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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003
COMMISSION FILE NUMBER 1-15799
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LADENBURG THALMANN FINANCIAL SERVICES INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
FLORIDA 65-0701248
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
590 MADISON AVENUE, 34TH FLOOR
NEW YORK, NEW YORK 10022
(Address of principal executive offices) (Zip Code)
(212) 409-2000
(Registrant's telephone number, including area code)
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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NAME OF EACH EXCHANGE ON
TITLE OF EACH CLASS WHICH REGISTERED
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Common Stock, par value $.0001 per share American Stock Exchange
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE
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 check mark if disclosure of delinquent filers pursuant to Item
405 Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information statement
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. Yes [X] No [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes [ ] No [X]
As of June 30, 2003 (the last business day of the Registrant's most
recently completed second fiscal quarter), the aggregate market value of the
Registrant's Common Stock (based on the closing price on the American Stock
Exchange on that date) held by non-affiliates of the Registrant was
approximately $7,000,000.
As of March 26, 2004, there were 43,627,130 shares of the Registrant's
Common Stock outstanding.
LADENBURG THALMANN FINANCIAL SERVICES INC.
FORM 10-K
TABLE OF CONTENTS
PAGE
PART I
Item 1. Business..................................................................................... 3
Item 2. Properties................................................................................... 17
Item 3. Legal Proceedings............................................................................ 18
Item 4. Submission of Matters to a Vote of Security Holders.......................................... 18
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters........................ 19
Item 6. Selected Financial Data...................................................................... 20
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.................................................................... 21
Item 7A. Quantitative and Qualitative Disclosures About Market Risk................................... 33
Item 8. Financial Statements and Supplementary Data.................................................. 33
Item 9. Changes In and Disagreements with Accountants on Accounting and
Financial Disclosure..................................................................... 33
Item 9A. Controls and Procedures...................................................................... 34
PART III
Item 10. Directors and Executive Officers of the Registrant........................................... 35
Item 11. Executive Compensation....................................................................... 38
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters.............................................................. 43
Item 13. Certain Relationships and Related Transactions............................................... 46
Item 14. Principal Accountant Fees and Services....................................................... 49
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K.............................. 49
SIGNATURES............................................................................................. 58
2
PART I
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
ITEM 1. BUSINESS.
GENERAL
We are engaged in retail and institutional securities brokerage,
investment banking services and investment activities through our principal
operating subsidiary, Ladenburg Thalmann & Co. Inc. ("Ladenburg"). We are
committed to establishing a significant presence in the financial services
industry by meeting the varying investment needs of our corporate, institutional
and retail clients.
Ladenburg is a full service broker-dealer that has been a member of the
New York Stock Exchange ("NYSE") since 1879. It provides its services
principally for middle market and emerging growth companies and high net worth
individuals through a coordinated effort among corporate finance, capital
markets, investment management, brokerage and trading professionals. Ladenburg
is subject to regulation by, among others, the Securities and Exchange
Commission ("SEC"), the NYSE and the National Association of Securities Dealers,
Inc. ("NASD") and is a member of the Securities Investor Protection Corporation
("SIPC"). Ladenburg currently has 179 registered representatives and 158 other
full time employees. Its private client services and institutional sales
departments serve approximately 70,000 accounts nationwide and its asset
management area provides investment management and financial planning services
to numerous individuals and institutions.
We were incorporated under the laws of the State of Florida in February
1996. Ladenburg was incorporated under the laws of the State of Delaware in
December 1971 and became our wholly owned subsidiary in May 2001. Our principal
executive offices, as well as those of Ladenburg, are located at 590 Madison
Avenue, New York, New York 10022 and both of our telephone numbers are (212)
409-2000. Ladenburg has branch offices located in Melville, New York, Boca
Raton, Florida, Great Neck, New York, Los Angeles, California, New York, New
York and Irvine, California. During the first quarter of 2003, we closed our
branch office in Cleveland, Ohio. During the second quarter of 2003, we closed
our branch office in Ft. Lauderdale, Florida, which constituted all of our
market making activity. Ladenburg Thalmann Europe, Ltd., a wholly-owned
subsidiary of Ladenburg, is a retail brokerage firm regulated by the Financial
Services Authority which maintained an office in London, England, but is
currently operating out of Ladenburg's principal executive office. Ladenburg
maintains a website located at www.ladenburg.com.
RECENT DEVELOPMENTS
EXECUTIVE CHANGES
On March 9, 2004, we entered into a Severance, Waiver and Release
Agreement with Victor M. Rivas, our president and chief executive officer. Under
the Severance Agreement, effective March 31, 2004, Mr. Rivas will retire from
all of his positions with us and our subsidiaries including Ladenburg. In
connection with Mr. Rivas' retirement, we entered into an Employment Agreement
with Charles I. Johnston pursuant to which Mr. Johnston will serve, effective
April 1, 2004, as president, chief executive officer and a member of our board
and as chairman and chief executive officer of Ladenburg. Most recently, Mr.
Johnston was a managing director and the global head of private client services
at Lehman Brothers, Inc. where he was responsible for all aspects of Lehman's
private client services business which included 440 brokers in 14 branches.
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DEBT CONVERSION
On March 29, 2004, we entered into an agreement with New Valley
Corporation and Frost-Nevada Investments Trust, the holders of our outstanding
$18,010 aggregate principal amount of senior convertible promissory notes,
pursuant to which such parties agreed to convert their notes and accrued
interest into common stock, subject to shareholder approval. Pursuant to the
agreement, New Valley and Frost-Nevada will convert their notes into
approximately 26,000,000 shares of common stock at reduced conversion prices of
$1.10 per share and $0.70 per share, respectively. The agreement is subject to,
among other things, approval by our shareholders at a special meeting that is
expected to be held in the second quarter of 2004. As a result of the
conversion, New Valley and Frost-Nevada will beneficially own approximately
12.5% and 27.6%, respectively, of our common stock. Concurrently with this
agreement, we entered into an agreement with Berliner Effektengesellschaft AG,
the holder of the remaining $1,990 aggregate principal amount of senior
convertible promissory notes, pursuant to which we will repurchase the notes
held by Berliner, plus all accrued interest thereon, for $1,000 in cash.
We currently anticipate recording a pre-tax charge in 2004 of
approximately $10,900 in our statements of operations upon closing of these
transactions. The charge reflects expense attributable to the reduction in the
conversion price of the notes to be converted, offset partially by the gain on
the repurchase of the Berliner notes. The net balance sheet effect of the
transactions will be an increase in our shareholders' equity of approximately
$22,900.
RETAIL BUSINESS
An increasing percentage of our revenues during the last several years
have been generated from the retail business of Ladenburg and Ladenburg Capital
Management Inc. ("Ladenburg Capital"), one of our former operating subsidiaries
(77.0% in 2003, 64.9% in 2002 and 48.2% in 2001). Ladenburg's private client
services and institutional sales departments currently serve approximately a
total of 70,000 accounts nationwide. Ladenburg charges commissions to our
individual and institutional clients for executing buy and sell orders of
securities on national and regional exchanges.
INVESTMENT BANKING ACTIVITIES
Revenues generated from the investment banking activities of Ladenburg
and Ladenburg Capital, represent 4.6%, 11.4% and 12.5% of our total revenues in
2003, 2002 and 2001, respectively. Our investment banking professionals maintain
relationships with businesses and provide them with advisory and investor
relations support. Services include:
o merger and acquisition consulting;
o management of and participation in underwriting of public and
private equity and debt financings;
o rendering appraisals, financial evaluations and fairness
opinions; and
o providing general banking and corporate finance consulting
services.
In the investment banking area, our subsidiaries have been active as
underwriters or selling group members in numerous public equity transactions.
Participation as a managing underwriter or in an underwriting syndicate involves
both economic and regulatory risks. An underwriter may incur losses if it is
unable to resell the securities it is committed to purchase. In addition, under
the federal securities laws, other laws and court decisions with respect to
underwriters' liabilities and limitations on the indemnification of underwriters
by issuers, an underwriter is subject to substantial potential liability for
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misstatements or omissions of material facts in prospectuses and other
communications with respect to such offerings. Acting as a managing underwriter
increases these risks. Underwriting commitments constitute a charge against net
capital and Ladenburg's ability to make underwriting commitments may be limited
by the requirement that it must at all times be in compliance with regulations
regarding its net capital.
INVESTMENT ACTIVITIES
Ladenburg also seeks to realize investment gains by purchasing, selling
and holding securities for its own account on a daily basis. Ladenburg engages
for its own account in the arbitrage of securities. We are required to commit
the capital necessary for use in these investment activities. The amount of
capital committed at any particular time will vary according to market, economic
and financial factors, including the other aspects of our business.
Additionally, in connection with our investment banking activities, Ladenburg
generally receives warrants that entitle it to purchase securities of the
corporate issuers for which it raises capital or provides advisory services.
LADENBURG ASSET MANAGEMENT PROGRAM
Ladenburg offers its customers an asset management program, the
Ladenburg Asset Management Program ("LAMP"), to assist its customers in
achieving their desired investment objectives. LAMP has the ability to formulate
mutual fund portfolios that are balanced, diversified and consistent with each
individual's short-term and long-term financial objectives. A variety of factors
are taken into consideration when building client portfolios with LAMP, such as
allocating investments into a blend of funds and creating portfolios that meet
each client's needs. The custom portfolios are monitored on a consistent basis
and updated periodically.
WEALTH MANAGEMENT STRATEGY
Ladenburg provides its customers with a broad range of wealth
management services in order to help them manage their financial resources.
Through our subsidiaries, Financial Partners Capital Management, Inc. and
Ladenburg Thalmann Asset Management, Inc., registered investment advisers, we
are able to provide clients with discretionary portfolio management and
financial planning.
Financial Partners Capital Management offers planning services
primarily to corporate executives and other high net-worth individuals. The
process includes a thorough evaluation of the client's current financial
position, income tax planning, estate and gift planning, comprehensive
retirement planning and cash flow analysis among other services.
Our subsidiaries also provide comprehensive investment management
services to high net-worth individuals, corporations and pension fund clients.
Through our subsidiary, Ladenburg Thalmann Asset Management Inc., a registered
investment adviser, we are able to give our clients the ability to invest with a
variety of money managers and investment funds. Ladenburg Thalmann Asset
Management's review process entails focusing on a client's tolerance for risk,
capital growth expectations and income requirements as well as analyzing whether
the client may benefit from investing in tax-advantaged products.
The Ladenburg Focus Fund, L.P. is an open ended private investment fund
that invests its capital in publicly traded equity securities and options
strategies for the benefit of a number of our clients. Our wholly owned
subsidiary, Ladenburg Capital Fund Management Inc., is the general partner of
this fund for which it receives an annual management fee based on the net assets
of the fund and an incentive fee based on the performance of the fund each year.
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ADMINISTRATION, OPERATIONS, SECURITIES TRANSACTIONS PROCESSING AND CUSTOMER
ACCOUNTS
Ladenburg does not hold any funds or securities for its customers.
Instead, it uses the services of a clearing agent on a fully disclosed basis.
This clearing agent processes all securities transactions and maintains customer
accounts on a fee basis. Customer accounts are protected through the SIPC for up
to $500, of which coverage for cash balances is limited to $100. In addition,
all customer accounts are fully protected by an Excess Securities Bond issued by
the Radian Asset Assurance, Inc. providing protection for the account's entire
net equity (both cash and securities). The services of this clearing agent
include billing, credit control, and receipt, custody and delivery of
securities. The clearing agent provides operational support necessary to
process, record, and maintain securities transactions for Ladenburg's brokerage
activities. It provides these services to Ladenburg's customers at a total cost
which we believe is less than it would cost us to process such transactions on
our own. The clearing agent also lends funds to Ladenburg's customers through
the use of margin credit. These loans are made to customers on a secured basis,
with the clearing agent maintaining collateral in the form of saleable
securities, cash or cash equivalents. Ladenburg has agreed to indemnify the
clearing broker for losses it may incur on these credit arrangements.
In November 2002, we renegotiated a clearing agreement with one of our
clearing brokers whereby this clearing broker became our primary clearing
broker, clearing substantially all of our business (the "Clearing Conversion").
As part of the new agreement with this clearing broker, we are realizing
significant cost savings from reduced ticket charges and other incentives. In
addition, under the new clearing agreement, an affiliate of the clearing broker
loaned us an aggregate of $3,500 (the "Clearing Loans") in December 2002. The
Clearing Loans and the related accrued interest are forgivable over various
periods, up to four years from the date of the Clearing Conversion, provided we
continue to clear our transactions through this clearing broker. As scheduled,
in November 2003, $1,500 of the Clearing Loans was forgiven. The remaining
principal balance on the Clearing Loans is scheduled to be forgiven as follows:
$667 in November 2004, $667 in November 2005 and $666 in November 2006. Upon the
forgiveness of the Clearing Loans, the forgiven amount is accounted for as other
revenues. However, if the clearing agreement is terminated for any reason prior
to the loan maturity date, the loan, less any amount that has been forgiven
through the date of the termination, plus interest, must be repaid on demand.
COMPETITION
Ladenburg encounters intense competition in all aspects of its business
and competes directly with many other securities firms for clients, as well as
registered representatives. Many of its competitors have significantly greater
financial, technical, marketing and other resources than it does. National
retail firms such as Merrill Lynch Pierce, Fenner & Smith Incorporated,
Citigroup Global Markets Inc. and Morgan Stanley/Dean Witter & Co. dominate the
industry. Ladenburg also competes with numerous regional and local firms. In
addition, a number of firms offer discount brokerage services to retail
customers and generally effect transactions at substantially lower commission
rates on an "execution only" basis, without offering other services such as
investment recommendations and research. Moreover, there is substantial
commission discounting by full-service broker-dealers competing for
institutional and retail brokerage business. A growing number of brokerage firms
offer online trading which has further intensified the competition for brokerage
customers. Although Ladenburg offers on-line account access to its customers to
review their account balances and activity, it currently does not offer any
online trading services to its customers. The continued expansion of discount
brokerage firms and online trading could adversely affect the retail business.
Other financial institutions, notably commercial banks and savings and loan
associations, offer customers some of the same services and products presently
provided by securities firms. While it is not possible to predict the type and
extent of competing services which banks and other institutions ultimately may
offer to customers, Ladenburg may be adversely affected to the extent those
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services are offered on a large scale basis. We try to compete through our
advertising and recruiting programs for registered representatives interested in
joining us.
GOVERNMENT REGULATION
The securities industry and our business is subject to extensive
regulation by the SEC, state securities regulators and other governmental
regulatory authorities. The principal purpose of these regulations is the
protection of customers and the securities markets. The SEC is the federal
agency charged with the administration of the federal securities laws. Much of
the regulation of broker-dealers, however, has been delegated to self-regulatory
organizations, principally the NASD Regulation, Inc., the regulatory arm of the
NASD, the NYSE and the Municipal Securities Rulemaking Board. These
self-regulatory organizations adopt rules, subject to approval by the SEC, which
govern its members and conduct periodic examinations of member firms'
operations. Securities firms are also subject to regulation by state securities
commissions in the states in which they are registered. Ladenburg is a
registered broker-dealer with the SEC and a member firm of the NYSE. It is
licensed to conduct activities as a broker-dealer in all 50 states.
Ladenburg Thalmann Europe is an authorized securities broker regulated
by the Financial Services Authority of the United Kingdom and, through the
European Community's passporting provisions, is authorized to conduct business
in all of the member countries of the European Community.
The regulations to which broker-dealers are subject cover all aspects
of the securities industry, including:
o sales methods and supervision;
o trading practices among broker-dealers;
o use and safekeeping of customers' funds and securities;
o capital structure of securities firms;
o record keeping; and
o the conduct of directors, officers and employees.
Additional legislation, changes in rules promulgated by the SEC and by
self-regulatory bodies or changes in the interpretation or enforcement of
existing laws and rules often directly affect the method of operation and
profitability of broker-dealers. The SEC and the self-regulatory bodies may
conduct administrative proceedings which can result in censure, fine, suspension
or expulsion of a broker-dealer, its officers, employees or registered
representatives.
NET CAPITAL REQUIREMENTS
As a registered broker-dealer and member of the NYSE, Ladenburg is
subject to the SEC's net capital rule, which is designed to measure the general
financial integrity and liquidity of a broker-dealer. Net capital is defined as
the net worth of a broker-dealer subject to certain adjustments. In computing
net capital, various adjustments are made to net worth which exclude assets not
readily convertible into cash. Additionally, the regulations require that
certain assets, such as a broker-dealer's position in securities, be valued in a
conservative manner so as to avoid over-inflation of the broker-dealer's net
capital. We compute net capital under the alternate method permitted by the net
capital rule. Under this method,
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Ladenburg is required to maintain net capital equal to $250. Compliance with the
net capital rule limits those operations of broker-dealers which require the
intensive use of their capital, such as underwriting commitments and principal
trading activities.
In addition to the above requirements, funds invested as equity capital
may not be withdrawn, nor may any unsecured advances or loans be made to any
stockholder of a registered broker-dealer, if, after giving effect to the
withdrawal, advance or loan and to any other withdrawal, advance or loan as well
as to any scheduled payments of subordinated debt which are scheduled to occur
within six months, the net capital of the broker-dealer would fall below 120% of
the minimum dollar amount of net capital required or the ratio of aggregate
indebtedness to net capital would exceed 10 to 1. Further, any funds invested in
the form of subordinated debt generally must be invested for a minimum term of
one year and repayment of such debt may be suspended if the broker-dealer fails
to maintain certain minimum net capital levels. For example, scheduled payments
of subordinated debt are suspended in the event that the ratio of aggregate
indebtedness to net capital of the broker-dealer would exceed 12 to 1 or its net
capital would be less than 120% of the minimum dollar amount of net capital
required. The net capital rule also prohibits payments of dividends, redemption
of stock and the prepayment, or payment in respect of principal or subordinated
indebtedness if net capital, after giving effect to the payment, redemption or
repayment, would be less than the specified percent (120%) of the minimum net
capital requirement.
At December 31, 2003, Ladenburg had net capital of $6,745 which
exceeded its minimum net capital requirement of $250 by $6,495. Failure to
maintain the required net capital may subject a firm to suspension or expulsion
by the NYSE, the SEC and other regulatory bodies and ultimately may require its
liquidation. Compliance with the net capital rule could limit Ladenburg's
operations that require the intensive use of capital, such as underwriting and
trading activities, and also could restrict our ability to withdraw capital from
it, which in turn could limit our ability to pay dividends, repay debt and
redeem or purchase shares of our outstanding capital stock.
PERSONNEL
At December 31, 2003, we had a total of approximately 324 employees, of
which 172 are registered representatives and 152 are other full time employees.
These employees are not covered by a collective bargaining agreement. We
consider our relationship with our employees to be good.
RISK FACTORS
WE HAVE INCURRED, AND MAY CONTINUE TO INCUR, SIGNIFICANT OPERATING LOSSES.
We incurred significant losses from operations during each of the past
three years. We cannot assure you that we will be able to achieve or sustain
revenue growth, profitability or positive cash flow on either a quarterly or
annual basis or that profitability, if achieved, will be sustained. If we are
unable to achieve or sustain profitability, we may not be financially viable in
the future and may have to curtail, suspend or cease additional operations.
IF WE ARE UNABLE TO REPAY OUR OUTSTANDING INDEBTEDNESS OBLIGATIONS WHEN DUE, OUR
OPERATIONS MAY BE MATERIALLY ADVERSELY AFFECTED.
At December 31, 2003, we had an aggregate of $29,500 of indebtedness,
$20,000 (plus an additional $3,414 of accrued interest at December 31, 2003) of
which is secured by our stock of our principal operating subsidiary, Ladenburg,
and matures on December 31, 2005. Although the holders of our secured
indebtedness have agreed to forbear receiving interest on the debt until January
15, 2005 and recently agreed to convert such indebtedness into shares of our
common stock, subject to shareholder
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approval, there is a risk that our shareholders will not approve the conversion
and the conversion will not occur. We cannot assure you that our operations will
generate funds sufficient to repay our other existing debt obligations as they
come due. Our failure to repay our indebtedness and make interest payments as
required by our debt obligations could have a material adverse affect on our
operations.
WE MAY INCUR SIGNIFICANT LOSSES FROM TRADING AND INVESTMENT ACTIVITIES DUE TO
MARKET FLUCTUATIONS AND VOLATILITY.
We generally maintain trading and investment positions in the equity
markets. To the extent that we own assets, i.e., have long positions, in those
markets, a downturn in those markets could result in losses from a decline in
the value of those long positions. Conversely, to the extent that we have sold
assets that we do not own, i.e., have short positions, in any of those markets,
an upturn in those markets could expose us to potentially unlimited losses as we
attempt to cover our short positions by acquiring assets in a rising market.
We may from time to time have a trading strategy consisting of holding
a long position in one security and a short position in another security from
which we expect to earn revenues based on changes in the relative value of the
two securities. If, however, the relative value of the two securities changes in
a direction or manner that we did not anticipate or against which we are not
hedged, we might realize a loss in those paired positions. In addition, we
maintain trading positions that can be adversely affected by the level of
volatility in the financial markets, i.e., the degree to which trading prices
fluctuate over a particular period, in a particular market, regardless of market
levels.
WE MAY NEED TO RAISE ADDITIONAL FUNDS IN THE NEAR FUTURE.
Our capital requirements continue to be adversely affected by our
inability to generate cash from operations. We have been forced to rely on
borrowings in order to generate working capital for our operations. Accordingly,
we may need to seek to raise additional capital through other available sources,
including through equity offerings or borrowing additional funds on a short-term
basis from third parties, including our current debtholders, shareholders and
clearing broker. As of December 31, 2003, we had cash and cash equivalents of
approximately $3,648. Accordingly, if we continue to be unable to generate cash
from operations and are unable to find sources of funding, it would have an
adverse impact on our liquidity and operations.
OUR EXPENSES MAY INCREASE DUE TO UNRESOLVED REAL ESTATE COMMITMENTS.
Ladenburg Capital may have potential liability under a terminated lease
for office space in New York City which it was forced to vacate during 2001 due
to the events of September 11, 2001. Ladenburg Capital no longer occupies the
space and believes it has no further lease obligation pursuant to the terms of
the lease. This lease, which, had it not terminated as a result of the events of
September 11, 2001, would have expired by its terms in March 2010, provides for
future minimum payments aggregating approximately $4,335, payable $644 in 2004,
$703 per year from 2005 through 2008 and $879 thereafter. Ladenburg Capital is
currently in litigation with the landlord in which it is seeking judicial
determination of the termination of the lease. If Ladenburg Capital is not
successful in this litigation, it plans to sublease the property. Ladenburg
Capital has provided for estimated costs in connection with this lease and has
recorded a liability at December 31, 2003 and 2002. Additional costs may be
incurred in connection with terminating this lease, or if not terminated, to the
extent of foregone rental income in the event Ladenburg Capital does not
sublease the office space for an amount at least equal to the lease obligations.
Such costs may have a material adverse effect on Ladenburg Capital's financial
position and liquidity.
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In May 2003, Ladenburg relocated approximately 95 of its employees from
its New York City office to its Melville, New York office. As a result of this
move, Ladenburg ceased using one of the several floors it occupies in its New
York City office, and the net book value of the leasehold improvements was
written off. In accordance with SFAS No. 146, as estimated future sublease
payments that could be reasonably obtained for the property exceed related
rental commitments under the lease, no liability for costs associated with
vacating the space has been provided. Additional costs may be incurred, to the
extent of foregone rental income in the event Ladenburg does not sublease the
office space for an amount at least equal to the lease obligations. Such costs
may have a material adverse effect on Ladenburg's financial position and
liquidity.
OUR BUSINESS COULD BE ADVERSELY AFFECTED BY A BREAKDOWN IN THE FINANCIAL
MARKETS.
As a securities broker-dealer, our business is materially affected by
conditions in the financial markets and economic conditions generally, both in
the United States and elsewhere around the world. Many factors or events could
lead to a breakdown in the financial markets including war, terrorism, natural
catastrophes and other types of disasters. These types of events could cause
people to begin to lose confidence in the financial markets and their ability to
function effectively. If the financial markets are unable to effectively prepare
for these types of events and ease public concern over their ability to
function, our revenues are likely to decline and our operations will be
adversely affected.
OUR REVENUES MAY DECLINE IN ADVERSE MARKET OR ECONOMIC CONDITIONS.
During the past several years, unfavorable financial and economic
conditions have reduced the number and size of the transactions in which we
provide underwriting services, merger and acquisition consulting and other
services. Our investment banking revenues, in the form of financial advisory and
underwriting fees, are directly related to the number and size of the
transactions in which we participate and therefore have been adversely affected
by the sustained downturn in the securities markets that prevailed through the
middle of 2003. Additionally, the downturn in market conditions led to a decline
in the volume of transactions that we executed for our customers and, therefore,
to a decline in the revenues we received from commissions and spreads. If these
adverse financial and economic conditions return and persist for any extended
period of time, we will incur a further decline in transactions and revenues
that we receive from commissions and spreads.
WE DEPEND ON OUR SENIOR EMPLOYEES AND THE LOSS OF THEIR SERVICES COULD HARM OUR
BUSINESS.
Our success is dependent in large part upon the services of several of
our senior executives and employees, including those of Ladenburg. We do not
maintain and do not intend to obtain key man insurance on the life of any
executive or employee. If our senior executives or employees terminate their
employment with us and we are unable to find suitable replacements in relatively
short periods of time, our operations may be materially and adversely affected.
WE FACE SIGNIFICANT COMPETITION FOR PROFESSIONAL EMPLOYEES.
From time to time, individuals we employ may choose to leave our
company to pursue other opportunities. We have experienced losses of registered
representatives, trading and investment banking professionals in the past, and
the level of competition for key personnel remains intense. We cannot assure you
that the loss of key personnel will not occur again in the future. The loss of a
registered representative or a trading or investment banking professional,
particularly a senior professional with a broad range of contacts in an
industry, could materially and adversely affect our operating results.
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OUR PRINCIPAL SHAREHOLDERS INCLUDING OUR DIRECTORS AND OFFICERS CONTROL A LARGE
PERCENTAGE OF OUR SHARES OF COMMON STOCK AND CAN SIGNIFICANTLY INFLUENCE OUR
CORPORATE ACTIONS.
At the present time, our executive officers, directors and companies
that these individuals are affiliated with beneficially own approximately 22.0%
of our common stock. Accordingly, these individuals and entities will be able to
significantly influence most, if not all, of our corporate actions, including
the election of directors and the appointment of officers. Additionally, this
ownership of our common stock may make it difficult for a third party to acquire
control of us, therefore possibly discouraging third parties from seeking to
acquire us. A third party would have to negotiate any possible transactions with
these principal shareholders, and their interests may be different from the
interests of our other shareholders. This may depress the price of our common
stock.
THE AMERICAN STOCK EXCHANGE MAY DELIST OUR COMMON STOCK FROM QUOTATION ON ITS
EXCHANGE.
Our common stock is currently quoted on the American Stock Exchange
("Exchange"). In order to continue quotation of our common stock, we must
maintain certain financial, distribution and stock price levels. Generally, we
must maintain a minimum amount in shareholders' equity (usually between $2
million and $4 million) and a minimum number of public shareholders (usually 300
shareholders or 200,000 shares held by our non-affiliates). Additionally, our
common stock cannot have what is deemed to be a "low selling price" as
determined by the Exchange.
In November 2003, we received notice from the Exchange indicating that
we were below certain of the continued listing standards of the Exchange,
specifically that we had sustained losses in two of its three most recent fiscal
years with shareholders' equity of less than $2 million, as set forth in Section
1003(a)(i) of the Exchange's Company Guide. We were afforded an opportunity to
submit our plan to regain compliance with the continued listing standards to the
Exchange and did so in December 2003. Upon acceptance of the plan, the Exchange
provided us with the extension until May 13, 2005 to regain compliance and will
allow us to maintain our listing on the Exchange through the plan period,
subject to periodic review of our progress by the Exchange's staff. If we do not
make progress consistent with the plan or regain compliance with the continued
listing standards by the end of the extension period, the Exchange could
initiate delisting procedures.
Additionally, on March 29, 2004, the last reported sale price of our
common stock was $0.91. If the Exchange determines that this is a "low selling
price," it may require us to effect a reverse split or suspend or remove our
common stock from listing on the Exchange. In determining whether a reverse
split or suspension or removal is appropriate, the Exchange will consider all
pertinent factors including market conditions in general, the number of shares
outstanding, plans which may have been formulated by management, applicable
regulations of the state or country of incorporation or of any governmental
agency having jurisdiction over the company and the relationship to other
Exchange policies regarding continued listing.
If the Exchange delists our common stock from trading on its exchange,
we could face significant material adverse consequences including:
o a limited availability of market quotations for our common
stock;
o a determination that our common stock is a "penny stock" which
will require brokers trading in our common stock to adhere to
more stringent rules and possibly resulting in a reduced level
of trading activity in the secondary trading market for our
common stock;
o a limited amount of news and analyst coverage for our company;
and
o a decreased ability to issue additional securities or obtain
additional financing in the future.
11
WE MAY LOSE CUSTOMERS AND OUR REVENUES MAY DECLINE DUE TO OUR LACK OF INTERNET
BROKERAGE SERVICE CAPABILITY.
A growing number of brokerage firms offer Internet brokerage services
to their customers in response to increased customer demand for these services.
While we intend to offer Internet brokerage services in the future, we may not
be able to offer services that will appeal to our current or prospective
customers and these services may not be profitable. Our failure to commence
Internet brokerage services in the near future could have a material adverse
effect on our business including the loss of our existing customers to
competitors that do offer these services. Additionally, if we commence Internet
brokerage services but are unable to attract customers for those services, our
revenues will decline.
WE RELY ON ONE PRIMARY CLEARING BROKER AND THE TERMINATION OF THE AGREEMENT WITH
THIS CLEARING BROKER COULD DISRUPT OUR BUSINESS.
Ladenburg primarily uses one clearing broker to process its securities
transactions and maintain customer accounts on a fee basis. The clearing broker
also provides billing services, extends credit and provides for control and
receipt, custody and delivery of securities. In November 2002, we completed the
Clearing Conversion and renegotiated our clearing agreement with this clearing
broker. In addition, under the new clearing agreement, an affiliate of the
clearing broker provided us with the Clearing Loans, aggregating to $3,500, with
various terms and maturing at various dates through December 2006. As scheduled,
in November 2003, $1,500 of the Clearing Loans was forgiven. The remaining
principal balance of the Clearing Loans is scheduled to be forgiven as follows:
$667 in November 2004, $667 in November 2005 and $666 in November 2006. Upon the
forgiveness of the Clearing Loans, the forgiven amount is accounted for as other
revenue. However, if the clearing agreement is terminated for any reason prior
to the loan maturity date, the loan, less any amount that has been forgiven
through the date of the termination, plus interest, must be repaid on demand.
Ladenburg depends on the operational capacity and ability of the
clearing broker for the orderly processing of transactions. In addition, by
engaging the processing services of a clearing firm, Ladenburg is exempt from
some capital reserve requirements and other regulatory requirements imposed by
federal and state securities laws. If the clearing agreement is terminated for
any reason, we would be forced to find an alternative clearing firm. We cannot
assure you that we would be able to find an alternative clearing firm on
acceptable terms to us or at all.
OUR CLEARING BROKER EXTENDS CREDIT TO OUR CLIENTS AND WE ARE LIABLE IF THE
CLIENTS DO NOT PAY.
Ladenburg permits its clients to purchase securities on a margin basis
or sell securities short, which means that the clearing firm extends credit to
the client secured by cash and securities in the clients' account. During
periods of volatile markets, the value of the collateral held by the clearing
broker could fall below the amount borrowed by the client. If margin
requirements are not sufficient to cover losses, the clearing broker sells or
buys securities at prevailing market prices, and may incur losses to satisfy
client obligations. Ladenburg has agreed to indemnify the clearing broker for
losses it may incur while extending credit to its clients.
12
WE ARE SUBJECT TO VARIOUS RISKS ASSOCIATED WITH THE SECURITIES INDUSTRY.
As a securities broker-dealer, Ladenburg is subject to uncertainties
that are common in the securities industry. These uncertainties include:
o the volatility of domestic and international financial, bond
and stock markets, as demonstrated by recent disruptions in
the financial markets;
o extensive governmental regulation;
o litigation;
o intense competition;
o substantial fluctuations in the volume and price level of
securities; and
o dependence on the solvency of various third parties.
As a result, revenues and earnings may vary significantly from quarter to
quarter and from year to year. In periods of low volume, profitability is
impaired because certain expenses remain relatively fixed. Ladenburg is much
smaller and has much less capital than many competitors in the securities
industry. In the event of a market downturn, our business could be adversely
affected in many ways. Our revenues are likely to decline in such circumstances
and, if we are unable to reduce expenses at the same pace, our profit margins
would erode.
OUR RISK MANAGEMENT POLICIES AND PROCEDURES MAY LEAVE US EXPOSED TO UNIDENTIFIED
RISKS OR AN UNANTICIPATED LEVEL OF RISK.
The policies and procedures we employ to identify, monitor and manage
risks may not be fully effective. Some methods of risk management are based on
the use of observed historical market behavior. As a result, these methods may
not predict future risk exposures, which could be significantly greater than the
historical measures indicate. Other risk management methods depend on evaluation
of information regarding markets, clients or other matters that are publicly
available or otherwise accessible by us. This information may not be accurate,
complete, up-to-date or properly evaluated. Management of operational, legal and
regulatory risk requires, among other things, policies and procedures to
properly record and verify a large number of transactions and events. We cannot
assure you that our policies and procedures will effectively and accurately
record and verify this information.
We seek to monitor and control our risk exposure through a variety of
separate but complementary financial, credit, operational and legal reporting
systems. We believe that we effectively evaluate and manage the market, credit
and other risks to which we are exposed. Nonetheless, the effectiveness of our
ability to manage risk exposure can never be completely or accurately predicted
or fully assured. For example, unexpectedly large or rapid movements or
disruptions in one or more markets or other unforeseen developments can have a
material adverse effect on our results of operations and financial condition.
The consequences of these developments can include losses due to adverse changes
in inventory values, decreases in the liquidity of trading positions, higher
volatility in earnings, increases in our credit risk to customers as well as to
third parties and increases in general systemic risk.
13
CREDIT RISK EXPOSES US TO LOSSES CAUSED BY FINANCIAL OR OTHER PROBLEMS
EXPERIENCED BY THIRD PARTIES.
We are exposed to the risk that third parties that owe us money,
securities or other assets will not perform their obligations. These parties
include:
o trading counterparties;
o customers;
o clearing agents;
o exchanges;
o clearing houses; and
o other financial intermediaries as well as issuers whose
securities we hold.
These parties may default on their obligations owed to us due to bankruptcy,
lack of liquidity, operational failure or other reasons. This risk may arise,
for example, from:
o holding securities of third parties;
o executing securities trades that fail to settle at the
required time due to non-delivery by the counterparty or
systems failure by clearing agents, exchanges, clearing houses
or other financial intermediaries; and
o extending credit to clients through bridge or margin loans or
other arrangements.
Significant failures by third parties to perform their obligations owed to us
could adversely affect our revenues and perhaps our ability to borrow in the
credit markets.
INTENSE COMPETITION FROM EXISTING AND NEW ENTITIES MAY ADVERSELY AFFECT OUR
REVENUES AND PROFITABILITY.
The securities industry is rapidly evolving, intensely competitive and
has few barriers to entry. We expect competition to continue and intensify in
the future. Many of our competitors have significantly greater financial,
technical, marketing and other resources than we do. Some of our competitors
also offer a wider range of services and financial products than we do and have
greater name recognition and a larger client base. These competitors may be able
to respond more quickly to new or changing opportunities, technologies and
client requirements. They may also be able to undertake more extensive
promotional activities, offer more attractive terms to clients, and adopt more
aggressive pricing policies. We may not be able to compete effectively with
current or future competitors and competitive pressures faced by us may harm our
business.
THE PRECAUTIONS WE TAKE TO PREVENT AND DETECT EMPLOYEE MISCONDUCT MAY NOT BE
EFFECTIVE AND WE COULD BE EXPOSED TO UNKNOWN AND UNMANAGED RISKS OR LOSSES.
We run the risk that employee misconduct could occur. Misconduct by
employees could include:
o employees binding us to transactions that exceed authorized
limits or present unacceptable risks to us;
o employees hiding unauthorized or unsuccessful activities from
us; or
o the improper use of confidential information.
These types of misconduct could result in unknown and unmanaged risks or losses
to us including regulatory sanctions and serious harm to our reputation. The
precautions we take to prevent and detect these activities may not be effective.
If employee misconduct does occur, our business operations could be materially
adversely affected.
14
WE ARE CURRENTLY SUBJECT TO EXTENSIVE SECURITIES REGULATION AND THE FAILURE TO
COMPLY WITH THESE REGULATIONS COULD SUBJECT US TO PENALTIES OR SANCTIONS.
The securities industry and our business is subject to extensive
regulation by the SEC, state securities regulators and other governmental
regulatory authorities. We are also regulated by industry self-regulatory
organizations, including the NYSE, the NASD and the Municipal Securities
Rulemaking Board.
Ladenburg is a registered broker-dealer with the SEC and a member firm
of the NYSE. Broker-dealers are subject to regulations which cover all aspects
of the securities business, including:
o sales methods and supervision;
o trading practices among broker-dealers;
o use and safekeeping of customers' funds and securities;
o capital structure of securities firms;
o record keeping; and
o the conduct of directors, officers and employees.
Much of the regulation of broker-dealers has been delegated to self-regulatory
organizations, principally the NASD Regulation, Inc., the regulatory arm of the
NASD, and the NYSE, which are our primary regulatory agencies. NASD Regulation
and the NYSE adopt rules, subject to approval by the SEC, that govern its
members and conducts periodic examinations of member firms' operations.
Compliance with many of the regulations applicable to us involves a
number of risks, particularly in areas where applicable regulations may be
subject to varying interpretation. The requirements imposed by these regulators
are designed to ensure the integrity of the financial markets and to protect
customers and other third parties who deal with us. Consequently, these
regulations often serve to limit our activities, including through net capital,
customer protection and market conduct requirements. If we are found to have
violated an applicable regulation, administrative or judicial proceedings may be
initiated against us that may result in:
o censure;
o fine;
o civil penalties, including treble damages in the case of
insider trading violations;
o the issuance of cease-and-desist orders;
o the deregistration or suspension of our broker-dealer
activities;
o the suspension or disqualification of our officers or
employees; or
o other adverse consequences.
15
The imposition of any of these or other penalties could have a material adverse
effect on our operating results and financial condition.
The regulatory environment is also subject to change. We may be
adversely affected as a result of new or revised legislation or regulations
imposed by the SEC, other federal or state governmental regulatory authorities,
or self-regulatory organizations. We also may be adversely affected by changes
in the interpretation or enforcement of existing laws and rules by these
governmental authorities and self-regulatory organizations.
FAILURE TO COMPLY WITH NET CAPITAL REQUIREMENTS COULD SUBJECT US TO SUSPENSION
OR REVOCATION BY THE SEC OR SUSPENSION OR EXPULSION BY THE NASD AND THE NYSE.
Ladenburg is subject to the SEC's net capital rule which requires the
maintenance of minimum net capital. We compute net capital under the alternate
method permitted by the net capital rule. Under this method, Ladenburg is
required to maintain net capital equal to $250. The net capital rule is designed
to measure the general financial integrity and liquidity of a broker-dealer. In
computing net capital, various adjustments are made to net worth which exclude
assets not readily convertible into cash. Additionally, the regulations require
that certain assets, such as a broker-dealer's position in securities, be valued
in a conservative manner so as to avoid over-inflation of the broker-dealer's
net capital. The net capital rule requires that a broker-dealer maintain a
certain minimum level of net capital. The particular levels vary in application
depending upon the nature of the activity undertaken by a firm. Compliance with
the net capital rule limits those operations of broker-dealers which require the
intensive use of their capital, such as underwriting commitments and principal
trading activities. The rule also limits the ability of securities firms to pay
dividends or make payments on certain indebtedness such as subordinated debt as
it matures. A significant operating loss or any charge against net capital could
adversely affect the ability of a broker-dealer to expand or, depending on the
magnitude of the loss or charge, maintain its then present level of business.
The NASD and the NYSE may enter the offices of a broker-dealer at any time,
without notice, and calculate the firm's net capital. If the calculation reveals
a deficiency in net capital, the NASD may immediately restrict or suspend
certain or all of the activities of a broker-dealer, including its ability to
make markets. Ladenburg may not be able to maintain adequate net capital, or its
net capital may fall below requirements established by the SEC, and subject us
to disciplinary action in the form of fines, censure, suspension, expulsion or
the termination of business altogether.
RISK OF LOSSES ASSOCIATED WITH SECURITIES LAWS VIOLATIONS AND LITIGATION.
Many aspects of our business involve substantial risks of liability. An
underwriter is exposed to substantial liability under federal and state
securities laws, other federal and state laws, and court decisions, including
decisions with respect to underwriters' liability and limitations on
indemnification of underwriters by issuers. For example, a firm that acts as an
underwriter may be held liable for material misstatements or omissions of fact
in a prospectus used in connection with the securities being offered or for
statements made by its securities analysts or other personnel. In recent years,
there has been an increasing incidence of litigation involving the securities
industry, including class actions that seek substantial damages. Our
underwriting activities will usually involve offerings of the securities of
smaller companies, which often involve a higher degree of risk and are more
volatile than the securities of more established companies. In comparison with
more established companies, smaller companies are also more likely to be the
subject of securities class actions, to carry directors and officers liability
insurance policies with lower limits or not at all, and to become insolvent.
Each of these factors increases the likelihood that an underwriter of a smaller
companies' securities will be required to contribute to an adverse judgment or
settlement of a securities lawsuit.
16
In the normal course of business, our operating subsidiaries have been
and continue to be the subject of numerous civil actions and arbitrations
arising out of customer complaints relating to our activities as a
broker-dealer, as an employer and as a result of other business activities. In
general, the cases involve various allegations that our employees had mishandled
customer accounts. We believe that, based on our historical experience and the
reserves established by us, the resolution of the claims presently pending will
not have a material adverse effect on our financial condition. However, although
we typically reserve an amount we believe will be sufficient to cover any
damages assessed against us, we have in the past been assessed damages that
exceeded our reserves. If we misjudged the amount of damages that may be
assessed against us from pending or threatened claims, or if we are unable to
adequately estimate the amount of damages that will be assessed against us from
claims that arise in the future and reserve accordingly, our financial condition
may be materially adversely affected.
POSSIBLE ADDITIONAL ISSUANCES WILL CAUSE DILUTION.
While we currently have outstanding 43,627,130 shares of common stock,
options to purchase a total of 5,453,030 shares of common stock, warrants to
purchase a total of 200,000 shares of common stock and senior convertible
promissory notes initially convertible into 11,296,746 shares of common stock,
we are authorized to issue up to 200,000,000 shares of common stock and are
therefore able to issue additional shares without being required under corporate
law to obtain shareholder approval. If we issue additional shares, or if our
existing shareholders exercise or convert their outstanding options or notes,
our other shareholders may find their holdings drastically diluted, which if it
occurs, means that they will own a smaller percentage of our company.
WE MAY ISSUE PREFERRED STOCK WITH PREFERENTIAL RIGHTS THAT MAY ADVERSELY AFFECT
YOUR RIGHTS.
The rights of our shareholders will be subject to and may be adversely
affected by the rights of holders of any preferred stock that we may issue in
the future. Our articles of incorporation authorize our board of directors to
issue up to 2,000,000 shares of "blank check" preferred stock and to fix the
rights, preferences, privilege and restrictions, including voting rights, of
these shares without further shareholder approval.
ITEM 2. PROPERTIES.
Our principal executive offices and those of Ladenburg and other
subsidiaries of ours are located at 590 Madison Avenue, 34th Floor, New York,
New York 10022, where we lease approximately 82,000 square feet of office space
pursuant to a lease that expires in June 2015. We also operate several branch
offices located in New York, Florida and California. In January 2003, we closed
our office in Cleveland, Ohio and in June 2003, we closed our office in Ft.
Lauderdale, Florida.
Ladenburg Capital may have potential liability under a terminated lease
for office space in New York City which it was forced to vacate during 2001 due
to the events of September 11, 2001. Ladenburg Capital no longer occupies the
space and believes it has no further lease obligation pursuant to the terms of
the lease. This lease, which, had it not terminated as a result of the events of
September 11, 2001, would have expired by its terms in March 2010, provides for
future minimum payments aggregating approximately $4,335, payable $644 in 2004,
$703 per year from 2005 through 2008 and $879 thereafter. Ladenburg Capital is
currently in litigation with the landlord in which it is seeking judicial
determination of the termination of the lease. If Ladenburg Capital is not
successful in this litigation, it plans to sublease the property. Ladenburg
Capital has provided for estimated costs in connection with this lease and has
recorded a liability at December 31, 2003 and 2002. Additional costs may be
incurred in connection with terminating this lease, or if not terminated, to the
extent of foregone rental income in the event Ladenburg Capital does not
sublease the office space for an amount at least equal to the lease obligations.
Such costs may have a material adverse effect on Ladenburg Capital's financial
position and liquidity.
17
In December 2003, Ladenburg Capital terminated its lease obligations
relating to the office it previously occupied in Bethpage, New York. As a result
of its settlement with the Bethpage landlord, Ladenburg Capital adjusted its
liability and a recorded a corresponding reduction in rent expense of $1,175 in
the fourth quarter of 2003. This reduction in rent expense, less rent accrued in
previous quarters during 2003, resulted in a net credit of $200 for the fiscal
year ended December 31, 2003.
Ladenburg ceased using one of the several floors it occupies in its New
York City office and is currently seeking to sublet the property. In accordance
with SFAS No. 146, Ladenburg's management evaluates Ladenburg's liability with
respect to this space on a quarterly basis, taking into account estimated future
sublease payments that could be reasonably obtained for the property. In these
evaluations, Ladenburg's management concluded that a liability for this matter
did not exist as of December 31, 2003. Additional costs may be incurred, to the
extent of foregone rental income in the event Ladenburg does not sublease the
office space for an amount at least equal to the lease obligations. Such costs
may have a material adverse effect on Ladenburg's financial position and
liquidity.
ITEM 3. LEGAL PROCEEDINGS.
See Note 9 to our Consolidated Financial Statements included in Part
II, Item 8 of this Annual Report on Form 10-K.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
18
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
On April 14, 2000, our common stock began trading on the Exchange under
the symbol "GBC." On May 7, 2001, we changed our name to Ladenburg Thalmann
Financial Services Inc. and on the same date our common stock began quotation on
the Exchange under the symbol "LTS." The following table sets forth the high and
low prices of the common stock for the periods specified.
HIGH($) LOW($)
------- ------
2004
First Quarter* 1.10 0.50
2003
Fourth Quarter 0.67 0.32
Third Quarter 0.43 0.22
Second Quarter 0.28 0.05
First Quarter 0.12 0.05
2002
Fourth Quarter 0.23 0.09
Third Quarter 0.35 0.13
Second Quarter 0.96 0.30
First Quarter 1.00 0.57
*Through March 29, 2004.
HOLDERS
On March 29, 2004, there were approximately 13,300 holders of record of
our common stock.
DIVIDENDS
To date, we have not paid or declared any dividends on our common
stock. The payment of future dividends, if any, will be at the discretion of our
board of directors after taking into account various factors, including our
financial condition, operating results, current anticipated cash needs as well
as any other factors that the board of directors may deem relevant. Our ability
to pay dividends in the future also may be restricted by our operating
subsidiaries' obligations to comply with the net capital requirements imposed on
broker-dealers by the SEC and the NASD. We do not intend to declare any
dividends in the foreseeable future, but instead intend on retaining all
earnings for use in our business.
RECENT SALES OF UNREGISTERED SECURITIES
On December 17, 2003, we issued ten-year options to various employees
to purchase an aggregate of 1,138,550 at $0.45 per share. The options vest in
three equal annual installments commencing on the first anniversary of the date
of grant. This transaction was effected in reliance on exemptions from
registration afforded by Section 4(2) of the Securities Act of 1933, as amended.
19
ITEM 6. SELECTED FINANCIAL DATA.
The selected financial data set forth below is derived from our audited
financial statements. This selected financial data should be read in conjunction
with the section under the caption "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and the Consolidated Financial
Statements included elsewhere in this Annual Report on Form 10-K:
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------------------------
2003 2002 2001 2000 1999
------------ ------------ ------------ ------------ ------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
OPERATING RESULTS: (a)
Total revenues ............................. $ 61,397 $ 79,573 $ 93,953 $ 89,584 $ 77,171
Total expenses ............................. 66,665 125,025 106,202 83,372 74,107
(Loss) income before income taxes .......... (5,420) (44,993) (12,249) 6,212 3,064
Net (loss) income .......................... (5,490) (46,393) (12,293) 5,090 4,006
Per common and equivalent share(b):
Basic and diluted:
(Loss) income per Common Share .......... $ (0.13) $ (1.10) $ (0.31) $ 0.15 $ 0.12
============ ============ ============ ============ ============
Basic and diluted weighted average
Common Shares (b) ....................... 42,567,798 42,025,211 39,458,057 34,647,170 34,647,170
============ ============ ============ ============ ============
BALANCE SHEET DATA:
Total assets ............................... $ 44,232 $ 48,829 $ 98,407 $ 50,354 $ 49,139
Total liabilities, excluding subordinated
liabilities .......................... 34,768 32,620 40,713 20,054 23,930
Subordinated debt .......................... 22,500 22,500 22,500 -- --
Shareholders' equity (capital deficit) ..... (16,172) (10,894) 35,194 30,300 25,209
OTHER DATA:
Ratio of assets to shareholders'
equity ................................ N/A N/A 2.80 1.66 1.95
Return on average equity ................... (40.6)% (381.8)% (38.0)% 18.3% 20.0%
Return on average equity
before income taxes ................... (40.1)% (370.3)% (37.5)% 22.4% 15.3%
Book value per share (b) ................... -- -- $ 0.84 $ 1.67 $ 1.39
Average registered representatives ......... 196 399 540 250 171
(a) The financial data prior to May 7, 2001 reflects Ladenburg's financial
results and the financial data afterwards reflects Ladenburg Thalmann
Financial Services' financial results.
(b) All per share data prior to May 7, 2001 have been retroactively
adjusted to reflect the number of equivalent shares received by the
former stockholders of Ladenburg in the form of common stock,
convertible notes and cash.
20
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
INTRODUCTION
We are engaged in retail and institutional securities brokerage,
investment banking services and proprietary trading through our principal
operating subsidiary, Ladenburg. Ladenburg is a full service broker-dealer that
has been a member of the NYSE since 1879. It provides its services principally
for middle market and emerging growth companies and high net worth individuals
through a coordinated effort among corporate finance, capital markets,
investment management, brokerage and trading professionals. Ladenburg is subject
to regulation by, among others, the SEC, the NYSE and the NASD and is a member
of the SIPC. Ladenburg currently has 179 registered representatives and 158
other full time employees. Its private client services and institutional sales
departments serve approximately 70,000 accounts nationwide and its asset
management area provides investment management and financial planning services
to numerous individuals and institutions.
Our consolidated financial statements include our accounts and the
accounts of our wholly-owned subsidiaries. Our subsidiaries include, among
others, Ladenburg, Ladenburg Capital, Ladenburg Thalmann Europe, Ltd. and
Ladenburg Capital Fund Management Inc.
Ladenburg Capital Fund Management ("LCFM") is the sole general partner
of the Ladenburg Focus Fund, L.P., an open-ended private investment fund that
invests its capital in publicly traded equity securities and options strategies.
Through December 31, 2002, the Company accounted for its investment in the
limited partnership using the equity method. Commencing in 2003, due to the
controlling voting interest of LCFM, the accounts of the limited partnership
were consolidated with the Company's accounts. In addition, the prior year
financial statements were adjusted to reflect the consolidation of the limited
partnership. This adjustment had no effect on the capital deficit at December
31, 2002, or the net loss for the year then ended, as previously reported. In
addition, certain reclassifications have been made to prior period financial
information to conform to the current period presentation.
Prior to May 7, 2001, Ladenburg Capital and Ladenburg Capital Fund
Management were our only operating subsidiaries. On May 7, 2001, we acquired all
of the outstanding common stock of Ladenburg, and we changed our name from GBI
Capital Management Corp. to Ladenburg Thalmann Financial Services Inc. As part
of the consideration for the shares of Ladenburg, we issued the former
stockholders of Ladenburg a majority interest in our common stock. For
accounting purposes, the acquisition has been accounted for as a reverse
acquisition. Under reverse acquisition accounting, we were treated as the
acquired entity as Ladenburg's former stockholders held a majority of our common
stock following the transaction. As a result, our operating results were
included as of May 7, 2001, the date of the acquisition, with the historical
financial statements of Ladenburg. As appropriate, in the discussion of
operating results, increases in reported revenues and expenses as a result of
the acquired operations of Ladenburg Thalmann Financial Services Inc. will be
referred to as the "Ladenburg Capital operations." In connection with the
acquisition, all per share data has been restated to reflect retroactively the
number of shares of common stock, convertible notes and cash received by the
former stockholders of Ladenburg. For additional information concerning this
transaction, see Note 3 to our consolidated financial statements and Item 13
included in this report.
RECENT DEVELOPMENTS
EXECUTIVE CHANGES. On March 9, 2004, we entered into a Severance,
Waiver and Release Agreement with Victor M. Rivas, our president and chief
executive officer. Under the Severance Agreement, effective March 31, 2004, Mr.
Rivas will retire from all of his positions with us and our subsidiaries
including Ladenburg. In connection with Mr. Rivas' retirement, we entered into
an Employment Agreement with Charles I. Johnston pursuant to which Mr. Johnston
will serve, effective April 1, 2004, as president, chief executive officer and a
member of our board and chairman and chief executive officer of Ladenburg. Most
recently, Mr. Johnston was a managing director and the global head of private
client services at Lehman Brothers where he was responsible for all aspects of
Lehman's private client services business which included 440 brokers in 14
branches.
21
DEBT CONVERSION. On March 29, 2004, we entered into an agreement with
New Valley Corporation and Frost-Nevada Investments Trust, the holders of our
outstanding $18,010 aggregate principal amount of senior convertible promissory
notes, pursuant to which such parties agreed to convert their notes and accrued
interest into common stock, subject to shareholder approval. Pursuant to the
agreement, New Valley and Frost Nevada will convert their notes into
approximately 26,000,000 shares of common stock at reduced conversion prices of
$1.10 per share and $0.70 per share, respectively. The agreement is subject to,
among other things, approval by our shareholders at a special meeting that is
expected to be held in the second quarter of 2004. As a result of the
conversion, New Valley and Frost-Nevada will beneficially own approximately
12.5% and 27.6%, respectively, of our common stock. Concurrently with this
agreement, we entered into an agreement with Berliner, the holder of the
remaining $1,990 aggregate principal amount of senior convertible promissory
notes, pursuant to which we will repurchase the notes held by Berliner, plus all
accrued interest thereon, for $1,000 in cash.
We currently anticipate recording a pre-tax charge in 2004 of
approximately $10,900 in our statements of operations upon closing of these
transactions. The charge reflects expense attributable to the reduction in the
conversion price of the notes to be converted, offset partially by the gain on
the repurchase of the Berliner notes. The net balance sheet effect of the
transactions will be an increase in our shareholders' equity of approximately
$22,900.
RENEGOTIATION OF CLEARING AGREEMENT. In November 2002, we renegotiated
our clearing agreement with one of our clearing brokers whereby this clearing
broker became our primary clearing broker, clearing substantially all of our
business ("Clearing Conversion"). As part of the new agreement with this
clearing agent, we are realizing significant cost savings from reduced ticket
charges and other incentives. In addition, under the new clearing agreement, an
affiliate of the clearing broker loaned us the an aggregate of $3,500 (the
"Clearing Loans') in December 2002. The Clearing Loans and related accrued
interest are forgivable over various periods, up to four years from the date of
the Clearing Conversion, provided we continue to clear our transactions through
our primary clearing broker. As scheduled, in November 2003, $1,500 of the
Clearing Loans was forgiven. The remaining principal balance of the Clearing
Loans is scheduled to be forgiven as follows: $667 in November 2004, $667 in
November 2005 and $666 in November 2006. Upon the forgiveness of the Clearing
Loans, the forgiven amount is accounted for as other revenues. However, if the
clearing agreement is terminated for any reason prior to the loan maturity date,
the loan, less any amount that has been forgiven through the date of the
termination, plus interest, must be repaid on demand.
LADENBURG CAPITAL MANAGEMENT. From August 1999 through November 2002,
Ladenburg Capital was one of our principal operating subsidiaries in the
securities brokerage industry. Ladenburg Capital previously operated as a
broker-dealer subject to regulation by the SEC and the NASD. Ladenburg Capital
acted as an introducing broker, market maker, underwriter and trader for its own
account. In July 2002, the market making activities of Ladenburg Capital were
terminated. Certain employees working in Ladenburg Capital's market making area
were offered employment with Ladenburg. In November 2002, Ladenburg Capital
terminated its remaining broker-dealer operations but continued with its other
line of business. Ladenburg Capital voluntarily filed at that time to withdraw
as a broker-dealer, which withdrawal became effective in January 2004. In
conjunction with providing employment to certain former Ladenburg Capital
brokers, Ladenburg agreed to and is currently servicing these brokers' customer
accounts.
22
LITIGATION. On May 5, 2003, a suit was filed in the U.S. District Court
for the Southern District of New York by Sedona Corporation against Ladenburg,
former employees of the Ladenburg, Pershing LLC and a number of other firms and
individuals. The plaintiff alleges, among other things, that certain defendants
(not Ladenburg) purchased convertible securities from plaintiff and then
allegedly manipulated the market to obtain an increased number of shares from
the conversion of those securities. Ladenburg acted as placement agent and not
as principal in those transactions. Plaintiff has alleged that Ladenburg and the
other defendants violated federal securities laws and various state laws. The
plaintiff seeks compensatory damages from the defendants of at least $660,000
and punitive damages of $2,000,000. Our motion to dismiss the lawsuit is
currently pending. We believe the plaintiffs' claims in this action are without
merit and intend to vigorously defend against them.
In October 2003, an arbitration panel awarded $1,100 in a customer
arbitration. Although we have increased our reserves to reflect this award, we
have moved in court to vacate this award. The motion to vacate is currently
pending. We have several other various pending arbitrations claiming substantial
amounts of damages, including one which is seeking compensatory damages of
$6,000.
EMPLOYEE STOCK PURCHASE PLAN. In November 2002, our shareholders
approved the Ladenburg Thalmann Financial Services Inc. Employee Stock Purchase
Plan (the "Plan"), under which a total of 5,000,000 shares of common stock are
available for issuance. Under this stock purchase plan, as currently
administered by the compensation committee, all full-time employees may use a
portion of their salary to acquire shares of our common stock. Option periods
have been initially set at three months long and commence on January 1, April 1,
July 1 and October 1 of each year and end on March 31, June 30, September 30 and
December 31 of each year. The Plan became effective November 6, 2002 and the
first option period commenced April 1, 2003. During the year ended December 31,
2003, 1,601,919 shares of our common stock were issued to employees under the
Plan, at an average price of $.1325 per share, resulting in a capital
contribution of $212.
CLOSING OF BRANCH OFFICES. In January 2003, we closed our Cleveland,
Ohio retail sales office. Additionally, in June 2003, we closed our Ft.
Lauderdale office, which constituted all of our market making activities. As a
result of our decision to eliminate our market making activities, our minimum
net capital requirement decreased from $1,000 to $250.
WRITE-OFF OF LEASEHOLD IMPROVEMENTS. In May 2003, Ladenburg relocated
approximately 95 of its employees from its New York City office to its Melville,
New York office. As a result of this move, Ladenburg ceased using one of the
several floors it occupies in its New York City office, and the net book value
of the leasehold improvements was written off. In conjunction with the write-off
of these leasehold improvements, the unamortized deferred rent credit
representing reimbursement from the landlord of such leasehold improvements was
also written-off. The write-off of unamortized leasehold improvements of $1,592,
net of the unamortized deferred rent credit of $813, resulted in a net charge to
operations of $779 during 2003.
CRITICAL ACCOUNTING POLICIES
GENERAL. The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities,
disclosure of contingent assets and liabilities and the reported amounts of
revenues and expenses. Actual results could differ from those estimates.
CLEARING ARRANGEMENTS. Ladenburg does not carry accounts for customers
or perform custodial functions related to customers' securities. Ladenburg
introduces all of its customer transactions, which are not reflected in these
financial statements, to its primary clearing broker, which maintains the
customers' accounts and clears such transactions. Additionally, the primary
clearing broker provides the clearing and depository operations for Ladenburg's
proprietary securities transactions. These activities may expose Ladenburg to
off-balance-sheet risk in the event that customers do not fulfill their
obligations with the
23
primary clearing broker, as Ladenburg has agreed to indemnify its primary
clearing broker for any resulting losses. We continually assess risk associated
with each customer who is on margin credit and record an estimated loss when we
believe collection from the customer is unlikely. We incurred losses from these
arrangements, prior to any recoupment from our financial consultants, of $184
and $233 for the years ended December 31, 2003 and 2002, respectively.
CUSTOMER CLAIMS. In the normal course of business, our operating
subsidiaries have been and continue to be the subject of numerous civil actions
and arbitrations arising out of customer complaints relating to our activities
as a broker-dealer, as an employer and as a result of other business activities.
In general, in addition to the litigation with the landlord discussed below, the
cases involve various allegations that our employees had mishandled customer
accounts. Due to the uncertain nature of litigation in general, we are unable to
estimate a range of possible loss related to lawsuits filed against us, but
based on our historical experience and consultation with counsel, we typically
reserve an amount we believe will be sufficient to cover any damages assessed
against us. We have accrued $4,999 and $6,201 for potential arbitration and
lawsuit losses as of December 31, 2003 and 2002, respectively. However, we have
in the past been assessed damages that exceeded our reserves. If we misjudged
the amount of damages that may be assessed against us from pending or threatened
claims, or if we are unable to adequately estimate the amount of damages that
will be assessed against us from claims that arise in the future and reserve
accordingly, our operating income would be reduced. Such costs may have a
material adverse effect on our future financial position, results of operations
or liquidity.
SEPTEMBER 11, 2001 EVENTS. On September 11, 2001, terrorists attacked
the World Trade Center complex in New York, which subsequently collapsed and
damaged surrounding buildings, including one occupied by a branch office of
Ladenburg Capital. These events resulted in the suspension of trading of U.S.
equity securities for four business days and precipitated the relocation of
approximately 180 employees to Ladenburg's mid-town New York headquarters. Some
of Ladenburg's and Ladenburg Capital's business was temporarily disrupted. We
are insured for loss caused by physical damage to property, including repair or
replacement of property. We are also insured for lost profits due to business
interruption, including costs related to lack of access to facilities. We will
record future reimbursements from insurance proceeds related to certain
September 11, 2001 expenses when the reimbursements are actually received.
Although the claim to the insurance carrier is significantly greater, the net
book value of the lost property, as well as the costs incurred to temporarily
replace some of the lost property, has been recorded as a receivable as of
December 31, 2003. We received insurance proceeds of $150 in July 2002
representing an advance relating to damaged property, which was applied against
our receivable. The receivable balance as of December 31, 2003, representing the
net book value of the damaged property and subsequent construction costs, was
$2,118. In October 2003, we filed a Proof of Loss with the insurance carrier,
for an amount in excess of the policy limits of approximately $7,800. There are
no assurances, however, that we will recover the full amount of insurance
available to Ladenburg and Ladenburg Capital as a result of this claim.
Ladenburg Capital is currently in litigation with its landlord seeking
a declaratory judgment that the lease in this building near the World Trade
Center be deemed terminated because, among other things, the premises were
unsafe and uninhabitable for a period of 270 days after September 11, 2001,
pursuant to a lease provision giving Ladenburg Capital the right to terminate in
those circumstances. We believe that Ladenburg Capital will prevail and intend
to pursue this claim vigorously. However, in the event that Ladenburg Capital
does not prevail, it may incur additional future expenses to terminate the
long-term commitment or, to the extent of foregone rental income in the event
Ladenburg Capital does not sublease the office space for an amount at least
equal to the lease obligations. Such costs may have a material adverse effect on
Ladenburg Capital's financial position and liquidity.
EXIT OR DISPOSAL ACTIVITY. During the fourth quarter of 2002, we early
adopted SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities". Under SFAS No. 146, a cost associated with an exit or disposal
activity shall be recognized and measured initially at its fair value in the
24
period in which the liability is incurred. For operating leases, a liability for
costs that will continue to be incurred under the lease for its remaining term
without economic benefit to the entity shall be recognized and measured at its
fair value when the entity ceases using the right conveyed by the lease (the
"cease-use date"). The fair value of the liability at the "cease-use date" shall
be determined based on the remaining lease rentals, reduced by estimated
sublease rentals that could be reasonably obtained for the property.
In May 2003, Ladenburg relocated approximately 95 of its employees from
its New York City office to its Melville, New York office. As a result of this
move, Ladenburg ceased using one of the several floors it occupies in its New
York City office, and the net book value of the leasehold improvements was
written off. In accordance with SFAS No. 146, as estimated future sublease
payments that could be reasonably obtained for the property exceed related
rental commitments under the lease, no liability for costs associated with
vacating the space has been provided. Additional costs may be incurred, to the
extent of foregone rental income in the event Ladenburg does not sublease the
office space for an amount at least equal to the lease obligations. Such costs
may have a material adverse effect on Ladenburg's financial position and
liquidity.
FAIR VALUE. "Trading securities owned" and "Securities sold, but not
yet purchased" on our consolidated statements of financial condition are carried
at fair value or amounts that approximate fair value, with related unrealized
gains and losses recognized in our results of operations. The determination of
fair value is fundamental to our financial condition and results of operations
and, in certain circumstances, it requires management to make complex judgments.
Fair values are based on listed market prices, where possible. If
listed market prices are not available or if the liquidation of our positions
would reasonably be expected to impact market prices, fair value is determined
based on other relevant factors, including dealer price quotations. Fair values
for certain derivative contracts are derived from pricing models that consider
market and contractual prices for the underlying financial instruments or
commodities, as well as time value and yield curve or volatility factors
underlying the positions.
Pricing models and their underlying assumptions impact the amount and
timing of unrealized gains and losses recognized, and the use of different
pricing models or assumptions could produce different financial results. Changes
in the fixed income and equity markets will impact our estimates of fair value
in the future, potentially affecting principal trading revenues. The illiquid
nature of certain securities or debt instruments also requires a high degree of
judgment in determining fair value due to the lack of listed market prices and
the potential impact of the liquidation of our position on market prices, among
other factors.
IMPAIRMENT OF GOODWILL. On January 1, 2002, we adopted SFAS No. 142,
"Goodwill and Other Intangible Assets," and were required to analyze our
goodwill for impairment issues on January 1, 2002 and on a periodic basis
thereafter. In connection with the reporting of results for the second quarter
of 2002, based on the overall declines in the U.S. equity markets and the
conditions prevailing in the broker-dealer industry, we engaged an independent
appraisal firm to value our goodwill as of June 30, 2002. Based on this
valuation, an impairment charge of $18,762 of goodwill was indicated and
recorded in September 2002. The goodwill was generated in the Ladenburg
acquisition in May 2001, and the charge reflected overall market declines since
the acquisition. See Note 2 to our consolidated financial statements for a
discussion of the adoption of SFAS No. 142.
VALUATION OF DEFERRED TAX ASSETS. We account for taxes in accordance
with SFAS No. 109, "Accounting for Income Taxes," which requires the recognition
of tax benefits or expense on the timing differences between the tax basis and
book basis of its assets and liabilities. Deferred tax assets and liabilities
are measured using the enacted tax rates expected to apply to taxable income in
the years in which those timing differences are expected to be recovered or
settled. Deferred tax amounts as of December 31, 2003, which consist principally
of the tax benefit of net operating loss carryforwards
25
and accrued expenses, amount to $20,598. After consideration of all the
evidence, both positive and negative, especially the fact we have sustained
operating losses during 2002 and 2003 and that we continue to be affected by
conditions in the economy, we have determined that a valuation allowance at
December 31, 2003 was necessary to fully offset the deferred tax assets based on
the likelihood of future realization. At December 31, 2003, we had net operating
loss carryforwards of approximately $35,100, expiring in various years from 2015
through 2024, of which approximately $116 are subject to restrictions on
utilization.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2003 COMPARED TO YEAR ENDED DECEMBER 31, 2002
Our revenues for 2003 decreased $18,176 from 2002 primarily as a result
of decreased commissions of $7,420, decreased net principal transactions of
$5,432, decreased investment banking fees of $6,337, net of increased other
revenues of 1,905. Our revenues were adversely affected by the decrease in our
number of registered representatives in 2003 versus 2002.
Our expenses for 2003 decreased $58,360 from 2002 primarily as a result
of the $18,762 impairment of goodwill in 2002, decreased compensation and
benefits of $16,205, decreased brokerage, communication and clearance fees of
$9,471, and decreased other expenses of $7,570.
Our revenues for 2003 consisted of commissions of $42,376, net
principal transactions of $5,159, investment banking fees of $2,804, investment
advisory fees of $2,459, interest and dividends of $1,773, syndicate and
underwriting income of $251 and other income of $6,575. Our revenues for 2002
consisted of commissions of $49,796, net principal transactions of $10,591,
investment banking fees of $9,141, investment advisory fees of $2,736, interest
and dividends of $2,381, syndicating and underwriting income of $258 and other
income of $4,670. Our expenses for 2003 consisted of compensation and benefits
of $40,671, write-off of leasehold improvements of $779 and various other
expenses of $25,215. Our expenses for 2002 consisted of compensation and
benefits of $56,876, impairment of goodwill of $18,762, write-off of furniture,
fixtures and leasehold improvements of $1,394 and other expenses of $47,993.
The $7,420 (14.9%) decrease in commission income was primarily a result
of a decrease in the number of registered representatives we employed during
2003 compared to 2002. We employed 172 registered representatives as of December
31, 2003 versus 239 as of December 31, 2002.
The $5,432 (51.3%) decrease in net principal transactions was primarily
the result of decreases in trading income of $3,979 in the 2003 period.
The $6,337 (69.3%) decrease in investment banking fees was primarily
the result of decreased revenue from private placement and advisory assignments
due to the decrease in capital markets activity in 2003 compared to 2002, as
well as a reduction in the number of professional staff in the corporate finance
area of the investment banking department, from 11 at December 31, 2002 to 8 at
December 31, 2003.
The decrease in compensation expense of $16,205 (28.5%) was primarily
due to the net decrease in revenues and various staff reductions in the third
and fourth quarters of 2002 as well as the first and second quarters of 2003.
The decrease of $9,471 (64.3%) decrease in brokerage, communication and
clearance fees is primarily due to the Clearing Conversion, the decrease in
proprietary trading activities and the decreased amount of agency commission
transactions in 2003 compared to 2002.
The $7,570 (52.3%) decrease in other expenses was primarily due to
decreases in advertising, customer arbitration settlements, insurance premiums
expense, license and registration fees, travel and valuation allowances relating
to receivables.
26
In connection with the reporting of the results for the second quarter
of 2002, based on the overall declines in the U.S. equity markets and the
conditions prevailing in the broker-dealer industry, the Company completed an
additional impairment review and recorded a $18,762 charge for the impairment of
goodwill, which was generated in the Ladenburg acquisition. The charge reflected
the overall market declines since the acquisition in May 2001. During this
review, an independent appraisal firm was engaged to value the Company's
goodwill as of June 30, 2002. The appraiser valued the businesses using a
weighted average of each unit's projected discounted cash flow, with a weighted
average cost of capital of 18.50%, and a fair market approach (using market
comparables for ten companies). The appraiser weighted the discounted cash flow
for each unit at 70% and the fair market approach at 30%. The discounted cash
flow was based on management's revised projections of operating results at June
30, 2002. Based on this valuation, an impairment charge of $18,762 of goodwill
was indicated and recorded for the second quarter of 2002.
In May 2003, Ladenburg relocated approximately 95 of its employees from
its New York City office to its Melville, New York office. As a result,
Ladenburg ceased using one of the several floors it occupies in its New York
City office. In accordance with SFAS No. 146, we have evaluated our liability
with respect to this space, taking into account estimated future lease payments
that could be reasonably obtained for the property. In this evaluation, we
concluded that the net book value of the leasehold improvements should be
written-off. Accordingly, the unamortized deferred rent credit representing
reimbursement from the landlord of such leasehold improvements was also
written-off. During the second quarter of 2003, the write-off of leasehold
improvements, net of accumulated amortization ($1,592) and the write-off of the
unamortized deferred rent credit ($813) resulted in a net charge to operations
of $779.
Income tax expense for 2003 was $70 compared to $1,400 in 2002. After
consideration of all the evidence, both positive and negative, especially the
fact we have sustained operating losses during 2002 and 2003 and that we
continue to be affected by conditions in the economy, management determined that
a valuation allowance at December 31, 2003 was necessary to fully offset the
deferred tax assets based on the likelihood of future realization. The income
tax rate for the 2003 and 2002 periods does not bear a customary relationship to
effective tax rates as a result of unrecognized net operating losses, the change
in valuation allowances, state and local income taxes and permanent differences.
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
Our revenues for 2002 decreased $14,380 from 2001 primarily as a result
of decreases in net principal transactions of $20,071 offset by an increase in
commissions of $10,040. Our revenues were adversely affected by the overall
declines in the U.S. equity markets and the continuing weak operating
environment for the broker-dealer industry. For comparative purposes, the 2002
period includes revenues generated by the Ladenburg Capital operations for the
full year while the 2001 period includes revenues generated by the Ladenburg
Capital operations from May 7, 2001 to December 31, 2001.
Our expenses for 2002, exclusive of the $18,762 goodwill impairment
charge, increased $61. The overall net increase includes an increase in rent and
occupancy of $3,050, an increase in professional services of $1,899 and a net
increase in various other expenses of $2,326, net of decreased employee
compensation of $5,865 and decreased brokerage, communication and clearance fees
of $1,349. For comparative purposes, the 2002 period includes expenses incurred
by the Ladenburg Capital operations for the full year while the 2001 period
includes expenses incurred by the Ladenburg Capital operations from May 7, 2001
to December 31, 2001.
27
Our revenues for 2002 consisted of commissions of $49,796, net
principal transactions of $10,591, investment banking fees of $9,141, syndicate
and underwriting income of $258, interest and dividends of $2,381, investment
advisory fees of $2,736 and other income of $4,670. Our revenues for 2001
consisted of commissions of $39,756, net principal transactions of $30,662,
investment banking fees of $11,698, syndicate and underwriting income of $652,
interest and dividends of $4,100, investment advisory fees of $2,696 and other
income of $4,389. Our expenses for 2002 consisted of employee compensation and
benefits of $56,876, impairment of goodwill of $18,762 and other expenses of
$49,387. Our expenses for 2001 consisted of employee compensation and benefits
of $62,741 and other expenses of $43,461.
The $10,040 (25.3%) increase in commissions was primarily the result of
the impact of the acquired Ladenburg Capital operations, which provided
additional commission income of $34,900 in 2002 versus $25,175 in the 2001
period.
The $2,557 (21.9%) decrease in investment banking fees was primarily
the result of decreased revenue from private placement and advisory assignments
due to the decrease in capital markets activity.
The $20,071 (65.5%) decrease in principal transactions was primarily
the result of decreases in trading income of $14,662 in the 2002 period and a
decrease in sales credits caused by the continued significant decline in the
market for equity securities.
The decrease in compensation expense of $5,865 (9.3%) was primarily due
to the net decrease in revenues.
As discussed above, in 2002, we recorded a $18,762 charge for the
impairment of goodwill, which was generated in the acquisition of the Ladenburg
Capital operations.
Income tax expense for 2002 was $1,400 compared to $44 in 2001. The
income tax rate for 2002 did not bear a customary relationship to effective tax
rates primarily as a result of an increase in the valuation allowance of
$12,844, state and local taxes and permanent differences. The income tax rate
for 2001 did not bear a customary relationship to effective tax rates primarily
as a result of the establishment of a valuation allowance of $4,565, state and
local taxes and permanent differences.
After consideration of all the evidence, both positive and negative,
especially the fact we have sustained operating losses during 2001 and for the
year ended December 31, 2002 and that we continue to be affected by conditions
in the economy, management has determined that a valuation allowance at December
31, 2002 was necessary to offset the deferred tax assets based on the likelihood
of future realization. Accordingly, during 2002, we increased our valuation
allowance to fully offset the deferred tax assets based on the likelihood of
future realization. In addition, the income tax rate for the 2002 and 2001
periods does not bear a customary relationship to effective tax rates as a
result of state and local income tax expense and limitations on the utilization
of net operating loss carrybacks.
LIQUIDITY AND CAPITAL RESOURCES
Approximately 58.7% of our assets at December 31, 2003 are highly
liquid, consisting primarily of cash and cash equivalents, trading securities
owned and receivables from clearing brokers, all of which fluctuate, depending
upon the levels of customer business and trading activity. Receivables from
broker-dealers, which are primarily from our primary clearing broker, turn over
rapidly. As a securities dealer, we may carry significant levels of securities
inventories to meet customer needs. A relatively small percentage of our total
assets are fixed. The total assets or the individual components of total assets
may vary significantly from period to period because of changes relating to
economic and market conditions, and proprietary trading strategies.
Ladenburg is subject to the net capital rules of the SEC. Therefore, it
is subject to certain restrictions on the use of capital and its related
liquidity. Ladenburg's regulatory net capital, as defined, of $6,745, exceeded
minimum capital requirements of $250 by $6,495 at December 31, 2003. Failure to
maintain the required net capital may subject Ladenburg to suspension or
expulsion by the NYSE, the SEC
28
and other regulatory bodies and ultimately may require its liquidation. The net
capital rule also prohibits the payment of dividends, redemption of stock and
prepayment or payment of principal of subordinated indebtedness if net capital,
after giving effect to the payment, redemption or prepayment, would be less than
specified percentages of the minimum net capital requirement. Compliance with
the net capital rule could limit the operations of Ladenburg that requires the
intensive use of capital, such as underwriting and trading activities, and also
could restrict our ability to withdraw capital from it, which in turn, could
limit our ability to pay dividends and repay and service our debt. In June 2003,
we closed our Ft. Lauderdale office, which constituted all of our market making
activities. As a result of our decision to eliminate our market making
activities, effective June 13, 2003, our minimum net capital requirement
decreased from $1,000 to $250.
Ladenburg, as guarantor of its customer accounts to its primary
clearing broker, is exposed to off-balance-sheet risks in the event that its
customers do not fulfill their obligations with the clearing broker. In
addition, to the extent Ladenburg maintains a short position in certain
securities, it is exposed to future off-balance-sheet market risk, since its
ultimate obligation may exceed the amount recognized in the financial
statements.
Net cash flows used in operating activities for the year ended December
31, 2003 were $6,254 as compared to $195 for the 2002 period. Cash used in
operating activities increased to $6,254 for the year ended December 31, 2003
compared with $195 in the prior year. The increase was primarily due to an
increase in receivables from clearing brokers, of $9,867 in 2003 compared to a
decrease of $16,542 in 2002, decreases of net operating assets of limited
partnership of $1,406 in 2003 versus increases of net operating assets of
limited partnership of $3,183 in 2002 and a decrease in income taxes receivable
of $2,224 in 2003 versus an increase of $1,725 in 2002. These changes were
offset by a $40,903 decrease in net loss and decreases of net trading securities
owned of $6,204 in 2003 versus $1,773 in 2002. Non-cash charges in 2002
associated with the impairment of goodwill ($18,762), write-off of deferred tax
assets ($3,339) and write-off of furniture, fixtures and leasehold improvements
of $1,394 contributed significantly to the decrease in net loss of $46,393 in
2002 and $5,490 in 2003.
Net cash flows used in investing activities for the year ended December
31, 2003 were $434 compared to net cash flows provided by investing activities
of $1,521 for the 2002 period. The difference is due to a decrease in purchases
of furniture, equipment and leasehold improvements during the 2003 period.
There was $1,416 of cash flows used in financing activities for the
year ended December 31, 2003, primarily representing $1,796 of distributions to
limited partners of the Ladenburg Focus Fund. There was $5,332 of cash flows
provided by financing activities for the year ended December 31, 2002 period,
representing the issuance by us of $5,000 of promissory notes payable offset by
the repayment of $2,000 of outstanding promissory notes payable and a decrease
in the amount of collateral required under our letter of credit agreement with
one of our landlords in the 2002 period.
We are obligated under several noncancellable lease agreements for
office space, which provide for minimum lease payments, net of lease abatement
and exclusive of escalation charges, of $4,526 in 2004 and approximately $5,126
per year until 2015. Such amounts exclude the lease referred to in the following
paragraph. In addition, one of the leases obligates the Company to occupy
additional space at the landlord's option, which may result in aggregate
additional lease payments of up to $976 through June 2015.
Ladenburg Capital may have potential liability under a terminated lease
for office space in New York City which it was forced to vacate during 2001 due
to the events of September 11, 2001. Ladenburg Capital no longer occupies the
space and believes it has no further lease obligation pursuant to the terms of
the lease. This lease, which, had it not terminated as a result of the events of
September 11, 2001, would have expired by its terms in March 2010, provides for
future minimum payments aggregating approximately $4,335 payable $644 in 2004,
$703 per year from 2005 through 2008 and $879 thereafter. Ladenburg Capital is
currently in litigation with the landlord in which it is seeking judicial
determination of the termination of the lease. If Ladenburg Capital is not
successful in this litigation, it plans to sublease the property. Ladenburg
Capital has provided for estimated costs in connection with this lease and has
recorded a liability at December 31, 2003 and 2002. Additional costs may be
incurred in connection with terminating this lease, or if not terminated, to the
extent of foregone rental income in the event Ladenburg Capital does not
sublease the office space for an amount at least equal to the lease obligations.
Such costs may have a material adverse effect on Ladenburg Capital's financial
position and liquidity.
29
Ladenburg ceased using one of the several floors it occupies in its New
York City office and is currently seeking to sublet the property. In accordance
with SFAS No. 146, Ladenburg's management evaluates Ladenburg's liability with
respect to this space on a quarterly basis, taking into account estimated future
sublease payments that could be reasonably obtained for the property. In these
evaluations, Ladenburg's management concluded that no liability for this lease
was required to be recorded as of December 31, 2003. Additional costs may be
incurred, to the extent of foregone rental income in the event Ladenburg does
not sublease the office space for an amount at least equal to the lease
obligations. Such costs may have a material adverse effect on Ladenburg's
financial position and liquidity.
In conjunction with the May 2001 acquisition of Ladenburg, we issued a
total of $20,000 principal amount of senior convertible promissory notes due
December 31, 2005 to New Valley Corporation, Berliner Effektengesellschaft AG
and Frost-Nevada, Limited Partnership (which was subsequently assigned to
Frost-Nevada Investments Trust). The $10,000 principal amount of notes issued to
New Valley and Berliner, the former stockholders of Ladenburg, bear interest at
7.5% per annum, and the $10,000 principal amount of the note issued to
Frost-Nevada bears interest at 8.5% per annum. The notes are currently
convertible into a total of 11,296,746 shares of our common stock and are
secured by a pledge of the stock of Ladenburg.
On August 31, 2001, we borrowed $1,000 from each of New Valley and
Frost-Nevada in order to supplement the liquidity of our broker-dealer
operations. The loans, which bore interest at 1% above the prime rate, were
repaid in January 2002. On March 27, 2002, we borrowed $2,500 from New Valley.
The loan, which bears interest at 1% above the prime rate, was due on the
earlier of December 31, 2003 or the completion of one or more equity financings
where we receive at least $5,000 in total proceeds. The terms of the loan
restrict us from incurring or assuming any indebtedness that is not subordinated
to the loan so long as the loan is outstanding. On July 16, 2002, we borrowed an
additional $2,500 from New Valley (collectively, with the March 2002 Loan, the
"2002 Loans") on the same terms as the March 2002 loan. In November 2002, New
Valley agreed in connection with the Clearing Loans, to extend the maturity of
the 2002 Loans to December 31, 2006 and to subordinate the 2002 Loans to the
repayment of the Clearing Loans.
On June 28, 2002, New Valley, Berliner and Frost-Nevada agreed with us
to forbear until May 15, 2003 payment of the interest due to them under the
senior convertible promissory notes held by these entities on the interest
payment dates of the notes commencing June 30, 2002 through March 2003 (the
"Forbearance Interest Payments"). On March 3, 2003, the holders of the senior
convertible promissory notes agreed to extend the interest forbearance period to
January 15, 2005 with respect to interest payments due through December 31,
2004. Interest on the deferred amounts accrues at 8% on the New Valley and
Berliner notes and 9% on the Frost-Nevada Investments Trust note. We also agreed
to apply any net proceeds from any subsequent public offerings to any such
deferred amounts owed to the holders of the notes to the extent possible. As of
December 31, 2003, accrued interest payments as to which a forbearance was
received amounted to $3,414. As discussed above, in March 2004, the holders of
our senior convertible promissory notes agreed to convert such notes into
approximately 26,000,000 shares of common stock at reduced conversion prices
ranging from $0.70 to $1.10 per share, subject to shareholder approval.
Concurrently with this agreement, we entered into an agreement with Berliner,
the holder of the remaining $1,990 aggregate principal amount of senior
convertible promissory notes, pursuant to which we will repurchase the notes
held by Berliner, plus all accrued interest thereon, for $1,000 in cash. We
currently anticipate recording a pre-tax charge in 2004 of approximately $10,900
in our statements of operations upon closing of these transactions. The charge
reflects expense attributable to the reduction in the conversion price of the
notes to be converted, offset partially by the gain on the repurchase of the
Berliner notes. The net balance sheet effect of the transactions will be an
increase in our shareholders' equity of approximately $22,900. Notwithstanding
the foregoing, we cannot assure you that our operations will generate funds
sufficient to repay our other existing debt obligations as they come due. Our
failure to repay our indebtedness and make interest payments as required by our
debt obligations could have a material adverse affect on our operations.
30
On October 8, 2002, we borrowed an additional $2,000 from New Valley.
The loan, which bore interest at 1% above the prime rate, matured on the
earliest of December 31, 2002, the next business day after we received our
federal income tax refund for the fiscal year ended September 30, 2002, and the
next business day after we received the Clearing Loans in connection with the
Clearing Conversion. This loan was repaid in December 2002 upon receipt of the
Clearing Loans.
Ladenburg also has $2,500 outstanding under a junior subordinated
revolving credit agreement with an affiliate of its primary clearing broker that
matures on October 31, 2004, under which borrowings incur interest at LIBOR plus
2%.
In November 2002, we consummated the Clearing Conversion whereby we now
clear substantially all of our business through one clearing agent, our primary
clearing broker. As part of the new agreement with this clearing agent, we are
realizing significant cost savings from reduced ticket charges and other
incentives. In addition, under the new clearing agreement, an affiliate of the
clearing broker loaned us the $3,500 of Clearing Loans. The Clearing Loans are
forgivable over various periods, up to four years from the date of the Clearing
Conversion. As scheduled, $1,500 of principal on the Clearing Loans was forgiven
in November 2003. The remaining principal balance of the Clearing Loans is
scheduled to be forgiven as follows: $667 in November 2004, $667 in November
2005 and $666 in November 2006. Upon the forgiveness of the Clearing Loans, the
forgiven amount is accounted for as other revenues. However, if the clearing
agreement is terminated for any reason prior to the loan maturity date, the
loan, less any amount that has been forgiven through the date of the
termination, plus interest, must be repaid on demand.
In December 2003, Ladenburg Capital settled its litigation with the
landlord and terminated its obligation under a lease expiring in 2007 relating
to office space in Bethpage, New York, which it vacated in 2002. As a result of
its settlement with the Bethpage landlord, Ladenburg Capital adjusted its
liability and recorded a corresponding reduction in rent expense of $1,175 in
the fourth quarter of 2003. This reduction in rent expense, less rent accrued in
previous quarters during 2003, amounted to a net credit of $200 for the fiscal
year ended December 31, 2003.
In the normal course of business, our operating subsidiaries have been
and continue to be the subject of numerous civil actions and arbitrations
arising out of customer complaints relating to our activities as a
broker-dealer, as an employer and