INVESTORS CAPITAL HOLDINGS, LTD. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED JUNE 30, 2013 AND 2012 (UNAUDITED)
| | | | | |
SIX MONTHS ENDED | | |
| | Period Ended September 30, |
| | 2013 | | | 2012 |
Cash flows from operating activities: | | | | | |
Net (loss) income | $ | (1,141,099) | | $ | 541,903 |
Adjustments to reconcile net (loss) income to net cash | | | | | |
provided by operating activities: | | | | | |
Depreciation and amortization | | 120,829 | | | 164,017 |
Deferred taxes, net | | (447,636) | | | 445,240 |
Stock-based compensation | | 197,884 | | | 90,903 |
Unrealized gain (loss) in marketable securities | | 14,618 | | | (19,974) |
Non-qualified deferred compensation investment | | 32,934 | | | 30,394 |
Market adjustment cash surrender value life insurance policy | | (10,329) | | | (1,519) |
Charge to commission expense (forgivable loans) | | 218,211 | | | 174,359 |
Allowance for bad debt expense | | 5,000 | | | 2,708 |
Change in operating assets and liabilities: | | | | | |
Accounts receivable and Other receivables | | 1,284,925 | | | (403,682) |
Prepaid expenses and other | | 304,719 | | | (142,391) |
Loans receivable from registered representatives | | (486,471) | | | (102,984) |
Income taxes | | (49,078) | | | (33,480) |
Accounts payable | | (578,708) | | | 185,720 |
Securities, net | | - | | | 7,863 |
Accrued expenses | | 825,171 | | | (41,076) |
Commissions payable | | 79,411 | | | 43,283 |
Unearned revenue | | 333,957 | | | 306,363 |
Net cash provided by operating activities | | 704,338 | | | 1,247,647 |
| | | | | |
Cash flows from investing activities: | | | | | |
Acquisition of property and equipment | | (9,054) | | | (4,684) |
Cash surrender value life insurance policies | | (18,000) | | | - |
Proceeds from investments | | (16,994) | | | - |
Net cash used in investing activities | | (44,048) | | | (4,684) |
| | | | | |
Cash flows from financing activities: | | | | | |
Excess tax benefit related to stock awards | | 40,529 | | | - |
Payments on note payable | | (1,057,186) | | | (1,298,392) |
Net cash used in financing activities | | (1,016,657) | | | (1,298,392) |
| | | | | |
Net decrease in cash and cash equivalents | | (356,367) | | | (55,429) |
Cash and cash equivalents, beginning of period | | 6,589,698 | | | 4,537,713 |
Cash and cash equivalents, end of period | $ | 6,233,331 | | $ | 4,482,284 |
| | | | | |
Supplemental disclosures of cash flow information: | | | | | |
Interest paid | $ | 13,774 | | $ | 13,803 |
Income taxes paid | $ | 11,000 | | $ | - |
| | | | | |
See notes to condensed consolidated financial statements. | | | | | |
INVESTORS CAPITAL HOLDINGS, LTD. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2013
(UNAUDITED)
Note 1 – Organization AND Basis of Presentation
Incorporated in 1995 under Massachusetts law and redomesticated under Delaware law in 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 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. (“ICCIA”) 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. |
· | Advisor Direct, Incorporated (“AD”) is a wholly-owned subsidiary. On January 24, 2013, Investors Capital Holdings, Ltd. acquired all the assets of a shell broker-dealer for the cash purchase price of $32,500. AD is a Broker-Dealer registered with the SEC and is a member of FINRA. AD is registered to operate as a (k)(1) Broker-Dealer where principal transactions are limited to mutual funds and/or variable annuities only. |
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 months and six months period ended September 30, 2013 are not necessarily indicative of the results that may be expected for the year ending March 31, 2014. The balance sheet at March 31, 2013 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, 2013 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, 2013. 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.
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 $82,950 and $86,379, for the three months period ended September 30, 2013 and 2012, respectively and $218,211 and $174,359 for the six months period ended September 30, 2013 and 2012, 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 4.25% to 8.25% annually. Loans to registered representatives are as follows:
| | | | | |
| | | | | |
| September 30, 2013 | | March 31, 2013 |
| | | | | |
Forgivable loans | $ | 1,353,806 | | $ | 1,115,765 |
Other loans | | 619,483 | | | 604,264 |
Less: allowance | | (222,596) | | | (232,596) |
Total loans | $ | 1,750,693 | | $ | 1,487,433 |
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 September 30, 2013 and March 31, 2013 was $304,758 and $330,587, 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 representative deferred compensation, legal settlement accruals, differences between depreciation expenses, and a state net operating loss for financial statement purposes versus tax return purposes.
The Company assesses the realizability of its deferred tax assets to determine whether or not a valuation allowance was required for some or all of its deferred tax assets. The Company considered negative evidence, including its current cumulative loss position for financial reporting purposes over the past three fiscal years, and positive evidence, including its recent earnings and history of taxable income in three of the past five years and its projections of taxable income in the future. The Company also considered that its GAAP losses generated in prior fiscal years included certain significant non-deductible and other non-recurring expenses.
Management concluded that due to the lack of predictability of financial markets, recent instability along with the ongoing regulatory and legal risks and their related defense costs inherent in our industry necessitate we maintain a valuation allowance of approximately $0.5 million. 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.
The Company recognizes and measures its unrecognized tax benefit or expense. The Company assesses the likelihood, based on their technical merit, that tax positions will be sustained upon examination based on the facts, circumstances and information available at the end of each period. The measurement of unrecognized tax expense or benefit is adjusted when new information is available or when an event occurs that requires a change. The Company recognizes the accrual of any interest and penalties related to unrecognized tax expense in income tax expense. No interest or penalties were recognized for the three months and six months period ended September 30, 2013 and 2012. The Company does not have any tax positions as of September 30, 2013 for which it is reasonably possible that the total amounts of unrecognized tax benefit or expense will significantly increase or decrease within twelve months of the reporting date.
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 September 30, 2013:
| | | | | | | | | | | | |
Fair Value Measurements on Recurring Basis | | | | | | | | | | | | |
Assets: | | Total | | | Level 1 | | | Level 2 | | | Level 3 | |
Securities owned at fair value | | | | | | | | | | | | |
Mutual funds | $ | 273,919 | | $ | 273,919 | | $ | - | | $ | - | |
Equities | | 1,306 | | | 1,306 | | | - | | | - | |
Asset backed securities | | 1,806 | | | - | | | 1,806 | | | - | |
Total Assets | $ | 277,031 | | $ | 275,225 | | $ | 1,806 | | $ | - | |
| | | | | | | | | | | | |
Liabilities: | | | | | | | | | | | | |
Securities sold, not yet purchased at fair value | | | | | | | | | | | | |
Exchange traded funds | $ | 17,818 | | $ | 17,818 | | $ | - | | $ | - | |
Equities | | 26,880 | | | 26,880 | | | - | | | - | |
Total Liabilities | $ | 44,698 | | $ | 44,698 | | $ | - | | $ | - | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
The following table presents the Company's fair value hierarchy for those financial assets and liabilities measured at fair value as of March 31, 2013:
| | | | | | | | | | | | |
| | | | | | | | | | | | |
Fair Value Measurements on Recurring Basis | | | | | | | | | | | | |
| | Total | | | Level 1 | | | Level 2 | | | Level 3 | |
Assets: | | | | | | | | | | | | |
Securities owned at fair value | | | | | | | | | | | | |
Mutual funds | $ | 256,509 | | $ | 256,509 | | $ | - | | $ | - | |
Equities | | 354 | | | 354 | | | - | | | - | |
Asset backed securities | | 2,040 | | | - | | | 2,040 | | | - | |
Total assets | $ | 258,903 | | $ | 256,863 | | $ | 2,040 | | $ | - | |
| | | | | | | | | | | | |
Liabilities: | | | | | | | | | | | | |
Securities sold, not yet purchased at fair value | | | | | | | | | | | | |
Equities | | 28,946 | | | 28,946 | | | - | | | - | |
Total Liabilities | $ | 28,946 | | $ | 28,946 | | $ | - | | $ | - | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
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, for which ICC is the NQ Plan’s sponsor. The unfunded NQ Plan enables eligible ICC’s Representatives to elect to defer a portion of earned commissions, as defined by the NQ Plan. The asset represents the representatives’ invested contributions of deferred commissions, investment gains and losses as well as insurance charges while the liability is comprised of the participant deferrals, unrealized gains and losses and any distributions. The total amount of deferred compensation was $149,225 and $108,710 for the three months period ended September 30, 2013 and 2012, respectively and $302,337 and $214,432 for the six months period ended September 30, 2013 and 2012, 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 arbitrations and other 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 securities, consumer protection, labor 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, and 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 $1,000,000 aggregate (effective January 2013 for only certain alternative investment products related to defense costs and indemnities) in any one case, subject to policy limitations and exclusions. Thereafter the $1,000,000 aggregate threshold, the Company’s exposure on these same investments is limited to $150,000 and a ten (10) percent coinsurance. For all other investment products, the Company’s exposure is $100,000 per claim.
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 Company’s General Counsel 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 September 30, 2013 and March 31, 2013, the Company had accrued professional fees relating to the Company’s defense in various legal matters and estimated probable settlement costs of approximately $2,671,834 and $1,534,660, respectively, included in accrued expenses and accounts payable. On October 28, 2013 litigation for a single class action trustee was settled for $2,005,000 which is adjusted and accrued as of September 30, 2013. Additionally, amounts due from the Company’s insurance carrier, totaling $1,000,000, are included in accounts receivable and other receivables on the consolidated balance sheet and included as a reduction of regulatory, legal and professional services in the condensed consolidated statement of operations.
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 September 30, 2013. Key components of the accrual include claims arising from alleged poor performance of certain alternative investments in real estate investments trusts that have experienced bankruptcy or other financial difficulties during or in connection with the recent recession and credit crisis.
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 the Company’s equity incentive plans (the “Equity Plans”) as of September 30, 2013 have been either fully vested at the date of grant or subject to vesting over time periods varying from one to seven 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 Condensed Consolidated Balance Sheets.
The following activity occurred during the three months ended September 30, 2013 and 2012:
| | | | | | | | |
| | | | | Weighted Ave | Weighted Average | | |
| | Shares | | | Stock Price | Vested Life | | Fair Value |
Non-vested at July 1, 2013 | | 413,634 | | $ | 3.84 | 2.53 years | $ | 1,588,355 |
Granted | | - | | | - | | | |
Less: vested | | (24,816) | | | 3.93 | | | (97,527) |
Less: canceled | | - | | | - | | | - |
Non-vested at September 30, 2013 | | 388,818 | | $ | 3.83 | 2.30 years | $ | 1,489,173 |
| | | | | | | | |
| | | | | | | | |
| | | | | Weighted Ave | Weighted Average | | |
| | Shares | | | Stock Price | Vested Life | | Fair Value |
Non-vested at July 1, 2012 | | 63,976 | | $ | 4.41 | 2.05 years | $ | 282,134 |
Granted | | - | | | - | | | - |
Less: vested | | (15,885) | | | 4.58 | | | (72,753) |
Less: canceled | | (589) | | | 5.68 | | | (3,346) |
Non-vested at September 30, 2012 | | 47,502 | | $ | 4.33 | 1.95 years | $ | 205,684 |
| | | | | | | | |
The Company’s net loss for the three months ended September 30, 2013 includes $0.05 million of compensation costs related to the Company’s grants of restricted stock to employees, $0.01 for grants to directors and $0.04 million for grants to independent representatives under the Plans. In the prior period, the Company’s net income included $0.02 million in stock compensation to directors, and $0.03 million in stock compensation to independent representatives under the Equity Plans.
The following activity occurred during the six months ended September 30, 2013 and 2012:
| | | | | | | |
| | | | | | | |
| | | | Weighted Ave | Weighted Average | | |
| | Shares | | Stock Price | Vested Life | | Fair Value $ |
Non-vested at 4/1/2013 | | 440,437 | $ | 3.85 | 2.74 years | $ | 1,695,682 |
Granted | | - | | - | | | - |
Less: vested | | (50,800) | $ | 3.94 | | | (200,152) |
Less: canceled | | (819) | | 4.46 | | | (3,653) |
Non-vested at 9/30/2013 | | 388,818 | $ | 3.83 | 2.30 years | $ | 1,489,173 |
| | | | | | | |
| | | | Weighted Ave | Weighted Average | | |
| | Shares | | Stock Price | Vested Life | | Fair Value $ |
Non-vested at 4/1/2012 | | 77,402 | $ | 4.41 | 2.54 years | $ | 341,343 |
Granted | | - | | - | | | - |
Less: vested | | (25,125) | | 4.48 | | | (112,560) |
Less: canceled | | (4,775) | | 4.88 | | | (23,302) |
Non-vested at 9/30/2012 | | 47,502 | $ | 4.33 | 1.95 years | $ | 205,684 |
The Company’s net loss for the six months ended September 30, 2013 includes $0.10 million of compensation costs related to the Company’s grants of restricted stock to employees, $0.02 for grants to directors and $0.08 million for grants to independent representatives under the Plans. In the prior period, the Company’s net income included $0.02 million in stock compensation to directors, and $0.06 million in stock compensation to independent representatives under the Equity Plans.
Stock Option Grants
The following table summarizes information regarding the Company's employee and director fixed stock options as of September 30, 2013 and, 2012:
| | | | | | |
Employee | | | | | | |
| | 2013 | | 2012 |
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 | | - | | | - | |
Exercised | | - | | | - | |
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 $654,000 at September 30, 2013 and $450,000 at September 30, 2012.
The following table summarizes further information about employee and Directors' fixed stock options outstanding as of September 30, 2013:
| | | | | | | | | | |
| | | | | | | | | | |
| 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
Operating segments are defined as components of a business about which separate financial information is available that is regularly evaluated by management in deciding how to allocate resources and in assessing performance. The Company evaluates performance based on profit and loss from operations before income taxes not including nonrecurring gains and losses.
The Company's has two operating segments, the independent broker-dealer provided by ICC and AD, and asset management and investment advisory services provided by ICA. ICCIA conducts the sale of insurance products and reports that activity at ICC.
The segments are strategic business units that are managed separately. They operate under different 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. ICCIA generates commissions from insurance products. ICA generates recurring revenue from fees earned on the value of assets under management. Lastly, AD is eligible to receive commissions on principal transactions of mutual funds and/or variable annuities only. AD, acquired on January 24, 2013, is operational but had no principal transactions during the current period.
The Company accounts for inter-segment services and transfers as if the services or transfers were to third parties, that is, at current market prices. In presenting segment data, all corporate overhead items are allocated to the segments, and inter-segment revenue, expense, receivables and payables are eliminated. Currently it is impractical to report segment information using geographical concentration.
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. There is no allocation of expenses for AD there are only direct costs for regulatory and professional services in maintaining its shell broker-dealer status.
In addition, ICC reimburses ICH in the form of a management fee for ICH-incurred overhead expenses that are necessary for ICC to effectively conduct its operations. This overhead primarily is in the nature of salaries and professional and legal fees incurred to obtain such services as audit engagements, legal advice, and industry expertise. The Company periodically reviews the effect that these agreements described above may have on the firm’s net capital.
Segment reporting primarily based on revenue components is as follows for the three months ended:
| | | | | | | | | | | |
| | September 30, 2013 |
| | Commissions | | Advisory | | ICH | | ICH Securities | | | Totals |
| | | | | | | | | | | |
Non-interest revenue | $ | 17,611,190 | | 4,607,317 | | (16,729) | | - | | $ | 22,201,778 |
Revenue from transaction with | | | | | | | | | | | |
other operating segments: | $ | 297,889 | | - | | | | - | | $ | 297,889 |
Interest and dividend income, net | $ | 76,019 | | - | | 2 | | 5 | | $ | 76,026 |
Depreciation and amortization | $ | 59,430 | | 917 | | - | | - | | $ | 60,347 |
Income (loss) from operations | $ | (1,509,307) | | 660,423 | | (65,464) | | 5 | | $ | (914,343) |
Period end total assets | $ | 17,071,481 | | 708,145 | | 2,714,727 | | 10,364 | | $ | 20,504,717 |
Corporate items and eliminations | $ | - | | - | | (1,477,175) | | - | | $ | (1,477,175) |
| | | | | | | | | | | |
| | September 30, 2012 |
| | Commissions | | Advisory | | ICH | | ICH Securities | | | Totals |
| | | | | | | | | | | |
Non-interest revenue | $ | 16,237,978 | $ | 4,033,714 | $ | (17,445) | $ | - | | $ | 20,254,247 |
Revenue from transaction with | | | | | | | | | | | |
other operating segments: | $ | 266,558 | | - | | | | - | | $ | 266,558 |
Interest and dividend income, net | $ | 68,513 | | - | | 7 | | - | | $ | 68,520 |
Depreciation and amortization | $ | 79,829 | | 1,167 | | - | | - | | $ | 80,996 |
Income (loss) from operations | $ | 10,888 | | 532,696 | | (113,951) | | 7 | | $ | 429,640 |
Period end total assets | $ | 13,933,230 | | 456,591 | | 2,912,360 | | 10,343 | | $ | 17,312,524 |
Corporate items and eliminations | $ | - | | - | | (1,728,824) | | - | | $ | (1,728,824) |
+
Segment reporting primarily based on revenue components is as follows for the six months ended:
| | | | | | | | | | | |
| | September 30, 2013 |
| | Commissions | | Advisory | | ICH | | ICH Securities | | | Totals |
| | | | | | | | | | | |
Non-interest revenue | $ | 36,168,380 | | 9,084,641 | | (32,873) | | - | | $ | 45,220,148 |
Revenue from transaction with | | | | | | | | | | | |
other operating segments: | $ | 632,264 | | - | | - | | - | | $ | 632,264 |
Interest and dividend income, net | $ | 140,638 | | | | 2 | | 10 | | $ | 140,650 |
Depreciation and amortization | $ | 119,912 | | 917 | | - | | - | | $ | 120,829 |
Income (loss) from operations | $ | (2,607,945) | | 1,145,571 | | (122,087) | | 10 | | $ | (1,584,451) |
Period end total assets | $ | 17,071,481 | | 708,145 | | 2,714,727 | | 10,364 | | $ | 20,504,717 |
Corporate items and eliminations | $ | - | | - | | (1,477,175) | | - | | $ | (1,477,175) |
| | | | | | | | | | | |
| | September 30, 2012 |
| | Commissions | | Advisory | | ICH | | ICH Securities | | | Totals |
| | | | | | | | | | | |
Non-interest revenue | $ | 32,799,117 | $ | 8,209,373 | $ | (30,373) | $ | - | | $ | 40,978,117 |
Revenue from transaction with | | | | | | | | | | | |
other operating segments: | $ | 496,474 | | - | | - | | - | | $ | 496,474 |
Interest and dividend income, net | $ | 147,160 | | - | | 13 | | - | | $ | 147,173 |
Depreciation and amortization | $ | 162,850 | | 1,167 | | - | | - | | $ | 164,017 |
Income (loss) from operations | $ | 29,554 | | 1,140,811 | | (291,715) | | 13 | | $ | 878,663 |
Period end total assets | $ | 13,933,230 | | 456,591 | | 2,912,360 | | 10,343 | | $ | 17,312,524 |
Corporate items and eliminations | $ | - | | - | | (1,728,824) | | - | | $ | (1,728,824) |
NOTE 9- SUBSEQUENT EVENTS
The Company has evaluated subsequent events through the date the financial statements were available to be filed. On October 2, 2013, RCS Capital Corporation (NYSE: RCAP) (“RCAP”) and Investors Capital Holdings, LTD. (“ICH”) announced its entry on October 1, 2013 into a letter of intent (the “Letter of Intent”)
under which RCAP expects to acquire ICH for aggregate consideration of approximately $52.2 million or for a share purchase price of $7.35 for each share of ICH common stock outstanding, on a fully diluted basis. Final terms are expected in a Definitive Merger Agreement. Pursuant to the terms of the letter of intent, the definitive merger agreement between the RCAP and ICH will require that ICH pay RCAP a $3 million termination fee, in certain circumstances, should the merger not be consummated and ICH consummates a business combination transaction with another party other than RCAP. In addition, ICH has agreed to a 45-day exclusivity period subject to reimbursement of certain expenses of RCAP. Finally, on October 27, 2013, the Company executed a definitive merger agreement (the “Merger Agreement”) with RCAP, pursuant to which RCAP will acquire ICH and its subsidiaries, including Investors Capital Corporation, for a total consideration of approximately $52.5 million comprised of cash and RCAP stock. The closing of the transaction is subject to customary closing conditions, including FINRA approval of the proposed change in control, as well as approval of the transaction by ICH stockholders. The transaction is expected to close in the first quarter of 2014.
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Management's Discussion and Analysis is a review, a discussion, and an analysis of our consolidated financial condition as of September 30, 2013 and March 31, 2013, the consolidated results of operations for the three months and six months period ended September 30, 2013 and 2012 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 and six months period ended September 30, 2013, (ii) the “prior period” means the three months and six months period ended September 30, 2012, (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. ICCIA facilitates the sale of insurance products.AD, also a broker-dealer subsidiary, is limited to principal transactions in mutual funds and/or variable annuities only.AD had no principal transactions during the current period. Our principal business location, executive offices, and administration offices are located at Six Kimball Lane, Suite 150, Lynnfield, MA 01940 and it is referred to as our Home office.
On October 27, 2013, RCS Capital Corporation, (“RCAP”) (NYSE: RCAP), a Delaware corporation, and a newly formed wholly owned subsidiary of RCAP entered into an agreement and plan of merger with Investors Capital Holdings, Ltd. (“ICH”) by which RCAP will acquire ICH for approximately $52.5 million, comprised of cash and RCAP common stock. Following the reverse merger, ICH and its subsidiaries, will continue to operate under current management and the “ICH” and “ICC” brands. Additionally, ICH’s Board of Directors voted to approve the agreement and plan of merger on October 27, 2013, as well the fairness opinion prepared for the purposes of evaluating this agreement. The transaction is subject to the approval of ICH’s stockholders, as well as certain regulatory approvals and filings and other customary closing conditions. The transaction is expected to close in the first quarter of 2014.
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, with our various programs. These services, for the most part, are conducted through our online brokerage platform. Other allocation services are performed directly by fund companies. ICA offers several advisory wrap programs that provide managed advisory accounts for our advisors’ clients, as follows:
A-MAP Suite of Advisory Wrap Programs- Rep-As-Portfolio Manager Program
ICA’s suite of A-MAP Program, including A-MAP, A-MAP AT, & A-MAP FT, enables the advisor to assist a client in creating a personalized investment portfolio. The advisor acts as the portfolio manager, with full investment discretion. A-MAP and A-MAP AT are programs where a platform fee is charged by ICA for its services as a registered investment advisor (“RIA”). A-MAP- FT is a program where ICA charges a flat fee in lieu of a platform fee for its services as an RIA.
Fund Select Advisory Wrap Program- Rep-As-Portfolio Manager Program
Fund Select is an advisory program where the advisor creates and manages a customized portfolio constructed primarily of mutual funds.
F-MAP Advisory Wrap Program – Firm managed ETF and Mutual Fund Wrap Program
F-MAP program utilizes a model portfolio established ICA which creates, manages, rebalances, reallocates, and reports on portfolios that consist of but are not limited to: no-load or load-waived mutual funds, ETF's, and/or variable annuities.
S-MAP Advisory Wrap Program – Separate Account Wrap Program
S-MAP is an advisory program where ICA has entered into agreements with Sub-Advisors who are selected by the representatives to provide advisory services to their clients. The S-MAP portfolios are not managed by ICA; rather they are managed by the Sub-Advisor on a discretionary basis.
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.
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, revenue 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 defense and settlement 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:
· | attracting productive and profitable representatives, and |
· | supporting representatives further develop their skills and practices, 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-months ended September 30, 2013 and 2012 are presented below:
| | | | | | | | | | |
| | Twelve Months Ended | | | Change |
| | September 30, 2013 | | | September 30, 2012 | | | Dollar | | Percentage |
Rep-generated revenue: | | | | | | | | | | |
Commission | $ | 68,867,325 | | $ | 62,737,738 | | $ | 6,129,587 | | 9.8% |
Advisory | | 17,297,894 | | | 15,782,395 | | | 1,515,499 | | 9.6% |
Other fee income | | 1,558,280 | | | 1,084,962 | | | 473,318 | | 43.6% |
| $ | 87,723,499 | | $ | 79,605,095 | | $ | 8,118,404 | | 10.2% |
| | | | | | | | | | |
Number of representatives | | 446 | | | 470 | | | (24) | | -5.1% |
| | | | | | | | | | |
Average revenue per representative | $ | 196,689 | | $ | 169,373 | | $ | 27,317 | | 16.1% |
The continued growth in the per capita rep-generated revenue is a direct result of attracting and recruiting new advisors, favorable market conditions and a focused practice management program.
COMPARISON OF THE THREE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
Results of Operations
| | | | | | | |
| Quarter Ended September 30, | | Change |
| 2013 | | 2012 | | Dollar | | Percentage |
Revenue: | | | | | | | |
Commission | $ 17,016,527 | | $ 15,779,387 | | $ 1,237,140 | | 7.8% |
Advisory fees | 4,535,767 | | 3,979,313 | | 556,454 | | 14.0% |
Other fee income | 313,906 | | 337,226 | | (23,320) | | -6.9% |
Other income | 411,604 | | 226,839 | | 184,765 | | 81.5% |
Total revenue | 22,277,804 | | 20,322,765 | | 1,955,039 | | 9.6% |
| | | | | | | |
Expenses: | | | | | | | |
Commissions and advisory fees expense | 17,871,474 | | 16,126,655 | | 1,744,819 | | 10.8% |
Compensation and benefits | 1,613,175 | | 1,460,708 | | 152,467 | | 10.4% |
Regulatory, legal and professional | 2,066,087 | | 977,627 | | 1,088,460 | | 111.3% |
Brokerage, clearing and exchange fees | 355,223 | | 364,697 | | (9,474) | | -2.6% |
Technology and communications | 373,909 | | 327,240 | | 46,669 | | 14.3% |
Advertising, marketing and promotion | 427,118 | | 231,424 | | 195,694 | | 84.6% |
Occupancy and equipment | 136,240 | | 178,191 | | (41,951) | | -23.5% |
Other administrative | 261,462 | | 221,748 | | 39,714 | | 17.9% |
Interest | 87,459 | | 4,835 | | 82,624 | | 1708.9% |
Total expenses | 23,192,147 | | 19,893,125 | | 3,299,022 | | 16.6% |
| | | | | | | |
Operating (loss) income | (914,343) | | 429,640 | | (1,343,983) | | -312.8% |
(Benefit) provision for income taxes | (132,825) | | 149,420 | | (282,245) | | -188.9% |
Net (loss) income | $ (781,518) | | $ 280,220 | | (1,061,738) | | -378.9% |
| | | | | | | |
Adjusted EBITDA: | $ (578,494) | | $ 563,387 | | $ (1,141,881) | | -202.7% |
| | | | | | | |
Adjustments to conform adjusted EBITDA to GAAP net (loss) income : | | | | | | | |
Benefit (provision) for income taxes | 132,825 | | (149,420) | | 282,245 | | -188.9% |
Interest expense | (87,459) | | (4,835) | | (82,624) | | 1708.9% |
Depreciation and amortization | (60,482) | | (80,996) | | 20,514 | | -25.3% |
Non-recurring professional fees | (88,081) | | - | | (88,081) | | 100.0% |
Non-cash compensation | (99,827) | | (47,916) | | (51,911) | | 108.3% |
Net (loss) income | $ (781,518) | | $ 280,220 | | $ (1,061,738) | | -378.9% |
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. 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.
Second quarter adjusted EBITDA, was $0.6 million loss, a decrease of 203.0% from a $0.6 million income Adjusted EBITDA before interest, taxes, depreciation, amortization, and non-cash compensation in the comparative quarter. This decrease is primarily due to the operating loss reported in the current period triggered from material legal settlements as well as professional costs incurred for the sale of ICH.
REVENUE
Revenue increased by $2.0 million or by 9.6% primarily due to an increase in top line revenue from both commissions and advisory fees as the Company is focused on growth, both organically through strong business development, advisor recruitment and improved market conditions.
Revenue from commissions increased by 7.8% or by $1.3 million primarily as a result of commissions earned from both our direct business and from brokerage transactions, also reflecting improved market conditions. Revenue from advisory services increased also as advisory assets under administration grew, benefiting from an improved stock market compared to last year at this time.
Our advisor managed program continues to contribute the majority of advisory fee revenue. Revenue decreased in the A-MAP program and revenue remained relatively flat for the F-MAP programs. These changes were offset by an increase in revenue and assets under management in our A-MAP FT program, another advisor managed program which includes a flat fee structure. These changes resulted both from new assets as well as from the continued shift of assets by our advisors into fee base programs that meet their clients’ needs.
Other fee income, which consists primarily of licensing fees, annual administrative fees, and technology fees, decreased 6.9%, largely due to fee rebates.
Other revenue, which consists of net marketing revenues and interest income, increased primarily from the increase in marketing allowances for product sales offset by a decrease in marketing allowances for sponsorship of events.
EXPENSES
Total expenses increased by $3.3 million, or 16.6%, principally as a result of increases in commissions and advisory fees compensated to our independent representatives and in regulatory, legal and professional costs. There were also increases in compensation and benefits, marketing and promotion, technology and communications, and interest expense. Offsetting these increases was a decrease in occupancy and equipment.
Commissions and advisory fees paid to our representatives represent a percentage of revenue of our broker-dealer; accordingly, the ratio of commissions and advisor fees payout is directly correlated to increased top line revenue in the current period as compared to the prior period. Accordingly, when the independent registered representatives increase their business, both our revenues and expenses increase as our representatives earn additional compensation based on the revenue produced.
Regulatory, legal and professional expenses more than doubled; this period’s 111.3% increase was driven principally by related legal costs incurred to litigate and resolve claims, including one particular claim settling for $2.1 million offset by $1.4 million the Company recovered from its insurance policies and $0.2 million in reserves.
Otherwise, the reserves largely pertain to claims made on sales of alternative investment products sold by our representatives prior to the recent recession, coupled with an increase in the Company’s self-insured retention, or deductible, specifically for those alternative investment products.
Finally, there was approximately $0.1 million in legal and professional fees incurred in connection with RCAP’s acquisition of the Company.
We will continue to incur legal fees, settlement costs and E&O premiums 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 increase in compensation and benefits is attributable to the Company’s salaries returning to base pay levels in the current period as compared to salary reductions in the prior period that were initiated in January 2012. Also, the Company had new strategic hires in the marketing and compliance departments. The Company’s non-cash compensation expense increased 104.6%, or $0.1 million, for the vesting of non-restricted grants made to employees, representatives and ICH Board members in February 2013.
The increase in marketing and promotion is the result of costs incurred for advertisements in financial service industry publications to promote brand awareness as well as our targeted recruiting campaigns. General marketing increased to further support branding from ICC’s Broker Dealer of the Year award and travel related costs for recruitment.
Technology and communications increased modestly due to increase per user rates on reporting software used by our representatives as a tool to provide consolidated client presentations. Interest expense increased as a result of quarterly interest charges for ICC’s subordinated loan which was funded in March, 2013.
Costs associated with occupancy and equipment decreased from the relocation of our Home Office to more cost effective space, and the result of a favorable outcome in litigation with our previous landlord pertaining to our former rental property lease of our former Home office Location. Per judge’s order earlier this year, the Company was released from all future lease obligations for that particular property.
All other expenses had minimal changes in comparing the current period to the prior period.
We had an income tax benefit of $0.1 million for the three months ended September 30, 2013 as compared to $0.1 million income tax provision for the prior period. The income tax rates for the 2013 and 2012 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.
OPERATING AND NET INCOME
While revenue increased, it was outpaced by both actual settlement costs and reserves for settling of pending litigation, thus generating an operating loss in the current period. Legal settlements on product sales sold prior to the recent recessions have significantly impacted our operating and net income results for several reporting periods. Management’s strategy and ultimately success for resolving these cases, along with its sustained organic and recruiting growth initiatives, will be necessary to improve the Company’s operating and net income results going forward.
The Company’s net loss was $0.8 million, or $0.12 per basic net loss per share, compared to net income of $0.3 million, or $0.04 basic and diluted net income per share, for the prior period.
COMPARISON OF THE SIX MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
| | | | | | | |
| Six Months Ended September 30, | | Change |
| 2013 | | 2012 | | Dollar | | Percentage |
Revenue: | | | | | | | |
Commission | $ 35,157,412 | | $ 31,867,893 | | $ 3,289,519 | | 10.3% |
Advisory fees | 8,978,549 | | 8,089,985 | | 888,564 | | 11.0% |
Other fee income | 533,127 | | 676,330 | | (143,203) | | -21.2% |
Other income | 691,709 | | 491,082 | | 200,627 | | 40.9% |
Total revenue | 45,360,797 | | 41,125,290 | | 4,235,507 | | 10.3% |
| | | | | | | |
Expenses: | | | | | | | |
Commissions and advisory fees expense | 36,611,321 | | 32,736,807 | | 3,874,514 | | 11.8% |
Compensation and benefits | 3,351,472 | | 3,039,968 | | 311,504 | | 10.2% |
Regulatory, legal and professional | 3,869,290 | | 1,853,258 | | 2,016,032 | | 108.8% |
Brokerage, clearing and exchange fees | 748,966 | | 702,798 | | 46,168 | | 6.6% |
Technology and communications | 716,773 | | 624,218 | | 92,555 | | 14.8% |
Advertising, marketing and promotion | 787,906 | | 472,698 | | 315,208 | | 66.7% |
Occupancy and equipment | 221,528 | | 364,299 | | (142,771) | | -39.2% |
Other administrative | 495,510 | | 438,778 | | 56,732 | | 12.9% |
Interest | 142,482 | | 13,803 | | 128,679 | | 932.3% |
Total expenses | 46,945,248 | | 40,246,627 | | 6,698,621 | | 16.6% |
| | | | | | | |
Operating (loss) income | (1,584,451) | | 878,663 | | (2,463,114) | | -280.3% |
(Benefit) provision for income taxes | (443,352) | | 336,760 | | (780,112) | | -231.7% |
Net (loss) income | $ (1,141,099) | | $ 541,903 | | (1,683,002) | | -310.6% |
| | | | | | | |
Adjusted EBITDA: | $ (1,035,175) | | $ 1,147,384 | | $ (2,182,559) | | -190.2% |
| | | | | | | |
Adjustments to conform adjusted EBITDA to GAAP net (loss) income : | | | | | | | |
Benefit (provision) for income taxes | 443,352 | | (336,760) | | 780,112 | | -231.7% |
Interest expense | (142,482) | | (13,803) | | (128,679) | | 932.3% |
Depreciation and amortization | (120,829) | | (164,017) | | 43,188 | | -26.3% |
Non-recurring professional fees | (88,081) | | - | | (88,081) | | - |
Non-cash compensation | (197,884) | | (90,901) | | (106,983) | | 117.7% |
Net (loss) income | $ (1,141,099) | | $ 541,903 | | $ (1,683,002) | | -310.6% |
ADJUSTED EBITDA
See information, above, regarding the relevance, calculation and use of adjusted EBITDA set forth in the comparison of the three month periods ended September 30, 2013 and 2012.
REVENUE
Revenues for the six months ended September 30, 2013 grew by 10.3% or by $4.2 million primarily from top line revenue growth in commissions and advisory fees. Facilitating this growth are continued efforts to attract new independent representatives, improved market conditions, and dedicated practice management initiatives.
The Company is focused on expansion and increasing its market share through marketing efforts to attract independent representatives to the firm along with retaining representatives by its quality customer service. The Company is also revamping its growth initiatives through seminars and conferences in assisting their sales force in growing their business.
EXPENSES
Expenses increased by $6.7 million or by 16.6 % primarily in commissions and advisory fees due to an increase in sales volume in addition to an increase in legal fees and settlement costs that continue to impact our operating results. Management is committed in improving its strategy and ultimately its success on these legal settlements, which has restrained the Company’s resources for investment in further growth.
Technology and communications increased modestly due to increase per user rates on reporting software used by our representatives as a tool to provide consolidated client presentations. Interest expense increased as a result of quarterly interest charges for ICC’s subordinated loan which was funded in March, 2013.
The other expense categories were consistent with that of the three month end analysis when comparing the six months period ended September 30, 2013 to the six months period ended September 30, 2012.
OPERATING AND NET INCOME
The Company reported an operating and net loss for the six months ended September 30, 2013. The $1.6 million operating loss and $1.1 million net loss was largely attributed to legal and professional fees incurred for the settlement of ongoing cases, including one alone for $0.5 million, and reserves recorded for future estimated legal settlements. The Company’s net loss was $1.1 million, or $0.17 per basic net loss per share, compared to net income of $0.5 million, or $0.08 basic and diluted net income per share, for the prior period.
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 September 30, 2013, cash and cash equivalents totaled $6.2 million as compared to $6.6 million as of March 31, 2013. Working capital as of September 30, 2013 was $6.1 million as compared to $7.5 million as of March 31, 2013. The ratio of current assets to current liabilities was 1.8 to 1 as of September 30, 2013, as compared to 1.9 to 1 as of March 31, 2013.
Operations provided $0.7 million in cash for the current period, as compared to $1.2 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 current period’s net loss versus the prior period’s net income, from account balances held at our clearing firm, from the change in the deferred tax asset, and significant changes in accounts payable, accrued legal expenses, and accounts receivable and other receivables related to settlements, including a $1.0 million in a receivable for a related insurance recovery.
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. These needs are to grow top line revenue organically through practice management initiatives and by continuing to recruit advisors to the firm.
Net cash flows used in investing activities in the current period represent purchases in equipment, contributions on an executive life insurance policy, and proceeds from other investments. Net cash flows used in the prior period also represent purchases in equipment.
Cash flows for financing activities in the current period decreased slightly when compared to the prior period
as we paid $1.1 million and $1.3 million in loan payments to finance E&O insurance premiums, respectively, for the periods ended September 30, 2013 and 2012. The Company has a line of credit (“line”) with specific financial covenants with its financial institution. Although there were no borrowings, the Company did achieve the required operating results to meet those covenants.
Subsequent from the balance sheet date and prior to the filing of this report, the Company finalized a material legal settlement and received a $1.0 million payment for coverage under an insurance policy pertaining to that settlement. That September 30, 2013 $1.0 million receivable was a non-allowable asset for regulatory net capital.
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, currently $2,000,000, 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 September 30, 2013, ICC had net capital of $2.31 million (i.e., an excess of $2.06 million) as compared to net capital of approximately $4.43 million (i.e., an excess of $4.18 million) as of March 31, 2013.
Commitments and Contingencies
Operating leases. On October 19, 2012 the Company entered into a lease for 14,045 square feet and began occupying that space on December 1, 2012 in Lynnfield, MA. This lease, which originally was for a term of sixteen months with expiration on March 31, 2014, has been amended to a three year extension, expiring on March 31, 2017. There was no change as to the rentable area of 14,045 square feet being leased; however, the lease calls for a “right of first refusal for additional space’ within that three year period contiguous with our space.
The total minimum rental due in future periods under these existing agreements as of September 30, 2013 are as follows:
| | | |
| | 2014 | $ 177,491 |
| | 2015 | 345,027 |
| | 2016 | 356,681 |
| | 2017 | 331,995 |
| | 2018 | 24,000 |
| | | $ 1,235,194 |
Total lease expense for office space approximated $0.07 and $0.06 million for the three months ended and $0.09 and $0.12 million for the six months ended September 30, 2013 and 2012, respectively.
Subsequent to March 31, 2013, the Company was released from its commercial lease agreement for its prior home office location at 230 Broadway, Lynnfield, MA. The Company is currently pursing damages in this matter.
Contingent transition loans. The Company offers loans and transition assistance to representatives mainly for recruiting or retention purposes. These commitments are contingent upon certain events occurring, including, but not limited to, the representatives joining the Company and meeting certain production requirements. As of September 30, 2013 and 2012, there were no such outstanding commitments.
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, 2013, 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.
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 $1,000,000 aggregate (effective January 2013 for only certain alternative investment products related to defense costs and indemnities) in any one case, subject to policy limitations and exclusions. Thereafter the $1,000,000 aggregate threshold, the Company’s exposure on these same investments is limited to $150,000 and a 10 percent coinsurance. For all other investment products, the Company’s exposure is $100,000 per claim.
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.
