,285 2,134,780 697,713 686,617 Investment advisory......................... 1,176,585 1,492,696 372,955 486,604 Corporate................................... 8,429 152,253 (139,818) 5,376 ------------- ------------- ------------ ------------ Total.................................. $ 13,339,936 $ 12,997,782 $ 4,546,030 $ 4,403,936 ============= ============= ============ ============ Gross profit: ------------- Trust and retirement........................ $ 3,173,721 $ 3,132,380 $ 1,002,698 $ 949,997 Mutual fund administration.................. 3,801,128 3,501,397 1,460,490 1,213,106 Banking..................................... 2,067,516 1,509,233 739,341 587,589 Brokerage................................... 607,221 823,397 139,990 267,207 Investment advisory......................... 971,667 1,356,449 298,850 440,890 Corporate................................... 7,983 152,253 (298) 5,376 ------------- ------------- ------------ ------------ Total.................................. $ 10,629,236 $ 10,475,109 $ 3,641,071 $ 3,464,165 ============= ============= ============ ============ Total assets: ------------- Trust and retirement........................ $ 3,061,531 $ 3,199,981 Mutual fund administration.................. 2,579,270 1,917,680 Banking..................................... 84,301,793 64,316,514 Brokerage................................... 689,409 750,970 Investment advisory......................... 1,350,491 1,401,080 Corporate................................... 5,144,384 1,264,341 Discontinued................................ -- 9,144,380 ------------- ------------- Total.................................. $ 97,126,878 $ 81,994,946 ============= ============= Depreciation and amortization: ----------------------------- Trust and retirement........................ $ 101,171 $ 99,879 Mutual fund administration.................. 94,658 78,634 Banking..................................... 132,708 118,236 Brokerage................................... 3,698 16,781 Investment advisory......................... 14,215 98,937 Corporate................................... (64,496) 190,013 ------------- ------------- Total.................................. $ 281,954 $ 602,480 ============= ============= Capital expenditures: -------------------- Trust and retirement........................ $ 39,670 $ 137,930 Mutual fund administration.................. 157,793 24,625 Banking..................................... 5,800 72,190 Brokerage................................... -- 8,216 Investment advisory......................... 3,890 9,742 Corporate................................... 7,830 79,335 Discontinued................................ -- 266,264 ------------- ------------- Total.................................. $ 214,983 $ 598,302 ============= ============= -12- UNIFIED FINANCIAL SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) SEPTEMBER 30, 2002 AND 2001 --------------------------- Note 11 - UNIFIED BANKING COMPANY STATEMENTS OF FINANCIAL CONDITION AND OPERATIONS Unified Banking Company commenced operations on November 1, 1999. Included in our consolidated financial statements at September 30,2002 and 2001 were the bank's total assets of $85,367,049 and $61,868,681, respectively, and total liabilities of $79,499,532 and $55,694,800, respectively. As of such dates, certain components of such assets and liabilities were as follows: SEPTEMBER 30, --------------------------- 2002 2001 ---------- ----------- Due from banks.............................................. $2,581,559 $ 1,384,679 Investments in securities: US agency securities...................................... 18,921,084 20,975,732 FHLB stock................................................ 502,200 189,600 Loans: Real estate loans......................................... 39,189,704 22,914,763 Commercial loans.......................................... 16,669,424 9,795,098 Installment loans......................................... 5,260,243 5,701,533 Other loans............................................... 36,167 159 Allowance for loan losses................................. 520,216 395,000 Bank deposits: Demand deposits........................................... 9,899,790 6,718,278 Official checks........................................... 272,666 220,312 NOW accounts.............................................. 2,306,868 1,186,852 Money market accounts..................................... 12,237,436 7,241,353 Savings accounts.......................................... 52,396 63,056 Time deposits............................................. 43,711,080 33,513,324 Other interest-bearing deposits........................... 5,675,935 4,788,500 Federal and borrowed funds.................................. 4,828,246 1,536,000 As discussed in Note 10, we report our results of operations in accordance with the AICPA guide for financial institutions (other than banks and insurance companies). If we reported our results of operations in accordance with the AICPA guide for banks, the results of operations for Unified Banking Company for the nine-and three-month periods ended September 30, 2002 at 2001 would have been as follows: NINE MONTHS ENDED THREE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------------- ----------------------------- 2002 2001 2002 2001 ------------- ------------- ------------ ------------ Interest and dividend income....... $ 3,385,041 $ 3,343,574 $ 1,228,919 $ 1,074,723 Loan fees.......................... 236,935 173,466 87,340 77,721 Other income....................... 226,785 145,697 75,079 101,267 ------------- ------------- ------------ ------------ Total revenue................. 3,848,761 3,662,737 1,391,338 1,253,711 Interest expense................... 2,217,091 2,590,748 798,429 813,294 ------------- ------------- ------------ ------------ Subtotal........................ 1,631,670 1,071,989 592,909 440,417 Provision for loan losses.......... (589,186) (90,000) (44,783) (35,000) ------------- ------------- ------------ ------------ Net revenue................... 1,042,484 981,989 548,126 405,417 Operating expenses................. 1,593,013 1,586,666 531,189 536,863 ------------- ------------- ------------ ------------ Profit (loss) before income taxes $ (550,529) $ (604,677) $ 16,937 $ (131,446) ============= ============= ============ ============ -13- UNIFIED FINANCIAL SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) SEPTEMBER 30, 2002 AND 2001 --------------------------- Note 11 - UNIFIED BANKING COMPANY STATEMENTS OF FINANCIAL CONDITION AND OPERATIONS (Continued) The revenue amounts in Note 10 for our banking operation include the "Subtotal" amounts reflected above for Unified Banking Company plus the revenues of Commonwealth Premium Finance Corporation. Note 12 - INVESTMENT IN AFFILIATE On May 23, 2000, we subscribed for 10 shares of VSX Holdings, LLC, a Delaware limited liability company, in exchange for $10 and certain intangible property rights. We currently own approximately 0.5% of the outstanding shares of VSX Holdings, but have the right to purchase up to an additional 1,990 (19.9%) shares at a price of $1 per share, upon the occurrence of certain specified events. Our investment in VSX Holdings is accounted for on the cost method of accounting. VSX Holdings is involved in the development of an alternative trading system to be known as VSX.com, which, upon and subject to organization and regulatory approval, will serve as a virtual,real-time private financial market place. In connection with the organization of VSX Holdings, a third-party investor made a $3.0 million loan to VSX Holdings, which loan is evidenced by a debenture issued by VSX Holdings to such investor. The debenture is secured by 85,000 shares of our common stock pledged by certain executive officers of our company. In addition, concurrent with the issuance of such debenture, we issued an option to the third-party investor to acquire shares of our common stock, which option has a five-year term. The investor may elect to foreclose on the pledged collateral or exercise the option. Pursuant to such option, the holder of the option and the debenture is entitled to surrender the debenture to us in payment of the exercise price of the option. During the years ending May 23, 2003, 2004 and 2005, the exercise price per share of our common stock subject to the option will be $55, $60 and $65, respectively. Should the investor foreclose on the pledged collateral, the executive officers would succeed to the option and/or the claim against VSX Holdings. Should the option be exercised prior to May 23, 2003 by the holder of the note (whether the investor, the executive officers or any other holder): (a) we would issue 54,545 shares of stock (50,000 after May 23, 2003) to the investor, the executive officers or any other holder, as the case may be, and (b) we would succeed to the $3.0 million claim against VSX Holdings. We also have entered into a management arrangement with VSX Holdings whereby we provide consulting and development services to VSX Holdings. For the nine months ended September 30, 2002 and 2001 and the three months ended September 30, 2002 and 2001, we received payments totaling $258,756 and $819,977, respectively,and $39,301 and $0, respectively, from VSX Holdings for such consulting and development services, which amounts are recorded as a reduction of "Other operating expenses" on our Consolidated Statements of Operations. -14- UNIFIED FINANCIAL SERVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) SEPTEMBER 30, 2002 AND 2001 --------------------------- Note 13 - INCOME (LOSS) PER SHARE OF STOCK Income (loss) per share of stock is computed using the number of common shares outstanding during the applicable period. Diluted income (loss) per share of stock is computed using the number of common shares outstanding and dilutive potential common shares(outstanding stock options). Dilutive potential common shares included in the diluted income (loss) per share calculation were determined using the treasury stock method. Under the treasury stock method, outstanding stock options are dilutive when the average "market price" of our common stock exceeds the option price during a period. In addition, proceeds from the assumed exercise of dilutive options along with the related tax benefit are assumed to be used to repurchase common shares at the average market price of such stock during the period. For the nine- and three-month periods ended September 30, 2002, all potential common shares were considered to be anti-dilutive and were excluded from the calculation of diluted loss per share. For the nine- and three-month periods ended September 30, 2001, 137,300 potential common shares were considered to be anti-dilutive and were excluded from the calculation of diluted loss per share. Note 14 - RELATED PARTY TRANSACTION As of September 30, 2002, $3,454,164 was eliminated from both bond investments and deposits on our Consolidated Statement of Financial Condition, which amount represented cash on deposit at our bank from various subsidiaries of our company. Note 15 - SALE OF INSURANCE OPERATIONS On December 17, 2001, we sold substantially all the assets and assigned substantially all of the liabilities of our insurance subsidiaries, Equity Insurance Managers, Inc., Equity Insurance Administrators, Inc. and 21st Century Claims Service, Inc., to Arthur J. Gallagher & Co. In connection with the sale, $800,000 in cash was deposited into an escrow account, and is subject to possible indemnification claims of Arthur J. Gallagher & Co.pursuant to the sale agreement. Any funds remaining in the escrow account after June 16, 2003 (and which are not subject to a claim made by Arthur J. Gallagher & Co. before such date) will be released to us. As of December 31, 2001, we established a long-term liability of $800,000 related to the escrow. As of September 30, 2002, we believed there was a current potential for approximately $300,000 in claims against the escrow. In addition,in connection with the sale, we received an interest-bearing note receivable of $800,000, which is subject to possible reduction in the event Arthur J. Gallagher does not achieve certain revenue or income targets for the year ending December 31, 2002 with respect to the business that it acquired from our insurance subsidiaries. As of December 31, 2001, we established a liability of $800,000 related to the revenue and income targets. As of September 30, 2002, we were not able to determine whether Arthur J. Gallagher & Co. would achieve such targets and, as a result, we did not adjust the liability as of such date. In accordance with generally accepted accounting principles, we will adjust the liability when definitive information is available with respect to such targets. -15- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS Certain statements contained in this Quarterly Report on Form 10-Q are or may constitute forward- looking statements (as such term is defined in the Private Securities Litigation Reform Act of 1995). Such forward-looking statements are based on current expectations, estimates and projections about Unified Financial Services' industries, management's beliefs and assumptions made by management. For example, a downturn in economic conditions generally and in particular those affecting bond and securities markets could lead to an exit of investors from mutual funds. Similarly, an increase in Federal and state regulations of the mutual fund, securities or banking industries or the imposition of regulatory penalties could have an effect on our operating results. In addition, by accepting deposits at fixed rates, at different times and for different terms, and lending funds at fixed rates for fixed periods, a bank accepts the risk that the cost of funds may rise and interest on loans and investment securities may be at a fixed rate. Similarly, the cost of funds may fall, but a bank may have committed by virtue of the term of a deposit to pay what becomes an above-market rate. Investments may decline in value in a rising interest rate environment. Loans have the risk that the borrower will not repay all funds due in a timely manner as well as the risk of total loss. Collateral may or may not have the value attributed to it. Although we believe our loan loss reserve and our allowance for doubtful accounts are adequate, they may prove inadequate if one or more large borrowers or clients, or numerous smaller borrowers or clients, or a combination of both, experience financial difficulty for individual, national or international reasons. Because the financial services industry is highly regulated, decisions of governmental authorities can have a major effect on operating results. These uncertainties, as well as others, are present in the financial services industry and we caution stockholders that management's view of the future on which we price and distribute our products and estimate costs of operations and regulations may prove to be other than as anticipated. In addition, our current expectations with respect to our five business lines, our ability to enhance stockholder value and aggressively and profitably grow assets under management and under service, our ability to provide a high level of service satisfaction and manage costs, our ability to expand profit margins, our ability to achieve future growth and the development of VSX Holdings as an alternative trading system may prove to be other than expected. Words such as "anticipates," "expects," "intends," "plans," "believes," "seeks," "estimates," variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict; therefore, actual results and outcomes may differ materially from what is expressed or forecasted in any such forward-looking statements. Such risks and uncertainties include those listed under "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2001. Unless required by law, we undertake no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. GENERAL Unified Financial Services, Inc., a Delaware holding company that was organized on December 7, 1989, provides financial products and services, principally through three principal businesses: o The provision of complete back-office and shareholder services for the assets of third-party mutual fund families, as well as our affiliated series funds; o Management and administration of 401(k) and other ERISA-directed assets; and -16- o Management of wealth for individuals through a suite of family-office services. The integration of our three principal businesses (mutual fund administration services, trust and retirement services and investment advisory services) with our banking and brokerage operations allows for the capture of additional profitable revenues. Further, this integration provides much greater control of the quality of our component services. Our fundamental objective is to enhance stockholder value by aggressively and profitably growing assets under management and under service. Our ability to provide a high level of service satisfaction, with an emphasis on managing costs, combined with a dedication to maintaining a highly trained and motivated workforce should lead to expanding profit margins. Our principal executive offices are located at 2424 Harrodsburg Road, Lexington, Kentucky 40503, telephone number (859) 296-2016. We and our subsidiaries also maintain offices at 431 North Pennsylvania Street, Indianapolis, Indiana, telephone number (317) 917-7001; 2353 Alexandria Drive, Lexington, Kentucky 40504, telephone number (859) 296-4407; 1400 Civic Place, Southlake, Texas 76092, telephone number (817) 431-2197; 36 West 44th Street, The Bar Association Building, Suite 1310, New York, New York 10036, telephone number (212) 852-8852; and One US Bank Plaza, Suite 2100, St. Louis, Missouri 63101, telephone number (314) 552-6440. The following presents management's discussion and analysis of our consolidated financial condition and results of operations as of the dates and for the periods indicated. This discussion should be read in conjunction with the other information set forth in this Quarterly Report on Form 10-Q, including our consolidated financial statements and the accompanying notes thereto. COMPARISON OF RESULTS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001 Revenue for the nine months ended September 30, 2002 compared to the same period of 2001 increased $342,154, or 2.6%, from $12,997,782 to $13,339,936. For such periods, gross profit increased $154,127, or 1.5%. For the first nine months of 2002 compared to the same period of 2001, trust and retirement services revenue increased $188,984, or 5.1%, primarily due to a small increase in assets under management. For such periods, trust and retirement services gross profit increased $41,341 after fees paid to advisor partners increased slightly year over year, increasing 2.9% from $3.056 million in 2001 to $3.144 million in 2002, and lower interest income and other income of $46,988 period over period. As of September 30, 2002, our trust and retirement services operation had approximately $485.8 million in assets under management compared to $482.7 million as of September 30, 2001. Our trust and retirement services assets under management remained relatively constant due to the addition of new client assets during such periods despite declines in the DJIA, S&P 500 and Nasdaq of approximately 24.2%, 28.9% and 39.9%, respectively, from September 30, 2001 to September 30, 2002. For such periods, mutual fund administration services revenue increased $379,316, or 9.5%, and mutual fund administration services gross profit increased $299,732, or 8.6%. As of September 30, 2002, we provided mutual fund administrative services to 31 mutual fund families consisting of approximately 194 portfolios and approximately $9.7 billion in assets under service, compared to 30 mutual fund families consisting of 145 portfolios and approximately $5.8 billion in mutual fund assets under service as of September 30, 2001. Approximately $2.8 billion of the increase in assets under service was added during the month of June 2002 with our commencement of services for the Huntington Funds. During the past 12 months, our mutual fund services operation added several new large clients, but also saw several -17- small clients discontinue operations due to market conditions. While our assets under service increased period to period, the mix of services (transfer agency, fund accounting and administrative services) that we provided to certain of our mutual fund clients changed. We recognize higher margins on administrative services and, to a lesser extent, fund accounting services compared to transfer agency services. Our pricing, in certain instances, also is dependent upon the number of shareholder accounts serviced. An omnibus account may represent a significant amount of assets under service, but would not generate as much in fees as an account with hundreds of shareholders but less assets under service. Period over period, transfer agency and fund accounting revenues increased $425,432 and $123,423, respectively, while administration services revenues declined $152,172. Banking revenue and gross profit (please see note 10) increased $558,283, or 37.0%, for the nine months ended September 30, 2002 compared to the same period of 2001, primarily due to an increase in net interest income of $424,000 and a $120,000 increase in secondary market loan revenue. Net loans as of September 30, 2002 increased to $61.2 million from $44.1 million as of September 30, 2001. Our banking operation's net interest margin increased from 1.56% for the nine months ended September 30, 2001 to 2.04% for the nine months ended September 30, 2002. During the first nine months of 2002, our net interest margin rose 48 basis points from the same period of 2001. We also experienced a$20,424,000 million, or 38.0%, increase in deposits from September 30, 2001 to September 30, 2002. Such deposits primarily were used to fund our banking operation's loan growth. During the nine months ended September 30, 2002, our banking operation charged-off $500,229 in loans that management previously had classified as doubtful, of which $455,000 represented one credit. We are working aggressively to collect these loans, and will continue to do so, but management believed it necessary to charge-off these loans at this time. As of September 30, 2002, our banking operation's ratio of non-performing loans to total loans was 0.21%, compared to 0% at September 30, 2001, after the charge-off of loans of $500,229. At September 30, 2002, our non-performing loans totaled $130,000. We are working aggressively to collect all non-performing loans, but may be required to increase our provision for loan losses in future quarters if we are unsuccessful in collecting these loans, which could have a material effect on our results of operations. For the nine months ended September 30, 2002 compared to the same period of 2001, brokerage revenue and gross profit declined $324,495, or 15.2%, and $216,177, or 26.3%, respectively. These declines primarily were attributable to a $99,098 decline in commission revenue collected from introducing firm clients and a $129,824 decline in commission revenue due to the loss of certain full service brokerage accounts following the death of the former President of Commonwealth Investment Services. Also contributing to such decline was a $73,011 decline in investment management fees resulting from lower trading volume. For such periods, investment advisory revenue and gross profit declined $316,109, or 21.2%, and $384,780, or 28.4%, respectively. Such declines primarily were due to the lower market value of assets under management at such operation. Assets under management at our investment advisory operation declined $133.3 million, or 37.6%, from $354.7 million at September 30, 2001 to $221.4 million at September 30, 2002. From September 30, 2001 to September 30, 2002, assets under management at our investment advisory operation declined approximately 15.2% due to the decline in the financial markets during such period (which decline was less than the overall decline in the financial markets). Such operation also experienced a loss of approximately $65.0 million in assets under management due to the transfer of the assets of the Liquid Green Money Market Fund to the Huntington Funds and the termination of such operation's relationship with one portfolio manager. -18- Corporate revenue and gross profit declined $143,826, or 94.5% and $144,272, or 94.8%, respectively, primarily due to our receipt in 2001 of $135,000 in settlement of a trademark dispute. Total expenses declined $878,249, or 7.0%, for the nine months ended September 30, 2002 compared to the nine months ended September 30, 2001. During the second half of 2001, management implemented certain expense cuts in an effort to improve the profitability of our company, which cuts were partially offset by a $589,186 increase in the provision for loan losses during 2002, primarily due to the write-off of one delinquent loan as discussed above. For such periods, employee compensation declined $729,694, or 10.2%. This decline primarily was attributable to salary reductions taken by certain officers of our company during the first quarter of 2002, which reductions ranged from 20% to 40% of such officers' annualized salary, and a reduced employee workforce. Telephone expense declined $112,658, or 37.0%, for the nine months ended September 30, 2002 compared to the same period of 2001 due to a change in our company's long distance provider and the termination of our wide area network. For such periods, depreciation and amortization expense declined $320,526 or 53.2%, primarily due to the effect of a reversal of a previous depreciation accrual and our adoption of Statement of Financial Accounting Standards No. 142, which required us to cease amortizing goodwill. Under recently adopted accounting rules, we will be required to periodically evaluate the carrying value of our goodwill balances to determine whether the value has been impaired. If we determine there has been an impairment, we will recognize a charge to our earnings in the quarter we determine the value has been impaired, which could be material. For such periods, interest expense declined $75,137, or 111.1%, due to our repayment of our outstanding term loan during December 2001. Program administration fees declined $136,590, or 86.8%, primarily due to a $190,000 insurance recovery in the first quarter of 2002 related to a loss recorded during 2001 at our mutual fund services operation. This recovery was partially offset by a $49,270 unrecoverable loss during the nine months ended September 30, 2002. Our provision for bad debt decreased $158,804 due to the write-off of certain uncollected receivables at our mutual fund operations during 2001. Our provision for loan losses increased $499,186, or 554.7%, for the nine months ended September 30, 2002 compared to the same period of 2001, primarily due to the expense associated with the $455,000 loan charged-off in June 2002. Unified Banking Company is required by Federal law to maintain a reserve for possible loan losses based upon the size of and risks associated with the loan portfolio. Insurance costs increased $42,239, or 33.8%, during such periods, primarily due to increased premiums associated with our insurance coverage. For such periods, other operating expense increased $95,834, or 9.4%, primarily due to a $819,977 benefit received by us during the nine months ended September 30, 2001 in connection with the construction and development of the VSX marketplace and its corresponding products, compared to a $258,756 benefit received by us during the nine months ended September 30, 2002. Removing the effect of the benefit received from VSX Holdings during 2001, other expenses declined $465,385, or 25.2%, primarily due to a $91,093, $57,354 and $267,270 decrease in travel and entertainment, advertising and other operating expenses, respectively, at our trust and retirement services operation. During 2001, our trust and retirement services operation incurred expenses related to the development of new client products and in connection with its conversion to a new data processing system. Such expenses were recorded as other operating expenses. For the nine months ended September 30, 2002, we recorded a $1,016,730 loss from continuing operations compared to a $1,429,828 loss for the same period of 2001. The $448,099 decline in loss during such periods was a result of the expense reductions discussed above as well as the revenue increase that we experienced in 2002. The results for the nine months ended September 30, 2002 also included a $6,919 income tax expense while the same period of 2001 included a $635,872 income tax benefit. -19- For the nine months ended September 30, 2002, we recorded $13,207 net income from discontinued operations compared to $1,039,012 in net income from discontinued operations for the same period of 2001. Discontinued operations for the nine months ended September 30, 2001 included the operating results of our insurance operations, which were sold in December 2001. We recorded a net loss of $1,003,523, or a basic and fully diluted loss per share of $0.35, for the nine months ended September 30, 2002 compared to a net loss of $390,816, or a basic and fully diluted loss per share of $0.14 and $0.13, respectively, for the same period of 2001. COMPARISON OF RESULTS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001 Revenue for the third quarter of 2002 compared to the third quarter of 2001 increased $142,094, or 3.2%, from $4,403,936 to $4,546,030. For such periods, gross profit increased $176,906, or 5.1%. For the second quarter of 2002 compared to the same quarter of 2001, trust and retirement services revenue decreased $72,647, or 5.6%, and gross profit increased $52,701, or 5.5%. During the third quarter of 2001, our trust and retirement services operation incurred substantial start-up costs associated with a new program. Such costs reduced our gross profit for such quarter, which contributed to the increase in gross profits for the third quarter of 2002 compared to the same quarter of 2001. For such quarters, mutual fund administration services revenue increased $310,735, or 23.1%, and gross profit increased $247,384, or 20.4%. As discussed above, as of September 30, 2002, we provided mutual fund administrative services to 31 mutual fund families consisting of approximately 194 portfolios and $9.7 billion in assets under services, compared to 30 mutual fund families consisting of 145 portfolios and $5.8 billion in assets under service as of September 30, 2001. Banking revenue and gross profit (please see note 10) increased $151,752, or 25.8%, for third quarter of 2002 compared to the same quarter of 2001, primarily due to an increase in net interest income of $175,000 and a $10,000 increase in secondary market loan revenue. Net loans as of September 30, 2002 increased $17.1 million from $44.1 million as of September 30, 2001. For the quarter ended September 30, 2002 compared to the same quarter of 2001, brokerage revenue decreased $128,871, or 18.8%, and gross profit declined $127,217, or 47.6%. These declines primarily were attributable to a $22,289 decline in commission revenue collected from introducing firm clients and a $19,088 decline in commission revenue due to the loss of certain full service brokerage accounts following the death of the former President of Commonwealth Investment Services. Also contributing to such decline was a $19,330 decline in trail commission income due to a decrease in asset levels of mutual funds for which our brokerage operation serves as distributor and a $24,270 decline in investment management fees. For such quarters, investment advisory revenue and gross profit declined $113,648, or 23.4%, and $142,039, or 32.2%, respectively. As discussed above, such declines primarily were due to the lower market value of assets under management resulting from the overall declines in the financial markets. Total expenses declined $617,146, or 14.1%, for the third quarter of 2002 compared to the same quarter of 2001. As discussed above, during the second half of 2001, management implemented certain expense cuts in an effort to improve the profitability of our company, which cuts were partially offset by a $589,186 increase in the provision for loan losses during 2002, primarily due to the write-off of one delinquent loan as discussed above. For such quarters, employee compensation declined $273,174, or 11.5%, primarily due to salary reductions taken by certain officers of our company during the first quarter -20- of 2002 and a reduced employee workforce. Employee insurance and benefits declined $38,522, or 11.6%, primarily due to a reduced employee workforce, partially offset by increased health insurance costs in 2002. Mail and courier expense increased $9,735, or 36.9%, primarily due to increased mailing costs associated with marketing efforts at our trust and retirement services operation. Telephone expense declined $40,720, or 45.1%, for the reasons discussed above. For such quarters, depreciation and amortization expense declined $164,628, or 75.3%, primarily due to the effect of a reversal of a previous depreciation accrual and our adoption of Statement of Financial Accounting Standards No. 142, which required us to cease amortizing goodwill. Under recently adopted accounting rules, we will be required to periodically evaluate the carrying value of our goodwill balances to determine whether the value has been impaired. If we determine there has been an impairment, we will recognize a charge to our earnings in the quarter we determine the value has been impaired, which could be material. For such quarters, interest expense declined $8,570, or 97.6%, due to our repayment of our outstanding term loan during December 2001. Our provision for bad debt increased $34,328, or 110.7%, due to reserves taken at our mutual fund services operation. Our provision for loan losses increased $9,783, or 28.0%, primarily due to an increase in the size of our banking operation's loan portfolio and our write-off of approximately $45,000 of non-performing loans. For such quarters, insurance expense declined $26,615, or 33.2%. The third quarter of 2001 included a $20,000 additional charge for worker's compensation premiums based upon an audit of our worker's compensation account for 2000 and a $20,000 additional insurance expense at our trust and retirement services operation. These additional charges in 2001 resulted in the decline in insurance costs for the third quarter of 2002 compared to the same quarter of 2001. Increased premiums associated with our insurance coverages for 2002 partially offset such declines. For such quarters, other operating expense declined $167,057, or 28.8%, primarily due to a $119,596 decline in expenses at our trust and retirement services operation, which expenses were described above. In addition, we received a $39,303 benefit during the third quarter of 2002 (compared to $0 during the same quarter of 2001) in connection with the construction and development of the VSX marketplace and its corresponding products. For the quarter ended September 30, 2002, we recorded a $132,402 loss from continuing operations compared to a $718,155 loss for the same quarter of 2001. The $585,753 decline in loss for such quarters was a result of the expense reductions described above and the increase in revenues we experienced during the third quarter of 2002. For the quarter ended September 30, 2002, we recorded $158 net loss from discontinued operations compared to $364,971 in net income from discontinued operations for the same quarter of 2001. Discontinued operations for the quarter ended September 30, 2001 included the operating results of our insurance operations, which were sold in December 2001. We recorded a net loss of $132,560, or a basic and fully diluted loss per share of $0.05, for the quarter ended September 30, 2002 compared to a net loss of $353,184, or a basic and fully diluted loss per share of $0.12, for the same quarter of 2001. LIQUIDITY AND CAPITAL RESOURCES LIQUIDITY. Our primary sources of liquidity historically have been and continue to be cash on hand, cash flow from operating activities, available borrowing capacity from capitalized leases and a loan from a regional bank. The net decrease in cash and cash equivalents at September 30, 2002 from December 31, 2001 was $2,206,592. The net decrease primarily was due to an increase in loans receivable, partially offset by increased customer deposits. -21- With respect to our banking operation, long-term liquidity is a function of the core deposit base and an adequate capital base. Our banking operation is committed to growth of its core deposit base and maintenance of its capital base. The growth of the deposit base is internally generated through product pricing and product development. During its first three years of operations, Unified Banking Company is required to maintain a consolidated Tier 1 capital to total assets ratio of at least 8.0%. As of September 30, 2002, Unified Banking Company had a consolidated ratio of Tier 1 capital to total assets of 8.96%. Short-term liquidity needs arise from continuous fluctuations in the flow of funds on both sides of the balance sheet resulting from growth and seasonal and cyclical customer demands. The securities portfolio provides stable long-term earnings as well as serving as a primary source of liquidity. The designation of securities as available-for-sale and held-to-maturity does not impact the portfolio as a source of liquidity due to the ability to enter into repurchase agreements using those securities. We anticipate continued loan demand in our market area. We have utilized, and expect to continue to utilize, Federal Home Loan Bank borrowings to fund a portion of future loan growth. Unified Banking Company experienced net growth in assets of 22.3% during the first nine months of 2002, while deposits increased 16.6% during the same period. We continue to emphasize growth in stable core deposits while utilizing the Federal Home Loan Bank and Federal funds purchased as necessary to balance liquidity and cost effectiveness. We closely monitor our level of liquidity to meet expected future needs. In February 2002, Unified Banking Company borrowed approximately $5.0 million in ten- to 15-year fixed rate amortizing advances from the Federal Home Loan Bank, which proceeds were invested in 15- to 20-year FNMA mortgage-backed securities. The interest spread between these assets and liabilities is approximately 1.25%. CAPITAL RESOURCES. Total stockholders' equity was $15,892,823 at September 30, 2002 compared to $16,748,911 at year-end 2001. The decrease in total stockholders' equity was due to our net loss for the nine months ended September 30, 2002, partially offset by $256,686 in unrealized gains on securities for such period. The growth of Unified Banking Company will have an effect on our working capital. It currently is anticipated that as Unified Banking Company grows, our working capital ratio will become more in line with ratios traditionally associated with bank holding companies. We believe that our existing capital resources should be adequate for the working capital requirements of our core businesses over the next twelve months. In the event that our plans or assumptions change, or if our resources available to meet unanticipated changes in business conditions prove to be insufficient to fund operations, we could be required to seek additional financing prior to that time. -22- ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK The business activities of our company expose it to a variety of risks. Management of these risks is necessary for the long-term profitability of our company. We manage these risks through the establishment of numerous policies, procedures and controls. The most significant risks that affect us are market risk and credit risk. We also are subject to regulatory risk. Market risk is the risk of loss to us resulting from changes in interest rates, equity prices or both. We are exposed to market risk since we, through our subsidiaries, maintain positions in fixed-income and equity securities. We primarily manage our risk through the establishment of trading policies and guidelines and through the implementation of control and review procedures. Our asset/liability strategy is to minimize the sensitivity of earnings to changes in interest rates while maintaining an acceptable net interest margin. Unified Banking Company's asset/liability committee monitors the interest rate sensitivity of the bank's balance sheet on a monthly basis. The committee reviews asset and liability repricing in the context of current and future interest rate scenarios affecting the economic climate in our market areas. Our pricing policy is that all earning assets and interest bearing liabilities be either based on floating rates or have a fixed rate not exceeding five years. Real estate mortgage loans held by us, while having long final maturities, are comprised of one-, two- or three-year adjustable rate loans. The adjustable basis of these loans significantly reduces interest rate risk. -23- The following table illustrates Unified Banking Company's estimated static gap with prepayments calculated as of September 30, 2002: TIME TO MATURITY OR REPRICING 0 TO 1 1 TO 2 2 TO 3 3 TO 6 6 TO 9 9 TO 12 12 TO 48 48 TO 51 >51 (DOLLARS IN THOUSANDS) IMMEDIATE MONTHS MONTHS MONTHS MONTHS MONTHS MONTHS MONTHS MONTHS MONTHS TOTALS --------- ------ ------ ------ ------ ------ ------ -------- -------- ------ ------ RATE SENSITIVE ASSETS Securities................. U.S. agencies............ $ -- $ 634 $ 611 $ 590 $1,654 $ 1,487 $ 1,341 $ 8,742 $ 352 $ 3,543 $ 18,954 FHLB stock............... 502 -- -- -- -- -- -- -- -- -- 502 -------- ------- ------ ----- ------ ------- ------- -------- ------ ------- -------- Total securities....... 502 634 611 590 1,654 1,487 1,341 8,742 352 3,543 19,456 -------- ------- ------ ----- ------ ------- ------- -------- ------ ------- -------- Loans Commercial Fixed.................. -- 113 40 41 123 326 128 1,919 616 846 4,152 Variable............... 12,518 -- -- -- -- -- -- -- -- -- 12,518 -------- ------- ------ ----- ------ ------- ------- -------- ------ ------- -------- Total commercial..... 12,518 113 40 41 123 326 128 1,919 616 846 16,670 -------- ------- ------ ----- ------ ------- ------- -------- ------ ------- -------- Real Estate Commercial Fixed................ -- 44 304 203 1,325 280 788 5,117 138 -- 8,199 Variable............. 4,209 -- -- -- -- -- -- -- -- -- 4,209 -------- ------- ------ ----- ------ ------- ------- -------- ------ ------- -------- Total commercial... 4,209 44 304 203 1,325 280 788 5,117 138 -- 12,408 -------- ------- ------ ----- ------ ------- ------- -------- ------ ------- -------- Residential Fixed................ -- 244 388 98 287 388 264 3,697 1,612 2,556 9,484 Variable............. 4,245 -- -- -- -- -- -- -- -- -- 4,245 Other................ -- 7 7 7 20 443 21 354 23 783 1,664 -------- ------- ------ ----- ------ ------- ------- -------- ------ ------- -------- Total residential.. 4,245 251 395 105 307 781 285 4,051 1,635 3,339 15,393 -------- ------- ------ ----- ------ ------- ------- -------- ------ ------- -------- Total real estate 8,454 295 699 308 1,632 1,061 1,073 9,168 1,773 3,339 27,801 -------- ------- ------ ----- ------ ------- ------- -------- ------ ------- -------- Construction Fixed.................. -- 6 -- -- -- -- -- -- -- -- 6 Variable............... 2,881 -- -- -- -- -- -- -- -- -- 2,881 -------- ------- ------ ----- ------ ------- ------- -------- ------ ------- -------- Total construction... 2,881 6 -- -- -- -- -- -- -- -- 2,887 -------- ------- ------ ----- ------ ------- ------- -------- ------ ------- -------- Personal Home equity loans...... 8,552 -- -- -- -- -- -- -- -- -- 8,552 Installment loans...... -- 227 287 169 753 370 516 941 102 18 3,383 Cash reserve loan...... 28 -- -- -- -- -- -- -- -- -- 28 Personal open end letters of credit.... 1,836 -- -- -- -- -- -- -- -- -- 1,836 Loans secured by deposits............. -- -- -- -- 1 1 11 27 -- -- 41 -------- ------- ------ ----- ------ ------- ------- -------- ------ ------- -------- Total personal....... 10,416 227 288 169 754 371 327 968 102 18 13,840 -------- ------- ------ ----- ------ ------- ------- -------- ------ ------- -------- Total loans................ 34,269 641 1,026 518 2,509 1,758 1,728 12,055 2,491 4,203 61,198 -------- ------- ------ ----- ------ ------- ------- -------- ------ ------- -------- TOTAL RATE SENSITIVE ASSETS....... $ 34,771 $ 1,274 $1,638 $1,107 $4,163 $ 3,245 $ 3,069 $ 20,797 $2,843 $ 7,746 $ 80,654 ======== ======= ====== ====== ====== ======= ======= ======== ====== ======= ======== -24- TIME TO MATURITY OR REPRICING 0 TO 1 1 TO 2 2 TO 3 3 TO 6 6 TO 9 9 TO 12 12 TO 48 48 TO 51 >51 (DOLLARS IN THOUSANDS) IMMEDIATE MONTHS MONTHS MONTHS MONTHS MONTHS MONTHS MONTHS MONTHS MONTHS TOTALS --------- ------ ------ ------ ------ ------ ------- -------- -------- ------ ------ RATE SENSITIVE LIABILITIES Interest bearing deposits NOW accounts............. $ 2,038 $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ 2,308 -------- -------- ------- -------- -------- -------- -------- ------- ------- -------- -------- Money market accounts Market rate accounts... 4,704 -- -- -- -- -- -- -- -- -- 4,704 Business market rate accounts............. 2,066 -- -- -- -- -- -- -- -- -- 2,066 Special personal MMDA................. 1,090 -- -- -- -- -- -- -- -- -- 1,090 Special business MMDA................. 4,378 -- -- -- -- -- -- -- -- -- 4,378 -------- -------- ------- -------- -------- -------- -------- ------- ------- -------- -------- Total money market accounts........... 12,238 -- -- -- -- -- -- -- -- -- 12,238 -------- -------- ------- -------- -------- -------- -------- ------- ------- -------- -------- Savings accounts......... 52 -- -- -- -- -- -- -- -- -- 52 -------- -------- ------- -------- -------- -------- -------- ------- ------- -------- -------- Time deposits CD's > 100K............ -- 718 898 1,315 4,670 2,000 1,570 6,361 100 -- 17,633 CD's < 100K............ -- 849 1,291 2,967 9,215 1,658 1,403 8,652 41 1 26,078 -------- -------- ------- -------- -------- -------- -------- ------- ------- -------- -------- Total time deposits.. -- 1,567 2,189 4,282 13,885 3,658 2,973 15,013 141 1 43,711 -------- -------- ------- -------- -------- -------- -------- ------- ------- -------- -------- Individual retirement accounts............. -- 63 128 85 452 88 2 4,821 32 4 5,676 -------- -------- ------- -------- -------- -------- -------- ------- ------- -------- -------- Total interest bearing deposits... 14,598 1,630 2,317 4,367 14,337 3,746 2,975 19,834 173 5 63,985 -------- -------- ------- -------- -------- -------- -------- ------- ------- -------- -------- Borrowed funds Repurchased agreements. -- 24 -- -- -- -- -- -- -- -- 24 FHLB borrowings........ -- 28 28 728 72 72 72 2,019 297 1,488 4,804 -------- -------- ------- -------- -------- -------- -------- ------- ------- -------- -------- Total borrowed funds. -- 52 28 728 72 72 72 2,019 297 1,488 4,828 -------- -------- ------- -------- -------- -------- -------- ------- ------- -------- -------- TOTAL RATE SENSITIVE LIABILITIES.. $ 14,598 $ 1,683 $ 2,346 $ 5,095 $ 14,410 $ 3,817 $ 3,048 $21,853 $ 471 $ 1,493 $ 68,813 ======== ======== ======= ======== ======== ======== ======== ======= ======= ======== ======== INCREMENTAL GAP REPORT SUMMARY INFORMATION Total rate sensitive assets $ 34,771 $ 1,274 $ 1,638 $ 1,107 $ 4,163 $ 3,245 $ 3,069 $20,797 $ 2,843 $ 7,746 Total rate sensitive liabilities.............. 14,598 1,683 2,346 5,095 14,410 3,817 3,048 21,853 471 1,493 Gap........................ 20,173 (409) (708) (3,988) (10,246) (572) 21 (1,056) 2,373 6,253 RSA/RSL.................... 2.38x 0.76x 0.70x 0.22x 0.29x 0.85x 1.01x 0.95x 6.04x 5.19x RSA/assets................. 0.41 0.01 0.02 0.01 0.05 0.04 0.04 0.24 0.03 0.09 RSL/assets................. 0.17 0.02 0.03 0.06 0.17 0.04 0.04 0.26 0.01 0.02 Gap/assets................. 23.63% -0.48% -0.83% -4.67% -12.00% -0.67% 0.03% -1.24% 2.78% 7.32% Gap/RSA.................... 58.02 -32.09 -43.21 -360.12 -246.13 -17.64 0.70 -5.08 83.44 80.73 CUMULATIVE GAP REPORT SUMMARY INFORMATION Total rate sensitive assets $ 34,771 $ 36,045 $37,683 $38,790 $ 42,953 $ 46,198 $ 49,267 $70,065 $ 72,908 $ 80,654 Total rate sensitive liabilities.............. 14,598 16,281 18,626 23,722 38,131 41,948 44,996 66,849 67,320 68,813 Gap........................ 20,173 19,764 19,057 15,068 4,822 4,250 4,271 3,216 5,588 11,841 RSA/RSL.................... 2.38x 2.21x 2.02x 1.64x 1.13x 1.10x 1.09x 1.05x 1.08x 1.17x RSA/assets................. 0.41 0.42 0.44 0.45 0.50 0.54 0.58 0.82 0.85 0.94 RSL/assets................. 0.17 0.19 0.22 0.28 0.45 0.49 0.53 0.78 0.79 0.81 Gap/assets................. 23.63% 23.15% 22.32% 17.65% 5.65% 4.98% 5.00% 3.77% 6.55% 13.87% Gap/RSA.................... 58.02 54.83 50.57 38.85 11.23 9.20 8.67 4.59 7.66 14.68 We measure the impact of interest rate changes on our income statement through the use of gap analysis. The gap represents the net position of assets and liabilities subject to repricing in specified time periods. During any given time period, if the amount of rate-sensitive liabilities exceeds the amount of rate-sensitive assets, a company would generally be considered negatively gapped and would benefit from falling rates over that period of time. Conversely, a positively gapped company would generally benefit from rising rates. -25- Interest rate changes do not affect all categories of assets and liabilities equally or simultaneously. There are other factors that are difficult to measure and predict that would influence the effect of interest rate fluctuations on our income statement. For example, a rapid drop in interest rates might cause our borrowers to repay their loans at a more rapid pace and certain mortgage-related investments to be prepaid more quickly than projected. This could mitigate some of the benefits of falling rates as are expected when negatively gapped. Conversely, a rapid rise in rates could give us an opportunity to increase our margins and stifle the rate of repayment on our mortgage-related loans, which would increase our returns. The following table shows the "rate shock" results of a simulation model that attempts to measure the effect of rising and falling interest rates over a two-year horizon in a rapidly changing rate environment. BASIS POINT PERCENTAGE CHANGE IN CHANGE IN NET INTEREST INCOME MARKET VALUE OF PORTFOLIO EQUITY INTEREST RATES PROJECTED CHANGE PROJECTED CHANGE -------------- ------------------- ------------------------------- -300 -14.19 -3.13 -200 -8.78 -4.46 -100 -4.10 0.19 0 -- -- 100 4.26 -6.83 200 8.30 -16.22 300 12.41 -25.98 We use a sensitivity model that simulated these interest rate changes on our earning assets and interest-bearing liabilities. This process allows us to explore the complex relationships among the inancial instruments in various interest rate environments. The preceding sensitivity analysis is based on numerous assumptions including: the nature and timing of interest rate levels, including the shape of the yield curve; prepayments on loans and securities; changes in deposit levels; pricing decisions on loans and deposits; reinvestment/replacement of asset and liability cash flows; and others. While assumptions are developed based upon current economic and local market conditions, we cannot make any assurances as to the predictive nature of these assumptions including how client preferences or competitor influences might change. Interest rate exposure is measured by the potential impact on our income statement of changes in interest rates. We use information from our gap analysis and rate shock calculations as input to help manage our exposure to changing interest rates. We use our rate shock information to tell us how much exposure we have to rapidly changing rates. -26- ITEM 4. CONTROLS AND PROCEDURES Within the 90 days prior to the date of this report, we carried out an evaluation, under the supervision and with the participation of our company's and our subsidiaries' management, including our company's president and chief executive officer along with our chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, our president and chief executive officer along with our chief financial officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to our company (including our consolidated subsidiaries) required to be included in our periodic SEC filings. There have been no significant changes in our internal controls or in other factors that could significantly affect internal controls subsequent to the date we carried out this evaluation. -27- PART II. OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: See Exhibit Index attached hereto. (b) Reports on Form 8-K. We did not file any Current Reports on Form 8-K during the quarter ended September 30, 2002. -28- SIGNATURES In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. UNIFIED FINANCIAL SERVICES, INC. (Registrant) Dated: November 8, 2002 By: /s/ John S. Penn --------------------------------------------------------- John S. Penn, President and Chief Executive Officer Dated: November 8, 2002 By: /s/ Thomas G. Napurano --------------------------------------------------------- Thomas G. Napurano, Executive Vice President and Chief Financial Officer -29- CERTIFICATION I, John S. Penn, certify that: (1) I have reviewed this quarterly report on Form 10-Q of Unified Financial Services, Inc.; (2) Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; (3) Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; (4) The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: (a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period for which this quarterly report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls as of a date within 90 days prior to the filing date of this quarterly report (the"Evaluation Date"); and (c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Effective Date; (5) The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent function): (a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and -30- (6) The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. November 8, 2002 /s/ John S. Penn -------------------------------------------- John S. Penn President and Chief Executive Officer -31- CERTIFICATION I, Thomas G. Napurano, certify that: (1) I have reviewed this quarterly report on Form 10-Q of Unified Financial Services, Inc.; (2) Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; (3) Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; (4) The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: (a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period for which this quarterly report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and (c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Effective Date; (5) The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent function): (a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and -32- (6) The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. November 8, 2002 /s/ Thomas G. Napurano -------------------------------------------- Thomas G. Napurano Chief Financial Officer -33- EXHIBIT INDEX Ex. No. Description ------- ----------- 10.1 Tri-Party Agreement, dated June 18, 2002, among Health Financial, Inc., Unified Trust Company, National Association and Dr. Gregory W. Kasten, is filed herewith.* 10.2 Waiver of Provisions of Employment Agreement, dated May 15, 2002, between Unified Financial Services, Inc. and Charles H. Binger, is filed herewith.* 10.3 Waiver of Provisions of Employment Agreement, dated May 15, 2002, between Unified Financial Services, Inc. and David F. Morris, is filed herewith.* 10.4 Line of Credit Note, dated July 22, 2002, by Commonwealth Premium Finance Corporation in favor of Bank One, Kentucky, NA, is filed herewith. 10.5 Continuing Guaranty, dated July 22, 2002, by Unified Financial Services, Inc. in favor of Bank One, Kentucky, NA, is filed herewith. 11.1 Computations of Earnings per Share, is filed herewith. 99.1 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, is filed herewith. 99.2 Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, is filed herewith. * Management or compensatory arrangement. -34-