- -------------------------------------------------------------------------------- Form 10-Q INVESTORS CAPITAL HOLDINGS LTD - ICH Filed: August 13, 2004 (period: June 30, 2004) Quarterly report which provides a continuing view of a company's financial position - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Table of Contents PART I ------- - -------------------------------------------------------------------------------- FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ITEM 4. CONTROLS AND PROCEDURES PART II ------- - -------------------------------------------------------------------------------- OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS SIGNATURES CERTIFICATION - -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q {X} QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2004 Commission File Number: 1-16349 INVESTORS CAPITAL HOLDINGS, LTD. (Exact name of registrant as specified in its charter) MASSACHUSETTS 04-3284631 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 230 Broadway Lynnfield, Massachusetts 01940 (Address of principal executive offices) (781) 593-8565 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] Number of shares outstanding of our only class of common stock as of August 11, 2004: 5,738,976 PART I FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS INVESTORS CAPITAL HOLDINGS, LTD. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) June 30, March 31, 2004 2004 -------------- ------------- Assets Current Assets Cash and cash equivalents .................................... $ 8,273,392 $ 8,112,567 Deposit with clearing organization, restricted ............... 175,000 175,000 Accounts receivable .......................................... 2,967,513 3,785,423 Investments in available-for-sale securities ................. 56,906 56,339 Marketable securities, at market value ....................... 114,126 17,422 Prepaid expenses ............................................. 278,150 310,270 -------------- ------------- 11,865,087 12,457,021 Property and equipment, net ....................................... 525,431 503,316 Long-Term Investments Equity investments, at cost .................................. 40,000 40,000 Investment in unconsolidated affiliate ....................... 87,311 85,820 -------------- ------------- 127,311 125,820 Other Assets Other assets ................................................. 71,980 99,295 Deferred tax asset, net ...................................... 68,004 69,721 Receivables from officers .................................... 55,396 64,400 Loans receivable from registered representatives ............. 50,000 69,306 -------------- ------------- 245,380 302,722 TOTAL ASSETS ............................................ $ 12,763,209 $ 13,388,879 ============== ============= Liabilities and Stockholders' Equity Current Liabilities Accounts payable ............................................. $ 704,396 $ 570,236 Accrued expenses ............................................. 239,971 435,067 Notes payable ................................................ 45,482 78,999 NASD settlement payable (current portion) .................... 50,572 54,375 Commissions payable .......................................... 1,648,103 2,078,196 Income taxes payable ......................................... 191,598 582,721 Securities sold, not yet purchased, at market value .......... 185,066 90,042 -------------- ------------- 3,065,188 3,889,636 Long-Term Liabilities NASD settlement payable ...................................... 84,867 94,304 -------------- ------------- 84,867 94,304 Total liabilities ....................................... 3,150,055 3,983,940 -------------- ------------- Commitments and contingencies Stockholders' Equity: Common stock, $.01 par value, 10,000,000 shares authorized; 5,732,450 issued and 5,728,565 outstanding in June 30, 2004; 5,731,598 issued and 5,727,713 outstanding in March 31, 2004. 57,325 57,316 Additional paid-in capital ................................... 8,524,552 8,520,931 Retained earnings ............................................ 1,048,686 844,670 Less: Treasury stock, 3,885 shares at cost ................. (30,135) (30,135) Accumulated other comprehensive income (loss) ................ 12,726 12,157 -------------- ------------- Total stockholders' equity ............................ 9,613,154 9,404,939 -------------- ------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ............................................ $ 12,763,209 $ 13,388,879 ============== ============= See Notes to Condensed Consolidated Financial Statements. 1 INVESTORS CAPITAL HOLDINGS, LTD. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) Three Months Ended June 30, ------------------------------ 2004 2003 Revenues: -------------- ------------- Commission, advisory & other fee income $ 13,918,699 $ 9,645,283 Marketing revenue, net 304,779 (7,722) Other income 91,720 90,922 -------------- ------------- Total Revenue 14,315,198 9,728,483 Commission and advisory fees 11,572,118 8,094,941 -------------- ------------- Gross profit 2,743,080 1,633,542 -------------- ------------- Operating expenses: Advertising 204,599 150,592 Communications 131,575 82,977 -------------- ------------- Selling 336,174 233,569 -------------- ------------- Compensation and Benefits 1,324,607 969,768 Regulatory, legal and professional 317,832 192,785 Occupancy 137,789 112,401 Other administrative expenses 245,861 221,459 -------------- ------------- Administrative 2,026,089 1,496,413 -------------- ------------- Total Operating Expenses 2,362,263 1,729,982 -------------- ------------- Operating income(Loss) 380,817 (96,440) -------------- ------------- Other expense: Interest expense 16,157 6,029 -------------- ------------- Total other expense 16,157 6,029 -------------- ------------- Income (loss) before taxes 364,660 (102,469) Provision for income taxes(Benefit) 160,644 (19,027) -------------- ------------- Net income (loss) $ 204,016 $ (83,442) ============== ============= Earnings (loss) per common share Basic earnings per common share: $ .04 $ ( .01) Diluted earnings (loss) per common share $ .03 $ ( .01) ============== ============= Share data: Weighted average shares used in basic earnings per common share calculations 5,727,914 5,717,380 Plus: Incremental shares from assumed exercise of stock options 196,993 - -------------- ------------- Weighted average shares used in diluted earnings per common share calculations 5,924,907 5,717,380 ============== ============= See Notes to Condensed Consolidated Financial Statements. 2 INVESTORS CAPITAL HOLDINGS, LTD. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY THREE MONTHS ENDED JUNE 30, 2004 AND 2003 (UNAUDITED) Accumulated Additional Retained Other Common Stock Paid-In Earnings Treasury Comprehensive ----------- --------- Capital (Deficit) Stock Income (Loss) Total Shares Amount ---------------------------------------------------------------------------------- Balance at April 1, 2003................... 5,721,265 $57,213 $8,169,292 $54,257 $(30,135) ($1,987) $8,248,640 Stock based compensation................... 29,266 29,266 Comprehensive loss: Net loss............................ (83,442) Net unrealized gain on securities... 5,345 Comprehensive loss............. (78,097) ---------------------------------------------------------------------------------- Balance at June 30, 2003................. 5,721,265 $57,213 $8,198,558 $(29,185) $(30,135) $3,358 $8,199,809 ================================================================================== Balance at April 1, 2004................... 5,731,598 $57,316 $8,520,931 844,670 $(30,135) $12,157 $9,404,939 Stock based compensation................... 1,954 1,954 Comprehensive gain: 852 9 1,667 1,676 Net income............................ 204,016 Net unrealized gain on securities... 569 Comprehensive gain............. 204,585 ---------------------------------------------------------------------------------- Balance at June 30, 2004..................... 5,732,450 $57,325 $8,524,552 $1,048,686 $(30,135) $12,726 $9,613,154 ================================================================================== See Notes to Condensed Consolidated Financial Statements. 3 INVESTORS CAPITAL HOLDINGS, LTD. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) Three Months Ended June 30, -------------------------- 2004 2003 ----------- ----------- Cash flows from operating activities: Net (loss) income........................................................... $ 204,016 $ (83,442) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization........................................... 38,611 33,633 Change in deferred taxes................................................ 1,717 5,152 Stock option compensation............................................... 1,954 29,266 Change in marketable securities......................................... (1,680) (14,413) Unrealized (gain) loss on investment in unconsolidated affiliates....... (1,491) (11,706) Changes in operating assets and liabilities: Decrease in accounts receivable............................... 817,910 114,126 Decrease in receivables from officers, prepaid expenses and other assets 68,441 34,167 Increase in income taxes receivable..................................... - (53,179) Increase in taxes payable............................................... (391,123) - (Decrease) increase in accounts payable and other liabilities........... 134,160 (7,938) (Decrease) increase in accrued expenses................................. (195,096) (23,793) Increase (decrease) in commissions payable.............................. (430,093) 104,797 ----------- ----------- Net cash provided by operating activities................. 247,326 126,670 ----------- ----------- Cash flows from investing activities: Purchases of property and equipment......................................... (60,726) (43,010) Decrease in loans receivable from registered representatives................ 19,306 39,727 ----------- ----------- Net cash used in investing activities.................. (41,420) (3,283) ----------- ----------- Cash flows from financing activities: Exercise of stock options .................................... 1,676 -- Payments on notes payable and NASD settlement.................. (46,757) (112,334) ----------- ----------- Net cash used in financing activities.................. (45,081) (112,334) ----------- ----------- Net increase in cash and cash equivalents........................... 160,825 11,053 Cash and cash equivalents, beginning of period...................... 8,112,567 7,090,643 ----------- ----------- Cash and cash equivalents, end of period............................ $8,273,392 $7,101,696 =========== =========== Supplemental disclosures of cash flow information: Interest paid.................................................. $ 16,157 $ 6,029 =========== =========== Income taxes paid.................................................. $ 550,000 $ 29,050 =========== =========== See Notes to Condensed Consolidated Financial Statements. 4 INVESTORS CAPITAL HOLDINGS, LTD. AND SUBSIDIARIES CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE QUARTER ENDED JUNE 30, 2004 (UNAUDITED) 1. ORGANIZATION, BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES Organization Incorporated in July 1995, Investors Capital Holdings, Ltd. ("ICH") is a financial services holding company that operates through its three subsidiaries, Investors Capital Corporation, Eastern Point Advisors, Inc. and ICC Insurance Agency, Inc. in two segments of the financial services industry. These two segments provide for the offering of (1) services related to corporate equity and debt securities, U.S. Government securities, municipal securities, mutual funds, variable annuities, variable life insurance, market information, Internet online trading and portfolio tracking, and records management and (2) financial planning services, investment advisory and asset management services, and the management of a retail mutual fund. These products and services are offered primarily through our network of independent registered representatives throughout the United States. Basis of Presentation The accompanying unaudited condensed consolidated financial statements of Investors Capital Holdings, Ltd. (the Company) 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. In the opinion of management, these financial statements contain all of the adjustments necessary for a fair presentation of the results of these interim periods. Certain footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted, although the Company believes the disclosures in these financial statements are adequate to make the information presented not misleading. Operating results for the three-month period ending June 30, 2004 are not necessarily indicative of the results that may be expected for the year ended March 31, 2005. The balance sheet at March 31, 2004 has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by GAAP for complete financial statements. These unaudited condensed consolidated financial statements should be read in conjunction with the Company's annual audited financial statements included in the Company's Form 10-K for the fiscal year ended March 31, 2004 filed with the Securities and Exchange Commission. Use of Estimates The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Reclassifications Certain amounts in the prior periods have been reclassified to remain consistent with the current fiscal year financial statement presentation. 5 2. SEGMENT INFORMATION The Company's reportable segments include investment services offered through Investors Capital Corporation (ICC) and asset management services offered through Eastern Point Advisors, Inc. (EPA). This investment services segment includes securities, insurance, financial planning and related services. ICC earns commissions as a broker for its customers in the purchase and sale of securities on major exchanges. Asset management services generate recurring annual revenue from fees received on the management of customer accounts. EPA provides asset management and portfolio design services to a mutual fund and a variety of investors. The segment data presented includes the allocation of all corporate overhead to each segment. Intersegment revenue and expense, and receivables and payables, are eliminated between segments. Currently it is impractical to report segment information using geographical concentration. For the year ended March 31, 2004, management changed its approach in identifying reportable segments. Management concluded that its reportable segments are to be shown on a stand alone basis, in accordance with SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information", ("SFAS 131"). Specifically, as ICH does not generate operating revenue, other than interest income, and does not meet the quantitative tests under SFAS 131, management concludes that ICH does not meet the definition of a reportable segment. Previously reported segment information has been restated to reflect the new presentation and to preserve comparability. Segment reporting is as follows: Three Months Ended June 30, --------------------------- 2004 2003 ------------ ------------ Non-interest revenues: ICC, investment services .................... $13,736,735 $ 9,105,004 EPA, asset management services............... 486,743 532,558 ------------ ------------ Total........................ $14,223,478 $ 9,637,562 ============ ============ Revenues from transactions with other operating segments: ICC............................... $ 336,605 $ 164,810 EPA............................... 37,401 70,633 ------------ ------------ Total........................ $ 374,006 $ 235,443 ============ ============ Interest and dividend income: ICC............................... $ 52,295 $ 42,013 ICH............................... 37,934 37,203 ------------ ------------ Total........................ $ 90,229 $ 79,216 ============ ============ Depreciation and amortization expense: ICC............................... $ 36,709 $ 31,902 EPA............................... 1,901 1,731 ------------ ------------ Total........................ $ 38,610 $ 33,633 ============ ============ 6 INVESTORS CAPITAL HOLDINGS, LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE QUARTER ENDED JUNE 30, 2004 (UNAUDITED) 2. SEGMENT INFORMATION (Continued) Three Months Ended June 30, --------------------------- 2004 2003 ------------ ------------ Income tax provision (benefit): ICC............................... $ 195,050 $ (4,114) EPA............................... (58,003) (50,317) ICH............................... 23,597 35,404 ------------ ------------ Total........................ $ 160,644 $ (19,027) ============ ============ Income (loss): ICC............................... $ 274,359 $ (21,137) EPA............................... (86,171) (75,379) ICH............................... 15,828 13,074 ------------ ------------ Total........................ $ 204,016 $ (83,442) ============ ============ Period end total assets: ICC............................... $ 8,465,163 $ 5,128,081 EPA............................... 460,290 583,478 ICH............................... 5,616,141 5,617,143 Corporate items and eliminations (1,778,385) (865,646) ------------ ------------ Total........................ $12,763,209 $10,463,056 ============ ============ 3. LITIGATION The Company is involved with various judicial, regulatory, and arbitration proceedings concerning matters arising in connection with the conduct of its business. At June 30, 2004, the Company was the co-defendant in several lawsuits with claims of approximately $3.9 million. Management believes, based on currently available information, that the results of such proceedings, in the aggregate, will not have a material, adverse effect on the firm's financial condition. The Company has Errors and Omissions ("E&O") insurance to protect itself from potential damages and/or legal costs associated with the aforementioned lawsuits, and as a result, in the majority of cases, the Company`s exposure is limited to between $75,000 and $100,000 per case, subject to policy limitations and exclusions. In accordance with Financial Accounting Standards Board ("FASB") Statement No. 5, "Accounting for Contingencies", the Company had accrued expenses of approximately $215,000 for the year ended June 30, 2004 related to legal fees and estimated probable settlement costs relating to the Company's defense in various lawsuits 4. STOCK BASED COMPENSATION The Company applies Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations in accounting for its stock option plans. During the first quarter of fiscal 2004, the Company adopted the disclosure provisions of SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure. The following table illustrates the effect on net earnings and earnings per share, had the Company adopted the fair value-based method of accounting for stock-based employee compensation for all periods presented. 7 Three Months Ended --------------------------- 2004 2003 ------------ ------------ Net income (loss), as reported $ 204,016 $ (83,442) Deduct: Total stock-based employee compensation expense determined under fair value-based method for all awards, net of related tax effects -- 2,639 ------------ ------------ Pro forma net income(loss) $ 204,016 $ (86,081) ============ ============ Earnings per share: Basic- as reported .04 (.01) Diluted-as reported .03 (.01) Basic - pro forma .04 (.01) diluted - pro forma .03 (.01) ITEM 2. Management's Discussion and Analysis Management's discussion and analysis reviews our consolidated financial condition as of June 30, 2004 and March 31, 2004, the consolidated results of operations for the three months ended June 30, 2004 and 2003 and, where appropriate, factors that may affect future financial performance. The discussion should be read in conjunction with the consolidated financial statements and related notes, included elsewhere in the Form 10-Q. Overview We are a financial services holding company that, through our subsidiaries, provides investment advisory, insurance, financial planning 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 any one of or by a multiple of these external factors. In addition, the passage of the Graham-Leach-Bliley Act in November of 1999 repealed depression-era laws that separated commercial, investment banking and insurance activities. Such repeal may result in the intensification of the environment in which we compete by increasing the number of companies doing business in the financial services arena. Critical Accounting Policies The condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States. The Company believes that of its significant accounting policies, those described below involve a high degree of judgment and complexity. These critical accounting policies require estimates and assumptions that affect the amounts of assets, liabilities, revenues and expenses reported in the consolidated financial statements. Due to their nature, estimates involve judgment based upon available information. Actual results or amounts could differ from estimates and the difference could have a material effect on the condensed consolidated financial statements. Therefore, understanding these policies is important in understanding the reported results of operations and the financial position of the Company. Valuation of Securities and Other Assets Substantially all financial instruments are reflected in the consolidated financial statements at fair value or amounts that approximate fair value, these include: cash, cash equivalents, and securities purchased under agreements to resell; deposits with clearing organizations; securities owned; and securities sold but not yet purchased. Unrealized gains and losses related to these financial instruments are reflected in net earnings or other comprehensive income in accordance with FASB 115, depending on the underlying purpose of the instrument. Where available, the Company uses prices from independent sources such as listed market prices, or broker or dealer price quotations. Fair values for certain derivative contracts are derived from pricing models that consider current market and contractual prices for the underlying financial instruments or commodities, as well as time value and yield curve or volatility factors underlying the positions. In addition, even where the value of a security is derived from an independent market price or broker or dealer quote, certain assumptions may be required to determine the fair value. For instance, the Company generally assumes that the size of positions in securities that the Company holds would not be large enough to affect the quoted price of the securities if the Company were to sell them, and that any such sale would happen in an orderly manner. However, these assumptions may be incorrect and the actual value realized upon disposition could be different from the current carrying value. 8 The Company's private equity investments have been reported at cost pursuant to Accounting Principles Board No.18 "The Equity Method of Accounting for Investments in Common Stock ("APB 18") as the Company does not exercise significant influence over these investments. Reserves The Company records reserves related to legal proceedings in "accrued expenses". 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 of the Company; previous results in similar cases; and legal precedents and case law. 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 consolidated financial statements and is recognized as a charge/credit to earnings in that period. The assumptions of management in determining the estimates of reserves may be incorrect and the actual disposition of a legal proceeding could be greater or less than the reserve amount. Results of Operations Three Months Ended June 30, 2004 compared with Three Months Ended June 30, 2003 Total revenue of $14.3 million increased by $4.6 million or 47.0% for the quarter ended June 30, 2004, compared with total revenue of $9.7 million for the quarter ended June 30, 2003. Consolidated commissions, advisory, and other fee income of $13.9 million for the quarter ended June 30, 2004, increased by $4.3 million or 44.8%, compared with consolidated commissions, advisory, and other fee income of $9.6 million for the quarter ended June 30, 2003. This increase can be attributed primarily to a $4.3 million increase in revenues provided by Investors Capital Corporation (ICC). Also, as a result of ICC obtaining dual designation as an Investment Advisor (Investors Capital Advisors), Eastern Point Advisors transferred approximately 73% of assets under management within the Pershing Securities Managed Asset Plan Platform in March, 2004, which contributed to ICC's increase in commission and advisory fee income for the quarter ended June 30, 2004. Eastern Point Advisors (EPA) contribution was relatively flat for the comparative periods. The overall increase was driven by $2.4 million in commissions generated from the sale of mutual funds and variable annuities during the quarter ended June 30, 2004. In addition, $1.9 million of additional commissions was generated from the brokerage business and other fees. Net marketing revenues of approximately $305,000 increased by approximately $313,000 for the quarter ended June 30,2004, compared to an approximate net marketing loss of $8,000 for the quarter ended June 30,2003. This increase was the result of Management's reporting the profitability of its preferred marketing programs on an individual event basis as compared to a consolidated event basis as reported during the same period ended June 30, 2003. Finally, other income was relatively the same for quarter ended June 30,2004 when compared to quarter ended June 30,2003. The significant increase in sales volume can be attributed to enhanced marketing efforts in recruiting and business development. The marketing department continues to focus its attention on attracting a sophisticated representative who can provide a more diversified and broader product base to clients. Additionally, the marketing team assisted the representatives in taking advantage of current market conditions through various workshops, regional and national meetings, and seminar training programs. Consolidated commissions and advisory fees of $11.6 million for the quarter ended June 30,2004, increased by $3.5 million or 43.2% compared to $8.1 million for the quarter ended June 30,2003. This change can be attributed to an increase of $3.5 million in commission expenses incurred by ICC. Included in the $3.5 million increase was the net result of a trading error of approximately $363,000 that occurred on April 20, 2004. The increase in commission expense is the direct result of an improvement in gross revenues as noted above. Cost of sales increased proportionately with sales from commission, advisory and other fee income on a percentage basis resulting in a comparative ratio of about one-to-one, 83.1% in 2004 and to 83.9% in 2003. The Company realized consolidated operating income of approximately $381,000 for the quarter ended June 30,2004, compared with an approximate operating loss of $96,000 for the quarter ended June 30,2003. This 496.9% increase in consolidated operating income is primarily the result of additional business generated by the brokerage firm (ICC). This increase in operating income came primarily from (ICC) as Eastern Point Advisors (EPA) had little or no contribution to the increase. Operating income improved by about $477,000. Gross profit rose by over $1.1 million or 67.9% while selling and administrative expenses increased by a lesser extent of approximately $632,000 or 36.6%. A breakdown of gross profit by product type, depicting both the dollar and percentage contribution, is presented in the following table: 9 % of Gross Profit Gross Profit 2004-2003 June 2004 June 2004 Product Type $ increase (decrease) increase change % Margin Change $ Gross Margin % Gross Margin - ------------------------------------------------------------------------------------------------------------------ Commissions-mutual $315,268 28.4% 34.9% $1,216,578 44.4% funds &variable annuities - ------------------------------------------------------------------------------------------------------------------ Commissions-trading 142,985 12.9% 47.8% 442,774 16.1% - ------------------------------------------------------------------------------------------------------------------ Commissions -Insurance 57,316 5.2% 457.2% 69,852 2.5% Products - ------------------------------------------------------------------------------------------------------------------ Commissions- Underwriting (23,061) (2.1)% (97.5)% 600 --% - ------------------------------------------------------------------------------------------------------------------ Advisory Services & 109,601 9.9% 43.9% 359,200 9.2% Administration Fees - ------------------------------------------------------------------------------------------------------------------ Licensing Revenue 191,077 17.2% 307.0% 253,315 13.1% - ------------------------------------------------------------------------------------------------------------------ Net Marketing Revenue 312,501 28.2% 4046.9% 304,779 11.1% - ----------------------------------------------------------------------------------------------------------------- Other Income & Revenues 3,851 .3% 253.1% 95,982 3.6% - ------------------------------------------------------------------------------------------------------------------ Total $1,109,538 100% N/A $2,743,080 100% - -------------------------------==========--------------======-----------======---------==========-------------==== As a percentage of the increase in gross profit, contributions from mutual funds, variable products, and trading activities represented 41.3% of the total increase while net marketing revenues comprised 28.2% of the increase. A margin increase of $315,268 or 34.9% was realized from sales of mutual funds and variable annuity products. Trading activities increased on a marginal basis by $142,985 or 47.8% between quarters ended 2004 and 2003. As a percentage of the June 30, 2004 gross profit, mutual funds and variable annuity products constitute 44.4% of the overall profit margin while trading activity represents 16.1%. The remainder of the profit margin is comprised of advisory services, 9.2%; net marketing revenues, 11.1%; and licensing, insurance products, underwriting and other income and revenues, 19.2%. Consolidated administrative expenses of approximately $2 million for the quarter ended June 30, 2004 increased by approximately $530,000 or 35.3%, compared with expenses of $1.5 million for quarter ended June 30, 2003. This increase is a result of an approximate $355,000 increase in compensation and benefits based on the acquisition of additional personnel to accommodate growth. Regulatory, legal, and professional fees increased by approximately $125,000 or about 65% due to added costs incurred for legal representation in litigation as a result of increased volume in our business over the last couple of years. Other administrative expenses increased by approximately $25,000 or 11.3% as a result of the write off of bad debts. As another factor of growth, the ratio of administrative expenses to profit margin has declined to 73.9% for the quarter ended June 30, 2004 from 91.6% for the quarter ended June 30, 2003. The Company is benefiting from the use of fixed costs applied to new business activity. Resources committed in technology and web-based reporting has guided the automation process of the business. More independent registered representatives are taking advantage of the technology. Through trading technology, representatives can process their own trades. This enables the brokerage firm to receive the benefits of "economies of scale" from fixed trading costs. The Company is able to process more transactions while maintaining stable administrative costs. Consolidated selling expenses were approximately $336,000 for the quarter ended June 30, 2004, an amount that increased by over $100,000 or 43.6% from $234,000 for the quarter ended June 30, 2003. This increase can be attributed to a rise in advertising costs by over $54,000 and a rise in communication costs by over $48,000. The increase in advertising related expenses were primarily the result of an increase in travel related expenses of over $50,000. The increase in communication expenses came from an approximate $20,000 increase in telephone related expenses and an approximate $25,000 in printing costs to continue to market our business in brokerage and advisory services and to promote our new mutual fund, the Eastern Point Advisors Rising Dividend Growth Fund. ICC and EPA bear the administrative and selling expenses for ICH in the form of management fees paid to ICH. These management fees, contained within the following chart, have been eliminated during consolidation in the accompanying financial statements. Based on a revised time study prepared by management, the allocation of these expenses between subsidiaries has changed from a 30% allocation to a 10% allocation, effective April 1,2004. June 2004 June 2003 - -------------------------------------------------------------------------------- ICC $336,605 $164,810 - -------------------------------------------------------------------------------- EPA 37,401 70,633 - -------------------------------------------------------------------------------- Total $374,006 $235,443 - -------------------------------========-----------------========---------------- 10 The Company recorded consolidated income taxes of about $161,000 for the quarter ended June 30, 2004, compared with an income tax benefit of about $19,000 for the quarter ended June 30,2003. This increase of about $180,000 or 947.4% can be attributed to the Company's increased profitability during the same period. The Company generated consolidated net income of over $204,000 for the quarter ended June 30, 2004, compared with a net loss of about $83,000 for the quarter ended June 30, 2003. This increase of over $287,000 or about 345% in net income can be attributed to a rise in operating income over the same period because of the growth of our various business lines. This fluctuation led to a rise of income before taxes of over $467,000 or 457.8% percent for the quarter ended June 30, 2004 when compared to quarter ended June 30,2003. The Company's improved profitability resulted primarily from ICC operations. Total revenues increased considerably over the same period, which led to a higher gross profit. In addition, operating expenses did not increase proportionately with gross profit, resulting in improved net income. The operational model the Company is investing resources in, makes substantial use of technology which enables the Company to accommodate growth in revenue through increased transaction processing without incurring incremental overhead. Liquidity and Capital Resources The Company believes that return on equity primarily is based on the use of capital in an efficient manner. Historically, we have financed our operations primarily through private equity and internally generated cash flow and not by incurring debt. As of June 30, 2004, cash and cash equivalents totaled $8.3 million as compared to $8.1 million as of March 31, 2004. Working capital as of June 30,2004 was $8.8 million as compared to $8.6 million as of March 31, 2004. Our ratio of current assets to current liabilities was 3.84 to 1 as of June 30, 2004 as compared to 3.21 to 1 as of March 31, 2004. As of June 30, 2004, the net capital ratio for the broker-dealer was 2.63 to 1 as compared to a 2.38 to 1 for the fiscal year ended March 31, 2004. The SEC Uniform Net Capital Rule (Rule 15c3-1) requires that we maintain a net capital of $100,000 and a ratio of aggregate indebtedness to net capital not to exceed 15 to 1. This SEC requirement is also referred to as the "net capital ratio" or the "net capital rule." Indebtedness generally includes all money owed by a company, and net capital includes cash and assets that are easily converted into cash. SEC rules also prohibit "equity capital," which, under the net capital rule, includes the subordinated loans from being withdrawn or cash dividends from being paid if our net capital ratio would exceed 10 to 1 if we would have less than our minimum required net capital. As of June 30, 2004, we had net capital of $1.4 million as compared to net capital of $1.8 million as of March 31,2004. This resulted in excess net capital of $1.2 million and $1.5 million, respectively, for the applicable periods. Net cash provided by operating activities was about $247,000 for the quarter ended June 30, 2004 as compared to net cash provided in operating activities of about $127,000 for the quarter ended June 30, 2003. The greater than $120,000 increase in 2004 compared to 2003 resulted primarily from an increase in net income and collections of accounts receivable offset by payments to commissions payable and income taxes payable. Net cash used in investing activities increased by over $38,000 for period ended June 30,2004 as compared to June 30,2003. The increase in cash used resulted from the purchase of fixed assets and a decrease in cash collections from the loans outstanding to registered representatives. Net cash used in financing activities decreased by over $67,000. The decrease in cash used resulted from less financing of insurance policies on D&O, employee liability, and fidelity bond. Risk Management Risks are an inherent part of the Company's business and activities. Management of these risks is critical to the Company's financial strength and profitability and requires communication, judgment and knowledge of financial trends and the economy as a whole. Senior management takes an active role in the risk management process. The principal risks involved in the Company's business activities are market, operational, regulatory and legal. Market Risk Market risk is the risk attributable to common macroeconomic factors such as gross domestic product, employment, inflation, interest rates, budget deficits and sentiment. Consumer and producer sentiment is critical to our business. The level of consumer confidence determines their willingness to spend, especially in the financial markets. It is this willingness to spend in the financial markets that is key to our business. A shift in spending in this area could negatively impact the Company. However, senior management is constantly monitoring these economic trends in order to enhance our product line to offset any potential negative impact. 11 Operational Risk Operational risk refers to the risk of loss resulting from the Company's operations, including, but not limited to, improper or unauthorized execution processing of transactions, deficiencies in the Company's technology or financial operating systems and inadequacies or breaches in the Company's control processes. Managing these risks is critical, especially in a rapidly changing environment with increasing transaction volume. Failure to manage these risks could result in financial loss to the Company. To mitigate these risks, the Company developed specific policies and procedures designed to identify and manage operational risk. These policies and procedures are reviewed and updated on a continuing basis to ensure that this risk is minimized. Regulatory and Legal Risk Regulatory and legal risk includes non-compliance with applicable legal and regulatory requirements and the risk of a large number of customer claims that could result in adverse judgments against the Company. The Company is subject to extensive regulation in all jurisdictions in which it operates. In this regard, the Company has instituted comprehensive procedures to address issues such as regulatory capital requirements, sales and trading practices, use of and safekeeping of customer funds, credit granting, collection activities, money-laundering and record keeping. Effects of Inflation The Company's assets are primarily liquid in nature and are not significantly affected by inflation. Management believes that the replacement cost of property and equipment will not materially affect operating results. However, the rate of inflation affects our expenses, including employee compensation and benefits, communications and occupancy, which may not be readily recoverable through charges for services provided. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information required by this item is contained in "Management's Discussion and Analysis of Financial Condition and Results of Operations" under the caption "Market Risk" of this Form 10-Q. ITEM 4. CONTROLS AND PROCEDURES Our Chief Executive Officer and Chief Financial Officer have concluded, based on their evaluation within 90 days of the filing date of this report, that our disclosure controls and procedures are effective for gathering, analyzing and disclosing the information we are required to disclose in our reports filed under the Securities Exchange Act of 1934. There have been no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of the previously mentioned evaluation. PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The Company operates in a highly litigious and regulated business and, as such, is a defendant or codefendant in various lawsuits and arbitrations incidental to its securities business. The Company is vigorously contesting the allegations of the complaints in these cases and believes that there are meritorious defenses in each. Counsel is unable to respond concerning the likelihood of an outcome, whether favorable or unfavorable, because of inherent uncertainties routine in these matters. Currently, there are various lawsuits and/or arbitrations filed against the Company. For the majority of claims, the Company's errors and omissions (E&O) policies limit the maximum exposure, subject to policy limitations and exclusions, in any one case to between $75,000 and $100,000, and in certain of these cases, the Company has the contractual right to seek indemnity from related parties. As such, Management, in consultation with counsel, believes that resolution of all such litigation is not expected to have a material adverse effect on the consolidated financial results of the Company. 12 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. INVESTORS CAPITAL HOLDINGS, LTD. By: /s/ Timothy B. Murphy ---------------------- Chief Financial Officer Date: August 13, 2004 13 CERTIFICATION ------------- I, Theodore E. Charles, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Investors Capital Holdings, Ltd.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: August 13, 2004 By: /s/ THEODORE E. CHARLES - ---------------------------- Theodore E. Charles Chief Executive Officer 14 CERTIFICATION ------------- I, Timothy B. Murphy, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Investors Capital Holdings, Ltd.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: August 13, 2004 By: /s/ TIMOTHY B. MURPHY - ------------------------- Timothy B. Murphy Chief Financial Officer 15