UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarter Ended December 31, 2004 Commission File Number 001-12629
----------------- ---------
OLYMPIC CASCADE FINANCIAL CORPORATION
-------------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 36-4128138
- ------------------------------- ---------------------------------
(State or other jurisdiction of (I.R.S. Employer incorporation or
organization) Identification No.)
875 North Michigan Avenue, Suite 1560, Chicago, Illinois 60611
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(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (312) 751-8833
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
Indicate by checkmark whether the registrant is an accelerated filer (as defined
in Rule 12b-2 of the Exchange Act). Yes |_| No |X|
The number of shares outstanding of registrant's common stock, par value $0.02
per share, at February 10, 2005 was 4,995,878.
OLYMPIC CASCADE FINANCIAL CORPORATION AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
ASSETS
December 31, September 30,
2004 2004
(unaudited) (see note below)
------------ ------------
CASH $ 204,000 $ 351,000
DEPOSITS WITH CLEARING ORGANIZATIONS 962,000 995,000
RECEIVABLES FROM BROKER-DEALERS AND CLEARING ORGANIZATIONS 3,499,000 3,821,000
OTHER RECEIVABLES, net of allowance for uncollectible accounts of $850,000
at December 31, 2004 and September 30, 2004, respectively 888,000 889,000
ADVANCES TO REGISTERED REPRESENTATIVES 1,762,000 1,736,000
SECURITIES HELD FOR RESALE, at market 604,000 149,000
FIXED ASSETS, net 292,000 301,000
SECURED DEMAND NOTE 1,000,000 1,000,000
OTHER ASSETS 541,000 480,000
------------ ------------
TOTAL ASSETS $ 9,752,000 $ 9,722,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
BANK OVERDRAFT $ 339,000 $ --
PAYABLE TO BROKER-DEALERS AND CLEARING ORGANIZATIONS 320,000 115,000
SECURITIES SOLD, BUT NOT YET PURCHASED, at market 284,000 33,000
ACCOUNTS PAYABLE, ACCRUED EXPENSES AND OTHER LIABILITIES 4,206,000 4,790,000
NOTES PAYABLE 1,850,000 1,855,000
------------ ------------
TOTAL LIABILITIES 6,999,000 6,793,000
------------ ------------
SUBORDINATED BORROWINGS 1,000,000 1,000,000
------------ ------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value, 200,000 shares authorized at December
31, 2004 and September 30, 2004, respectively; 50,000 shares
designated as
Series A at December 31, 2004 and September 30, 2004, respectively -- --
Series A 9% cumulative convertible preferred stock, $.01 par value, 50,000
shares authorized at December 31, 2004 and September 30, 2004, respectively;
31,177 shares issued and outstanding (liquidation preference: $3,117,700)
at December 31, 2004 and September 30, 2004 -- --
Common stock, $.02 par value, 30,000,000 shares authorized at December 31, 2004
and September 30, 2004, respectively; 4,995,878 and 4,984,332 issued
and outstanding, at December 31, 2004 and September 30, 2004, respectively 100,000 100,000
Additional paid-in capital 14,798,000 14,790,000
Accumulated deficit (13,145,000) (12,961,000)
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 1,753,000 1,929,000
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 9,752,000 $ 9,722,000
============ ============
Note: The balance sheet at September 30, 2004 has been derived from the audited
consolidated financial statements at that date.
See notes to condensed consolidated financial statements.
2
OLYMPIC CASCADE FINANCIAL CORPORATION AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
---- Three Months Ended ----
December 31, December 31,
2004 2003
------------ ------------
REVENUES:
Commissions $ 10,295,000 $ 11,372,000
Net dealer inventory gains 1,196,000 2,064,000
Investment banking 106,000 332,000
Interest and dividends 503,000 669,000
Transfer fees and clearing services 865,000 583,000
Gains on extinguishments of debt -- 375,000
Other 143,000 124,000
------------ ------------
TOTAL REVENUES 13,108,000 15,519,000
------------ ------------
EXPENSES:
Commissions 9,495,000 10,561,000
Employee compensation and related expenses 1,236,000 1,277,000
Clearing fees 347,000 711,000
Communications 465,000 579,000
Occupancy and equipment costs 716,000 670,000
Professional fees 414,000 355,000
Litigation settlement -- 400,000
Interest 119,000 51,000
Taxes, licenses, registration 110,000 100,000
Other administrative expenses 390,000 351,000
------------ ------------
TOTAL EXPENSES 13,292,000 15,055,000
------------ ------------
NET (LOSS) INCOME (184,000) 464,000
Preferred stock dividends (71,000) (63,000)
------------ ------------
Net (loss) income attributable to common stockholders $ (255,000) $ 401,000
============ ============
NET (LOSS) INCOME PER COMMON SHARE
Basic:
Net (loss) income available to common stockholders $ (0.05) $ 0.12
============ ============
Diluted:
Net (loss) income available to common stockholders $ (0.05) $ 0.07
============ ============
Weighted average number of shares outstanding
Basic 4,993,368 3,367,558
============ ============
Diluted 4,993,368 5,441,964
============ ============
See notes to condensed consolidated financial statements.
3
OLYMPIC CASCADE FINANCIAL CORPORATION AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
-----Three Months Ended-----
December 31, December 31,
2004 2003
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net (loss) income $ (184,000) $ 464,000
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities
Depreciation and amortization 34,000 45,000
Amortization of note discount 45,000 8,000
Gain on extinguishment of debt -- (375,000)
Forgiveness of loan -- (137,000)
Litigation settlement -- 400,000
Changes in assets and liabilities
Deposits with clearing organizations 33,000 472,000
Receivables from broker-dealers, clearing organizations and others 297,000 489,000
Securities held for resale, at market (455,000) (532,000)
Other assets (61,000) (37,000)
Payables (379,000) (1,072,000)
Securities sold, but not yet purchased, at market 251,000 462,000
----------- -----------
Net cash (used in) provided by operating activities (419,000) 187,000
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of fixed assets (25,000) (44,000)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Payment of notes payable (50,000) (500,000)
Increase in cash overdraft 339,000 182,000
Exercise of stock options and warrants 8,000 --
----------- -----------
Net cash provided by (used in) financing activities 297,000 (318,000)
----------- -----------
NET DECREASE IN CASH (147,000) (175,000)
CASH BALANCE
Beginning of the period 351,000 451,000
----------- -----------
End of the period $ 204,000 $ 276,000
=========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest $ 77,000 $ 51,000
=========== ===========
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND
FINANCING ACTIVITIES
Gain on extinguishment of debt $ -- $ 375,000
=========== ===========
Forgiveness of loan $ -- $ 137,000
=========== ===========
See notes to condensed consolidated financial statements.
4
OLYMPIC CASCADE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
(UNAUDITED)
NOTE 1. BASIS OF PRESENTATION
The accompanying consolidated financial statements of Olympic Cascade Financial
Corporation ("Olympic" or the "Company") have been prepared in accordance with
generally accepted accounting principles for interim financial statements and
with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.
Accordingly, they do not include all of the information and disclosures required
for annual financial statements. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation have been included. The consolidated financial statements as of and
for the periods ended December 31, 2004 and December 31, 2003 are unaudited. The
results of operations for the interim periods are not necessarily indicative of
the results of operations for the fiscal year. These consolidated financial
statements should be read in conjunction with the consolidated financial
statements and related footnotes included thereto in the Company's Annual Report
on Form 10-K for the fiscal year ended September 30, 2004.
Reclassifications - Certain amounts shown in the prior period's condensed
consolidated financial statements have been reclassified to conform with the
current period's condensed consolidated financial statement presentation. These
reclassifications had no effect on net income (loss) or stockholders' equity
(deficit) as previously presented.
NOTE 2. RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the Financial Accounting Standards Board ("FASB") issued its
final standard on accounting for share-based payments ("SBP"), FASB Statement
No. 123R (revised 2004), "Share-Based Payment". The Statement requires companies
to expense the value of employee stock options and similar awards. Under FAS
123R, SBP awards result in a cost that will be measured at fair value on the
awards' grant date, based on the estimated number of awards that are expected to
vest. Compensation cost for awards that vest would not be reversed if the awards
expire without being exercised. The effective date for the Company is interim
and annual periods beginning after June15, 2005, and applied to all outstanding
and unvested SBP awards at a company's adoption. Management has not yet
determined the impact of this pronouncement on the Company's financial
statements.
Stock-Based Compensation - During fiscal year 2003, the Company adopted
Statement of Financial Accounting Standard ("SFAS") No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure." This statement amended
SFAS No. 123, "Accounting for Stock-Based Compensation." As permitted under SFAS
No. 123, the Company continues to apply the Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees." As required under SFAS No.
148, the following table presents pro forma net income (loss) attributable to
common stockholders for basic and diluted net income (loss) per share as if the
fair value-based method had been applied to all awards.
5
Three Months Ended
December 31, 2004 December 31, 2003
-------------------------------------------
Net (loss) income attributable to common stockholders - as reported $ (255,000) $ 401,000
Stock-based employee compensation cost determined
under fair value method, net of tax effects (78,000) (9,000)
-------------------------------
Net (loss) income attributable to common stockholders - pro forma $ (333,000) $ 392,000
===============================
(Loss) earnings per share Basic (loss) earnings per share:
Net (loss) income attributable to common stockholders - as reported $ (0.05) $ 0.12
Per share stock-based employee compensation cost
determined under fair value method, net of tax effects (0.02) --
-------------------------------
Net (loss) income attributable to common stockholders - pro forma $ (0.07) $ 0.12
===============================
Diluted (loss) earnings per share:
Net (loss) income attributable to common stockholders - as reported $ (0.05) $ 0.07
Per share stock-based employee compensation cost
determined under fair value method, net of tax effects (0.02) --
-------------------------------
Net (loss) income attributable to common stockholders - pro forma $ (0.07) $ 0.07
===============================
The Black-Scholes option valuation model is used to estimate the fair value of
the options granted. No options were granted in the quarters ended December 31,
2004 and 2003. The model includes subjective input assumptions that can
materially affect the fair value estimates. The model was developed for use in
estimating the fair value of traded options that have no vesting restrictions
and that are fully transferable. For example, the expected volatility is
estimated based on the most recent historical period of time equal to the
weighted average life of the options granted. Options issued under the Company's
option plans have characteristics that differ from traded options. In
management's opinion, this valuation model does not necessarily provide a
reliable single measure of the fair value of its employee stock options.
Principal assumptions used in applying the Black-Scholes model along with the
results from the model were as follows:
2004 2003
--------------------------------
Assumptions:
Risk-free interest rate 2.50% 4.01%
Expected life, in years 3.0 5.0
Expected volatility 125% 311%
Results:
Fair value of options granted $ -- $ 0.52
In January 2003, the Financial Accounting Standards Board ("FASB") issued
Interpretation 46, "Consolidation of Variable Interest Entities". In general, a
variable interest entity is a corporation, partnership, trust, or any other
legal structure used for business purposes that either (a) does not have equity
investors with voting rights or (b) has equity investors that do not provide
sufficient financial resources for the entity to support its activities.
Interpretation 46 requires a variable interest entity to be consolidated by a
company if that company is subject to a majority of the risk of loss from the
variable interest entity's activities or entitled to receive a majority of the
entity's residual returns or both. The consolidation requirements of
Interpretation 46 apply immediately to variable interest entities created after
January 31, 2003. For variable interest entities created or acquired prior to
February 1, 2003, the provisions of FIN 46 must be applied for the first interim
or annual period beginning after March 15, 2004. The adoption of Interpretation
46 did not have an impact on the Company's consolidated financial statements
6
NOTE 3. SECURITIES HELD FOR RESALE AND SECURITIES SOLD, BUT NOT YET PURCHASED
The following table shows the quoted market values of the Company's securities
held for resale and securities sold, but not yet purchased as of December 31,
2004:
Securities held Securities sold, but
for resale not yet purchased
--------------- --------------------
Corporate Stocks $ 46,000 $ 8,000
Corporate Bonds 251,000 250,000
Government Obligations 307,000 26,000
-------- --------
$604,000 $284,000
======== ========
NOTE 4. CLEARING AGREEMENTS
In the first quarter of fiscal year 2003, First Clearing Corporation ("First
Clearing") loaned the Company $375,000 in the form of clearing fee rebates. The
loan was due to be repaid in January 2004.
In December 2003, the Company engaged in various discussions with the NASD
relating to the Security Agreement between National Securities Corporation
("National") and First Clearing, and its effect on the computation of National's
net capital. As a result of these discussions, on December 15, 2003, the Company
and First Clearing agreed in principle to the following: (1) National's clearing
deposit was reduced from $1,000,000 to $500,000; (2) the excess $500,000
resulting from this reduction was paid to First Clearing to reduce the Company's
outstanding loan balance on its promissory note; and (3) the Security Agreement
between National and First Clearing was terminated. Furthermore, First Clearing
forgave payment of the $375,000 loan that was due to be paid in January 2004,
resulting in a $375,000 gain on extinguishment of debt in the first quarter of
fiscal year 2004.
In February 2004, the Company paid First Clearing $250,000 to fully repay its
promissory note that had a balance of approximately $1,006,000 at such time. As
a result of the repayment of this note, the Company realized a gain on
extinguishment of debt of approximately $756,000 in the second quarter of fiscal
year 2004. Additionally, National and First Clearing mutually agreed to
terminate their clearing relationship.
In June 2004, National entered into an agreement with Fiserv Securities, Inc.
("Fiserv") to clear its brokerage business. The conversion from First Clearing
to Fiserv was completed in the first week of October 2004. As part of this
transaction, Fiserv provided National with an $800,000 conversion assistance
payment, $250,000 of which was paid in June 2004, $250,000 of which was paid in
August 2004, and $300,000 of which was paid in October 2004. The Company
believes that the overall effect of the new clearing relationship is beneficial
to the Company's cost structure, liquidity and capital resources.
NOTE 5. CONTINGENCIES
In June 2002, National was named, together with others, as a defendant in a
class action lawsuit relating to a series of private placements of securities in
Fastpoint Communications, Inc. in the Superior Court for the State of California
for the County of San Diego. Plaintiffs are seeking approximately $14.0 million,
but no specific amount of damages has been sought against National in the
complaint. National filed its answer in April 2003. In January 2004, the court
entered an order denying class certification. As a result of this order denying
class certification, the only remaining claims against National are the
individual claims asserted by the two class representatives totaling $60,000.
Plaintiffs have filed an appeal of this order and it is now fully briefed. The
action in the lower court, including a pending motion for summary judgment, has
been stayed. National believes it has meritorious defenses and intends to
vigorously contest class certification and defend this action, although the
ultimate outcome of the matter cannot be determined at this time. Accordingly,
the Company is unable to predict the outcome of this matter, and no adjustments
have been made in the consolidated financial statements in response to this
matter.
7
The NASD has been engaged in an industry-wide investigation of mutual fund
trading activities. National is one of the numerous broker-dealers that were
contacted by the NASD with respect to this investigation. The NASD identified
certain customer mutual fund transactions ordered through National during the
time period from October 2000 to February 2003 that it believed constituted
mutual fund timing and/or excessive trading activity. National engaged in
discussions and negotiations with the NASD to informally resolve these matters.
Such resolution resulted in a settlement in August 2004, whereby National,
without admitting or denying any violations, agreed to make both restitution and
pay a fine to the NASD, that in the aggregate approximated $600,000.
Additionally, the Company is obligated to pay the fines imposed by the NASD on
two executive officers totaling $50,000 pursuant to its indemnification
obligations. The unpaid balance of approximately $244,000 at December 31, 2004
has been included in "Accounts Payable, Accrued Expenses and Other Liabilities"
in the accompanying consolidated statements of financial condition.
The Company is also a defendant in various other arbitrations and administrative
proceedings, lawsuits and claims, seeking damages aggregating approximately $1.5
million (exclusive of unspecified punitive damages related to certain claims and
inclusive of expected insurance coverage). The Company has filed a counterclaim
for approximately $220,000 in one such proceeding. These matters arise out of
the normal course of business. The Company intends to vigorously defend itself
in these actions, and believes that the eventual outcome of these matters will
not have a material adverse effect on the Company. However, the ultimate outcome
of these matters cannot be determined at this time. The amounts related to such
matters that are reasonably estimable and which have been accrued at December
31, 2004 and 2003, is $212,000 and $164,000, respectively, and have been
included in "Accounts Payable, Accrued Expenses and Other Liabilities" in the
accompanying consolidated statements of financial condition. The Company has
included in "Professional fees" litigation and NASD related expenses of $321,000
and $298,000 for the first quarter of fiscal year 2005 and 2004, respectively.
NOTE 6. CUMULATIVE DIVIDENDS ON CONVERTIBLE PREFERRED STOCK
The holders of the Company's Series A Convertible Preferred Stock are to receive
dividends on a quarterly basis at a rate of 9% per annum per share. Such
dividends are cumulative and accrue whether or not declared by the Company's
Board of Directors, but are payable only when, as and if declared by the
Company's Board of Directors. At December 31, 2004, the amount of accumulated
dividends on the Company's 31,177 issued and outstanding shares of preferred
stock was approximately $253,000.
NOTE 7. INCOME (LOSS) PER COMMON SHARE
Basic income (loss) per share is computed on the basis of the weighted average
number of common shares outstanding. Diluted income (loss) per share is computed
on the basis of the weighted average number of common shares outstanding plus
the potential dilution that could occur if securities or other contracts to
issue common shares were exercised or converted. Stock options and warrants, and
conversion of the cumulative convertible preferred stock, were excluded from the
diluted loss per share computation for the three-month period ended December 31,
2004, since the Company incurred a loss for this period and the inclusion of
such securities would be antidilutive.
8
The following table sets forth the components used in the computation of basic
and diluted income (loss) per common share:
Three Months Ended
December 31, 2004 December 31, 2003
------------------------------------
Numerator:
Net (loss) income $ (184,000) $ 464,000
Preferred stock dividends (71,000) (63,000)
-------------------------------
Numerator for basic earnings per share--net (loss) income
attributable to common stockholders - as reported $ (255,000) $ 401,000
===============================
Denominator:
Denominator for basic earnings per share--weighted average shares 4,993,368 3,367,558
-------------------------------
Effective of dilutive securities:
Stock options -- 27,757
Warrants -- 191,651
Assumed comversion of Series A preferred stock -- 1,854,998
-------------------------------
Dilutive potential common shares -- 2,074,406
-------------------------------
Denominator for diluted earnings per share--adjusted
weighted-average shares and assumed conversions 4,993,368 5,441,964
===============================
Net (loss) income available to common stockholders
Basic: $ (0.05) $ 0.12
===============================
Diluted: $ (0.05) $ 0.07
===============================
For the three-month periods ended December 31, 2004 and 2003, 3,334,780 and
1,868,689 shares, respectively, attributable to outstanding stock options and
warrants were excluded from the calculation of diluted net income (loss) per
share because the effect was antildilutive.
NOTE 8. EXTENSION OF NOTES
In February 2004, National and the holder of a $1.0 million secured demand note
that was initially scheduled to mature on February 1, 2004, extended the term of
the secured demand note to March 1, 2005. National and the holder have agreed
that at maturity, subject to NASD approval that was received in February 2005,
this secured demand note will be extended to March 1, 2006. Additionally, two
noteholders have extended the maturity date on $1.0 million of notes issued to
them by the Company from January 25, 2004 to July 31, 2005, and effective
February 1, 2004, the interest rate on such notes was increased from 9% to 12%
per annum.
The Company is accreting the total allocated fair value of $158,000 over the
extended 18-month term of these notes. Such accretion has been included in
"Interest" on the accompanying condensed consolidated December 31, 2004
financial statements.
NOTE 9. PRIVATE PLACEMENTS
In January 2004, the Company consummated a private offering of its securities to
a limited number of accredited investors pursuant to Rule 506 of Regulation D
under the Securities Act of 1933, as amended (the "Securities Act") wherein the
Company issued an aggregate of $200,000 of three-year, 10% senior subordinated
promissory notes to five unaffiliated parties. The noteholders received
three-year warrants to purchase an aggregate of 50,000 shares of Common Stock at
an exercise price of $1.40 per share, with an allocated fair value of
approximately $40,000. In December 2004, the Company rescinded a note in the
principal amount of $25,000 and a warrant to purchase 6,250 shares of Common
Stock.
9
In February 2004, the Company consummated a private offering of its securities
to a limited number of accredited investors pursuant to Rule 506 of Regulation D
under the Securities Act wherein the Company issued an aggregate of $850,000 of
three-year, 10% senior subordinated promissory notes to four unaffiliated
parties. The noteholders received three-year warrants to purchase an aggregate
of 170,000 shares of Common Stock at an exercise price of $1.50 per share, with
an allocated fair value of approximately $143,000.
The Company is accreting the total allocated fair value of $183,000 over the
three-year term of these promissory notes. Such accretion has been included in
"Interest" in the accompanying consolidated financial statements.
In the fourth quarter of fiscal year 2004, the Company consummated a private
placement of its securities to a limited number of accredited investors pursuant
to Rule 506 of Regulation D under the Securities Act. Each unit in the offering
sold for $1.60 and consisted of two shares of Common Stock and one three-year
warrant to purchase one share of Common Stock at a per share price of $1.50. Net
proceeds of approximately $930,000 were received in the fourth quarter of fiscal
year 2004, and the Company correspondingly issued 1,250,000 shares of Common
Stock and 625,000 warrants.
NOTE 10. STOCKHOLDERS' EQUITY
At the Company's annual meeting of shareholders on March 16, 2004, the
shareholders voted, effective immediately, to amend the Company's Certificate of
Incorporation to decrease the number of shares of the Company's common stock,
par value $.02 per share, from 60,000,000 shares to 30,000,000 shares, and to
increase the number of shares of Preferred Stock, par value $.01 per share, from
100,000 shares to 200,000 shares.
In the quarter ended December 31, 2004, the Company received proceeds of
approximately $7,500 from the exercise of outstanding warrants.
NOTE 11. THE AMERICAN STOCK EXCHANGE
In February 2003, the Company received notification from The American Stock
Exchange (the "AMEX") indicating that it was not in compliance with the listing
standard relating to shareholders' equity of less than $2.0 million and losses
from continuing operations and/or net losses in two out of our three most recent
fiscal years. The Company submitted a plan to the AMEX indicating compliance
within a maximum of 18 months. In May 2003, the AMEX notified the Company that
it had accepted its plan of compliance and granted the Company an extension of
time to August 5, 2004 to satisfy the financial standards requirement. The
Company, however, was unable to comply with the listing standard. Consequently,
on November 1, 2004 the Common Stock was removed from the AMEX and commenced
trading on the Over-the-Counter Bulletin Board.
NOTE 12. POTENTIAL MERGER
In October 2004, the Company entered into a preliminary letter of intent to
consummate a merger or other similar combination with First Montauk Financial
Corp. On February 10, 2005 the Company and First Montauk signed a definitive
merger agreement. The merger is subject to numerous conditions, including
affirmative vote of the Company and First Montauk shareholders, regulatory
approvals, and other customary closing conditions.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The Private Securities Litigation Reform Act of 1995 provides a safe harbor for
forward-looking statements. This Quarterly Report may contain certain statements
of a forward-looking nature relating to future events or future business
performance. Any such statements that refer to the Company's estimated or
anticipated future results or other non-historical facts are forward-looking and
reflect the Company's current perspective of existing trends and information.
These statements involve risks and uncertainties that cannot be predicted or
quantified and, consequently, actual results may differ materially from those
expressed or implied by such forward-looking statements. Such risks and
uncertainties include, among others, risks and uncertainties detailed in the
Company's Annual Report on Form 10-K, filed with the Securities and Exchange
Commission on December 28, 2004. Any forward-looking statements contained in or
incorporated into this Quarterly Report speak only as of the date of this
Quarterly Report. The Company undertakes no obligation to update publicly any
forward-looking statement, whether as a result of new information, future events
or otherwise.
RESULTS OF OPERATIONS
Three Months Ended December 31, 2004 Compared to Three Months Ended December 31,
2003
The Company's first quarter of fiscal year 2005 resulted in a decrease in
revenues, and a comparatively lesser decrease in expenses compared to the same
period last year. The decrease in revenues is primarily due to the weaker
securities markets experienced by the Company, and the Company's cessation of
its market making activities. As a result, the Company reported a net loss
before income taxes of $184,000 compared with net income before income taxes of
$464,000 for the first quarters of fiscal years 2005 and 2004, respectively.
This represents a reduction of $648,000 from the prior period.
Three Months Ended
December 31, Increase (Decrease)
------------------------------------- -------------------------------
2004 2003 Amount Percent
----------------- ----------------- ----------------- ------------
Commissions $ 10,295,000 $ 11,372,000 $ (1,077,000) (9%)
----------------- ----------------- -----------------
Proprietary trading 1,155,000 1,663,000 (508,000) (31%)
Market making -- 335,000 (335,000) n/a
Mark-ups and mark-downs 41,000 66,000 (25,000) (38%)
----------------- ----------------- -----------------
Net dealer inventory gains 1,196,000 2,064,000 (868,000) (42%)
Investment banking 106,000 332,000 (226,000) (68%)
Interest and dividends 503,000 669,000 (166,000) (25%)
Transfer fees and clearance services 865,000 583,000 282,000 48%
Gains on extinguishments of debt -- 375,000 (375,000) n/a
Other 143,000 124,000 19,000 15%
----------------- ----------------- -----------------
$ 13,108,000 $ 15,519,000 $ (2,411,000) (16%)
================= ================= =================
Total revenues decreased $2,411,000, or 16%, in the first quarter of fiscal year
2005 to $13,108,000 from $15,519,000 in the first quarter of fiscal year 2004.
This decrease is mainly due to the weaker securities markets that reduced
commission revenues, the number of commission tickets generated, and the charge
per ticket that affects commission revenue. During the first quarter of fiscal
year 2005, total trading volume decreased by approximately 49%, compared to the
first quarter of fiscal year 2004. This decrease is attributable to the current
cessation of the Company's market making activities. Trading volume in this
period related to retail brokerage decreased 20%. Commission revenue decreased
$1,077,000, or 9%, to $10,295,000 from $11,372,000 during the first quarter of
fiscal year 2005 compared with the same period in fiscal year 2004. Net dealer
inventory gains, which includes profits on proprietary trading, market making
activities and customer mark-ups and mark-downs, decreased $868,000, or 42%, to
$1,196,000 from $2,064,000 during the first quarter of fiscal year 2005 compared
with the same period in fiscal year 2004. The decrease is due to a reduction in
proprietary trading in the bond market, reflecting an overall decline in this
market compared to the strength that has been realized in the equity markets,
and the current cessation of the Company's market making activities. During the
first quarter of fiscal year 2005, revenues from proprietary trading decreased
$508,000, or 31%, to $1,155,000 from $1,663,000 in the same period of fiscal
year 2004, revenues from market making activities decreased to $0 from $335,000
in the first quarter of fiscal year 2005, and revenues from customer mark-ups
and mark-downs decreased $25,000, or 38%, to $41,000 from $66,000 in the first
quarter of fiscal year 2004.
11
Investment banking revenue decreased $226,000, or 68%, to $106,000 from $332,000
in the first quarter of fiscal year 2005 compared with the first quarter of
fiscal year 2004. The decrease in investment banking revenues is attributable to
the Company having completed a private placement in the first quarter of fiscal
year 2004. Interest and dividend income decreased $166,000 or 25%, to $503,000
from $669,000 in the first quarter of fiscal year 2005 compared with the same
period last year. The decrease in interest income is attributable to a decrease
in the interest rate charged for debit balances in National's customers'
accounts from the same period last year. Transfer fees increased $282,000, or
48%, to $865,000 in the first quarter of fiscal year 2005 from $583,000 in the
first quarter of fiscal year 2004. The increase is due to higher transfer fees
for trades generated from the retail brokerage business of brokers recently
associated with the Company.
The Company realized a gain of $375,000 on debt forgiveness from its prior
clearing firm, First Clearing, in the first quarter of fiscal year 2004. Other
revenue, consisting of asset management fees and miscellaneous transaction fees
and trading fees, increased $19,000, or 15%, to $143,000 from $124,000 during
the first quarter of fiscal year 2005 compared to the first quarter of fiscal
year 2004. The increase is due to a higher level of assets under management
attributable to the opening of new customer accounts.
Three Months Ended
December 31, Increase (Decrease)
------------------------------------- -------------------------------
2004 2003 Amount Percent
----------------- ----------------- ----------------- ------------
Commission expense related to:
Commission revenue $ 8,655,000 $ 9,003,000 $ (348,000) (4%)
Net dealer inventory gains 754,000 1,292,000 (538,000) (42%)
Investment banking 86,000 266,000 (180,000) (68%)
----------------- ----------------- -----------------
Commissions 9,495,000 10,561,000 (1,066,000) (10%)
Employee compensation 1,236,000 1,277,000 (41,000) (3%)
Clearing fees 347,000 711,000 (364,000) (51%)
Communications 465,000 579,000 (114,000) (20%)
Occupancy and equipment costs 716,000 670,000 46,000 7%
Professional fees 414,000 355,000 59,000 17%
Litigation settlement -- 400,000 (400,000) n/a
Interest 119,000 51,000 68,000 133%
Taxes, licenses and registration 110,000 100,000 10,000 10%
Other administrative expenses 390,000 351,000 39,000 11%
----------------- ----------------- -----------------
$13,292,000 $15,055,000 $ (1,763,000) (12%)
================= ================= =================
In comparison with the 16% decrease in total revenues, total expenses decreased
12% or $1,763,000 to $13,292,000 for the first quarter of fiscal year 2005
compared to $15,055,000 in the first quarter of fiscal year 2004. The decrease
in total expenses is a result of lower commission expenses directly associated
with commission revenues, lower clearing fees and the litigation settlement in
the first quarter of fiscal year 2004.
12
Commission expense, which includes expenses related to commission revenue, net
dealer inventory gains and investment banking, decreased $1,066,000, or 10%, to
$9,495,000 in the first quarter of fiscal year 2005 from $10,561,000 in the
first quarter of fiscal year 2004. Commission expense related to commission
revenue decreased $348,000, or 4%, to $8,655,000 in the first quarter of fiscal
year 2005 from $9,003,000 in the first quarter of fiscal year 2004; commission
expense related to net dealer inventory gains decreased $538,000, or 42%, to
$754,000 in the first quarter of fiscal year 2005 from $1,292,000 in the first
quarter of fiscal year 2004; and commission expense related to investment
banking decreased $180,000, or 68%, to $86,000 in the first quarter of fiscal
year 2005 from $266,000 in the first quarter of fiscal year 2004. Commission
expense as a percentage of commission revenues increased to 84% in the first
quarter of fiscal year 2005 from 79% in the first quarter of fiscal year 2004.
This increase is attributable to changes in the production of particular
brokers, not all of who are paid at the same commission rate and an increase in
the amortization of advances to registered representatives. The commission
expense as a percentage of both net dealer inventory gains and investment
banking was relatively unchanged between the first quarter of fiscal year 2005
and the first quarter of fiscal year 2004. Commission expense includes the
amortization of advances to registered representatives of $233,000 and $115,000
for the first quarter of fiscal years 2005 and 2004, respectively. These amounts
fluctuate based upon the amounts of advances outstanding and the time period for
which the registered representatives have agreed to be affiliated with National.
Employee compensation expense decreased $41,000, or 3%, to $1,236,000 in the
first quarter of fiscal year 2005 from $1,277,000 in the first quarter of fiscal
year 2004. The decrease is attributable to bonuses based on operating income
that were paid to senior management in the first quarter of fiscal year 2004.
Overall, combined commission and employee compensation expense, as a percentage
of revenue increased to 82% from 78% in the first quarters of fiscal year 2005
and 2004, respectively. The increase is attributable to an overall higher payout
percentage to National's retail brokers.
Clearing fees decreased $364,000, or 51%, to $347,000 in the first quarter of
fiscal year 2005 from $711,000 in the first quarter of fiscal year 2004. The
reduction in clearing fees is attributable to the lower trading volume in the
first quarter of fiscal year 2005 compared to the first quarter of fiscal year
2004, and lower clearing costs associated with the Company's new clearing
agreement. Clearing fees were reduced by forgiveness of debt that was fully
repaid in February 2004, from the Company's prior clearing firm based on ticket
volume in the amount of $136,000 in the first quarter of fiscal year 2004.
Communication expenses decreased $114,000 or 20%, to $465,000 from $579,000 in
the first quarter of fiscal year 2005 compared to the first quarter of fiscal
year 2004. The decrease is due a reduction in the number of quotation machines
resulting from the current cessation of the Company's market making activities.
Occupancy costs increased $46,000, or 7%, to $716,000 from $670,000. The
increase in occupancy expense is due to additional space at the Company's New
York office. Professional fees increased $59,000, or 17%, to $414,000 from
$355,000 in the first quarter of fiscal year 2005 compared to the first quarter
of fiscal year 2004. The increase in professional fees is due to an increase in
the legal fees relating to various lawsuits and arbitrations. In January 2004,
an arbitration panel awarded damages against the Company of approximately
$400,000 related to an employment contract with a former employee of the
Company. This amount was recorded as "Litigation settlement" and accrued in the
first quarter of fiscal year 2004.
Interest expense increased $68,000, or 133%, to $119,000 from $51,000 in the
first quarter of fiscal year 2005 compared to the first quarter of fiscal year
2004. The increase is due to interest on the notes issued by the Company in the
second quarter of fiscal year 2004, and the amortization of $113,000
attributable to those notes, and other notes that were modified in the second
quarter of fiscal year 2004. Taxes, licenses and registration increased $10,000,
or 10%, to $110,000 from $100,000 in the first quarter of fiscal year 2005
compared to the first quarter of fiscal year 2004. Other administrative expenses
increased $39,000 or 11% to $390,000 from $351,000 in the first quarter of
fiscal year 2005 compared to the first quarter of fiscal year 2004. The increase
in other expenses is due to costs incurred relating to the Company's change of
clearing firms.
13
The Company reported a net loss before income taxes of $184,000 in the first
quarter of fiscal year 2005 compared to net income before income taxes of
$464,000 in the first quarter of fiscal year 2004. Overall, the net loss
attributable to common stockholders in the first quarter of fiscal year 2005 was
$255,000, or $.05 per common share, as compared to the diluted earnings
attributable to common stockholders of $401,000, or $.07 per common share in the
first quarter of fiscal year 2004. The net loss attributable to common
stockholders for the first quarter of fiscal year 2005 and the net income
attributable to common stockholders for the first quarter of fiscal year 2004
reflects $71,000 and $63,000 of cumulative but unpaid preferred stock dividends,
in both fiscal quarters, on the Company's Preferred Stock.
Liquidity and Capital Resources
National, as a registered broker-dealer, is subject to the SEC's Uniform Net
Capital Rule 15c3-1, which requires the maintenance of minimum net capital.
National has elected to use the alternative standard method permitted by the
rule. This requires that National maintain minimum net capital equal to the
greater of $250,000 or a specified amount per security based on the bid price of
each security for which National is a market maker. At December 31, 2004,
National's net capital exceeded the requirement by $1,111,000.
Advances, dividend payments and other equity withdrawals from the Company's
subsidiary are restricted by the regulations of the SEC and other regulatory
agencies. These regulatory restrictions may limit the amounts that a subsidiary
may dividend or advance to the Company.
The Company extends unsecured credit in the normal course of business to its
brokers. The determination of the appropriate amount of the reserve for
uncollectible accounts is based upon a review of the amount of credit extended,
the length of time each receivable has been outstanding, and the specific
individual brokers from whom the receivables are due.
The objective of liquidity management is to ensure that the Company has ready
access to sufficient funds to meet commitments, fund deposit withdrawals and
efficiently provide for the credit needs of customers.
In January 2004, the Company consummated a private offering of its securities to
a limited number of accredited investors pursuant to Rule 506 of Regulation D
under the Securities Act wherein the Company issued an aggregate of $200,000 of
three-year, 10% senior subordinated promissory notes to five unaffiliated
parties. The noteholders received three-year warrants to purchase an aggregate
of 50,000 shares of Common Stock at an exercise price of $1.40 per share, with
an allocated fair value of approximately $40,000. In December 2004, the Company
rescinded a note in the principal amount of $25,000 and a warrant to purchase
6,250 shares of Common Stock.
In February 2004, the Company consummated a private offering of its securities
to a limited number of accredited investors pursuant to Rule 506 of Regulation D
under the Securities Act wherein the Company issued an aggregate of $850,000 of
three-year, 10% senior subordinated promissory notes to four unaffiliated
parties. The noteholders received three-year warrants to purchase an aggregate
of 170,000 shares of Common Stock at an exercise price of $1.50 per share, with
an allocated fair value of approximately $143,000.
The Company is accreting the total allocated fair value of $183,000 over the
three-year term of these promissory notes. Such accretion has been included in
"Interest" in the accompanying consolidated financial statements.
In July 2004, the Company filed a Registration Statement on Form S-3 under the
Securities Act for the resale of certain shares of Common Stock and shares of
Common Stock issuable upon the exercise of certain warrants previously issued in
connection with private placement transactions, and certain warrants that were
issued in the private placements that have been completed in the current fiscal
year. The Registration Statement became effective on August 11, 2004.
14
In the fourth quarter of fiscal year 2004, the Company consummated a private
placement of its securities to a limited number of accredited investors pursuant
to Rule 506 of Regulation D under the Securities Act. Each unit in the offering
sold for $1.60 and consisted of two shares of Common Stock and one three-year
warrant to purchase one share of Common Stock at a per share price of $1.50. Net
proceeds of approximately $930,000 were received in the fourth quarter of fiscal
year 2004, and the Company correspondingly issued 1,250,000 shares of Common
Stock and 625,000 warrants.
In the first quarter of fiscal year 2003, First Clearing loaned the Company an
additional $375,000 in the form of clearing fee rebates. The loan was due to be
repaid in January 2004.
In December 2003, the Company engaged in various discussions with the NASD
relating to the Security Agreement between National and First Clearing, and its
effect on the computation of National's net capital. As a result of these
discussions, on December 15, 2003, the Company and First Clearing agreed in
principle to the following: (1) National's clearing deposit was reduced from
$1,000,000 to $500,000; (2) the excess $500,000 resulting from this reduction
was paid to First Clearing to reduce the Company's outstanding loan balance on
its promissory note; and (3) the Security Agreement between National and First
Clearing was terminated. Furthermore, First Clearing forgave payment of the
$375,000 loan that was due to be paid in January 2004, resulting in a $375,000
gain on extinguishment of debt in the first quarter of fiscal year 2004.
In February 2004, the Company paid First Clearing $250,000 to fully repay its
promissory note that had a balance of approximately $1,006,000 at such time. As
a result of the repayment of this note, the Company realized a gain on
extinguishment of debt of approximately $756,000 in the second quarter of fiscal
year 2004. Additionally, National and First Clearing mutually agreed to
terminate their clearing relationship.
In June 2004, National entered into an agreement with Fiserv to clear its
brokerage business. The conversion from First Clearing to Fiserv was completed
in the first week of October 2004. As part of this transaction, Fiserv provided
National with an $800,000 conversion assistance payment, $250,000 of which was
paid in June 2004, $250,000 of which was paid in August 2004, and $300,000 of
which was paid in October 2004. The Company believes that the overall effect of
the new clearing relationship is beneficial to the Company's cost structure,
liquidity and capital resources.
In February 2004, National and the holder of a $1.0 million secured demand note
that was initially scheduled to mature on February 1, 2004, extended the term of
the secured demand note to March 1, 2005. National and the holder have agreed
that at maturity, subject to NASD approval that was received in February 2005,
this secured demand note will be extended to March 1, 2006. Additionally, two
noteholders have extended the maturity date on $1.0 million of notes issued to
them by the Company from January 25, 2004 to July 31, 2005, and effective
February 1, 2004, the interest rate on such notes was increased from 9% to 12%
per annum.
In the quarter ended December 31, 2004, the Company received proceeds of
approximately $7,500 from the exercise of outstanding warrants.
In October 2004, the Company entered into a preliminary letter of intent for a
merger or other similar combination with First Montauk Financial Corp. The
letter of intent is subject to numerous conditions, including: satisfactory
completion of due diligence, finalization of the terms of the combination and
structure of the transaction; negotiation, preparation and execution of
definitive transaction documents, compliance with state and federal securities
laws and regulations, and corporate, shareholder and regulatory approvals.
15
The Company believes that despite the current weaker market conditions, the
Company will have sufficient funds to maintain its current level of business
activities during fiscal year 2005. If market conditions should weaken further,
the Company would need to consider curtailing certain of its business
activities, further reducing its fixed overhead costs and/or seek additional
sources of financing.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's primary market risk arises from the fact that it engages in
proprietary trading and historically made dealer markets in equity securities.
Accordingly, the Company may be required to maintain certain amounts of
inventories in order to facilitate customer order flow. The Company may incur
losses as a result of price movements in these inventories due to changes in
interest rates, foreign exchange rates, equity prices and other political
factors. The Company is not subject to direct market risk due to changes in
foreign exchange rates. However, the Company is subject to market risk as a
result of changes in interest rates and equity prices, which are affected by
global economic conditions. The Company manages its exposure to market risk by
limiting its net long or short positions. Trading and inventory accounts are
monitored daily by management and the Company has instituted position limits.
Credit risk represents the amount of accounting loss the Company could incur if
counterparties to its proprietary transactions fail to perform and the value of
any collateral proves inadequate. Although credit risk relating to various
financing activities is reduced by the industry practice of obtaining and
maintaining collateral, the Company maintains more stringent requirements to
further reduce its exposure. The Company monitors its exposure to counterparty
risk on a daily basis by using credit exposure information and monitoring
collateral values. The Company maintains a credit committee, which reviews
margin requirements for large or concentrated accounts and sets higher
requirements or requires a reduction of either the level of margin debt or
investment in high-risk securities or, in some cases, requiring the transfer of
the account to another broker-dealer.
The Company monitors its market and credit risks daily through internal control
procedures designed to identify and evaluate the various risks to which the
Company is exposed. There can be no assurance, however, that the Company's risk
management procedures and internal controls will prevent losses from occurring
as a result of such risks.
The following table shows the quoted market values of the Company's securities
held for resale ("long"), securities sold, but not yet purchased ("short") and
net positions as of December 31, 2004:
Long Short Net
-------- -------- --------
Corporate Stocks $ 46,000 $ 8,000 $ 38,000
Corporate Bonds 251,000 250,000 1,000
Government Obligations 307,000 26,000 281,000
-------- -------- --------
$604,000 $284,000 $320,000
======== ======== ========
ITEM 4A. CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures. Based on the evaluation of the
Company's disclosure controls and procedures (as defined in the Exchange Act
Rules 13a-15(e) and 15d-15(e)) required by the Exchange Act Rules 13a-15(b) or
15d-15(b), the Company's Chief Executive Officer and Acting Chief Financial
Officer have concluded that, as of the end of the period covered by this report,
the Company's disclosure controls and procedures were adequate and effective to
ensure that material information relating to the Company and its consolidated
subsidiaries would be made known to them by others within those entities,
particularly during the period in which this quarterly report on Form 10-Q was
being prepared.
16
Changes in internal controls. There were no significant changes in the Company's
internal controls or in other factors that could significantly affect those
controls and procedures subsequent to the date of our evaluation nor any
significant deficiencies or material weaknesses in such disclosure controls and
procedures requiring corrective actions.
Item 4B. OTHER INFORMATION
There is no other information to be disclosed by the Company during the first
quarter of fiscal year 2005 that has not been reported on a current report on
Form 8-K.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
During the quarter, there were no significant developments in the Company's
legal proceedings. For a detailed discussion of the Company's legal proceedings,
please refer to Note 5 herein, and the Company's Annual Report on Form 10-K for
the fiscal year ended September 30, 2004.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
(a) Exhibits
31.1 Chief Executive Officer's Certificate pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Acting Chief Financial Officer's Certificate pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
32.1 Chief Executive Officer's Certificate pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Acting Chief Financial Officer's Certificate pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
17
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
OLYMPIC CASCADE FINANCIAL CORPORATION AND SUBSIDIARY
February 11, 2005 By: /s/ Mark Goldwasser
--------------------------------------------
Mark Goldwasser
President and Chief Executive Officer
February 11, 2005 By: /s/ Robert H. Daskal
--------------------------------------------
Robert H. Daskal
Acting Chief Financial Officer
18