UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2004
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 of incorporation or organization) (I.R.S. Employer
Identification No.)
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
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 the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date. As of May 8, 2004, the
Registrant had the following number of shares of common stock, $0.01 par value
per share, outstanding: 1,888,743.
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
JB Oxford Holdings, Inc. and Subsidiaries
Consolidated Statements of Financial Condition
March 31, 2004 December 31, 2003
(Unaudited)
-------------------- --------------------
Assets:
Cash and cash equivalents $ 5,831,319 $ 6,897,970
Cash and cash equivalents segregated under federal and other
regulations 110,847,999 130,748,572
Receivable from broker-dealers and clearing organizations 15,774,536 29,337,358
Receivable from customers (net of allowance for doubtful accounts of
$2,803,913 and $2,781,305) 102,808,913 78,372,056
Other receivables 816,100 2,139,865
Marketable securities owned - at market value 838,828 432,060
Notes receivable from shareholder 2,500,000 2,500,000
Furniture, equipment, and leasehold improvements (at cost - net of
accumulated depreciation and amortization of $6,769,222 and
$6,352,333) 1,906,688 2,195,783
Clearing deposits 5,396,834 6,542,595
Intangible assets (net of accumulated amortization of $3,899,618 and
$3,558,678) 2,616,897 2,957,837
Other assets 1,151,566 780,771
-------------------- --------------------
Total assets $250,489,680 $262,904,867
==================== ====================
See accompanying notes.
2
JB Oxford Holdings, Inc. and Subsidiaries
Consolidated Statements of Financial Condition
March 31, 2004 December 31, 2003
(Unaudited)
------------------ ------------------
Liabilities and shareholders' equity:
Liabilities:
Payable to broker-dealers and clearing organizations $ 37,326,238 $ 40,331,755
Payable to customers 189,682,266 195,340,295
Securities sold, not yet purchased - at market value 71,128 1,957,909
Accounts payable and accrued liabilities 5,222,732 5,436,675
Loans from shareholders 5,418,696 5,418,696
Notes payable 3,417,153 3,458,819
------------------ ------------------
Total liabilities 241,138,213 251,944,149
------------------ ------------------
Commitments and contingencies
Shareholders' equity:
Common stock ($.01 par value, 100,000,000 shares authorized, 1,888,743
and 1,756,499 shares issued) 18,887 17,565
Additional paid-in capital 18,504,431 18,039,086
Retained deficit (8,258,650) (5,425,090)
Treasury stock at cost, 46,994 and 83,244 shares (913,201) (1,670,843)
------------------ ------------------
Total shareholders' equity 9,351,467 10,960,718
------------------ ------------------
Total liabilities and shareholders' equity $250,489,680 $262,904,867
================== ==================
See accompanying notes.
3
JB Oxford Holdings, Inc. and Subsidiaries
Consolidated Statements Of Operations
(Unaudited)
For The Three Months Ended
March 31,
------------------------------------------------
2004 2003
---------------------- ------------------------
Revenues:
Clearing and execution $ 559,344 $ 789,383
Trading profits 30,575 560,992
Commissions 2,286,537 2,012,616
Interest 1,333,717 1,522,312
Other 18,408 104,022
---------------------- ------------------------
Total Revenues 4,228,581 4,989,325
---------------------- ------------------------
Expenses:
Employee compensation 1,489,828 1,934,739
Clearing and floor brokerage 266,676 258,550
Communications 555,033 543,256
Occupancy and equipment 970,806 1,143,311
Interest 257,120 333,495
Data processing charges 670,002 532,399
Professional services 1,253,899 591,067
Promotional 132,932 66,064
Bad debts 22,038 15,578
Amortization of intangible assets 340,939 370,621
Other operating expenses 458,540 201,905
---------------------- ------------------------
Total Expenses 6,417,813 5,990,985
---------------------- ------------------------
Loss before income taxes (2,189,232) (1,001,660)
Income tax provision (benefit) 2,200 (320,389)
---------------------- ------------------------
Net Loss $(2,191,432) $ (681,271)
====================== ========================
Basic Net Loss Per Share $(1.23) $(0.45)
Diluted Net Loss Per Share $(1.23) $(0.45)
Weighted average number of shares
Basic 1,786,764 1,506,170
Diluted 1,786,764 1,506,170
See accompanying notes.
4
JB Oxford Holdings, Inc. and Subsidiaries
Consolidated Statements Of Cash Flows
(Unaudited)
For The Three Months Ended
March 31,
------------------------------------------
2004 2003
------------------------------------------
Increase (decrease) in cash and cash equivalents:
Cash flows from operating activities:
Net loss $(2,191,432) $ (681,271)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Depreciation and amortization 727,828 709,741
Provision for bad debts 22,038 15,578
Changes in assets and liabilities:
Cash segregated under federal and other regulations 19,900,573 (10,704,853)
Receivable from broker-dealers and clearing organizations 13,562,822 (19,591,540)
Receivable from customers (24,458,895) 12,961,941
Other receivables 1,323,765 (83,833)
Securities owned (406,768) (1,851,004)
Clearing deposits 1,145,761 (48,408)
Other assets (370,795) (222,403)
Payable to broker-dealers and clearing organizations (3,005,517) 9,302,537
Payable to customers (5,658,029) 3,198,208
Securities sold not yet purchased (1,886,781) 55,316
Accounts payable and accrued liabilities 368,239 2,753,084
Income taxes payable/receivable -- (335,000)
------------------------------------------
Net cash used in operating activities (927,191) (4,521,907)
------------------------------------------
Cash flows from investing activities:
Capital expenditures (97,794) (74,667)
------------------------------------------
Net cash used in investing activities (97,794) (74,667)
------------------------------------------
Cash flows from financing activities:
Repayments of notes payable (41,666) --
------------------------------------------
Net cash used in financing activities (41,666) --
------------------------------------------
Net (decrease) in cash and cash equivalents (1,066,651) (4,596,574)
Cash and cash equivalents at beginning of the quarter 6,897,970 5,579,755
------------------------------------------
Cash and cash equivalents at end of the quarter $ 5,831,319 $ 983,181
==========================================
See accompanying notes.
5
JB Oxford Holdings, Inc. and Subsidiaries
Notes To Consolidated Financial Statements
(Unaudited)
Note 1. Company's Quarterly Report Under Form 10-Q
In the opinion of Management, the accompanying unaudited financial
statements contain all adjustments (all of which are normal and recurring in
nature) necessary to present fairly the financial statements of JB Oxford
Holdings, Inc. and subsidiaries (the "Company") for the periods presented. The
results of operations for the interim periods presented are not necessarily
indicative of the results to be expected for the full year. The accompanying
financial information should be read in conjunction with the Company's 2003
Annual Report on Securities and Exchange Commission ("SEC") Form 10-K. Footnote
disclosures that substantially duplicate those in the Company's Annual Report on
Form 10-K, including significant accounting policies, have been omitted.
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. The Company has incurred recurring
operating losses, has limited access to capital and has significant pending
litigation. Further, there is significant uncertainty with respect to the
outcome of a pending SEC investigation into the late trading conducted by the
Company. The report of the Company's independent accountants for the year ended
December 31, 2003, included an explanatory paragraph expressing substantial
doubt about the Company's ability to continue as a going concern.
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 2. Shareholders' Equity and Earnings Per Share
Effective January 1, 2004, the Company paid a bonus to employees in the
form of 36,250 shares of treasury stock. The market value at the time of the
grant was $115,514 and the original cost was $757,642. Additionally, the Company
issued 132,244 shares of its previously authorized unissued common stock in
connection with an acquisition of intangible assets. The total value of the
stock in the amount of $466,667 was determined based on the average closing
price for the ten business days prior to issuance.
6
The following table reconciles the numerators and denominators of the
basic and diluted earnings per share computation:
For The Three Months Ended March 31,
2004 2003
--------------------- ------------------
Basic Earnings Per Share
Net loss $(2,191,432) $(681,271)
--------------------- ------------------
Income available to common stockholders (numerator) (2,191,432) (681,271)
===================== ==================
Weighted average common shares outstanding (denominator) 1,786,764 1,506,170
===================== ==================
Basic Earnings Per Share $(1.23) $(0.45)
===================== ==================
Diluted Earnings Per Share
Net loss $(2,191,432) $(681,271)
Interest on convertible debentures, net of income tax -- --
--------------------- ------------------
Income available to common stockholders plus assumed conversions
(numerator) $(2,191,432) $(681,271)
===================== ==================
Weighted average common shares outstanding 1,786,794 1,506,170
Weighted average options outstanding -- --
Weighted average convertible debentures -- --
Stock acquired with option proceeds -- --
--------------------- ------------------
Weighted average common shares and assumed conversions outstanding 1,786,794 1,506,170
(denominator)
===================== ==================
Diluted Earnings Per Share $(1.23) $(0.45)
===================== ==================
The assumed conversions of options and convertible debt 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 the assumed conversions had been used, the
fully diluted shares outstanding for the quarters ended March 31, 2004 and 2003
would be 3,816,474 and 3,535,926, respectively.
The options carry exercise prices ranging from $2.20 to $91.25 at March
31, 2003 and 2002. Options to purchase 256,825 shares of common stock at March
31, 2004 expire at various dates through October 4, 2012.
Note 3. Stock 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. SFAS No 148 Accounting for Stock-Based Compensation - Transition and
Disclosure" requires the Company to provide information required by SFAS 123 on
a quarterly basis. No options were issued during the quarters ended March 31,
2004 and 2003. There is no pro forma net income or earnings per share to report
for those respective periods.
7
A summary of the status of the Company's stock options as of March 31 2004, and
2003, and changes during the periods ending on those dates is presented below:
March 31, 2004 March 31, 2003
Weighted Weighted
Shares average Shares average
------- -------- ------- --------
Outstanding at 256,825 $15.66 256,200 $26.88
be-ginning of period
Granted -- -- --
Exercised -- -- --
Forfeited (200) 35.94 (1,475) 11.06
------- -------
Outstanding at end of
period 256,625 15.64 254,725 15.75
======= =======
Options exercisable 256,625 15.64 253,225 15.88
at quarter-end
Weighted-average fair
value of options
granted during the
period $-- $--
Note 4. Regulatory Requirements
National Clearing Corp ("NCC") and JB Oxford & Company ("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 March 31, 2004, NCC had net capital of $9,164,823, which was $7,040,287
in excess of the minimum amount required. 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 computes its net capital requirement in accordance with the aggregate
indebtedness standard. The Rule requires the maintenance of minimum net capital
and requires the ratio of aggregate indebtedness to net capital, both as
defined, not to exceed 15 to 1. At March 31, 2004, JBOC had net capital of
$480,037, which was $473,955 in excess of the minimum amount required. At
December 31, 2003, JBOC had net capital of $420,575, which was $414,478 in
excess of the minimum amount required. JBOC's net capital ratio was less than 1
to 1 for both periods.
Note 5. Contingent Liabilities
The Company and its subsidiaries are a party to a number of pending legal
or administrative proceedings incidental to the Company's business, including
customer brokerage transactions claims as well as matters related to the
8
Company's clearing services. All of the legal, arbitration and administrative
proceedings have arisen in the ordinary conduct of its business. Those that may
have a significant impact on the Company have been reported in previous filings.
There has been no significant change in the legal and administrative proceedings
reported in the Company's Form 10-K and Form 10-K/A at December 31, 2003.
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 specific amounts
related to this matter, as the amount of loss is not estimable at this time. The
Company maintains a general litigation accrual, which it believes are adequate
to cover the minimum estimated loss. 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.
Litigation Related to Oeri Notes
The Company is a party to a lawsuit entitled EBC Trust v. JB Oxford Holdings,
Inc., et al., 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 from a
former shareholder. 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. 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.
9
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 counter-sued 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.
USAO Settlement Agreement Related to Prior Management
In April 2004, the Los Angeles Office of the United States Attorney's
Office (the "USAO") agreed to accept a lump sum payment of $500,000 in full
settlement of all amounts remaining due under the Settlement Agreement,
previously reported in the 2003 Form 10-K and prior filings. This settlement is
expected to be finalized in the second quarter of 2004.
Note 6. Supplemental Disclosures of Cash Flow Information
For The Three Months Ended March 31,
------------------------------------------------
2004 2003
---------------------- ----------------------
Supplemental Disclosures of Cash Flow Information
Cash paid during the quarter for:
Interest $218,152 $281,102
Income taxes 2,200 9,233
Supplemental disclosure of non-cash investing and financing activities:
Treasury stock bonus issued to employees in the amount of $115,514 and
$142,695 for 2004 and 2003, respectively.
Common stock issued to acquire intangible assets in the amount of $466,667
for 2004.
10
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Special Note Regarding Forward-Looking Statements
Certain statements in this Quarterly Report on Form 10-Q, particularly under
Items 2 and 3, as well as certain information provided periodically in writing
or orally by us, constitute "forward-looking statements" within the meaning of
the Private Securities Litigation Reform Act of 1995. These forward-looking
statements involve known and unknown risks, uncertainties, and other factors
which may cause the actual results, performance, or achievements of the Company
to be materially different from any future results, performance, or
achievements, expressed or implied by such forward-looking statements.
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 business is headquartered in Los Angeles and we have additional
branches in New York and Minneapolis.
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.jboxford.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.
Recent Developments
In April 2004, the Los Angeles Office of the United States Attorney's Office
(the "USAO") agreed to accept a lump sum payment of $500,000 in full settlement
of all amounts remaining due under the Settlement Agreement, previously reported
in the 2003 Form 10-K and prior filings. This settlement is expected to be
finalized in the second quarter of 2004.
On April 12, 2004, the Company received a "Wells Notice" from the staff of the
SEC's Pacific Regional office, stating its intention to recommend that the SEC
institute civil and administrative proceedings against the Company related to
the SEC investigation of mutual fund trading practices by its NCC subsidiary. As
previously reported, the Company's subsidiary, NCC, received a similar notice
from the SEC in November 2003. The Company has responded to the notice, and is
attempting to seek a prompt resolution of these matters, although there is no
assurance that such resolution can be reached or that the ultimate impact on the
Company will not be material.
11
On April 15, 2004, James G. Lewis resigned as President and Chief Operating
Officer, and as a director, of JB Oxford Holdings, Inc. The Board of Directors
elected Christopher Jarratt to serve as President until the next election of
officers of the Company. Mr. Lewis continues to assist the Company through his
affiliation with Third Capital, LLC.
On April 30, 2004, we introduced our new customer website developed internally
using technology obtained in a prior acquisition. In addition to providing our
customers with a state-of-the-art trading platform offering expanded market
information and research tools, the upgrade allows us full control over future
development of the website, while allowing us to operate the website at a
significant cost savings over our previous outsourced website.
Discount Brokerage Services
JBOC provides a full line of brokerage services and products to customers,
including the ability to buy and sell securities, security options, mutual
funds, fixed income products, annuities and other investment securities. We
continue to upgrade and improve our 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, JBOC's Internet sites (www.jboxford.com
and www.mrstock.com) provide market quotes, charts, company research, and
customer account information, such as cash balances, portfolio balances and
similar information.
The discount brokerage division has suffered substantially with the downturn in
the brokerage industry over the past three years. We believe that JBOC can
recover from the volume declines in this business line, through our ability to
provide high quality, flexible, and customer-sensitive responses and services.
We continually upgrade our computer systems and services within each of our
divisions to utilize and take advantage of technological developments.
Clearing and Execution Services
NCC is self-clearing and provides clearing and execution services to JBOC and
other broker-dealers that are independent from the Company. The clearing
business offers a high return on capital, and we believe that by careful
selection and monitoring of NCC's correspondents, this business division will
make a positive contribution to our overall brokerage operations.
Market Making Activities
In order to facilitate the execution of security transactions for our own
customers and the customers of our correspondents, NCC acts as a market maker
for approximately 200 public corporations whose stocks are traded on the NASDAQ
National Market System, NYSE or other national exchanges. The number of
companies in which NCC acts as a market maker fluctuates depending upon various
factors, including trading volume and the number of employees in a trading
capacity. Our market making activities concentrate on the execution of
unsolicited transactions for customers and are required to be in compliance with
the rules of the National Association of Securities Dealers, Inc. ("NASD")
regarding best execution.
12
Results of Operations
Revenues
Our total revenues were $4,228,581 in the first quarter 2004, a decrease of 15%
from $4,989,325 in the first quarter of 2003. The primary reason for the
decrease was a decline in trading profits of 95% to $30,575 in the current
quarter from $560,992 in the first quarter of 2003. Additionally, clearing and
execution revenues decreased 29% to $559,344 in the first quarter of 2004 from
$789,383 in the first quarter of 2003. Interest revenue also decreased 12% to
$1,333,717 in the first quarter of 2004 from $1,522,312 in the first quarter of
2003.
Commission revenue increased $273,921 or 14% to $2,286,537 in the first quarter
2004 compared to $2,012,616 in the first quarter of 2003. Trading volumes and
commission revenue have shown slight growth out over the past year. For 2004, we
anticipate commission revenue will continue to track the overall trading volumes
within the industry. We are continuing to look for opportunities to grow our
business through acquisitions of accounts from compatible discount and on-line
brokerage operations of other firms. Although we have completed acquisitions in
the past year, there can be no assurance that we will complete any additional
acquisitions, or if completed, that they will be successful.
Interest revenues decreased $188,595 or 12% to $1,333,717 in the first quarter
2004 compared to $1,522,312 in the first quarter of 2003. Net interest income
decreased 9% from $1,188,817 in the first quarter 2003 to $1,076,597 in the
first quarter 2004. The changes in interest revenues are consistent with usual
fluctuation of debit balances in brokerage margin accounts as well as changes in
broker-call rates on which the interest charged to customers is calculated.
Rates have not changed significantly over the past year. Rather, declining
margin balances has been the most significant factor for the decrease. Balances
have increased, however at the end of the quarter ended March 31, 2004.
Trading profits decreased 95% to $30,575 in the first quarter of 2004 from
$560,992 in the first quarter of 2003. The decrease in trading profits resulted
from a realized loss of approximately $150,000 in one security position the
Company incurred in the first quarter of 2004. Volumes in firm proprietary
trading accounts have decreased by 67% from the first quarter of 2003 to the
first quarter of 2004. Management has scaled back its trading room due to
declining volumes of the securities in which the Company makes a market;
however, management is continuing to explore new sources of order flow.
Clearing and execution revenues decreased $230,039 or 29% to $559,344 in the
first quarter 2004 compared to $789,383 in the first quarter of 2003. The
decrease represents a reduction of $274,305 of revenue generated from inactivity
fees from the first quarter of 2003 compared to the first quarter of 2004. The
decrease results from inactive accounts being closed or moved to other
broker-dealers. We will continue to search for opportunities to attract new
correspondent broker business.
Expenses
Expenses totaled $6,417,813 for the first quarter of 2004, an increase of 7%
from $5,990,985 in the first quarter of 2003. The increase is attributable to
the increase of $662,832 in professional services incurred in the first quarter
13
of 2004. Decreases in certain expense items reflect the impact of cost
containment measures taken by management during the past several years. Many of
our expenses, including clearing expense, interest expense, and data processing
charges, are directly related to commission revenues, interest revenues and
trading revenues.
Employee compensation decreased by 23% in the first quarter of 2004 to
$1,489,828 from $1,934,739 in the first quarter of 2003. Interest expense
decreased 23% to $257,120 in the first quarter of 2004 from $333,495 in the
first quarter of 2003. These decreases are in line with the revenue decreases
discussed above.
Professional services increased by $662,832 or 112% in the first quarter of 2004
to $1,253,899 from $591,067 in the first quarter of 2003. Legal fees increased
$665,878 as a result of the SEC mutual fund investigation involving the Company
and NCC.
Occupancy and equipment expenses have decreased $172,505 or 15% to $970,806 in
the first quarter of 2004 from $1,143,311 in the first quarter of 2003. These
costs have decreased as property and equipment lease commitments have ended.
Data processing expense increased by $137,603 during the first quarter of 2004
compared to the first quarter of 2003. Charges from our back office service
provider increased $51,788, mostly from the slight increase in trade
transactions we have processed. The remainder of the increase is from the
addition of certain market data services and web site content.
Other expense increased by $256,635 during the first quarter of 2004 compared to
the first quarter of 2003. The most significant reason for the increase is a
credit item in the first quarter of 2003 in the amount of $253,183, which
reduced other expenses for that period.
Management continues to examine ways to contain costs and improve efficiencies.
We will continue to seek ways to cut costs and add revenues.
Liquidity and Capital Resources
We finance our operations through the use of funds generated from the business
of our subsidiaries, mainly NCC and JBOC. NCC holds the majority of our
corporate assets consisted of cash or assets readily convertible to cash. 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 standards and the use of customer cash and
securities. See Note 4, "Regulatory Requirements," to the financial statements
for regulatory requirements of the Company.
During the most recent five fiscal quarters, NCC's excess net capital has
declined from $7,656,245 at December 31, 2002 to $7,040,287. If this trend
continues, our liquidity could further decrease and we will need to raise
additional capital. If additional capital is raised through the issuance of
equity securities, or securities which are convertible into equity securities,
our existing shareholders may experience 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. If such funds are
14
needed, there can be no assurance that additional financing will be available or
whether it will be available on terms satisfactory to us.
Notwithstanding this trend, we currently expect our cash resources and available
credit and stock loan facilities will be sufficient to fund our expected working
capital and capital expenditure requirements for the foreseeable future.
However, if future positive cash flow is not realized, or expenses increase due
to adverse results in legal or arbitration proceedings or for other
unanticipated reasons, we will need to raise additional funds in order to
continue in business, respond to competitive pressures, develop additional
products and services, or take advantage of strategic opportunities.
We have suffered recurring operating losses, 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. The report of the Company's independent accountants
for the year ended December 31, 2003, included an explanatory paragraph
expressing substantial doubt about the Company's ability to continue as a going
concern.
Liquidity at March 31, 2003
Our cash position decreased during the first quarter of 2004 by $1,066,651 to
$5,831,319. This compares with a net decrease in cash and cash equivalents of
$4,596,574 in the first quarter of 2003. The fluctuation in our cash position is
impacted by the settlement cycles of the business, which relate directly to the
cash provided from or used in operations.
We do not anticipate making any principal payments on loans from shareholders
due December 31, 2004, in the amount of $5,418,696. These notes have
historically been extended each year. We also do not anticipate making any
payments on notes payable in the principal amount of $2,889,375 (See "Litigation
Related to Oeri Notes" in Legal Proceedings above).
Cash Flows From Operating Activities
Net cash used in operating activities was $927,191 for the first quarter of
2004, compared to cash of $4,521,907 used in operations during the first quarter
of 2003. Our net cash provided by or used in operating activities is impacted by
changes in the brokerage-related assets and liabilities of NCC.
During the first quarter of 2003, the most significant source of cash was the
decrease in cash segregated under federal and other regulations of $19,900,573.
Additionally, receivables from broker-dealer and clearing organizations
decreased to provide cash of $13,562,822. These sources of cash were offset by
the increase in receivables from customers which used cash of $24,458,895 and a
decrease in payables to customers of $5,658,029.
Cash Flows Used In Investing Activities
The net cash used in investing activities during the first quarter of 2004 was
$97,794 compared with $74,667 during the same quarter of 2003. All of the cash
used for investing activities in the respective periods was for capital
expenditures. We presently have no plans to open additional offices and no
significant commitments for capital expenditures. Therefore, our requirement for
capital resources is not material to the business as a whole. We continue to
look for opportunities to grow our business through the acquisition of customer
accounts, and, if such acquisitions are made, we may expend our resources on
such acquisitions.
Cash Flows From Financing Activities
The net cash used in financing activities during the first quarter of 2004 was
$41,666 compared with no cash used by financing activities in the first quarter
of 2003. The cash used in 2004 was for the repayment of notes payable.
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 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 fully in
these investigations.
On November 6, 2003, our NCC subsidiary 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. On
April 12, 2004, we received a subsequent "Wells Notice" on the same subject
matter directed to the Company. We have responded to the Wells Notices and
believe we are cooperating in connection with the notices. 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
16
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 IT SHARES.
As of April 10, 2004, we had approximately 1.8 million shares of common
stock outstanding. The convertible notes currently held by Third Capital
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
March 31, 2004, our NCC subsidiary had net capital of $9,164,823, which was
$7,040,287 in excess of the minimum amount required. At December 31, 2003 NCC
17
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 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 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.
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
18
significant, it could have a material adverse effect on our business, financial
condition and operating results.
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. 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.
19
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.
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
20
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 ELECTRONIC
SYSTEMS WHICH SUPPORT 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
assurance that hackers, computer viruses and other problems will not result in a
21
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 $2.13 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
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
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
22
and 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.
Item 3. 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 these forward-looking statements. See Item 2 "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Special Note Regarding Forward-Looking Statements" above. We are exposed to
market risk related to changes in interest rates and equity security price risk.
The Company does not have derivative financial instruments for speculative or
trading purposes.
23
Retail broker-dealers with clearing operations, such as ourselves, 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 the unpaid customer debits,
together with losses, which may be 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 of our control which affect the securities markets, 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 its working capital and reserves that are required to be segregated under
federal or other regulations, the Company invests primarily in U.S. Treasury
securities purchased under agreements to resell. These agreements have maturity
dates ranging from one to seven days, and do not present a material interest
rate risk.
Equity Price Risk
NCC acts as a market maker for approximately 200 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 risk;
however, the Company does not maintain a significant inventory of equity
securities.
Item 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
As of March 31,2004, we carried out an evaluation (the "Evaluation"), under the
supervision and with the participation of our President and Chief Executive
Officer ("CEO") and Chief Financial Officer ("CFO"), of the effectiveness of the
design and operation of our disclosure controls and procedures pursuant to
Exchange Act Rule 13a-15 ("Disclosure Controls"). Based upon the Evaluation, our
CEO and CFO concluded that, subject to the limitations noted below, our
Disclosure Controls are effective in timely alerting them to material
information required to be included in our periodic SEC reports.
24
Changes in Internal Controls
We have also evaluated our internal controls for financing reporting, and there
have been no significant changes in our internal controls during the quarter
ended March 31, 2004, that have materially affected or are reasonably likely to
materially affect the Company's internal controls over financial reporting.
Limitations on the Effectiveness of Controls
Our management, including our CEO and CFO, does not expect that our Disclosure
Controls and internal controls will prevent all error and all fraud. A control
system, no matter how well conceived and operated, can provide only reasonable,
not absolute, assurance that the objectives of the control system are met.
Further, the design of a control system must reflect the fact that there are
resource constraints, and the benefits of controls must be considered relative
to their costs. Because of the inherent limitations in all control systems, no
evaluation of controls can provide absolute assurance that all control issues
and instances of fraud, if any, within the company have been detected. These
inherent limitations include the realities that judgments in decision-making can
be faulty, and that breakdowns can occur because of simple error or mistake.
Additionally, controls can be circumvented by the individual acts of some
persons, by collusion of two or more people, or by management or board override
of the control.
The design of any system of controls also is based in part upon certain
assumptions about the likelihood of future events, and there can be no assurance
that any design will succeed in achieving its stated goals under all potential
future conditions; over time, control may become inadequate because of changed
conditions, or the degree of compliance with the policies or procedures may
deteriorate. Because of the inherent limitations in a cost-effective control
system, misstatements due to error or fraud may occur and not be detected.
CEO and CFO Certifications
Appearing immediately following the Signatures section of this report 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 provides 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.
PART II - OTHER INFORMATION
Item 1. 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
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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, our NCC subsidiary 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. On April 12, 2004
we received a subsequent "Wells Notice" on the some subject matter directed to
the Company. We have responded to the Wells Notices and believe we are
cooperating in connection with the notices. 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 specific amount related to this
matter, as the amount of loss is not estimable at this time. We maintain a
general litigation accrual which we believe is adequate to cover the minimum
estimated loss. 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
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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 April 2004, the Los Angeles Office of the United States Attorney's
Office (the "USAO") agreed to accept a lump sum payment of $500,000 in full
settlement of all amounts remaining due under the Settlement Agreement,
previously reported in the 2003 Form 10-K and prior filings. This settlement is
expected to be finalized in the second quarter of 2004.
Litigation Related to Oeri Notes
The Company is a party to a lawsuit entitled EBC Trust v. JB Oxford Holdings,
Inc., et al., 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. In addition, 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 accrued 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
27
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,
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.
Item 2. Changes in Securities, Use of Proceeds and Issuer Repurchases of
Equity Securities
None.
Item 3. Defaults upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
Item 5. Other Events
During March 2004, the Company solicited proposals from potential audit
firms for preparation of the 2004 financial statements for the Company and its
subsidiaries. The decision to seek a new audit firm was based, in part, on the
28
fact that the current audit staff is required to transition off the audit under
the provisions of The Sarbanes-Oxley Act of 2002. On April 12, 2004 the Company
and its subsidiaries received notification from Ernst & Young LLP that it would
not stand for re-election for the audit of the December 31, 2004 financial
statements. On April 16, 2004, the Company's Audit Committee of the Board of
Directors selected BDO Seidman, LLP as its new independent accountant, subject
to execution of a mutually agreeable engagement letter. The Company executed an
engagement letter with BDO Seidman, LLP on May 10, 2004. The Company has not
consulted the newly engaged accountants during the two most recent fiscal years
or the interim period between December 31, 2003, and May 10, 2004, regarding the
application of accounting principles to a specified transaction or any matter
that was subject to any disagreement or reportable event.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
31.1 Certification of Christopher L. Jarratt, Chief Executive Officer,
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Michael J. Chiodo, Chief Financial Officer, pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Christopher L. Jarratt, Chief Executive Officer,
pursuant to 18 U.S.C. ss. 1350.
32.2 Certification of Michael J. Chiodo, Chief Financial Officer, pursuant
to 18 U.S.C. ss. 1350.
(b) Reports on Form 8-K.
During the first quarter, we filed a Report on Form 8-K, dated April 19,
2004, reporting the resignation of Ernst & Young LLC as our independent
accountants. The report also provided disclosure of the receipt of a "Wells
Notice" on April 12, 2004 and the resignation of James G. Lewis, its President
and Chief Operating Officer on April 15,2004.
Pursuant to the requirements 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/ Michael J. Chiodo
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Michael J. Chiodo
Chief Financial Officer
May 13, 2002
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