UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarter Ended June 30, 2004 Commission File Number 001-12629
------------- ---------
OLYMPIC CASCADE FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 36-4128138
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
875 North Michigan Avenue, Suite 1560, Chicago, Illinois 60611
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(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (312) 751-8833
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by checkmark whether the registrant is an accelerated filer (as defined
in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
The number of shares outstanding of registrant's common stock, par value $0.02
per share, at August 12, 2004 was 3,634,332.
1
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
OLYMPIC CASCADE FINANCIAL CORPORATION AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
ASSETS
June 30, September 30,
2004 2003
(unaudited) (see note below)
-------------- ---------------
CASH $ 313,000 $ 451,000
DEPOSITS WITH CLEARING ORGANIZATIONS 769,000 1,041,000
RECEIVABLES FROM BROKER-DEALERS AND CLEARING ORGANIZATIONS 2,905,000 3,724,000
OTHER RECEIVABLES, net of reserve for uncollectible accounts of $725,000 and $650,000
at June 30, 2004 and September 30, 2003, respectively 810,000 709,000
ADVANCES TO REGISTERED REPRESENTATIVES 1,674,000 644,000
SECURITIES HELD FOR RESALE, at market 613,000 374,000
FIXED ASSETS, net 303,000 247,000
SECURED DEMAND NOTE 1,000,000 1,000,000
OTHER ASSETS 592,000 545,000
-------------- ---------------
TOTAL ASSETS $ 8,979,000 $ 8,735,000
============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
PAYABLE TO BROKER-DEALERS AND CLEARING ORGANIZATIONS $ -- $ 258,000
SECURITIES SOLD, BUT NOT YET PURCHASED, at market 741,000 116,000
ACCOUNTS PAYABLE, ACCRUED EXPENSES AND OTHER LIABILITIES 3,738,000 4,520,000
NOTES PAYABLE 1,812,000 3,170,000
-------------- ---------------
TOTAL LIABILITIES 6,291,000 8,064,000
-------------- ---------------
SUBORDINATED BORROWINGS 1,000,000 1,000,000
-------------- ---------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY (DEFICIT)
Series A 9% cumulative convertible preferred stock, $.01 par value,
50,000 shares authorized; 31,177 shares issued and outstanding
(liquidation preference: $3,117,700) at June 30, 2004, and 27,825
shares issued and outstanding (liquidation preference: $2,782,500)
at September 30, 2003, respectively -- --
Common stock, $.02 par value, 30,000,000 shares authorized, 3,557,409
shares and 3,367,558 shares issued and outstanding at June 30,
2004 and
September 30, 2003, respectively 71,000 67,000
Additional paid-in capital 13,694,000 12,628,000
Accumulated deficit (12,077,000) (13,024,000)
-------------- ---------------
TOTAL STOCKHOLDERS' EQUITY (DEFICIT) 1,688,000 (329,000)
-------------- ---------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) $ 8,979,000 $ 8,735,000
============== ===============
Note: The balance sheet at September 30, 2003 has been derived from the audited
consolidated financial statements at that date.
2
OLYMPIC CASCADE FINANCIAL CORPORATION AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended Nine Months Ended
------------------------------------- ---------------------------------
June 30, June 30, June 30, June 30,
2004 2003 2004 2003
------------------- --------------- --------------- ---------------
REVENUES:
Commissions $ 10,852,000 $ 10,566,000 $ 37,525,000 $ 22,461,000
Net dealer inventory gains 1,715,000 3,192,000 5,767,000 9,417,000
Interest and dividends 937,000 359,000 2,468,000 975,000
Transfer fees and clearing services 769,000 572,000 2,098,000 1,293,000
Investment banking 398,000 214,000 1,098,000 345,000
Gain on extinguishment of debt -- -- 1,131,000 --
Other 183,000 172,000 515,000 570,000
------------------- --------------- --------------- ---------------
TOTAL REVENUES 14,854,000 15,075,000 50,602,000 35,061,000
------------------- --------------- --------------- ---------------
EXPENSES:
Commissions 10,296,000 10,328,000 34,604,000 23,274,000
Employee compensation and related expenses 1,399,000 898,000 4,207,000 2,979,000
Clearing fees 635,000 769,000 2,397,000 1,993,000
Communications 751,000 694,000 2,061,000 1,961,000
Occupancy and equipment costs 807,000 628,000 2,248,000 2,057,000
Interest 118,000 31,000 260,000 109,000
Professional fees 637,000 382,000 1,462,000 912,000
Litigation settlement -- -- 400,000 --
Taxes, licenses, registration 182,000 95,000 444,000 229,000
Other 339,000 887,000 1,069,000 1,935,000
------------------- --------------- --------------- ---------------
TOTAL EXPENSES 15,164,000 14,712,000 49,152,000 35,449,000
------------------- --------------- --------------- ---------------
NET INCOME (LOSS) (310,000) 363,000 1,450,000 (388,000)
Preferred stock dividends (70,000) (62,000) (196,000) (187,000)
------------------- --------------- --------------- ---------------
Net income (loss) attributable to common
stockholders $ (380,000) $ 301,000 $ 1,254,000 $ (575,000)
=================== =============== =============== ===============
NET INCOME (LOSS) PER COMMON SHARE
Basic:
Net income (loss) attributable to common
stockholders $ (0.11) $ 0.09 $ 0.37 $ (0.18)
=================== =============== =============== ===============
Diluted:
Net income (loss) attributable to common
stockholders $ (0.11) $ 0.06 $ 0.21 $ (0.18)
=================== =============== =============== ===============
Weighted average number of shares outstanding
Basic 3,397,885 3,367,558 3,377,630 3,110,530
=================== =============== =============== ===============
Diluted 3,397,885 5,229,722 6,055,194 3,110,530
=================== =============== =============== ===============
3
OLYMPIC CASCADE FINANCIAL CORPORATION AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended
------------------------------------------
June 30, 2004 June 30, 2003
------------------- --------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ 1,450,000 $ (388,000)
Adjustments to reconcile net income (loss) to net
cash used in operating activities
Depreciation and amortization 128,000 174,000
Amortization of note discount 81,000 --
Provision for doubtful accounts 75,000 300,000
Gain on extinguishment of debt (1,131,000) --
Forgiveness of loan (251,000) (325,000)
Changes in assets and liabilities
Restricted cash -- 309,000
Deposits with clearing organizations 272,000 649,000
Receivables from broker-dealers, clearing organizations
and others (387,000) (2,392,000)
Securities held for resale, at market (239,000) (1,497,000)
Other assets (47,000) (292,000)
Payables (1,037,000) 3,059,000
Securities sold, but not yet purchased, at market 625,000 190,000
-------------------- ---------------------
Net cash used in operating activities (461,000) (213,000)
-------------------- ---------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of fixed assets (184,000) (65,000)
-------------------- ---------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net proceeds from issuance of notes payable and warrants 1,032,000 --
Payment of notes payable (750,000) 49,000
Decrease in cash overdraft -- (408,000)
Net proceeds from issuance of common stock and warrants -- 554,000
Proceeds from exercise of employee stock options and warrants 225,000 --
-------------------- ---------------------
Net cash provided by financing activities 507,000 195,000
-------------------- ---------------------
NET DECREASE IN CASH (138,000) (83,000)
CASH BALANCE
Beginning of the period 451,000 325,000
-------------------- ---------------------
End of the period $ 313,000 $ 242,000
=================== ====================
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash paid
during the period for:
Interest $ 85,000 $ 109,000
=================== ====================
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND
FINANCING ACTIVITIES
Conversion of accounts payable to loan payable $ -- $ 375,000
=================== ====================
Gain on extinguishment of debt $ 1,131,000 $ --
=================== ====================
Exchange of accounts payable for common stock $ -- $ 50,000
=================== ====================
Forgiveness of loan $ 251,000 $ 325,000
=================== ====================
4
OLYMPIC CASCADE FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2004
(UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION
The accompanying consolidated financial statements of Olympic Cascade Financial
Corporation ("Olympic" or the "Company") have been prepared in accordance with
generally accepted accounting principles for interim financial statements and
with the instructions to Form 10-Q under the Securities Exchange Act of 1934, as
amended (the "Exchange Act") and Rule 10-01 of Regulation S-X under the Exchange
Act. Accordingly, they do not include all of the information and disclosures
required for annual financial statements. In the opinion of management, all
adjustments (consisting of normal recurring accruals) considered necessary for a
fair presentation have been included. The condensed consolidated financial
statements as of and for the three and nine month periods ended June 30, 2004
and June 30, 2003 are unaudited. The results of operations for the interim
periods are not necessarily indicative of the results of operations for the
fiscal year. These consolidated financial statements should be read in
conjunction with the consolidated financial statements and related footnotes
included thereto in the Company's Annual Report on Form 10-K for the fiscal year
ended September 30, 2003.
Reclassifications - Certain amounts shown in the prior period's condensed
consolidated financial statements have been reclassified to conform with the
current period's condensed consolidated financial statement presentation. These
reclassifications had no effect on net income (loss) or stockholders' equity
(deficit) as previously presented.
NOTE 2 - RECENT ACCOUNTING PRONOUNCEMENTS
Stock-Based Compensation - During the quarter ended March 31, 2003, the Company
adopted Statement of Financial Accounting Standard ("SFAS") No. 148, "Accounting
for Stock-Based Compensation - Transition and Disclosure." This statement
amended SFAS No. 123, "Accounting for Stock-Based Compensation." As permitted
under SFAS No. 123, the Company continues to apply the Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees." As required
under SFAS No. 148, the following table presents pro forma net income (loss)
attributable to common stockholders for basic and diluted net income (loss) per
share as if the fair value-based method had been applied to all awards.
5
Three Months Ended Nine Months Ended
----------------------------------- ----------------------------------
June 30, 2004 June 30, 2003 June 30, 2004 June 30, 2003
----------------------------------- ----------------------------------
Net income (loss) attributable to common stockholders - as
reported $ (380,000) 301,000 $ 1,254,000 $ (575,000)
Stock-based employee compensation cost determined under
fair value method, net of tax effects (90,000) (11,000) (163,000) (26,000)
----------------------------------- ----------------------------------
Net income (loss) attributable to common stockholders - pro
forma $ (470,000) 290,000 $ 1,091,000 $ (601,000)
=================================== ==================================
Earnings (loss) per share
Basic earnings (loss) per share:
Net income (loss) attributable to common stockholders - as
reported $ (0.11) $ 0.09 $ 0.37 $ (0.18)
Per share stock-based employee compensation cost
determined under fair value method, net of tax effects (0.03) - (0.05) (0.01)
----------------------------------- ----------------------------------
Net income (loss) attributable to common stockholders - pro
forma $ (0.14) $ 0.09 $ 0.32 $ (0.19)
=================================== ==================================
Diluted earnings (loss) per share:
Net income (loss) attributable to common stockholders - as
reported $ (0.11) $ 0.06 $ 0.21 $ (0.18)
Per share stock-based employee compensation cost
determined under fair value method, net of tax effects (0.03) - (0.03) (0.01)
----------------------------------- ----------------------------------
Net income (loss) attributable to common stockholders - pro
forma $ (0.14) $ 0.06 $ 0.18 $ (0.19)
=================================== ==================================
The Black-Scholes option valuation model was used to estimate the fair value of
the options granted in the quarter and nine months ended June 30, 2004 and 2003.
The model includes subjective input assumptions that can materially affect the
fair value estimates. The model was developed for use in estimating the fair
value of traded options that have no vesting restrictions and that are fully
transferable. For example, the expected volatility is estimated based on the
most recent historical period of time equal to the weighted average life of the
options granted. Options issued under the Company's option plans have
characteristics that differ from traded options. In the Company's opinion, this
valuation model does not necessarily provide a reliable single measure of the
fair value of its employee stock options. Principal assumptions used in applying
the Black-Scholes model along with the results from the model were as follows:
6
2004 2003
-------- --------
Assumptions:
Risk-free interest rate 2.48% 4.01%
Dividend 0.00% 0.00%
Expected life, in years 3.0 5.0
Expected volatility 123% 311%
Results:
Fair value of options granted $ 1.47 $ 0.36
In January 2003, the Financial Accounting Standards Board ("FASB") issued
Interpretation Number 46, "Consolidation of Variable Interest Entities" ("FIN
No. 46"). This interpretation of Accounting Research Bulletin ("ARB") No. 51,
"Consolidated Financial Statements," provides guidance for identifying a
controlling interest in a variable interest entity ("VIE") established by means
other than voting interests. FIN No. 46 also requires consolidation of a VIE by
an enterprise that holds such a controlling interest. In December 2003, the FASB
completed its deliberations regarding the proposed modification to FIN No. 46
and issued Interpretation Number 46(R), "Consolidation of Variable Interest
Entities - an Interpretation of ARB No. 51" ("FIN No. 46(R)"). The decisions
reached included a deferral of the effective date and provisions for additional
scope exceptions for certain types of variable interests. Application of FIN No.
46(R) is required in financial statements of public entities that have interests
in VIEs or potential VIEs commonly referred to as special-purpose entities for
periods ending after December 15, 2003. Application by public entities (other
than small business issuers) for all other types of entities is required in
financial statements for the first reporting period ending after March 15, 2004.
The adoption of FIN No. 46(R) did not have an impact on the Company's
consolidated financial position, results of operations or cash flows.
NOTE 3 - SECURITIES HELD FOR RESALE AND SECURITIES SOLD, BUT NOT YET PURCHASED
The following table shows the quoted market values of the Company's securities
held for resale and securities sold, but not yet purchased as of June 30, 2004:
Securities held Securities sold, but
for resale not yet purchased
---------------------- -----------------------
Corporate Stocks $ 255,000 $ 148,000
Corporate Bonds 10,000 194,000
Government Obligations 348,000 399,000
---------------------- -----------------------
$ 613,000 $ 741,000
====================== =======================
NOTE 4 - CLEARING AGREEMENTS
In the first quarter of fiscal year 2003, First Clearing Corporation ("First
Clearing") loaned the Company an additional $375,000 in the form of clearing fee
rebates. The loan was payable in January 2004.
In December 2003, the Company engaged in various discussions with the National
Association of Securities Dealers, Inc. (the "NASD") relating to the Security
Agreement between National Securities Corporation, the Company's wholly-owned
7
subsidiary ("National") and First Clearing, and its effect on the computation of
National's net capital. As a result of these discussions, on December 15, 2003,
the Company and First Clearing agreed in principle to the following: (1)
National's clearing deposit was reduced from $1,000,000 to $500,000; (2) the
excess $500,000 resulting from this reduction was paid to First Clearing to
reduce the Company's outstanding loan balance on its promissory note to First
Clearing; and (3) the Security Agreement between National and First Clearing was
terminated. Furthermore, First Clearing forgave payment of the $375,000 loan
that was due to be paid in January 2004, resulting in a $375,000 gain on
extinguishment of debt in the first quarter of fiscal year 2004. National is
required to maintain minimum net capital equal to the greater of $250,000 or a
specified amount per security based on the bid price of each security for which
National is a market maker. At June 30, 2004, National's net capital exceeded
the requirement by $518,000.
In February 2004, the Company paid First Clearing $250,000 to fully repay its
promissory note that had a balance of approximately $1,006,000 at such time. As
a result of the repayment of this note, the Company realized a gain on
extinguishment of debt of approximately $756,000 in the second quarter of fiscal
year 2004. Additionally, National and First Clearing mutually agreed to
terminate their clearing relationship by June 30, 2004.
On June 22, 2004, National entered into an agreement with Fiserv Securities,
Inc. ("Fiserv") to clear its brokerage business. The conversion from First
Clearing to Fiserv is expected to be completed in the first week of October
2004. As part of this transaction, Fiserv will provide National with an $800,000
conversion assistance payment, $250,000 of which was paid upon execution of the
clearing agreement, $250,000 of which is payable in mid-August 2004, and
$300,000 of which is payable upon completion of the conversion in October 2004.
The Company believes that the overall effect of the new clearing relationship
will be beneficial to the Company's cost structure, liquidity and capital
resources.
NOTE 5 - CONTINGENCIES
In April 2002, a former executive officer of the Company, Craig M. Gould,
commenced an action against the Company claiming a breach of his employment
contract, and seeking approximately $850,000 in damages. The arbitration
commenced in July 2003 and was completed in December 2003. In January 2004, the
arbitration panel awarded damages against the Company of approximately $400,000
that was accrued in the quarter ended December 31, 2003. The Company paid this
award during the quarter ended March 31, 2004.
In June 2002, National was named, together with others, as a defendant in a
class action lawsuit relating to a series of private placements of securities of
Fastpoint Communications, Inc. in the Superior Court for the State of California
for the County of San Diego. Plaintiffs are seeking approximately $14.0 million,
but no specific amount of damages has been sought against National in the
complaint. National filed its answer in April 2003. In January 2004, the court
entered an order denying class certification. Plaintiffs have filed an appeal of
this order and briefing has recently commenced. The action in the lower court
has been stayed. National believes it has meritorious defenses and intends to
vigorously defend this action, although the ultimate outcome of the matter
cannot be determined at this time. Accordingly, no adjustments have been made in
the consolidated financial statements in response to this matter.
The NASD has recently commenced an industry-wide investigation of mutual fund
trading activities. National is one of the numerous broker-dealers that have
been contacted by the NASD with respect to this investigation. The NASD has
identified certain customer mutual fund transactions ordered through National
during the time period from October 2000 to February 2003 that it believes may
have constituted mutual fund timing and/or excessive trading activity. National
has been engaged in ongoing discussions and negotiations with the NASD to
informally resolve these matters. Such resolution could result in a settlement,
8
whereby National, without admitting or denying any violations, would make both
restitution and pay a fine to the NASD, that in the aggregate would approximate
$600,000. Despite our on-going discussions and negotiations with the NASD, no
assurances can be given that informal resolution will be achieved, that a formal
proceeding will not be commenced, or that the possible resulting penalties and
fines would not be in a materially greater amount. If required to litigate this
matter, National believes it has meritorious defenses, and if necessary, intends
to vigorously defend this matter, although the ultimate outcome cannot be
determined at this time. Accordingly, no adjustments have been made in the
consolidated financial statements in response to this matter.
The Company is also a defendant in various other arbitrations and administrative
proceedings, lawsuits and claims, seeking damages aggregating approximately $2.2
million (exclusive of specified punitive damages of approximately $5.6 million,
unspecified punitive damages related to certain claims and expected insurance
coverage). The Company has filed a counterclaim for approximately $220,000 in
one such proceeding. These matters arise out of the normal course of business.
The Company intends to vigorously defend itself in these actions, although the
ultimate outcome of these matters cannot be determined at this time. At June 30,
2004, the amount of $388,000 related to such matters that is reasonably
estimable has been included in "Accounts Payable, Accrued Expenses and Other
Liabilities" on the accompanying condensed consolidated statements of financial
condition. The Company has included in "Professional fees" litigation and NASD
related expenses of $484,000 and $1,183,000 in the third quarter and first nine
months of fiscal year 2004, respectively.
NOTE 6 - CUMULATIVE DIVIDENDS ON CONVERTIBLE PREFERRED STOCK
The holders of the Company's Series A Convertible Preferred Stock (the "Series A
Preferred Stock") are entitled to receive dividends on a quarterly basis at a
rate of 9% per annum, per share. Such dividends are cumulative and accrue
whether or not declared by the Company's Board of Directors, but are payable
only when, as and if declared by the Company's Board of Directors. In March
2004, the Company's Board of Directors declared an in-kind dividend in the
aggregate of 3,352 shares of Series A Preferred Stock, in payment of
approximately $503,000 of dividends accrued through January 31, 2004. Such
shares were issued on March 31, 2004. At June 30, 2004, the amount of
accumulated dividends on the Company's 31,177 issued and outstanding shares of
Series A Preferred Stock was $111,000.
NOTE 7 - INCOME (LOSS) PER COMMON SHARE
Basic income (loss) per share is computed on the basis of the weighted average
number of common shares outstanding. Diluted income (loss) per share is computed
on the basis of the weighted average number of common shares outstanding plus
the potential dilution that could occur if securities or other contracts to
issue common shares were exercised or converted. Stock options and warrants, and
conversion of the Series A Preferred Stock, were excluded from the diluted loss
per share computation for the three-month period ended June 30, 2004 and for the
nine-month period ended June 30, 2003, since the Company incurred a loss for
these periods and the inclusion of such securities would be antidilutive.
9
The following table sets forth the components used in the computation of basic
and diluted income (loss) per common share:
Three Months Ended Nine Months Ended
---------------------------------- ----------------------------------
June 30, 2004 June 30, 2003 June 30, 2004 June 30, 2003
---------------------------------- ----------------------------------
Net income (loss) attributable to
common stockholders - basic $ (310,000) $ 363,000 $ 1,450,000 $ (388,000)
Effect of dilutive securities -
preferred stock dividends (70,000) (62,000) (196,000) (187,000)
---------------------------------- ----------------------------------
Net income (loss) attributable
to common stockholders - diluted $ (380,000) $ 301,000 $ 1,254,000 $ (575,000)
================================== ==================================
Basic-weighted average common shares
outstanding 3,397,885 3,367,558 3,377,630 3,110,530
Dilutive stock options and warrants - 7,166 599,099 -
Weighted average assumed conversion of 9%
cumulative convertible preferred stock - 1,854,998 2,078,465 -
---------------------------------- ----------------------------------
Diluted-weighted average common shares
outstanding 3,397,885 5,229,722 6,055,194 3,110,530
================================== ==================================
Net income (loss) attributable to common
stockholders - basic $ (0.11) $ 0.09 $ 0.37 $ (0.18)
================================== ==================================
Net income (loss) attributable to common
stockholders - diluted $ (0.11) $ 0.06 $ 0.21 $ (0.18)
================================== ==================================
For the three-month periods ended June 30, 2004 and 2003, 2,747,647 shares and
2,356,065 shares, respectively, attributable to outstanding stock options and
warrants were excluded from the calculation of diluted net income (loss) per
share because the effect was antidilutive. For the nine-month periods ended June
30, 2004 and 2003, 975,150 shares and 2,376,065 shares, respectively,
attributable to outstanding stock options and warrants were excluded from the
calculation of diluted net income (loss) per share because the effect was
antidilutive.
NOTE 8 - THE AMERICAN STOCK EXCHANGE
In February 2003, the Company received a letter from The American Stock Exchange
(the "Exchange") indicating that it was not in compliance with certain listing
standards relating to (1) shareholders' equity of less than $2.0 million and
losses from continuing operations and/or net losses in two out of its three most
recent fiscal years, and (2) the requirement to have and maintain an audit
committee comprised of at least three independent directors. The Company
submitted to the Exchange a plan that indicated compliance with these items. In
May 2003, the Exchange notified the Company that it had accepted the Company's
plan of compliance and granted the Company an extension until August 5, 2004 to
satisfy the financial standards requirements, and an extension until July 18,
2003 to comply with the independent audit committee requirement, which was
satisfied in July 2003. The Company will be subject to periodic review by the
Exchange Staff during the extension period. As of August 12, 2004, the Company
has not received any notification from the Exchange with respect to the
10
financial standards requirements. Failure to make progress consistent with the
plan or to regain compliance with the continued listing standards by the end of
the extension period could result in the Company's common stock being delisted
from the Exchange. In the event that the Company fails to comply with the
listing standards, the Company's common stock could trade on the OTC Bulletin
Board or in the "pink sheets" maintained by the National Quotation Bureau, Inc.
Such alternatives are generally considered to be less efficient markets, and the
Company's stock price, as well as the liquidity of the Company's common stock,
may be adversely impacted as a result.
NOTE 9 - EXTENSION OF NOTES
In February 2004, National and the holder of a $1.0 million secured demand note
that matured on February 1, 2004, extended the term of the $1.0 million secured
demand note to March 1, 2005. Upon completion of the note renewal, the
noteholder's warrant to purchase 75,000 shares of the Company's common stock at
a price of $5.00 per share, that was to expire on February 1, 2004, was repriced
to $1.25 per share, with an allocated fair value of approximately $68,000, and
the expiration date of such warrants was extended to July 31, 2005. The
expiration date for the noteholder's warrant to purchase an additional 75,000
shares of the Company's common stock at a price of $1.75 per share was also
extended from January 25, 2004 to July 31, 2005.
In January 2004, two other noteholders extended the maturity dates on $1.0
million of notes issued to them by the Company from January 25, 2004 to July 31,
2005. Effective February 1, 2004, the interest rate on each note was increased
to 12% from 9% per annum. Additionally, each of the noteholders' warrants to
purchase, in the aggregate, 100,000 shares of the Company's common stock at a
price of $5.00 per share expiring on February 1, 2004 was repriced to $1.25 per
share, with an allocated fair value of approximately $90,000, and the expiration
date of such warrants was extended to July 31, 2005. The expiration date for the
noteholders' warrants to purchase, in the aggregate, an additional 100,000
shares of the Company's common stock at a price of $1.75 per share was also
extended from January 25, 2004 to July 31, 2005.
The Company is amortizing the total allocated fair value of $158,000 over the
extended 18-month term of these notes. Such amortization has been included in
"Interest" on the accompanying condensed consolidated June 30, 2004 financial
statements.
NOTE 10 - PRIVATE PLACEMENTS
In January 2004, the Company consummated a private offering of its securities to
a limited number of accredited investors pursuant to Rule 506 of Regulation D
under the Securities Act of 1933, as amended (the "Securities Act") wherein the
Company issued an aggregate of $200,000 of three-year, 10% senior subordinated
promissory notes to five unaffiliated parties. The noteholders received
three-year warrants to purchase an aggregate of 50,000 shares of the Company's
common stock at an exercise price of $1.40 per share, with an allocated fair
value of approximately $40,000.
In February 2004, the Company consummated a private offering of its securities
to a limited number of accredited investors pursuant to Rule 506 of Regulation D
under the Securities Act wherein the Company issued an aggregate of $850,000 of
three-year, 10% senior subordinated promissory notes to four unaffiliated
parties. The noteholders received three-year warrants to purchase an aggregate
of 170,000 shares of the Company's common stock at an exercise price of $1.50
per share, with an allocated fair value of approximately $143,000. National
acted as the placement agent for the private offering. The offering period for
the private offering expired on May 30, 2004.
The Company is amortizing the total allocated fair value of $183,000 over the
three-year term of these promissory notes. Such amortization has been included
in "Interest" on the accompanying condensed consolidated June 30, 2004 financial
statements. The holders of the warrants received certain registration rights
relating to the common stock issuable upon exercise of the warrants.
11
NOTE 11 - STOCKHOLDERS' EQUITY
At the Company's annual meeting of shareholders on March 16, 2004, the
shareholders voted, effective immediately, to amend the Company's Certificate of
Incorporation to decrease the number of shares of the Company's common stock,
par value $.02 per share, from 60,000,000 shares to 30,000,000 shares, and to
increase the number of shares of Preferred Stock, par value $.01 per share, from
100,000 shares to 200,000 shares.
In the quarter ended June 30, 2004, the Company received proceeds of $225,000
from the exercise of outstanding employee stock options and warrants.
PART II. OTHER INFORMATION
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The Private Securities Litigation Reform Act of 1995 provides a safe harbor for
forward-looking statements. This Quarterly Report may contain certain statements
of a forward-looking nature relating to future events or future business
performance. Any such statements that refer to the Company's estimated or
anticipated future results or other non-historical facts are forward-looking and
reflect the Company's current perspective of existing trends and information.
These statements involve risks and uncertainties that cannot be predicted or
quantified and, consequently, actual results may differ materially from those
expressed or implied by such forward-looking statements. Such risks and
uncertainties include, among others, risks and uncertainties detailed in the
Company's Annual Report on Form 10-K, filed with the Securities and Exchange
Commission on December 29, 2003. Any forward-looking statements contained in or
incorporated into this Quarterly Report speak only as of the date of this
Quarterly Report. The Company undertakes no obligation to update publicly any
forward-looking statement, whether as a result of new information, future events
or otherwise.
RESULTS OF OPERATIONS
Three Months Ended June 30, 2004 Compared to Three Months Ended June 30, 2003
The Company's third quarter of fiscal year 2004 resulted in revenues only
slightly lower compared to the third quarter of fiscal year 2003, but sharply
lower compared to the second quarter of fiscal year 2004, and a modest increase
in expenses compared to the same period last year. The lower revenues are
primarily due to the recent weaker securities markets. As a result, the Company
reported a net loss before income taxes of $310,000 compared with net income
before income taxes of $363,000 for the third quarters of fiscal years 2004 and
2003, respectively.
Total revenues decreased $221,000, or 1%, in the third quarter of fiscal year
2004 to $14,854,000 from $15,075,000 in the third quarter of fiscal year 2003.
This decrease reflects the weaker securities markets that impact trading volume,
the number of commission tickets generated, and the charge per ticket that
affects commission revenue. During the third quarter of fiscal year 2004,
trading volume increased by approximately 14%, compared to the third quarter of
fiscal year 2003. Commission revenue increased $286,000, or 3%, to $10,852,000
from $10,566,000 during the third quarter of fiscal year 2004 compared with the
12
same period in fiscal year 2003. Net dealer inventory gains, which includes
profits on proprietary trading, market making activities and customer mark-ups
and mark-downs, decreased $1,477,000, or 46%, to $1,715,000 from $3,192,000
during the third quarter of fiscal year 2004 compared with the same period in
fiscal year 2003. The decrease is primarily due to a reduction in proprietary
trading in the bond market, reflecting an overall decline in this market, and
the weaker equity markets in general. During the third quarter of fiscal year
2004, revenues from proprietary trading decreased $1,337,000, or 46%, to
$1,561,000 from $2,898,000 in the third quarter of fiscal year 2003, revenues
from market making activities decreased $85,000, or 37%, to $147,000 from
$232,000 in the third quarter of fiscal year 2003, and revenues from customer
mark-ups and mark-downs decreased $56,000, or 89%, to $7,000 from $63,000 in the
third quarter of fiscal year 2003.
Investment banking revenue increased $184,000, or 86%, to $398,000 from $214,000
in the third quarter of fiscal year 2004 compared with the third quarter of
fiscal year 2003. The increase in investment banking revenues is attributed to
the Company's completion of private placements and an initial public offering
during the current quarter. Interest and dividend income increased $578,000 or
161%, to $937,000 from $359,000 in the third quarter of fiscal year 2004
compared with the same period last year. The increase in interest income is
attributable to an increase in the amount of customer debits in National's
customers' accounts and an increase in the interest rate charged to such debits
from the same period last year. Transfer fees increased $197,000, or 34%, to
$769,000 in the third quarter of fiscal year 2004 from $572,000 in the third
quarter of fiscal year 2003. The increase is due to increased fees charged on
certain accounts.
Other revenue, consisting of asset management fees and miscellaneous transaction
fees and trading fees, increased $11,000, or 6%, to $183,000 from $172,000
during the third quarter of fiscal year 2004 compared to the third quarter of
fiscal year 2003. The increase is due to an increase in asset management fees in
the third quarter of fiscal year 2004 compared to the same period last year.
In comparison with the 1% decrease in total revenues, total expenses increased
3% or $452,000 to $15,164,000 for the third quarter of fiscal year 2004 compared
to $14,712,000 in the third quarter of fiscal year 2003. The increase in total
expenses is primarily attributable to increased employee compensation and
increased professional fees.
Commission expense, which includes expenses related to commission revenue, net
dealer inventory gains and investment banking, decreased $32,000, or less than
1%, to $10,296,000 in the third quarter of fiscal year 2004 from $10,328,000 in
the third quarter of fiscal year 2003. In the third quarter of fiscal year 2004
compared to the third quarter of fiscal year 2003, commission expense related to
commission revenue increased $1,060,000, or 13%, to $9,230,000 from $8,170,000;
commission expense related to net dealer inventory gains decreased $1,239,000,
or 62%, to $748,000 from $1,987,000; and commission expense related to
investment banking increased $147,000, or 86%, to $318,000 from $171,000. The
increase of commission expense as a percentage of commission revenues and the
decrease of commission expense as a percentage of net dealer inventory gains are
both attributable to changes in the production of particular brokers, not all of
whom are compensated at the same commission rate. Commission expense as a
percentage of investment banking was relatively unchanged between the third
quarter of fiscal year 2004 and the third quarter of fiscal year 2003.
Commission expense includes the amortization of advances to registered
representatives of $215,000 and $198,000 for the third quarter of fiscal year
2004 and 2003, respectively. These amounts fluctuate based upon the amounts of
advances outstanding and the time period for which the registered
representatives have agreed to be affiliated with National.
Employee compensation expense increased $501,000, or 56%, to $1,399,000 in the
third quarter of fiscal year 2004 from $898,000 in the third quarter of fiscal
year 2003. This increase is attributable to the hiring of new employees and
salary increases for certain employees. Overall, combined commission and
employee compensation expense, as a percentage of revenue increased to 79% from
74% in the third quarter of fiscal year 2004 and 2003, respectively.
13
Clearing fees decreased $134,000, or 17%, to $635,000 in the third quarter of
fiscal year 2004 from $769,000 in the third quarter of fiscal year 2003.
Clearing fees in the third quarter of fiscal year 2004 were reduced by the
$250,000 conversion assistance payment the Company received from its new
clearing firm, Fiserv, to offset conversion costs incurred by the Company. In
the third quarter of fiscal year 2003, clearing fees were reduced by forgiveness
of debt, that was fully repaid in February 2004, from the Company's current
clearing firm based on ticket volume in the amount of $133,000. Communication
expenses increased $57,000, or 8%, to $751,000 from $694,000 in the third
quarter of fiscal year 2004 compared to the third quarter of fiscal year 2003.
The increase is due to an increase in voice and data charges. Occupancy costs
increased $179,000, or 29%, to $807,000 from $628,000 in the third quarter of
fiscal year 2004 compared to the third quarter of fiscal year 2003. The increase
in occupancy expense is due to the expansion of office facilities in order to
accommodate new brokers. Professional fees increased $255,000, or 67%, to
$637,000 from $382,000 in the third quarter of fiscal year 2004 compared to the
third quarter of fiscal year 2003. The increase in professional fees is due to
an increase in the legal fees relating to various lawsuits and arbitrations, and
legal fees related to the NASD investigation of mutual fund trading activities
and other regulatory matters. Professional fees include litigation and NASD
related expenses of $484,000 and $213,000 in the third quarter of fiscal year
2004 and 2003, respectively.
Interest expense increased $87,000, or 281%, to $118,000 from $31,000 in the
third quarter of fiscal year 2004 compared to the third quarter of fiscal year
2003. The increase is due to interest on the notes issued by the Company in the
second quarter of fiscal year 2004, and the amortization of $42,000 attributable
to newly issued notes and modified notes. Taxes, licenses and registration
increased $87,000, or 92%, to $182,000 from $95,000 in the third quarter of
fiscal year 2004 compared to the third quarter of fiscal year 2003. The increase
in taxes, licenses and registration expense is due to an increase in the number
of brokers associated with the Company from the prior period. Other expenses
decreased $548,000, or 62%, to $339,000 from $887,000 in the third quarter of
fiscal year 2004 compared to the third quarter of fiscal year 2003. The decrease
in other expenses is due to the Company's efforts to control its fixed operating
expenses, net of an increase in the reserve for uncollectible accounts on its
other receivables, related to registered representatives formerly associated
with National in the amount of $75,000 and $300,000 in the third quarter of
fiscal year 2004 and 2003, respectively.
The Company reported a net loss before income taxes of $310,000 in the third
quarter of fiscal year 2004 compared to net income before income taxes of
$363,000 in the third quarter of fiscal year 2003.
Overall, the diluted net loss attributable to common stockholders in the third
quarter of fiscal year 2004 was $380,000, or $.11 per common share, as compared
to diluted net earnings attributable to common stockholders of $301,000, or $.06
per common share in the third quarter of fiscal year 2003. The net loss
attributable to common stockholders for the third quarter of fiscal year 2004
and the net income attributable to common stockholders for the third quarter of
fiscal year 2003 reflects $70,000 and $62,000, respectively, of cumulative
dividends on the Company's Series A Preferred Stock.
Nine Months Ended June 30, 2004 Compared to Nine Months Ended June 30, 2003
The Company's first nine months of fiscal year 2004 resulted in a significant
increase in revenues, and a comparatively lesser increase in expenses compared
to the same period last year. The increase in revenues is primarily due to the
improved securities markets experienced during the first six months of the
fiscal year, which weakened during the third quarter of fiscal year 2004, and
the gain on extinguishments of debt. As a result of this overall improvement,
the Company reported net income before income taxes of $1,450,000 compared with
a net loss before income taxes of $388,000 for the first nine months of fiscal
years 2004 and 2003, respectively. This represents an improvement of $1,838,000
from the prior period.
14
Total revenues increased $15,541,000, or 44%, in the first nine months of fiscal
year 2004 to $50,602,000 from $35,061,000 in the first nine months of fiscal
year 2003. This increase is mainly due to the improved securities markets
experienced during the first six months of the fiscal year that increased
commission revenues, the number of commission tickets generated, and the charge
per ticket that affects commission revenue. During the first nine months of
fiscal year 2004, trading volume increased by approximately 27%, compared to the
first nine months of fiscal year 2003. Commission revenue increased $15,064,000,
or 67%, to $37,525,000 from $22,461,000 during the first nine months of fiscal
year 2004 compared with the same period in fiscal year 2003. Net dealer
inventory gains, which includes profits on proprietary trading, market making
activities and customer mark-ups and mark-downs, decreased $3,650,000, or 39%,
to $5,767,000 from $9,417,000 during the first nine months of fiscal year 2004
compared with the same period in fiscal year 2003. The decrease is due to a
reduction in proprietary trading in the bond market, reflecting an overall
decline in this market compared to the strength realized in the equity markets
during the first six months of the current fiscal year. During the first nine
months of fiscal year 2004, revenues from proprietary trading decreased
$3,528,000, or 41%, to $4,987,000 from $8,515,000 in the first nine months of
fiscal year 2003, revenues from market making activities decreased $78,000, or
11%, to $663,000 from $741,000 in the first nine months of fiscal year 2003, and
revenues from customer mark-ups and mark-downs decreased $44,000, or 27%, to
$117,000 from $161,000 in the first nine months of fiscal year 2003.
Investment banking revenue increased $753,000, or 218%, to $1,098,000 from
$345,000 in the first nine months of fiscal year 2004 compared with the first
nine months of fiscal year 2003. The increase in investment banking revenues is
attributed to the Company's completion of private placements and an initial
public offering during the current period. Interest and dividend income
increased $1,493,000 or 153%, to $2,468,000 from $975,000 in the first nine
months of fiscal year 2004 compared with the same period last year. The increase
in interest income is attributable to an increase in the amount of customer
debits in National's customers' accounts and an increase in the interest rate
charged to such debits from the same period last year. Transfer fees increased
$805,000, or 62%, to $2,098,000 in the first nine months of fiscal year 2004
from $1,293,000 in the first nine months of fiscal year 2003. The increase is
due to the increase in transaction volume associated with the Company's retail
brokerage business during the first six months of the current year, and
increased fees charged on certain accounts.
The Company realized a gain on extinguishment of debt of $1,131,000 from its
clearing firm, First Clearing, in the first nine months of fiscal year 2004 (See
Note 4). Other revenue, consisting of asset management fees and miscellaneous
transaction fees and trading fees, decreased $55,000, or 10%, to $515,000 from
$570,000 during the first nine months of fiscal year 2004 compared to the first
nine months of fiscal year 2003. The decrease is due to reduced fees
attributable to a reduction in the volume of institutional business in the first
nine months of fiscal year 2004 compared to the same period last year.
In comparison with the 44% increase in total revenues, total expenses increased
39% or $13,703,000 to $49,152,000 for the first nine months of fiscal year 2004
compared to $35,449,000 in the first nine months of fiscal year 2003. The
increase in total expenses is primarily a result of greater commission expenses
directly associated with commission revenues. The increase in total expenses was
minimized by the Company's efforts to streamline its operations and control the
fixed expenses associated with its business.
Commission expense, which includes expenses related to commission revenue, net
dealer inventory gains and investment banking, increased $11,330,000, or 49%, to
$34,604,000 in the first nine months of fiscal year 2004 from $23,274,000 in the
first nine months of fiscal year 2003. In the first nine months of fiscal year
2004 compared to the first nine months of fiscal year 2003, commission expense
related to commission revenue increased $13,574,000, or 80%, to $30,549,000 from
$16,975,000; commission expense related to net dealer inventory gains decreased
15
$2,846,000, or 47%, to $3,177,000 from $6,023,000; and commission expense
related to investment banking increased $602,000, or 218%, to $878,000 from
$276,000. The increase of commission expense as a percentage of commission
revenues and the decrease of commission expense as a percentage of net dealer
inventory gains are both attributable to changes in the production of particular
brokers, not all of whom are compensated at the same commission rate. Commission
expense as a percentage of investment banking was relatively unchanged between
the first nine months of fiscal year 2004 and the first nine months of fiscal
year 2003. Commission expense includes the amortization of advances to
registered representatives of $483,000 and $574,000 for the first nine months of
fiscal year 2004 and 2003, respectively. These amounts fluctuate based upon the
amounts of advances outstanding and the time period for which the registered
representatives have agreed to be affiliated with National.
Employee compensation expense increased $1,228,000, or 41%, to $4,207,000 in the
first nine months of fiscal year 2004 from $2,979,000 in the first nine months
of fiscal year 2003. This increase is attributable to the hiring of new
employees, salary increases for certain employees and the establishment of a
bonus pool for senior management. Overall, combined commission and employee
compensation expense, as a percentage of revenue increased to 77% from 75% in
the first nine months of fiscal year 2004 and 2003, respectively.
Clearing fees increased $404,000, or 20%, to $2,397,000 in the first nine months
of fiscal year 2004 from $1,993,000 in the first nine months of fiscal year
2003. Although there was an increase in trading volume, clearing fees, as a
percentage of related revenues, decreased due to an increase in the number of
lower priced tickets from the prior period. Clearing fees in the third quarter
of fiscal year 2004 were reduced by the $250,000 conversion assistance payment
the Company received from its new clearing firm, Fiserv, to offset conversion
costs incurred by the Company. Clearing fees were reduced by forgiveness of
debt, that was fully repaid in February 2004, from the Company's clearing firm
based on ticket volume in the amount of $250,000 and $325,000 in the first nine
months of fiscal year 2004 and 2003, respectively. Communication expenses
increased $100,000, or 5%, to $2,061,000 from $1,961,000 in the first nine
months of fiscal year 2004 compared to the first nine months of fiscal year
2003. The increase is due to an increase in voice and data charges. Occupancy
costs increased $191,000, or 9%, to $2,248,000 from $2,057,000 in the first nine
months of fiscal year 2004 compared to the first nine months of fiscal year
2003. The increase in occupancy expense is due to the expansion of office
facilities in order to accommodate new brokers. Professional fees increased
$550,000, or 60%, to $1,462,000 from $912,000 in the first nine months of fiscal
year 2004 compared to the first nine months of fiscal year 2003. The increase in
professional fees is due to an increase in the legal fees relating to various
lawsuits and arbitrations, and legal fees related to the NASD investigation of
mutual fund trading activities and other regulatory matters. Professional fees
include litigation and NASD related expenses of $1,183,000 and $529,000 in the
first nine months of fiscal year 2004 and 2003, respectively.
In January 2004, an arbitration panel awarded damages against the Company of
approximately $400,000 related to an employment contract with a former employee
of the Company. This amount was recorded as "Litigation settlement" and paid
during the first nine months of fiscal year 2004.
Interest expense increased $151,000, or 139%, to $260,000 from $109,000 in the
first nine months of fiscal year 2004 compared to the first nine months of
fiscal year 2003. The increase is due to interest on the notes issued by the
Company in the second quarter of fiscal year 2004, and the amortization of
$68,000 attributable to newly issued notes and modified notes. Taxes, licenses
and registration increased $215,000, or 94%, to $444,000 from $229,000 in the
first nine months of fiscal year 2004 compared to the first nine months of
fiscal year 2003. The increase in taxes, licenses and registration expense is
due to an increase in the number of brokers associated with the Company from the
prior period. Other expenses decreased $866,000, or 45%, to $1,069,000 from
$1,935,000 in the first nine months of fiscal year 2004 compared to the first
nine months of fiscal year 2003. The decrease in other expenses is due to the
Company's efforts to control its fixed operating expenses, net of an increase in
the reserve for uncollectible accounts on its other receivables, related to
registered representatives formerly associated with National in the amount of
$75,000 and $300,000 in the first nine months of fiscal year 2004 and 2003,
respectively.
16
The Company reported net income before income taxes of $1,450,000 in the first
nine months of fiscal year 2004 compared to a net loss before income taxes of
$388,000 in the first nine months of fiscal year 2003.
Overall, the diluted net earnings attributable to common stockholders in the
first nine months of fiscal year 2004 was $1,254,000, or $.21 per common share,
as compared to the diluted net loss attributable to common stockholders of
$575,000, or $.18 per common share in the first nine months of fiscal year 2003.
The net income attributable to common stockholders for the first nine months of
fiscal year 2004 reflects $196,000 of cumulative preferred stock dividends, and
the net loss attributable to common stockholders for the first nine months of
fiscal year 2003 reflects $187,000 of cumulative dividends, on the Company's
Series A Preferred Stock.
LIQUIDITY AND CAPITAL RESOURCES
National, as a registered broker-dealer, is subject to Rule 15c3-1, the Uniform
Net Capital Rule of the Securities and Exchange Commission (the "SEC"), that
requires the maintenance of minimum net capital. National has elected to use the
alternative standard method permitted by the rule. This requires that National
maintain minimum net capital equal to the greater of $250,000 or a specified
amount per security based on the bid price of each security for which National
is a market maker. On December 12, 2003, the Company was advised by the NASD
that, pursuant to National's pledge of its assets as security for loans to the
Company from First Clearing (such loans aggregated $2,131,000 as of September
30, 2003), National was inadvertently not in compliance with its net capital
requirements. Accordingly, at September 30, 2003, National reported an excess
net capital deficiency of $829,000. This compliance requirement was corrected on
December 15, 2003, upon termination of the security agreement with First
Clearing. At June 30, 2004, National's net capital exceeded the requirement by
$518,000.
Advances, dividend payments and other equity withdrawals from the Company's
subsidiary are restricted by the regulations of the SEC and other regulatory
agencies. These regulatory restrictions may limit the amounts that a subsidiary
may dividend or advance to the Company.
The objective of liquidity management is to ensure that the Company has ready
access to sufficient funds to meet commitments, fund deposit withdrawals and
efficiently provide for the credit needs of customers.
In July 2004, the Company filed a Registration Statement on Form S-3 under the
Securities Act for the resale of certain shares of common stock and shares of
common stock issuable upon the exercise of certain warrants previously issued in
connection with private placement transactions, and certain warrants that were
issued in the private placements that have been completed in the current fiscal
year. The Registration Statement became effective on August 11, 2004.
In August 2001, the Company entered into an agreement with First Clearing under
which First Clearing provides clearing and related services for National. The
Clearing Agreement expanded the products and services capabilities for
National's retail and institutional business, and enabled National to
consolidate its existing clearing operations and reduce the fixed overhead
associated with its self-clearing activities.
The conversion to First Clearing began in December 2001 and was completed in
March 2002. It is standard business practice in the brokerage industry for
clearing firms to provide financial support to correspondent clearing firms. As
such, in connection with the Clearing Agreement, the Company executed a ten-year
promissory note in favor of First Clearing under which the Company immediately
borrowed $1,000,000. The funds were contributed by the Company to National, and
were being used as a deposit to secure National's performance under the Clearing
Agreement. The Clearing Agreement also provided for another $1,000,000 loan that
17
was extended to the Company upon substantial completion of the conversion on
December 31, 2001 that was also contributed to National. The amount of the note
that was repayable on each anniversary date was the principal, and interest if
any, then outstanding divided by the remaining life of the note. Borrowings
under the promissory note were forgivable annually based on achieving certain
business performance and trading volumes of the Company over the life of the
loan.
In connection with the Clearing Agreement, additional borrowings were available
to the Company upon the attainment by National of certain volume and
profitability goals. In finalizing the conversion, a dispute arose among the
Company, US Clearing (one of its former clearing firms) and First Clearing,
regarding the responsibility for debit balances in certain trading accounts. The
three parties agreed to share the expense equally. The Company's share of this
settlement, $548,000, was advanced to the Company by First Clearing and added to
the existing promissory note. As part of the settlement, the minimum level of
stockholders' equity the Company was required to maintain under the promissory
note was reduced from $2,000,000 to $1,000,000 and no further borrowings are
available under the promissory note, as amended.
In the first quarter of fiscal year 2003, First Clearing loaned the Company an
additional $375,000 in the form of clearing fee rebates. The loan was due to be
paid in January 2004.
In December 2003, the Company engaged in various discussions with the NASD
relating to the Security Agreement between National and First Clearing, and its
effect on the computation of National's net capital. As a result of these
discussions, on December 15, 2003, the Company and First Clearing agreed in
principle to the following: (1) National's clearing deposit was reduced from
$1,000,000 to $500,000, (2) the excess $500,000 was paid to First Clearing to
reduce the Company's outstanding loan balance on its promissory note and (3) the
Security Agreement between National and First Clearing was terminated.
Furthermore, First Clearing forgave payment of the $375,000 that was due to be
paid in January 2004.
In February 2004, the Company paid First Clearing $250,000 to fully repay its
promissory note. As a result of the repayment of this note, the Company realized
a gain on extinguishment of debt of approximately $756,000. Additionally,
National and First Clearing mutually agreed to terminate their clearing
relationship by June 30, 2004.
On June 22, 2004, National entered into an agreement with Fiserv to clear its
brokerage business. The conversion from First Clearing to Fiserv is expected to
be completed in the first week of October 2004. As part of this transaction,
Fiserv will provide National with an $800,000 conversion assistance payment,
$250,000 of which was paid upon execution of the clearing agreement, $250,000 of
which is payable in mid-August 2004, and $300,000 of which is payable upon
completion of the conversion in October 2004. The Company believes that the
overall effect of the new clearing relationship will be beneficial to the
Company's cost structure, liquidity and capital resources.
As of June 30, 2004, advances to registered representatives increased $1,030,000
to $1,674,000 from $644,000 as of September 30, 2003. This increase is
attributable to advances made to registered representatives who became
affiliated with National during this period.
In February 2004, National and the holder of a $1.0 million secured demand note
that matured on February 1, 2004, extended the term of the $1.0 million secured
demand note to March 1, 2005 (See Note 9).
In January 2004, two other noteholders extended the maturity dates on $1.0
million of notes issued to them by the Company from January 25, 2004 to July 31,
2005. Effective February 1, 2004, the interest rate on each note was increased
to 12% from 9% per annum (See Note 9).
In January 2004, the Company issued an aggregate of $200,000 of three-year, 10%
senior subordinated promissory notes to five unaffiliated parties. Such
18
noteholders received three-year warrants, with certain registration rights, to
purchase an aggregate of 50,000 shares of the Company's common stock at an
exercise price of $1.40 per share (See Note 10).
In February 2004, the Company issued an aggregate of $850,000 of three-year, 10%
senior subordinated promissory notes to four unaffiliated parties. Such
noteholders received three-year warrants, with certain registration rights, to
purchase an aggregate of 170,000 shares of the Company's common stock at an
exercise price of $1.50 per share (See Note 10).
In the quarter ended June 30, 2004, the Company received proceeds of $225,000
from the exercise of outstanding employee stock options and warrants.
Although the Company has operated profitably in the first nine months of fiscal
year 2004, it reported a loss in the third quarter resulting from the weaker
securities market. These market conditions have weakened further in the fourth
quarter of fiscal year 2004. If market conditions do not improve, the Company
may consider curtailing certain of its business activities, further reducing
fixed overhead costs and/or seeking additional sources of financing.
Additionally, the Company may need to secure additional financing in order to
assure that it has adequate regulatory capital at such time that a proposed
settlement is reached with the NASD regarding the investigation of mutual fund
trading activities (See Note 5 herein). The Company's ability to obtain such
financing may be adversely affected by recent developments relating to the
listing of the Company's common stock on The American Stock Exchange (See Note 8
herein).
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's primary market risk arises from the fact that it engages in
proprietary trading and makes dealer markets in equity securities. Accordingly,
the Company may be required to maintain certain amounts of inventories in order
to facilitate customer order flow. The Company may incur losses as a result of
price movements in these inventories due to changes in interest rates, foreign
exchange rates, equity prices and other political factors. The Company is not
subject to direct market risk due to changes in foreign exchange rates. However,
the Company is subject to market risk as a result of changes in interest rates
and equity prices, which are affected by global economic conditions. The Company
manages its exposure to market risk by limiting its net long or short positions.
Trading and inventory accounts are monitored daily by management and the Company
has instituted position limits.
Credit risk represents the amount of accounting loss the Company could incur if
counterparties to its proprietary transactions fail to perform and the value of
any collateral proves inadequate. Although credit risk relating to various
financing activities is reduced by the industry practice of obtaining and
maintaining collateral, the Company maintains more stringent requirements to
further reduce its exposure. The Company monitors its exposure to counterparty
risk on a daily basis by using credit exposure information and monitoring
collateral values. The Company maintains a credit committee, which reviews
margin requirements for large or concentrated accounts and sets higher
requirements or requires a reduction of either the level of margin debt or
investment in high-risk securities or, in some cases, requiring the transfer of
the account to another broker-dealer.
The Company monitors its market and credit risks daily through internal control
procedures designed to identify and evaluate the various risks to which the
Company is exposed. There can be no assurance, however, that the Company's risk
management procedures and internal controls will prevent losses from occurring
as a result of such risks.
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The following table shows the quoted market values of the Company's securities
held for resale ("long"), securities sold, but not yet purchased ("short") and
net positions as of June 30, 2004:
Long Short Net
---------------- ------------------ --------------
Corporate Stocks $ 255,000 $ 148,000 $ 107,000
Corporate Bonds 10,000 194,000 (184,000)
Government Obligations 348,000 399,000 (51,000)
---------------- ------------------ --------------
$ 613,000 $ 741,000 $ (128,000)
================ ================== ==============
ITEM 4 - CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures. Based on the evaluation of the
Company's disclosure controls and procedures (as defined in the Exchange Act
Rules 13a-15(e) and 15d-15(e)) required by the Exchange Act Rules 13a-15(b) or
15d-15(b), the Company's Chief Executive Officer and Acting Chief Financial
Officer have concluded that, as of the end of the period covered by this report,
the Company's disclosure controls and procedures were effective.
Changes in internal controls. There were no significant changes in the Company's
internal controls or in other factors that has materially affected, or is
reasonably likely to materially affect, internal control over financial
reporting subsequent to the date of our evaluation.
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
The NASD has recently commenced an industry-wide investigation of mutual fund
trading activities. National is one of the numerous broker-dealers that have
been contacted by the NASD with respect to this investigation. The NASD has
identified certain customer mutual fund transactions ordered through National
during the time period from October 2000 to February 2003 that it believes may
have constituted mutual fund timing and/or excessive trading activity. National
has been engaged in ongoing discussions and negotiations with the NASD to
informally resolve these matters. Such resolution could result in a settlement,
whereby National, without admitting or denying any violations, would make both
restitution and pay a fine to the NASD, that in the aggregate would approximate
$600,000. Despite our on-going discussions and negotiations with the NASD, no
assurances can be given that informal resolution will be achieved, that a formal
proceeding will not be commenced, or that the possible resulting penalties and
fines would not be in a materially greater amount. If required to litigate this
matter, National believes it has meritorious defenses, and if necessary, intends
to vigorously defend this matter, although the ultimate outcome cannot be
determined at this time.
During the quarter ended June 30, 2004, there were no other significant
developments in the Company's legal proceedings. For a detailed discussion of
the Company's legal proceedings, please refer to Note 5 herein, and the
Company's Annual Report on Form 10-K for the fiscal year ended September 30,
2003.
ITEM 2 - CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
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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 Chief Executive Officer's Certificate pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Acting Chief Financial Officer's Certificate pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
32.1 Chief Executive Officer's Certificate pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Acting Chief Financial Officer's Certificate pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
The Company filed a Report on Form 8-K on June 24, 2004 reporting
that National Securities Corporation entered into a new agreement to
clear its brokerage business.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
OLYMPIC CASCADE FINANCIAL CORPORATION AND SUBSIDIARY
August 13, 2004 By: /s/ Mark Goldwasser
---------------------------------
Mark Goldwasser
President and Chief Executive Officer
August 13, 2004 By: /s/ Robert H. Daskal
---------------------------------
Robert H. Daskal
Acting Chief Financial Officer
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