Back to GetFilings.com
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 JUNE 30, 2004
OR
[X] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
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 by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes No X
----- -----
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date. As of August 6, 2004, the
Registrant had the following number of shares of common stock, $0.01 par value
per share, outstanding: 1,841,749.
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
JB OXFORD HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
June 30, 2004 December 31,
(Unaudited) 2003
------------- ------------
ASSETS:
Cash and cash equivalents $ 2,966,616 $ 6,897,970
Cash and cash equivalents segregated under federal and other
regulations -- 130,748,572
Receivable from broker-dealers and clearing organizations -- 29,337,358
Receivable from customers (net of allowance for doubtful
accounts of $0 and $2,781,305) -- 78,372,056
Other receivables 270,953 2,139,865
Marketable securities owned - at market value -- 432,060
Notes receivable from shareholder 2,500,000 2,500,000
Assets held for sale 230,640,443 --
Furniture, equipment, and leasehold improvements (at cost - net of
accumulated depreciation and amortization of $2,935,820 and
$6,352,333) 155,006 2,195,783
Clearing deposits -- 6,542,595
Intangible assets (net of accumulated amortization of $0 and
$3,558,678) -- 2,957,837
Other assets 123,665 780,771
------------ ------------
TOTAL ASSETS $236,656,683 $262,904,867
============ ============
See accompanying notes.
2
JB OXFORD HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
June 30, 2004 December 31,
(Unaudited) 2003
------------- ------------
LIABILITIES AND SHAREHOLDERS' EQUITY:
LIABILITIES:
Payable to broker-dealers and clearing organizations $ -- $ 40,331,755
Payable to customers -- 195,340,295
Securities sold, not yet purchased - at market value -- 1,957,909
Liabilities associated with assets held for sale 215,974,143 --
Accounts payable and accrued liabilities 4,300,218 5,436,675
Loans from shareholders 5,418,696 5,418,696
Notes payable 3,375,486 3,458,819
------------ ------------
TOTAL LIABILITIES 229,068,543 251,944,149
------------ ------------
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 18,504,430 18,039,086
Retained deficit (10,021,976) (5,425,090)
Treasury stock at cost, 46,994 and 83,244 shares (913,201) (1,670,843)
------------ ------------
TOTAL SHAREHOLDERS' EQUITY 7,171,059 10,960,718
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $236,656,683 $262,904,867
============ ============
See accompanying notes.
3
JB OXFORD HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
For The Six Months Ended For The Three Months Ended
June 30, June 30,
2004 2003 2004 2003
----------- ----------- ----------- -----------
REVENUES:
Interest $ 115,787 $ 116,755 $ 57,864 $ 58,407
Other -- 10,110 -- 9,954
----------- ----------- ----------- -----------
Total revenues 115,787 126,865 57,867 68,361
----------- ----------- ----------- -----------
EXPENSES:
General and administrative 894,895 726,261 574,700 433,602
Interest 321,778 322,247 160,889 161,123
Depreciation and amortization 272,341 139,271 128,771 63,781
----------- ----------- ----------- -----------
Total expenses 1,489,014 1,187,700 863,696 658,506
----------- ----------- ----------- -----------
Loss from continuing operations
before income taxes (1,373,227) (1,060,835) (805,829) (590,145)
Income tax expense (benefit) 6,100 (550,211) 5,700 (476,344)
----------- ----------- ----------- -----------
Net loss from continuing operations (1,379,327) (510,624) (811,529) (113,801)
Loss from discontinued operations (2,575,432) (1,957,124) (951,797) (1,672,676)
----------- ----------- ----------- -----------
Net loss $(3,954,759) $(2,467,748) $(1,763,326) $(1,786,477)
=========== =========== =========== ===========
Basic net loss per share:
From continuing operations $ (0.76) $ (0.34) $ (0.44) $ (0.08)
From discontinued operations (1.42) (1.30) (0.52) (1.11)
Basic net loss per share
(2.18) (1.64) (0.96) (1.19)
Diluted net loss per share:
From continuing operations $ (0.76) $ (0.34) $ (0.44) $ (0.08)
From discontinued operations (1.42) (1.30) (0.42) (1.11)
Diluted net loss per share
(2.18) (1.64) (0.96) (1.19)
Weighted average number of shares
Basic 1,814,256 1,506,434 1,841,749 1,506,695
Diluted 1,814,256 1,506,434 1,841,749 1,506,695
See accompanying notes.
4
JB OXFORD HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For The Six Months Ended
June 30,
--------------------------------
2004 2003
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (3,954,759) $ (2,467,748)
Adjustments to reconcile net loss to cash used in operating activities:
Depreciation and amortization 1,064,674 1,395,226
Provision for bad debts 38,735 35,077
Deferred income taxes, net -- 880,000
Changes in assets and liabilities:
Cash segregated under federal and other regulations 21,012,946 (7,105,790)
Receivable from broker-dealers and clearing organizations 12,613,801 (13,325,933)
Receivable from customers (14,139,314) 18,574,803
Other receivables 1,315,127 160,769
Securities owned (444,238) 364,605
Clearing deposits 1,410,003 (2,863,734)
Other assets (338,958) (182,623)
Payable to broker-dealers and clearing organizations (5,145,865) (8,297,818)
Payable to customers (14,553,426) 6,511,319
Securities sold, not yet purchased (1,956,525) 535,451
Accounts payable and accrued liabilities (554,276) 642,134
Income taxes receivable -- 2,563,066
------------ ------------
Net cash used in operating activities (3,632,075) (2,581,196)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (215,946) (109,475)
------------ ------------
Net cash used in investing activities (215,946) (109,475)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments of notes payable (83,333) --
------------ ------------
Net cash used in financing activities (83,333) --
------------ ------------
NET DECREASE IN CASH AND CASH EQUIVALENTS (3,931,354) (2,690,671)
CASH AND CASH EQUIVALENTS AT BEGINNING OF THE PERIOD 6,897,970 5,579,755
------------ ------------
CASH AND CASH EQUIVALENTS AT END OF THE PERIOD $ 2,966,616 $ 2,889,084
============ ============
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 alleged late
trading of mutual funds 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.
On June 4, 2004, the Company signed an asset purchase agreement with
Ameritrade, Inc., a subsidiary of Ameritrade Holding Corporation, to sell the
online retail accounts of JB Oxford & Company ("JBOC"), a subsidiary of JB
Oxford Holdings, Inc. for up to $26 million in cash, subject to certain
adjustments and an escrow. In addition, the Company is actively seeking a buyer
for its correspondent clearing operation. Please see Note 4 "Discontinued
Operations" for more information.
6
NOTE 2. EARNINGS PER SHARE
The following table reconciles the numerators and denominators of the
basic and diluted earnings per share computation:
For The Six Months Ended For The Three Months Ended
June 30, June 30,
2004 2003 2004 2003
----------- ----------- ----------- -----------
BASIC EARNINGS PER SHARE:
Net loss $(3,954,759) $(2,467,748) $(1,763,326) $(1,786,477)
----------- ----------- ----------- -----------
Loss available to common stockholders
(numerator) $(3,954,759) $(2,467,748) $(1,763,326) $(1,786,477)
=========== =========== =========== ===========
Weighted average common shares outstanding
(denominator) 1,814,256 1,506,434 1,841,749 1,506,695
=========== =========== =========== ===========
Basic earnings per share $ (2.18) $ (1.64) $ (0.96) $ (1.19)
=========== =========== =========== ===========
DILUTED EARNINGS PER SHARE:
Net Loss $(3,954,759) $(2,467,748) $(1,763,326) $(1,786,477)
----------- ----------- ----------- -----------
Loss available to common stockholders plus
assumed conversions (numerator) $(3,954,759) $(2,467,748) $(1,763,326) $(1,786,477)
=========== =========== =========== ===========
Weighted average common shares outstanding 1,814,256 1,506,434 1,841,749 1,506,695
----------- ----------- ----------- -----------
Weighted average common shares and assumed
conversions outstanding (denominator) 1,814,256 1,506,434 1,841,749 1,506,695
=========== =========== =========== ===========
Diluted earnings per share $ (2.18) $ (1.64) $ (.096) $ (1.19)
=========== =========== =========== ===========
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 the assumed conversions would have been used, the fully
diluted shares outstanding for the six months ended June 30, 2004 and 2003 would
be 3,846,239 and 3,538,525, respectively.
The excluded options carry exercise prices ranging from $2.20 to $91.25 at
June 30, 2004 and 2003. Options to purchase 256,600 shares of common stock at
June 30, 2004 expire at various dates through October 4, 2012.
NOTE 3. EQUITY TRANSACTIONS AND STOCK OPTIONS
During the first quarter of 2004, the Company issued 132,244 shares of
common stock related to the acquisition of intangible assets in the amount of
$466,667 in connection with the Mr. Stock transaction. The average closing
market price for the ten days prior to issuance was used to determine the number
of shares issued. The $466,667 was previously included in accounts payable prior
to issuance. See "Litigation Related to Account Acquisitions" included at Note 5
for additional information.
7
On January 2, 2004, the Company provided a treasury stock bonus to all
employees who had been with Company for six months or more. All employees who
were employed by the Company for one year or longer received 500 shares, while
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 $757,642 and the market value at the time of the
bonus was $115,514, the difference of $642,128 was charged to retained earnings
in 2004.
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 six months ended June 30,
2004 and 2003; and there is no pro forma attribution expense on previously
issued options for those respective periods.
A summary of the status of the Company's stock options as of June 30, 2004
and 2003, and changes during the periods ending on those dates is presented
below:
June 30, 2004 June 30, 2003
Weighted Weighted
Shares average Shares average
------------ ---------- -------------- ----------
Outstanding at 256,825 $15.66 257,200 $15.72
be-ginning of period
Forfeited (225) 41.94 (375) 32.37
------------ --------------
Outstanding at end of
period 256,600 15.63 256,825 15.66
============ ==============
Options exercisable 256,600 15.63 255,725 15.88
at quarter-end
Weighted-average fair
value of options
granted during the
period $-- $--
NOTE 4. ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS
On June 4, 2004, the Company signed an asset purchase agreement with
Ameritrade, Inc., a subsidiary of Ameritrade Holding Corporation, to sell the
online retail accounts of JB Oxford & Company ("JBOC"), a subsidiary of JB
Oxford Holdings, Inc. for up to $26 million in cash, subject to certain
adjustments and an escrow. In addition, the Company is actively seeking a buyer
for its correspondent clearing operation. The sale of both these asset groups is
expected to take place prior to the end of the year. These asset groups are the
brokerage operations (both clearing and retail brokerage segments) of the
Company and provide substantially all of its operating revenues. These asset
groups have also met the criteria defined by SFAS No. 144 to be reported as
discontinued operations.
8
The brokerage assets and related liabilities have been reclassified and
reported as assets and liabilities held for sale. No impairment of value has
been recognized, as management currently believes the carrying value of these
assets will be fully recoverable from the proceeds of the sale, less any costs
to sell. Additionally, the Company has no plan of liquidation nor is it the
current intention of management to liquidate the Company. The Company will have
cash to address its various legal matters following the sale and may identify
potential new operations. The following table represents the components of
assets and associated liabilities held for sale at June 30, 2004.
Cash and cash equivalents segregated under federal and other regulations $109,735,626
Receivable from broker-dealer and clearing organizations 16,723,557
Receivable from customers (net of allowance for doubtful accounts of
$2,820,040) 92,472,635
Other receivable 553,785
Marketable securities owned at market value 876,298
Furniture, equipment, and leasehold improvements (at cost net of
accumulated depreciation and amortization of $4,220,389) 1,646,635
Clearing deposits 5,132,592
Intangible assets (net of accumulated amortization of $4,031,264) 2,503,251
Other assets 996,064
--------------
Total assets held for sale $230,640,443
==============
Payable to broker-dealer and clearing organizations (35,185,890)
Payable to customers (180,786,869)
Securities sold, not yet purchased at market value (1,384)
--------------
Total liabilities associated with assets held for sale $215,974,143
==============
The following table reflects detailed amounts of revenue, expense and loss
reported in discontinued operations for the respective periods ended June 30,
2004 and 2003. Operations previously reported have been restated to reflect the
change in status to discontinued operations. No gain or loss on sale is
included currently because the sale transactions have not yet closed. It is
anticipated that such transactions will close prior to the end of the year.
9
For The Six Months Ended For The Three Months Ended
June 30, June 30,
2004 2003 2004 2003
----------- ----------- ----------- -----------
REVENUES:
Commissions $ 4,035,980 $ 4,132,050 $ 1,749,442 $ 2,119,434
Interest 2,632,447 2,812,434 1,356,651 1,348,470
Trading profits 211,786 1,268,188 181,211 707,196
Clearing and execution 1,186,763 1,436,909 627,419 647,526
Other 64,010 259,068 45,602 155,199
----------- ----------- ----------- -----------
Total revenues 8,130,986 9,908,646 3,960,325 4,977,825
----------- ----------- ----------- -----------
EXPENSES:
Employee compensation 2,959,932 3,560,914 1,523,796 1,687,901
Clearing and floor brokerage 495,636 516,130 228,975 260,747
Communications 1,076,287 1,056,474 487,872 515,515
Occupancy and equipment 1,467,669 2,024,439 661,746 988,929
Interest 198,096 329,345 101,865 156,974
Data processing charges 1,172,784 1,104,532 502,782 578,412
Professional services 1,854,936 910,594 779,329 440,712
Promotional 138,333 118,973 49,943 53,141
Bad debts 38,735 35,077 16,697 19,499
Amortization of intangible assets 454,586 741,241 113,647 370,620
Other operating expenses 843,224 2,027,573 441,070 1,891,051
----------- ----------- ----------- -----------
Total Expenses 10,700,218 12,425,292 4,907,722 6,963,501
----------- ----------- ----------- -----------
Loss before income taxes (2,569,232) (2,516,646) (947,397) (1,985,676)
Income tax expense (benefit) 6,200 (559,522) 4,400 (313,000)
----------- ----------- ----------- -----------
Loss from discontinued operations $(2,575,432) $(1,957,124) $ (951,797) $(1,672,676)
=========== =========== =========== ===========
NOTE 5. REGULATORY REQUIREMENTS
National Clearing Corp ("NCC") and JBOC are subject to the SEC's Uniform
Net Capital Rule ("the Rule"), which requires the maintenance of minimum net
capital. NCC and JBOC have elected to use the alternative method permitted by
the Rule, which requires them 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.
10
At June 30, 2004, NCC had net capital of $8,480,016, which was $6,549,024
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.
At June 30, 2004, JBOC had net capital of $300,283, which was $50,283 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.
NOTE 6. 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
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 and
Form 10-Q at March 31, 2004, except as disclosed below.
SEC MUTUAL FUND INVESTIGATION
In the course of the ongoing mutual fund investigations, 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 Act of 1933, Sections 10(b), 15(b) and 21C of the
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. On April 12, 2004, the
Company itself received a subsequent "Wells Notice" on the same subject matter.
The Company believes it has complied with all requests for documents and
provided testimonies in reponse to subpoenas from the New York Attorney General,
the SEC and the National Association of Securities Dealers ("NASD") regarding
the allegations of NCC's violation in forward pricing principles. While the
Company admits no wrongdoing and intends to vigorously defend itself, no
assurance can be given as to the outcome of the 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 reserve, which it believes is adequate to cover
the minimum estimated loss. However, substantial penalties in excess of the
general litigation reserve 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,
11
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 Stanley 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.
On June 29, 2004 EBC Trust filed a summons and complaint with the United States
District Court for the Central District of California. The action requests the
imposition of a constructive trust on the proceeds of the Ameritrade Acquisition
sufficient to satisfy the disputed obligations discussed above. The Company
plans to raise the same defenses as discussed 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 of 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 was
finalized and payment made in June of 2004.
12
NOTE 7. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
For The Six Months Ended June 30,
-------------------------------------------------
2004 2003
----------------------- -----------------------
Supplemental Disclosures of Cash Flow Information
Cash paid for:
Interest $386,312 $573,185
Income taxes 12,300 75,974
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.
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 websites, www.jboxford.com and www.mrstock.com, allow
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.
13
Recent Developments
On June 7, 2004, we announced that Ameritrade, Inc., a subsidiary of Ameritrade
Holding Corporation, had signed a definitive agreement to purchase the online
retail accounts of JBOC. The purchase price will not exceed $26 million and is
subject to adjustment based upon the number of accounts actually transferred at
the closing. The transaction is expected to close prior to the end of the year,
and is subject to regulatory approval and approval of our shareholders. Third
Capital Partners, LLC has agreed to convert its holdings of our convertible
notes with an aggregate principal amount of approximately $5.4 million into
approximately 2 million shares of our common stock, representing approximately
52% of our total outstanding shares, on a fully-diluted basis, and has agreed to
vote such shares in favor of the approval of the transaction.
We are also actively seeking a buyer for our correspondent clearing operation
and hope to effect a sale of that business prior to the end of the year. The
correspondent clearing operation conducted by NCC and the retail brokerage
operation conducted by JBOC provide substantially all of our operating revenues.
Subsequent to the sale of these assets, the net proceeds will be utilized to
address pending legal matters and for other general expenses.
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 was finalized in June
of 2004.
On April 12, 2004, we 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.
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. 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. We have entered into a definitive agreement to sell the
online retail accounts as discussed above in "Recent Developments" and Note 4
"Assets Held for Sale and Discontinued Operations."
14
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. We believe the correspondent clearing
customer base has value. We are actively seeking a buyer for our correspondent
clearing operation, as such, this operation has been classified as discontinued
operations as discussed in Note 4 "Assets Held for Sale and Discontinued
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 70 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.
Results of Operations
Six Months Ended June 30, 2004 Compared with Six Months Ended June 30, 2003
Continuing Operations
Revenues, that consists primarily of interest earned, were $115,787 in the first
half 2004, a decrease of $11,078 from $126,865 in the first half of 2003. This
decrease resulted from a one time insurance refund received as the result of a
policy cancellation in the second quarter of 2003 in the amount of $9,544.
Our general and administrative expense increased by $168,713 or 23% to $894,895
in the first half of 2004 from $726,182 in the first half of 2003. This increase
resulted from professional fees that increased $221,235 to $622,036 in the first
half of 2004 from $400,801 in the first half of 2003. These fees were incurred
due to the SEC mutual fund investigation and the Wells notice received by the
Parent Company, and the litigation related to the Oeri note. See Note 6 above.
General and administrative expenses included employee compensation of $111,170
and $113,719 for the six months ended June 30, 2004 and 2003, respectively.
Discontinued Operations
Loss from discontinued operations amounted to $2,575,432 in the first half of
2004 compared to $1,957,124 in the first half of 2003. This is a change of
$618,308 or 32% increase in the loss.
15
Revenues from Discontinued Operations
Our total brokerage revenues were $8,130,986 in the first half 2004, a decrease
of 18% from $9,908,646 in the first half of 2003. The primary reason for the
decrease in brokerage revenue was a decline in trading profits of 83% to
$211,786 in the current period from $1,268,188 in the first half of 2003.
Additionally, clearing and execution revenues decreased 17% to $1,186,763 in the
first half of 2004 from $1,436,909 in the first half of 2003. Commission
revenues decreased $96,070 or 2% to $4,035,980 in the first half of 2004 from
$4,132,050 in the first half of 2003. Interest revenue decreased 6% to
$2,632,447 in the first half of 2004 from $2,812,434 in the first half of 2003.
Commission revenue decreased $96,070, or 2% to $4,035,980 in the first half 2004
compared to $4,132,050 in the first half of 2003. The slight decrease in
commission revenue, when compared to a 12% increase in the number of trades
executed for customers over the same period, reflects JBOC's adoption during
2003 of a more competitive pricing schedule.
Interest revenues from brokerage operations decreased $179,987 or 6% to
$2,632,447 in the first half 2004 compared to $2,812,434 in the first half of
2003. Net interest income decreased 2% from $2,483,089 in the first half 2003 to
$2,434,351 in the first half 2004. The changes in interest revenues reflect
decreased yields on bank deposits and a decline in segregated cash balances,
offset by increased customer margin balances over the same period.
Trading profits decreased 83% to $211,786 in the first half of 2004 from
$1,268,188 in the first half of 2003. The decrease in trading profits resulted
primarily from a 70% decrease in volumes in firm proprietary trading accounts,
augmented by a loss of approximately $150,000 in one security position in the
first quarter of 2004. Management has scaled back its trading operation due to
declining volumes in 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 $250,146 or 17% to $1,186,763 in the
first half 2004 compared to $1,436,909 in the first half of 2003. The largest
factor in the decrease was a $207,543 decrease in inactivity fee revenues from
the first half of 2003 compared to the first half of 2004. The decrease results
from inactive accounts being closed or moved to other broker-dealers.
Expenses from Discontinued Operations
Expenses from brokerage activities totaled $10,700,218 for the first half of
2004, a decrease of 14% from $12,425,292 in the first half of 2003. Included in
the expense of 2003 is a $1,500,000 accrual for the abandonment of leased
property in Oakland, California related to the acquisition of the Mr. Stock
accounts. Excluding this one-time item, expenses decreased $225,074 or 2% during
the first half of 2004 compared to the first half of 2003. The largest increase
was attributable to the increase of $944,342 in professional services incurred
in the first half of 2004 when compared with the first half of 2003. 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 were directly
related to commission revenues, interest revenues and trading revenues. Assets
that are classified as held for sale cease to be deprecated and amortized. There
was also a decrease of $417,081 in depreciation and amortization expense that
would have otherwise been expensed, because certain furniture, fixtures and
intangible assets were held for sale.
16
Employee compensation from brokerage operations decreased by 17% in the first
half of 2004 to $2,959,932 from $3,560,914 in the first half of 2003, as the
Company continued to reduce its workforce. Interest expense decreased 40% to
$198,096 in the first half of 2004 from $329,345 in the first half of 2003. This
decrease was in line with the revenue decreases discussed above.
Professional services increased by $944,345 or 104% in the first half of 2004 to
$1,854,936 from $910,594 in the first half of 2003. Legal fees increased
$1,045,536 as a result of the SEC mutual fund investigation involving the
Company and NCC.
Occupancy and equipment expenses decreased $556,770 or 28% to $1,467,669 in the
first half of 2004 from $2,024,439 in the first half of 2003, as property and
equipment lease commitments have ended. Additionally, depreciation expense was
reduced by $189,788 because of assets held for sale. Amortization expense
decreased $286,655 during the first half of 2004 compared to the first half of
2003, of which $227,293 was because the intangible assets were classified as
held for sale.
Other expense decreased by $1,184,349 during the first half of 2004 compared to
the first half of 2003. The most significant reason for the change is a one-time
charge in the first half of 2003 of $1,500,000 for the abandonment of leased
property in Oakland, California related to the acquisition of the Mr. Stock
accounts. This charge was offset in part by an unrelated credit item in the
first half of 2003 in the amount of $253,183.
Quarter Ended June 30, 2004 Compared with Quarter Ended June 30, 2003
Continuing Operations
Revenues, that consists primarily of interest earned, revenues were $57,867 in
the second quarter 2004, a decrease of $10,494 from $68,361 in the second
quarter of 2003. This decrease resulted from a one time insurance refund
received as the result of a policy cancellation in the second quarter of 2003 in
the amount of $9,544.
Our general and administrative expense increased by $140,434 or 32% to $574,036
in the second quarter of 2004 from $433,602 in the second quarter of 2003. This
increase resulted from professional fees that increased $164,128 to $443,744 in
the second quarter of 2004 from $279,616 in the second of 2003. These fees were
incurred due to the SEC mutual fund investigation and the litigation related to
the Oeri notes. See Note 6 above. General and administrative expenses included
employee compensation of $57,477 and $51,993 for the three months ended June 30,
2004 and 2003, respectively.
Discontinued Operations
We recorded a net loss from discontinued operations of $951,797 for the quarter
ended June 30, 2004. This compares with a net loss of $1,672,676 for the quarter
ended June 30, 2003.
17
Total brokerage revenues for the second quarter of 2004 were $3,960,325, a
decrease of $1,017,500 or 20% from the comparable quarter of 2003. Lower trading
volumes during the second quarter of 2004 caused commission revenue to decrease
$369,992 or 17% in the same period compared with the second quarter of 2003, and
$537,094 or 23% when compared with the first quarter of 2004.
Clearing revenue decreased $20,107 or 3% during the second quarter of 2004
compared with the second quarter of 2003, and increased $68,077 or 12% compared
with the first quarter of 2004, primarily due to declining inactivity fees
described above.
Interest revenue from brokerage operations increased $8,181 or 1% to $1,356,651
from $1,348,470 for the second quarter of 2004 compared with the second quarter
of 2003. Interest revenue increased as a result of rising margin balances. Net
interest income increased $63,290 or 5% to $1,254,786 in the second quarter of
2004 from $1,191,496 in the second quarter of 2003.
Total brokerage expenses for the second quarter of 2004 were $5,451,541, a
decrease of $1,749,863 or 24% from the comparable quarter of 2003. Interest
expense decreased $55,109 or 35% during the second quarter of 2004 compared with
the second quarter of 2003 on lower customer credit balances and interest rates.
Employee compensation from brokerage operations decreased $164,105 or 10% to
$1,523,796 in the second quarter of 2004 from $1,687,901 during the second
quarter of 2003, due to workforce reductions. Professional services expenses
increased $338,617 or 77% in the second quarter of 2004 when compared to the
second quarter of 2003, due to increased legal fees as a result of the SEC
mutual fund investigation involving the Company and NCC.
Occupancy and equipment expenses decreased $327,183 or 33% in the second quarter
of 2004 when compared with the second quarter of 2003. Depreciation expense was
reduced by $189,788 because of assets held for sale that would have otherwise
been recorded. Amortization expense decreased $256,973 during the second quarter
of 2004 compared to the second quarter of 2003, of which $227,293 was because
the intangible assets were classified as held for sale. Data processing charges
decreased $75,630 or 13% on lower trading volumes in the second quarter of 2004
when compared with the second quarter of 2003.
Other expenses decreased $1,449,981 or 77% in the second quarter of 2004
compared with the second quarter of 2003. This decrease is the result of a
one-time charge in the amount of $1,500,000 during the second quarter of 2003
for the abandonment of leased property in Oakland, California, related to the
acquisition of the Mr. Stock accounts.
Management continues to examine ways to cut costs and improve efficiencies, but
there can be no assurance that we will be able to do so.
Liquidity and Capital Resources
We finance our operations through the use of funds generated from the business
of our subsidiaries, NCC and JBOC. The majority of our corporate assets are held
by NCC, and consist 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 stock
18
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 six fiscal quarters, NCC's excess net capital has
declined from $7,656,245 at December 31, 2002 to $6,549,024. 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 alleged late trading conducted by NCC.
The report of our independent accountants for the year ended December 31, 2003,
included an explanatory paragraph expressing substantial doubt about our ability
to continue as a going concern.
As a result of these and other considerations, our Board of Directors concluded
that it was in the best interest of our shareholders to effect a sale of the
online retail brokerage business conducted by JBOC. On June 4, 2004, we signed
an asset purchase agreement with Ameritrade, Inc., a subsidiary of Ameritrade
Holding Corporation, to sell the online retail accounts of JBOC. The purchase
price will not exceed $26 million and is subject to adjustment based upon the
number of accounts actually transferred at the closing. The transaction is
expected to close prior to the end of the year, and is subject to regulatory
approval and approval of our shareholders. Third Capital Partners, LLC has
agreed to convert its holdings of our convertible notes with an aggregate
principal amount of approximately $5.4 million into approximately 2 million
shares of our common stock, representing approximately 52% of the total
outstanding shares, on a fully-diluted basis, and has agreed to vote such shares
in favor of the approval of the transaction. In addition, we are actively
seeking a buyer for our correspondent clearing operation and hope to effect a
sale of that business prior to the end of the year. The correspondent clearing
operation conducted by NCC and the retail brokerage operation conducted by JBOC
provide substantially all of our operating revenues. Subsequent to the sale of
these assets, the net proceeds will be utilized to address pending legal matters
and for other general expenses.
Liquidity at June 30, 2004
Our cash position decreased during the first half of 2004 by $3,931,354 to
$2,966,616. This compares with a net decrease in cash and cash equivalents of
$2,690,671 in the first half 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. Instead, the holder has
agreed to convert this note into approximately 2 million shares of our common
stock (See Other Events in Part II, below). 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 in Part II, below).
Cash Flows From Operating Activities
Net cash used in operating activities (including discontinued operating
activities) was $3,632,075 for the first half of 2004, compared to cash of
$2,581,196 used in operations during the first half 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.
19
During the first half of 2004, the most significant source of cash was the
decrease in cash segregated under federal and other regulations of $21,012,946.
Additionally, receivables from broker-dealer and clearing organizations
decreased to provide cash of $12,613,801. These sources of cash were offset by
the increase in receivables from customers, which used cash of $14,139,314, and
a decrease in payables to customers of $14,553,426.
Cash Flows Used In Investing Activities
The net cash used in investing activities during the first half of 2004 was
$215,946 compared with $109,475 during the first half 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.
Cash Flows From Financing Activities
The net cash used in financing activities during the first half of 2004 was
$83,333 compared with no cash used in financing activities in the first half 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 of which
we do not presently know or that we currently deem to be 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.
20
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 that 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 the Company admits no wrongdoing and intends to
vigorously defend itself, no assurance can be given as to the outcome of these
matters. 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 these matters could have a
material adverse effect on the financial position and results of operations of
the Company.
WE COULD BE HARMED IF THE AMERITRADE TRANSACTION IS NOT COMPLETED.
On June 4, 2004, the Company signed an asset purchase agreement with
Ameritrade, Inc., a subsidiary of Ameritrade Holding Corporation, to sell the
online retail accounts of JBOC. The purchase price will not exceed $26 million
and is subject to adjustment based upon the number of accounts actually
transferred at the closing. If we are unable to complete this transaction, we
may be forced to find another buyer for the retail online brokerage accounts.
Because of declining net capital of NCC, which may not be sufficient for it to
carry on its business, we may be required to clear JBOC's business through
another broker dealer as an introducing broker pending such sale, which would
increase our expenses and reduce our revenues.
THIRD CAPITAL HAS AGREED TO CONVERT ITS NOTES INTO SHARES OF COMMON STOCK AND
OUR STOCK PRICE COULD MATERIALLY DECLINE IF THIRD CAPITAL SELLS IT SHARES.
As of August 6, 2004, we had approximately 1.85 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.
Third Capital Partners has agreed to convert the convertible notes in full, and
as a result, the ownership percentage of our current shareholders will be
significantly diluted. Third Capital Partners will own approximately 52% 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 could cause the price of our stock to fall or could prevent the price from
rising.
21
In addition to the adverse effect a price decline would have on our
shareholders, 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
June 30, 2004, our NCC subsidiary had net capital of $8,480,016, which was
$6,549,024 in excess of the minimum amount required. At December 31, 2003 NCC
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 experienced further declines in our trading
volumes during the second quarter of 2004. 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 and 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.
22
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 downward 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 and for the first six months of
2004. 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 are 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.
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.
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
23
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.
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 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
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 affect our
revenues from clients in such country or region.
24
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 IF OUR TRANSACTIONS
PROCESS IS SLOW.
We receive and process trade orders through internal trading software and
the Internet. 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
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 $1.90 and
as high as $6.25. 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.
25
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 that
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. Third Capital
Partners has agreed to convert these notes to common stock in conjunction with
the Ameritrade transaction; however, if the transaction is not completed and
Third Capital does not convert the notes we may not be able to repay the Notes
or otherwise obtain an extension from Third Capital Partners. This 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
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.
26
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 TO COMPLETE THE AMERITRADE
SALE.
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 70% since
January 2001. Further, there can be no assurance that we can retain our existing
personnel especially in light of the Ameritrade transaction, with current
employees searching for new jobs and careers.
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.
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 that 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.
27
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 term certificates
of deposit and savings accounts. The certificates of deposit have original terms
ranging from one to twelve months. Certificates of deposit with terms longer
than one month comprise less than 10% of total cash, and consequently do not
present a material interest rate risk.
Equity Price Risk
NCC acts as a market maker for approximately 70 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 that 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 June 30, 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.
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 June 30, 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.
28
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
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
29
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 reserve, which, we believe is adequate to cover the minimum
estimated loss. However, substantial penalties in excess of the general
litigation reserve 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
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 was
finalized and payment of $500,000 was made in June of 2004.
30
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
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.
31
On June 29, 2004 EBC Trust filed a summons and complaint with the United States
District Court for the Central District of California. The action requests the
imposition of a constructive trust on the proceeds of the Ameritrade Acquisition
sufficient to satisfy the disputed obligations discussed above. The Company
plans to raise the same defenses as discussed 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.
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
On June 7, 2004, we issued the press release announcing that Ameritrade,
Inc., a subsidiary of Ameritrade Holding Corporation, had signed a definitive
agreement to purchase the online retail accounts of JB Oxford & Company, our
wholly owned subsidiary. The purchase price will not exceed $26 million and is
subject to adjustment based upon the number of accounts actually transferred at
the closing. The transaction is expected to close prior to the end of the year,
is subject to regulatory approval and approval of our shareholders. Third
Capital Partners, LLC has agreed to convert its holdings of our convertible
notes with an aggregate principal amount of approximately $5.4 million into
approximately 2 million shares of our common stock, representing approximately
52% of the total outstanding shares, on a fully-diluted basis, and has agreed to
vote such shares in favor of the approval of the transaction.
During March 2004, we solicited proposals from potential audit firms for
preparation of our 2004 consolidated financial statements. The decision to seek
a new audit firm was based, in part, on the fact that the current audit staff is
required to transition off the audit under the provisions of The Sarbanes-Oxley
32
Act of 2002. On April 12, 2004 we received notification from Ernst & Young LLP,
along with NCC and JBOC, that it would not stand for re-election for the audit
of the December 31, 2004 financial statements. On April 16, 2004, our Audit
Committee of the Board of Directors selected BDO Seidman, LLP as our new
independent accountant, subject to execution of a mutually agreeable engagement
letter. We executed an engagement letter with BDO Seidman, LLP on May 10, 2004.
We have 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 second quarter, we filed a Report on Form 8-K, dated June 17,
2004, reporting that Ameritrade, Inc., a subsidiary of Ameritrade Holding
Corporation, had signed a definitive agreement to purchase the online retail
accounts of JB Oxford & Company.
Also during the second 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
- ---------------------------
Michael J. Chiodo
Chief Financial Officer
August 13, 2004
33