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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 3L, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______________ TO _______________
COMMISSION FILE NUMBER 0-16240
JB OXFORD HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
UTAH 95-4099866
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
9665 Wilshire Blvd., Suite 300 Beverly Hills, California 90212
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (310) 777-8888
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Title of each class Common stock, $0.01 par value:
Indicate by check mark whether the Registrant (l) has filed all reports
required to be filed by Section l3 or l5(d) of the Securities Exchange Act of
l934 during the preceding 12 months and (2) has been subject to such filing
requirements for the past 90 days. Yes X No ___
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [ ].
Indicate by checkmark whether the registrant is an accelerated filer (as
defined in rule 12b-2 of the Act). [ ].
The aggregate market value of the voting stock held by non-affiliates of
the registrant as of the last business day of the registrant's most recently
completed second fiscal quarter was approximately $6,567,711 computed based on
the closing price of the stock on June 30, 2003.
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date: 1,806,871 shares
outstanding at March 4, 2004.
Documents Incorporated by Reference: Portions of the registrant's
definitive proxy statement for the 2004 annual meeting, which will be filed on
or before 120 days after December 31, 2003, are incorporated by reference into
Part III, Items 10 - 14 of this Form 10-K.
PART I
ITEM 1. BUSINESS
OVERVIEW
Through our wholly-owned subsidiaries, we are engaged in the business of
providing brokerage and related financial services to retail customers and
broker-dealers nationwide. We are a fully integrated brokerage firm, providing
retail brokerage services, clearing services and market making services to our
customers.
Our retail subsidiary is JB Oxford & Company ("JBOC"). JBOC is a registered
broker-dealer offering discount and electronic brokerage services to the
investing public. JBOC's website is www.jboc.com, which allows customers to
review account information, conduct market research, place trades, and manage
their account online. JBOC has retail offices in Beverly Hills, New York and
Minneapolis.
Our clearing subsidiary is National Clearing Corp ("NCC"). NCC is also a
registered broker-dealer, offering clearing services to independent
broker-dealers ("correspondents"). NCC's largest correspondent is JBOC. In
addition, NCC acts as a market maker in stocks traded on the NASDAQ National
Market System and other national exchanges.
We were incorporated in Delaware on March 31, 1987, and completed our initial
public offering in September 1987. We changed our state of incorporation to Utah
in 1990. Our business is headquartered in Beverly Hills, California and we
currently operate additional offices in New York, New York and Minneapolis,
Minnesota.
Our principal executive offices are located at 9665 Wilshire Boulevard, Suite
300, Beverly Hills, California 90212 and our telephone number at such address is
(310) 777-8888. Our Internet address is www.jboxford.com and we make our filings
with the Securities and Exchange Commission available from our website free of
charge.
OUR OPERATIONS
Our operations are conducted through our two wholly-owned subsidiaries, JBOC and
NCC. JBOC provides our retail brokerage services and NCC provides our clearing
and execution services.
Our Brokerage Services
In 1994, we began our strategy of providing retail investors a full line of
brokerage services at discount prices. This strategy proved successful as few
brokerage firms provided brokerage services at discount prices at that time. We
were able to capitalize on this early position by providing customer service and
attention comparable to that offered by larger full-service brokerage firms
charging higher fees. Today, we offer a full line of products and services to
customers, which includes the ability to buy and sell securities, equity and
index options, mutual funds, fixed income products, and other investment
securities. To this end, we strive to employ experienced, knowledgeable account
representatives that are familiar with all of the financial products in which
our customers focus their trading activity. We derive revenue from the
commissions we charge for transactions in securities by our customers. The
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commission rates we charge may vary depending on the particular security and
other variables such as volume of activity and quantities purchased. Because the
commission revenue is derived from trading activity, our revenue in this regard
can fluctuate based upon the trading activity of our customers.
In 1995, in order to continue our commitment to providing a full line of
brokerage services to our customers, we began providing electronic brokerage
services. These services initially included computer trading through a dial-up
networking connection and automated telephonic trading services. Since that
time, we made many improvements to these services, including the launch of
Internet trading in 1996. Through 2003, we continued to upgrade and improve our
electronic brokerage technologies in order to provide our customers with the
resources necessary to conveniently and economically execute securities
transactions and access related financial information. In addition to our
trading capabilities, our internet site, www.jboxford.com, currently provides
market quotes, charts, company research, and customer account information, such
as cash balances, portfolio positions and related information.
In early 2004, we redesigned our website to include an upgraded navigational
scheme and richer financial content. Our trading site provides integration of
charts, market quotes, company research, customer account information such as
cash balances and portfolio balances, and includes mutual fund and bond trading,
unlike many of our competitors.
We also cater to customers within niche markets by providing services that
address the particular needs of these customer bases. Examples include Asian,
Latin American and European customers. These niche-marketing efforts initially
began as an outgrowth of our commitment to meeting the needs of our domestic
U.S. customers, such as providing account representatives who are fluent in a
customer's preferred language. With the growth in the electronic delivery of
financial services, it is becoming economically feasible to provide these
services to both domestic and international customers using the internet.
Our Clearing and Execution Services
We are a self-clearing broker-dealer, which, as of March 19, 2004, provides
clearing and execution services for 16 correspondents, including, JBOC, our
wholly-owned introducing broker-dealer. We are registered with the SEC and the
NASD and are a member of the following organizations: Chicago Stock Exchange,
Pacific Stock Exchange, Cincinnati Stock Exchange, DTC, NSCC and Options
Clearing Corporation. We are registered as a securities broker-dealer in all 50
states, the District of Columbia, and Puerto Rico.
We are focused on the selection and monitoring of our correspondents. We
continue to look for opportunities to selectively add new correspondents, in an
effort to replace clearing business that has been lost through attrition and
decreasing market volumes. In 2003, we added four new correspondents. Our
clearing services business unit focuses on three distinct business revenue
generation opportunities. In addition to clearing services, we also target
market making and interest income from customer margin account activities.
Clearing Services
The clearing relationship involves the sharing of broker-dealer responsibilities
between the introducing broker and the clearing broker. Our correspondents
(i.e., introducing brokers) are responsible for all customer relationships,
including customer contact, opening customer accounts, determining customer
suitability, accepting and/or placing customer orders, and responding to
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customer inquiries. We act as the clearing broker, providing clearing services
including the receipt, confirmation, settlement, delivery and record-keeping
functions involved in securities transactions as well as providing back office
functions such as: maintaining customer accounts; extending credit (in a margin
account) to the customer; settling security transactions with the Depository
Trust Clearing Corporation ("DTCC"); preparing customer trade confirmations and
statements; performing certain cashiering and safe-keeping functions;
transmitting tax information to the customer and tax authorities; forwarding
proxies and other shareholder information to customers; and similar activities.
In providing clearing and execution services to correspondents, we assume
certain responsibilities for the possession and control of customer securities
and assets.
We derive our clearing and execution services revenue from agreed upon fees for
such services with our correspondents. These fees are generally based on the
greater of the total of fixed charge per transaction or a minimum monthly fee
together with the direct reimbursement of miscellaneous expenses. Because our
revenue in this regard is based on the number of transactions, it is subject to
fluctuation depending on the level of correspondent customer transactions.
In providing clearing services to correspondents, we assume certain
responsibilities for the possession and control of customer securities and
assets. As a result, our statements of financial condition reflect amounts
receivable from customers on margin loans as well as amounts payable to
customers and correspondents related to free credit balances held by us for the
benefit of customers and correspondents. A free credit balance is a customer
cash balance that we may use to offset debits owed by customers. We have
established procedures with respect to our use of customer free credit balances
in accordance with SEC requirements, including periodically providing customers
with a written statement showing their free credit balance.
In the event of a business failure of a correspondent, we typically do not
experience a material decrease in revenue. Because the revenue from such
correspondents is derived based upon the activity of the underlying customers of
the correspondent, to the extent we still are able to provide services to these
customers, we maintain a revenue stream. Further, since none of our
correspondents have possession or control of customer funds or securities, the
failure of the correspondent does not jeopardize these assets. There have been a
number of correspondent failures over the years. To date, these failures have
not had a significant impact on our earnings. However, because we function as a
clearing agent, we are subject to being named in litigation from time to time in
connection with transactions we clear, which can expose us to significant risk
and/or loss. See Management's Discussion and Analysis of Financial Condition and
Results of Operation - Risk Factors." We evaluate the risks associated with our
correspondents by reviewing:
o the financial condition of the correspondent;
o the disciplinary records of the principals and brokers of the
correspondent; and
o the nature and level of activity of the correspondent and its
customers.
Based upon our review of the above factors, we determine what restrictions are
required to be placed on the activities of the correspondents and their
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customers, the fees to be charged for services to be provided, and the amount of
the clearing deposit required to be maintained by the correspondent at all
times.
There are inherent risks in operating as a clearing agent. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations - Risk
Factors" below. Acting as a clearing agent in the securities business requires
both working capital and capital for regulatory requirements. See "Governmental
Regulations - Net Capital Requirements" below, for a more extensive discussion
of capital requirements.
Market Making Activities
In order to facilitate the execution of security transactions for the customers
of our correspondents and for other brokerage firms, we act as a market maker
for approximately 300 public corporations whose stocks are traded on the NASDAQ
National Market System, New York Stock Exchange, or other national exchanges.
The number of companies for which we act as a market maker fluctuates depending
upon various factors, including trading volume and the number of employees
acting in a trading capacity. We derive revenue in our market making activities
by going at risk against the market to fill customer orders, and then entering
into further trades to close the position. Our revenue in this regard is the
difference between the prices we fill customer orders and the prices we incur to
close the positions. Because these activities are subject to many variables,
including the specific security, the level of overall trading in the market and
the activities of competitors who are also market making, the revenue we derive
from these activities will vary. Generally, we do not maintain inventories of
securities for sale to our customers.
In any transaction for or with a customer, we are required to use reasonable
diligence to ascertain the best inter-dealer market for the subject security and
buy or sell in such market so that the resultant price to the customer is as
favorable as possible under prevailing market conditions. Typically, this
requires that all customer orders be filled at or better than the National Best
Bid, Best Offer ("NBBO") price. We have established policies for executing
trading activity within the regulatory guidelines to which we are subject. We
execute only market orders, not limit orders. All limit orders are sent to other
market centers or participants for execution. For the orders we execute, these
regulations govern, in material part, the following:
o The timeliness of order execution;
o The price at which orders are executed relative to the National Best
Bid Offer ("NBBO") price;
o The timeliness of reporting filled orders to the customer and the
NASD; and
o Record-keeping regarding all orders received and executed.
We continually review and monitor these activities to ensure the established
policies are adhered to and that we operate in compliance with applicable
regulatory requirements. In addition, all of our market making activity is
reviewed on a near constant basis by the NASD through its automated trade review
system.
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Interest Income
We derive a portion of our income from interest generated on the margin accounts
of our customers and our correspondents' customers. A margin account allows the
customer to deposit less than the full cost of the security purchased while we
lend the balance of the purchase price to the customer, secured by the purchased
securities. Customers are charged interest on the amount borrowed to finance
their margin transactions, generally ranging from 0.25% below to 2.75% above the
nationally published broker call rate. As of December 31, 2003, the total of all
debit balances held in active margin accounts was approximately $75 million. We
finance our margin lending business primarily through customer free credit
balances.
Customer free credit balances were approximately $190 million as of December 31,
2003. These credit balances were available to finance customer margin balances,
subject to the requirements of SEC rules. Pursuant to written agreements with
customers, broker-dealers are permitted by SEC regulations to lend customer
securities held as collateral in margin accounts to other broker-dealers and
clearing organizations. We utilize these stock loan arrangements to partially
finance customer debit balances.
In addition to the above financing, we have established uncommitted lines of
revolving credit with banking institutions approximating $25,000,000 and other
uncommitted lines with broker-dealers, based upon available loan collateral. The
uncommitted nature of the lines of revolving credit with banking institutions
means that the financial institutions are not committed to loaning us funds at
the time we request a draw on the line of credit. As a result, we may not be
able to access the revolving line of credit at the time we need to without
additional conditions being imposed upon us or at all. All lines of credit are
maintained by NCC and are secured by customer margin securities; as such, they
are subject to the sufficiency of such collateral for advances.
Since we make loans to customers collateralized by customer securities, we incur
the risk of market decline that could reduce the value of the customer's
underlying collateral securities below the customer's loan amount. For this
reason, credit exposure must be monitored and actions must be taken on a timely
basis to mitigate and minimize our exposure to these risks. We mitigate our
credit exposure by monitoring the adequacy of collateral from both individual
customers and correspondents. Additionally, we are required to have procedures
in place to prevent customers from violating margin rules established by the
Board of Governors of the Federal Reserve System and the NASD, which further
limit the amount of money that can be lent to customers, based on the collateral
securing such loans. Generally, these rules require customers to borrow not more
than 50% of the initial purchase price of equity securities, and to maintain
equity of at least 25% at all times. Our internal house policies, however,
generally require customers to maintain equity of at least 30% at all times. In
addition to an assessment of the underlying securities held in the account, we
do a credit check on the customer at the time a margin account is opened to
evaluate the credit worthiness of the customer and review the account
information provided by the customer at the time the account is opened. Existing
margin accounts and loans are monitored by our computer systems on a daily basis
to ensure regulatory margin limits are not exceeded due to fluctuation in the
value of the securities in the account providing the collateral for the margin
loan. We did not incurred any significant losses as a result of our customer
margin activities during 2002 and 2003.
OUR CUSTOMER ACCOUNT ACQUISITION STRATEGY
In 2001, we commenced a strategy that included the acquisition of existing
accounts from various broker-dealers. During 2001 and 2002 we paid aggregate
consideration of $6,872,689 in connection with the execution of this strategy.
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Through this strategy we were able to add over 35,000 additional accounts. These
transactions were typically funded with a combination of cash and our common
stock. In connection with these transactions, we recorded the value of the
accounts acquired as intangible assets, which are being amortized over four
years based upon their estimated useful life. Intangible assets are reviewed for
impairment annually and whenever events or changes indicate the carrying value
of an asset may not be recoverable. Impairment is determined based upon the
estimated discounted cash flow of the intangible assets being held.
OUR INTERNAL RESTRUCTURING
In April 2003, JB Oxford & Company formally changed its name to National
Clearing Corp, in anticipation of separating the retail and clearing functions
of JB Oxford & Company into two separate entities. Also at this time,
Stocks4Less, Inc. (formerly an inactive subsidiary) was renamed JB Oxford &
Company, and granted to National Clearing Corp the right to use the JB Oxford
name until the separation was completed.
Effective on or about October 1, 2003, all of the retail activities of
National Clearing Corp were transferred to JB Oxford & Company. At that time,
National Clearing Corp ceased use of the JB Oxford name, and commenced
operations under its own name. Since that time, JB Oxford & Company has operated
as a retail correspondent firm of National Clearing Corp. National Clearing Corp
no longer has any retail customers. Its business is limited to clearing and
execution services for correspondent firms, including JB Oxford & Company.
GOVERNMENTAL REGULATIONS
General Securities Industry Regulations. The securities industry is subject to
extensive regulation and broker-dealers are subject to regulations covering all
aspects of the securities business. The SEC, NASD, and other self-regulatory
organizations and state and foreign regulators can, among other things, fine,
issue cease-and-desist orders to, suspend or expel a broker-dealer or any of its
officers or employees. While we neither actively solicit new foreign accounts
nor have established offices outside of the United States, our websites are
accessible worldwide over the Internet and we currently have account holders
located outside the United States. These accounts make up less than 5% of our
accounts and are spread across many jurisdictions. Any adverse action by foreign
regulators with respect to regulatory compliance in foreign jurisdictions could
adversely effect our revenues from clients in such country or region.
Our ability to comply with applicable laws and rules is largely dependent on our
internal system to ensure compliance, as well as our ability to attract and
retain qualified compliance personnel. We could be subject to disciplinary or
other actions in the future due to claimed noncompliance, which could have a
material adverse effect on our operations and profitability.
Federal Regulations. In general, broker-dealers are required to register with
the Securities and Exchange Commission ("SEC") and to be members of the National
Association of Securities Dealers "NASD." As such, we are subject to
requirements of the Securities Exchange Act of 1934 and the rules promulgated
thereunder relating to broker-dealers and to the Rules of Fair Practice of the
NASD. These regulations are extensive and establish, among other things, the
following:
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o minimum net capital requirements for our operating subsidiaries, NCC
and JBOC.
o rules regarding the possession and control of customer funds and
securities;
o rules regulating the reserves required to be maintained by clearing
broker-dealers to protect customer assets; and
o rules regulating the trading of securities on behalf of customers
and the Company.
State Regulations. We are also subject to regulation under various state laws in
all 50 states and the District of Columbia, including registration requirements.
For the most part, however, state regulators typically rely on the existing
federal and self-regulatory organization rules for governing the actions of
broker-dealers.
Clearing Regulations. In its capacity as a clearing firm, NCC is a member of the
National Securities Clearing Corporation ("NSCC"), The Depository Trust &
Clearing Corporation ("DTCC") and the Options Clearing Corporation ("OCC"), each
of which is registered as a clearing agency with the SEC. As a member of these
clearing agencies, NCC is required to comply with the rules of such clearing
agencies, including rules relating to possession and control of client funds and
securities, margin lending and execution and settlement of transactions.
Margin Regulations. Margin lending activities are subject to limitations imposed
by the Federal Reserve and NASD. In general, these regulations provide that in
the event of a significant decline in the value of securities collateralizing a
margin account, we are required to obtain additional collateral from the
borrower.
In connection with these regulations we are subjected to periodic reviews by
federal and industry regulators. These reviews can result in required revisions
to our operations and our firm if we are deemed to not be in compliance. The
results and findings of such reviews are discussed with management and to date
have not had a material adverse impact on our operations. Because of the
extensive nature of the regulations and regulators we are subject to, there can
be no assurance that we will not be deemed to be in violation in the future
despite our best efforts at compliance.
Net Capital Requirements. We are subject to SEC Rule 15c3-1, Net Capital
Requirements For Brokers or Dealers, which establishes minimum net capital
requirements for broker-dealers. Rule 15c3-1 is designed to measure financial
integrity and liquidity in order to assure the broker-dealer's financial
stability within the securities market. The net capital required under Rule
15c3-1 depends in part upon the activities engaged in by the broker-dealer.
In computing net capital under Rule 15c3-1, various adjustments are made to
exclude assets not readily convertible into cash and to reduce the value of
other assets, such as a firm's position in securities. A deduction is made
against the market value of the securities to reflect the possibility of a
market decline prior to sale. Compliance with Rule 15c3-1 could require
intensive use of capital and could limit our future business operations. Failure
to comply with the minimum net capital requirements of Rule 15c3-1 would require
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us to increase the level of our capital, which could limit our ability to pay
our debts and/or interest obligations, and may subject us to certain
restrictions that may be imposed by the SEC, the NASD, and other regulatory
bodies. Moreover, in the event that we cannot or elect not to increase the level
of capital into that business or otherwise bring us into compliance, we would
ultimately be forced to cease operations. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Risk Factors."
For NCC, we have elected to use the alternative method of net capital
computation, as permitted by Rule 15c3-1, which requires us to maintain minimum
net capital, as defined, equal to the greater of $250,000 or 2% of aggregate
debit balances arising from customer transactions, as defined. At December 31,
2003, NCC had net capital of $9,554,544, which was $7,873,465 in excess of the
minimum amount required. JBOC, as an introducing broker-dealer, had net capital
requirements of only $5,000, as it does not hold customer funds or securities.
At December 31, 2003, JBOC had net capital of $420,575, which was $414,478 in
excess of the minimum amount required. We file a Form X-17A-5 containing our Net
Capital calculations on a monthly basis with the NASD. In addition, these
calculations are reviewed during all periodic examinations by our regulators.
Reviews of our Form X-17A filings have not resulted in any material action being
taken by the NASD with respect to our Net Capital Requirements.
OUR INSURANCE
Company. We maintain general liability insurance in amounts we believe are
sufficient for our operations. These current policies expire in April of 2004.
Some of the claims against us, however, could exceed the scope of our coverage
in effect or coverage of particular claims or damages could be denied. In
addition, we may not be able to obtain adequate insurance at a reasonable cost
in the future.
Customer Accounts. We are a member of the Securities Investor Protection
Corporation ("SIPC"), which provides our customers with insurance protection for
amounts of up to $500,000 each, with a limitation of $100,000 on claims for cash
balances in the event of our liquidation. In addition, we have also acquired an
additional $10,000,000 per account, $50,000,000 in the aggregate, in insurance
coverage through Lloyds of London as added protection for individual customers'
securities accounts, covering all of our customers and customers of our
correspondents that we carry. SIPC and excess SIPC insurance is generally
available in the event of the failure or insolvency of a brokerage firm, to
re-pay customers up to the amount of insurance available. It does not insure
against investment losses in customer accounts. Coverage does not protect
against losses from changes in the market value of customer investments, or
insure the quality of investments. Coverage is also not available to accounts of
executive officers and directors of the Company as well as to accounts of
broker-dealers.
OUR COMPETITION
Brokerage Services. The market for discount and electronic brokerage services is
rapidly evolving and intensely competitive. We face direct competition from
firms offering discount and electronic brokerage services such as Charles Schwab
& Co., Inc., Fidelity Brokerage Services, Inc., Waterhouse Investment Services,
Inc. (a subsidiary of Toronto Dominion Bank), Ameritrade, Inc. (a subsidiary of
Ameritrade Holding Corporation), and E*TRADE Group, Inc. We also encounter
competition from established traditional full commission brokerage firms such as
UBS PaineWebber, Merrill Lynch, Pierce, Fenner & Smith Incorporated and Smith
Barney, Inc. (a subsidiary of Citigroup, Inc.), among other traditional firms,
which typically also offer their customers on-line services. In addition, we
compete with financial institutions, mutual fund sponsors and other
organizations. Further, the
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industry is currently undergoing consolidation, which may strengthen our
competitors, and this trend is expected to continue. Competition for these
services is based upon many factors, including reputation, size, experience,
advertising, services, relationship, cost and reliability. Many of our
competitors in the business have significantly greater resources than we have.
Clearing Services. Our clearing and execution business faces competition in
seeking new correspondents from other clearing broker-dealers, such as Bear
Stearns Global Clearing Services, Pershing Investments, LLC, Penson Financial
Services, Inc., and other such firms. Competition is based upon many factors,
including reputation, size, experience, advertising, services, relationship,
cost and reliability. Many of our competitors in this business have
significantly greater resources than we have.
OUR EMPLOYEES
As of March 4, 2004, we had approximately 89 employees. Between January 2001 and
mid-2003, we reduced our workforce by approximately 62% due to the market
slowdown and a reduction in transaction volume. Since that time, our workforce
has remained steady. As demand for our products and services increases in the
future, we expect to need to correspondingly increase our personnel.
ITEM 2. PROPERTIES
Our principal offices and the principal offices of NCC are located at 9665
Wilshire Boulevard, 3rd Floor, Beverly Hills, California 90212. As of March 20,
2004, we lease or conduct our operations from, and have our administrative
offices at, the following locations:
Location Area (Sq. Feet) Principal Use Lease
-------- --------------- ------------- -----
9665 Wilshire Blvd., 2nd, 3rd, 5th and 27,240 Administration and Expires Dec. 2010
8th Floors, Beverly Hills, CA 90212 NCC Operations
9601 Wilshire Blvd., Suite GF-3, Beverly 8,258 JBOC - Operations Expires Jun. 2004
Hills, CA 90210
One Exchange Plaza, 19th Floor 6,050 JBOC - Operations Expires Jun. 2006
New York, NY 10006
109 South Seventh Street, Suite 111 1,100 JBOC - Operations Expires Feb. 2008
Minneapolis, MN 55402
1333 Broadway 1,285 NCC - Operations Expires Dec. 2005
Oakland, CA
Our offices, and the offices and facilities of our subsidiaries, are considered
by management to be generally suitable and adequate for their intended purpose.
With our reductions in force over the past two years, some of our office space
has been vacated. We negotiated an early release from our former Miami office
lease, and we have sublet our excess space in New York and Los Angeles.
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ITEM 3. LEGAL PROCEEDINGS
In addition to those matters described below, we are from time to time
subject to legal arbitration or administrative proceedings arising in the
ordinary course of our business, including claims by customers relating to
brokerage services as well as matters related to our clearing services. We are
also subject to periodic regulatory audits and inspections by the SEC and NASD
which could give rise to claims against us. While we make a provision for a
liability when it is probable that a liability has been incurred and the amount
of the loss can be reasonably estimated, legal matters are inherently
unpredictable and expensive to defend. If there are adverse outcomes in our
legal proceedings, it could have a material adverse effect on our business and
financial condition. Those proceedings that management believes may have a
significant impact are described below.
SEC MUTUAL FUND INVESTIGATION
We are currently under investigation by the SEC, the New York State Attorney
General ("NYAG") and the US Attorney's Office for the Central District of
California ("USAO") related to allegations that we improperly processed mutual
fund trade orders which, among other allegations, enabled certain hedge fund and
mutual fund customers to engage in "late trading." The alleged transactions took
place between May 2002 and September 2003 and we have terminated our
arrangements with the subject customers. Since August 2003 we have been
providing the SEC and the NYAG with documents and testimony in response to
subpoenas and we believe that we have been cooperating in these investigations.
On November 6, 2003, we received a "Wells Notice" as part of the SEC's
investigation informing us that the staff of the SEC's Pacific Regional Office
intended to recommend that the SEC bring civil and administrative enforcement
actions against us based on alleged violations of federal securities laws
related to the alleged mutual fund trading transactions. We have responded to
the Wells Notice and believe we are cooperating in connection with the notice.
To that end, we have had several meetings with the SEC with the goal of settling
this matter.
In the event charges are filed against us related to the SEC, NYAG and/or USAO
investigations, we could be subject to significant sanctions and penalties,
including but not limited to suspension or revocation of our licensing and
registration as a broker-dealer, and substantial monetary fines which could have
a material adverse effect on our business and financial condition. Furthermore,
our reputation could suffer and any damage to our reputation could cause us to
lose existing customers and fail to attract new customers which would have a
material adverse effect on our business and financial condition. While NCC
admits no wrongdoing and intends to vigorously defend itself, no assurance can
be given as to the outcome of this matter. Although the likelihood of loss is
probable, the Company has not accrued any amounts related to this matter, as the
amount of loss is not estimable at this time. However, substantial penalties
from fines or settlements resulting from an adverse outcome or judgment in this
matter could have a material adverse effect on the financial position and
results of operations of the Company
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OTHER REGULATORY MATTERS
In April 2003 we were notified by the SEC in the course of a routine examination
that we had a deficiency since September 2002 in our required reserve account
deposits in violation of SEC rules. This deficiency identified by the SEC, which
ranged between $120 million and $145 million, was caused primarily as a result
of our deposit of customer funds into certificates of deposit and money market
accounts at a financial institution in excess of the amount of funds permitted
to be maintained at any one financial institution. Our inadvertent inclusion of
accounts maintained by certain of our executive officers and directors in our
reserve account calculations also contributed to the deficiency since under the
SEC rules we are not permitted to include such accounts in our calculations. We
subsequently brought our required reserve accounts into compliance within the
two weeks requested by the SEC. Although the deficiency was in violation of the
SEC rules, at no time were any customer funds at risk of loss. The NASD
subsequently required us to pay a $15,000 fine and the matter was concluded in
early 2004.
USAO SETTLEMENT AGREEMENT RELATED TO PRIOR MANAGEMENT
In February 2000, we entered into a settlement agreement with the United States
Attorney's Office for the Central District of California (the "USAO") in
connection with an investigation commenced in 1997 by the USAO of certain of our
former affiliates and management. The USAO investigation, and the concurrent
investigation by the SEC, related to an alleged failure to disclose the
relationship of an individual who was purported to be secretly in control of the
company and the trading practices of such individual. Our current executive
officers and directors were not the subject of the USAO or SEC investigations.
While we maintained our innocence, we agreed to pay $2,000,000 to the USAO over
a period of three years in settlement of the investigation and to offset the
USAO's costs of its investigation. We recognized a charge of $2,300,000 in the
fourth quarter of 1999 to account for the settlement agreement with the USAO and
an anticipated settlement with the SEC.
Under the terms of the settlement agreement, if we fail to make payment of any
installment when due, the entire unpaid balance will become immediately due and
payable, and if we sell a controlling interest in our operating subsidiary to a
third party, the remaining unpaid installments must be paid prior to the closing
of the sale.
In May 2002, the settlement agreement was amended to modify the payment schedule
for the balance owing of $1,000,000 under the settlement agreement. No payment
was required to be made in 2002 and the balance was to be paid in equal annual
installments in February 2003 and February 2004. In February 2003, the USAO
agreed to extend the due date on the $500,000 payment then due under the
settlement agreement. We made a partial payment of $50,000 on March 31, 2003,
and the USAO extended the time for any further payment. As of December 31, 2003,
the Company owed a balance of $950,000. The Company made a partial payment of
$50,000 in February 2004, and is continuing to negotiate with the USAO regarding
the timing and amount of subsequent payments. The Company originally accrued
payments related to this matter totaling $3.0 million, to cover both the
settlement with the USAO, and a potential settlement with the SEC. The SEC
notified the Company in 2002 that it had closed its investigation without action
or monetary assessment. Accordingly, the amount accrued has been reduced to
$950,000 at year end, the remaining balance due to the USAO.
12
LITIGATION RELATED TO OERI NOTES
The Company is a party to a lawsuit entitled EBC Trust v. JB Oxford Holdings,
Inc., et als., pending in the Federal District Court in Los Angeles. In this
suit, EBC Trust, as the assignee of certain notes described below issued by the
Company is seeking payment of the $2.9 million of such notes. The Company issued
$2,867,500 in demand notes to former shareholders during 1997. The notes bore
interest at 8 1/4%, payable quarterly. In 1998, $250,000 was paid on the demand
notes. In 1999, $728,125 of the debt was forgiven by Oeri Financial, Inc. and
Felix A. Oeri (collectively "Oeri"), leaving a balance due of $1,889,375, which
was reclassified to notes payable in 1999. A $1,000,000 subordinated loan
agreement, payable to Oeri Finance, Inc., matured by its terms on March 31,
1999. The balance due was reclassified to note payable at that time.
Since in or about March 1999, the Company has refused to make payment under the
notes payable totaling approximately $2.9 million, plus interest, and has
asserted defenses and counterclaims against the alleged holders of the notes
related to: i) an award entered jointly against the Company and the holders
related to alleged wrongful conduct by the Company in clearing certain customer
accounts during the time that the holders of the notes payable ran the Company;
and, ii) the Company has acquired a Judgment against Oeri Finance, Inc., which
it intends to use as a set-off against claims on the notes payable. The amount
of the Judgment acquired is substantially in excess of the total claimed due on
the notes payable.
In July 2002, the court magistrate granted a pre-judgment attachment against the
assets of the Company in favor of EBC Trust. In January 2003, the Court reversed
the magistrate's order and dissolved the attachment. In January 2003, EBC Trust
amended its claim to assert additional claims against the Company and to add
claims against the officers and directors of the Company, as well as to add a
claim against NCC under the $1,000,000 Oeri subordinated note. By Order dated
October 14, 2003, in response to motions filed by the Company, the Court
dismissed several claims, struck portions of the Amended Complaint, and
compelled EBC Trust to arbitrate all claims against NCC.
As to the remaining claims, the Company has asserted a number of defenses to EBC
Trust's claims, including fraud, and contribution related to a judgment entered
against EBC Trust's predecessor-in-interest under the notes payable and NCC in
an NASD arbitration commenced by Stanly J. Cohen, Receiver for Secured Equity
Title and Appraisal Agency Corp. NCC settled all of the claims against it in
that matter in 2002, and as a part of that settlement, obtained the assignment
from Secured Equity of a Judgment against Oeri Finance, Inc. Accordingly, the
Company has asserted a claim of offset for the Judgment against Oeri Finance,
Inc.
In December 2003, EBC Trust commenced an arbitration action with the National
Association of Securities Dealers, Inc., against JBOC, seeking recovery on the
$1,000,000 subordinated note originally issued to RMS Network, Inc., and
subsequently assigned with approval from the Company and the NASD to Oeri
Finance, Inc. The Company intends to vigorously defend the action and believes
that it has meritorious defenses including, without limitation: i) the suit is
brought against the wrong party; ii) no valid assignment has ever been approved
by the Company or the NASD to EBC Trust, as required by the terms of the note;
and iii) the Company will assert an offset for the Judgment obtained against
Oeri Finance, Inc., described above. The Company has recorded liabilities of
approximately $2.9 million on its balance sheet in notes payable, additionally,
13
the Company has $816,429 of accrued interest related to these notes included in
accounts payable and accrued expenses.
LITIGATION RELATED TO ACCOUNT ACQUISITIONS
In October 2002, Share King LLC, as successor to Mr. Stock, Inc. commenced an
arbitration proceeding related to the acquisition by us of the accounts of Mr.
Stock. We countersued for violations of the purchase agreement by Mr. Stock.
That litigation was settled in August 2003, on terms more favorable to us than
we originally accrued for, and the cost of the Mr. Stock acquisition was
adjusted down $356,174 in 2003, as a result of settlement of the arbitration. As
a part of the settlement, we are required to distribute cash and/or stock, at
our election to Share King LLC. In early 2004, a further dispute arose with
Share King LLC regarding the registration requirements related to the stock to
be issued. A decision is pending on that matter by the arbitration panel. If we
receive an adverse ruling from the panel, we could be required to make
subsequent payments to Share King LLC in cash, instead of in our choice of cash
and/or stock.
See also Note 16 "Commitments and Contingencies" of the Notes to the
Consolidated Financial Statements, below.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of our security holders during the 4th
quarter of 2003.
14
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY & RELATED SHAREHOLDER MATTERS
Our common stock is traded in the over-the-counter market with prices quoted on
the NASD's Automated Quotation System SmallCap market ("NASDAQ") under the
trading symbol "JBOH." Quotations given are from NASDAQ and represent prices
between dealers exclusive of a retail mark-up, mark-down, or commission. They do
not necessarily represent actual transactions. Prices have been retroactively
adjusted to give effect to the 1 for 10 reverse stock split that was effected in
2002.
STOCK PRICE AND DIVIDEND DATA
Month Ended
1-31-04 2-29-04
-------------- -------------
Price range of common stock
High $3.75 $5.19
Low 2.75 3.00
Close at end of period 3.26 4.07
- ----------------------------------------------------------------------------------------------
Quarter Ended
3-31-03 6-30-03 9-30-03 12-31-03
-------------- ------------- -------------- --------------
Price range of common stock
High $3.30 $5.10 $6.25 $4.01
Low 1.95 2.13 2.90 2.76
Close at end of period 2.30 4.46 3.75 3.12
- ----------------------------------------------------------------------------------------------
Quarter Ended
3-31-02 6-30-02 9-30-02 12-31-02
-------------- ------------- -------------- --------------
Price range of common stock
High $21.50 $15.20 $10.00 $4.83
Low 9.90 7.50 2.60 1.60
Close at end of period 15.50 10.10 2.70 2.67
- ----------------------------------------------------------------------------------------------
The number of record holders of our common stock as of March 4, 2004 was 328. We
believe the number of beneficial holders of our common stock as of March 4,
2004, the most recent date for which this data is available to us, was
approximately 10,000.
Dividends
We have not declared or paid cash dividends on our common stock. Given our past
expansion and overall business growth, management believes it has been prudent
to retain and increase our capital base. We do not currently anticipate paying
cash dividends. Future payments of dividends will depend upon, among other
factors, regulatory restrictions, our consolidated earnings, overall financial
condition, and cash and capital requirements.
15
Sales of Unregistered Securities
In February 2003, we reported on Form 8-K that we had entered into a Note
Extension Agreement whereby the maturity dates of our $3,418,696 Senior Secured
Convertible Note and our $2,000,000 Secured Convertible Note, both held by Third
Capital Partners, LLC, were extended for an additional year to December 31,
2003. As consideration for the extension, and to reflect the effect of the
reverse split which occurred in October 2002, the conversion rate on the Notes
was adjusted to $2.67 per share, which was the closing price of our common stock
on the Nasdaq SmallCap Market on December 31, 2002. Under the adjusted
conversion rate, the Notes are convertible into 2,029,474 shares of common
stock. The issuance of the convertible notes was not registered under the
Securities Act of 1933 in reliance upon the exemption set forth in Section 4(2)
of that Act relating to transactions by an issuer not involving a public
offering. On December 31, 2003, the Company and Third Capital Partners, LLC,
agreed to extend the term of both notes until December 31, 2004.
In September we issued 120,000 shares of our common stock to OCC Ventures, LLC,
in reliance upon the exemption set forth in Section 4(2).
16
ITEM 6. SELECTED FINANCIAL DATA
The information set forth below should be read and reviewed in conjunction with
the Management's Discussion and Analysis, consolidated financial statements, and
related notes, included under Items 7 and 8 of this report. The historical
results presented below are not necessarily indicative of future results. All
per share amounts have been adjusted to give retroactive affect of the 1 for 10
reverse stock split effective in October 2002.
JB OXFORD HOLDINGS, INC.
SELECTED CONSOLIDATED FINANCIAL INFORMATION
(Amounts in thousands, except per share data)
Income Statement Data: 2003 2002 2001 2000 1999 (2)
---------------------- ---- ---- ---- ---- --------
Revenues $ 19,900 $ 22,388 $ 35,348 $ 100,862 $ 104,212
Net Income (Loss) (5,949) (7,474) (6,942) 4,973 10,445
Basic Earnings (Loss) Per Share (3.83) (5.21) (4.95) 3.50 7.31
Diluted Earnings (Loss) Per Share (3.83) (5.21) (4.95) 2.25 4.49
Dividends -- -- -- -- --
Balance Sheet Data:
- -------------------
Total Assets $ 262,905 $ 264,585 $ 262,439 $ 352,254 $ 497,739
Long-term and Subordinated Debt 403 -- -- 3,734 --
Liabilities (Excluding Long-Term) 251,541 248,362 239,656 318,628 471,368
Total Shareholders' Equity 10,961 16,223 22,783 29,892 26,371
Book Value Per Share (1) 6.55 11.12 16.40 21.27 18.33
(1) Computed using shareholders' equity divided by total outstanding common
stock.
(2) Reclassification of Extraordinary Item:
During the year ended December 31, 1999, Oeri Finance (a former shareholder of
the Company) forgave a note payable in the gross amount of $728,125 (See Note 13
to the financial statements). The forgiveness of debt was reported as an
extraordinary item in the 1999 financial statements. The amount reported in the
statement of operations was $436,875, which is net of income taxes of $291,250.
.. FAS 145: "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections. FAS 145 states: "Any gain or loss
on extinguishment of debt that was classified as an extraordinary item in prior
periods presented that does not meet the criteria in Opinion 30 for
classification as an extraordinary item shall be reclassified." Accordingly, the
forgiveness of debt reported in 1999 has been reclassified.
17
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Special Note Regarding Forward-Looking Statements
Some of the statements contained in this section of the Annual Report on Form
10-K constitute "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995 (the "Reform Act"). These
forward-looking statements involve known and unknown risks, uncertainties, and
other factors which may cause our actual results, performance, or achievements
to be materially different from any future results, performance, or
achievements, expressed or implied by the forward-looking statements, including,
but not limited to, those risks and uncertainties discussed under "Risk Factors"
after Item 7A below.
Executive Level Overview
Through our wholly-owned subsidiaries, we are engaged in the business of
providing brokerage and related financial services to retail customers and
broker-dealers nationwide. We are a fully integrated brokerage firm, providing
retail brokerage services, clearing services and market making services to our
customers.
Our retail subsidiary is JB Oxford & Company ("JBOC"). JBOC is a registered
broker-dealer offering discount and electronic brokerage services to the
investing public. JBOC's website is www.jboc.com, which allows customers to
review account information, conduct market research, place trades, and manage
their accounts online. JBOC has retail offices in Beverly Hills, New York and
Minneapolis.
Our clearing subsidiary is National Clearing Corp ("NCC"). NCC is also a
registered broker-dealer, offering clearing services to independent
broker-dealers ("correspondents"). NCC's largest correspondent is JBOC. In
addition, NCC acts as a market maker in stocks traded on the NASDAQ National
Market System and other national exchanges.
The financial services industry is a dynamic and ever-changing industry.
Management believes that continued improvements in technology and the widespread
use of technology, including the Internet, is dramatically changing the way
financial services are provided. The ability to obtain quotes, make trades, and
obtain account information instantly through the Internet has come to be
expected by many investors. Management believes that additional technologies,
products and services will become commonplace in the not too distant future.
Management's strategy is to position us to take advantage of the opportunities
presented by the expected changes in the financial services industry. We
continually update our web site at www.jboxford.com to improve speed, allow
easier navigation and expand selection of timely market information and research
tools. In early 2004 we redesigned our web site to include an upgraded
navigational scheme and richer financial content. Our trading site provides
integration of charts, quotes and research, and includes bond and mutual fund
trading.
Critical Accounting Policies
Use of Estimates. The preparation of financial statements in conformity with
Generally Accepted Accounting Policies ("GAAP") requires management to make
estimates and assumptions that affect reported amounts of assets and liabilities
18
and disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the year.
Actual results may differ from those estimates.
Marketable Securities Owned and Securities Sold Not Yet Purchased. Marketable
equity and other securities owned and securities sold, not yet purchased, are
reported at prevailing market prices. Other equity securities included in
securities owned that are not publicly traded are reported at estimated fair
value. The Company estimates fair values of such securities using cost, in
addition to economic and operating trends of the investments and other relevant
information. Realized and unrealized gains and losses on securities owned and
securities sold, not yet purchased, are included in trading profits, net.
Allowance for Doubtful Accounts. On an ongoing basis, the Company reviews its
allowance for doubtful accounts on receivables from broker-dealer and clearing
organizations, customer receivables and other receivables. The Company
establishes allowances to cover known and inherent losses. Management primarily
considers the value of collateral being held as a basis of determining the
adequacy of its allowance for doubtful accounts. Accounts are charged off to the
allowance once the collateral is liquidated and other collection efforts have
been exhausted.
Intangible Assets. Intangible assets consist of customer accounts acquired from
other securities broker dealers and are carried at cost net of accumulated
amortization. Amortization is provided for using an estimated useful life of
four years. Intangible assets are reviewed for impairment annually and whenever
events or changes indicate the carrying value of an asset may not be
recoverable. Impairment is determined based upon the estimated discounted cash
flow of the intangible assets being held.
Income Taxes. Income taxes are accounted for under the asset and liability
method. Deferred tax assets and liabilities are recognized for future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. A valuation allowance is
provided when management believes it is more likely than not that the net
deferred tax asset will not be realized. Conversely, when it subsequently
becomes apparent that a valuation allowance is no longer required due to changes
in circumstances, this portion of the valuation allowance is reversed and
reduces our overall income tax expense. The effect on deferred tax assets and
liabilities of a change in the rates is recognized in income in the period that
includes the enactment date.
Fair Value of Financial Instruments. Substantially all of the Company's
financial assets and liabilities are carried at market or estimated fair value
or are carried at amounts that approximate current fair value because of their
short-term nature. Estimates are made at a specific point in time based on
relevant market information and information about the financial instruments.
Recent Accounting Pronouncements
In December 2002, the FASB issued SFAS No. 148 "Accounting for Stock Based
Compensation -Transition and Disclosure-an amendment of FASB No.123" This
Statement amends SFAS No.123 "Accounting for Stock-Based Compensation" ("SFAS
No. 123") to provide alternative methods of transition for a voluntary change to
the fair value based method of accounting for stock-based employee compensation.
19
In addition, the Statement amends the disclosure requirements of SFAS No. 123 to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based compensation and the effect of
the method used on reported results. This Statement is effective for fiscal
years beginning after December 15, 2002. The Company plans to continue to
account for stock-based employee compensation under APB 25 to provide disclosure
of the impact of the fair value based method on reported income. Employee stock
options have characteristics that are significantly different from those of
traded options, including vesting provisions and trading limitations that impact
their liquidity. Therefore, the existing option pricing models, such as
Black-Scholes, do not necessarily provide a reliable measure of the fair value
of employee stock options. Refer to Note 14 of the Notes to Consolidated
Financial Statements for pro forma disclosure of the impact of stock options
utilizing the Black-Scholes valuation method.
In January 2003, the Financial Accounting Standard Board ("FASB") issued
Interpretation ("FIN") No. 46, "Consolidation of Variable Interest Entitles."
This statement addresses the consolidation of variable interest entities
("VIE"). A VIE is corporation, partnership, trust or other legal structure used
for business purposes that either does not have equity investors with
substantive voting rights or has equity investors that do not provide sufficient
financial resources for the entity to support its activities. FIN No. 46
required a VIE to be consolidated by a company if that company is subject to a
majority of the VIE's risk of loss or if it is entitled to receive a majority of
the VIE's residual returns. The adoption of the statement did not have a
material effect on the Company's financial position or results of operations.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." This statement
modifies the accounting for certain financial instruments with characteristics
of both liabilities and equity. The Company adopted SFAS 150 effective July 1,
2003. The impact of the adoption had no effect on the Company's financial
condition or results of operations.
Going Concern
The accompanying consolidated financial statements have been prepared on a going
concern basis, which reflects the realization of assets and the satisfaction of
liabilities in the normal course of business. As shown in the accompanying
consolidated financial statements, the Company incurred losses of $5,948,964,
$7,474,158 and $6,941,756 during the years ended December 31, 2003, 2002, and
2001, respectively. Additionally, the Company has legal proceedings related to
the ongoing mutual fund investigations (as disclosed in Footnote 16, Commitments
and Contingencies). These deteriorating financial results of the Company and the
uncertainty of legal proceedings against it may cause substantial doubt
regarding the Company's ability to meet its obligations as they become due in
the normal course of business. Please see Note 3 to the financial statements:
Going Concern.
20
Results of Operations
Year Ended December 31, 2003 Compared to Year Ended 2002
Revenues
Our total revenues were $19,900,126 in 2003, a decrease of 11% from $22,387,879
in 2002. This decrease of $2.5 million was primarily attributable to decreases
of $2.4 million in interest income, $1.0 million in clearing and execution and
$0.6 million in other revenue which were partially offset by increases of $0.7
million in commissions and $0.7 million in trading profits.
Clearing and Execution. Clearing and execution revenues are generated
principally through transaction charges to our correspondent brokers. Clearing
and execution revenues decreased 25% to $2,897,911 in 2003, from $3,887,612 in
2002. The decrease in 2003 was primarily attributable to a 24% decline in total
trade volume, and from servicing a lower number of correspondents. There has
also been a downward trend of the pricing to clear for correspondent brokers.
Trading Profits. Trading profits are realized and unrealized revenues generated
from market making activities and other proprietary trading. Revenues from
trading profits increased 49% to $2,187,974 in 2003, from $1,471,277 in 2002.
The increase in 2003 was primarily attributable to profits from proprietary
trading of approximately $1.0 million offset by a 34% decline in order flow
related to trading volumes. Proprietary trading opportunities include
event-based situations in which the firm will take either a long or short
position in a specific security or securities.
Commissions. Commission revenues are generated from security transactions from
our retail customers. Commission revenues increased 9% to $8,880,695 in 2003,
from $8,171,012 in 2002. Total JBOC retail discount and on-line trade volume
increased 25% in 2003. This was in part due to the acquisition of customer
accounts during 2002, offset by a revised commission schedule implemented in
April 2003 which lowered average commissions. In 2004, we will continue to
search for opportunities to acquire compatible discount and on-line brokerage
operations of other firms, in an effort to expand our customer base and
transaction volume. Interest. Interest is earned principally from retail
customer margin balances. Other interest is earned from investments made in cash
required to be segregated by federal and other regulations. Interest revenues
decreased 29% to $5,632,688 in 2003, from $7,979,705 in 2002. This was
attributable to declines in receivables due from customers and in customer
segregated cash balances as well as declines in the interest rate earned on
segregated balances.
Other. Other revenue consists of fees charged to retail customers and
correspondents incidental to the securities business, in addition to other
miscellaneous amounts earned. Other revenues decreased 66% to $300,858 in 2003,
from $878,193 in 2002. The revenue in 2002 was in large part due to receipt of a
legal settlement and a World Trade Center Recovery Grant. Management anticipates
that other revenues will continue to account for a negligible percentage of
total revenues in the future.
21
Expenses
Operating expenses decreased 27% to $24,806,742 in 2003 from $33,762,037 in
2002. The decrease was primarily attributable to a decrease of $2.1 million in
employee compensation, $1.4 million in occupancy and equipment, $1.2 million in
professional services and $1.1 million in promotional expenses, offset by an
increase of $0.5 million in other expense. Management continues to look at ways
to contain costs and improve operating efficiencies through technology, as well
as provide for ways in which we may grow total revenues.
Employee and Broker Compensation. Compensation expense is salary and benefits
paid to and on behalf of employees of the Company. All brokers and traders
employed by the company are considered employees. Expenses for employee salaries
and broker compensation decreased 25% in 2003 to $6,408,314 from $8,547,186 in
2002. The decrease was primarily attributable to the decrease in the number of
employees of 21% to 91 in 2003 from 115 in 2002, partially offset by annual
salary increases. We continue to monitor our work force and make reductions when
necessary.
Clearing and Floor Brokerage. Clearance and Floor brokerage expense consists of
costs incidental to the comparison, receipt, settlement, custody and delivery
functions involved in securities transactions. Clearing and floor brokerage
expense decreased 5% in 2003 to $996,809 from $1,045,760 in 2002. The decrease
was attributable to lower trading volumes.
Communications. Communications expense consist of the preparation and delivery
of confirmations and statements to retail customers as well as market data and
communication costs for our website operation and telephones. Communications
expense decreased 23% in 2003 to $2,113,303 from $2,743,150. The decrease was
attributable to reduced costs for statements and confirmations production and
reduction in telephone and data communications costs.
Occupancy and Equipment. Occupancy and equipment costs consist of office and
equipment rental along with related maintenance and deprecation expense.
Occupancy and equipment costs decreased 25% to $4,122,942 in 2003, from
$5,493,046 in 2002. The decrease was attributable to the sublet of unused office
space, and expiration of lease commitments for equipment partially offset by the
establishment of offices in Minneapolis, Minnesota and Oakland, California, and
higher costs for utilities. Additionally, lease commitments for office space in
Beverly Hills will expire on June 30, 2004. The Company has no intention of
renewing this lease. This represents a lease commitment of in excess of $25,000
a month or $300,000 a year.
Interest. Interest cost consists principally of monies paid on retail customer
credit balances. Interest expense decreased 41% to $1,218,536 in 2003, from
$2,053,339 in 2002. The decrease was attributable to a substantial decrease in
the rate paid on customer free credit balances.
Data Processing. Data processing costs are computer service bureau expenses to
operate our back office accounting and securities system, as well as third party
data processing for our website. Data processing expense decreased 4% to
$2,287,153 in 2003, from $2,379,306 in 2002. The decrease in data processing
expense for 2003 was the result of re-negotiated contract pricing with our back
office service provider with more favorable terms in 2003 and a reduction in
total trade volume. To reduce data processing costs the Company is charged for,
the
22
Company "bunches" or groups certain trades prior to uploading them to the
service bureau. This bunching occurs on trades for which multiple executions are
provided for the same order. Trades are bunched for transactions in the same
security, same side (buy or sell) and have the same price.
Professional Services. Professional services are expenses incurred for outside
legal counsel and independent public accountants, as well as consulting fees
paid to Third Capital. Professional services expense decreased 33% to $2,485,631
in 2003 from $3,714,979 in 2002. The decrease was primarily due to a 54%
decrease in legal expense. We are reducing our reliance on outside counsel for
arbitration matters that may arise and we expect that this will reduce the
professional fees paid in 2004.
Promotional. Promotional expense consists of advertising and name branding of
the Company and its subsidiaries. Promotional expense decreased 82% in 2003 to
$251,031 from $1,361,100 in 2002. The decrease was primarily due to the
termination of advertising utilizing print media and an increased use of
Internet based advertising services.
Bad Debt Expense. Bad debt expense is a function of the commission revenue and
specific write-offs that may occur based on the collateral in customer margin
accounts. Bad debt expense decreased 42% to $80,122 in 2003 from $138,512 in
2002.
Settlement Expense. Settlement expense consists of the amounts paid or accrued
in the settlement of arbitrations and other legal matters. Settlement expense
decreased 78% to $464,500 in 2003 from $2,111,249 in 2002. The expense recorded
in 2002 was in large part the result of an arbitration award to Secured Equity
Title and Appraisal Company for $3,000,000. This was partially offset by the
reversal of $960,000 accrued for an anticipated payment to the Securities and
Exchange Commission.
Amortization of Intangible Assets. Amortization expense consists of charging to
expense the cost of intangible assets acquired including any impairment of
value. Amortization expense of intangible assets decreased 20% to $1,442,908 in
2003 from $1,802,021 in 2002. This expense relates to the amortization of the
cost of customer accounts acquired from other broker dealers. The decrease was
attributable to the decline in impairment expense of $0 compared to an
impairment expense of $563,726 in 2002, partially offset by a higher
amortization rate. We will continue to monitor the carrying value of these
intangible assets.
Other Operating Expenses. Other operating expenses consist of insurance,
registration, travel, supplies and other costs incidental to the operations of
the business. Included in this category for 2003 was the $1,500,000 charge for
the abandonment of the lease in Oakland, California. Other operating expenses
increased 24% to $2,935,493 in 2003 from $2,372,390 in 2002. The increase was
primarily attributable to the abandonment of the Oakland lease, partially offset
by reduced travel and entertainment expense.
Effective Tax Rate. Our effective tax rate varied from our statutory federal
rate due to changes in state taxes net of federal benefit and other temporary or
permanent differences. (See Note 12. "Income Taxes" of the Notes to Consolidated
Financial Statements, below.)
23
Year Ended December 31, 2002 Compared to Year Ended 2001
Revenues
Our total revenues were $22,387,879 in 2002, a decrease of 37% from $35,347,821
in 2001. This decrease of $13.0 million is primarily attributable to decreases
of $7.0 million in interest revenue, $4.3 million in commissions, $1.6 million
in trading profits and $0.1 million in clearing and execution, partially offset
by an increase of $0.1 million in other revenue.
Clearing and execution. Clearing and execution revenues decreased 2% to
$3,887,612 in 2002, from $3,985,922 in 2001. The decrease in 2002 is partially
attributable to a decline in correspondent trade volumes partially offset by a
higher pricing mix.
Trading profits. Trading profits decreased 52% to $1,471,277 in 2002, from
$3,095,203 in 2001. The decrease in 2002 is attributable to a 46% decline in
trade volumes, which is related to the decline in trades from both retail
customers and correspondents.
Commissions. Commission revenues decreased 35% to $8,171,012 in 2002, from
$12,498,400 in 2001. Commission revenue is attributable to the 32% decline in
retail trade volume generated by our customers.
Interest. Interest revenues decreased 47% to $7,979,705 in 2002, from
$14,968,622 in 2001. The decrease in 2002 is partially attributable to the
decline in customer margin balances and partially offset by increased earnings
on cash and customer segregated cash balances.
Other. Other revenues increased 10% to $878,193 in 2002, from $799,674 in 2001.
The increase in 2002 was not attributable to any significant or single factor.
Expenses
Operating expenses totaled $33,762,037 in 2002, a decrease of 24% from
$44,401,627 in 2001. This decrease of $10.6 million was primarily attributable
decreases of $5.5 million in interest expense, $3.2 million in employee and
broker compensation, $1.8 million in communications expense, $1.1 million in
data processing charges, and $1.0 million in professional services, partially
offset by an increase of $0.5 million in promotional expenses. As a percentage
of total revenues, total operating expenses accounted for 151% and 126% in 2002
and 2001, respectively.
Salaries and broker compensation. Salaries and broker compensation decreased 25%
in 2002 to $8,547,186 from $11,451,551 in 2001. We continue to monitor our work
force and make reductions when necessary. The decrease in 2002 was primarily
attributable to a reduction in our workforce and the change in broker
compensation to a salary based sales force from commission-based compensation,
partially offset by annual salary and benefits costs increases.
Clearing and floor brokerage. Clearing and floor brokerage expense decreased 41%
to $1,045,760 in 2002 from $1,773,473 in 2001. The decrease in 2002 was
primarily attributable to lower trading volumes in our retail and correspondent
businesses.
24
Communications. Communications expense decreased 40% to $2,743,150 in 2002 from
$4,588,327 in 2001. The decrease in 2002 was primarily attributable to decreases
in market data services, telephone and data communications, postage, printing
and confirmation services, partially offset by an increase in statements
services.
Occupancy and equipment. Occupancy and equipment expense decreased 6% to
$5,493,046, from $5,838,467 in 2001. These costs have remained fairly static
during the three years ended 2002, however management believes these costs will
decline in 2003 as lease commitments expire. We vacated our Miami office in late
2002 and took a charge for rent expense of approximately $203,123 in the fourth
quarter of 2002 for the remaining lease commitment, which expired in June 2003.
Interest expense. Interest expense decreased 73% to $2,053,339 in 2002 from
$$7,534,686 in 2001. The decrease in 2002 was primarily attributable to a
decrease in stock loan activity and lower free credit balances.
Data processing charge. Data processing expense decreased 32% to $2,379,306 in
2002, from $3,484,346 in 2001. The decrease in 2002 was attributable to the
overall decline in back office service provider costs due to decline in trade
volume for all of our activities, in addition to a new contract negotiated with
our back office service provider with more favorable terms in 2001.
Professional services. Professional services expense decreased 21% to $3,714,979
in 2002 from $4,725,033 in 2001. The decrease in 2002 was attributable to a
decrease in legal fees and outside consultant fees. We are reducing our reliance
on outside counsel for arbitration matters that may arise and we expect that
this will reduce the professional fees paid in 2003.
Promotional. Promotional expense increased 52% in 2002 to $1,361,100 from
$895,536 in 2001. The increase in 2002 was primarily attributable to increased
print media advertising spending. In 2001, we discontinued the use of television
ads and began to use the print media as our main source of name branding.
Bad debt expense. Bad debt expense decreased 88% to $138,512 in 2002 from
$1,146,244 in 2001. The decrease in 2002 was primarily attributable to lower
customer margin balances.
Settlement expense. Settlement expense increased 773% to $2,111,249 in 2002,
from $241,792 in 2001. The increase in 2002 was primarily attributable to the
settlement after an arbitration award to Secured Equity Title and Appraisal
Company, partially offset in part by the reversal of $960,000 that had been
accrued for an anticipated settlement with the SEC, which action was terminated
by the SEC in early 2002 (See Note 16. "Commitments and Contingencies" of the
Notes to Consolidated Financial Statements, below). In 2000 we accrued an
additional $500,000 for the anticipated settlement with the SEC.
Amortization of intangible assets. Amortization expense of intangible assets
increased 474% to $1,802,021 in 2002 from $313,750 in 2001. The increase in 2002
is primarily attributable to the amortization of the cost of customer accounts
acquired from other broker dealers during late 2001 and 2002. Included in the
amortization for 2002 is an impairment of expense of $563,726. The impairment
25
charge is related to the intangible assets recorded for the acquisition of
customer accounts for two acquisitions. Fair value was determined by calculating
the discounted cash flows on the underlying customer accounts over the estimated
useful life of the intangibles.
Our effective tax rate varied from our statutory federal rate due to changes in
state taxes net of federal benefit and other temporary or permanent differences.
(See Note 12. "Income Taxes" of the Notes to Consolidated Financial Statements,
below.)
Non-recurring Charges
In the fourth quarter of 2000, we recorded an additional $500,000 for the
anticipated settlement with the SEC. The accrual for the anticipated settlement
with the SEC was reversed in the amount of $1,000,000 in early 2002 when we were
notified that the SEC was discontinuing its investigation. Additionally, in 2002
we accrued a settlement expense of $3,000,000 as the result of an arbitration
award to Secured Equity Title and Appraisal Company. (See Note 16. "Commitments
and Contingencies" of the Notes to Consolidated Financial Statements, below.)
Liquidity and Capital Resources
Going Concern
As shown in the accompanying consolidated financial statements, the Company
incurred losses of $5,948,964, $7,474,158 and $6,941,756 during the years ended
December 31, 2003, 2002, and 2001 respectively. Additionally, the Company has
legal proceedings related to the ongoing mutual fund investigations (as
disclosed in Footnote 16, Commitments and Contingencies). These deteriorating
financial results of the Company and the uncertainty of legal proceedings
against it may cause substantial doubt regarding the Company's ability to meet
its obligations as they become due in the normal course of business. Please see
Note 3 to the financial statements: Going Concern.
We finance our business through the use of funds generated from the business
operations of our subsidiaries, mainly NCC. Additionally, NCC has established
uncommitted lines of revolving credit with banking institutions with an
aggregate borrowing limit of approximately $25,000,000 at December 31, 2003.
Further, we have available stock loan financing when necessary. Amounts borrowed
bear interest at a fluctuating rate based on the broker call and prime rates.
Both bank loans and stock loans are collateralized by customer margin
securities. As such, they are subject to the sufficiency of such collateral for
advances. The Company has no other sources of debt financing currently
available.
The majority of our corporate assets at December 31, 2003, 2002 and 2001 were
held by our subsidiary, NCC, and consisted of cash or assets readily convertible
to cash, or receivables secured by marketable securities. Our statement of
financial condition reflects this largely liquid financial position. Receivables
with other brokers and dealers primarily represent current open transactions
that typically settle within a few days, or stock borrow and loan transactions
where the contracts are adjusted to market values daily. Additionally, NCC is
subject to the requirements of the NASD and the SEC relating to liquidity, net
capital, and the use of customer cash and securities. (See Item 1. "Business
26
Overview - Net Capital Requirements" above.) At December 31, 2003, NCC had
regulatory net capital of $9,554,544, which exceeded the minimum requirement by
$7,873,465. Our net capital has declined from $9,452,719 and $18,975,361 at
December 31, 2002 and 2001. If this trend continues the Company will be forced
to limit its brokerage activity. Because our subsidiary companies are subject to
the Net Capital Rule, there are restrictions on advances to affiliates,
repayment of subordinated liabilities, dividend payments and other equity
withdrawals that are subject to regulatory notification.
We are uncertain that our current cash resources and available credit facilities
, will be sufficient to fund our expected working capital and capital
expenditure requirements for the current calendar year. In the event our working
capital is not sufficient, in order to expand our business, respond to
competitive pressures, develop additional products and services or take
advantage of strategic opportunities, we may need to raise additional funds
through debt or equity offerings. If funds are raised through the issuance of
equity securities, or securities which are convertible into equity securities,
our existing shareholders may experience additional dilution in ownership
percentages or book value. Additionally, such securities may have rights,
preferences and privileges senior to those of the holders of our common stock.
We cannot give any assurance that additional funds will not be needed. If
additional funds are needed, there can be no assurance that additional financing
will be available or whether it will be available on terms satisfactory to us.
On December 31 2002, Third Capital Partners, LLC, the beneficial owner of our
secured convertible notes in the aggregate principal amount of $5,418,696,
maturing December 31, 2002, agreed to again extend the repayment of both notes
for a period of 12 additional months, to December 31, 2003. As consideration for
the extension, and to reflect the effect of the reverse split which occurred in
October 2002, the conversion rate on the Notes was adjusted to $2.67 per share,
which was the closing price of the Company's common stock on the Nasdaq SmallCap
Market on December 31, 2002. These notes were again extended on December 31,
2003, for an additional year, until December 31, 2004. No further change was
made at that time to the conversation rate. We will continue to make interest
payments only on each note, and no other terms of the notes were affected by the
extension agreements.
Liquidity at December 31, 2003, 2002 and 2001
Our cash and cash equivalents increased by $1,318,215 to $6,897,970 in 2003.
This compares with a net decrease in cash and cash equivalents of $1,114,577 in
2002 and an decrease of $1,309,668 in 2001. The fluctuation in our cash position
can be impacted by the settlement cycles of the business which relate directly
to the cash provided from, or used in, operations.
Cash Flows From Operating Activities
Net cash provided by operating activities was $2,844,559, $3,099,728 and
$4,700,100 for 2003, 2002 and 2001, respectively. Our net cash provided by
operating activities is impacted by changes in the brokerage-related assets and
liabilities of NCC.
During 2003, the most significant use of cash was a decrease in receivable from
broker-dealers and clearing organizations of $20,988,125 and a decrease in
clearing deposits of $2,035,329. The most significant source of cash in
operations was in cash segregated under federal and other regulations of
$15,426,651 and receivable from customers of $3,966,085.
27
During 2002, the most significant use of cash for operating activities was an
increase in cash segregated under federal and other regulations of $66,775,306
and an increase in payables to broker-dealers and clearing organizations of
$12,521,538. The most significant sources of cash provided by operating
activities were reductions in receivables from broker-dealer and clearing
organizations of $44,019,430, and receivables from customers of $19,084,588.
Additionally, an increase in amounts payable to customers provided cash of
$23,659,104.
During 2001, the most significant use of cash in operations was a decrease in
payables to broker-dealers and clearing organizations of $59,505,496 and
increase in receivable from broker-dealers and clearing organizations of
$45,106,278. These changes relate to a decrease in stock loaned and an increase
in stock borrowed during 2001. An increase in cash segregated under federal and
other regulations and payable to customers used cash of $41,855,227 and
18,125,486, respectively. The most significant source of cash in operations was
a decrease in receivable from customers of $175,723,929.
Cash Flows Used In Investing Activities
The net cash used in investing activities during 2003, 2002 and 2001 was
$835,175, $2,123,807 and $3,834,688, respectively. Funds used in 2002 and 2001
include $1,753,707 and $2,510,000, respectively, used to acquire the right to
service certain customer accounts. The Company issued common stock in the amount
of $155,556 and $913,982 during 2003 and 2002 as consideration to acquire rights
to service these accounts. The value of the stock was determined based upon the
market value at the time of issuance or immediately preceding issuance. The
remaining cash uses were a direct result of our capital expenditures during
these periods. Our requirement for capital resources is not material to the
business as a whole. Although we continually upgrade our information and
communication systems, future expenditures for upgrading our various information
and communication systems are not estimated to be material to our operations. As
technology advances, however, management intends to remain competitive and may
incur costs accordingly. We have no plans to open additional offices in 2004 and
have no significant commitments for capital expenditures.
Cash Flows From Financing Activities
Financing activities provided (used) cash of $(41,667), $(2,740,000), and
$(2,175,080) in 2003, 2002 and 2001, respectively. In 2003, 2002 and 2001,
repayments of notes payable of $41,667, $2,740,000 and $2,008,000, respectively,
was the most significant use of cash for financing activities.
28
JB OXFORD & COMPANY
SHORT TERM BORROWING
(Amounts in thousands)
Category of aggregate short-term
borrowings a b c d e
------------------------------------------------
Year Ended December 31, 2003 collateralized by:
Customer securities $ -- $ -- $ -- $ -- n/a
Year Ended December 31, 2002
collateralized by:
Customer securities $ -- $ -- $ 1,000 $ 3 4.0%
Year Ended December 31, 2001
collateralized by:
Customer securities $ -- $ -- $ 21,000 $ 700 5.8%
a) Balance at end of period
b) Weighted average interest rate at end of the period c) Maximum amount
outstanding during the period d) Average amount outstanding during the period e)
Weighted average interest rate during the period
The weighted average interest rate during the period was calculated by factoring
the balances at the end of each month at the various rates, and computing a
weighted average on the results.
To assure stability, management continually explores additional sources of
capital to increase our liquidity and capital base. The following table of our
material contractual obligations as of December 31, 2003, summarizes the
aggregate effect that these obligations are expected to have on our cash flows
in the periods indicated (in thousands):
Contractual obligations: Less Than 1 More Than 5
------------------------ ------------ -----------
Total Year 1-3 Years 3-5 Years Years
----- ---- --------- --------- -----
Note payable (1) $ 569 $ -- $ -- $ 569 $ --
Convertible debt (including interest)(2) 488 -- 488 -- --
Operating lease obligations 9,822 396 1,296 5,740 2,390
Purchase obligations (3) 1,766 83 1,766 -- --
Total contractual obligations $12,645 $479 $3,550 $6,309 $2,390
(1) Does not include any payments on notes payable in the principal amount of
$2,889,375. See Note 16 Commitments and Contingencies regarding litigation
with EBC Trust
(2) Does not include any principal payments on convertible debentures due
December 31, 2004 in the amount of $5,418,696. These notes have
historically been extended each year.
29
(3) Represents cost of contractually guaranteed minimum processing
volumes with certain of our third party vendors.
Impact of Inflation
Inflation has had a minimal impact on our operations and financial condition in
recent years. We will continually monitor costs and productivity and will adjust
prices and operations as necessary to meet inflationary impacts or market
changes.
Off-Balance Sheet Financial Arrangements
In the normal course of business, our customer and correspondent clearing
activities involve the execution, settlement and financing of various customer
securities transactions. These activities may expose us to off-balance-sheet
credit risk in the event that the customer is unable to fulfill their contracted
obligations. Our customer securities activities are transacted on either a cash
or margin basis. In margin transactions, we extend credit to the customer,
subject to various regulatory and internal margin requirements, collateralized
by cash and securities in the customer's account. We monitor collateral and
required margin levels daily and, pursuant to such guidelines, request customers
to deposit additional collateral or reduce securities positions when necessary.
We are also exposed to credit risk when our margin accounts or a customer margin
account is collateralized by a concentration of a particular security and when
that security decreases in value.
In addition, we execute and clear customer short sale transactions. Such
transactions may expose us to off-balance sheet risk in the event that margin
requirements are not sufficient to fully cover losses that customers may incur.
In the event that the customer fails to satisfy their obligations, we may be
required to purchase financial instruments at prevailing market prices in order
to fulfill the customer's obligations.
Securities sold but not yet purchased represent obligations of the Company to
purchase the securities at prevailing market prices. Therefore, the future
satisfaction of such obligations may be for an amount greater or less than the
amount recorded. The ultimate gain or loss is dependent on the price at which
the underlying financial instrument is purchased to settle the Company's
obligation under the sale commitment.
We record customer transactions on a settlement date basis, which is generally
three business days after trade date. We are, therefore, exposed to risk of loss
on these transactions in the event of the customer's or broker's inability to
meet the terms of their contractual obligations, in which case we may have to
purchase or sell financial instruments at prevailing market prices. Settlement
of these transactions is not expected to have a material effect on our statement
of financial condition.
As a securities broker-dealer, we provide services to both individual investors
and correspondents. Our exposure to credit risk associated with the
nonperformance of these customers in fulfilling their contractual obligations
pursuant to securities transactions can be directly impacted by volatile trading
markets.
We are a market maker for numerous public corporations whose stocks are traded
on the NASDAQ National Market System, NYSE or other national exchanges. We
30
select companies in which we make a market based on a review of the current
market activity, and also to facilitate trading activity of our own and
correspondent's clients. Market making may result in a concentration of
securities which may expose us to additional off-balance sheet risk.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk Disclosures
The following discussion about our market risk disclosures involves
forward-looking statements. Actual results could differ materially from those
projected in the forward-looking statements. See Item 1. "Business Overview -
Forward-Looking Statements and Risk Factors" above. We are exposed to market
risks related to changes in interest rates and equity security price risk. We do
not have derivative financial instruments for speculative or trading purposes.
Retail broker-dealers with clearing operations such as us are exposed to risks
that exceed the simple risk of loss of business due to the loss of retail
customers and/or correspondents. Broker-dealers engaged in clearing operations
for other correspondent broker-dealers are exposed to losses beyond the loss of
business in the event that the correspondent fails. These risks result where the
total assets, securities held in inventory, and cash of the failed correspondent
are insufficient to cover both the unpaid customer debits and any, together with
losses that may have been generated in the correspondent's trading account. We
have established procedures to review a correspondent's inventory and activities
in an effort to prevent such losses in the event of a correspondent's failure.
However, there can be no assurance that our procedures will be effective in
avoiding losses.
Areas outside our control that affect the securities market, such as severe
downturns or declines in market activity, may cause substantial financial
exposure. This is particularly true with regard to the receivables that are
carried in customers' margin accounts. A significant decline in market value may
decrease the value of securities pledged in the margin accounts to a point that
the margin loans would exceed such value. While we are authorized to liquidate
the securities and to utilize the correspondent's account balances to cover any
shortfall, in a worst case scenario, such collateral may not be sufficient to
cover all losses.
Interest Rate Sensitivity and Financial Instruments
For our working capital and reserves that are required to be segregated under
federal or other regulations, we invest primarily in U.S. bank certificates of
deposit and savings accounts. The certificates of deposit have maturity dates
ranging from three to six months, and do not present a material interest rate
risk.
Equity Price Risk
JBOC acts as a market maker for approximately 300 public corporations whose
stocks are traded on the NASDAQ National Market System, NYSE or other national
exchanges. We select companies in which we make a market based on a review of
the current market activity, and also to facilitate trading activity of its own
and correspondent's clients. Market making may result in a concentration of
securities that may expose us to additional risk; however, we do not maintain a
significant inventory of equity securities.
31
RISK FACTORS
You should carefully consider the risks described below before making
an investment decision in our securities. The risks and uncertainties described
below are not the only ones we face and there may be additional risks that we do
not presently know of or that we currently deem immaterial. All of these risks
may impair our business operations. The forward-looking statements in this
report involve risks and uncertainties and actual results may differ materially
from the results we discuss in the forward-looking statements. If any of the
following risks actually occur, our business, financial condition or results of
operations could be materially adversely affected. In that case, the trading
price of our stock could decline, and you may lose all or part of your
investment.
WE COULD BE HARMED BY A CURRENT SEC, NYAG AND USAO MUTUAL FUND INVESTIGATION.
We are currently under investigation by the SEC, the New York State
Attorney General ("NYAG") and the US Attorney's Office for the Central Authority
of California ("USAO") related to allegations that we improperly processed
mutual fund trade orders which, among other allegations, enabled certain hedge
fund and mutual fund customers to engage in "late trading." The alleged
transactions took place between May 2002 and September 2003 and we have
terminated our arrangements with the subject customers. Since August 2003 we
have been providing the SEC and the NYAG with documents and testimony in
response to subpoenas and we believe that we have been cooperating fully in
these investigations.
On November 6, 2003, we received a "Wells Notice" as part of the SEC's
investigation informing us that the staff of the SEC's Pacific Regional Office
intended to recommend that the SEC bring civil and administrative enforcement
actions against us based on alleged violations of federal securities laws
related to the alleged late trading transactions. We have responded to the Wells
Notice and believe we are cooperating in connection with the notice. To that
end, we have had several meetings with the SEC with the goal of settling this
matter.
In the event charges are filed against us related to the SEC, NYAG
and/or USAO investigations, we could be subject to significant sanctions and
penalties, including but not limited to suspension or revocation of our
licensing and registration as a broker-dealer, and substantial monetary fines
which could have a material adverse effect on our business and financial
condition. Furthermore, our reputation could suffer and any damage to our
reputation could cause us to lose existing customers and fail to attract new
customers which would have a material adverse effect on our business and
financial condition. While NCC admits no wrongdoing and intends to vigorously
defend itself, no assurance can be given as to the outcome of this matter.
Although the likelihood of loss is probable, the Company has not accrued any
amounts related to this matter, as the amount of loss is not estimable at this
time. However, substantial penalties from fines or settlements resulting from an
adverse outcome or judgment in this matter could have a material adverse effect
on the financial position and results of operations of the Company.
OUR CURRENT SHAREHOLDERS WILL BE SIGNIFICANTLY DILUTED IF THIRD CAPITAL CONVERTS
THE NOTES INTO SHARES OF COMMON STOCK AND OUR STOCK PRICE COULD MATERIALLY
DECLINE IF THIRD CAPITAL SELLS ITS SHARES.
As of March 4, 2004, we had approximately 1.8 million shares of common
stock outstanding. The convertible notes currently held by Third Capital
32
Partners are convertible into approximately 2 million shares of common stock. If
Third Capital Partners elects to convert the convertible notes in full the
ownership percentage of our current shareholders will be significantly diluted
and Third Capital Partners will own approximately 53% of our common stock.
If Third Capital Partners sells substantial amounts of our common stock
into the public market, it could cause a significant decrease in our stock
price. Furthermore, the awareness that a large number of shares is available for
sale under this registration statement could cause the price of our stock to
fall or could prevent the price from rising.
In addition to the adverse effect a price decline would have on our
shareholders, it could impede our ability to raise capital through the issuance
of securities or utilize our common stock for acquisitions. Furthermore, if the
price decline is significant enough, it could result in our common stock being
delisted from the NASDAQ SmallCap Market. A delisting of our shares could
further harm our stock price and make it more difficult for our shareholders to
sell their shares.
OUR FAILURE TO MAINTAIN THE NET CAPITAL LEVELS REQUIRED BY VARIOUS REGULATORS
COULD ADVERSELY AFFECT OUR BUSINESS.
The SEC, the NASD and various other regulatory agencies have stringent
rules with respect to the maintenance of specific levels of net capital by
securities broker-dealers. Net capital is the net worth of a broker or dealer
(assets minus liabilities), less deductions for certain types of assets. If a
firm fails to maintain the required net capital it may be subject to suspension
or revocation of registration by the SEC and suspension or expulsion by the
NASD, and could ultimately lead to the firm's liquidation. If such net capital
rules are changed or expanded, or if there is an unusually large charge against
net capital, operations that require the intensive use of capital would be
limited. Such operations may include trading activities and the financing of
customer account balances. A large operating loss or charge against net capital
could adversely affect our ability to expand or even maintain our present levels
of business, which could have a material adverse effect on our business,
financial condition and operating results. Also, our ability to withdraw capital
from brokerage subsidiaries could be restricted, which in turn could limit our
ability to pay dividends, repay debt and redeem or purchase shares of our
outstanding stock. Our net capital has declined over the past three years. At
December 31, 2003 we had net capital of $9,554,544, as compared to $9,452,719
and $18,975,361 at December 31, 2002 and 2001, respectively.
WE HAVE INCURRED OPERATING LOSSES IN THE PAST AND MAY INCUR FUTURE OPERATING
LOSSES.
We incurred net operating losses of approximately $5 million for the year
ended December 31, 2003, approximately $11 million for the year ended December
31, 2002, and approximately $9 million in 2001. As direct result of the downturn
in the U.S. securities markets that began in early 2000, and continued through
the first six months of 2003, we have suffered a significant reduction in
transaction volume, and consequently revenues. While volumes have stabilized in
the last 6 months of 2003, and we continue to implement cost containment
measures that have reduced our expenses, we cannot assure you that our negative
cash flow and net losses from operations will not continue or increase for the
foreseeable future. If we continue to incur losses and negative cash flow, we
may need additional capital to fund working capital and cash flow deficits.
There can be no assurance that such capital will be available to us, or if
available, on terms that are not substantially dilutive to existing
33
shareholders. Additionally, we could lose our uncommitted lines of credit, which
would greatly restrict our ability to finance our operations. Although we were
profitable in 2000, we may never generate sufficient revenues to achieve or
sustain profitability or generate positive cash flow.
OUR BUSINESS IS ADVERSELY AFFECTED BY DOWNTURNS IN THE U.S. SECURITIES MARKETS.
We, like other securities firms, are directly affected by economic and
political conditions, broad trends in business and finance and changes in volume
and price levels of securities transactions. In recent years, the U.S.
securities markets have fluctuated considerably and a downturn in these markets
has adversely affected our operating results. In March 2000, the stock market
entered into a protracted down-trend, resulting in reduced transaction volume,
and consequently, revenues. In 2001, the stock markets were closed for four days
as a result of the events of September 11, which had a negative impact on our
revenues. In 2002, low trading volume and financial losses continued. The
invasion of Iraq in 2003 resulted in further reduced trading volumes which
contributed to our operating losses in 2003. When trading volume is low, our
profitability is likely to be adversely affected because our overhead remains
relatively fixed. Severe market fluctuations in the future could have a material
adverse effect on our business, financial condition and operating results. Some
of our competitors with more diverse product and service offerings might
withstand such a downturn in the securities industry better than we would.
DEMAND AND MARKET ACCEPTANCE FOR OUR SERVICES ARE SUBJECT TO A HIGH LEVEL OF
UNCERTAINTY.
The market for discount and electronic brokerage services, particularly
over the Internet, is rapidly evolving. Consequently, demand and market
acceptance for recently introduced services and products are subject to a high
level of uncertainty. Much of our growth will depend on consumers adopting the
Internet as a method of doing business. The Internet could lose its viability
due to slow development or adoption of standards and protocols to handle
increased activity, or due to increased governmental regulation. Moreover,
several key issues including security, reliability, cost, ease of use,
accessibility and quality of service continue to be concerns and may negatively
affect the growth of Internet use or commerce on the Internet.
WE ARE EXPOSED TO CERTAIN CREDIT RISKS WITH OUR CUSTOMERS.
We allow customers to purchase securities on margin. Therefore, we are
subject to risks inherent in extending credit. All borrowing by customers is
secured by security positions in their accounts. Furthermore, the amounts
customers can borrow is limited by regulatory agencies such as the Federal
Reserve Bank and the NASD. When the market is rapidly declining, the value of
the collateral we hold can fall below the amount of a customer's indebtedness
which increases the risk that the customer will not be able to repay us. Under
specific regulatory guidelines, any time we borrow or lend securities, we must
correspondingly disburse or receive cash deposits. If we fail to maintain
adequate cash deposit levels at all times, we run the risk of loss if there are
sharp changes in market values of many securities and parties to the borrowing
and lending transactions fail to honor their commitments. If such losses are
significant, it could have a material adverse effect on our business, financial
condition and operating results.
34
OUR CLEARING OPERATIONS EXPOSE US TO LOSSES BEYOND THE LOSS OF BUSINESS.
Our clearing operations expose us to risks that exceed the simple risk of
loss of business due to loss of retail customers or correspondents. If the
correspondent fails, possible losses include its obligations to customers and
other third parties, and any losses in the correspondent's own trading accounts.
We have established procedures to review a correspondent's own customer and firm
accounts and activities in an effort to prevent such losses if a correspondent
fails but there can be no assurance that such procedures will be effective in
every case. Any such losses could have a material adverse effect on our
business, financial condition and operating results.
OUR SUCCESS IS DEPENDENT UPON THE DEVELOPMENT AND ENHANCEMENT OF OUR SERVICES
AND PRODUCTS.
Our future success depends in part on our ability to develop and enhance
our services and products. We recently introduced online bond trading and
expanded our market maker and money management services. There can be no
assurance that this change in our business mix will increase our revenues or
otherwise be successful. There are significant risks in the development of new
services and products or enhanced versions of existing services and products,
particularly in our electronic brokerage business. We may also experience
difficulties that could delay or prevent the development, introduction or
marketing of these services and products. Additionally, these new services and
products may not adequately meet the requirements of the marketplace or achieve
market acceptance. If we are unable to develop and introduce enhanced or new
services and products quickly enough to respond to market or customer
requirements, or if they do not achieve market acceptance, our business,
financial condition and operating results will be materially adversely affected.
THE DISCOUNT AND ELECTRONIC BROKERAGE SERVICES MARKET IS HIGHLY COMPETITIVE.
The market for discount and electronic brokerage services is rapidly
evolving and intensely competitive. We face direct competition from firms
offering discount and electronic brokerage services such as Charles Schwab &
Co., Inc., Fidelity Brokerage Services, Inc., TD Waterhouse Investment Services,
Inc. (a subsidiary of the Toronto-Dominion Bank), Ameritrade, Inc. (a subsidiary
of Ameritrade Holding Corporation), and E*TRADE Group, Inc. We also encounter
competition from established full commission brokerage firms such as UBS
Financial Services, Inc. (a subsidiary of UBS AG), Merrill Lynch, Pierce, Fenner
& Smith Incorporated and Smith Barney, Inc. (a subsidiary of Citigroup, Inc.),
among other traditional firms which typically also offer their customers on-line
services. In addition, we compete with financial institutions, mutual fund
sponsors and other organizations. Further, the industry is currently undergoing
consolidation, which may strengthen our competitors, and this trend is expected
to continue. Many of our competitors have longer operating histories and
significantly greater financial, technical, marketing and other resources than
we do. In addition, many of our competitors have greater name recognition and
larger customer bases that could be leveraged, thereby gaining market share from
us. Our competitors may conduct more extensive promotional activities and offer
better terms and lower prices to customers than we do. There can be no assurance
that we will be able to compete effectively with current or future competitors
or that such competition will not have a material adverse effect on our
business, financial condition and operating results.
35
THE LOSS OF SIGNIFICANT CUSTOMERS COULD ADVERSELY AFFECT OUR BUSINESS.
While no single correspondent broker-dealer or customer represents more
than 10% of our revenues, we have several significant customers whose loss, in
the aggregate, could have a material adverse effect on our financial condition
and operating results. While we believe that the likelihood of losing a
substantial number of such customers is remote, there can be no assurance that
such event will not occur.
OUR PLANS TO EXPAND THROUGH ACQUISITIONS OF OTHER COMPANIES MAY HAVE A MATERIAL
ADVERSE EFFECT ON OUR BUSINESS.
During 2001 and 2002, we acquired approximately 35,800 customer accounts
from six other broker-dealers at a total cost of $6,872,689 and we plan to
continue to expand our business through strategic acquisitions. Our industry is
currently undergoing consolidation and there is intensive competition for
acquisitions, which may make acquisitions increasingly expensive. Any lack of
capital for additional acquisitions may limit our ability to grow. We will be
competing for acquisition opportunities with entities that have greater
resources than we do and we plan on using our previously authorized, unissued
common stock as consideration, which may limit our opportunities. Any issuance
of our equity securities in acquisitions will have a dilutive effect on our
current shareholders. We cannot assure you that we will be able to successfully
identify, negotiate and consummate suitable acquisitions. In addition, there can
be no assurance that any such acquisitions will generate profits. Furthermore,
completed acquisitions entail numerous risks, including difficulties in the
assimilation of acquired operations and products, diversion of management's
attention from other business concerns, assumption of unknown material
liabilities, amortization of acquired intangible assets and potential loss of
key employees and customers of acquired companies. We have limited experience in
assimilating acquired organizations into our operations. We cannot assure you
that we will be able to integrate successfully any operations, personnel,
services or products that might be acquired in the future. Our failure to
successfully complete and assimilate acquisitions could have a material adverse
effect on our business, financial condition and operating results.
OUR BUSINESS IS DEPENDENT ON RELATIONSHIPS WITH ONLINE AND INTERNET SERVICE
PROVIDERS AND SOFTWARE AND INFORMATION SERVICES PROVIDERS.
We have established a number of relationships with online and Internet
service providers and software and information service providers. These
relationships allow us to provide:
o Financial information to our customers, including quote, chart and
records services;
o Access to our website for trading;
o Routing of orders for execution; and
o Clearance of trades with contra-parties.
36
These services are typically offered by a variety of competing vendors. We
attempt to enter into relationships with the vendors that we believe will
provide our customers with quality services, comparable or superior to those of
our competitors and at costs acceptable to us. These relationships are generally
subject to long-term agreements. There can be no assurance that any such
relationships will be maintained, or that if they are maintained, they will be
successful or profitable. Additionally, we may not develop any new such
relationships in the future.
OUR BUSINESS IS SUBJECT TO EXTENSIVE REGULATION UNDER BOTH FEDERAL AND STATE
LAWS.
The securities industry is subject to extensive regulation and
broker-dealers are subject to regulations covering all aspects of the securities
business. The SEC, NASD, and other self-regulatory organizations and state and
foreign regulators can, among other things, fine, issue cease-and-desist orders
to, suspend or expel a broker-dealer or any of its officers or employees. While
we neither actively solicit new foreign accounts nor have established offices
outside of the United States, our websites are accessible worldwide over the
Internet and we currently have account holders located outside the United
States. These accounts make up less than 5% of our accounts and are spread
across many jurisdictions. Any adverse action by foreign regulators with respect
to regulatory compliance in foreign jurisdictions could adversely effect our
revenues from clients in such country or region.
Our ability to comply with applicable laws and rules is largely dependent
on our internal system to ensure compliance, as well as our ability to attract
and retain qualified compliance personnel. We could be subject to disciplinary
or other actions in the future due to claimed noncompliance, which could have a
material adverse effect on our operations and profitability.
WE COULD SUFFER SUBSTANTIAL LOSSES AND CUSTOMER LITIGATION IF OUR ONLINE TRADING
SYSTEMS FAIL OR OUR TRANSACTIONS PROCESS IS SLOW.
We receive and process trade orders through internal trading software, the
Internet, and touch-tone telephone. Thus, we depend heavily on the integrity of
the electronic systems supporting this type of trading. Heavy stress placed on
our systems during peak trading times or interference from third parties over
the Internet could cause our systems to operate too slowly or to fail. If our
systems or any other systems in the trading process slow down significantly or
fail even for a short time, our customers would suffer delays in trading,
potentially causing substantial losses and possibly subjecting us to claims for
such losses or to litigation claiming fraud or negligence. During a systems
failure, we may be able to take orders by telephone. However, only associates
with securities broker's licenses can accept telephone orders, and an adequate
number of associates may not be available to take customer calls in the event of
a systems failure. In addition, a hardware or software failure, power or
telecommunications interruption, natural disaster or act of terrorism could
cause a systems failure. Any systems failure that interrupts our operations
could have a material adverse effect on our business, financial condition and
operating results.
OUR BUSINESS COULD SUFFER IF WE CANNOT PROTECT THE CONFIDENTIALITY OF CUSTOMER
INFORMATION.
An important element of our operations is the secure transmission of
confidential information over public networks. We rely on encryption and
authentication technology to provide secure transmission of confidential
information. While we have not experienced problems in the past, there can be no
37
assurance that hackers, computer viruses and other problems will not result in a
breach of security. If a compromise of our security were to occur, it could have
a material adverse effect on our business, financial condition and operating
results.
THE TRADING PRICE OF OUR COMMON STOCK HAS BEEN AND MAY CONTINUE TO BE SUBJECT TO
WIDE FLUCTUATIONS.
During the past twelve months, our common stock traded as low as $1.95 and
as high as $6.25 (all prices have been adjusted to reflect the one for ten
reverse stock split which was effective October 15, 2002). Our stock price may
fluctuate in response to a number of events and factors, such as quarterly
variations in operating results, announcements of technological innovations or
new products by our company or our competitors, changes in financial estimates
and recommendations by securities analysts, the operating and stock price
performance of other companies that investors may consider comparable, and news
reports relating to trends in our markets. In addition, the stock market in
general, and the market prices for Internet related companies in particular,
have experienced extreme volatility that has often been unrelated to operating
performance. These broad market and industry fluctuations may adversely affect
the price of our common stock, regardless of our operating performance.
YOUR INTERESTS AS A STOCKHOLDER MAY CONFLICT WITH OUR CONTROLLING SHAREHOLDERS,
OUR CHIEF EXECUTIVE OFFICER AND OUR PRESIDENT.
Our executive officers, directors and principal shareholders beneficially
own approximately 56% of our outstanding common stock, including shares issuable
upon conversion of certain debt. As a result, our controlling shareholders have
the power to control or direct our business affairs including matters requiring
stockholder approval. This concentration of ownership could effectively delay,
defer or prevent a change in control or other significant corporate transactions
that might give you the opportunity to realize a premium over our then
prevailing stock price. In addition, various conflicts of interest may arise in
the future as a result of our relationship with Third Capital Partners, LLC,
("Third Capital Partners"), a company controlled by our Chief Executive Officer
who also serves on our Board of Directors. Serving us as an officer and director
as well as Third Capital Partners could result in our Chief Executive Officer
being placed in a conflict of interest should he have to make decisions which
have materially different implications for us and for Third Capital Partners. An
affiliate of Third Capital Partners receives management fees from us, which
could influence decisions. In addition, Third Capital Partners is the beneficial
owner of the aggregate principal sum of $5,418,696 of our 9% Secured Convertible
Notes (the "Notes"). Third Capital Partners has extended the due date of the
Notes from time to time most recently through December 31, 2004, but there can
be no assurance that they will continue to do so in the future. Our inability to
repay the Notes or otherwise obtain an extension from Third Capital Partners
could have a material adverse effect on our financial condition.
THE LOSS OF CERTAIN KEY EXECUTIVE OFFICERS COULD HARM OUR BUSINESS.
Our success is substantially dependent upon the continuing services of
certain key executive officers, especially our Chief Executive Officer and our
President. We do not have written employment agreements with our key executive
officers and do not maintain "key person" life insurance on any of our executive
officers. There can be no assurance that any of our executive officers will
38
continue to work for us nor can there be any assurance that upon ceasing to work
for us they will not compete against us. The loss of our Chief Executive Officer
or President could have a material adverse effect on our business, financial
condition and results of operations.
OUR SHAREHOLDER RIGHTS PLAN AND THE ABILITY OF OUR BOARD OF DIRECTORS TO ISSUE
PREFERRED STOCK COULD DETER TAKEOVER BIDS EVEN IF THOSE BIDS ARE IN THE
SHAREHOLDERS' BEST INTERESTS.
We adopted a shareholder rights plan designed to encourage parties seeking
to acquire us to negotiate with and seek the approval of our Board of Directors.
In addition, we have 10,000,000 shares of authorized preferred stock, of which
9,800,000 remain available for issuance to third parties selected by management.
Our shareholder rights plan and the ability of our Board of Directors to
establish the terms and provisions of different series of preferred stock could
discourage unsolicited takeover bids from third parties even if those bids are
in the shareholders' best interests.
SECURITIES LITIGATION COULD ADVERSELY AFFECT OUR BUSINESS.
The securities brokerage business involves substantial risks of liability
and corresponding litigation including class action and other suits that
generally seek substantial damages including punitive damages. Like other
securities brokerage firms, from time to time we are named as a defendant in
civil lawsuits and arbitrations. Any significant monetary judgments against us
in the course of litigation could have a material adverse effect on our
business, financial condition and operating results.
WE MAY BE UNABLE TO HIRE AND RETAIN SKILLED PERSONNEL.
The success of our business is dependent upon having adequate levels of
personnel with experience in the computer and brokerage business as well as
persons with the necessary broker-dealer licenses. As a result of the prolonged
market downturn, we have reduced our personnel by approximately 62% since
January 2001 and in the event that there is a significant increase in demand for
our products and services in the future we may not have adequate personnel to
handle the demand which could have a material adverse effect on our business,
financial condition and operating results. Further, there can be no assurance
that we can retain our existing personnel especially those whose stock options
are largely underwater and might have little long-term incentive to stay with
us. We expect competition for qualified personnel to be intense in the event of
a sustained upswing in the stock markets and there can be no assurance that we
will be able to hire or retain skilled or licensed personnel to meet any
increased demand.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Some of the information set forth in this prospectus and in the documents
incorporated herein by reference contain "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995. In addition, we
may make other written and oral communications from time to time that contain
such statements. Forward-looking statements, including statements as to industry
trends, future expectations and other matters that do not relate strictly to
historical facts, are based on certain assumptions by management. These
statements are often identified by the use of words such as "may," "will,"
39
"expect," "believe," "anticipate," "intend," "could," "estimate," or "continue"
and similar expressions or variations, and are based on various beliefs and
assumptions, some of which are beyond our control. Such forward-looking
statements are subject to risks, uncertainties and other factors that could
cause actual results to differ materially from future results expressed or
implied by such forward-looking statements. Important factors that could cause
actual results to differ materially from the forward-looking statements include,
among others, the risks described under "Risk Factors" above. We caution readers
to carefully consider such factors. Further, such forward-looking statements
speak only as of the date on which such statements are made and we undertake no
obligation to update any forward-looking statements to reflect events or
circumstances after the date of such statements.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and schedules required to be filed by Item 8 of this
form are contained herein as follows:
Page
----------
Report of Independent Auditors 41
Report of Independent Public Accountants 42
Consolidated Statements of Financial Condition December 31, 2003, and 2002 43-44
Consolidated Statements of Operations Years Ended December 31, 2003, 2002, and 2001 45-46
Consolidated Statements of Changes in Shareholders' Equity Years Ended December 31, 2003, 2002, and 2001 47
Consolidated Statements of Cash Flows Years Ended December 31, 2003, 2002, and 2001 48
Notes to Consolidated Financial Statements 49-72
Financial Statement Schedule I - Condensed Financial Statements (Parent Company Only) 73-86
Financial Statement Schedule II - Valuation and Qualifying Accounts 87
40
REPORT OF INDEPENDENT AUDITORS
To the Shareholders and Board of Directors of
JB Oxford Holdings, Inc.
We have audited the accompanying consolidated statements of financial condition
of JB Oxford Holdings, Inc. (a Utah corporation) and subsidiaries (the Company)
as of December 31, 2003 and 2002, and the related statements of operations,
changes in shareholders' equity and cash flows for the years then ended. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by the Company's management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of JB Oxford Holdings, Inc. and
subsidiaries at December 31, 2003 and 2002, and the results of their operations
and their cash flows for the years then ended in conformity with accounting
principles generally accepted in the United States.
The accompanying financial statements have been prepared assuming that JB Oxford
Holdings, Inc. will continue as a going concern. As more fully described in Note
3, the Company has incurred recurring operating losses, has limited access to
capital markets and has significant pending litigation. Further, there is a
significant uncertainty with respect to the outcome of the SEC investigation
into the late trading conducted by the Company. These conditions raise
substantial doubt about the Company's ability to continue as a going concern.
Management's plans with respect to these matters are also described in Note 3.
The financial statements do not include any adjustments to reflect the possible
future effects on the recoverability of assets or the amounts of liabilities
that may result from the outcome of this uncertainty.
Our audits were performed for the purpose of forming an opinion on the basic
financial statements taken as a whole. The Financial Statement Schedules I and
II are presented for purposes of additional analysis and are not a required part
of the basic consolidated financial statements. Such information has been
subjected to the auditing procedures applied in our audits of the basic
financial statements and, in our opinion, is fairly stated in all material
respects in relation to the basic financial statements taken as a whole.
ERNST & YOUNG LLP
Los Angeles, California
March 10, 2004
41
We are including in this Annual Report on Form 10-K, pursuant to Rule 2-02(e) of
Regulation S-X, a copy of the prior year's Report of Independent Public Accounts
from the prior independent public accountants, Arthur Andersen LLP ("Andersen").
This report was previously issued by Andersen, for filing with our Annual Report
on Form 10-K for fiscal year 2001, and has not been reissued by Andersen.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders and Board of Directors of JB Oxford Holdings, Inc.:
We have audited the accompanying consolidated statements of financial condition
of JB Oxford Holdings, Inc. (a Utah corporation) and subsidiaries (the
"Company") as of December 31, 2001 and 2000, and the related consolidated
statements of operations, changes in shareholders' equity and cash flows for
each of the three years in the period ended December 31, 2001. These financial
statements, and the schedules referred to below, are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and schedules based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of JB Oxford Holdings, Inc. and
subsidiaries as of December 31, 2001 and 2000, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2001 in conformity with accounting principles generally accepted in
the United States.
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The Financial Statement Schedules I and
II are presented for purposes of additional analysis and are not a required part
of the basic financial statements. Such information has been subjected to the
auditing procedures applied in our audits of the basic financial statements and,
in our opinion, is fairly stated in all material respects in relation to the
basic financial statements taken as a whole.
Arthur Andersen LLP
Los Angeles, California
February 27, 2002
42
JB OXFORD HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
December 31
2003 2002
-------------- -------------
ASSETS:
Cash and cash equivalents $ 6,897,970 $ 4,930,253
Restricted cash COMMENT 76 -- 654,846
Cash segregated under federal and other regulations 130,748,572 146,175,223
Receivable from broker-dealers and clearing organizations 29,337,358 8,349,233
Receivable from customers (net of allowance for doubtful
accounts of $2,781,305 and $2,701,183) 78,372,056 82,418,263
Other receivables 2,139,865 950,278
Securities owned - at market value 432,060 629,083
Note receivable from Shareholder 2,500,000 2,500,000
Furniture, equipment, and leasehold improvements (at cost
- net of accumulated depreciation and amortization of
$6,352,333 and $5,088,794) 2,195,783 2,624,147
Income taxes receivable -- 4,561,915
Deferred income taxes -- 1,042,348
Clearing deposits 6,542,595 4,507,266
Intangible assets (net of accumulated amortization of
$3,558,678 and $2,115,771) 2,957,837 4,756,918
Other assets 780,771 484,872
------------- -------------
TOTAL ASSETS $262,904,867 $264,584,645
============= =============
43
JB OXFORD HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION - CONTINUED
December 31
2003 2002
------------ -------------
LIABILITIES AND SHAREHOLDERS' EQUITY:
LIABILITIES:
Payable to broker-dealers and clearing $40,331,755 $38,813,043
organizations
Payable to customers 195,340,295 193,595,006
Securities sold, not yet purchased - at market 1,957,909 138,484
value
Accounts payable and accrued liabilities 5,436,675 7,507,410
Loans from shareholder 5,418,696 5,418,696
Notes payable 3,458,819 2,889,375
------------- -------------
TOTAL LIABILITIES 251,944,149 248,362,014
------------- -------------
COMMITMENTS AND /CONTINGENCIES (NOTE 16)
SHAREHOLDERS' EQUITY:
Common stock ($0.01 par value, 100,000,000
shares authorized; 1,756,499 and 1,589,939
shares issued) 17,565 15,899
Additional paid-in capital 18,039,086 17,496,396
Retained earnings (deficit) (5,425,090) 1,329,564
Treasury stock, 83,244 and 130,494 shares at cost (1,670,843) (2,619,228)
------------- -------------
TOTAL SHAREHOLDERS' EQUITY 10,960,718 16,222,631
------------- -------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY 262,904,867 $264,584,645
============ =============
See accompanying notes.
44
JB OXFORD HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31
2003 2002 2001
------------- ------------- -------------
REVENUES:
Clearing and execution $2,897,911 $3,887,612 $3,985,922
Trading profits, net 2,187,974 1,471,277 3,095,203
Commissions 8,880,695 8,171,012 12,498,400
Interest 5,632,688 7,979,785 14,968,622
Other 300,858 878,193 799,674
------------- ------------- -------------
Total revenues 19,900,126 22,387,879 35,347,821
------------- ------------- -------------
EXPENSES:
Employee and broker compensation 6,408,314 8,547,185 11,451,551
Clearing and floor brokerage 996,809 1,045,760 1,773,473
Communications 2,113,303 2,743,150 4,588,327
Occupancy and equipment 4,122,942 5,493,046 5,838,467
Interest 1,218,536 2,053,339 7,534,686
Data processing charges 2,287,153 2,379,306 3,484,346
Professional services 2,485,631 3,714,979 4,725,033
Promotional 251,031 1,361,100 895,536
Bad debt expense 80,122 138,512 1,146,244
Settlement expense 464,500 2,111,249 241,792
Amortization of intangible assets 1,442,908 1,802,021 313,750
Other operating expenses 2,935,493 2,372,390 2,408,422
------------- ------------- -------------
Total expenses 24,806,742 33,762,037 44,401,627
------------- ------------- -------------
Loss from operations (4,906,616) 11,374,159) (9,053,806)
Income tax provision (benefit) 1,042,348 (3,900,000) (2,112,050)
------------- ------------- -------------
Net loss $(5,948,964) $(7,474,158) $(6,941,756)
============= ============= =============
See accompanying notes.
45
JB OXFORD HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS - CONTINUED
Year Ended December 31
2003 2002 2001
------------- ------------- -------------
BASIC NET LOSS PER SHARE:
Loss before income taxes and
extraordinary item $(3.83) $(5.21) $(4.95)
------------- ------------- -------------
Basic net loss per share $(3.83) $(5.21) $(4.95)
============= ============= =============
DILUTED LOSS PER SHARE:
Loss before income taxes and
extraordinary item $(3.83) $(5.21) $(4.95)
------------- ------------- -------------
Diluted net loss per share $(3.83) $(5.21) $(4.95)
============= ============= =============
Weighted average number of shares of
common stock and assumed conversions
Basic 1,552,568 1,435,198 1,401,076
Diluted 1,552,568 1,435,198 1,401,076
All share amounts have been adjusted to give retroactive affect of the 1 for 10
reverse stock split effective in October 2002.
See accompanying notes.
46
JB OXFORD HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Common Stock
----------------------
Shares Amount Additional Retained Treasury Total
Paid-in Earnings
Capital (Deficit) Stock
---------- ---------- ------------ ------------- ----------- ------------
Balance at 1,519,323 15,193 16,583,120 15,745,478 (2,452,148) 29,891,643
January 1, 2001
Net loss -- -- -- (6,941,756) -- (6,941,756)
Acquisition of
treasury stock -- -- -- -- (167,080) (167,080)
---------- ---------- ------------ ------------- ----------- ------------
Balance at 1,519,323 15,193 16,583,120 8,803,722 (2,619,228) 22,782,807
December 31, 2001
Issuance of
common stock 70,741 706 913,276 -- -- 913,982
Net loss -- -- -- (7,474,158) -- (7,474,158)
---------- ---------- ------------ ------------- ----------- ------------
Balance at 1,589,939 15,899 17,496,396 1,329,564 (2,619,228) 16,222,631
December 31, 2002
Treasury stock
bonus (805,690) 948,385 142,695
Issuance of
common stock 166,560 1,666 542,690 -- -- 544,356
Net loss -- -- -- (5,948,964) -- (5,948,964)
---------- ---------- ------------ ------------- ----------- ------------
Balance at
December 31, 2003 1,756,499 $17,565 $18,039,086 $(5,425,090) $(1,670,843) $10,960,718
========== ========== ============ ============= =========== ============
See accompanying notes.
47
JB OXFORD HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31
2003 2002 2001
------------- ------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(5,948,964) $(7,474,158) $(6,941,756)
Adjustments to reconcile net income (loss)
to net cash provided by (used in)
operating activities:
Depreciation and amortization 2,706,447 3,485,632 1,868,052
Deferred rent -- -- (191,083)
Provision for bad debts 80,122 138,512 1,146,244
Provision (benefit) for deferred
income taxes 1,042,348 (391,961) 1,290,790
Loss on disposal of furniture,
equipment and leasehold improvements -- 178,100 --
Changes in assets and liabilities:
Restricted cash 654,846 (654,846) --
Cash segregated under federal and
other regulations 15,426,651 (66,775,306) (41,855,227)
Receivable from broker-dealers and
clearing organizations (20,988,125) 44,019,430 (45,106,278)
Receivable from customers 3,966,085 19,084,588 175,723,929
Other receivables (1,189,587) 398,007 753,293
Securities owned 197,023 723,757 (1,030,057)
Clearing deposits (2,035,329) 692,011 2,672,440
Other assets (295,899) 721,373 354,012
Payable to broker-dealers and clearing
organizations 1,518,712 (12,521,538) (59,505,496)
Payable to customers 1,745,289 23,659,104 (18,125,486)
Securities sold not yet purchased 1,819,425 (708,101) 739,865
Accounts payable and accrued
liabilities (416,400) (1,484,061) (3,615,596)
Income taxes payable/refundable 4,561,915 9,185 (3,477,546)
------------- ------------- -------------
Net cash provided by operating activities 2,844,559 3,099,728 4,700,100
------------- ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Note receivable -- -- --
Acquisitions of customer accounts -- (1,753,707) (2,510,000)
Purchase of furniture, equipment and (835,175) (370,100) (1,324,688)
leasehold improvements
------------- ------------- -------------
Net cash used in investing activities (835,175) (2,123,807) (3,834,688)
------------- ------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Advances (repayments) of notes payable (41,667) (2,740,000) (2,008,000)
Issuance of common stock -- -- --
Acquisition of treasury stock -- -- (167,080)
------------- ------------- -------------
Net cash provided by (used in) financing
activities (41,667) (2,740,000) (2,175,080)
------------- ------------- -------------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS 1,967,717 (1,764,079) (1,309,668)
CASH AND CASH EQUIVALENTS AT BEGINNING OF
YEAR 4,930,253 6,694,332 8,004,000
------------- ------------- -------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $6,897,970 $4,930,253 $6,694,332
============= ============= =============
See accompanying notes.
49
JB OXFORD HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION
Reporting Entity
The accompanying consolidated financial statements for 2003, 2002 and 2001
include the accounts of JB Oxford Holdings, Inc., a Utah Corporation, and its
subsidiaries, National Clearing Corp ("NCC"), formerly known as JB Oxford &
Company, JB Oxford & Company ("JBOC"), formerly known as Stocks4Less, Inc., JB
Oxford Insurance Services, Inc., FiCorp, Inc., ISP Solutions, Inc., Reynolds
Kendrick Stratton, Inc. and Prolyx Data Systems, Inc. (collectively referred to
as the Company or JBOH). Of these subsidiaries, only NCC and JBOC were active in
2003, and both are wholly-owned subsidiaries of JB Oxford Holdings, Inc. The
accounting and reporting policies of the Company are in accordance with
accounting principles generally accepted in the United States (GAAP). The
Company operates in a single industry, the securities industry. The Company
derives its revenues primarily from its retail brokerage services operations in
JBOC, and its correspondent clearing services and market making activities at
NCC. Inter-company balances have been eliminated in the consolidated financial
statements. Additionally, minority shareholders' interests in non-operating
subsidiaries are not separately presented, as the amounts are not significant.
The corporate offices of the Company are located in Beverly Hills, California.
JBOC's brokerage division currently has branches in Beverly Hills, California;
New York, New York; and Minneapolis, Minnesota.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the year. Actual results may differ from those estimates.
Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with original
maturities of three months or less to be cash equivalents. Highly liquid
investments are both readily convertible to known amounts of cash and are so
near their maturity that they present insignificant risk of changes in value
because of interest rate changes.
Allowance for Doubtful Accounts
On an ongoing basis, the Company reviews its allowance for doubtful accounts on
receivables from broker-dealer and clearing organizations, customer receivables
and other receivables. The Company establishes allowances to cover known and
49
inherent losses. Management primarily considers the value of collateral being
held as a basis of determining the adequacy of its allowance for doubtful
accounts. Accounts are charged to the allowance once the collateral is
liquidated and other collection efforts have been exhausted.
Securities Lending Activities
Securities borrowed and securities loaned transactions are generally reported as
collateralized financings except where letters of credit or other securities are
used as collateral. Securities borrowed transactions require the Company to
deposit cash, letters of credit, or other collateral with the lender. With
respect to securities loaned, the Company receives collateral in the form of
cash or other collateral (typically marketable securities) in an amount
generally in excess of the market value of securities loaned. The Company
monitors the market value of securities borrowed and loaned on a daily basis,
with additional collateral obtained or refunded as necessary.
Marketable Securities Owned and Securities Sold Not Yet Purchased
Marketable equity and other securities owned and securities sold, not yet
purchased, are reported at prevailing market prices. Other equity securities
included in securities owned that are not publicly traded are reported at
estimated fair value. The Company estimates fair values of such securities using
cost, in addition to economic and operating trends of the investments and other
relevant information. Realized and unrealized gains and losses on securities
owned and securities sold, not yet purchased, are included in trading profits,
net.
Other Receivables
Other receivables consist principally of dividends and interest, customer money
market funds receivable, and accruals of clearing fees and other miscellaneous
income. The accruals are recorded when the earning process has been completed.
Also included in other receivable at December 31,2003 is $1,565,496 of
receivable of unsettled transactions to adjust the Company's marketable
securities to a trade date basis, the related amount at December 31, 2002 was
$0.
Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred
tax assets and liabilities are recognized for future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases. Deferred tax
assets and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected to
be recovered or settled. A valuation allowance is provided when management
believes it is more likely than not that the net deferred tax asset will not be
realized. The effect on deferred tax assets and liabilities of a change in the
rates is recognized in income in the period that includes the enactment date.
50
Furniture, Equipment and Leasehold Improvements
Furniture, equipment and leasehold improvements are carried at cost net of
accumulated depreciation and amortization. Depreciation on furniture and
equipment is provided for on accelerated and straight-line bases using an
estimated useful life of three to five years. Leasehold improvements are
amortized over the lesser of the useful life of the improvement or the term of
the lease. Expenditures for repairs and maintenance that do not significantly
increase the life of the assets are charged to operations as incurred.
Intangible Assets
Intangible assets consists customer accounts acquired from other securities
broker dealer and are carried at cost net of accumulated amortization.
Amortization is provided for using an estimated useful life of four years.
Intangible assets are reviewed for impairment annually and whenever events or
changes indicate the carrying value of an asset may not be recoverable.
Impairment is determined based upon the estimated discounted cash flow of the
intangible assets being held.
Treasury Stock
The Company carries treasury stock acquired at cost. All treasury stock owned
was acquired in the open market. On January 2, 2003 the Company provided a
treasury stock bonus to all employees who had been with Company for six months
or more. All employees received 500 shares, except those who were with the
Company for less than one year received 250 shares. The Company required
employees to hold the shares for one year prior to selling. The cost of the
treasury stock was $948,385 and the market value at the time of the bonus was
$142,695, the difference of $805,690 was charged to retained earnings in 2003.
Fair Value of Financial Instruments
Substantially all of the Company's financial assets and liabilities are carried
at market or estimated fair value or are carried at amounts that approximate
current fair value because of their short-term nature. Estimates are made at a
specific point in time based on relevant market information and information
about the financial instruments.
Revenue Recognition and Securities Transactions
The Company records its security transactions on a settlement date basis (the
date the trade settles with its customers and contra parties) and accrues its
commission revenue and related expenses on a trade date basis (the date the
trade is executed). Current realized and unrealized trading profits and losses
are included in income. Unrealized profits and losses are determined based upon
the current market values of securities held in Company proprietary accounts.
The Company recognizes interest income and related expense when earned.
Clearing, execution and other revenues are recorded when the earning cycle has
been completed.
Promotional Expense
Advertising costs are expensed as incurred.
51
Earnings Per Share
Basic earnings per share of common stock are computed by dividing net income by
the weighted average number of common shares outstanding.
Diluted earnings per share are computed by dividing net income adjusted for the
after-tax amount of interest associated with convertible debt and any other
charges resulting from assumed conversion of potential common shares by the
weighted average number of shares of common stock and dilutive securities
outstanding during the period. Dilutive securities are options that are freely
exercisable into common stock at less than market prices, and the convertible
debentures (after giving retroactive effect to the elimination of interest
expense, net of tax). Common shares and equivalents are not included in the
weighted average number of shares when the inclusion would increase the earnings
per share or decrease the loss per share.
The following table reconciles the numerators and denominators of the basic and
diluted earnings per share computation (all shares amounts have been adjusted to
give retroactive affect of the 1 for 10 reverse stock split effective in October
15, 2002):
Year Ended December 31
2003 2002 2001
-------------- ------------ -----------
BASIC EARNINGS PER SHARE
Net loss $(5,948,964) $(7,474,158) $(6,941,756)
-------------- ------------ -----------
Income available to common )
shareholders (numerator) $(5,948,964) $(7,474,158) $(6,941,756
============== ============ ===========
Weighted average common shares 1,552,568 1,435,198 1,401,076
outstanding (denominator)
============== ============ ===========
Basic Loss Per Share $(3.83) $(5.21) $(4.95)
============== ============ ===========
Year Ended December 31
2003 2002 2001
-------------- ------------ -----------
DILUTED EARNINGS PER SHARE
Net income (loss) $(5,948,964) $(7,474,158) $(6,941,756)
Interest on convertible debentures,
net of income tax -- -- --
-------------- ------------ -----------
Income available to common
shareholders plus assumed
conversions (numerator) $(5,948,964) $(7,474,158) $(6,941,756)
============== ============ ===========
Weighted average common shares 1,552,568 1,435,198 1,401,076
outstanding
Weighted average options outstanding -- -- --
Weighted average convertible -- -- --
debentures
Stock acquired with proceeds -- -- --
-------------- ------------ -----------
Weighted average common shares and 1,552,568 1,435,198 1,401,076
assumed conversions outstanding
(denominator)
============== ============ ===========
Diluted earnings (loss) per share $(3.83) $(5.21) $(4.95)
============== ============ ===========
52
The assumed conversions have been excluded in computing the diluted earnings per
share when there is a net loss for the period. They have been excluded because
their inclusion would reduce the loss per share or be anti-dilutive. If included
at December 31, 2003, conversion of the convertible debentures would add an
additional 2,029,474 shares of common stock to the above totals.
Stock-Based Compensation
The Company measures compensation cost under Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees" (APB No. 25), using the
intrinsic value method and provides pro forma disclosure of net earnings and
earnings per share as if the fair-valued-based method of accounting had been
applied. See Footnote 14 "Options and Warrants".
Reclassifications
Certain reclassifications have been made to the 2002 and 2001 consolidated
financial statements to conform with presentation in the 2003 consolidated
financial statements.
Recent Accounting Pronouncements
In December 2002, the FASB issued SFAS No. 148 "Accounting for Stock Based
Compensation -Transition and Disclosure-an amendment of FASB No.123" This
Statement amends SFAS No.123 "Accounting for Stock-Based Compensation" ("SFAS
No. 123") to provide alternative methods of transition for a voluntary change to
the fair value based method of accounting for stock-based employee compensation.
In addition, the Statement amends the disclosure requirements of SFAS No. 123 to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based compensation and the effect of
the method used on reported results. This Statement is effective for fiscal
years beginning after December 15, 2002. The Company plans to continue to
account for stock-based employee compensation under APB 25 to provide disclosure
of the impact of the fair value based method on reported income. Employee stock
options have characteristics that are significantly different from those of
traded options, including vesting provisions and trading limitations that impact
their liquidity. Therefore, the existing option pricing models, such as
Black-Scholes, do not necessarily provide a reliable measure of the fair value
of employee stock options. Refer to Note 14 of the Notes to Consolidated
Financial Statements for proforma disclosure of the impact of stock options
utilizing the Black-Scholes valuation method.
In January 2003, the Financial Accounting Standard Board ("FASB") issued
Interpretation ("FIN") No. 46, "Consolidation of Variable Interest Entities."
This statement addresses the consolidation of variable interest entities
("VIE"). A VIE is corporation, partnership, trust or other legal structure used
for business purposes that either does not have equity investors with
substantive voting rights or has equity investors that do not provide sufficient
financial resources for the entity to support its activities. FIN No. 46
requires a VIE to be consolidated by a company if that company is subject to a
majority of the VIE's risk of loss or if it is entitled to receive a majority of
the VIE's residual returns. The adoption of the statement did not have a
material effect on the Company's financial position or results of operations.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." This statement
modifies the accounting for certain financial instruments with characteristics
of both liabilities and equity. The Company adopted SFAS 150 effective July 1,
2003. The impact of the adoption had no effect on the `Company's financial
condition or results of operations.
53
NOTE 3. GOING CONCERN
The accompanying consolidated financial statements have been prepared on a going
concern basis, which reflects the realization of assets and the satisfaction of
liabilities in the normal course of business. As shown in the accompanying
consolidated financial statements, the Company incurred losses of $5,948,964,
$7,474,158 and $6,941,756 during the years ended December 31, 2003, 2002, and
2001 respectively.
As noted in the preceding paragraph, the Company has incurred recurring
operating losses, they have limited access to capital and have significant
pending litigation. Further, there is significant uncertainty with respect to
the outcome of the SEC investigation into the late trading conducted by the
Company.
Should the outcome or judgment against the Company from the SEC proceedings
related to the ongoing mutual fund investigations (as disclosed in Note 16,
Commitments and Contingencies) be significant, the demand for payment resulting
from such outcome or judgment coupled with the Company's deteriorating financial
results may cause substantial doubt regarding the Company's ability to meet its
obligations as they become due in the normal course of business. Should the
Company be unable to meet its obligations as they become due, the Company would
be forced to immediately file for protection under Chapter 11 of the United
States Bankruptcy Code (Chapter 11).
The Company's ability to continue as a going concern is dependent upon several
factors, including, but not limited to, its ability to (i) generate sufficient
cash flows to meet its obligations, (ii) obtain additional or restructure
financing, (iii) continue to obtain uninterrupted supplies from vendors, and
(iv) reduce capital expenditures and operating expenses.
The Company is considering alternatives to raise additional capital, decrease
expenses and improve liquidity. Included in management's plans are to move its
headquarters at the end of its lease commitments to lower rent expense, changes
in vendor services to reduce data processing expenses, issuance of additional
equity securities to raise capital and if necessary conversion of convertible
debt into common stock to extinguish debt. However, there can be no assurance
that the Company's efforts to raise adequate capital and improve liquidity will
be timely or successful. The accompanying consolidated financial statements do
not include any adjustments relating to the possible future effects on the
recoverability and classification of assets or the amounts and classification of
liabilities that might be necessary should the Company file for protection under
Chapter 11 or be unable to continue as a going concern.
NOTE 4. RESTRICTED CASH
At December 31, 2002, the US Marshall's' office was holding $654,846 pursuant to
a prejudgment writ of attachment. In January 2003, the writ was dissolved and
all assets previously held by the US Marshall's office were returned to JB
Oxford Holdings, Inc. See Note 16, "Commitments and Contingencies," below.
NOTE 5. CASH SEGREGATED UNDER FEDERAL AND OTHER REGULATIONS
Cash of $129,991,136 and $145,242,292 at December 31, 2003 and 2002,
respectively, have been segregated in a special reserve bank account for the
exclusive benefit of customers under Rule 15c3-3 of the Securities Exchange Act
of 1934, as amended. The Company had excess funds of $839,824, and $917,140 at
54
December 31, 2003 and 2002. Cash of $757,436 and 932,931 has been segregated in
a special reserve bank account for the benefit of introducing brokers at
December 31, 2003 and 2002, see 15, regulatory requirements.
NOTE 6. RECEIVABLE FROM AND PAYABLE TO BROKER-DEALERS AND CLEARING ORGANIZATIONS
Amounts receivable from and payable to broker-dealers and clearing organizations
result from the Company's normal trading activities and consist of the
following:
December 31, 2003
------------------------
Receivable Payable
----------- -----------
Deposits for securities borrowed/loaned $29,232,316 $38,557,179
Securities failed to deliver/receive 27,856 203,363
Receivable from/payable to correspondents 20 1,143,978
Payable to clearing organizations -- 269,480
Other 77,163 157,755
----------- -----------
Total $29,337,358 $40,331,755
=========== ===========
December 31, 2002
------------------------
Receivable Payable
----------- -----------
Deposits for securities borrowed/loaned $8,209,178 $37,449,293
Securities failed to deliver/receive 37,462 6,025
Receivable from/payable to correspondents 102,593 1,217,587
Payable to clearing organizations -- 140,138
----------- -----------
Total $8,349,233 $38,813,043
=========== ===========
Securities borrowed and securities loaned represent cash paid or received for
securities borrowed or loaned from other broker-dealers. The equivalent value in
cash is deposited by the borrower. All open positions are adjusted to market
values daily. These deposits approximate the market value of the underlying
securities. The Company has received securities with a market value of
$23,284,978 in stock borrow transactions that has been repledged in stock loan
transactions.
Securities failed to deliver and receive represent the contract value of
securities that have not been delivered or received subsequent to settlement
date. At December 31, 2003, the market value of the securities failed to deliver
was $31,370 and failed to receive was $80,692. At December 31, 2002, the market
value of the securities failed to deliver was $32,384 and failed to receive was
$4,613.
The amounts receivable from and payable to clearing organizations represents
securities failed to deliver and failed to receive on a continuous net
settlement basis. All open positions are adjusted to market value daily.
The Company clears security transactions for correspondent broker-dealers.
Settled securities and related transactions for these correspondents are
included in payable to correspondents.
55
NOTE 7. RECEIVABLE FROM AND PAYABLE TO CUSTOMERS
Receivables from customers include amounts due on cash and margin transactions.
Payables to customers represent debit balances in the customer accounts.
Securities owned by customers are held as collateral for receivables. Such
collateral is not reflected in the financial statements.
NOTE 8. MARKETABLE SECURITIES OWNED AND SECURITIES SOLD, NOT YET PURCHASED
Marketable securities owned and sold, not yet purchased consist of trading and
investment securities at quoted market values, as illustrated below:
Sold, But Not
Owned Yet Purchased
------------------- ----------------
Balances as of December 31, 2003:
Equity securities $321,202 $1,957,909
U.S. government and other securities 100,000 --
Securities owned not readily marketable 10,858 --
------------------- ----------------
Total $432,060 $1,957,909
=================== ================
Balances as of December 31, 2002:
Equity securities $441,023 $138,484
Securities owned not readily marketable 188,060 --
------------------- ----------------
Total $629,083 $138,484
=================== ================
As a part of its ongoing trading activities the Company may hold financial
instruments for trading purposes. These instruments consist of options and
warrants and are not used as hedge instruments to reduce financial market risks.
The Company does not trade futures, forwards, swaps or any other derivative
financial instruments except options and warrants. The Company held no options
or warrants at December 31, 2003 and 2002. Trading gains or losses relating to
options and warrants are not material to the operations of the Company.
NOTE 9. FURNITURE, EQUIPMENT AND LEASEHOLD IMPROVEMENTS
The following table summarizes the Company's furniture, equipment and leasehold
improvements:
December 31
-----------------------
2003 2002
----------- -----------
Furniture and equipment $6,780,692 $5,928,973
Leasehold improvements 1,767,424 1,783,967
----------- -----------
8,548,116 7,712,940
Less: Accumulated depreciation and amortization (6,352,333) (5,088,794)
----------- -----------
$2,195,783 $2,624,147
=========== ===========
For the years ended December 31, 2003, 2002 and 2001, occupancy and equipment
expense includes depreciation and amortization expense of $1,263,539, $1,683,611
and $1,554,300, respectively.
NOTE 10. NOTES PAYABLE AND UNCOMMITTED LINES
NCC maintains uncommitted customer financing arrangements with an aggregate
borrowing limit approximating $25,000,000. Amounts loaned bear interest at a
fluctuating rate based on broker call and prime rates and are fully
collateralized by marketable securities. The Company had no such loans
outstanding at December 31, 2003 and 2002.
56
At December 31, notes payable related to customer activity consisted of the
following (See Note 13 for discussion of related party notes reclassified to
notes payable):
Balance at
end of a b c d
period
------------ -------- ----------- ------------ ----------
2003
Collateralized by:
Customer
securities $ -- -- $ -- $ -- n/a
2002
Collateralized by:
Customer
securities $ -- -- $1,000,000 $ 2,778 4.0%
--------------
$ --
==============
a) Weighted average interest rate at end of period.
b) Maximum amount outstanding during the period.
c) Average amount outstanding during the period.
d) Weighted average interest rate during the period. This amount was
calculated by factoring the balances at the end of each month at the
various rates, and computing a weighted average on the results.
Interest expense related to these notes was $0, $111 and $40,646 for the years
ended December 31, 2003, 2002 and 2001, respectively.
At December 31, the detail of notes payable is as follows:
December 31
2003 2002
------------- --------------
Demand notes payable $2,889,375 $2,889,375
Note payable 569,444 --
------------- --------------
Total notes payable $3,458,819 $2,889,375
------------- --------------
The demand notes payable are contested obligations on notes payable to former
shareholders of the Company, or their assignees. The Company is vigorously
contesting the claims. More information on the claims is set forth in the former
shareholder transactions section of Note 13, below.
The note payable is the result of a settlement and release agreement dated
September 4, 2003 associated with the abandonment of the lease in Oakland,
California. The terms called for the execution of a non-interest bearing
promissory note in the amount of $611,111 due in 44 equal monthly payments
commencing October 1, 2003. For information on notes payable to current related
parties, please see Note 13, below.
57
NOTE 11. CONVERTIBLE PREFERRED STOCK
The Company is authorized to issue 10,000,000 shares of $10 par value
convertible preferred stock, of which 9,800,000 shares remain. The Company
previously issued 200,000 shares that were retired upon conversion to common
shares. The preferred shares carry a minimum of a 6% cumulative dividend and
have a liquidation preference of $10 per share. Any other preferences to be
given are to be determined by the Board of Directors at the time of issuance.
There are no shares of convertible preferred stock currently outstanding.
NOTE 12. INCOME TAXES
The income tax (benefit) provision consists of the following components:
Year Ended December 31
2003 2002 2001
--------------- --------------- ---------------
Current
Federal $ -- $(3,509,039) $(3,402,840)
State -- -- --
--------------- --------------- ---------------
$ -- $(3,508,039) $(3,402,840)
--------------- --------------- ---------------
Deferred
Federal $(1,594,142) $ (391,961) $ 739,400
State (242,810) (551,390) (158,390)
Valuation
Allowance 2,879,300 551,390 709,780
--------------- --------------- ---------------
1,042,348 (391,961) 1,290,790
--------------- --------------- ---------------
Total $1,042,348 $(3,900,000) $(2,112,050)
=============== =============== ===============
The major components of deferred tax assets net, are as follows:
December 31
2003 2002
------------- -------------
Deferred tax assets:
Bad debts reserve $ 306,827 $384,929
Depreciation 37,618 386,127
Amortization of intangible assets 1,179,112 688,551
State taxes - NOL 2,854,645 1,032,541
Accrued liabilities 15,866 64,968
Less: Valuation allowance (4,394,068) (1,514,768)
------------- -------------
Total deferred tax assets $ -- $1,042,348
------------- -------------
Reconciliations of the provision for income taxes to the expected income tax
based on statutory rates are as follows:
58
Year Ended December 31
2003 2002 2001
----------- ------------ ------------
Provision (benefit)- Federal statutory
rate $(1,717,316) $(3,980,956) $(3,078,294)
Increase (decrease) in income taxes
resulting from:
State taxes (242,810) (634,000) (342,545)
Other 123,174 80,956 428,021
Valuation allowance 2,879,300 634,000 880,768
----------- ------------ ------------
Total $1,042,348 $(3,900,000) $(2,112,050)
=========== ============ ============
A valuation allowance has been placed against 100% of the federal and state net
deferred tax asset as of December 31, 2002 and 2001 due to the uncertainty of
its ultimate realization. For tax purposes at December 31, 2003, the Company had
a Federal net operating loss (NOL) of $5.6 million, which can be carried forward
and will expire in 2023 and a state NOL of $2.8 million, $5.2 million and $6.4
million, which will be suspended until 2013, 2014, and 2015 respectively.
NOTE 13. RELATED PARTY TRANSACTIONS
THIRD CAPITAL PARTNERS, LLC
The Company has entered into four transactions with Third Capital Partners, LLC
("TCP") and a related affiliate, Third Capital, LLC. They are as follows:
1. On or about May 26, 1998, TCP acquired $3,418,695.59 principal amount of
the 9% Secured Convertible Note, issued pursuant to the Company's Senior
Secured Convertible Note Purchase Agreement dated March 10, 1995, and
having a maturity date of December 31, 1999. The note, when issued, was
convertible into the Company's $0.01 par value common stock at a rate of
$1.00 per share, before adjustment for the 1-for-10 reverse split which
occurred in October 2002. Under the initial conversion rate, this note was
convertible into 3,418,695 shares of common stock, before adjustment for
the reverse split.
On or about June 8, 1998, TCP acquired $2,000,000.00 principal amount of
the 9% Secured Convertible Note, issued pursuant to the Company's Senior
Secured Convertible Note Purchase Agreement dated June 8, 1998, and having
a maturity date of December 31, 1999 (the two notes are together referred
to as the "Secured Convertible Notes"). As part of the acquisition, the
Company and TCP agreed to adjust the conversion rate for the Secured
Convertible Notes to $0.70 per share, before adjustment for the 1-for-10
reverse split which occurred in October 2002. After the adjustment in
conversion rate, the Secured Convertible Notes were convertible into
7,740,993 shares of common stock, before adjustment for the reverse split.
The issuance of the Secured Convertible Notes was not registered under the
Securities Act of 1933 in reliance upon the exemption set forth in Section
4(2) of that Act relating to transactions by an issuer not involving a
public offering.
On or about November 8, 1999, the maturity date for the Secured
Convertible Notes was extended to December 31, 2000. On or about December
13, 2000, the maturity date for the Secured Convertible Notes was extended
to December 31, 2001. On or about December 31, 2001, the maturity date for
59
the Secured Convertible Notes was extended to December 31, 2002. On or
about December 31, 2002, the Company and TCP entered into a Note Extension
Agreement which, i) extended the maturity date to December 31, 2003, and
ii) adjusted the conversion rate to $2.67 per share of common stock, the
closing price of the Company's common stock on the Nasdaq SmallCap Market
on December 31, 2002. As a result, and after giving effect to the 1-for-10
reverse split which occurred in October 2002, the Secured Convertible
Notes are convertible into 2,029,474 shares of common stock. On December
31, 2002, the maturity date for the Secured Convertible Notes was extended
to December 31, 2004. The conversion rate currently remains at $2.67 per
share, and the Secured Convertible Notes are currently convertible into
2,029,474 shares of common stock. Related interest expense for 2003, 2002
and 2001 was $487,683, $487,683, and $486,943 for the Secured Convertible
Notes.
2. On or about February 18, 1999, the Company approved a transaction between
TCP and Oeri Finance, Inc., and Felix A. Oeri (collectively, "Oeri"). Oeri
was a substantial shareholder of the Company prior to this transaction,
and Felix A. Oeri was Chairman of the Company's Board of Directors. The
transaction consisted of the following:
a. The Company agreed to waive certain rights it had under a Right of
First Refusal, dated May 27, 1998, to acquire shares of Company
stock held by Oeri;
b. Oeri forgave the outstanding balance of $728,125 (reported as an
extraordinary item net of income tax in 1999) due from the Company
under a Promissory Note dated May 27, 1998, in the original amount
of $1,213,125;
c. The Company transferred to Oeri Finance, Inc. all equipment and
furniture in its Basel, Switzerland office;
d. The Company established the JB Oxford Revocable Government Trust
(the "Trust"), and loaned it $586,915, which was used to purchase
469,540 shares of the Company's common stock at an average price of
$1.25 (46,954 shares at $12.50, after adjustment for the reverse
stock split in October 2002). The Trust terminated pursuant to its
terms on February 18, 2001, and ownership of the Trust's shares of
the Company's common stock were transferred to the Company in
satisfaction of the loan; and,
e. The Company agreed to allow TCP to acquire 100,000 shares of the
Company's common stock from Oeri Finance, Inc. for total
consideration of $10.00 (10,000 shares after adjustment for the
reverse stock split in October 2002).
Subsequent to these transactions, Oeri filed 13D statements with the SEC
indicating ownership of less than 5% of the Company's stock.
3. On or about December 13, 2000, the Company loaned $2,500,000 to TCP,
pursuant to a written Promissory Note, payable on or before December 31,
2001. The note bears interest at the rate of 9 1/4%, and may be pre-paid
in whole or in part without penalty. The loan was a re-classification of a
portion of a pre-existing margin debt owed by TCP to the Company's
brokerage subsidiary, and was secured by the $2,000,000 Secured
Convertible Note and Company common stock. The re-classification was
entered into to ensure that the amount of the remaining portion of the
margin debt complied with the Company's lending policies.
60
By agreement dated December 31, 2001, the maturity date for the Promissory
Note was extended to December 31, 2002. Effective on or about March 22,
2002, as part of a restructuring of inter-company debts between the
Company and its wholly-owned subsidiary, NCC (then known as JB Oxford &
Company), the Promissory Note was assigned to NCC, and the maturity date
was extended to December 31, 2007.
4. By agreement dated December 16, 1999, the Company agreed to pay a monthly
advisory fee to Third Capital, LLC, an affiliate of TCP, in the amount of
$85,000, included in professional services, plus all direct and indirect
expenses incurred in providing such advisory services to the Company and
its subsidiaries. Since that time, members of Third Capital, LLC have held
the executive positions of Chairman, Chief Executive Officer, and
President of the Company and its subsidiaries. Effective October 2001,
Third Capital, LLC agreed to reduce its fee by 10%, to $76,500 per month,
plus expenses. The advisory fee paid to Third Capital, LLC was $918,000,
$918,000, and $1,042,276 in 2003, 2002, and 2001, respectively.
FORMER SHAREHOLDER TRANSACTIONS
The Company issued $2,867,500 in demand notes to former shareholders during
1997. The notes bore interest at 8 1/4%, payable quarterly. In 1998, $250,000
was paid on the demand notes. In 1999, $728,125 of the debt was forgiven by Oeri
(see 2b, above), leaving a balance due of $1,889,375, which was reclassified to
notes payable in 1999.
A $1,000,000 subordinated loan agreement, payable to Oeri Finance, Inc., matured
by its terms on March 31, 1999. The balance due was reclassified to note payable
at that time.
Since in or about March 1999, the Company has refused to make payment under the
notes payable totaling approximately $2.9 million, plus interest, and has
asserted defenses and counterclaims against the alleged holders of the notes
related to: i) an award entered jointly against the Company and the holders
related to alleged wrongful conduct by the Company in clearing certain customer
accounts during the time that the holders of the notes payable ran the Company;
and, ii) the Company has acquired a Judgment against Oeri Finance, Inc., which
it intends to use as a set-off against claims on the notes payable. The amount
of the Judgment acquired is substantially in excess of the total claimed due on
the notes payable. (For a further discussion of the pending litigation related
to these claims, please see Note 16, paragraphs 2 and 3.)
NOTE 14. OPTIONS AND WARRANTS
At December 31, 2003, the Company had three stock option plans, each of which is
described below. As the exercise price of the Company's employee stock options
equaled the market price of the underlying stock on the date of grant, no
compensation cost has been recognized in accordance with APB Opinion 25.
The Company has adopted an employee stock option plan (the "Plan") pursuant to
which 92,000 shares of common stock have been authorized for issuance to
61
officers and full-time employees of the Company. Under the Plan, 48,000 options
have been issued and converted to common stock, while 22,850 options are
outstanding at December 31, 2003 leaving 21,150 options available for future
issuance. The Plan is administered by the Company's Board of Directors, which
determines, among other things, the persons to be granted options under the
Plan, the number of shares subject to each option and the option price, which
shall not be less than market value.
The Company has adopted a non-employee directors' stock option plan (the
"Director's Plan") pursuant to which 95,000 shares of common stock have been
authorized for issuance to directors who are not employees of the Company. Under
the Director's Plan, 16,000 options to purchase common stock are outstanding at
December 31. No options have been converted to common stock under this plan
leaving 79,000 options available for future issuance. The Director's Plan is
administered by the Company's Board of Directors, which determines, among other
things, the persons to be granted options under the Director's Plan, the number
of shares subject to each option and the option price, which shall not be less
than market value. In addition, any action under the Director's Plan, must be
approved by the affirmative vote of a majority of the directors who are not then
eligible to participate in the Director's Plan.
The Company has adopted the 1998 Stock Option and Award Plan (the "1998 Plan"),
pursuant to which 350,000 shares of common stock have been authorized for
issuance to officers, employee directors and key employees of the Company. Under
the 1998 Plan, 219,475 options to purchase common stock are outstanding at
December 31, 2003, of which 217,900 are held by executive officers of the
Company. No options have been converted to common stock under this plan leaving
130,525 options available for future issuance. The Plan is administered by the
Company's Compensation Committee of the Board of Directors, which determines,
among other things, the persons to be granted options under the 1998 Plan, the
number of shares subject to each option and the option price, which shall not be
less than market value for incentive options.
SFAS No.123, "Accounting for Stock-Based Compensation," requires the Company to
provide pro forma information regarding net income and earnings per share in
accordance with the compensation based method prescribed in SFAS No. 123. The
Company estimates the fair value of each stock option at the grant date by using
the Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in 2003, 2002, and 2001, respectively: expected
dividend yield of 0% for all three years; computed volatility of 19%, 28%, and
22%, respectively; risk-free interest rates of 1.5%, 1.5%, and 3.5%,
respectively; and expected life of 5 years for all three years. The weighted
average fair value of options granted during 2003, 2002 and 2001 was $0.85,
$0.63, and $0.63, respectively.
Under the accounting provisions of SFAS No. 123, as amended by SFAS 148, the
Company uses the intrinsic value method to account for stock based employee
compensation. There are no stock based compensation costs included in the net
loss as reported for the years ended December 31, 2003, 2002, and 2001. The
Company's net loss and earnings per share would have been adjusted to the pro
forma amounts indicated below:
62
Year Ended December 31
2003 2002 2001
------------- ------------ ------------
Net loss:
As reported $(4,966,945) $(7,474,158) $(6,941,756)
Stock based compensation, net of
tax 2,115 529 194,354
------------- ------------ ------------
Pro forma $(4,969,060) $(7,474,687) $(7,136,110)
============= ============ =============
Basic earnings per share:
As reported $(3.83) $(5.21) $(4.95)
Pro forma (3.83) (5.21) (5.09)
Diluted earnings per share:
As reported $(3.83) $(5.21) $(4.95)
Pro forma (3.83) (5.21) (5.09)
A summary of the status of the Company's stock options as of December 31, 2003,
2002, and 2001, and changes during the years ending on those dates is presented
below:
December 31, 2003 December 31, 2002 December 31, 2001
Weighted Weighted Weighted
Shares average Shares average Shares average
--------- -------- ---------- -------- ---------- --------
Outstanding at
beginning of
year 256,200 $15.72 383,120 $26.88 310,850 $29.37
Granted 2,500 4.26 1,500 2.20 75,100 17.17
Exercised -- -- -- -- -- --
Forfeited (375) 32.37 (128,420) 49.43 (2,830) 37.40
--------- -------- ---------- -------- ---------- --------
Outstanding at
end of year 258,325 15.59 256,200 15.72 383,120 26.88
========= =========- ==========
Options
exercisable
at year-end 256,825 15.66 254,217 15.81 320,300 $27.61
Weighted-average
fair value of
options
granted
during the
year $0.63 $4.60
Information relating to stock options and warrants at December 31, 2003,
summarized by exercise price is as follows:
63
Options Outstanding Options Exercisable
Number Weighted-Average Weighted-Average Number Weighted-Average
Outstanding at Contractual Exercise Price Exercisable at Exercise Price
Exercise Prices 12/31/03 Life 12/31/03
------------------ ------------------- ---------------- ----------------- ------------------- ----------------
$2.20 1,500 9 $2.20 1,500 $2.20
3.76 1,500 10 3.76 -- 3.76
5.00 1,000 9 5.00 1,000 5.00
6.25 2,500 5 6.25 2,500 6.25
12.19 5,000 4 12.19 5,000 12.19
13.13 155,000 4 13.13 155,000 13.13
17.80 1,350 3 17.80 1,350 17.80
18.20 66,000 7 18.20 66,000 18.20
19.70 1,500 4 19.70 1,500 19.70
22.50 15,000 2 22.50 15,000 22.50
23.20 5,000 3 23.20 5,000 23.20
35.94 200 7 35.94 200 35.94
36.88 1,200 6 36.88 1,200 36.88
74.40 100 6 74.40 100 74.40
90.00 475 5 90.00 475 90.00
91.25 1,000 5 91.25 1,000 91.25
------------------- -------------------
Total 258,325 5 $15.59 256,825 $15.66
=================== ===================
NOTE 15. REGULATORY REQUIREMENTS
NCC and JBOC are subject to the Securities and Exchange Commission's Uniform Net
Capital Rule (the Rule), which requires the maintenance of minimum net capital.
NCC has elected to use the alternative method permitted by the Rule, which
requires it to maintain minimum net capital, as defined, equal to the greater of
$250,000 or two percent of aggregate debit balances arising from customer
transactions, as defined. The Rule also provides, among other things, for a
restriction on the payment of cash dividends, payments on subordinated
borrowings or the repurchase of capital stock if the resulting excess net
capital would fall below 5% of aggregate debits.
At December 31, 2003, NCC had net capital of $9,554,544, which was $7,873,465 in
excess of the minimum amount required. At December 31, 2002, NCC had net capital
of $9,452,719, which was $7,656,245 in excess of the minimum amount required.
JBOC computes its net capital requirement in accordance with the aggregate
indebtedness standard. The Rule requires the maintenance of minimum net capital
and require that the ratio of aggregate indebtedness to net capital, both as
defined, shall not exceed 15 to 1. At December 31, 2003, JBOC had net capital of
$420,575, which was $414,478 in excess of the minimum amount required. At
December 31, 2002, JBOC had net capital of $20,744, which was $15,744 in excess
of the minimum amount required of $5,000. JBOC's net capital ratio was less than
1-to-1 for both years.
NCC performs a required computation for the proprietary accounts of introducing
brokers ("PAIB") similar to the customer reserve computation set forth in SEC
Rule 15c3-3. As of December 31, 2003, PAIB debits aggregated $69,264, and
credits totaled $809,133. As of December 31, 2002, PAIB debits aggregated
$86,533, and credits totaled $933,926. Included in the balance of cash
64
segregated under federal and other regulations as of December 31, 2003, and 2002
was $757,280 and $932,931, respectively, of cash held in a PAIB reserve account.
NOTE 16. COMMITMENTS AND CONTINGENCIES
The Company is a party to a number of pending legal, arbitration or
administrative proceedings incidental to its business, including customer claims
regarding brokerage transactions, and claims related to clearing services
arising out of the failure of certain correspondent firms. All of the legal,
arbitration and administrative proceedings have arisen in the ordinary conduct
of its business. Those proceedings that management believes may have a
significant impact on the Company are described below. However, there can be no
assurance that in the future, other current or future proceedings will not have
a material adverse effect on the Company's financial condition or results of
operations. In particular, if the Company is required to pay a judgment in
excess of the amount reserved, such a payment would negatively impact the
financial condition of the Company.
SEC MUTUAL FUND INVESTIGATION
In the course of the ongoing mutual fund investigations, the NCC received a
"Wells Notice" from the staff of the SEC's Los Angeles office on November 6,
2003, stating it intention to recommend that the SEC institute civil and
administrative proceedings against NCC seeking injunctive relief, disgorgement,
prejudgment interest and civil penalties for alleged violations of Sections 8A
and 17(a) of the Securities Exchange Act of 1933, Sections 10)(b), 15(b) and 21C
of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder and Sections
9(b) and 9(f) of the Investment Company Act of 1940 and Rule 22c-1 thereunder.
The Company believes it has complied with all requests of documents and provided
testimonies in response to subpoenas from the New York Attorney General, the SEC
and the NASD regarding the allegations of NCC's violation in forward pricing
principles. While NCC admits no wrongdoing and intends to vigorously defend
itself, no assurance can be given as to the outcome of this matter. Although the
likelihood of loss is probable, the Company has not accrued any amounts related
to this matter, as the amount of loss is not estimable at this time. However,
substantial penalties from fines or settlements resulting from an adverse
outcome or judgment in this matter could have a material adverse effect on the
financial position and results of operations of the Company.
OTHER REGULATORY MATTERS
In April 2003 we were notified by the SEC in the course of a routine examination
that we had a deficiency since September 2002 in our required reserve account
deposits in violation of SEC rules. This deficiency identified by the SEC, which
ranged between $120 million and $145 million, was caused primarily as a result
of our deposit of customer funds into certificates of deposit and money market
accounts at a financial institution in excess of the amount of funds permitted
to be maintained at any one financial institution. Our inadvertent inclusion of
accounts maintained by certain of our executive officers and directors in our
reserve account calculations also contributed to the deficiency since under the
SEC rules we are not permitted to include such accounts in our calculations. We
subsequently brought our required reserve accounts into compliance within the 2
weeks requested by the SEC. Although the deficiency was in violation of the
applicable SEC rules, at no time were any customer funds at risk of loss. The
NASD subsequently required us to pay a $15,000 fine and the matter was concluded
in early 2004.
65
USAO SETTLEMENT AGREEMENT RELATED TO PRIOR MANAGEMENT
In February 2000, we entered into a settlement agreement with the United States
Attorney's Office for the Central District of California (the "USAO") in
connection with the USAO's investigation of certain of our former affiliates and
management which investigation commenced in 1997. The USAO investigation, and
the concurrent investigation by the SEC, related to an alleged failure to
disclose the relationship of an individual who was purported to be secretly in
control of the company and the trading practices of such individual. Our current
executive officers and directors were not the subject of the USAO or the SEC
investigations.
While we maintained our innocence, we agreed to pay $2,000,000 to the USAO over
a period of three years in settlement of the investigation and to offset the
USAO's costs of its investigation. We recognized a charge of $2,300,000 in the
fourth quarter of 1999 to account for the settlement agreement with the USAO and
an anticipated settlement with the SEC.
Under the terms of the settlement agreement, if we fail to make payment of any
installment when due, the entire unpaid balance will become immediately due and
payable, and if we sell a controlling interest in our operating subsidiary to a
third party, the remaining unpaid installments must be paid prior to the closing
of the sale.
In May 2002, the settlement agreement was amended to modify the payment schedule
for the balance owing of $1,000,000 under the settlement agreement. No payment
was required to be made in 2002 and the balance was to be paid in equal annual
installments in February 2003 and February 2004. In February 2003, the USAO
agreed to extend the due date on the $500,000 payment then due under the
settlement agreement. We made a partial payment of $50,000 on March 31, 2003,
and the USAO extended the time for any further payment. As of December 31, 2003,
the Company owed a balance of $950,000. The Company made a partial payment of
$50,000 in February 2004, and is continuing to negotiate with the USAO regarding
the timing and amount of subsequent payments. The Company originally accrued
payments related to this matter totaling $3.0 million, to cover both the
settlement with the USAO, and a potential settlement with the SEC. The SEC
notified the Company in 2002 that it had closed its investigation without action
or monetary assessment. Accordingly, the amount accrued has been reduced to
$950,000 at year end, the remaining balance due to the USAO.
LITIGATION RELATED TO OERI NOTES
The Company is a party to a lawsuit entitled EBC Trust v. JB Oxford Holdings,
Inc., et als., pending in the Federal District Court in Los Angeles. In this
suit, EBC Trust is seeking payment of the $2.9 million in notes payable
described above in the former shareholder transaction section of Note 13. In
July 2002, the court magistrate granted a pre-judgment attachment against the
assets of the Company in favor of EBC Trust. In January 2003, the Court reversed
the magistrate's order and dissolved the attachment. In January 2003, EBC Trust
amended its claim to assert additional claims against the Company and to add
claims against the officers and directors of the Company, as well as to add a
claim against NCC under the $1,000,000 Oeri subordinated note. By Order dated
October 14, 2003, in response to motions filed by the Company, the Court
dismissed several claims, struck portions of the Amended Complaint, and
compelled EBC Trust to arbitrate all claims against NCC.
66
As to the remaining claims, the Company has asserted a number of defenses to EBC
Trust's claims, including fraud, and contribution related to a judgment entered
against EBC Trust's predecessor-in-interest under the notes payable and NCC in
an NASD arbitration commenced by Stanly J. Cohen, Receiver for Secured Equity
Title and Appraisal Agency Corp. NCC settled all of the claims against it in
that matter in 2002, and as a part of that settlement, obtained the assignment
from Secured Equity of a Judgment against Oeri Finance, Inc. Accordingly, the
Company has asserted a claim of offset for the Judgment against Oeri Finance,
Inc. As stated in Note 13, the Company has recorded liabilities of approximately
$2.9 million on its balance sheet in notes payable, additionally, the Company
has $816,429 of accrued interest related to these notes included in accounts
payable and accrued expenses.
In December 2003, EBC Trust commenced an arbitration action with the National
Association of Securities Dealers, Inc., against JBOC, seeking recovery on the
$1,000,000 subordinated note originally issued to RMS Network, Inc., and
subsequently assigned with approval from the Company and the NASD to Oeri
Finance, Inc. The Company intends to vigorously defend the action and believes
that it has meritorious defenses including, without limitation: i) the suit is
brought against the wrong party; ii) no valid assignment has ever been approved
by the Company or the NASD to EBC Trust, as required by the terms of the note;
and iii) the Company will assert an offset for the Judgment obtained against
Oeri Finance, Inc., described above.
LITIGATION RELATED TO ACCOUNT ACQUISITIONS
In October 2002, Share King LLC, as successor to Mr. Stock, Inc. commenced an
arbitration proceeding related to the acquisition by us of the accounts of Mr.
Stock. We countersued for violations of the purchase agreement by Mr. Stock.
That litigation was settled in August 2003, on terms more favorable to us than
we originally accrued for, and the cost of the Mr. Stock acquisition was
adjusted down $356,174 in 2003, as a result of settlement of the arbitration. As
a part of the settlement, we are required to distribute cash and/or stock, at
our election to Share King LLC. In early 2004, a further dispute arose with
Share King LLC regarding the registration requirements related to the stock to
be issued. A decision is pending on that matter by the arbitration panel. If we
receive an adverse ruling from the panel, we could be required to make
subsequent payments to Share King LLC in cash, instead of in our choice of cash
and/or stock.
Future annual minimum rental payments required under operating leases that have
initial or remaining non-cancellable lease terms in excess of one year as of
December 31, 2003, were as follows:
Year ending December 31:
2004 $ 1,975,144
2005 1,557,860
2006 1,566,260
2007 1,167,545
2008 1,178,136
Thereafter 2,377,454
------------------
Total $9,822,399
==================
67
The Company received certain concessions for a lease included above which is
being amortized ratably over the lease term. Rent expense on the above
commitments was as follows:
Year ending December 31:
2004 $2,299,373
2005 2,675,129
2006 2,698,264
The Company offers its employees participation in a 401(k) savings plan.
Eligible employees are able to contribute a portion of their compensation. The
Company matches 25% of these contributions up to 6% of the employee's wage. This
expense for 2003, 2002 and 2001 amounted to $106,503, $28,296 and $61,413.
NOTE 17. ACQUISITIONS OF CUSTOMER ACCOUNTS
During the year ended December 31, 2003, the Company did not acquire customer
accounts of other brokerage firms. The Company acquired the customer accounts of
Stockwalk.com. Inc. Wall Street Equities, Inc., Sunlogic Securities, and Mr.
Stock, Inc, in 2002, and Bull and Bear, Inc. and eCapitalist, Inc. in 2001. The
cost of these acquisitions is $4,362,689 and $2,510,000 in 2002 and 2001,
respectively. The cost of the Mr. Stock acquisition was adjusted down $356,174
in 2003, as a result of settlement of litigation related to the acquisitions,
and has been included in the statement of financial condition net of accumulated
amortization of $3,558,678 and $2,115,771. The Company is amortizing these
intangible assets over four years, which is the estimated useful life. Estimated
aggregate amortization expense for the four succeeding fiscal years is as
follows:
Year ending December 31:
2004 1,363,758
2005 1,150,812
2006 443,267
2007 and thereafter --
-------------
$2,957,837
=============
Amortization expense of $1,442,908, $1,238,295 and $313,750 was recorded during
the years ended December 31, 2003, 2002 and 2001, respectively. Additionally, in
2002 the Company recognized an impairment charge of $563,726, in addition to the
$1,238,295 amortization above, which is included in amortization expense. The
impairment charge is related to the intangible assets recorded for the
acquisition of customer accounts for two acquisitions. Fair value was determined
by calculating the discounted cash flows on the underlying customer accounts
over the estimated useful life of the intangibles.
The Company believes no impairment of intangible assets is necessary at December
31, 2003 as estimated cash flows over the estimated useful life exceeds the cost
less accumulated amortization.
NOTE 18 SEGMENT AND GEOGRAPHIC INFORMATION
During 2003, the Company split its brokerage operations into two subsidiaries,
based on the types of clients and the services provided to those clients.
Clearing Brokerage Services, organized as National Clearing Corp, provides
68
clearing and execution services to correspondent broker dealers, and also
engages in market making and proprietary trading. Retail Brokerage Services,
organized as JB Oxford & Company, provides brokerage services to retail
customers. JBOC is a correspondent broker dealer customer of NCC. Financial
information of these separate subsidiaries is evaluated regularly by the chief
operating decision maker of the Company in deciding how to allocate resources
and in assessing performance.
The Company previously reported no separate reporting segments. However, with
the formal split of its brokerage operations, management now evaluates the
performance of each subsidiary as a separate operating segment. Segment
information relating to periods prior to the formal separation of the Company's
brokerage operations has been created in a manner that reflects internal
organization after the formal separation.
Revenues and expenses include those that are directly related to each segment.
Revenues and expenses from inter-segment transactions are based on specific
criteria or agreed-upon rates with such amounts eliminated in consolidation.
Individual segments also include expenses relating to various items, such as
corporate overhead, that are internally allocated by the Company. The Company
generally evaluates performance of the segments based on total revenues and
profit or loss before provision for income taxes. Substantially all of the
interest earned and interest expense is contained in the clearing brokerage
services division, with the exception of $487,683 of interest expense incurred
each year on the notes payable to shareholders which is included in the other
segment. All amortization expense on intangible assets is included in the retail
brokerage services
2003 2002 2001
------------- ------------- --------------
Revenues:
Clearing Brokerage
Services $13,699,222 $15,809,325 $24,859,710
Retail Brokerage Services 7,893,058 8,087,572 12,356,140
Other(1) (1,692,157) (1,509,018) (1,868,029)
------------- ------------- --------------
Total Revenues $19,900,126 22,387,879 $35,347,821
============= ============= ==============
Pre-Tax Income:
Clearing Brokerage
Services $ 1,311,083 $(6,386,105) $(3,450,446)
Retail Brokerage Services (3,911,522) (5,244,413) (5,050,471)
Other(1) (2,306,177) 256,359 (552,889)
------------- ------------- --------------
Total Pre-Tax Income $(4,906,616) $(11,374,159) (9,053,806)
============= ============= ==============
Assets:
Clearing Brokerage
Services $258,481,048 $251,258,860 $261,311,585
Retail Brokerage Services 4,084,488 6,453,057 3,902,947
Other(1) 339,331 6,872,728 (2,775,115)
-------------- ------------- --------------
Total Assets $262,904,867 $264,584,645 $262,439,417
============== ============= ==============
(1) Includes consolidation and elimination entries and items allocated to the
holding company and various immaterial subsidiaries.
The Company has no international or foreign operations; its retail segment does,
however, service foreign accounts. Additionally, the Company has no single
customer or groups of customers under common control that constitute more than
10% of its consolidated revenues.
69
NOTE 19. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
In the normal course of business, the Company's customer and correspondent
clearing activities involve the execution, settlement and financing of various
customer securities transactions. These activities may expose the Company to
off-balance-sheet credit risk in the event that the customer is unable to
fulfill their contracted obligations. The Company's customer securities
activities are transacted on either a cash or margin basis. In margin
transactions, the Company extends credit to the customer, subject to various
regulatory and internal margin requirements, collateralized by cash and
securities in the customer's account. The Company monitors collateral and
required margin levels daily and, pursuant to such guidelines, requests
customers to deposit additional collateral or reduce securities positions when
necessary. The Company is also exposed to credit risk when its margin accounts
or a margin account is collateralized by a concentration of a particular
security and when that security decreases in value.
In addition, the Company executes and clears customer short sale transactions.
Such transactions may expose the Company to off-balance sheet risk in the event
that margin requirements are not sufficient to fully cover losses that customers
may incur. In the event that the customer fails to satisfy their obligations,
the Company may be required to purchase financial instruments at prevailing
market prices in order to fulfill the customer's obligations.
Securities sold but not yet purchased represent obligations of the Company to
purchase the securities at prevailing market prices. Therefore, the future
satisfaction of such obligations may be for an amount greater or less than the
amount recorded. The ultimate gain or loss is dependent on the price at which
the underlying financial instrument is purchased to settle the Company's
obligation under the sale commitment.
In accordance with industry practice, the Company records customer transactions
on a settlement date basis, which is generally three business days after trade
date. The Company is therefore exposed to risk of loss on these transactions in
the event of the customer's or broker's inability to meet the terms of his
contractual obligations, in which case the Company may have to purchase or sell
financial instruments at prevailing market prices. Settlement of these
transactions did not have a material effect on the Company's financial condition
or results of operations.
As a securities broker-dealer, the Company provides services to both individual
investors and correspondents. The Company's exposure to credit risk associated
with the nonperformance of these customers in fulfilling their contractual
obligations pursuant to securities transactions can be directly impacted by
volatile trading markets.
The Company is a market maker for numerous public corporations whose stocks are
traded on the NASDAQ National Market System, NYSE or other national exchanges.
The Company selects companies in which it makes a market based on a review of
the current market activity, and also to facilitate trading activity of its own
and correspondent's clients. Market making may result in a concentration of
securities which may expose the Company to additional off-balance sheet risk.
70
NOTE 20. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Year Ended December 31
2003 2002 2001
Cash paid for:
Interest $1,062,663 $1,942,628 $7,299,563
Income taxes 79,977 330,308 70,000
Cash received from income tax refund --
4,629,066 3,854,492 --
Supplemental disclosure of non-cash investing and financing activities:
For the Year Ended December 31, 2003:
Treasury stock used to pay stock bonuses to employees of $142,695. Note payable
executed on lease abandonment of $611,111 less payments of $41,667 120,000
common shares, issued in connection with lease abandonment, valued at market
value of $388,800 46,560 common shares, issued in connection with Mr. Stock
account acquisition, valued at the average closing price on the 10 business days
preceding issuance, of $155,556. For the Year Ended December 31, 2002: 70,741
common shares, valued at market prices at the date of issuance, issued to
acquire intangible assets valued at $913,982.
71
NOTE 21. UNAUDITED SUPPLEMENTAL QUARTERLY FINANCIAL INFORMATION
Below is selected quarterly financial data for each fiscal quarter during the
years ended December 31, 2003 and 2002. This information should be read in
conjunction with the consolidated financial statements included elsewhere
herein.
First Second Third Fourth
Quarter Quarter Quarter Quarter
------------- ----------- ----------- --------------
2003
Revenues $4,989,325 $5,046,186 $3,969,582 $5,895,033
Income (loss) before taxes (1,001,660) (2,575,821) (1,714,380) 385,245
Net income (loss) (681,271) (1,786,477) (1,139,391) (2,341,825)
Basic earnings per share (0.45) (1.19) (0.73) (1.43)
Diluted earnings per share (0.45) (1.19) (0.73) (1.43)
2002
Revenues $5,276,121 $5,961,733 $5,492,035 $5,657,990
Income (loss) before taxes (617,874) (5,208,141) (1,755,631) (3,792,512)
Net income (loss) (407,874) (3,518,141) (1,085,631) (2,662,512)
Basic earnings per share (0.29) (2.47) (0.74) (1.82)
Diluted earnings per share (0.29) (2.47) (0.74) (1.82)
Unusual or infrequently occurring items:
Fourth quarter 2003:
During the Forth quarter of 2003 the Company provided an allowance for its
federal income tax receivable in the amount of $1,615,051 and deferred taxes in
the amount of $982,019. This increased income tax expense for the quarter.
Second quarter 2003:
During the Second quarter of 2003 the Company took a $1,500,000 charge for the
abandonment of the lease in Oakland, California.
Second quarter 2002:
During the second quarter of 2002 the Company accrued a $3,000,000 charge
related the arbitration award to Secured Equity Title and Appraisal Company.
First quarter 2002:
During the first quarter of 2002 the Company reversed $960,000 accrued for an
anticipated payment to the Securities and Exchange Commission.
72
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On June 27, 2002, we engaged Ernst & Young LLP to serve as our independent
auditors for 2002. Prior to that date, Arthur Andersen LLP had served as our
independent public accountant. The decision to replace Arthur Andersen LLP was
recommended by the Audit Committee of our Board of Directors and approved by our
Board of Directors. The Audit Committee of our Board of Directors again
recommended Ernst & Young LLP to serve as our independent auditors for 2003, and
this was approved by our Board of Directors.
During 2003, there were no disagreements with Ernst & Young LLP on any matter of
accounting principles or practices, financial statement disclosure or auditing
scope or procedure with respect to our consolidated financial statements that if
not resolved to the independent accountants' satisfaction, would have caused
them to make reference to the subject matter of the disagreement in connection
with their reports on our consolidated financial statements for the fiscal year
ended December 31, 2003 and there were no other matters or reportable events as
defined in Item 304(a)(1)(v) of Regulation S-K.
The report of Arthur Andersen LLP dated February 27, 2002 expressed an
unqualified opinion on the consolidated financial statements for JB Oxford
Holdings and subsidiaries as of and for the two years ended December 31, 2001
and 2000.
Furthermore, during the fiscal years ended December 31, 2001 and 2000, and the
subsequent interim period up through June 27, 2002, there were no disagreements
with Arthur Andersen LLP on matters of accounting principle or practices,
financial statement disclosure, or audit scope or procedure that, if not
resolved to their satisfaction, would have caused Arthur Andersen LLP to refer
to the subject matter in connection with their report on our consolidated
financial statements for such years; and there were no reportable events as
defined in Item 304(a)(1)(v) of Regulation S-K.
We provided Arthur Andersen LLP with a copy of the foregoing disclosures. A copy
of a letter dated June 27, 2002 from Arthur Andersen LLP addressed to the
Securities and Exchange Commission stating its agreement with such statements is
attached as Exhibit 16 to our Form 8-K filed on June 28, 2002.
During the two fiscal years and the subsequent interim period up through June
27, 2002, we did not consult Ernst & Young LLP, with respect to the application
of accounting principles to a specified transaction, either completed or
proposed, or the type of audit opinion that might be rendered on our
consolidated financial statements, or any other matters or reportable events
listed in Items 304(a)(1)(iv) and (v) of Regulation S-K.
ITEM 9A. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
We have adopted internal controls and procedures in order to ensure that the
information required to be disclosed in the report is recorded, processed,
summarized and reported on a timely basis. We carried out an evaluation (the
"Evaluation"), under the supervision and with the participation of our
73
Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO"), of the
effectiveness of the design and operation of our disclosure controls and
procedures ("Disclosure Controls") as of the end of the period covered by this
report. Based on the Evaluation, our CEO and CFO concluded that our disclosure
controls and procedures are effective as of the end of the period covered by
this report.
CHANGES IN INTERNAL CONTROLS
We have also evaluated our internal controls for financing reporting, and there
have been no changes in our internal controls during the most recent fiscal
quarter that have materially affected, or is reasonably likely to materially
affect our internal controls over financial reporting.
CEO AND CFO CERTIFICATIONS
In Exhibits 31.1 and 31.2 of this report there are certifications of the CEO and
the CFO. The certifications are required in accordance with Section 302 of the
Sarbanes-Oxley Act of 2002 (the "Section 302 Certifications"). This Item of this
report, which you are currently reading is the information concerning the
Evaluation referred to in the Section 302 Certifications and this information
should be read in conjunction with the Section 302 Certifications for a more
complete understanding of the topics presented.
74
PART III
ITEMS 10, 11, 12, AND 13. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT;
EXECUTIVE COMPENSATION; SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT; AND CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by these Items is omitted because the Company will
file, by April 29, 2004, a definitive proxy statement pursuant to Regulation
14A, which information is incorporated herein by reference as if set out in
full.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Fees paid to Ernst & Young LLP, the Company's Principal Auditors:
2003 2002
-------- -------
Audit Fees $174,026 $201,250
Audit-Related Fees 5,335 (1) --
Tax Services -- --
All Other Fees -- --
(1) Consulting regarding asset acquisitions
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
The financial statements and schedules required to be filed by Item 8 of this
form and paragraph (d) are contained herein as follows:
Page
--------
Report of Independent Auditors 41
Report of Independent Public Accountants 42
Consolidated Statements of Financial Condition December 31, 2002 and
2001 43-44
Consolidated Statements of Operations Years Ended December 31, 2002,
2001 and 2000 45-46
Consolidated Statements of Changes in Shareholders' Equity
(Deficit)Years Ended December 31, 2002, 2001 and 2000 47
Consolidated Statements of Cash Flows Years Ended December 31, 2002,
2001 and 2000 48
Notes to Consolidated Financial Statements 49-72
Financial Statement Schedule I - Condensed Financial Statements (Parent
Company Only) 79-86
Financial Statement Schedule II - Valuation and Qualifying Accounts 87
Listed below are exhibits as required by Item 601 of Regulation S-K:
INCORPORATED BY REFERENCE
----------------------------------
EXHIBIT FILING FILED
NUMBER EXHIBIT DESCRIPTION FORM FILE NO EXHIBIT DATE HEREWITH
- ------- ------------------- ---- ------- ------- ------ --------
2.1 Purchase Agreement dated as of May 8-K 0-16240 2.1 6/18/98
21, 1998 by and among the Company,
Third Capital Partners, LLC, a
Tennessee limited liability
company, 3421643 Canada Inc., a
Canadian corporation, Felix A. Oeri
and Oeri Finance Inc.
3.1 Articles of Incorporation of JBOH, 8-K 0-16240 1.0 10/30/90
as amended, October 16, 1990.
3.2 By-Laws of JBOH, as amended 10-K 0-16240 3.2 12/31/99
November 24, 1998.
75
INCORPORATED BY REFERENCE
----------------------------------
EXHIBIT FILING FILED
NUMBER EXHIBIT DESCRIPTION FORM FILE NO EXHIBIT DATE HEREWITH
- ------- ------------------- ---- ------- ------- ------ --------
4.1 9% Secured Convertible Note Due 8-K 0-16240 4.1 6/18/98
December 31, 1999 in the principal
amount of $2,000,000 between the
Company and Third Capital Partners,
LLC
4.2 Rights Agreement between the Company 10-K 0-16240 4.2 12/31/02
Company and Transfer Online, as
Rights Agent.
10.1 Standard Office Lease between St. 10-K 0-16240 10.3 12/31/92
George Beverly Hills, Inc. and OTRA
Clearing, Inc., dated January 31,
1992, to lease Beverly Hills office
space.
10.2 Data Service Agreement between 10-Q 0-16240 10.0 6/30/92
Securities Industry Software Corp.
and OTRA Clearing, Inc., dated June
8, 1992.
10.3 Assignment and Assumption 10-K 0-16240 10.8 12/31/93
Agreement for Beverly Hills office
space between JBOH and RKSI,
executed as of December 31, 1993.
10.4 Commercial office lease Agreement 10-Q 0-16240 10.1 6/30/95
between Bank of Communications. and
JB Oxford & Company, executed as of June, 1995, to lease New York
office space.
10.5 Commercial office lease Agreement 10-K 0-16240 10.16 12/31/95
between Brickell Square Corporation
Limited and JB Oxford Holdings,
Inc., executed as of February 21,
1996, to lease Miami office space.
10.6 JB Oxford Revocable Government 8-K 0-16240 10.1 3/8/99
Trust Agreement, dated as of
February 18, 1999, by and between
JB Oxford Holdings, Inc. and Third
Capital Partners, LLC, as Trustee.
10.7 Extension Agreement dated November 10-Q 0-16240 4.3 9/30/99
8, 1999, between the Company and
Third Capital Partners, LLC,
extending the maturity date of the
9% Senior Secured Convertible Note
in the principal amount of
$3,418,969.
10.8 Extension Agreement dated November 10-Q 0-16240 4.4 9/30/99
8, 1999, between the Company and
Third Capital Partners, LLC,
extending the maturity date of the
9% Secured Convertible Note in the
principal amount of $2,000,000.
76
INCORPORATED BY REFERENCE
----------------------------------
EXHIBIT FILING FILED
NUMBER EXHIBIT DESCRIPTION FORM FILE NO EXHIBIT DATE HEREWITH
- ------- ------------------- ---- ------- ------- ------ --------
10.9 Amendment No. 6 to Commercial 10-K 0-16240 10.9 12/31/00
office lease Agreement between Arden Realty Limited Partnership and JB
Oxford & Company, executed as of December 21, 2000, to lease Beverly
Hills office space.
10.10 Amendment No. 7 to Commercial 10-K 0-16240 10.10 12/31/00
office lease Agreement between
Arden Realty Limited Partnership
and JB Oxford & Company, executed
as of March 21, 2001, to lease
Beverly Hills office space.
10.11 Commercial office lease Agreement 10-K 0-16240 10.11 12/31/00
between Kennedy-Wilson Properties,
Ltd. and JB Oxford & Company,
executed as of January 18, 2001, to
lease Beverly Hills office space.
10.12 Extension Agreement dated December 10-K 0-16240 10.12 12/31/00
13, 2000, between the Company and
Third Capital Partners, LLC,
extending the maturity date of the
9% Senior Secured Convertible Note
in the principal amount of
$3,418,969.
10.13 Extension Agreement dated December 10-K 0-16240 10.13 12/31/00
13, 2000, between the Company and
Third Capital Partners, LLC,
extending the maturity date of the
9% Secured Convertible Note in the
principal amount of $2,000,000.
10.14 Extension Agreement dated December 10-K 0-16240 10.14 12/31/01
31, 2001, between the Company and
Third Capital Partners, LLC,
extending the maturity date of the
9% Senior Secured Convertible Note
in the Principal amount of
$3,418,969.
10.15 Extension Agreement dated December 10-K 0-16240 10.15 12/31/01
31, 2001, between the Company and
Third Capital Partners, LLC,
extending the maturity date of the
9% Secured Convertible Note in the
Principal amount of $2,000,000.
10.16 Note Extension Agreement dated 8-K 0-16240 4.1 2/13/03
December 31, 2002 between the
Company and Third Capital Partners,
LLC.
16 Letter to SEC from Arthur Andersen 8-K 0-16240 16.0 6/28/02
dated June 27, 2002.
21 List of Subsidiaries. X
23.1 Consent of Ernst & Young. X
77
INCORPORATED BY REFERENCE
----------------------------------
EXHIBIT FILING FILED
NUMBER EXHIBIT DESCRIPTION FORM FILE NO EXHIBIT DATE HEREWITH
- ------- ------------------- ---- ------- ------- ------ --------
23.2 Notice regarding consent of Arthur X
Andersen LLP, Independent Public
Accountants.
24 Power of Attorney (appears on X
signature page of this report)
28 Employee Stock Ownership Plan. 10-K 0-16240 28 12/31/88
31.1 Rule 13a-14(a)/15d-14(a) X
Certification of Christopher L. Jarratt, Chief Executive Officer,
pursuant to Section 906 of Sarbanes-Oxley Act of 2002, filed herewith.
31.2 Rule 13a-14(a)/15d-14(a) X
Certification of Michael J. Chiodo,
Chief Financial Officer, pursuant
to Section 906 of Sarbanes-Oxley
Act of 2002, filed herewith.
32.1 Section 1350 Certifications. X
32.2 Section 1350 Certifications. X
REPORTS ON FORM 8-K
On November 18, 2003, the Company filed a Report on Form 8-K, dated November 18,
2003, reporting under Item 9 Regulation FD Disclosure, its results of operations
and financial condition for the third quarter of 2003.
78
SCHEDULE I. CONDENSED FINANCIAL INFORMATION (PARENT COMPANY ONLY)
JB OXFORD HOLDINGS, INC. STATEMENTS OF FINANCIAL CONDITION
December 31
2003 2002
------------ ------------
ASSETS:
Cash and cash equivalents $ 26,464 $ 745,969
Cash subject to prejudgment writ of attachment -- 654,846
Investment in subsidiaries 17,303,557 18,857,192
Receivables from subsidiaries 4,270,715 2,848,881
Income taxes receivable -- 3,745,244
Deferred income taxes -- 1,862,019
Other assets 182,420 52,442
------------ ------------
TOTAL ASSETS $ 21,783,156 $ 28,108,747
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY:
LIABILITIES:
Accounts payable and accrued liabilities $ 2,944,923 $ 4,578,045
Loans from shareholders 5,418,696 5,418,696
Notes payable 2,458,819 1,889,375
------------ ------------
TOTAL LIABILITIES 10,822,438 11,886,116
------------ ------------
COMMITMENTS AND CONTINGENCIES (NOTE 5)
SHAREHOLDERS' EQUITY:
Common stock ($0.01 par value, 100,000,000
shares authorized; 1,756,499 and 1,589,939
shares issued) 17,565 15,899
Additional paid-in capital 18,039,086 17,496,396
Retained earnings (deficit) (5,425,090) 1,329,564
Treasury stock, 83,244 and 130,494 shares at cost (1,670,843) (2,619,228)
------------ ------------
TOTAL SHAREHOLDERS' EQUITY 10,960,718 16,222,631
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 21,783,156 $ 28,108,747
============ ============
See accompanying notes.
79
JB OXFORD HOLDINGS, INC. STATEMENTS OF OPERATIONS
For The Years Ended December 31
2003 2002 2001
------------ ------------ ------------
REVENUES $ 641,146 $ 2,376,011 $ 4,366,405
------------ ------------ ------------
EXPENSES
General and administrative 2,230,678 1,271,365 3,508,483
Interest expense 643,556 736,481 1,128,057
Bad debt and settlement expense -- 141,667
------------ ------------ ------------
Total expenses 2,874,234 2,007,846 4,778,207
------------ ------------ ------------
Income (loss) before equity interest (2,233,088) 368,165 (411,802)
in subsidiary income
Equity interest in subsidiary income
(loss) (2,673,528) (11,742,373) (8,642,004)
------------ ------------ ------------
Income (loss) before income taxes (4,906,616) (11,374,208) (9,053,806)
Income tax provision (benefit) 1042,348 (3,900,000) (2,112,050)
------------ ------------ ------------
Net income (loss) $ (5,948,964) $ (7,474,208) $ (6,941,756)
============ ============ ============
JB OXFORD HOLDINGS, INC. STATEMENTS OF CASH FLOWS
For The Years Ended December 31
2003 2002 2001
----------- ----------- -----------
Net cash provided by (used in) operating
activities $ 185,341 $ 1,625,031 $ 3,772,603
----------- ----------- -----------
Cash flows from investing activities:
Investment in subsidiaries (250,000) (55,000) (77,500)
Acquisitions of customer accounts -- (1,753,707) (2,400,000)
Capital expenditures -- -- (1,536)
----------- ----------- -----------
Net cash used in investing activities (250,000) (1,808,707) (2,479,036)
----------- ----------- -----------
Cash flows from financing activities:
Notes payable -- (2,740,000) (2,008,000)
Purchase of treasury stock -- -- (167,080)
----------- ----------- -----------
Net cash provided by (used in) financing
activities -- (2,740,000) (2,175,080)
----------- ----------- -----------
Net increase (decrease) in cash and cash
equivalents (61,659) 583,738 (881,513)
Cash and cash equivalents at beginning of
year 91,123 162,231 1,043,744
----------- ----------- -----------
Cash and cash equivalents at end of year $ 26,464 $ 745,969 $ 162,231
=========== =========== ===========
See accompanying notes.
80
JB OXFORD HOLDINGS, INC. NOTES TO CONDENSED FINANCIAL INFORMATION
NOTE 1. BASIS OF PRESENTATION
The parent company only financial statements present JB Oxford Holdings, Inc.'s
statements of financial condition, operations and cash flows by accounting for
the investment in its consolidated subsidiaries using the equity method.
The accompanying condensed financial information should be read with the
consolidated financial statements and notes to the consolidated financial
statements.
NOTE 2. REVENUES
The Company receives substantially all of its revenues from its subsidiaries.
Management fees of $480,000, $2,160,000 and $3,000,000 were received from NCC in
2003, 2002 and 2001, respectively. The balance of revenues for 2003, 2002 and
2001 consists of rents received from subsidiaries for office space and furniture
and equipment and interest earned on cash balances.
NOTE 3. RESTRICTIONS ON THE TRANSFER OF FUNDS FROM SUBSIDIARY
TO THE PARENT
NCC and JBOC, as part of normal broker-dealer activities have minimum net
capital requirements as imposed by regulatory agencies that restricts the amount
of funds that can be transferred to the Parent Company. See Note 15 to the
consolidated financial statements for discussion of these requirements.
NOTE 4. LOANS FROM SHAREHOLDERS/RELATED PARTY TRANSACTIONS
THIRD CAPITAL PARTNERS, LLC
The Company has entered into four transactions with Third Capital Partners, LLC
("TCP") and a related affiliate, Third Capital, LLC. They are as follows:
1. On or about May 26, 1998, TCP acquired $3,418,695.59 principal amount of
the 9% Secured Convertible Note, issued pursuant to the Company's Senior
Secured Convertible Note Purchase Agreement dated March 10, 1995, and
having a maturity date of December 31, 1999. The note, when issued, was
convertible into the Company's $0.01 par value common stock at a rate of
$1.00 per share, before adjustment for the 1-for-10 reverse split which
occurred in October 2002. Under the initial conversion rate, this note was
convertible into 3,418,695 shares of common stock, before adjustment for
the reverse split.
On or about June 8, 1998, TCP acquired $2,000,000.00 principal amount of
the 9% Secured Convertible Note, issued pursuant to the Company's Senior
Secured Convertible Note Purchase Agreement dated June 8, 1998, and having
a maturity date of December 31, 1999 (the two notes are together referred
to as the "Secured Convertible Notes"). As part of the acquisition, the
Company and TCP agreed to adjust the conversion rate for the Secured
Convertible Notes to $0.70 per share, before adjustment for the 1-for-10
reverse split which occurred in October 2002. After the adjustment in
conversion rate, the Secured Convertible Notes were convertible into
81
7,740,993 shares of common stock, before adjustment for the reverse split.
The issuance of the Secured Convertible Notes was not registered under the
Securities Act of 1933 in reliance upon the exemption set forth in Section
4(2) of that Act relating to transactions by an issuer not involving a
public offering.
On or about November 8, 1999, the maturity date for the Secured
Convertible Notes was extended to December 31, 2000. On or about December
13, 2000, the maturity date for the Secured Convertible Notes was extended
to December 31, 2001. On or about December 31, 2001, the maturity date for
the Secured Convertible Notes was extended to December 31, 2002. On or
about December 31, 2002, the Company and TCP entered into a Note Extension
Agreement which, i) extended the maturity date to December 31, 2003, and
ii) adjusted the conversion rate to $2.67 per share of common stock, the
closing price of the Company's common stock on the Nasdaq SmallCap Market
on December 31, 2002. As a result, and after giving effect to the 1-for-10
reverse split which occurred in October 2002, the Secured Convertible
Notes are convertible into 2,029,474 shares of common stock. On December
31, 2002, the maturity date for the Secured Convertible Notes was extended
to December 31, 2004. The conversion rate currently remains at $2.67 per
share, and the Secured Convertible Notes are currently convertible into
2,029,474 shares of common stock. Related interest expense for 2003, 2002
and 2001 was $487,683, $487,683, and $486,943 for the Secured Convertible
Notes.
2. On or about February 18, 1999, the Company approved a transaction between
TCP and Oeri Finance, Inc., and Felix A. Oeri (collectively, "Oeri"). Oeri
was a substantial shareholder of the Company prior to this transaction,
and Felix A. Oeri was Chairman of the Company's Board of Directors. The
transaction consisted of the following:
a. The Company agreed to waive certain rights it had under a Right of
First Refusal, dated May 27, 1998, to acquire shares of Company
stock held by Oeri;
b. Oeri forgave the outstanding balance of $728,125 (reported as an
extraordinary item net of income tax in 1999) due from the Company
under a Promissory Note dated May 27, 1998, in the original amount
of $1,213,125;
c. The Company transferred to Oeri Finance, Inc. all equipment and
furniture in its Basel, Switzerland office;
d. The Company established the JB Oxford Revocable Government Trust
(the "Trust"), and loaned it $586,915, which was used to purchase
469,540 shares of the Company's common stock at an average price of
$1.25 (46,954 shares at $12.50, after adjustment for the reverse
stock split in October 2002). The Trust terminated pursuant to its
terms on February 18, 2001, and ownership of the Trust's shares of
the Company's common stock were transferred to the Company in
satisfaction of the loan; and,
e. The Company agreed to allow TCP to acquire 100,000 shares of the
Company's common stock from Oeri Finance, Inc. for total
consideration of $10.00 (10,000 shares after adjustment for the
reverse stock split in October 2002).
82
Subsequent to these transactions, Oeri filed 13D statements with the SEC
indicating ownership of less than 5% of the Company's stock.
3. On or about December 13, 2000, the Company loaned $2,500,000 to TCP,
pursuant to a written Promissory Note, payable on or before December 31,
2001. The note bears interest at the rate of 9 1/4%, and may be pre-paid
in whole or in part without penalty. The loan was a re-classification of a
portion of a pre-existing margin debt owed by TCP to the Company's
brokerage subsidiary, and was secured by the $2,000,000 Secured
Convertible Note and Company common stock. The re-classification was
entered into to ensure that the amount of the remaining portion of the
margin debt complied with the Company's lending policies.
By agreement dated December 31, 2001, the maturity date for the Promissory
Note was extended to December 31, 2002. Effective on or about March 22,
2002, as part of a restructuring of inter-company debts between the
Company and its wholly-owned subsidiary, NCC (then known as JB Oxford &
Company), the Promissory Note was assigned to NCC, and the maturity date
was extended to December 31, 2007.
4. By agreement dated December 16, 1999, the Company agreed to pay a monthly
advisory fee to Third Capital, LLC, an affiliate of TCP, in the amount of
$85,000 plus all direct and indirect expenses incurred in providing such
advisory services to the Company and its subsidiaries. Since that time, t
0 6 members of Third Capital, LLC have held the executive positions of
Chairman, Chief Executive Officer, and President of the Company and its
subsidiaries. Effective October 2001, Third Capital, LLC agreed to reduce
its fee by 10%, to $76,500 per month, plus expenses. The advisory fee paid
to Third Capital, LLC was $918,000, $918,000, and $1,042,276 in 2003,
2002, and 2001.
FORMER SHAREHOLDER TRANSACTIONS
The Company issued $2,867,500 in demand notes to former shareholders during
1997. The notes bore interest at 8 1/4%, payable quarterly. In 1998, $250,000
was paid on the demand notes. In 1999, $728,125 of the debt was forgiven by Oeri
(see 2b, above), leaving a balance due of $1,889,375, which was reclassified to
notes payable in 1999.
A $1,000,000 subordinated loan agreement, payable to Oeri Finance, Inc., matured
by its terms on March 31, 1999. The balance due was reclassified to note payable
at that time.
Since in or about March 1999, the Company has refused to make payment under the
notes payable totaling approximately $2.9 million, plus interest, and has
asserted defenses and counterclaims against the alleged holders of the notes
related to: i) an award entered jointly against the Company and the holders
related to alleged wrongful conduct by the Company in clearing certain customer
accounts during the time that the holders of the notes payable ran the Company;
and, ii) the Company has acquired a Judgment against Oeri Finance, Inc., which
it intends to use as a set-off against claims on the notes payable. The amount
of the Judgment acquired is substantially in excess of the total claimed due on
the notes payable. (For a further discussion of the pending litigation related
to these claims, please see Note 16, paragraphs 2 and 3.)
83
NOTE 5. COMMITMENTS AND CONTINGENCIES
The Company is a party to a number of pending legal, arbitration or
administrative proceedings incidental to its business, including customer claims
regarding brokerage transactions, and claims related to clearing services
arising out of the failure of certain correspondent firms. All of the legal,
arbitration and administrative proceedings have arisen in the ordinary conduct
of its business. Those proceedings that management believes may have a
significant impact on the Company are described below. However, there can be no
assurance that in the future, other current or future proceedings will not have
a material adverse effect on the Company's financial condition or results of
operations. In particular, if the Company is required to pay a judgment in
excess of the amount reserved, such a payment would negatively impact the
financial condition of the Company.
SEC MUTUAL FUND INVESTIGATION
In the course of the ongoing mutual fund investigations, the NCC received a
"Wells Notice" from the staff of the SEC's Los Angeles office on November 6,
2003, stating it intention to recommend that the SEC institute civil and
administrative proceedings against NCC seeking injunctive relief, disgorgement,
prejudgment interest and civil penalties for alleged violations of Sections 8A
and 17(a) of the Securities Exchange Act of 1933, Sections 10)(b), 15(b) and 21C
of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder and Sections
9(b) and 9(f) of the Investment Company Act of 1940 and Rule 22c-1 thereunder.
The Company believes it has complied with all requests of documents and provided
testimonies in response to subpoenas from the New York Attorney General, the SEC
and the NASD regarding the allegations of NCC's violation in forward pricing
principles. While NCC admits no wrongdoing and intends to vigorously defend
itself, no assurance can be given as to the outcome of this matter. Although the
likelihood of loss is probable, the Company has not accrued any amounts related
to this matter, as the amount of loss is not estimable at this time. However,
substantial penalties from fines or settlements resulting from an adverse
outcome or judgment in this matter could have a material adverse effect on the
financial position and results of operations of the Company.
OTHER REGULATORY MATTERS
In April 2003 we were notified by the SEC in the course of a routine examination
that we had a deficiency since September 2002 in our required reserve account
deposits in violation of SEC rules. This deficiency identified by the SEC, which
ranged between $120 million and $145 million, was caused primarily as a result
of our deposit of customer funds into certificates of deposit and money market
accounts at a financial institution in excess of the amount of funds permitted
to be maintained at any one financial institution. Our inadvertent inclusion of
accounts maintained by certain of our executive officers and directors in our
reserve account calculations also contributed to the deficiency since under the
SEC rules we are not permitted to include such accounts in our calculations. We
subsequently brought our required reserve accounts into compliance within the 2
weeks requested by the SEC. Although the deficiency was in violation of the
applicable SEC rules, at no time were any customer funds at risk of loss. The
NASD subsequently required us to pay a $15,000 fine and the matter was concluded
in early 2004.
84
USAO SETTLEMENT AGREEMENT RELATED TO PRIOR MANAGEMENT
In February 2000, we entered into a settlement agreement with the United States
Attorney's Office for the Central District of California (the "USAO") in
connection with the USAO's investigation of certain of our former affiliates and
management which investigation commenced in 1997. The USAO investigation, and
the concurrent investigation by the SEC, related to an alleged failure to
disclose the relationship of an individual who was purported to be secretly in
control of the company and the trading practices of such individual. Our current
executive officers and directors were not the subject of the USAO or the SEC
investigations.
While we maintained our innocence, we agreed to pay $2,000,000 to the USAO over
a period of three years in settlement of the investigation and to offset the
USAO's costs of its investigation. We recognized a charge of $2,300,000 in the
fourth quarter of 1999 to account for the settlement agreement with the USAO and
an anticipated settlement with the SEC.
Under the terms of the settlement agreement, if we fail to make payment of any
installment when due, the entire unpaid balance will become immediately due and
payable, and if we sell a controlling interest in our operating subsidiary to a
third party, the remaining unpaid installments must be paid prior to the closing
of the sale.
In May 2002, the settlement agreement was amended to modify the payment schedule
for the balance owing of $1,000,000 under the settlement agreement. No payment
was required to be made in 2002 and the balance was to be paid in equal annual
installments in February 2003 and February 2004. In February 2003, the USAO
agreed to extend the due date on the $500,000 payment then due under the
settlement agreement. We made a partial payment of $50,000 on March 31, 2003,
and the USAO extended the time for any further payment. As of December 31, 2003,
the Company owed a balance of $950,000. The Company made a partial payment of
$50,000 in February 2004, and is continuing to negotiate with the USAO regarding
the timing and amount of subsequent payments. The Company originally accrued
payments related to this matter totaling $3.0 million, to cover both the
settlement with the USAO, and a potential settlement with the SEC. The SEC
notified the Company in 2002 that it had closed its investigation without action
or monetary assessment. Accordingly, the amount accrued has been reduced to
$950,000 at year end, the remaining balance due to the USAO.
The Company is a party to a lawsuit entitled EBC Trust v. JB Oxford Holdings,
Inc., et als., pending in the Federal District Court in Los Angeles. In this
suit, EBC Trust is seeking payment of the $2.9 million in notes payable
described above in the former shareholder transaction section of Note 13. In
July 2002, the court magistrate granted a pre-judgment attachment against the
assets of the Company in favor of EBC Trust. In January 2003, the Court reversed
the magistrate's order and dissolved the attachment. In January 2003, EBC Trust
amended its claim to assert additional claims against the Company and to add
claims against the officers and directors of the Company, as well as to add a
claim against NCC under the $1,000,000 Oeri subordinated note. By Order dated
October 14, 2003, in response to motions filed by the Company, the Court
dismissed several claims, struck portions of the Amended Complaint, and
compelled EBC Trust to arbitrate all claims against NCC. As to the remaining
claims, the Company has asserted a number of defenses to EBC Trust's claims,
including fraud, and contribution related to a judgment entered against EBC
85
Trust's predecessor-in-interest under the notes payable and NCC in an NASD
arbitration commenced by Stanly J. Cohen, Receiver for Secured Equity Title and
Appraisal Agency Corp. NCC settled all of the claims against it in that matter
in 2002, and as a part of that settlement, obtained the assignment from Secured
Equity of a Judgment against Oeri Finance, Inc. Accordingly, the Company has
asserted a claim of offset for the Judgment against Oeri Finance, Inc. As stated
in Note 13, the Company has recorded liabilities of approximately $2.9 million
on its balance sheet in notes payable, which management believes is a sufficient
reserve for any adverse decision in this matter.
In or about December 2003, EBC Trust commenced an arbitration action with the
National Association of Securities Dealers, Inc., against JBOC, seeking recovery
on the $1,000,000 subordinated note originally issued to RMS Network, Inc., and
subsequently assigned with approval from the Company and the NASD to Oeri
Finance, Inc. The Company intends to vigorously defend the action and believes
that it has meritorious defenses including, without limitation: i) the suit is
brought against the wrong party; ii) The suit is brought by the wrong party, as
no valid assignment has ever been approved by the Company or the NASD to EBC
Trust, as required by the terms of the note; and iii) the Company will assert an
offset for the Judgment obtained against Oeri Finance, Inc., described above. As
stated in Note 13, the Company has recorded liabilities of approximately $2.9
million on its balance sheet in notes payable, which management believes is a
sufficient reserve for any adverse decision in this and the preceding matter.
LITIGATION RELATED TO ACCOUNT ACQUISITIONS
In October 2002, Share King LLC, as successor to Mr. Stock, Inc. commenced an
arbitration proceeding related to the acquisition by us of the accounts of Mr.
Stock. We countersued for violations of the purchase agreement by Mr. Stock.
That litigation was settled in August 2003, on terms more favorable to us than
we originally accrued for, and the cost of the Mr. Stock acquisition was
adjusted down $356,174 in 2003, as a result of settlement of the arbitration. As
a part of the settlement, we are required to distribute cash and/or stock, at
our election to Share King LLC. In early 2004, a further dispute arose with
Share King LLC regarding the registration requirements related to the stock to
be issued. A decision is pending on that matter by the arbitration panel. If we
receive an adverse ruling from the panel, we could be required to make
subsequent payments to Share King LLC in cash, instead of in our choice of cash
and/or stock.
Future annual minimum rental payments required under operating leases that have
initial or remaining non-cancellable lease terms in excess of one year as of
December 31, 2003, were as follows:
Year ending December 31:
2004 $9,977
2005 2,494
2006 --
2007 --
2008 --
Thereafter --
--------------
Total $12,471
==============
86
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
Additions
Balance at charged
beginning to costs Balance at
of period and Deductions end of
expenses period
2003:
Allowance for:
Receivable from customers $2,701,183 $ 80,122 $ -- $2,781,305
2002:
Allowance for:
Receivable from customers $2,625,178 $ 138,512 $ (62,507) $2,701,183
2001:
Allowance for:
Receivable from customers $2,577,451 $1,146,244 $(1,098,517) $2,625,178
Deductions represent amounts written off.
87
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, JB Oxford Holdings, Inc. has duly caused this report to be signed
on its behalf by the undersigned thereunto duly authorized.
JB Oxford Holdings, Inc.
/s/ Christopher L. Jarratt
- ----------------------------------
Christopher L. Jarratt,
Chairman of the Board and
Chief Executive Officer
KNOW ALL MEN BY THESE PRESENTS that each person whose signature appears
below constitutes and appoints Christopher L. Jarratt his or her true and lawful
attorney-in-fact and agent, with full power of substitution and resubstitution,
for him or her and in his name or her name, place and stead, in any and all
capacities, to sign any and all amendments to this Annual Report of Form 10-K,
and to file the same, with all exhibits thereto and other documents in
connection therewith, with the Securities and Exchange Commission, granting unto
said attorney-in-fact and agent, full power to do and perform each and every act
and things required and necessary to be done in and about the premises, as fully
as he or she might or could do in person, hereby ratifying and confirming all
that said attorney-in-fact and agent or his substitutes or substitute, may
lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of JB Oxford Holdings,
Inc. and in the capacities and on the date indicated:
/s/ Michael J. Chiodo /s/ Mark M. Grossi
- ----------------------------------- ---------------------------------------
Michael J. Chiodo Mark M. Grossi, Director
Chief Financial Officer, Treasurer,
Chief Accounting Officer
Chief Executive Officer
/s/ Christopher L. Jarratt /s/ James G. Lewis
- ---------------------------------- --------------------------------------
Christopher L. Jarratt James G. Lewis, Director
Chairman of the Board and
/s/ David G. Mahood
--------------------------------------
David G. Mahood, Director
/s/ Terry N. Pefanis
--------------------------------------
March 29, 2004 Terry N. Pefanis, Director
88