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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended Commission File No: 001-12629
September 30, 2004
OLYMPIC CASCADE FINANCIAL CORPORATION
(Exact Name of Registrant as specified in its charter)
DELAWARE 36-4128138
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
875 NORTH MICHIGAN AVENUE, SUITE 1560, CHICAGO, IL 60611
(Address, including zip code, of principal executive offices)
Registrant's telephone number, including area code: (312) 751-8833
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common - Stock $.02
par value
(Title of class)
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
of Regulation S-K of this chapter is not contained herein, and will not be
contained, to the best of Registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. | |
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). YES | | NO |X|
As of December 17, 2004, the aggregate market value of voting and non-voting
common equity held by non-affiliates of the registrant, based on the closing
sales price for the registrant's common stock, as quoted on the Over-the-Counter
Bulletin Board was approximately $4,150,000 (calculated by excluding shares
owned beneficially by directors and officers). As of December 17, 2004 there
were 4,995,878 shares of the registrant's common stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Company's Proxy Statement filed with the Securities and Exchange
Commission (the "SEC") in connection with the Company's Annual Meeting of
Shareholders to be held on or about March 22, 2005 (the "Company's 2005 Proxy
Statement") are incorporated by reference into Part III hereof.
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PART I
ITEM 1. BUSINESS
Statements made in this report that relate to future plans, events, financial
results or performance are forward-looking statements as defined under the
Private Securities Litigation Reform Act of 1995. These statements are based
upon current information and expectations. Actual results may differ materially
from those anticipated as a result of certain risks and uncertainties. For
details concerning these and other risks and uncertainties, see Part I, Item 1,
"Risk Factors" of this report, as well as the Company's other reports on Forms
10-K, 10-Q and 8-K subsequently filed with the SEC from time to time. Readers
are cautioned not to place undue reliance on these forward-looking statements,
which speak only as of the date hereof. The Company undertakes no obligation to
republish revised forward-looking statements to reflect events or circumstances
after the date hereof or to reflect the occurrence of unanticipated events.
GENERAL
Olympic Cascade Financial Corporation, a Delaware corporation organized in 1996
("Olympic" or the "Company"), is a financial services organization operating
through its wholly owned subsidiary, National Securities Corporation, a
Washington corporation organized in 1947 ("National"). National conducts a
national securities brokerage business through its main offices in Seattle,
Washington and New York, New York, as well as 45 other branch offices located
throughout the country, and one office outside the country. National's business
includes securities brokerage for individual and institutional clients,
market-making trading activities, asset management and corporate finance
services.
National provides a broad range of securities brokerage and investment services
to a diverse retail and institutional clientele, as well as corporate finance
and investment banking services to corporations and businesses. National's
brokers operate as independent contractors. A registered representative who
becomes an affiliate of National establishes his own office and is responsible
for the payment of expenses associated with the operation of such office,
including rent, utilities, furniture, equipment, stock quotation machines and
general office supplies. In return, the registered representative is entitled to
retain a higher percentage of the commissions generated by his sales than a
registered representative at a traditional employee-based brokerage firm. This
arrangement allows National to operate with a reduced amount of fixed costs and
lowers the risk of operational losses for non-production.
RECENT TRANSACTIONS
RECAPITALIZATION TRANSACTIONS
In fiscal year 2002, the Company completed a series of transactions under which
certain new investors (collectively, the "Investors") obtained a significant
ownership in the Company through a $1,572,500 investment in the Company and by
purchasing a majority of shares held by Steven A. Rothstein and family, the
former Chairman, Chief Executive Officer and principal shareholder of the
Company (the "Investment Transaction"). The Investors included Triage Partners
LLC ("Triage"), an affiliate of Steven B. Sands, the current Chairman of the
Company, and One Clark LLC ("One Clark"), an affiliate of Mark Goldwasser, the
current Chief Executive Officer and President of the Company. Triage purchased
an aggregate of 7,863 shares of the Company's Series A Convertible Preferred
Stock, $.01 par value per share (the "Series A Preferred Stock") from the
Company and One Clark purchased an aggregate of 7,862 shares of the Company's
Series A Preferred Stock from the Company, which is convertible into shares of
the Company's common stock, $.02 par value per share (the "Common Stock") at a
price of $1.50 per share. The Company incurred $100,000 of legal costs related
to these capital transactions. In connection with the Investment Transaction,
Triage also purchased 285,000 shares of Common Stock from Mr. Rothstein and his
affiliates at a price of $1.50 per share. In addition, Mr. Rothstein and his
affiliates granted Triage a three-year voting proxy on the balance of their
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Common Stock (274,660 shares) expiring on December 28, 2004. In March 2004 the
Company's Board of Directors declared an in-kind dividend of Series A Preferred
Stock, resulting in the issuance to both Triage and One Clark of an additional
954 shares. As of September 30, 2004, Triage and One Clark own 8,817 and 8,816
shares, respectively, of the Company's Series A Preferred Stock.
Concurrent with the Investment Transaction, two unrelated individual noteholders
holding $2.0 million of the Company's debt converted one-half of their debt into
the same class of Series A Preferred Stock that was sold in the Investment
Transaction. The noteholders also had 100,000 of their 200,000 warrants to
acquire shares of Common Stock repriced from an exercise price of $5.00 per
share to $1.75 per share. In January 2004, the two noteholders extended the
maturity dates on the remaining $1.0 million of notes from January 25, 2004 to
July 31, 2005. Also, effective February 1, 2004, the interest rate on each note
was increased to 12% from 9% per annum. Additionally, each of the noteholders'
warrants to purchase, in the aggregate, 100,000 shares of Common Stock at a
price of $5.00 per share expiring on February 1, 2004 was repriced to $1.25 per
share, and the expiration date of such warrants was extended to July 31, 2005.
The expiration date for the noteholders' warrants to purchase, in the aggregate,
an additional 100,000 shares of Common Stock at a price of $1.75 per share was
also extended from January 25, 2004 to July 31, 2005.
In February 2001, National executed a $1.0 million secured demand note
collateral agreement with Peter Rettman, an employee of National and a director
of the Company, to borrow securities that can be used by the Company for
collateral agreements. The note bears interest at 5% per annum that is paid
monthly, and initially matured on February 1, 2004. The note holder also
received a warrant to purchase 75,000 shares of Common Stock at a price of $5.00
per share that initially expired on February 1, 2004. In February 2004, the term
of the $1.0 million secured demand note was extended to March 1, 2005, and the
warrant to purchase 75,000 shares of Common Stock at a price of $5.00 per share,
that was to expire on February 1, 2004, was repriced to $1.25 per share, and the
expiration date of such warrant was extended to July 31, 2005. The expiration
date for the noteholder's warrant to purchase an additional 75,000 shares of
Common Stock at a price of $1.75 per share was also extended from January 25,
2004 to July 31, 2005.
PRELIMINARY LETTER OF INTENT WITH FIRST MONTAUK FINANCIAL CORP.
In October 2004, the Company entered into a preliminary letter of intent to
consummate a merger or other similar combination with First Montauk Financial
Corp., a publicly traded company whose wholly owned subsidiary is also a
registered broker-dealer with a similar business to National. The letter of
intent is subject to numerous conditions, including: satisfactory completion of
due diligence, finalization of the terms of the combination and structure of the
transaction, negotiation, preparation and execution of definitive transaction
documents, compliance with state and federal securities laws and regulations,
and corporate, shareholder and regulatory approvals. No assurance can be given
that the Company will enter into a definitive agreement with First Montauk
Financial Corp.
SECURITIES TRANSACTIONS
In the fourth quarter of fiscal year 2002, the Company raised an aggregate of
$210,000 pursuant to the sale of Series A Preferred Stock (on the same terms and
conditions as the equity sold to the Investors) to the individual retirement
account of Mr. Rothstein.
In the first quarter of fiscal year 2003, the Company consummated a private
placement of its securities (the "Private Offering") to a limited number of
accredited investors pursuant to Rule 501 of Regulation D under the 1933
Securities Act, as amended (the "Securities Act"). Each unit in the Private
Offering sold for $0.65 and consisted of one share of Common Stock and one
three-year warrant to purchase one share of Common Stock at a per share price of
$1.25. Net proceeds of $554,500 closed in the first quarter of fiscal year 2003,
and the Company correspondingly issued 1,016,186 shares of Common Stock and
1,016,186 warrants. National acted as the placement agent on a best efforts
basis for the private offering. In consideration of the services rendered by
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National, at each closing, National was (i) paid a cash fee equal to ten percent
(10%) of the gross proceeds received by us at each closing, and (ii) issued
warrants to purchase 10% of the number of shares of Common Stock included in the
units exercisable at $0.65 per share and warrants to purchase 10% of the number
of shares of Common Stock issuable upon exercise of warrants included in the
units at an exercise price of $1.25 per share. The offering period for the
private offering expired on February 17, 2003.
In January 2003, the Company issued 76,923 shares of Common Stock and a
three-year warrant to purchase 76,923 shares of Common Stock at $1.25 per share
to D'Ancona & Pflaum LLC, as payment of approximately $51,000 of legal fees that
were accrued as of September 30, 2002. The warrants issued in connection with
the Private Offering and the warrants issued to D'Ancona & Pflaum have been
included along with the proceeds of the shares of Common Stock issued as
additional paid-in capital.
In January 2004, the Company consummated a private offering of its securities to
a limited number of accredited investors pursuant to Rule 506 of Regulation D
under the Securities Act wherein the Company issued an aggregate of $200,000 of
three-year, 10% senior subordinated promissory notes to five unaffiliated
parties. The noteholders received three-year warrants to purchase an aggregate
of 50,000 shares of Common Stock at an exercise price of $1.40 per share, with
an allocated fair value of approximately $40,000. In December 2004, the Company
rescinded a note in the principal amount of $25,000 and a warrant to purchase
6,250 shares of Common Stock.
In February 2004, the Company consummated a private offering of its securities
to a limited number of accredited investors pursuant to Rule 506 of Regulation D
under the Securities Act wherein the Company issued an aggregate of $850,000 of
three-year, 10% senior subordinated promissory notes to four unaffiliated
parties. The noteholders received three-year warrants to purchase an aggregate
of 170,000 shares of Common Stock at an exercise price of $1.50 per share, with
an allocated fair value of approximately $143,000. National acted as the
placement agent for the private offering. The offering period for the private
offering expired on May 30, 2004.
The Company is accreting the total allocated fair value of the warrants of
$183,000 over the three-year term of these promissory notes. Such accretion has
been included in "Interest" in the accompanying consolidated financial
statements. The holders of the warrants received certain registration rights
relating to the Common Stock issuable upon exercise of the warrants.
In July 2004, the Company filed a Registration Statement on Form S-3 under the
Securities Act for the resale of certain shares of Common Stock and shares of
Common Stock issuable upon the exercise of certain warrants previously issued in
connection with private placement transactions, and certain warrants that were
issued in the private placements that have been completed in the current fiscal
year. The Registration Statement became effective on August 11, 2004.
In the fourth quarter of fiscal year 2004, the Company consummated a private
placement of its securities to a limited number of accredited investors pursuant
to Rule 501 of Regulation D under the Securities Act. Each unit in the offering
sold for $1.60 and consisted of two shares of Common Stock and one three-year
warrant to purchase one share of Common Stock at a per share price of $1.50. Net
proceeds of approximately $930,000 closed in the fourth quarter of fiscal year
2004, and the Company correspondingly issued 1,250,000 shares of Common Stock
and 625,000 warrants.
CLEARING RELATIONSHIPS
In August 2001, the Company entered into an agreement with First Clearing
Corporation ("First Clearing"), a wholly owned subsidiary of Wachovia
Corporation, under which First Clearing provided clearing and related services
for National (the "Clearing Agreement"). The Clearing Agreement expanded the
products and services capabilities for National's retail and institutional
business, and enabled National to consolidate its existing clearing operations
and reduced the fixed overhead associated with its self-clearing activities.
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The conversion from a self-clearing firm to First Clearing began in December
2001 and was completed in March 2002. In connection with the Clearing Agreement,
the Company executed a ten-year promissory note in favor of First Clearing under
which the Company immediately borrowed $1,000,000. The funds were contributed by
the Company to National, and were used as a deposit to secure National's
performance under the Clearing Agreement. The Clearing Agreement also provided
for another $1,000,000 loan that was extended to the Company upon substantial
completion of the conversion on December 31, 2001, which funds were also
contributed by the Company to National. Principal and interest under the
promissory note were forgivable based on achieving certain business performance
and trading volumes of the Company over the life of the loan.
In connection with the Clearing Agreement, additional borrowings were available
to the Company upon the attainment by National of certain volume and
profitability goals. In finalizing the conversion, a dispute arose among the
Company, US Clearing (one of its former clearing firms) and First Clearing,
regarding the responsibility for debit balances in certain trading accounts. The
three parties agreed to share the debit balance write-offs equally. The
Company's share of this settlement, $548,000, was advanced to the Company by
First Clearing and added to the existing promissory note. Additionally, National
received its clearing deposit, net of miscellaneous expenses, of $975,000 from
US Clearing, and concurrently terminated its clearing agreement with US
Clearing.
In the first quarter of fiscal year 2003, First Clearing loaned the Company an
additional $375,000 in the form of clearing fee rebates. The loan was due to be
repaid in January 2004.
In December 2003, the Company engaged in various discussions with the National
Association of Securities Dealers, Inc. (the "NASD") relating to the Security
Agreement between National and First Clearing, and its effect on the computation
of National's net capital. As a result of these discussions, on December 15,
2003, the Company and First Clearing agreed in principle to the following: (1)
National's clearing deposit was reduced from $1,000,000 to $500,000; (2) the
excess $500,000 was paid to First Clearing to reduce the Company's outstanding
loan balance on its promissory note; and (3) the Security Agreement between
National and First Clearing was terminated. Furthermore, First Clearing forgave
payment of the $375,000 loan that was due to be paid in January 2004, resulting
in a $375,000 gains on extinguishments of debt in the first quarter of fiscal
year 2004.
In February 2004, the Company paid First Clearing $250,000 to fully repay its
promissory note that had a balance of approximately $1,006,000 at such time. As
a result of the repayment of this note, the Company realized gains on
extinguishments of debt of approximately $756,000 in the second quarter of
fiscal year 2004. Additionally, National and First Clearing mutually agreed to
terminate their clearing relationship.
On June 22, 2004, National entered into an agreement with Fiserv Securities,
Inc. ("Fiserv") to clear its brokerage business. The conversion from First
Clearing to Fiserv was completed in the first week of October 2004. As part of
this transaction, Fiserv provided National with an $800,000 conversion
assistance payment, $250,000 of which was paid upon execution of the clearing
agreement, $250,000 of which was paid in mid-August 2004, and $300,000 of which
was paid in October 2004. The Company believes that the overall effect of the
new clearing relationship will be beneficial to the Company's cost structure,
liquidity and capital resources.
FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
The Company realized approximately 88% of its total revenues in fiscal year 2004
from brokerage services, principal and agency transactions, and investment
banking. During fiscal year 2004, brokerage services, that consist of retail
brokerage commissions, represent 74% of total revenues, principal and agency
transactions, that consist of net dealer inventory gains, represent 12% of total
revenues, and investment banking, that consist of corporate finance commissions
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and fees, represent 2% of total revenues. For a more detailed analysis of our
results by segment, see Item 7, "Management Discussion and Analysis of Financial
Condition and Results of Operation."
BROKERAGE SERVICES
Brokerage services to retail clients are provided through the Company's sales
force of investment executives at National.
NATIONAL SECURITIES CORPORATION
National is registered as a broker-dealer with the SEC and is licensed in 50
states, the District of Columbia and Puerto Rico. National is also a member of
the NASD, the Municipal Securities Rulemaking Board ("MSRB") and the Securities
Investor Protection Corporation ("SIPC").
National's goal is to meet the needs of its investment executives and their
clients. To foster individual service, flexibility and efficiency, and to reduce
fixed costs, investment executives at National act as independent contractors
responsible for providing their own office facilities, sales assistants,
telephone and quote service, supplies and other items of overhead. Investment
executives are given broad discretion to structure their own practices and to
specialize in different areas of the securities market subject to supervisory
procedures. In addition, investment executives have direct access to research
materials, management, traders, and all levels of support personnel.
The brokerage services provided by the investment executives at National include
execution of purchases and sales of stocks, bonds, mutual funds, annuities and
various other securities for individual and institutional customers. In fiscal
year 2004, stocks represent approximately 81% of the Company's business, bonds
represent approximately 11% of the Company's business, and mutual funds and
annuities make up the remaining 8% of the Company's business. The percentage of
each type of business varies over time as the investment preferences of the
Company's customers change based on market conditions.
Typically, National does not recommend particular securities to customers.
Recommendations to customers are determined by individual investment executives
based upon their own research and analysis, subject to applicable NASD customer
suitability standards. Most investment executives perform fundamental (as
opposed to technical) analysis. Solicitations may be by telephone, seminars or
newsletters. Investment executives may request trading to acquire an inventory
position to facilitate sales to customers (subject to the investment executive's
own risk). Supervisory personnel review trading activity from inventory
positions to ensure compliance with applicable standards of conduct.
Investment executives in the brokerage industry are traditionally compensated on
the basis of set percentages of total commissions and mark-ups generated. Most
brokerage firms bear substantially all of the costs of maintaining their sales
forces, including providing office space, sales assistants, telephone service
and supplies. The average commission paid to investment executives in the
brokerage industry generally ranges from 30% to 50% of total commissions
generated.
Since National requires most of its investment executives to absorb their own
overhead and expenses, it pays a higher percentage of the net commissions and
mark-ups generated by its investment executives, as compared to traditional
investment executives in the brokerage industry. This arrangement also reduces
fixed costs and lowers the risk of operational losses for non-production.
National's operations include execution of orders, processing of transactions,
internal financial controls and compliance with regulatory and legal
requirements.
As a result of the slowdown in the financial markets and the Company's change
from a self-clearing brokerage firm to an introducing brokerage firm, the
Company has scaled back its employee staff. As of September 30, 2004, the
Company had 83 employees and 307 independent contractors. Of these totals, 324
were registered representatives. Persons who have entered into independent
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contractor agreements are not considered employees for purposes of determining
the Company's obligations for federal and state withholding, unemployment and
social security taxes. The Company's independent contractor arrangements conform
with accepted industry practice, and therefore, the Company does not believe
there is a material risk of an adverse determination from the tax authorities
that would have a significant effect on the Company's ability to recruit and
retain investment executives, or on the Company's current operations and
financial results of operations. No employees are covered by collective
bargaining agreements, and the Company believes its relations are good with both
its employees and independent contractors.
The Company's business plan includes the growth of its retail and institutional
brokerage business. The financial markets experienced a slowdown in fiscal years
2000 and 2001 that continued through the first half of fiscal year 2003. The
markets improved in the second half of fiscal year 2003 and the first half of
fiscal year 2004, but weakened again in the second half of fiscal year 2004. In
response to theses slowdowns, the Company scaled back certain business
activities, including: proprietary trading, market-making trading, and online
investing services. The Company believes that consolidation within the industry
is inevitable. Concerns attributable to the weakened market and increased
competition help explain the increasing number of acquisition opportunities
continuously introduced to the Company. The Company is focused on maximizing the
profitability of its existing operations, while it continues to seek selective
strategic acquisitions.
In August 2001, the Company entered into an agreement with First Clearing, under
which First Clearing provided clearing and related services for National. In
December 2001, the Company commenced clearing with First Clearing. The Clearing
Agreement significantly expanded the products and services capabilities for
National's retail and institutional business by providing National's registered
representatives with access to information from First Clearing, including
various daily market analysis reports, equity research reports, software to
analyze customer portfolios, as well as asset management products and various
other equity, debt and mutual fund offerings. Additionally, the Clearing
Agreement enabled National to consolidate its existing clearing operations and
reduced fixed overhead associated with its self-clearing activities.
On June 22, 2004, National entered into an agreement with Fiserv to clear its
brokerage business. The conversion from First Clearing to Fiserv was
substantially completed in the first week of October 2004.
Periodic reviews of controls are conducted, and administrative and operations
personnel meet frequently with management to review operating conditions.
Compliance and operations personnel monitor compliance with applicable laws,
rules and regulations.
WESTAMERICA INVESTMENT GROUP
In December 2001, the Company's former subsidiary, WestAmerica Investment Group,
("WestAmerica"), voluntarily withdrew its membership with the NASD and ceased
conducting business as a broker-dealer, and filed for Chapter 7 Bankruptcy
protection in accordance with the U.S. Bankruptcy Code. Until December 2001,
WestAmerica was registered as a broker-dealer with the SEC and licensed in 44
states, Puerto Rico and the District of Columbia. WestAmerica was also a member
of the NASD, the MSRB and the SIPC. WestAmerica offered traditional securities
brokerage and financial planning business and fee-based investment management
business to its retail clients. WestAmerica had been operating as a separate
legal entity, and the Company believes it will not have any ongoing liability
for any unpaid obligations of WestAmerica.
CANTERBURY SECURITIES CORPORATION
The Company's former subsidiary, Canterbury Securities Corporation
("Canterbury") was registered as a broker-dealer with the SEC and was licensed
in Illinois. Canterbury was acquired in June 2000 for cash of $30,000 and the
issuance of five-year warrants to acquire 5,000 shares of Common Stock at a
price of $6.375 per share. Canterbury was a member of the NASD, the MSRB and the
SIPC. Canterbury formerly engaged in private placement transactions. Canterbury
had no retail customer accounts and operated pursuant to the exemptive
provisions of SEC Rule 15c3-3(k)(2)(i). Since its acquisition, Canterbury had no
activity. In May 2002, pursuant to an agreement made simultaneous with the
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Investment Transaction, the Company sold Canterbury for its book value to Steven
A. Rothstein, the former Chairman, Chief Executive Officer and principal
shareholder of the Company.
PRINCIPAL AND AGENCY TRANSACTIONS
The Company buys and maintains inventories in equity securities as a
"market-maker" for sale of those securities to other dealers and to customers
through National. The Company may also maintain inventories in corporate,
government and municipal debt securities for sale to customers.
In October 2000, the Company opened a branch office of National in New York
City. This office specializes in broker-to-broker fixed income transactions and
equity market making activities. At National, a staff of four traders and five
assistants in its New York and Seattle offices manage an inventory of securities
and conduct market-making activities. In February 2001, National expanded its
New York market-making trade activities. By July 2001, National made markets in
approximately 2,000 securities comprised mainly of equities traded on the NASDAQ
and OTC Bulletin Board. As a result of the losses attributable to a slow-down in
the broader market, National subsequently has substantially reduced its
market-making trading activities. As of September 30, 2004, National did not
make markets in any securities, in preparation for the commencement of its
clearing relationship with Fiserv. National anticipates that it will engage in
some market-making trading activity in the future, which would include companies
for which National managed or co-managed a public offering.
The Company's trading departments require a commitment of capital. Most
principal transactions place the Company's capital at risk. Profits and losses
are dependent upon the skill of the traders, price movements, trading activity
and the size of inventories. Since the Company's trading activities occasionally
may involve speculative and thinly capitalized stocks, including stabilizing the
market for securities which it has underwritten, the Company imposes position
limits to reduce its potential for loss.
In executing customer orders to buy or sell a security in which the Company
makes a market, the Company may sell to, or purchase from, customers at a price
that is substantially equal to the current inter-dealer market price plus or
minus a mark-up or mark-down. The Company may also act as agent and execute a
customer's purchase or sale order with another broker-dealer market-maker at the
best inter-dealer market price available and charge a commission. The Company
believes its mark-ups, mark-downs and commissions are competitive based on the
services it provides to its customers.
In executing customer orders to buy or sell listed and over-the-counter
securities in which it does not make a market, the Company generally acts as an
agent and charges commissions that the Company believes are competitive, based
on the services the Company provides to its customers.
INVESTMENT BANKING
National provides corporate finance and investment banking services, including
underwriting the sale of securities to the public and arranging for the private
placement of securities with investors. National's corporate finance operations
provide a broad range of financial and corporate advisory services, including
mergers and acquisitions, project financing, capital structure and specific
financing opportunities. National has also underwritten both equity securities
and convertible corporate bonds as initial or secondary public offerings.
COMPETITION
The Company is engaged in a highly competitive business. With respect to one or
more aspects of its business, its competitors include member organizations of
the NYSE and other registered securities exchanges in the United States and
Canada, and members of the NASD. Many of these organizations have substantially
greater personnel and financial resources and more sales offices than the
Company. Discount brokerage firms affiliated with commercial banks provide
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additional competition, as well as companies that provide electronic on-line
trading. In many instances, the Company is also competing directly for customer
funds with investment opportunities offered by real estate, insurance, banking,
and savings and loans industries. For a further discussion of risks facing the
Company, please see "Risk Factors."
GOVERNMENT REGULATION AND SUPERVISION
The securities industry and National's 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 that adopt rules, subject to approval by the SEC, which govern
their 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. National is a registered
broker-dealer with the SEC and a member of the NASD. It is licensed to conduct
activities as a broker-dealer in all 50 states.
In addition, as a registered broker-dealer and member of the NASD, National 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 that 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 Securities Exchange Act of 1934, as amended (the "Exchange Act"), and the
NASD Conduct Rules require the Company's subsidiary to supervise the activities
of its investment executives. As part of providing such supervision, National
maintains Written Supervisory Procedures and a Compliance Manual. Compliance
personnel and outside auditors conduct inspections of branch offices
periodically to review compliance with the Company's procedures. A registered
principal provides onsite supervision at each of the Company's larger offices.
The other offices (averaging two investment executives per office) are not
required by NASD rules to have a registered principal on site and are therefore
supervised by registered principals of National. Designated principals review
customer trades to ensure compliance with the NASD Conduct Rules including
mark-up guidelines.
In May 2002, without admitting or denying the alleged violations, National
accepted and consented to the entry of the following findings by NASD
Regulation: at various times in 2001, the firm violated SEC Rule 17-A-4, SEC
Rule 17-A-3, NASD Rule 3010, NASD Rule 3110, and NASD rule 6620(A). The firm was
censured and fined $7,500 in a settlement dated May 2, 2002.
In July 2002, without admitting or denying the alleged violations, National
accepted and consented to the entry of the following findings by NASD
Regulation: at various times in 2000 and 2001, the firm violated NASD Conduct
Rule 11870. The firm was censured and fined $1,000 in a settlement dated July
2002.
In September 2002, without admitting or denying the alleged violations, National
accepted and consented to the entry of the following findings by NASD
Regulation: at various times in 2001, the firm violated NASD Conduct Rules 2110,
Rule 6240(a)(3), and Rule S6240(b)(3). The firm was censured and fined $7,500 in
a settlement dated September 27, 2002.
In July 2003, without admitting or denying the alleged violations, National
accepted and consented to the entry of the following findings by NASD
Regulation: at various times in 2001, the firm violated SEC Rule 11Ac1-4. The
firm was censured and fined $7,500 in a settlement dated July 24, 2003.
-9-
In September 2003, without admitting or denying the alleged violations, National
accepted and consented to the entry of the following findings by the Florida
Office of Financial Regulation: at various times in 2001 and 2002, the firm
violated certain record keeping rules. The firm agreed to update its Written
Supervisory Procedures, and the firm was fined $15,000 in a final administrative
order dated September 5, 2003.
In January 2004, National entered into a consent order with the State of
Missouri for alleged failure to supervise one representative by allowing him to
maintain incomplete or blank securities related business forms signed by clients
or potential clients in violation of record keeping requirements under
409.4-411(c)(1) of the 2003 Act. The firm agreed to provide its Missouri
registered agents with notice to cease this activity immediately and destroy all
such forms; the firm was fined $13,000.
The NASD was engaged in an industry-wide investigation of mutual fund trading
activities. National is one of the numerous broker-dealers that was contacted by
the NASD with respect to this investigation. The NASD identified certain
customer mutual fund transactions ordered through National during the time
period from October 2000 to February 2003 that it believed constituted mutual
fund timing and/or excessive trading activity. National engaged in discussions
and negotiations with the NASD to informally resolve these matters. In August
2004, such resolution resulted in a settlement, whereby National, without
admitting or denying any violations, agreed to make both restitution and pay a
fine to the NASD, that in the aggregate approximate $600,000. Additionally, the
Company is obligated to pay the fines imposed by the NASD on two executive
officers totaling $50,000 pursuant to its indemnification obligations.
VENTURE CAPITAL
In March 2001, the Company had its initial closing of Robotic Ventures Fund I,
L.P. (the "Fund"), a venture capital fund dedicated to investing in companies
engaged in the business of robotics and artificial intelligence. The Fund raised
a total of $5.2 million, $265,000 of which was capital directly invested by the
Company into the Fund, representing a 5.1% limited partnership interest in the
Fund. The Company serves as the managing member of Robotic Ventures Group LLC,
the general partner of the Fund (the "Fund General Partner"). As the managing
member of the Fund General Partner, the Company is entitled to a 2% management
fee paid by the Fund. Additionally, the Company invested $1,000, and owns 24.5%
of the limited liability company membership interests in the Fund General
Partner, which is entitled to 20% of the profits generated by the Fund after
investors in the Fund receive the return of their invested capital, representing
a 4.9% indirect interest in the profits of the Fund. The Company keeps the books
and records of the Fund and oversees the Fund's investments. From time to time,
employees of National will work with and advise the Fund's investee companies on
its business plan, capital structure and future goals. The Company has not been
compensated or engaged to provide any management or advisory services to the
investee companies. In February 2002, due to a dramatic slowdown in the
technology venture markets, the Fund returned a majority of the uninvested
capital to the investors, representing approximately 50% of the funds raised,
and no further management fees are to be paid.
The carrying amount of the Company's investment in the Fund was $107,000 and
$107,000 at September 30, 2004 and September 30, 2003, respectively. The
Company's investment in the Fund is accounted for in accordance with the equity
method of accounting. The Company recognized a loss on this investment of $0 and
$29,000 during fiscal years 2004 and 2003, respectively. During the formation of
the Fund, the Company incurred various start-up expenses that were subsequently
reimbursed by the Fund.
-10-
RISK FACTORS
The financial statements contained in this report and the related discussion
describe and analyze the Company's financial performance and condition for the
periods indicated. For the most part, this information is historical. The
Company's prior results, however, are not necessarily indicative of the
Company's future performance or financial condition. The Company, therefore, has
included the following discussion of certain factors that could affect the
Company's future performance or financial condition. These factors could cause
the Company's future performance or financial condition to differ materially
from its prior performance or financial condition or from management's
expectations or estimates of the Company's future performance or financial
condition. These factors, among others, should be considered in assessing the
Company's future prospects and prior to making an investment decision with
respect to the Company's stock. The risks described below are not the only ones
facing us. Additional risks not presently known to us or that we currently
believe are immaterial may also impair our business operations.
OPERATING RESULTS HAVE RESULTED IN REPORTING LOSSES.
Although the Company was profitable in fiscal year 2004, it realized losses in
both the third and fourth quarters of fiscal year 2004, and it has reported
losses of approximately $843,000, $3.4 million and $7.9 million in fiscal years
2003, 2002 and 2001, respectively. There is no assurance that the Company will
be profitable in the future. The Company's losses were primarily attributable to
the market slowdowns and reduced trading activity and volatility. The Company
anticipates that with improved market conditions and increased revenues it may
again be profitable for the fiscal year; however, there can be no assurance that
current levels of revenue realized in fiscal year 2004 will continue and that
recent profitability will continue to be realized. If we are unable to achieve
or sustain profitability, we may need to curtail, suspend or terminate certain
operations.
THE COMPANY MAY REQUIRE ADDITIONAL FINANCING.
In order for the Company to have the opportunity for future success and
profitability, it periodically may need to obtain additional financing, either
through borrowings, public offerings, private offerings, or some type of
business combination (e.g., merger, buyout, etc.). The Company has actively
pursued a variety of funding sources, and has consummated certain transactions,
including the Investment Transaction and private offerings in order to address
the capital requirements of the Company. The Company may need to seek to raise
additional capital through other available sources, including borrowing
additional funds from third parties and there can be no assurance that it will
be successful in such pursuits. Additionally, the issuance of new securities to
raise capital will cause the dilution of shares held by current stockholders.
Accordingly, if we are unable to generate adequate cash from operations, and if
we are unable to find sources of funding, it would have an adverse impact on our
liquidity and operations.
IF THE COMPANY IS UNABLE TO PAY ITS OUTSTANDING DEBT OBLIGATIONS WHEN DUE, THE
COMPANY'S OPERATIONS MAY BE MATERIALLY ADVERSELY AFFECTED.
At September 30, 2004, we had an aggregate indebtedness of $2,855,000, of which
$2,000,000 matures in during fiscal year 2005. The Company cannot assure you
that our operations will generate funds sufficient to repay our existing debt
obligations as they come due. The Company's failure to repay its indebtedness
and make interest payments as required by our debt obligations, could have a
material adverse affect on the Company's operations.
THE COMPANY'S LETTER OF INTENT WITH FIRST MONTAUK FINANCIAL CORP. IS PRELIMINARY
AND THERE IS NO ASSURANCE THAT A TRANSACTION WILL BE CONSUMMATED.
-11-
On October 12, 2004, the Company announced that it had entered into a letter of
intent with First Montauk Financial Corp. for a merger or other combination of
the companies. First Montauk Financial Corp. is the parent company of First
Montauk Securities Corp., a registered securities broker/dealer headquartered in
Red Bank, New Jersey. The letter of intent is subject to numerous conditions,
including: satisfactory completion of due diligence, finalization of the terms
of the combination and structure of the transaction; negotiation, preparation
and execution of definitive transaction documents, compliance with state and
federal securities laws and regulations, and corporate, shareholder and
regulatory approvals. As a result of the foregoing uncertainties, no assurances
can be given that the transaction will be consummated.
EVEN IF A TRANSACTION WITH FIRST MONTAUK FINANCIAL CORP. IS CONSUMMATED, THE
COMPANY MAY NOT REALIZE THE FINANCIAL AND STRATEGIC GOALS THAT ARE CONTEMPLATED
BY SUCH TRANSACTION.
Even if a merger or other combination agreement between the Company and First
Montauk Financial Corp. is consummated, the financial and strategic goals that
are contemplated by such transaction may not be realized. In addition, such
transaction could be dilutive to earnings, and we could overpay for such
transaction. Additionally, we may not be successful in our efforts to integrate
the companies. Integration of the companies will divert management and other
resources from other important matters, and we could experience delays or
unusual expenses in the integration process. Further, we may become responsible
for liabilities associated with First Montauk Financial Corp.'s business to the
extent they are not covered by indemnification or by insurance.
BECAUSE THE COMMON STOCK MAY BE SUBJECT TO "PENNY STOCK" RULES, THE MARKET FOR
THE COMMON STOCK MAY BE LIMITED.
If the Common Stock becomes subject to the Securities and Exchange Commission's
(the "SEC") penny stock rules, broker-dealers may experience difficulty in
completing customer transactions and trading activity in the Company's
securities may be adversely affected. If at any time the Common Stock has a
market price per share of less than $5.00, and the Company does not have net
tangible assets of at least $2,000,000 or average revenue of at least $6,000,000
for the preceding three years, transactions in the Common Stock may be subject
to the "penny stock" rules promulgated under the Exchange Act. Under these
rules, broker-dealers who recommend such securities to persons other than
institutional accredited investors:
o must make a special written suitability determination for the
purchaser;
o receive the purchaser's written agreement to a transaction prior to
sale;
o provide the purchaser with risk disclosure documents which identify
certain risks associated with investing in "penny stocks" and which
describe the market for these "penny stocks" as well as a
purchaser's legal remedies; and
o obtain a signed and dated acknowledgment from the purchaser
demonstrating that the purchaser has actually received the required
risk disclosure document before a transaction in a "penny stock" can
be completed.
If the Common Stock becomes subject to these rules, broker-dealers may find it
difficult to effectuate customer transactions and trading activity in the
Company's securities may be adversely affected. As a result, the market price of
the Company's securities may be depressed, and stockholders may find it more
difficult to sell the Company's securities.
NATIONAL IS SUBJECT TO VARIOUS RISK ASSOCIATED WITH THE SECURITIES INDUSTRY.
As a securities broker-dealer, National 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;
-12-
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. 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.
FAILURE TO COMPLY WITH NET CAPITAL REQUIREMENTS COULD SUBJECT US TO SANCTIONS
IMPOSED BY THE SEC OR THE NASD.
National 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. National is required to maintain net capital
equal to the greater of $250,000 or a specified amount per security based on the
bid price of each security for which National is a market maker. The net capital
rule is designed to measure the general financial integrity and liquidity of a
broker-dealer. Compliance with the net capital rule limits those operations of
broker-dealers that 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. The NASD 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. National 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.
THE COMPANY'S BUSINESS COULD BE ADVERSELY AFFECTED BY A BREAKDOWN IN THE
FINANCIAL MARKETS.
As a securities broker-dealer, National's 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, the Company's revenues are likely to decline and the Company's
operations will be adversely affected.
MARKET FLUCTUATIONS MAY REDUCE THE COMPANY'S REVENUES AND PROFITABILITY.
The Company's revenue and profitability may be adversely affected by declines in
the volume of securities transactions and in market liquidity. Additionally, the
Company's profitability may be adversely affected by losses from the trading or
underwriting of securities or failure of third parties to meet commitments.
National acts as a market maker in publicly traded common stocks. In market
making transactions, the Company undertakes the risk of price changes or being
unable to resell the common stock it holds or being unable to purchase the
common stock it has sold. These risks are heightened by the illiquidity of many
of the common stocks the Company trades and/or makes a market. Any losses from
the Company trading activities, including as a result of unauthorized trading by
the Company's employees, could have a material adverse effect on the Company's
business, financial condition, results of operations or cash flows.
-13-
Lower securities price levels may also result in a reduced volume of
transactions, as well as losses from declines in the market value of common
stocks held for trading purposes. During periods of declining volume and
revenue, the Company's profitability would be adversely affected. Declines in
market values of common stocks and the failure of issuers and third parties to
perform their obligations can result in illiquid markets.
COMPETITION WITH OTHER FINANCIAL FIRMS MAY HAVE A NEGATIVE EFFECT ON THE
COMPANY'S BUSINESS.
The Company competes directly with national and regional full-service
broker-dealers and a broad range of other financial service firms, including
banks and insurance companies. Competition has increased as smaller securities
firms have either ceased doing business or have been acquired by or merged into
other firms. Mergers and acquisitions have increased competition from these
firms, many of which have significantly greater financial, technical, marketing
and other resources than the Company has. Many of these firms offer their
customers more products and research than currently offered by the Company.
These competitors may be able to respond more quickly to new or changing
opportunities, technologies and client requirements. The Company also faces
competition from companies offering discount and/or electronic brokerage
services, including brokerage services provided over the Internet, which the
Company is currently not offering and does not intend to offer in the
foreseeable future. These competitors may have lower costs or provide more
services, and may offer their customers more favorable commissions, fees or
other terms than those offered by the Company. To the extent that issuers and
purchasers of securities transact business without the assistance of the
Company, the Company's operating results could be adversely affected.
THE COMMON STOCK HAS BEEN DELISTED FROM THE AMERICAN STOCK EXCHANGE AND
ACCORDINGLY ITS LIQUIDITY AND PRICE MAY BE ADVERSELY AFFECTED.
The Common Stock was previously listed on The American Stock Exchange (the
"AMEX"). In February 2003, the Company received notification from the AMEX
indicating that it was not in compliance with the listing standard relating to
shareholders' equity of less than $2.0 million and losses from continuing
operations and/or net losses in two out of our three most recent fiscal years.
The Company submitted a plan to the AMEX indicating compliance within a maximum
of 18 months. In May 2003, the AMEX notified the Company that it had accepted
its plan of compliance and granted the Company an extension of time to August 5,
2004 to satisfy the financial standards requirement. The Company, however, was
unable to comply with the listing standard. Consequently, on November 1, 2004
the Common Stock was removed from the AMEX and commenced trading on the
Over-the-Counter Bulletin Board. Such alternative is generally considered to be
a less efficient market, and the Company's stock price, as well as the liquidity
of the Common Stock, may be adversely impacted as a result.
THE COMPANY IS CURRENTLY SUBJECT TO EXTENSIVE SECURITIES REGULATION AND THE
FAILURE TO COMPLY WITH THESE REGULATIONS COULD SUBJECT THE COMPANY TO PENALTIES
OR SANCTIONS.
The securities industry and the Company's business are subject to extensive
regulation by the SEC, state securities regulators and other governmental
regulatory authorities. The Company is also regulated by industry
self-regulatory organizations, including the NASD and the MSRB. National is a
registered broker-dealer with the SEC and member firms of the NASD.
Broker-dealers are subject to regulations which cover all aspects of the
securities business, including sales methods and supervision, trading practices
among broker-dealers, use and safekeeping of customers' funds and securities,
capital structure of securities firms, record keeping, and the conduct of
directors, officers and employees. The regulatory environment is also subject to
change.
Compliance with many of the regulations applicable to the Company involves a
number of risks, particularly in areas where applicable regulations may be
subject to varying interpretation. These regulations often serve to limit the
-14-
Company's activities, including through net capital, customer protection and
market conduct requirements. If the Company is found to have violated an
applicable regulation, administrative or judicial proceedings may be initiated
against the Company that may result in a censure, fine, civil penalties,
issuance of cease-and-desist orders, the deregistration or suspension of the
Company's broker-dealer activities, the suspension or disqualification of the
Company's officers or employees, or other adverse consequences. The imposition
of any of these or other penalties could have a material adverse effect on the
Company's operating results and financial condition.
THE COMPANY RELIES ON CLEARING BROKERS AND UNILATERAL TERMINATION OF THE
AGREEMENTS WITH THESE CLEARING BROKERS COULD DISRUPT THE COMPANY'S BUSINESS.
The Company changed from a self-clearing brokerage firm to an introducing
brokerage firm, using third party clearing brokers to process its securities
transactions and maintain customer accounts on a fee basis for the Company. The
clearing brokers also provide billing services, extend credit and provide for
control and receipt, custody and delivery of securities. The Company's
broker-dealers depend on the operational capacity and ability of the clearing
brokers for the orderly processing of transactions. In addition, by engaging the
processing services of a clearing firm, the Company is exempt from some capital
reserve requirements and other regulatory requirements imposed by federal and
state securities laws. If the clearing agreements are unilaterally terminated
for any reason, the Company would be forced to find alternative clearing firms
without adequate time to negotiate the terms of a new clearing agreement and
without adequate time to plan for such change. There can be no assurance that if
there were a unilateral termination of its clearing agreement that the Company
would be able to find an alternative clearing firm on acceptable terms to them
or at all.
In December 2003, National and its clearing firm, First Clearing, mutually
agreed to terminate their clearing relationship by June 30, 2004. On June 22,
2004, National entered into an agreement with Fiserv to act as clearing agent
for its brokerage business. The conversion from First Clearing to Fiserv was
substantially completed in the first week of October 2004.
The Company 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 client's account. During periods of
volatile markets, the value of the collateral held by the clearing brokers could
fall below the amount borrowed by the client. If margin requirements are not
sufficient to cover losses, the clearing brokers sell or buy securities at
prevailing market prices, and may incur losses to satisfy client obligations.
The Company's has agreed to indemnify the clearing brokers for losses they incur
while extending credit to the Company's clients.
CREDIT RISK EXPOSES THE COMPANY TO LOSSES CAUSED BY FINANCIAL OR OTHER PROBLEMS
EXPERIENCED BY THIRD PARTIES.
The Company is exposed to the risk that third parties that owe it money,
securities or other assets will not perform their obligations. These parties
include trading counterparts, customers, clearing agents, exchanges, clearing
houses, and other financial intermediaries as well as issuers whose securities
the Company holds. These parties may default on their obligations owed to the
Company due to bankruptcy, lack of liquidity, operational failure or other
reasons. This risk may arise, for example, from holding securities of third
parties, 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 extending
credit to clients through bridge or margin loans or other arrangements.
Significant failures by third parties to perform their obligations owed to the
Company could adversely affect the Company's revenues and perhaps the Company's
ability to borrow in the credit markets.
-15-
ADVERSE RESULTS OF CURRENT LITIGATION AND POTENTIAL SECURITIES LAW LIABILITY
WOULD RESULT IN FINANCIAL LOSSES AND DIVERT MANAGEMENT'S ATTENTION TO BUSINESS.
Many aspects of the Company's business involve substantial risks of liability.
There has been an increase in litigation and arbitration within the securities
industry in recent years, including class action suits seeking substantial
damages. The Company is subject to potential claims by dissatisfied customers,
including claims alleging they were damaged by improper sales practices such as
unauthorized trading, sale of unsuitable securities, use of false or misleading
statements in the sale of securities, mismanagement and breach of fiduciary
duty. National may be liable for the unauthorized acts of its retail brokers if
it fails to adequately supervise their conduct. As an underwriter, the Company
may be subject to substantial potential liability under federal and state law
and court decisions, including liability for material misstatements and
omissions in securities offerings. The Company may be required to contribute to
a settlement, defense costs or a final judgment in legal proceedings or
arbitrations involving a past underwriting and in actions that may arise in the
future. National carries "Errors and Omissions" insurance to protect against
arbitrations; however, the policy is limited in items and amounts covered and
there can be no assurance that it will cover a complaint. The adverse resolution
of any legal proceedings involving the Company could have a material adverse
effect on the Company's business, financial condition, results of operations or
cash flows.
THE COMPANY DEPENDS ON SENIOR EMPLOYEES AND THE LOSS OF THEIR SERVICES COULD
HARM OUR BUSINESS.
The Company depends on the continued services of its management team,
particularly Mark Goldwasser, the Company's President and Chief Executive
Officer, as well as its ability to hire additional members of management, and to
retain and motivate its other officers and key employees. In July 2003 the
compensation committee of the Company and Mr. Goldwasser agreed to enter into an
employment agreement for an annual base salary of $300,000. Mr. Goldwasser has
been salaried at that rate since July 2003. The Company's future success also
depends on its continuing ability to attract and retain highly qualified
personnel.
THE COMPANY FACES SIGNIFICANT COMPETITION FOR REGISTERED REPRESENTATIVES.
From time to time registered representatives affiliated with National employs
may choose to leave our company to pursue other opportunities. The level of
competition for registered representatives remains intense. The loss of a
significant number of registered representatives could materially and adversely
affect the Company's operating results.
THE PRICE OF THE COMMON STOCK IS VOLATILE.
The price of the Common Stock has fluctuated substantially. (See Part II, Item
5). The market price of the Common Stock may be highly volatile as a result of
factors specific to the Company and the securities markets in general. Factors
affecting volatility may include: variations in the Company's annual or
quarterly financial results or those of its competitors; conditions in the
economy in general; and changes in applicable laws or regulations, or their
judicial or administrative interpretations affecting the Company or its
subsidiary or the securities industry. In addition, volatility of the market
price of the Common Stock is further affected by its thinly traded nature.
WE HAVE RESTRICTED SHARES OUTSTANDING THAT MAY DEPRESS THE PRICE OF THE COMMON
STOCK.
As of September 30, 2004, of the 4,984,332 outstanding shares of Common Stock,
1,350,000 shares may be deemed restricted shares and, in the future, may be sold
in compliance with Rule 144 under the Securities Act. Rule 144 provides that a
person holding restricted securities for one year may sell shares in brokerage
transactions, subject to limitations based on the number of shares outstanding
and trading volume. A person who is not affiliated with us and who has held
restricted securities for two years is not subject to these limitations as long
as the other conditions of Rule 144 are met. Such sales may have a depressive
effect on the price of the Common Stock in the open market.
-16-
THE COMPANY'S 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, the Company's executive officers, directors and entities
that these individuals are affiliated with own approximately 21% of Common
Stock, including shares of Common Stock issuable upon conversion of the Series A
Preferred Stock, and excluding stock options and warrants. Accordingly, these
individuals and entities will be able to significantly influence most, if not
all, of our corporate actions, including the election of directors, the
appointment of officers, and potential merger or acquisition transactions.
ITEM 2. PROPERTIES
The Company owns no real property. Its corporate headquarters are shared with
National in leased space in Chicago, Illinois and New York, New York. The
Company leases office space in Boca Raton, Florida, and through its subsidiary,
the Company leases office space in Chicago, New York, Seattle, Washington and
Los Angeles, California. Independent contractors individually lease the branch
offices that are operated by those independent contractors.
Leases expire at various times through June 2012. The Company believes the rent
at each of its locations is at current market rates. At current production
levels, the Company believes that certain of its leased space in Chicago and New
York is excessive, and has sublet this space to third parties.
ITEM 3. LEGAL PROCEEDINGS
Fastpoint Communications, Inc. - In June 2002, National was named, together with
others, as a defendant in a class action lawsuit relating to a series of private
placements of securities in Fastpoint Communications, Inc. in the Superior Court
for the State of California for the County of San Diego, Case No GIC 791372. In
August 2002, plaintiffs filed an amended complaint alleging violations of state
statutory and common law as well as of Section 12 of the Securities Act of 1933,
15 U.S.C. ss. 77l. Plaintiffs are seeking approximately $14.0 million, but no
specific amount of damages has been sought against National in the complaint.
The complaint asserts claims in connection with National's role as placement
agent in a series of private placements of securities in Fastpoint. Plaintiffs
allege that the private placement memoranda contained false and misleading
statements or omitted facts necessary to make statements not misleading.
National filed its answer in April 2003. In January 2004, the court entered an
order denying class certification. As a result of this order denying class
certification, the only remaining claims against National are the individual
claims asserted by the two class representatives totaling $60,000. Plaintiffs
have filed an appeal of this order and it is in the process of being briefed.
The action in the lower court, including a pending motion for summary judgment,
has been stayed. The Company believes it has meritorious defenses and intends to
vigorously contest class certification and defend this action, although the
ultimate outcome of the matter cannot be determined at this time. Accordingly,
the Company is unable to predict the outcome of this matter, and no adjustments
have been made in the consolidated financial statements in response to this
matter.
Craig M. Gould - In April 2002, a former executive officer of the Company, Craig
M. Gould, commenced an action against the Company, in the matter titled Gould
vs. Olympic Cascade Financial Corporation, et al., NASD No. 02-03542. Mr. Gould
claimed a breach of his employment contract, and sought approximately $850,000
in damages. The arbitration commenced in July 2003, and was completed in
December 2003. In January 2004, the arbitration panel awarded damages against
the Company of approximately $400,000 that was accrued in the quarter ended
December 31, 2003. The Company paid this award during the quarter ended March
31, 2004.
-17-
NASD - The NASD was engaged in an industry-wide investigation of mutual fund
trading activities. National is one of the numerous broker-dealers that was
contacted by the NASD with respect to this investigation. The NASD identified
certain customer mutual fund transactions ordered through National during the
time period from October 2000 to February 2003 that it believed constituted
mutual fund timing and/or excessive trading activity. National engaged in
discussions and negotiations with the NASD to informally resolve these matters.
Such resolution resulted in a settlement, whereby National, without admitting or
denying any violations, agreed to make both restitution and pay a fine to the
NASD, that in the aggregate approximate $600,000. Additionally, the Company is
obligated to pay the fines imposed by the NASD on two executive officers
totaling $50,000 pursuant to its indemnification obligations. The Company has
included the $650,000 in "Professional fees" for the year ended September 30,
2004. The unpaid balance of approximately $562,000 at September 30, 2004 has
been included in "Accounts Payable, Accrued Expenses and Other Liabilities" in
the accompanying consolidated statements of financial condition.
The Company is also a defendant in various other arbitrations and administrative
proceedings, lawsuits and claims, seeking damages aggregating approximately $1.1
million (exclusive of specified punitive damages of approximately $300,000,
unspecified punitive damages related to certain claims and expected insurance
coverage). The Company has filed a counterclaim for approximately $220,000 in
one such proceeding. These matters arise out of the normal course of business.
The Company intends to vigorously defend itself in these actions, and believes
that the eventual outcome of these matters will not have a material adverse
effect on the Company. However, the ultimate outcome of these matters cannot be
determined at this time. The amounts related to such matters that are reasonably
estimable and which have been accrued at September 30, 2004 and 2003, is
$731,000 and $366,000, respectively, and have been included in "Accounts
Payable, Accrued Expenses and Other Liabilities" in the accompanying
consolidated statements of financial condition. The Company has included in
"Professional fees" litigation and NASD related expenses of $1,674,000, $945,000
and $499,000 for the fiscal years ended September 30, 2004, 2003 and 2002,
respectively.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders in the fourth
quarter of fiscal year ended September 30, 2004.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK, RELATED
STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
MARKET INFORMATION
On November 1, 2004, the Common Stock commenced trading under the symbol "OLYD"
on the Over-the-Counter Bulletin Board. Previously, the Common Stock traded on
the AMEX under the symbol "OLY".
The high and low sales prices for the Common Stock for the period October 1,
2002 to September 30, 2004, as listed on the AMEX, were as follows:
-18-
PERIOD HIGH LOW
- ------ ---- ---
October 1, 2002/December 31, 2002 $0.60 $0.25
January 1, 2003/March 31, 2003 $0.45 $0.25
April 1, 2003/June 30, 2003 $1.00 $0.20
July 1, 2003/September 30, 2003 $1.73 $0.85
October 1, 2003/December 31, 2003 $1.69 $1.17
January 1, 2004/March 31, 2004 $3.13 $1.30
April 1, 2004/June 30, 2004 $2.50 $1.35
July 1, 2004/September 30, 2004 $1.85 $0.60
The closing price of the Common Stock on December 17, 2004, as quoted on the
Over-the-Counter Bulletin Board, was $.89 per share.
SHAREHOLDERS
As of September 30, 2004, the Company had approximately 1,000 shareholders,
including those shareholders holding stock in street name and trust accounts.
DIVIDENDS
Delaware law authorizes the Company's Board of Directors to declare and pay
dividends with respect to the Common Stock either out of its surplus (as defined
in the Delaware Corporation Law) or, in case there is no such surplus, out of
its net profits for the fiscal year in which the dividend is declared and/or the
preceding fiscal year; provided, however, that no dividend may be paid out of
net profits unless the Company's capital exceeds the aggregate amount
represented by the issued and outstanding stock of all classes having a
preference in the distribution of assets. The Company's ability to pay dividends
in the future also may be restricted by its operating subsidiary's obligation to
comply with the net capital requirements imposed on broker-dealers by the SEC
and the NASD. Prior to the issuance of the Series A Preferred Stock in the
Investment Transaction, no shareholder held preferential rights in liquidation.
The Company has never declared a cash dividend and does not presently foresee
declaring one in the coming fiscal year.
The holders of the Series A Convertible preferred stock are entitled to receive
dividends on a quarterly basis at a rate of 9% per annum, per share. Such
dividends are cumulative and accrue whether or not declared by the Company's
Board of Directors, but are payable only when, as and if declared by the
Company's Board of Directors. In March 2004, the Company's Board of Directors
declared an in-kind dividend in the aggregate of 3,352 shares of Series A
Preferred Stock, in payment of approximately $503,000 of dividends accrued
through January 31, 2004. Such shares were issued on March 31, 2004. At
September 30, 2004, the amount of accumulated dividends on the Company's 31,177
issued and outstanding shares of Series A Preferred Stock was $182,000.
SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
Item 12 of Part III contains information concerning securities authorized for
issuance under our equity compensation plans.
RECENT SALES OF UNREGISTERED SECURITIES
The securities described below were sold by us during fiscal year 2003 without
being registered under the Securities Act. All such sales made in reliance on
Section 4(2) and/or Rule 506 promulgated thereunder of the Securities Act were,
to the best of our knowledge, made to investors that, either alone or together
with a representative that assisted such investor in connection with the
-19-
applicable investment, had such sufficient knowledge and experience in financial
and business matters to be capable of evaluating the merits and risks connected
with the applicable investment. In January 2004, the Company consummated a
private offering of its securities to a limited number of accredited investors
wherein the Company issued an aggregate of $200,000 of three-year, 10% senior
subordinated promissory notes to five unaffiliated parties. The noteholders
received three-year warrants to purchase an aggregate of 50,000 shares of the
Company's common stock at an exercise price of $1.40 per share, with an
allocated fair value of approximately $40,000. The warrants are exercisable at
any time within three years from their issuance. In December 2004, the Company
rescinded a note in the principal amount of $25,000 and a warrant to purchase
6,250 shares of Common Stock.
In February 2004, the Company consummated a private offering of its securities
to a limited number of accredited investors wherein the Company issued an
aggregate of $850,000 of three-year, 10% senior subordinated promissory notes to
four unaffiliated parties. The noteholders received three-year warrants to
purchase an aggregate of 170,000 shares of the Common Stock at an exercise price
of $1.50 per share, with an allocated fair value of approximately $143,000. The
warrants are exercisable at any time within three years from their issuance.
National acted as the placement agent for the private offering. The offering
period for the private offering expired on May 30, 2004.In the fourth quarter of
fiscal year 2004, the Company consummated a private placement of its securities
to a limited number of accredited investors. Each unit in the offering sold for
$1.60 and consisted of two shares of the Common Stock and one three-year warrant
to purchase one share of Common Stock at a per share price of $1.50. The
warrants are exercisable at any time within three years from their issuance. Net
proceeds of $930,500 closed in the fourth quarter of fiscal year 2004, and the
Company correspondingly issued 1,250,000 shares of Common Stock and 625,000
warrants.
ITEM 6. SELECTED FINANCIAL DATA
Set forth below is the historical financial data with respect to the Company for
the fiscal years ended 2004, 2003, 2002, 2001 and 2000. This information has
been derived from, and should be read in conjunction with, the audited financial
statements, which appear elsewhere in this report. The financial data for the
fiscal years ended 2002, 2001 and 2000 have been restated to reflect the
discontinued operations of the Company's former subsidiary, WestAmerica. The
information for the fiscal year 2002 has been revised to reflect the cumulative
dividends on the Series A Preferred Stock. All information is expressed in
thousands of dollars except for per share information.
Fiscal Year
--------------------------------------------------------------------------
2004 2003 2002 2001 2000
--------------------------------------------------------------------------
Net revenues $ 63,591 $ 50,158 $ 42,002 $ 50,224 $ 56,213
Net income (loss) from continuing
operations before extraordinary items 566 (843) (3,745) (7,338) 1,356
Preferred stock dividends (266) (250) (168) - -
Net income (loss) per common share
from continuing operations 0.05 (0.34) (1.73) (3.33) 0.64
Total assets 9,722 8,735 7,948 77,599 92,696
Long-term obligations 866 1,536 3,969 3,000 608
Stockholders' equity (deficit) 1,929 (329) (91) 622 8,039
Cash dividends - - - - -
-20-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The Private Securities Litigation Reform Act of 1995 provides a safe harbor for
forward-looking statements. This Report may contain certain statements of a
forward-looking nature relating to future events or future business performance.
Any such statements that refer to the Company's estimated or anticipated future
results or other non-historical facts are forward-looking and reflect the
Company's current perspective of existing trends and information. These
statements involve risks and uncertainties that cannot be predicted or
quantified and, consequently, actual results may differ materially from those
expressed or implied by such forward-looking statements. Such risks and
uncertainties include, among others, risks and uncertainties detailed in Item 1
above. Any forward-looking statements contained in or incorporated into this
Report speak only as of the date of this Report. The Company undertakes no
obligation to update publicly any forward-looking statement, whether as a result
of new information, future events or otherwise.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The SEC recently issued proposed guidance for disclosure of critical accounting
policies and estimates. The Company's most critical accounting policies relate
to income recognition, income taxes, and stock-based compensation. The SEC
defines "critical accounting estimates" as those that require application of
management's most difficult, subjective or complex judgments, often as a result
of the need to make estimates about the effects of matters that are inherently
uncertain and may change in subsequent periods. In fiscal years 2004 and 2003,
the Company estimated its ability to collect the receivables due from its
registered representatives. These receivables are derived from debts owed to the
Company and from money advanced to the registered representatives that may be
forgiven over time based on the representatives' affiliation with, and
production at, National. The Company also estimated the amount of reserves
necessary to cover existing contingencies.
RESULTS OF OPERATIONS
FISCAL YEAR 2004 COMPARED WITH FISCAL YEAR 2003
The Company's fiscal year 2004 resulted in an increase in revenues and a
comparatively lesser increase in expenses compared with fiscal year 2003. The
increase in revenues is primarily due to the improved securities markets
experienced during the first six months of fiscal year 2004, which weakened
during the second six months of the fiscal year, and the gains on
extinguishments of debt. As a result of this overall improvement, the Company
reported net income before income taxes of $566,000 compared with a net loss
before income taxes of $843,000 for the fiscal years 2004 and 2003,
respectively. This represents an improvement of $1,409,000 from the prior year.
-21-
Fiscal Year Increase (Decrease)
------------------------------------- -------------------------------
2004 2003 Amount Percent
----------------- ----------------- ----------------- ------------
Commissions $46,881,000 $34,218,000 $12,663,000 37%
----------------- ----------------- -----------------
Proprietary trading 6,642,000 10,249,000 (3,607,000) (35%)
Market making 645,000 1,115,000 (470,000) (42%)
Mark-ups and mark-downs 117,000 200,000 (83,000) (42%)
----------------- ----------------- -----------------
Net dealer inventory gains 7,404,000 11,564,000 (4,160,000) (36%)
Investment banking 1,548,000 425,000 1,123,000 264%
Interest and dividends 3,420,000 1,416,000 2,004,000 142%
Transfer fees and clearance services 2,806,000 1,850,000 956,000 52%
Gains on extinguishments of debt 1,131,000 - 1,131,000 n/a
Other 401,000 685,000 (284,000) (41%)
----------------- ----------------- -----------------
$63,591,000 $50,158,000 $13,433,000 27%
================= ================= =================
Total revenues increased $13,443,000, or 27%, in fiscal year 2004 to $63,591,000
from $50,158,000 in fiscal year 2003. This increase is mainly due to the
improved securities markets in the first six months of fiscal year 2004 compared
to fiscal year 2003, that increased commission revenues, the number of
commission tickets generated, and the charge per ticket that affects commission
revenue, and the gains on extinguishments of debt. During fiscal year 2004,
trading volume increased by approximately 7%, compared to fiscal year 2003.
Commission revenue increased $12,663,000, or 37%, to $46,881,000 from
$34,218,000 during fiscal year 2004 compared with fiscal year 2003. Net dealer
inventory gains, which includes profits on proprietary trading, market making
activities and customer mark-ups and mark-downs, decreased $4,160,000, or 36%,
to $7,404,000 from $11,564,000 during fiscal year 2004 compared with fiscal year
2003. While all categories of net dealer inventory gains decreased in fiscal
year 2004, the decrease is primarily due to a reduction in proprietary trading
in the bond market, reflecting an overall decline in this market compared to the
strength realized in the equity markets during the first six months of the
current fiscal year, and the reduction in the Company's market-making trading
activities. During fiscal year 2004, revenues from proprietary trading decreased
$3,607,000, or 35% to $6,642,000 from $10,249,000 in fiscal year 2003; revenues
from market making activities decreased $470,000, or 42%, to $645,000 from
$1,115,000 in fiscal year 2003; and revenues from customer mark-ups and
mark-downs decreased $83,000, or 42%, to $117,000 from $200,000 in fiscal year
2003.
Investment banking revenue increased $1,123,000, or 264%, to $1,548,000 from
$425,000 in fiscal year 2004 compared with fiscal year 2003. The increase in
investment banking revenues is primarily attributed to the Company's completion
of private placements and an initial public offering in fiscal year 2004.
Interest and dividend income increased $2,004,000 or 142%, to $3,420,000 from
$1,416,000 in fiscal year 2004 compared with fiscal year 2003. The increase in
interest income is attributable to an increase in the amount of customer debits
in National's customers' accounts and an increase in the interest rate charged
to such debits from the prior year. Transfer fees increased $956,000, or 52%, to
$2,806,000 in fiscal year 2004 from $1,850,000 in fiscal year 2003. The increase
is due to an increase in transaction volume associated with the Company's retail
brokerage business, and increased fees charged on certain accounts.
The Company realized gains on extinguishments of debt of $1,131,000 from its
prior clearing firm, First Clearing, in fiscal year 2004. Other revenue,
consisting of asset management fees and miscellaneous transaction fees and
trading fees, decreased $284,000, or 41%, to $401,000 from $685,000 during
fiscal year 2004 compared to fiscal year 2003. The decrease is due to reduced
fees attributable to a reduction in the volume of institutional business in
fiscal year 2004 compared to the same period last year.
-22-
Fiscal Year Increase (Decrease)
------------------------------------- -------------------------------
2004 2003 Amount Percent
----------------- ----------------- ----------------- ------------
Commission expense related to:
Commission revenue $ 38,980,000 $ 26,931,000 $12,049,000 45%
Net dealer inventory gains 3,714,000 7,312,000 (3,598,000) (49%)
Investment banking 1,238,000 340,000 898,000 264%
----------------- ----------------- -----------------
Commissions 43,932,000 34,583,000 9,349,000 27%
Employee compensation 5,449,000 4,021,000 1,428,000 36%
Clearing fees 2,391,000 2,714,000 (323,000) (12%)
Communications 2,589,000 2,693,000 (104,000) (4%)
Occupancy and equipment costs 2,983,000 2,891,000 92,000 3%
Professional fees 2,559,000 1,526,000 1,033,000 68%
Litigation settlement 400,000 - 400,000 n/a
Interest 397,000 193,000 204,000 106%
Taxes, licenses and registration 560,000 407,000 153,000 38%
Other administrative expenses 1,765,000 1,973,000 (208,000) (11%)
----------------- ----------------- -----------------
$ 63,025,000 $ 51,001,000 $12,024,000 24%
================= ================= =================
In comparison with the 27% increase in total revenues, total expenses increased
$12,024,000 or 24%, to $63,025,000 in fiscal year 2004 compared to $51,001,000
in fiscal year 2003. The increase in total expenses is a result of greater
commission expenses directly associated with commission revenues. The increase
in total expenses was minimized by management's efforts to streamline its
operations and reduce fixed expenses associated with its salaried employees,
communication and occupancy expenses.
Commission expense, which includes expenses related to commission revenue, net
dealer inventory gains and investment banking, increased $9,349,000, or 27%, to
$43,932,000 in fiscal year 2004 from $34,583,000 in fiscal year 2003. Commission
expense related to commission revenue increased $12,049,000, or 45%, to
$38,980,000 in fiscal year 2004 from $26,931,000 in fiscal year 2003; commission
expense related to net dealer inventory gains decreased $3,598,000, or 49%, to
$3,714,000 in fiscal year 2004 from $7,312,000 in fiscal year 2003; and
commission expense related to investment banking increased $898,000, or 264%, to
$1,238,000 in fiscal year 2004 from $340,000 in fiscal year 2003. All categories
of commission expense as a percentage of the related revenues were relatively
consistent between fiscal year 2004 and fiscal year 2003. The increase of
commission expense as a percentage of commission revenues is attributable to
changes in the production of particular brokers, not all of whom are compensated
at the same commission rate. The decrease of commission expense as a percentage
of net dealer inventory gains is attributable to the reduction in the Company's
market-making trading activities. Commission expense as a percentage of
investment banking revenue was relatively unchanged between fiscal year 2004 and
fiscal year 2003. Commission expense includes the amortization of advances to
registered representatives of $763,000 and $710,000 for fiscal year 2004 and
2003, respectively. These amounts fluctuate based upon the amounts of advances
outstanding and the time period for which the registered representatives have
agreed to be affiliated with National.
Employee compensation expense increased $1,428,000, or 36%, to $5,449,000 in
fiscal year 2004 from $4,021,000 in fiscal year 2003. This increase is
attributable to the hiring of new employees, salary increases for certain
employees and the establishment of a bonus pool for senior management. Overall,
combined commission and employee compensation expense, as a percentage of
revenue increased slightly to 78% from 77% in fiscal years 2004 and 2003,
respectively.
Clearing fees decreased $323,000, or 12%, to $2,391,000 in fiscal year 2004 from
$2,714,000 in fiscal year 2003. Although there was an increase in trading
volume, clearing fees, as a percentage of related revenues, decreased due to an
increase in the number of lower priced tickets from the prior year. Clearing
fees in fiscal year 2004 were reduced by the $800,000 conversion assistance
-23-
payment the Company received from its new clearing firm, Fiserv, to offset
conversion costs incurred by the Company. Clearing fees were reduced by
forgiveness of debt, that was fully repaid in February 2004, from the Company's
prior clearing firm based on ticket volume in the amount of $251,000 and
$454,000 in fiscal year 2004 and 2003, respectively.
Communication expenses decreased $104,000 or 4% to $2,589,000 from $2,693,000 in
fiscal year 2004 compared to fiscal year 2003. The decrease is due to the
reduction in the Company's market-making trading activities. Occupancy costs
increased $92,000, or 3%, to $2,983,000 from $2,891,000 in fiscal year 2004
compared to fiscal year 2003. The increase in occupancy expense is due to the
expansion of office facilities in order to accommodate new brokers. Professional
fees increased $1,033,000, or 68%, to $2,559,000 from $1,526,000 in fiscal year
2004 compared to fiscal year 2003. The increase in professional fees is due to
an increase in the legal fees relating to various lawsuits and arbitrations, and
the legal fees, fines and restitution payments related to the NASD investigation
of mutual fund trading activities and other regulatory matters. Professional
fees include litigation and NASD related expenses of $1,674,000 and $945,000 in
fiscal year 2004 and 2003, respectively. In January 2004, an arbitration panel
awarded damages against the Company of approximately $400,000 related to an
employment contract with a former employee of the Company. This amount was
recorded as "Litigation settlement" and paid in fiscal year 2004.
Interest expense increased $204,000, or 106%, to $397,000 from $193,000 in
fiscal year 2004 compared to fiscal year 2003. The increase is due to interest
on the notes issued by the Company in the second quarter of fiscal year 2004,
and the amortization of $113,000 attributable to newly issued notes and modified
notes. Taxes, licenses and registration increased $153,000, or 38%, to $560,000
from $407,000 in fiscal year 2004 compared to fiscal year 2003. The increase in
taxes, licenses and registration expense is due to an increase in the number of
brokers associated with the Company from the prior year. Other administrative
expenses decreased $208,000 or 11% to $1,765,000 from $1,973,000 in fiscal year
2004 compared to fiscal year 2003. The decrease in other administrative expenses
is due to the Company's efforts to control its fixed operating expenses, net of
an increase in the allowance for uncollectible accounts on its other
receivables, related to registered representatives formerly associated with
National in the amount of $200,000 and $441,000 in fiscal year 2004 and 2003,
respectively.
The Company reported income before income taxes of $566,000 in fiscal year 2004
compared to a net loss before income taxes of $843,000 in fiscal year 2003.
Overall, the net income attributable to common stockholders in fiscal year 2004
was $300,000, or basic net income attributable to common stockholders of $.08
per common share and diluted net income attributable to common stockholders of
$.07 per common share, as compared to the basic and diluted loss attributable to
common stockholders of $1,093,000, or $.34 per common share in fiscal year 2003.
The net income and net loss attributable to common stockholders for fiscal years
2004 and 2003 reflects $266,000 and $250,000 of cumulative dividends,
respectively, on the Company's Preferred Stock.
FISCAL YEAR 2003 COMPARED WITH FISCAL YEAR 2002
The Company's fiscal year 2003 resulted in an increase in revenues and a
comparatively lesser increase in expenses compared with fiscal year 2002. The
increase in revenues is primarily due to the improved securities markets in the
second six months of fiscal year 2003 compared to a year ago. As a result of
losses incurred primarily in the first six months of fiscal year 2003, the
Company reported a net loss from continuing operations before income taxes of
$843,000 compared with a net loss from continuing operations before income taxes
of $3,825,000 for fiscal year 2002, an improvement of $2,982,000. The decrease
in net loss is a result of the increase in revenues combined with management's
efforts to reduce the fixed costs associated with its business.
-24-
Fiscal Year Increase (Decrease)
------------------------------------- -------------------------------
2003 2002 Amount Percent
----------------- ----------------- ----------------- ------------
Commissions $34,218,000 $28,168,000 $ 6,050,000 21%
----------------- ----------------- -----------------
Proprietary trading 10,249,000 9,160,000 1,089,000 12%
Market making 1,115,000 891,000 224,000 25%
Mark-ups and mark-downs 200,000 191,000 9,000 5%
----------------- ----------------- -----------------
Net dealer inventory gains 11,564,000 10,242,000 1,322,000 13%
Investment banking 425,000 253,000 172,000 68%
Interest and dividends 1,416,000 1,640,000 (224,000) (14%)
Transfer fees and clearance services 1,850,000 1,343,000 507,000 38%
Other 685,000 356,000 329,000 92%
----------------- ----------------- -----------------
$50,158,000 $ 42,002,000 $ 8,156,000 19%
================= ================= =================
Total revenues from continuing operations increased $8,156,000, or 19%, in
fiscal year 2003 to $50,158,000 from $42,002,000 in fiscal year 2002. This
increase is mainly due to the improved securities markets in the second six
months of fiscal year 2003 compared to fiscal year 2002. The number of
commission tickets generated, and the charge per ticket affects commission
revenue and net dealer inventory gains. During fiscal year 2003, trading volume
increased by approximately 18%, compared to fiscal year 2002. Commission revenue
increased $6,050,000, or 21%, to $34,218,000 from $28,168,000 during fiscal year
2003 compared with fiscal year 2002. Net dealer inventory gains, which includes
profits on proprietary trading, market making activities and customer mark-ups
and mark-downs, increased $1,322,000, or 13%, to $11,564,000 from $10,242,000
during fiscal year 2003 compared with fiscal year 2002. During fiscal year 2003,
revenues from proprietary trading increased $1,089,000, or 12% to $10,249,000
from $9,160,000 in fiscal year 2002; revenues from market making activities
increased $224,000, or 25%, to $1,115,000 from $891,000 in fiscal year 2002; and
revenues from customer mark-ups and mark-downs increased $9,000, or 5%, to
$200,000 from $191,000 in fiscal year 2002. The increase in commission revenue
and net dealer inventory gains is due to the improved securities markets in the
second six months of fiscal year 2003.
Investment banking revenue increased $172,000, or 68%, to $425,000 from $253,000
in fiscal year 2003 compared with fiscal year 2002. The increase in investment
banking revenues is primarily attributed to the Company's completing a private
placement in the third quarter of fiscal year 2003. Interest and dividend income
decreased $224,000 or 14%, to $1,416,000 from $1,640,000 in fiscal year 2003
compared with fiscal year 2002. The decrease in interest income is attributable
to a decrease in the amount of customer debits in National's customers' accounts
during most of fiscal year 2003, and a decrease in interest rates from the prior
year. Transfer fees increased $507,000, or 38%, to $1,850,000 in fiscal year
2003 from $1,343,000 in fiscal year 2002. The increase is due to an increase in
transaction volume associated with the Company's retail brokerage business.
Other revenue, consisting of asset management fees and miscellaneous transaction
fees and trading fees, increased $329,000, or 92%, to $685,000 from $356,000
during fiscal year 2003 compared to fiscal year 2002. The increase is primarily
due to increased transaction fees and trading fees.
-25-
Fiscal Year Increase (Decrease)
------------------------------------- -------------------------------
2003 2002 Amount Percent
----------------- ----------------- ----------------- ------------
Commission expense related to:
Commission revenue $26,931,000 $20,186,000 $ 6,745,000 33%
Net dealer inventory gains 7,312,000 5,965,000 1,347,000 23%
Investment banking 340,000 202,000 138,000 68%
----------------- ----------------- -----------------
Commissions 34,583,000 26,353,000 8,230,000 31%
Employee compensation 4,021,000 5,091,000 (1,070,000) (21%)
Clearing fees 2,714,000 4,241,000 (1,527,000) (36%)
Communications 2,693,000 2,866,000 (173,000) (6%)
Occupancy and equipment costs 2,891,000 3,513,000 (622,000) (18%)
Professional fees 1,526,000 1,093,000 433,000 40%
Interest 193,000 511,000 (318,000) (62%)
Taxes, licenses and registration 407,000 411,000 (4,000) (1%)
Other administrative expenses 1,973,000 1,748,000 225,000 13%
----------------- ----------------- -----------------
$ 51,001,000 $ 45,827,000 $ 5,174,000 11%
================= ================= =================
In comparison with the 19% increase in total revenues, total expenses increased
$5,174,000 or 11%, to $51,001,000 for fiscal year 2003 compared to $45,827,000
in fiscal year 2002. The increase in total expenses is a result of greater
commission expenses directly associated with commission revenues, as well as a
$441,000 increase in its reserve for uncollectible accounts on its other
receivables. The increase in total expenses was minimized by management's
efforts to streamline its operations and reduce fixed expenses associated with
its salaried employees, communication and occupancy expenses.
Commission expense, which includes expenses related to commission revenue, net
dealer inventory gains and investment banking, increased $8,230,000, or 31%, to
$34,583,000 in fiscal year 2003 from $26,353,000 in fiscal year 2002. Commission
expense related to commission revenue increased $6,745,000, or 33%, to
$26,931,000 in fiscal year 2003 from $20,186,000 in fiscal year 2002; commission
expense related to net dealer inventory gains increased $1,347,000, or 23%, to
$7,312,000 in fiscal year 2003 from $5,965,000 in fiscal year 2002; and
commission expense related to investment banking revenue increased $138,000, or
68%, to $340,000 in fiscal year 2003 from $202,000 in fiscal year 2002. All
categories of commission expense as a percentage of the related revenues were
relatively consistent between fiscal year 2003 and fiscal year 2002. Commission
expense includes the amortization of advances to registered representatives of
$710,000 and $584,000 in fiscal year 2003 and 2002, respectively. These amounts
fluctuate based upon the amounts of advances outstanding and the time period for
which the registered representatives have agreed to be affiliated with National.
Employee compensation expense decreased $1,070,000, or 21%, to $4,021,000 in
fiscal year 2003 from $5,091,000 in fiscal year 2002. This decrease is due to
management's ongoing efforts to reduce its fixed costs associated with salaried
employees. Overall, combined commission and employee compensation expense, as a
percentage of revenue increased slightly to 77% from 75% in fiscal years 2003
and 2002, respectively.
Clearing fees decreased $1,527,000, or 36%, to $2,714,000 in fiscal year 2003
from $4,241,000 in fiscal year 2002. Although there was an increase in trading
volume, clearing fees as a percentage of related revenues decreased due to a
change in the number of lower priced tickets from the prior period, and a one
time clearing charge of $548,000 incurred in fiscal year 2002. Clearing fees
were reduced by forgiveness of debt from the Company's prior clearing firm based
on ticket volume in the amount of $454,000 and $339,000 in fiscal year 2003 and
2002, respectively.
-26-
Communication expenses decreased $173,000 or 6% to $2,693,000 from $2,866,000 in
fiscal year 2003 compared to fiscal year 2002. The decrease is due to a
reduction in voice and data charges. Occupancy costs decreased $622,000, or 18%,
to $2,891,000 from $3,513,000 in fiscal year 2003 compared to fiscal year 2002.
The decrease in occupancy expense is due to the Company's renegotiating certain
long-term office leases, and finding subtenants to occupy unused space.
Professional fees increased $433,000, or 40%, to $1,526,000 from $1,093,000 in
fiscal year 2003 compared to fiscal year 2002. The increase in professional fees
is due to an increase in the legal fees relating to various lawsuits and
arbitrations. Professional fees include litigation and NASD related expenses of
$945,000 and $499,000 in fiscal year 2003 and 2002, respectively.
Interest expense decreased $318,000, or 62%, to $193,000 from $511,000 in fiscal
year 2003 compared to fiscal year 2002. The decrease is primarily due to the
Company's change from a self-clearing brokerage firm to an introducing brokerage
firm during the first quarter of fiscal year 2002, and a decrease in interest
rates in 2003 from 2002. Taxes, licenses and registration decreased $4,000, or
1%, to $407,000 from $411,000 in fiscal year 2003 compared to fiscal year 2002.
Other administrative expenses increased $225,000 or 13% to $1,973,000 from
$1,748,000 in fiscal year 2003 compared to fiscal year 2002. The increase in
other administrative expenses is due to the Company's increase of its allowance
for uncollectible accounts on its other receivables related to registered
representatives formerly associated with National, by $441,000 during fiscal
year 2003, as compared to $209,000 in fiscal year 2002.
The Company reported a loss from continuing operations before income taxes of
$843,000 in fiscal year 2003 compared to a loss from continuing operations
before income taxes of $3,825,000 for fiscal year 2002.
In the first quarter of fiscal year 2002, the Company recorded a gain of
$300,000 from discontinued operations related to the write-off of WestAmerica's
net liabilities. Overall, the diluted loss attributable to common stockholders
in fiscal year 2003 was $1,093,000, or $.34 per common share, as compared to the
diluted loss attributable to common stockholders of $3,613,000, or $1.60 per
common share in fiscal year 2002. The net loss attributable to common
stockholders for fiscal years 2003 and 2002 reflects $250,000 and $168,000 of
cumulative but unpaid preferred stock dividends, respectively, on the Company's
Preferred Stock issued during fiscal year 2002.
LIQUIDITY AND CAPITAL RESOURCES
National, as a registered broker-dealer, is subject to the SEC's Uniform Net
Capital Rule 15c3-1, that requires the maintenance of minimum net capital.
National has elected to use the alternative standard method permitted by the
rule. This requires that National maintain minimum net capital equal to the
greater of $250,000 or a specified amount per security based on the bid price of
each security for which National is a market maker. At September 30, 2004,
National reported excess net capital of $1,154,000.
In December 2001, WestAmerica voluntarily withdrew its membership with the NASD,
ceased conducting business as a broker-dealer, and filed for Chapter 7
Bankruptcy protection in accordance with the U.S. Bankruptcy Code. WestAmerica
has been operated as a separate legal entity, and although the Company believes
it will not have any ongoing liability for any unpaid obligations of
WestAmerica, there can be no assurances that creditors of WestAmerica will not
seek recovery of their claims from the Company.
Advances, dividend payments and other equity withdrawals from the Company's
subsidiary are restricted by the regulations of the SEC and other regulatory
agencies. These regulatory restrictions may limit the amounts that a subsidiary
may dividend or advance to the Company.
The Company extends unsecured credit in the normal course of business to its
brokers. The determination of the appropriate amount of the reserve for
uncollectible accounts is based upon a review of the amount of credit extended,
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the length of time each receivable has been outstanding, and the specific
individual brokers from whom the receivables are owing. The allowance for
doubtful accounts increased by $200,000 in fiscal year 2004, reflecting the
amount of loss that can be reasonably estimated by management.
The objective of liquidity management is to ensure that the Company has ready
access to sufficient funds to meet commitments, fund deposit withdrawals and
efficiently provide for the credit needs of customers.
As a result of the losses throughout fiscal year 2001, notably those of the
fourth quarter, attributable in part to the unprecedented events in September
2001, the Company concluded that existing capital would not be sufficient to
satisfy existing operations. The Company explored various transactions to
finance the Company's operations. In December 2001, the Company completed a
series of transactions (the "Investment Transaction") that are more fully
described in Part 1. The Company continued to incur operating losses throughout
fiscal year 2002, and as a result, the Company believed that its then existing
capital was not sufficient to satisfy its current level of operations.
Accordingly, the Company pursued additional sources of capital from various
potential investors. In the fourth quarter of fiscal year 2002, the Company
completed $210,000 of investments in the form of an issuance of Series A
Preferred Stock and continued to seek additional investments.
In the first quarter of fiscal year 2003, the Company consummated a private
placement of its securities to a limited number of accredited investors pursuant
to Rule 501 of Regulation D under the Securities Act. Each unit in the offering
sold for $0.65 and consisted of one share of Common Stock and one three-year
warrant to purchase one share of Common Stock at a per share price of $1.25. Net
proceeds of $554,500 closed in the first quarter of fiscal year 2003, and the
Company correspondingly issued 1,016,186 shares of Common Stock and 1,016,186
warrants.
In January 2003, the Company issued 76,923 shares of Common Stock and a
three-year warrant to purchase 76,923 shares of Common Stock at $1.25 per share
to D'Ancona & Pflaum, as payment of $50,000 of legal fees that were accrued as
of September 30, 2002. The warrants issued in connection with the offering
consummated in the first quarter of fiscal year 2003 and the warrants issued to
D'Ancona & Pflaum have been included along with the proceeds of the shares of
Common Stock issued as additional paid-in capital.
In January 2004, the Company consummated a private offering of its securities to
a limited number of accredited investors pursuant