INVESTORS CAPITAL HOLDINGS, LTD. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED JUNE 30, 2012 AND 2011 (UNAUDITED)
Cash flows from operating activities: | | | | | |
Net income (loss) | $ | 261,682 | | $ | (1,255,709) |
Adjustments to reconcile net income (loss) to net cash | | | | | |
provided by operating activities: | | | | | |
Depreciation and amortization | | 83,021 | | | 103,687 |
Change in valuation allowance on deferred tax asset | | - | | | 24,008 |
Deferred taxes | | 266,855 | | | (53,018) |
Stock-based compensation | | 42,985 | | | 48,069 |
Unrealized loss (gain) in marketable securities | | (7,023) | | | 3,560 |
Non-qualified deferred compensation investment | | 12,905 | | | 10,717 |
Market adjustment cash surrender value life insurance policy | | 7,216 | | | 356 |
Charge to commission expense (forgivable loans) | | 87,980 | | | 9,167 |
Allowance for bad debt expense | | - | | | 73,263 |
Change in operating assets and liabilities: | | | | | |
Accounts receivable | | (345,201) | | | 1,286,992 |
Prepaid expenses and other | | (44,633) | | | (123,990) |
Loans receivable from registered representatives | | 330 | | | (208,278) |
Income taxes | | (79,515) | | | 465,225 |
Accounts payable | | 15,449 | | | 5,307 |
Securities, net | | 22,296 | | | (214,004) |
Accrued expenses | | 78,933 | | | 447,925 |
Commissions payable | | (37,040) | | | 55,212 |
Unearned revenues | | (7,922) | | | 14,525 |
Net cash provided by operating activities | | 358,318 | | | 693,014 |
| | | | | |
Cash flows from investing activities: | | | | | |
Acquisition of property and equipment | | (2,703) | | | (41,981) |
Cash surrender value life insurance policies | | - | | | (18,221) |
Payments on note receivable | | - | | | 75,181 |
Capitalized software | | - | | | (25,891) |
Net cash used in investing activities | | (2,703) | | | (10,912) |
| | | | | |
Cash flows from financing activities: | | | | | |
Payments on note payable | | (673,263) | | | (531,695) |
Net cash used in financing activities | | (673,263) | | | (531,695) |
| | | | | |
Net increase (decrease) in cash and cash equivalents | | (317,648) | | | 150,407 |
Cash and cash equivalents, beginning of period | | 4,537,713 | | | 4,587,195 |
| | | | | |
Cash and cash equivalents, end of period | $ | 4,220,065 | | $ | 4,737,602 |
Supplemental disclosures of cash flow information: | | | | | |
Interest paid | $ | 8,968 | | $ | 7,944 |
Income taxes paid | $ | - | | $ | - |
| | | | | |
See notes to condensed consolidated financial statements | | | | | |
INVESTORS CAPITAL HOLDINGS, LTD. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2012
(UNAUDITED)
Note 1 – Organization AND Basis of Presentation
Incorporated in 1995 under Massachusetts law and redomesticated under Delaware law in November 2007, Investors Capital Holdings, Ltd. ("ICH") is a holding company whose wholly-owned subsidiaries assist a nationwide network of independent registered representatives ("representatives") in providing a diversified line of financial services to the public including securities brokerage, investment advice, asset management, financial planning and insurance. Our subsidiaries include the following:
| · | Investors Capital Corporation ("ICC") is duly registered under the Securities Exchange Act of 1934 (the “Exchange Act”), the Investment Advisers Act of 1940 and applicable state law to provide broker-dealer and investment advisory services nationwide. ICC’s national network of independent financial representatives is licensed to provide these services through ICC under the regulatory purview of the Securities and Exchange Commission (the “SEC”), the Financial Industry Regulatory Authority (“FINRA”) and state securities regulators. ICC executes and clears its public customer accounts on a fully disclosed basis through Pershing, LLC (“Pershing”). ICC, doing business as Investors Capital Advisors (“ICA”), also provides investment advisory services. |
| · | ICC Insurance Agency, Inc. facilitates the sale of insurance and annuities by our representatives. |
| · | Investors Capital Holdings Securities Corporation ("ICH Securities") holds cash, cash equivalents, interest income and dividend income for ICH. |
BASIS OF PRESENTATION:
The condensed consolidated financial statements are unaudited and have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. In the opinion of management, the interim data includes all adjustments, consisting of normal recurring adjustments, necessary for a fair statement of the results for the periods presented. Because of the nature of the Company’s business, interim period results may not be indicative of full year or future results.
The accompanying interim unaudited condensed consolidated financial statements of Investors Capital Holdings, Ltd. and its subsidiaries (the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”) for interim financial information and with the instructions to Quarterly Report on Form 10-Q. Accordingly, they do not include all of the information and footnotes required by US GAAP for complete financial statements. In the opinion of management, these financial statements contain all of the adjustments necessary for a fair presentation of the results of the interim periods presented. Operating results for the three month period ended June 30, 2012 are not necessarily indicative of the results that may be expected for the year ending March 31, 2013. The balance sheet at March 31, 2012 has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by US GAAP for complete financial statement presentation. For further information, refer to the audited consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K (the “Form 10-K”) for the fiscal year ended March 31, 2012 filed with the SEC, for additional disclosures and a description of accounting policies.
There have been no material changes from the critical accounting policies set forth in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” of our annual report on Form 10-K for the year ended March 31, 2012. Please refer to those sections for disclosures regarding the critical accounting policies related to our business
Certain prior year items have been reclassified to conform to the current period’s presentation. These reclassifications had no effect on previously reported results of operations. All significant intercompany balances and transactions have been eliminated.
The Company has evaluated subsequent events through the date of this filing.
Recent Accounting Pronouncements
There have been no recent accounting pronouncements to disclose for this reporting period.
Note 2 - Loans to Registered Representatives
ICC has granted loans to certain registered representatives with the stipulation that the loans will be forgiven if the representatives remain licensed with the Company for an agreed upon period of time, generally one to five years, and/or meet specified performance and/or revenue targets. Upon forgiveness, the loans are charged to commission expense for financial reporting purposes. Loans charged to commission expense totaled $87,980 and $9,167 for the quarters ended June 30, 2012 and 2011, respectively.
Some loans to registered representatives are not subject to a forgiveness contingency. These loans, as well as loans that have failed the forgiveness contingency, are repaid to the Company by deducting a portion of the representatives’ commission payouts throughout the commission cycle until the loans are repaid.
Interest charged on these loans to representatives range from 3% to 9.00% annually. Loans to registered representatives included in receivables from employees and registered representatives are as follows:
| June 30, 2012 | | March 31, 2012 |
| | | | | |
Forgivable loans | $ | 1,027,572 | | $ | 1,057,497 |
Other loans | | 698,632 | | | 757,018 |
Less: allowance | | (157,334) | | | (157,334) |
Total loans | $ | 1,568,870 | | $ | 1,657,181 |
Included in other loans is a loan receivable from a registered representative in connection with a regulatory matter settled with the Massachusetts Securities Division on October 27, 2010. This representative has agreed to reimburse the Company for certain amounts paid by the Company with respect to this regulatory matter. The amount due on this receivable at June 30, 2012 and March 31, 2012 was $373,053 and $391,560, respectively.
NOTE 3 - INCOME TAXES
The Company uses the asset and liability method to account for income taxes, which requires recognition of deferred tax assets, subject to valuation allowances, and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income or loss in the period that includes the enactment date.
The Company, in preparing its income tax provision, bases the calculation on its annual projection of income or loss from operations. The annual projection is reconciled on a quarterly basis to changes in estimates, and at year end the calculation is based on the reported results of operations. Certain expenses are not deductible for tax purposes, creating permanent differences that increase or decrease the income tax provision and effective income tax rate.
Deferred income taxes are the result of timing differences between book and taxable income and consist primarily of deferred compensation, legal accruals, differences between depreciation expenses, and a net operating loss for financial statement purposes versus tax return purposes.
The Company has assessed the realizability of its deferred tax assets to determine whether or not an additional valuation allowance was required for some or all of its deferred tax assets. The Company also considered its current period reporting results and compared these results to its quarterly projection. Management, in a transitional period, feels confident it will achieve profitability and future taxable income; however, it has concluded that the sustained uncertainty in the global economy and its impact on the U.S. financial markets along with the ongoing legal risks and related defense costs inherent in the industry necessitated a valuation allowance in the amount of approximately $0.5 million as of March 31, 2012. If future operations exceed current projections, management may conclude such valuation allowance is no longer needed. Conversely, if future operating results do not meet current projections, it is possible that an additional valuation allowance may be needed in future periods. Currently, the Company has maintained its position on the $0.5 million valuation allowance which is netted against its deferred tax asset as of June 30, 2012.
The Company reserves for potential payments of tax to various tax authorities related to uncertain tax positions and other issues. Reserves related to uncertain tax positions are based on a determination of whether and how much of a tax benefit taken in our tax filings or positions is more likely than not to be realized, assuming that the matter in question will be raised by the tax authorities. Potential interest and penalties associated with such uncertain tax positions are recorded as a component of income tax expense. We believe appropriate provisions for outstanding issues have been made.
NOTE 4 – FAIR VALUE MEASUREMENTS
The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market. Valuation techniques that are consistent with the market, income or cost approach are used to measure fair value.
The fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value into three broad levels:
| · | Level 1 - Inputs are unadjusted quoted prices in active markets for identical assets or liabilities the Company have the ability to access. |
| · | Level 2 - Inputs are inputs (other than quoted prices included within Level 1) that are observable for the asset or liability, either directly or indirectly. |
| · | Level 3 - Inputs include unobservable inputs for the asset or liability and rely on management's own assumptions about the assumptions that market participants would use in pricing the asset or liability. |
(The unobservable inputs should be developed based on the best information available in the circumstances and may include the Company’s own data.)
The inputs or methodology used for valuing securities are not necessarily an indication of the risk associated with investing in those securities. The following table presents the Company's fair value hierarchy for those financial assets and liabilities measured at fair value as of June 30, 2012:
Fair Value Measurements on Recurring Basis | | | | | | | | | | | | |
| | Total | | | Level 1 | | | Level 2 | | | Level 3 | |
Securities owned at fair value | | | | | | | | | | | | |
Mutual funds (1) | $ | 232,592 | | $ | 232,592 | | $ | - | | $ | - | |
Equities | | - | | | - | | | - | | | - | |
Asset backed securities | | 2,607 | | | | | | 2,607 | | | | |
Total assets | $ | 235,199 | | $ | 232,592 | | $ | 2,607 | | $ | - | |
Liabilities: | | | | | | | | | | | | |
Securities sold, not yet purchased at fair value | | | | | | | | | | | | |
Mutual funds | $ | 11,705 | | $ | 11,705 | | $ | - | | $ | - | |
Equities | | | | | | | | | | | | |
Asset backed securities | | - | | | - | | | - | | | - | |
Total Liabilities | $ | 11,705 | | $ | 11,705 | | $ | - | | $ | - | |
| (1) | The asset mutual funds has a mutual fund with a fair value of $11,499 included in the non-qualified deferred compensation investment. |
The following table presents the Company's fair value hierarchy for those financial assets and liabilities measured at fair value as of March 31, 2012:
| | | | | | | | | | | | |
Fair Value Measurements on Recurring Basis | | | | | | | | | | | | |
| | Total | | | Level 1 | | | Level 2 | | | Level 3 | |
Assets: | | | | | | | | | | | | |
Securities owned at fair value | | | | | | | | | | | | |
Mutual funds | $ | 227,987 | | $ | 227,987 | | $ | - | | $ | - | |
Equities | | 4,796 | | | 4,796 | | | - | | | - | |
Asset backed securities | | 2,671 | | | | | | 2,671 | | | | |
Total assets | $ | 235,454 | | $ | 232,783 | | $ | 2,671 | | $ | - | |
| | | | | | | | | | | | |
Liabilities: | | | | | | | | | | | | |
Securities sold, not yet purchased at fair value | | | | | | | | | | | | |
Mutual funds | $ | 286 | | $ | 286 | | $ | - | | $ | - | |
Asset backed securities | | 7,900 | | | 7,900 | | | - | | | - | |
Total Liabilities | $ | 8,186 | | $ | 8,186 | | $ | - | | $ | - | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
NOTE 5 – Non-Qualified Deferred Compensation Plan
Effective December 2007, the Company established the Investors Capital Holdings, Ltd. Deferred Compensation Plan (the “NQ Plan”) as well as a Rabbi Trust Agreement for this plan. ICC is the NQ Plan’s sponsor. The unfunded NQ Plan enables eligible ICC Representatives to elect to defer a portion of earned commissions, as defined by the NQ Plan. The total amount of deferred compensation was $a105,722 and $103,156 for the three months ended June 30, 2012 and 2011, respectively.
NOTE 6- LITIGATION AND REGULATORY MATTERS
In the ordinary course of business, the Company and its subsidiaries are routinely defendants in or parties to pending and threatened legal actions and proceedings brought on behalf of various claimants, some of which seek material and/or indeterminable amounts. Certain of these actions and proceedings are based on alleged violations of consumer protection, securities and other laws and may involve claims for substantial monetary damages asserted against the Company and its subsidiaries. Also, the Company and its subsidiaries are subject to regulatory examinations, information gathering requests, inquiries, investigations and formal administrative proceedings that may result in fines or other negative impact on the Company. ICC, as a duly registered broker/dealer and investment advisor, is subject to regulation by the SEC, FINRA, NYSE - Amex (formerly the American Stock Exchange) and other state securities regulators.
The Company maintains Errors and Omissions (“E&O”) insurance to protect itself from potential damages and/or legal costs associated with certain litigation and arbitration proceedings and, as a result, in the majority of cases, the Company’s exposure is limited to $100,000 or $250,000 (effective January 2012 for only alternative investment product related settlements) in any one case, subject to policy limitations and exclusions.
The Company also maintains a fidelity bond to protect itself from potential damages and/or legal costs related to fraudulent activities pursuant to which the Company’s exposure is usually limited to a $350,000 deductible per case, subject to policy limitations and exclusions.
The Company recognizes a legal liability when management believes it is probable that a liability has been incurred and the amount can be reasonably estimated. Conclusions on the likelihood that a liability has been incurred and estimates as to the amount of the liability are based on consultations with the General Counsel of the broker-dealer who, when situations warrant, may engage and consult external counsel to assist with the evaluation and handle certain matters. Legal fees for defense costs are expensed as incurred and classified as professional services within the consolidated statements of income.
As of June 30, 2012 and March 31, 2012, the Company had accrued expenses of approximately $1,193,041 and $1,217,300, respectively, in legal fees and estimated probable settlement costs relating to the Company’s defense in various legal matters. It is possible that some of the matters could require the Company to pay damages or make other payments or establish accruals in amounts that could not be estimated and/or could exceed those accrued as of June 30, 2011. Key components of both the June 30, 2012 and March 31, 2012 accrual included (i) estimated settlements and claims arising from alleged poor performance of certain real estate investments trusts (“REITs”) and oil and gas limited partnerships that have experienced bankruptcy or other financial difficulties during or in connection with the recent global liquidity crisis and (ii) regulatory assessments that exceeded our expectations.
Note 7 - Stock Based Compensation
The Company periodically issues common stock to employees, directors, officers, representatives and other key individuals in accordance with the provisions of the shareholder approved equity compensation plans. The Company measures and recognizes compensation expense for all share-based awards made to representatives,
officers, employees and directors based on estimated fair values.
Stock Awards
Shares of stock granted under Company’s equity incentive plans (the “Equity Plans”) as of June 30, 2012 have been either fully vested at date of grant or subject to vesting over time periods varying from one to five years after the date of grant, unvested shares being subject to forfeiture in the event of termination of the grantee’s relationship with the Company, other than for death or disability. The compensation cost associated with these stock grants is recognized over the vesting period of the shares and is calculated as the market value of the shares on the date of grant. Stock grants have been recorded as deferred compensation, which is a component of paid-in capital within stockholders’ equity on the Company’s Consolidated Balance Sheets.
The following activity occurred during the three months ended June 30, 2012:
| | | | | | | |
| | | | | | | |
| | | | Weighted Ave | Weighted Average | | |
| | Shares | | Stock Price | Vested Life | | Fair Value $ |
Non-vested at April 1, 2012 | | 77,402 | $ | 4.41 | 2.54 years | $ | 341,343 |
| | | | | | | |
Granted | | - | | - | | | - |
Less: vested | | (9,240) | | 4.30 | | | (39,732) |
Less: canceled | | (4,186) | | 4.77 | | | (19,967) |
| | | | | | | |
Non-vested at June 30, 2012 | | 63,976 | $ | 4.41 | 2.05 years | $ | 282,134 |
| | | | | | | |
| | | | Weighted Ave | Weighted Average | | |
| | Shares | | Stock Price | Vested Life | | Fair Value $ |
Non-vested at April 1, 2011 | | 35,891 | $ | 3.72 | 1.99 years | $ | 133,515 |
| | | | | | | |
Granted | | - | | - | | | - |
Vested | | (6,916) | | 3.84 | | | (26,557) |
Canceled | | (645) | | 3.35 | | | (2,154) |
| | | | | | | |
Non-vested at June 30, 2011 | | 28,330 | $ | 3.70 | 1.89 years | $ | 104,828 |
The Company’s net income for the three months ended June 30, 2012 includes $0.01 million of compensation costs related to the Company’s grants of restricted stock to directors and $0.03 million for grants to independent representatives under the Plans. In the prior period, the Company’s net loss included $0.03 million of stock compensation to executives, and $0.02 million in compensation to independent representatives under the plans.
Stock Option Grants
The following table summarizes information regarding the Company's employee and director fixed stock options as of June 30, 2012 and, 2011:
Fixed Options | | | Weighted-Average | | | Weighted-Average |
| | Shares | Exercise Price | | Shares | Exercise Price |
Outstanding at beginning of period | | 150,000 | $1.00 | | 150,000 | $1.00 |
Granted | | - | | | - | |
Canceled | | - | | | - | |
Outstanding at end of period | | 150,000 | $1.00 | | 150,000 | $1.00 |
| | | | | | |
Options exercisable at period end | | 150,000 | | | 150,000 | |
| | | | | | |
Weighted-average fair value of | | | | | | |
options granted during the period | | - | | | - | |
The intrinsic value of the stock options was $480,000 at June 30, 2012 and $795,000 at June 30, 2011.
The following table summarizes further information about employee and Directors' fixed stock options outstanding as of June 30, 2012:
| Options Outstanding | | | Options Exercisable |
| Range of Exercise Prices | Number Outstanding | Weighted-Average RemainingContractual Life | | | Exercise Price | Number Exercisable | | | Weighted-Average Exercise Price |
| | | | | | | | | | |
$ | 1.00 | 150,000 | | | $ | 1.00 | 150,000 | | $ | 1.00 |
Note 8 - Segment Information
The Company's reportable operating segments are (i) independent brokerage services offered through ICC and (ii) asset management (investment advisory) services offered through ICC, doing business as ICA. The segments are strategic business units that are managed separately. They operate under different and complex regulatory systems, provide different services and require distinct marketing strategies and varied technological and operational support. They also have differing revenue models; ICC earns transactional commissions and various fees in connection with the brokerage of securities for its customers, whereas ICA generates recurring revenue from fees that are based on the value of assets under management.
Assets are allocated among ICH and its subsidiaries based upon legal ownership and the services provided. Total period-end assets are presented on a stand-alone basis, i.e., without inter-company eliminations. The Company does not allocate income taxes or unusual items to segments. Corporate items and eliminations are presented in the following table for the purpose of reconciling the stand-alone asset amounts to total consolidated assets.
Currently, management allocates all expenses separately to the parent and ICC, including allocation of costs associated with shared personnel, based upon time studies and a determination of which entities are the beneficiaries of the services rendered by the personnel. Within ICC, expenses are further allocated between the two segments, ICC and ICA as follows: overhead expenses pro rata to revenue, direct full-time and time-shared employee costs based on the segments being served, and other personnel-related expenses pro rata to head count.
Segment reporting is as follows for the quarter ended:
| | Commissions | | Advisory | | ICH | | ICH Securities | | | Totals |
| | | | | | | | | | | |
Non-interest revenue | $ | 16,561,142 | $ | 4,175,658 | $ | (12,928) | $ | - | | $ | 20,723,872 |
Revenue from transaction with | | | | | | | | | | | |
other operating segments: | | 229,916 | | - | | - | | - | | $ | 229,916 |
Interest and dividend income, net | | 78,647 | | - | | 6 | | - | | $ | 78,653 |
Depreciation and amortization | | 81,854 | | 1,167 | | - | | - | | $ | 83,021 |
Income (loss) from operations | | 55,901 | | 570,878 | | (177,763) | | 6 | | $ | 449,022 |
Period end total assets | | 13,765,374 | | 421,381 | | 2,517,783 | | 10,336 | | $ | 16,714,874 |
Corporate items and eliminations | | - | | - | | - | | - | | $ | (1,471,237) |
| | | | | | | | | | | |
| | Commissions | | Advisory | | ICH | | ICH Securities | | | Totals |
| | | | | | | | | | | |
Non-interest revenue | $ | 17,120,079 | $ | 4,230,071 | $ | (10,717) | $ | - | | $ | 21,339,433 |
Revenue from transaction with | | | | | | | | | | | |
other operating segments: | | 356,546 | | - | | - | | - | | $ | 356,546 |
Interest and dividend income, net | | 103,226 | | - | | 55 | | 13 | | $ | 103,294 |
Depreciation and amortization | | 102,520 | | 1,167 | | - | | - | | $ | 103,687 |
Income (loss) from operations | | (943,389) | | 516,434 | | (389,220) | | 13 | | $ | (816,162) |
Period end total assets | | 15,304,156 | | 884,387 | | 2,470,587 | | 10,303 | | $ | 18,669,433 |
Corporate items and eliminations | | - | | - | | (780,386) | | - | | $ | (780,386) |
+
NOTE 9- SUBSEQUENT EVENTS
Several events took place after the balance sheet date but prior to the filing of this document. First, on July 5, 2012, ICH entered into a purchase and sale agreement, still pending FINRA approval, to purchase a shell broker dealer. Second, effective August 2, 2012, the Company fully satisfied all contractual obligations for compensation, benefits and other amounts as set forth in the Consultant Agreement of its former Chairman, Theodore E. Charles, as filed with the SEC on August 2, 2011. Finally, effective August 06, 2012, the Company terminated the piggy back clearing agreement it entered into with Essex Securities dated June 24, 2003, whose owner is the spouse of the Company’s former Chairman. The Company has evaluated subsequent events through the date the financial statements were available to be filed. There were no material subsequent events requiring adjustment to or disclosure in these financial statements.
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Management's Discussion and Analysis reviews our consolidated financial condition as of June 30, 2012 and March 31, 2012, the consolidated results of operations for the three months ended June 30, 2012 and 2011 and, as appropriate, factors that may affect future financial performance. The discussion should be read in conjunction with the condensed consolidated financial statements and related notes included elsewhere in this Form 10-Q. Unless context requires otherwise, as used in this Management’s Discussion and Analysis (i) the “current period” means the three months ended June 30, 2012, (ii) the “prior period” means the three months ended June 30, 2011, (iii) an increase or decrease compares the current period to the prior period, and (iv) non-comparative amounts refer to the current period.
FORWARD-LOOKING STATEMENTS
This report contains certain “forward-looking statements” within the meaning of the U.S. Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Exchange Act. Forward-looking statements relate to expectations, beliefs, projections, future plans, strategies, anticipated events, trends and other matters that are not historical facts and may include words such as "anticipate," "believe," "plan," "estimate," "expect," "intend," "will," "should," "may," and other similar expressions. These forward-looking statements reflect our current views about future events and are subject to risks, uncertainties and changes in circumstances that might cause future events, achievements or results to differ materially from those expressed or implied by the forward-looking statements. Readers are directed to discussions of risks and uncertainties that may be found in this report and other documents filed by the Company with the SEC. We specifically disclaim any obligation to update or revise any forward-looking information, whether as a result of new information, future developments or otherwise.
Overview
We are a financial services holding company that, through our subsidiaries, provides brokerage, investment advisory, insurance and related services. We operate in a highly regulated and competitive industry that is influenced by numerous external factors such as economic conditions, marketplace liquidity and volatility, monetary policy, global and national political events, regulatory developments, competition and investor preferences. Our revenues and net earnings may be either enhanced or diminished from period to period by these and other external factors.
OUR BUSINESS
We operate primarily through our subsidiary, ICC, as a broker-dealer and, doing business as ICA, as a registered investment advisor, with a national network of independent financial representatives.
Broker-Dealer Services
We provide broker-dealer services in support of trading and investment by our representatives’ customers in securities, including corporate equity and debt securities, U.S. Government securities, municipal securities, mutual funds, limited partnerships and other alternative investments, variable annuities and variable life insurance. We also provide related services such as market information, Internet brokerage, portfolio tracking facilities and records management.
Investment Advisory Services
We provide investment advisory services, including asset allocation and portfolio rebalancing, for our representative’s customers through ICA.
Recruitment and Support of Representatives
A key component of our business strategy is to recruit well-established, productive representatives who provide superior service to their clients. Additionally, we assist our representatives in developing and expanding their business by providing a variety of support services and a diversified range of investment products for their clients. We focus on providing substantial added value to our representatives’ practices, enabling them to be more productive, particularly in high margin lines such as advisory services and brokerage.
Support provided to assist representatives in pursuing consistent, profitable sales growth takes many forms, including automated trading systems, targeted financial assistance and a network of communication links with investment product companies. Regional and national conventions provide forums for interaction to improve product knowledge, sales and client satisfaction. In addition, we provide our representatives with programs and tools to grow their businesses both through new client acquisition and advancement of existing client relationships. These programs enhance our ability to attract and retain productive representatives.
OUR PROCESS
Online Brokerage
Registered representatives have direct market access to submit security transactions for their clients through the use of an online brokerage platform for trade execution serviced by Pershing acting as our clearing firm.
Check and Application
Check and application revenue is obtained through a process where a check and a product application is delivered to us for processing that includes principal review and submission to the variable annuity, mutual fund, direct participation or other investment product company. Investments in technology are facilitating our migration over time from a paper intensive to a more paperless process. This shortens the transaction cycle, reduces errors and creates greater efficiencies.
Bond Brokerage
Our fixed-income brokerage desk uses a network of regional and primary dealers to execute trades across a broad array of fixed income asset classes. The desk also utilizes dealer-only electronic services that allow the desk to offer inventory and to execute trades. Our fixed income traders work with our representatives to develop portfolios for clients.
Asset Allocation
Asset allocation services are made available through ICA. Our services include the design, selection and rebalancing of investment portfolios on behalf of our representatives' clients. We also provide tools, services and guidance that enable our representatives to provide these investment services directly to their clients. These services, for the most part, are conducted through our online brokerage platform. Other allocation services are performed directly by fund companies.
CRITICAL ACCOUNTING POLICIES
In General
Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”). The Company believes that of its significant accounting policies and litigation and regulatory matters to the Company’s condensed consolidated financial statements contained herein), those dealing with revenue recognition, allowance for doubtful accounts receivable, taxes and accrual of legal expenses involve a particularly high degree of judgment and complexity. Our accounting policies require estimates and assumptions that affect the amounts of assets, liabilities, revenues and expenses reported in the condensed consolidated financial statements. By their nature, estimates involve judgment based upon available information. Actual results or amounts can and do differ from estimates and the differences can have a material
effect on the condensed consolidated financial statements. Therefore, understanding these policies is important to understanding the reported results of operations and the financial position of the Company.
Off Balance Sheet Risk
We execute securities transactions on behalf of our customers on a fully-disclosed basis. If either the customer or a counter-party fails to perform, we, by agreement with our clearing broker, may be required to discharge the obligations of the non-performing party. In such circumstances, we may sustain a loss if the market value of the security is different from the contract value of the transaction. We seek to control off-balance sheet risk by monitoring the market value of securities held or given as collateral in compliance with regulatory and internal guidelines. Pursuant to such guidelines, our clearing company requires that we reduce positions when necessary. We also complete credit evaluations where there is thought to be credit risk.
Reserves
We record reserves related to legal proceedings in “accrued expenses” in the condensed consolidated balance sheet. The determination of these reserve amounts requires significant judgment on the part of management. Management considers many factors including, but not limited to: the amount of the claim; the amount of the loss in the client’s account; the basis and validity of the claim; the possibility of wrongdoing on the part of an employee or representative of the Company; previous results in similar cases; and legal precedents. Each legal proceeding is reviewed with counsel in each accounting period and the reserve is adjusted as deemed appropriate by management. Any change in the reserve amount is recorded in the condensed consolidated financial statements and is recognized as a charge/credit to earnings in that period. The assumptions made by management in determining the estimates of reserves may be incorrect and the actual costs upon settlement of a legal proceeding may be greater or less than the reserved amount. See “Note 6, Litigation and Regulatory Matters”.
KEY INDICATORS OF FINANCIAL PERFORMANCE FOR MANAGEMENT
Management periodically reviews and analyzes our financial performance across a number of measurable factors considered to be particularly useful in understanding and managing our business. Key metrics in this process include productivity and practice diversification of representatives, top line commission and advisory services revenues, operating expenses, legal costs, taxes, earnings per share and adjusted EBITDA.
PRODUCTIVITY OF REPRESENTATIVES
Management believes that improving the overall quality of our independent representatives is a key to achieving growth in revenues and earnings. We believe that upgrading the business practices of our representatives not only grows revenue, but assists in limiting the cost of overhead functions and representative noncompliance. We strive to continually improve the overall quality of our force of representatives by:
| · | assisting representatives to improve their skills and practices, |
| · | recruiting higher-producing representatives, and |
| · | terminating low quality representatives. |
A key metric that we use to assess the average quality of our producing (non-staff) representatives is per capita rep-generated revenue based on a rolling 12-month period. Data for the 12-month periods ended June 30, 2012 and 2011 are presented below:
| | | | | | | | | | |
| | Twelve Months Ended | | | Change |
| | June 30, 2012 | | | June 30, 2011 | | | Dollar | | Percentage |
Rep-generated revenue: | | | | | | | | | | |
Commission | $ | 62,616,936 | | $ | 68,350,777 | | $ | (5,733,841) | | -8.4% |
Advisory | | 15,886,118 | | | 15,428,500 | | | 457,618 | | 3.0% |
Other fee income | | 856,306 | | | 715,961 | | | 140,345 | | 19.6% |
| $ | 79,359,360 | | $ | 84,495,238 | | $ | (5,135,878) | | -6.1% |
Number of representatives | | 467 | | | 525 | | | (58) | | -11.0% |
| | | | | | | | | | |
Average revenue per representative | $ | 169,934 | | $ | 160,943 | | $ | 8,991 | | 5.6% |
We believe that the 5.6% growth in per capita rep-generated revenue is the result of organic revenue growth from recruiting higher-producing representatives, and continually paring down of the number of lower-producing registered representatives.
COMPARISON OF THE THREE MONTHS ENDED JUNE 30, 2012 AND 2011
Results of Operations
| | | | | | | |
| Quarter Ended June 30, | | Change |
| 2012 | | 2011 | | Dollar | | Percentage |
Revenues: | | | | | | | |
Commission | $ 16,088,506 | | $ 16,916,508 | | $ (828,002) | | -4.9% |
Advisory fees | 4,110,673 | | 4,183,052 | | (72,379) | | -1.7% |
Other fee income | 339,103 | | 103,393 | | 235,710 | | 228.0% |
Other income | 264,243 | | 239,773 | | 24,470 | | 10.2% |
Total revenue | 20,802,525 | | 21,442,726 | | (640,201) | | -3.0% |
| | | | | | | |
Expenses: | | | | | | | |
Commissions and advisory fees expense | 16,610,153 | | 17,094,637 | | (484,484) | | -2.8% |
Compensation and benefits | 1,579,260 | | 2,103,025 | | (523,765) | | -24.9% |
Regulatory, legal and professional | 875,632 | | 1,275,790 | | (400,158) | | -31.4% |
Brokerage, clearing and exchange fees | 338,101 | | 505,460 | | (167,359) | | -33.1% |
Technology and communications | 296,978 | | 368,832 | | (71,854) | | -19.5% |
Marketing and promotion | 241,273 | | 307,018 | | (65,745) | | -21.4% |
Occupancy and equipment | 186,108 | | 235,411 | | (49,303) | | -20.9% |
Other administrative | 217,030 | | 360,771 | | (143,741) | | -39.8% |
Interest | 8,968 | | 7,944 | | 1,024 | | 12.9% |
Total expenses | 20,353,503 | | 22,258,888 | | (1,905,385) | | -8.6% |
| | | | | | | |
Operating income (loss) | 449,022 | | (816,162) | | 1,265,184 | | -155.0% |
Provision for income taxes | 187,340 | | 439,547 | | (252,207) | | -57.4% |
| | | | | | | |
Net income (loss) | $ 261,682 | | $ (1,255,709) | | 1,517,391 | | -120.8% |
Adjusted EBITDA: | $ 583,998 | | $ (352,390) | | $ 936,388 | | -265.7% |
| | | | | | | |
Adjustments to conform adjusted EBITDA to GAAP Net income (loss): | | | | | | | |
Income tax provision | (187,340) | | (439,547) | | 252,207 | | -57.4% |
Interest expense | (8,968) | | (7,944) | | (1,024) | | 12.9% |
Depreciation and amortization | (83,021) | | (108,468) | | 25,447 | | -23.5% |
Non-cash compensation | (42,987) | | (48,069) | | 5,082 | | -10.6% |
Non-recurring professional fees | - | | (299,291) | | 299,291 | | -100.0% |
| | | | | | | |
Net income (loss) | $ 261,682 | | $ (1,255,709) | | $ 1,517,391 | | -120.8% |
ADJUSTED EBITDA
Earnings before interest, taxes, depreciation and amortization (“EBITDA”), as adjusted by eliminating other non-cash expense, gains or losses on sales of assets, and various non-recurring items (“adjusted EBITDA”), is a key metric we use in evaluating our financial performance. Adjusted EBITDA eliminates items that we believe
are not part of our core operations, are non-recurring items of revenue or expense, or do not involve a cash outlay, such as stock-related compensation and professional fees incurred in connection with the Company’s registration statement on Form S-3 that closed on August 2, 2011 and related matters. We consider adjusted EBITDA important in monitoring and evaluating our financial performance on a consistent basis across multiple time periods. We also use adjusted EBITDA as an important measure, among others, to analyze and evaluate financial and strategic planning decisions.
Adjusted EBITDA is considered a non-US GAAP financial measure as defined by Regulation G promulgated by the SEC under the Securities Act. Adjusted EBITDA should be considered in conjunction with, rather than as a substitute for, important US GAAP financial measures including pre-tax income, net income and cash flows from operating activities. Items excluded from adjusted EBITDA are significant and necessary components to the operations of our business; therefore, adjusted EBITDA should only be used as a supplemental measure of our operating performance.
First quarter Adjusted EBITDA, was $0.58 million, an increase of 265.7% from a $0.35 million loss before interest, taxes, depreciation, amortization, and non-recurring professional fees in the comparative quarter, primarily due to increased operating income in the current period.
REVENUE
Revenues decreased by $0.64 million or by 3.00% primarily due to a reduction in commission revenue while advisory fees were consistent with the prior period. The decline in commission revenue can be attributed to lower trading volume resulting from investor’s cautious sentiment due to current market conditions. Also, commissions earned from our direct business slowed, with resulting fewer investment contributions. Advisory fees remained steady mostly because of asset values increasing concurrent with positive market growth comparative to the financial markets during the prior period.
Our advisor-directed managed assets program, A-MAP, where investment advisory services are provided directly by our independent representatives, continues to contribute the majority of advisory services revenue.
Other fee income increased primarily as a result of technology fees from newly released Capital Connect, as well as licensing fees, annual administrative fees, and financial planning fees.
The increase in other revenue, which consists of net marketing revenues and interest income, resulted primarily from an increase in marketing allowances from product sponsor programs reflecting an increase in sales volumes of alternative investment products.
EXPENSES
Total expenses decreased by $1.91 million, or 8.56 %, principally as a result of decreases in commissions and advisors fees paid to our representatives, compensation and benefits, and regulatory, legal and non-recurring professional fees.
Commissions and advisory fees paid to our representatives represent a percentage of revenue of our broker-dealer; accordingly, much of the $0.48 million decrease in commissions and advisor fees payout reflects a corresponding decrease in revenue. Our ratio of commission payout as compared to the total of representative-produced revenue increased this quarter as a result of forgivable loan amortization, advisory platform fees, and a reduction in trading volume.
The decrease in regulatory, legal and professional expenses was driven principally by a decrease in nonrecurring professional fees related to our registration statement on Form S-3 and related matters which were completed in the prior period. Also, there was also a decline in legal settlements in this period as compared to the prior period in which we had a settlement for disgorgement of commissions on alternative investments products.
We will continue to incur legal fees and settlement costs as we operate in a litigious, regulated industry. In addition, from time to time regulatory agencies and self-regulatory organizations institute investigations into
industry or firm practices, that also may result in the imposition of financial or other sanctions. We invest significant resources to mitigate litigation and regulatory exposure by promoting sound operational procedures and obtaining comprehensive insurance coverage.
The decrease in compensation and benefits is attributable to the cost management initiatives the Company implemented in January 2012, offset by increased health benefit costs and one-time separation costs associated with former employees.
We had an income tax provision of $0.19 million for the three months ended June 30, 2012 as compared to $0.44 million income tax provision for the prior period. The income tax rates for the 2012 and 2011 periods do not bear a customary relationship to effective tax rates primarily as a result of the increase in the permanent differences created by various accruals for each of the periods presented, particularly regulatory assessments, costs that were associated with our registration statement filing, and non-deductible executive compensation.
OPERATING AND NET INCOME
Results of operations were positively impacted by reduced operating costs in all categories. Specifically, we had fewer litigation and regulatory settlements, reduced professional fees and lower total compensation costs. The Company reported $0.45 million in operating income as compared to $0.82 million of operating loss for the prior period. The Company’s net income was $0.26 million, or $0.04 per basic and diluted net income per share, compared to net loss of $1.26 million, or $0.19 basic and diluted net loss per share, for the prior period.
The Company’s net profit of $0.26 million was principally the result of decreased non-recurring professional fees, as well as ongoing evaluation of strategic costs. The Company implemented specific expense reductions during the fourth quarter of last year to lessen exposure to operating losses while applying resources to sustain our recruiting and technology initiatives, all the while addressing growing compliance requirements. The Company is focused on growing revenues organically, therefore is supporting its representatives in growing their business through our internally developed CapitalCONNECT technology and related practice management programs.
Liquidity and Capital Resources
Our primary source of liquidity remains cash flows from operations, primarily from our broker-dealer and investment advisory business. Decisions on the allocation of capital include projected profitability and available cash flows, risk management and regulatory capital requirements. A key to this approach is ensuring that industry-standard controls are effective to support our operations and those of our representatives while ensuring sufficient liquidity.
As of June 30, 2012, cash and cash equivalents totaled $4.22 million as compared to $4.54 million as of March 31, 2012. Working capital as of June 30, 2012 was $4.88 million as compared to $4.16 million as of March 31, 2012. The ratio of current assets to current liabilities was 1.79 to 1 as of June 30, 2012, as compared to 1.61 to 1 as of March 31, 2012.
Operations provided $0.36 million in cash for the current period, as compared to $0.69 million of operating cash provided in the prior period. When comparing the current period cash flow to the prior period cash flow from operating activities the significant changes were from net income and from account balances held at our clearing firm.
For our current level of operating activities, we believe that our operations and current capital resources will be sufficient to fund our working capital needs for the next twelve months. The Company may, however, seek additional capital within the next 12 months, should it elect to continue pursuing a strategy that incorporates the use of both forgivable and non-forgivable loans to induce newly-recruited financial advisors to join ICC.
Net cash flows used in investing activities in the current period represent purchases in equipment, collection of principal payments on a note receivable, capitalization of software for internal use, and contributions on an executive life insurance policy. Net cash flows used in the prior period were relatively consistent with the current period’s investing activities.
Cash flows for financing activities in the current period increased slightly when compared to the prior period as we paid $0.67 million and $0.53 million in loan payments to finance E&O insurance premiums, respectively, for the periods ended June 30, 2012 and 2011. The Company has a line of credit (“line”) with specific financial covenants with its financial institution. This line was renewed and amended, effective April 19, 2012. Although there were no borrowings, the Company achieved the required operating results to meet those covenants as of June 30, 2012.
REGULATORY NET CAPITAL
Cash disbursements can have a material impact on our registered broker dealer’s regulatory net capital. ICC is subject to the SEC Uniform Net Capital Rule (Rule 15c3-1) which requires our broker-dealer subsidiary to maintain minimum net capital. As of March 31, 2011 and going forward, ICC computes net capital requirements under the alternative method, which requires firms to maintain minimum net capital, as defined, equal to the greater of $250,000 or 2% of aggregate debit balances. Repayment or prepayment of subordinated debt, if any, and withdrawal of equity from retiring partners or officers is subject to net capital not falling below 5% of aggregate debits or 120% of minimum net capital requirement.
As of June 30, 2012, ICC had net capital of $2.01 million (i.e., an excess of $1.76 million) as compared to net capital of approximately $1.43 million (i.e., an excess of $1.18 million) as of March 31, 2012.
Commitments and Contingencies
We are obligated under various lease agreements covering office space, which will expire March 31, 2015. Options to renew for additional terms are included under the lease agreement. Certain leases contain provisions for escalation of minimum lease payments contingent upon increases in real estate taxes. The Company is currently attempting to resolve a dispute with the lessor, specific to the tenancy at 230 Broadway Lynnfield, MA as a result of property damages that are preventing occupancy and use of all leased space.
The total minimum rental due in future periods under these existing agreements as of June 30, 2012 is as follows for the years ended March 31,
| | | |
| | 2013 | $ 211,687 |
| | 2014 | 276,354 |
| | 2015 | 282,214 |
| | 2016 | 24,000 |
| | 2017 | 24,000 |
| | | |
| | | $ 818,255 |
Total lease expense for office space approximated $0.06 and $0.09 million for the three months ended June 30, 2012 and 2011, respectively.
ITEM 4. CONTROLS AND PROCEDURES
Report of Management on Internal Control Over Financial Reporting
Disclosure controls are procedures designed to ensure that information required to be disclosed in the Company's reports filed under the Exchange Act, such as this report, is recorded, processed, summarized, and reported within the time periods specified in the SEC's rules and forms. Disclosure controls are also designed to ensure that such information is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable, not absolute, assurance of achieving the desired control objectives, as the Company's are designed to do, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
As of June 30, 2012, we carried out an evaluation, under the supervision and with the participation of our management, including our Principal Executive Officer and Principal Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act. Based upon that evaluation, our Principal Executive Officer and Principal Financial Officer concluded that our disclosure controls and procedures are effective in enabling us to record, process, summarize and report information required to be included in our periodic SEC filings within the required time period, and to ensure that information required to be disclosed in such reports that we file or submit under the Securities Exchange Act is accumulated and communicated to our management, including our Principal Executive Officer and Principal Financial Officer, to allow timely decisions required regarding required disclosure.
There have been no changes in our internal controls over financial reporting that occurred during the period covered by this Report that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company operates in a highly litigious and regulated business, and the Company often is made a defendant in arbitrations and other legal proceedings that are incidental to our securities business. The Company typically vigorously contests the allegations of the complaints and believes that there are meritorious defenses in these matters. From time to time the Company also is the subject of regulatory investigations and proceedings. Counsel often is unable to confidently predict the likelihood of an outcome, whether favorable or unfavorable, in such matters because of routine and inherent uncertainties. For the majority of pending claims, the Company's current errors and omissions (E&O) policy limits the Company’s maximum exposure in any one case to $100,000 or $100,000/$250,000 ($250,000 is effective January 2012 for alternative investment product only related settlements) in any one case, subject to policy limitations and exclusions. The Company also maintains a fidelity bond to protect itself from potential damages and/or legal costs related to fraudulent activities pursuant to which the Company’s exposure is usually limited to $350,000, subject to policy limitations and exclusions.
ITEMS 2 – 5.
None.
