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 SEPTEMBER 30, 2004
OR
|_| 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.)
15165 Ventura Boulevard, Suite 330, Sherman Oaks, CA 91403
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (818) 907-6580 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 November 6, 2004, the
Registrant had the following number of shares of common stock, $0.01 par value
per share, outstanding: 3,692,419.
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
JB OXFORD HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
Sep. 30, 2004 December 31,
(Unaudited) 2003
------------ ------------
ASSETS:
Cash and cash equivalents $ 1,818,699 $ 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 272,311 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 188,763,433 --
Furniture, equipment, and leasehold improvements (at cost -
net of accumulated depreciation and amortization of $2,958,602
and $6,352,333) 132,223 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 112,463 780,771
------------ ------------
TOTAL ASSETS $193,599,129 $262,904,867
============ ============
See accompanying notes.
2
JB OXFORD HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
Sept 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 174,258,841 --
Accounts payable and accrued liabilities 6,593,222 5,436,675
Loans from shareholders -- 5,418,696
Notes payable 3,333,819 3,458,819
------------- -------------
TOTAL LIABILITIES $ 184,185,882 $ 251,944,149
------------- -------------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY:
Common stock ($.01 par value, 100,000,000 shares authorized;
3,739,413 and 1,756,499 shares issued) 37,394 17,565
Additional paid-in capital 23,282,397 18,039,086
Retained deficit (12,993,343) (5,425,090)
Treasury stock at cost, 46,994 and 83,244 shares (913,201) (1,670,843)
------------- -------------
TOTAL SHAREHOLDERS' EQUITY 9,413,247 10,960,718
------------- -------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 193,599,129 $ 262,904,867
============= =============
See accompanying notes.
3
JB OXFORD HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
For The Nine Months Ended For The Three Months Ended
September 30, September 30,
2004 2003 2004 2003
----------- ----------- ----------- -----------
REVENUES:
Interest $ 173,673 $ 174,913 $ 57,887 $ 58,158
Brokerage 288,113 -- 195,916 --
Other 100,000 10,111 100,000 --
----------- ----------- ----------- -----------
Total revenues 561,786 185,024 353,803 58,158
----------- ----------- ----------- -----------
EXPENSES:
General and administrative 1,531,248 993,730 537,077 168,228
Interest 482,667 483,372 160,889 161,124
Depreciation and amortization 116,354 149,330 36,840 44,371
----------- ----------- ----------- -----------
Total expenses 2,130,269 1,626,432 734,806 373,723
----------- ----------- ----------- -----------
Loss from continuing operations
before income taxes (1,568,483) (1,441,408) (381,003) (315,565)
Income tax expense (benefit) 6,100 (581,228) -- (31,017)
----------- ----------- ----------- -----------
Net loss from continuing operations (1,574,583) (860,180) (381,003) (284,548)
Loss from discontinued operations (5,351,543) (2,746,959) (2,590,364) (854,843)
----------- ----------- ----------- -----------
Net loss $(6,926,126) $(3,607,139) $(2,971,367) $(1,139,391)
=========== =========== =========== ===========
Basic net loss per share:
From continuing operations $ (0.81) $ (0.57) $ (0.17) $ (0.18)
From discontinued operations (2.74) (1.80) (1.17) (0.55)
Basic net loss per share
(3.55) (2.37) (1.34) (0.73)
Diluted net loss per share:
From continuing operations $ (0.81) $ (0.57) $ (0.17) $ (0.18)
From discontinued operations (2.74) (1.80) (1.17) (0.55)
Diluted net loss per share
(3.55) (2.37) (1.34) (0.73)
Weighted average number of shares
Basic 1,949,404 1,523,665 2,216,761 1,557,565
Diluted 1,949,404 1,523,665 2,216,761 1,557,565
See accompanying notes.
4
JB OXFORD HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For The Nine Months Ended
September 30,
-----------------------------
2004 2003
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (6,926,126) $ (3,607,139)
Adjustments to reconcile net loss to cash used in operating activities:
Depreciation and amortization 1,111,672 2,066,476
Provision for bad debts 51,340 55,285
Deferred income taxes, net -- 880,000
Changes in assets and liabilities:
Cash segregated under federal and other regulations 27,581,674 3,892,369
Receivable from broker-dealers and clearing organizations 18,434,836 (12,471,683)
Receivable from customers 14,697,423 12,731,314
Other receivables 1,557,422 393,547
Securities owned (489,590) 596,400
Clearing deposits 1,703,957 (5,245,728)
Other assets (199,183) (66,063)
Payable to broker-dealers and clearing organizations (29,739,160) (10,245,587)
Payable to customers (31,675,092) 5,578,508
Securities sold, not yet purchased (1,956,866) 2,525,619
Accounts payable and accrued liabilities 1,116,506 (410,284)
Income taxes receivable -- 1,992,066
------------ ------------
Net cash used in operating activities (4,731,187) (1,334,897)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (223,084) (170,351)
------------ ------------
Net cash used in investing activities (223,084) (170,351)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments of notes payable (125,000) --
------------ ------------
Net cash used in financing activities (125,000) --
------------ ------------
NET DECREASE IN CASH AND CASH EQUIVALENTS (5,079,271) (1,505,248)
CASH AND CASH EQUIVALENTS AT BEGINNING OF THE PERIOD 6,897,970 5,579,755
------------ ------------
CASH AND CASH EQUIVALENTS AT END OF THE PERIOD $ 1,818,699 $ 4,074,507
============ ============
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 consolidated
financial statements contain all adjustments necessary to present fairly the
consolidated 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 consolidated 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. That transaction closed on October 8, 2004, with the
final purchase price fixed at $25,870,000.00. On August 20, 2004, the Registrant
entered into an agreement with North American Clearing, Inc. to sell all of its
clearing rights for the correspondent accounts of its wholly-owned subsidiary
National Clearing Corp. ("NCC"). Under the terms of the agreement, the
Registrant received an initial payment of $100,000, and will receive 50% of the
revenue related to the transferred correspondent accounts over the next five
years, up to a maximum total payment of $2.5 million. 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 Nine Months Ended For The Three Months Ended
September 30, September 30,
2004 2003 2004 2003
----------- ----------- ----------- -----------
BASIC EARNINGS PER SHARE:
Net loss $(6,926,126) $(3,607,139) $(2,971,367) $(1,139,391)
----------- ----------- ----------- -----------
Loss available to common stockholders $(6,926,126) $(3,607,139) $(2,971,367) $(1,139,391)
(numerator)
=========== =========== =========== ===========
Weighted average common shares outstanding 1,949,404 1,523,665 2,216,761 1,557,565
(denominator)
=========== =========== =========== ===========
Basic earnings per share $ (3.55) $ (2.37) $ (1.34) $ (0.73)
=========== =========== =========== ===========
DILUTED EARNINGS PER SHARE:
Net Loss $(6,926,126) $(3,607,139) $(2,971,367) $(1,139,391)
----------- ----------- ----------- -----------
Loss available to common stockholders plus
assumed conversions (numerator) $(6,926,126) $(3,607,139) $(2,971,367) $(1,139,391)
=========== =========== =========== ===========
Weighted average common shares outstanding 1,949,404 1,523,665 2,216,761 1,557,565
----------- ----------- ----------- -----------
Weighted average common shares and assumed 1,949,404 1,523,665 2,216,761 1,557,565
conversions outstanding (denominator)
=========== =========== =========== ===========
Diluted earnings per share $ (3.55) $ (2.37) $ (1.34) $ (0.73)
=========== =========== =========== ===========
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 were used, the fully diluted shares
outstanding for the nine months ended September 30, 2004 and 2003 would be
3,694,935 and 3,855,609, respectively.
The excluded options carry exercise prices ranging from $2.20 to $91.25 at
September 30, 2004 and 2003. Options to purchase 151,250 shares of common stock
at September 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. These shares and 46,560 shares that were issued in December
2003 in the amount of $155,556 have been returned to the Company and cancelled
as of September 30, 2004, in settlement of a dispute regarding the registration
requirements of the Mr. Stock shares. See "Litigation Related to Account
Acquisitions" included at Note 6 for additional information. Earnings per share
for the periods ended September 30, 2004 have been calculated as if the shares
were cancelled on September 30, 2004.
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.
On September 13, 2004 the secured convertible debentures were converted to
common stock in accordance with the terms of the notes. The debentures
representing notes payable in the amount of $5,418,696 were converted into
2,029,474 shares of the Company's common stock at the rate of $2.67 per share.
This conversion was a requirement of the asset purchase agreement in the sale of
online retail accounts to Ameritrade.
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 nine months ended September
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 September 30,
2004 and 2003, and changes during the periods ending on those dates is presented
below:
September 30, 2004 September 30, 2003
Weighted Weighted
Shares average Shares average
--------- --------- --------- ---------
Outstanding at 256,825 $ 15.66 257,200 $ 15.72
be-ginning of period
Forfeited (105,575) 14.63 (375) 32.37
--------- ---------
Outstanding at end of
period 151,250 16.34 256,825 15.66
========= =========
Options exercisable 151,250 16.34 255,725 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. That transaction closed on October 8, 2004, with the final purchase
price fixed at $25,870,000.00. On August 20, 2004, the Registrant entered into
an agreement with North American Clearing, Inc. to sell all of its clearing
rights for the correspondent accounts of its wholly-owned subsidiary National
Clearing Corp. ("NCC"). Under the terms of the agreement, the Registrant
received an initial payment of $100,000 in October 2004, and will receive 50% of
the revenue related to the transferred correspondent accounts over the next five
years, up to a maximum total payment of $2.5 million. 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 met the criteria defined by SFAS No. 144 to be reported as
discontinued operations as of June 30, 2004.
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 September 30, 2004.
Cash and cash equivalents segregated under federal and other regulations $103,166,898
Receivable from broker-dealer and clearing organizations 10,902,522
Receivable from customers (net of allowance for doubtful accounts of
$2,832,645) 63,623,293
Other receivable 310,132
Marketable securities owned at market value 921,650
Furniture, equipment, and leasehold improvements (at cost net of
accumulated depreciation and amortization of $4,050,817) 1,629,558
Clearing deposits 4,838,638
Intangible assets (net of accumulated amortization of $4,031,264) 2,503,251
Other assets 867,491
------------
Total assets held for sale $188,763,433
============
Payable to broker-dealer and clearing organizations 10,592,595
Payable to customers 163,665,203
Securities sold, not yet purchased at market value 1,043
------------
Total liabilities associated with assets held for sale $174,258,841
============
The following table reflects detailed amounts of revenue, expense and loss
reported in discontinued operations for the respective periods ended September
30, 2004 and 2003. Operations previously reported have been restated to reflect
the change in status to discontinued operations. Revenue of $100,000 was
received in September 2004 on the sale of the correspondent clearing operation
and is included in other revenue on a continuing operations basis. No gain on
sale is included as of September 30, 2004 on the Ameritrade transaction because
the sale did not close until October 2004.
9
For The Nine Months Ended For The Three Months Ended
September 30, September 30,
2004 2003 2004 2003
------------ ------------ ------------ ------------
REVENUES:
Commissions $ 5,149,891 $ 6,325,195 1,197,131 $ 2,193,145
Interest 3,780,347 4,063,845 1,147,900 1,251,411
Trading profits 296,320 1,002,314 93,511 (265,874)
Clearing and execution 1,710,736 2,153,758 523,973 716,849
Other 91,515 274,957 27,504 15,893
------------ ------------ ------------ ------------
Total revenues 11,028,809 13,820,069 2,990,019 3,911,424
------------ ------------ ------------ ------------
EXPENSES:
Employee compensation 3,863,159 5,002,361 985,727 1,540,767
Clearing and floor brokerage 741,119 495,463 264,789 249,333
Communications 1,390,512 1,540,609 319,783 484,135
Occupancy and equipment 2,472,886 2,962,874 798,303 904,122
Interest 281,585 418,783 83,489 89,439
Data processing charges 2,534,293 1,718,807 1,367,509 614,275
Professional services 2,499,879 1,327,395 644,942 416,801
Promotional 163,632 165,970 25,299 46,997
Bad debts 51,340 55,285 12,605 20,208
Amortization of intangible assets 454,586 1,101,968 -- 360,727
Other operating expenses 1,921,161 2,611,007 1,077,937 583,435
------------ ------------ ------------ ------------
Total Expenses 16,374,152 17,400,522 5,580,383 5,310,239
------------ ------------ ------------ ------------
Loss before income taxes (5,345,343) (3,850,453) (2,590,364) (1,398,815)
Income tax expense (benefit) 6,200 (1,103,494) -- (543,972)
------------ ------------ ------------ ------------
Loss from discontinued operations $ (5,351,543) $ (2,746,959) $ (2,590,364) $ (854,843)
============ ============ ============ ============
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 September 30, 2004, NCC had net capital of $6,507,975, which was
$5,172,622 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 September 30, 2004, JBOC had net capital of $310,303, which was $60,303
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 June 30, 2004, except as disclosed below.
SEC MUTUAL FUND INVESTIGATION
On or about August 24, 2004, the SEC's Los Angeles Office commenced a civil
lawsuit against the Company, NCC, and three of its former officers and
employees, alleging violations of Section 17(a) of the Securities Act of 1933,
Section 10(b) of the Exchange Act of 1934 and Rule 10b-5 thereunder, and Section
22(c) of the Investment Company Act of 1940 and Rule 22c-1 thereunder. The suit
seeks unspecified monetary damages and penalties, as well as other remedies
against the individual defendants. The suit contends that the Company wrongfully
allowed customers to place mutual fund trades after 4:00p.m. EST, and wrongfully
assisted clients in "market timing" of mutual funds. While the Company admits no
wrongdoing and intends to vigorously defend itself, no assurance can be given as
to the outcome of this matter. Although the likelihood of loss is probable, the
Company has not accrued any specific amounts related to this matter, as the
amount of loss is not estimable at this time. The Company maintains a litigation
reserve, which it believes is adequate to cover the minimum estimated loss.
However, substantial penalties in excess of the 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 CORRESPONDENT CLEARING
On August 20, 2004, NCC settled two pending arbitrations involving claims of
approximately 60 former customers of correspondent firms that previously cleared
through NCC. The settlement called for a lump sum payment by the Registrant of
$1.25 million on or before October 18, 2004, which payment was timely made. The
Company evaluated the adequacy of its litigation reserve at the end of the third
quarter. As a result of this settlement, the Company recorded a charge of
$750,000.
11
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. In October 2004, we settled the dispute with Share King LLC by making
a one-time payment of $1.4 million. As a part of that settlement, all shares
issued to Share King LLC were returned to the Company to be cancelled.
NOTE 7. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
For The Nine Months
Ended Sept 30,
----------------------
2004 2003
-------- --------
Supplemental Disclosures of Cash Flow Information
Cash paid for:
Interest $647,347 $784,545
Income taxes 12,300 71,977
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.
Cancellation of common stock issued to acquire intangible assets in the
amount of $155,556 for 2004 (See Note 3 Equity Transactions and Stock Options).
Conversion of convertible debentures representing notes payable in the
amount of $5,418,696 were converted into 2,029,474 shares of the Company's
common stock 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.
12
Business Overview
Through our wholly-owned subsidiaries, we were previously engaged in the
business of providing brokerage and related financial services to retail
customers and broker-dealers nationwide. With the completion of the transactions
with Ameritrade, Inc. and North American Clearing, we now provide market making
and institutional trading services only. See Note 4, Assets Held for Sale and
Discontinued Operations. Our business is headquartered in Los Angeles,
California.
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 JB Oxford & Company ("JBOC"). The purchase price of $26
million was subject to adjustment based upon the number of accounts actually
transferred at the closing. The transaction closed on October 8, 2004, with the
final purchase price being set at $25.87 million. As a condition to that
transaction closing, Third Capital Partners, LLC converted 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.
On August 20, 2004, the Registrant entered into an agreement with North American
Clearing, Inc. to sell all of its clearing rights for the correspondent accounts
of its wholly-owned subsidiary National Clearing Corp. ("NCC"). Under the terms
of the agreement, the Registrant received an initial payment of $100,000, and
will receive 50% of the revenue related to the transferred correspondent
accounts over the next five years, up to a maximum total payment of $2.5
million.
On or about August 24, 2004, the SEC's Los Angeles Office commenced a civil
lawsuit against the Company, NCC, and three of its former officers and
employees, alleging violations of Section 17(a) of the Securities Act of 1933,
Section 10(b) of the Exchange Act of 1934 and Rule 10b-5 thereunder, and Section
22(c) of the Investment Company Act of 1940 and Rule 22c-1 thereunder. The suit
seeks unspecified monetary damages and penalties, as well as other remedies
against the individual defendants. The suit contends that the Company wrongfully
allowed customers to place mutual fund trades after 4:00p.m. EST, and wrongfully
assisted clients in "market timing" of mutual funds. While the Company admits no
wrongdoing and intends to vigorously defend itself, no assurance can be given as
to the outcome of this matter. Although the likelihood of loss is probable, the
Company has not accrued any specific amounts related to this matter, as the
amount of loss is not estimable at this time. The Company maintains a litigation
reserve, which it believes is adequate to cover the minimum estimated loss.
However, substantial penalties in excess of the 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.
13
Market Making Activities
In order to facilitate the execution of security transactions for our own
customers, NCC acts as a market maker for approximately 10 public corporations
whose stocks are traded on the NASDAQ National Market System, 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
Nine Months Ended September 30, 2004 Compared with Nine Months Ended September
30, 2003
Continuing Operations
Revenues from ongoing institutional sales and trading services provided $213,580
in commission revenue and $74,533 in trading profits for the nine months ended
September 30, 2004. The Company did not provide such services in 2003. Interest
earned for the nine months ended September 30, 2004 amounted to $173,673. This
compares to $174,913 of interest earned in the first nine months of 2003. The
Company also generated $100,000 from the sale of its correspondent clearing
operation during the nine months ended September 30, 2004.
Our general and administrative expense increased by $537,518 or 54% to
$1,531,248 in the first nine months of 2004 from $993,730 in the first nine
months of 2003. This increase resulted primarily from professional fees that
increased $461,310 to $882,163 in the first nine months of 2004 from $420,853 in
the first nine months of 2003. These fees were incurred largely due to the SEC
mutual fund investigation and the lawsuit against the Parent Company. See Note 6
above. General and administrative expenses included employee compensation of
$336,328 and $265,585 for the nine months ended September 30, 2004 and 2003,
respectively.
Discontinued Operations
Loss from discontinued operations amounted to $5,351,543 in the first nine
months of 2004 compared to $2,746,959 in the first nine months of 2003. This is
a change of $1,604,584 or 58% increase in the loss.
Revenues from Discontinued Operations
Our total discontinued brokerage revenues were $11,028,809 in the first nine
months of 2004, a decrease of 20% from $13,820,069 in the first nine months of
2003. The primary reason for the decrease in brokerage revenue was a decline in
Commission revenues of $1,175,304 or 19% to $5,149,891 in the first nine months
of 2004 from $6,325,195 in the first nine months of 2003. Additionally, trading
profits decreased 70% to $296,320 in the current period from $1,002,314 in the
first nine months of 2003. Clearing and execution revenues decreased 21% to
$1,710,736 in the first nine months of 2004 from $2,153,758 in the first nine
months of 2003. Interest revenue decreased 7% to $3,780,347 in the first nine
months of 2004 from $4,063,845 in the first nine months of 2003.
14
Discontinued retail commission revenue decreased $1,175,304, or 19% to
$5,149,891 in the first nine months of 2004 compared to $6,325,195 in the first
nine months of 2003. The decrease in commission revenue, is the result of fewer
trade transactions and also reflects JBOC's adoption during 2003 of a more
competitive pricing schedule.
Interest revenues from brokerage operations decreased $283,498 or 7% to
$3,780,347 in the first nine months of 2004 compared to $4,063,845 in the first
nine months of 2003. Net interest income decreased 4% from $3,645,062 in the
first nine months of 2003 to $3,498,762 in the first nine months of 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 70% to $296,320 in the first nine months of 2004 from
$1,002,314 in the first nine months 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.
Clearing and execution revenues decreased $443,022 or 21% to $1,710,736 in the
first nine months of 2004 compared to $2,153,758 in the first nine months of
2003. The largest factor in the decrease was a $232,416 decrease in inactivity
fee revenues from the first nine months of 2003 compared to the first nine
months of 2004. The decrease results from inactive accounts being closed or
moved to other broker-dealers.
Expenses from Discontinued Operations
Expenses from discontinued brokerage activities totaled $15,374,152 for the
first nine months of 2004, a decrease of 13% from $17,670,522 in the first nine
months 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
$796,370 or 5% during the first nine months of 2004 compared to the first nine
months of 2003. The largest increase was attributable to the increase of
$1,172,484 in professional services incurred in the first nine months of 2004
when compared with the first nine months 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 $568,232 in amortization expense that would have otherwise been
expensed, because customer intangible assets were held for sale.
Employee compensation from discontinued brokerage operations decreased by 23% in
the first nine months of 2004 to $3,863,159 from $5,002,361 in the first nine
months of 2003, as the Company continued to reduce its workforce. Interest
expense decreased 33% to $281,585 in the first nine months of 2004 from $418,783
in the first nine months of 2003. This decrease was in line with the revenue
decreases discussed above.
15
Professional services increased by $1,172,484 or 88% in the first nine months of
2004 to $2,499,879 from $1,327,395 in the first nine months of 2003. Legal fees
included in professional services increased $1,190,271 primarily as a result of
the SEC mutual fund investigation involving NCC.
Occupancy and equipment expenses decreased $489,988 or 17% to $2,472,886 in the
first nine months of 2004 from $2,962,874 in the first nine months of 2003, as
property and equipment lease commitments have ended. Included in 2004 is the
accrual of $315,000 that was paid in November 2004 to terminate the lease in
Beverly Hills. The termination of these lease eliminated a total lease
commitment of $7,068,602 from November 2004 through December 2010. Included in
data processing expense for the nine months ended September 30, 2004 is the
accrual of $1,000,000 relating to the buy out of a data processing provider
service agreement. This contract, prior to the buy out, required payments of
approximately $2,200,000 over the next four years. Payment of the $1,000,000 is
required prior to the end of 2004. Additionally, amortization expense decreased
$647,382 during the first nine months of 2004 compared to the first nine months
of 2003, of which $568,232 was because the intangible assets were classified as
held for sale in 2004.
Other expense decreased by $689,846 during the first nine months of 2004
compared to the first nine months of 2003. The most significant reason for the
change is a one-time charge in the first nine months 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 the
accrual of $750,000 in the third quarter 2004 related to the settlement of a
correspondent clearing case (see Note 6 Contingent Liabilities).
Quarter Ended September 30, 2004 Compared with Quarter Ended September 30, 2003
Continuing Operations
Revenues from ongoing institutional sales and trading services provided $130,360
in commission revenue and $65,556 in trading profits for the quarter ended
September 30, 2004. The Company did not provided such services in 2003. Interest
earned for the quarter ended September 30, 2004 amounted to $57,887. This
compares to $58,158 of interest earned in the third quarter of 2003. The Company
also generated $100,000 from the sale of its correspondent clearing operation
during the quarter ended September 30, 2004.
Our general and administrative expense increased by $368,228 or 219% to $537,077
in the third quarter of 2004 from $168,228 in the third quarter of 2003. This
increase resulted from professional fees that increased $240,076 to $260,128 in
the third quarter of 2004 from $20,052 in the third quarter of 2003. These fees
were incurred due to the SEC mutual fund investigation and the litigation
related to the Oeri notes. See Note 6 to the accompanying financial statements.
General and administrative expenses included employee compensation of $142,658
and $52,546 for the three months ended September 30, 2004 and 2003,
respectively. The increase in 2004 relates to commissions paid on commissions
generated on institutional sales and trading services.
Discontinued Operations
We recorded a net loss from discontinued operations of $2,590,364 for the
quarter ended September 30, 2004. This compares with a net loss of $854,843 for
the quarter ended September 30, 2003.
16
Total discontinued brokerage revenues for the third quarter of 2004 were
$2,990,019, a decrease of $921,405 or 24% from the comparable quarter of 2003.
Lower trading volumes during the third quarter of 2004 caused commission revenue
to decrease $996,014 or 45% in the same period compared with the third quarter
of 2003, and $552,311 or 32% when compared with the second quarter of 2004.
Clearing revenue decreased $192,876 or 27% during the third quarter of 2004
compared with the third quarter of 2003, and decreased $103,446 or 16% compared
with the second quarter of 2004, primarily due to the sale of the correspondent
clearing operation that occurred during the first week of September 2004.
Interest revenue from brokerage operations decreased $103,511 or 8% to
$1,147,900 from $1,251,411 for the third quarter of 2004 compared with the third
quarter of 2003. Interest revenue decreased as a result of declining margin
balances, which was partially offset by increases in margin interest rates. Net
interest income decreased $97,561 or 8% to $1,064,411 in the third quarter of
2004 from $1,161,972 in the third quarter of 2003.
Total discontinued brokerage expenses for the third quarter of 2004 were
$4,580,383, a decrease of $729,859 or 14% from the comparable quarter of 2003.
Interest expense decreased $5,950 or 7% during the third quarter of 2004
compared with the third quarter of 2003 on lower customer credit balances and
interest rates.
Employee compensation from discontinued brokerage operations decreased $555,040
or 36% to $985,727 in the third quarter of 2004 from $1,540,767 during the third
quarter of 2003, due to workforce reductions. Professional services expenses
increased $228,414 or 55% in the third quarter of 2004 when compared to the
third quarter of 2003, due to increased legal fees as a result of the SEC mutual
fund investigation involving NCC.
Occupancy and equipment expenses decreased $105,819 or 12% in the third quarter
of 2004 when compared with the third quarter of 2003. Included in data
processing expense for the quarter ended September 30, 2004 is the accrual of
$1,000,000 relating to the buy out of a data processing provider service
agreement, as explained above. Amortization expense decreased $360,727 during
the third quarter of 2004 compared to the third quarter of 2003, no amortization
was provided for in the third quarter 2004 because intangible assets were
classified as held for sale. Data processing charges decreased $246,766 or 40%
on lower trading volumes in the third quarter of 2004 when compared with the
third quarter of 2003.
Other expenses increased $494,502 or 85% in the third quarter of 2004 compared
with the third quarter of 2003. This increase results from the accrual of
$750,000 in the third quarter 2004 related to the settlement of a correspondent
clearing case (see Note 6 Contingent Liabilities).
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.
17
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
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 seven fiscal quarters, NCC's net capital has declined
from $9,452,719 at December 31, 2002 to $6,507,975 at September 30, 2004. 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 was $25.87 million. The transaction closed on October 8, 2004 and JBOC
received the initial required payment of $14.0 million. Third Capital Partners,
LLC has converted 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. In addition, we have sold our
correspondent clearing operation to North American Clearing, Inc. for $100,000
and 50% of the revenue over the next five years for the transferred accounts, up
to a maximum total payment of $2.5 million. The net proceeds will be utilized to
address pending legal matters and for other general expenses.
Liquidity at September 30, 2004
Our cash position decreased during the first nine months of 2004 by $5,079,271
to $1,818,699. This compares with a net decrease in cash and cash equivalents of
$1,505,248 in the first nine months 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
converted these notes 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).
18
Cash Flows From Operating Activities
Net cash used in operating activities (including discontinued operating
activities) was $4,731,187 for the first nine months of 2004, compared to cash
of $1,334,897 used in operations during the first nine months of 2003. Our net
cash provided by or used in operating activities is impacted by changes in the
brokerage-related assets and liabilities of NCC.
During the first nine months of 2004, the most significant source of cash was
the decrease in cash segregated under federal and other regulations of
$27,581,674. Additionally, receivables from broker-dealer and clearing
organizations decreased to provide cash of $18,434,836, and customer receivables
decreased to provide cash of $14,697,423. These sources of cash were offset by
the decreases in payables to broker-dealers and clearing organizations of
$29,739,160 and payables to customers of $31,675,092 that are uses of cash. The
net loss of $5,926,126 also used cash in operations.
Cash Flows Used In Investing Activities
The net cash used in investing activities during the first nine months of 2004
was $223,084 compared with $170,351 during the first nine months 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 nine months of 2004
was $125,000 compared with no cash used in financing activities in the first
nine months 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.
19
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.
On or about August 24, 2004, the SEC's Los Angeles Office commenced a
civil lawsuit against the Company, NCC, and three of its former officers and
employees, alleging violations of Section 17(a) of the Securities Act of 1933,
Section 10(b) of the Exchange Act of 1934 and Rule 10b-5 thereunder, and Section
22(c) of the Investment Company Act of 1940 and Rule 22c-1 thereunder. The suit
seeks unspecified monetary damages and penalties, as well as other remedies
against the individual defendants. The suit contends that the Company wrongfully
allowed customers to place mutual fund trades after 4:00p.m. EST, and wrongfully
assisted clients in "market timing" of mutual funds. While the Company admits no
wrongdoing and intends to vigorously defend itself, no assurance can be given as
to the outcome of this matter. Although the likelihood of loss is probable, the
Company has not accrued any specific amounts related to this matter, as the
amount of loss is not estimable at this time. The Company maintains a litigation
reserve, which it believes is adequate to cover the minimum estimated loss.
However, substantial penalties in excess of the 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.
THIRD CAPITAL HAS CONVERTED 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 were converted into approximately 2 million shares of common stock on
September 8, 2004. As a result, the ownership percentage of our shareholders
other than Third Capital Partners has been significantly diluted. Third Capital
Partners now owns 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.
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.
20
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 a result of the sales to
Ameritrade and North American Clearing, the Company is reviewing its options for
ongoing business and investment of the proceeds from the sales. However, any
such new business venture may require additional capital. 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 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.
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 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. 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.
21
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.
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.
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.
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 have 10,000,000 shares of authorized preferred stock, of which
9,800,000 remain available for issuance to third parties selected by management.
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.
22
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
September 30, 2004, our NCC subsidiary had net capital of $7,507,975, which was
$6,172,622 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.
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.
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.
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.
23
Equity Price Risk
NCC acts as a market maker for approximately 10 public corporations whose stocks
are traded on the NASDAQ National Market System 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 September 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 were 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 September 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.
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.
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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
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.
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On or about August 24, 2004, the SEC's Los Angeles Office commenced a
civil lawsuit against the Company, NCC, and three of its former officers and
employees, alleging violations of Section 17(a) of the Securities Act of 1933,
Section 10(b) of the Exchange Act of 1934 and Rule 10b-5 thereunder, and Section
22(c) of the Investment Company Act of 1940 and Rule 22c-1 thereunder. The suit
seeks unspecified monetary damages and penalties, as well as other remedies
against the individual defendants. The suit contends that the Company wrongfully
allowed customers to place mutual fund trades after 4:00p.m. EST, and wrongfully
assisted clients in "market timing" of mutual funds. While the Company admits no
wrongdoing and intends to vigorously defend itself, no assurance can be given as
to the outcome of this matter. Although the likelihood of loss is probable, the
Company has not accrued any specific amounts related to this matter, as the
amount of loss is not estimable at this time. The Company maintains a litigation
reserve, which it believes is adequate to cover the minimum estimated loss.
However, substantial penalties in excess of the 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.
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.
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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.
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 in defense of this claim.
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. In October 2004, we settled the dispute with Share King LLC by making
a one-time payment of $1.4 million. As a part of that settlement, all shares
issued to Share King LLC were returned to the Company to be cancelled.
27
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
On September 13, 2004, Third Capital Partners, LLC exercised its
conversion rights under two 9% Secured Convertible Notes in the aggregate
principal sum of $5,418,696. Upon conversion, the Company issued 2,029,474
shares of its common stock, par value $.01 per share, to Third Capital Partners.
The shares were issued at the conversion rate of $2.67 per share, as required by
the terms of the Secured Convertible Notes.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
ITEM 5. OTHER INFORMATION
None.
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 third quarter, we filed a Report on Form 8-K, dated August 24,
2004, reporting that North American Clearing, Inc., had signed a definitive
agreement to purchase the correspondent clearing accounts of National Clearing
Corp. The filing also reported the settlement of two pending arbitration
matters, and our financial results for the second quarter of 2004.
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Also, after the end of third quarter, but before the date hereof, we filed
a Report on Form 8-K, dated October 12, 2004, reporting that the transaction
with Ameritrade, Inc., a subsidiary of Ameritrade Holdings, Corporation, had
been consummated.
Pursuant to the requirements of the Securities Exchange Act of 1934, JB
Oxford Holdings, Inc. has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
JB Oxford Holdings, Inc.
/s/ Michael J. Chiodo
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Michael J. Chiodo
Chief Financial Officer
November 22, 2004
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