- -------------------------------------------------------------------------------- Form 10-Q INVESTORS CAPITAL HOLDINGS LTD - ICH Filed: February 14, 2005 (period: December 31, 2004) Quarterly report which provides a continuing view of a company's financial position - -------------------------------------------------------------------------------- Form 10-Q INVESTORS CAPITAL HOLDINGS LTD - ICH Filed: February 14, 2005 (period: December 31, 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 EX-31.1 EX-31.2 EX-32.1 EX-32.2 - -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended December 31, 2004 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the period from _______ to_________ 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) - -------------------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) 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 February 7, 2005: 5,742,432 PART I FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS INVESTORS CAPITAL HOLDINGS, LTD. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) December 31, March 31, 2004 2004 ------------- ------------ Assets Current Assets Cash and cash equivalents .................................... $ 8,969,356 $ 8,112,567 Deposit with clearing organization, restricted ............... 175,000 175,000 Accounts receivable .......................................... 3,509,985 3,785,423 Investments in available-for-sale securities ................. ------- 56,339 Marketable securities, at market value ....................... 21,143 17,422 Prepaid expenses ............................................. 195,865 310,270 ------------- ------------- 12,871,349 12,457,021 Property and equipment, net ....................................... 573,459 503,316 Long-Term Investments Equity investments, at cost .................................. 40,000 40,000 Investment in unconsolidated affiliate ....................... 152,267 85,820 ------------- ------------- 192,267 125,820 Other Assets Other assets ................................................. 54,560 99,295 Deferred tax asset, net ...................................... 64,263 69,721 Receivables from officers .................................... 37,079 64,400 Loans receivable from registered representatives ............. 281,267 69,306 ------------- ------------- 437,169 302,722 TOTAL ASSETS ............................................ $ 14,074,244 $ 13,388,879 ============= ============= Liabilities and Stockholders' Equity Current Liabilities Accounts payable ............................................. $ 754,232 $ 570,236 Accrued expenses ............................................. 92,060 435,067 Unearned revenue.............................................. 1,583,010 ------ Notes payable ................................................ 16,375 78,999 NASD settlement payable (current portion) .................... ------ 54,375 Commissions payable .......................................... 1,519,555 2,078,196 Income taxes payable ......................................... 99,847 582,721 Securities sold, not yet purchased, at market value .......... 131,731 90,042 ------------- ------------- 4,196,810 3,889,636 Long-Term Liabilities NASD settlement payable ...................................... ------ 94,304 ------------- ------------ ------ 94,304 Total liabilities ....................................... 4,196,810 3,983,940 ------------- ------------ 1 INVESTORS CAPITAL HOLDINGS, LTD. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) December 31, March 31, 2004 2004 ------------- ------------ Commitments and contingencies Stockholders' Equity: Common stock, $.01 par value, 10,000,000 shares authorized; 5,742,298 issued and 5,738,413 outstanding at December 31, 2004; 5,731,598 issued and 5,727,713 outstanding at March 31, 2004. 57,423 57,316 Additional paid-in capital ................................... 8,595,734 8,520,931 Retained earnings ............................................ 1,254,412 844,670 Less: Treasury stock, 3,885 shares at cost ................. (30,135) (30,135) Accumulated other comprehensive income ....................... ------ 12,157 ------------ ------------ Total stockholders' equity ............................ 9,877,434 9,404,939 ------------ ------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ............. $ 14,074,244 $ 13,388,879 ============ ============ See Notes to Condensed Consolidated Financial Statements. 2 INVESTORS CAPITAL HOLDINGS, LTD. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) Three Months Ended December 31, ----------------------------- 2004 2003 Revenues: ------------- ------------ Commission, advisory & other fee income $ 13,175,490 $ 13,010,336 Marketing revenue, net 251,918 425,095 Other income 153,453 83,738 ------------- ------------ Total revenue 13,580,861 13,519,169 Commission and advisory fees 10,527,798 10,799,273 ------------- ------------ Gross profit 3,053,063 2,719,896 ------------- ------------ Operating expenses: Advertising 179,561 135,260 Communications 137,802 114,765 ------------- ------------ Selling 317,363 250,025 ------------- ------------ Compensation and benefits 1,435,213 1,277,317 Regulatory, legal and professional 325,244 334,816 Occupancy 151,606 115,384 Other administrative expenses 208,880 230,614 ------------- ------------ Administrative 2,120,943 1,958,131 ------------- ------------ Total operating expenses 2,438,306 2,208,156 ------------- ------------ Operating income 614,757 511,740 ------------- ------------ Other expense: Interest expense 8,218 7,842 ------------- ------------ Total other expense 8,218 7,842 ------------- ------------ Income before taxes 606,539 503,898 Provision for income taxes 251,316 197,268 -------------- ------------- Net income $ 355,223 $ 306,630 ============= ============ Earnings per common share: Basic earnings per common share $ .06 $ .05 ============= ============ Diluted earnings per common share $ .06 $ .05 ============= ============ Share data: Weighted average shares used in basic earnings per common share calculations 5,736,916 5,721,185 Plus: Incremental shares from assumed exercise of stock options 171,466 193,964 ------------- ------------ Weighted average shares used in diluted earnings per common share calculations 5,908,382 5,915,149 ============= ============ See Notes to Condensed Consolidated Financial Statements. 3 INVESTORS CAPITAL HOLDINGS, LTD. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) Nine Months Ended December 31, ------------------------------ 2004 2003 Revenues: ------------- ------------ Commission, advisory & other fee income $ 39,291,999 $ 33,950,162 Marketing revenue, net 706,869 492,912 Other income 337,379 256,293 ------------- ------------ Total revenue 40,336,247 34,699,367 Commission and advisory fees 32,416,497 27,939,103 ------------- ------------ Gross profit 7,919,750 6,760,264 ------------- ------------ Operating expenses: Advertising 583,438 439,687 Communications 379,756 301,934 ------------- ------------ Selling 963,194 741,621 ------------- ------------ Compensation and benefits 4,065,595 3,245,979 Regulatory, legal and professional 1,049,054 823,039 Occupancy 433,891 336,857 Other administrative expenses 659,206 712,398 ------------- ------------ Administrative 6,207,746 5,118,273 ------------- ------------ Total operating expenses 7,170,940 5,859,894 ------------- ------------ Operating income 748,810 900,370 ------------- ------------ Other expense: Interest expense 32,091 17,872 ------------- ------------ Total other expense 32,091 17,872 ------------- ------------ Income before taxes 716,719 882,498 Provision for income taxes 306,977 389,505 ------------- ------------ Net income $ 409,742 $ 492,993 ============= ============ Earnings per common share: Basic earnings per common share $ .07 $ .08 ============= ============ Diluted earnings per common share $ .07 $ .08 ============= ============ Share data: Weighted average shares used in basic earnings per common share calculations 5,732,367 5,718,653 Plus: Incremental shares from assumed exercise of stock options 185,882 145,504 ------------- ------------ Weighted average shares used in diluted earnings per common share calculations 5,918,249 5,864,157 ============= ============ See Notes to Condensed Consolidated Financial Statements. 4 INVESTORS CAPITAL HOLDINGS, LTD. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY THREE MONTHS ENDED DECEMBER 31, 2004 AND 2003 (UNAUDITED) ACCUMULATED COMMON STOCK ADDITIONAL RETAINED OTHER --------- ------- PAID-IN EARNINGS TREASURY COMPREHENSIVE SHARES AMOUNT CAPITAL STOCK INCOME (LOSS) TOTAL ------------------------------------------------------------------------------ Balance at October 1, 2003.................. 5,721,265 $57,213 $8,249,934 $ 240,620 $(30,135) $4,588 $8,522,220 Stock based compensation.................... 190,173 190,173 Stock issued (employees).................... 10,000 100 (100) Comprehensive income: Net income........................... 306,630 Net unrealized gain on securities.... 5,346 Comprehensive income............ 311,976 ------------------------------------------------------------------------------ Balance at December 31, 2003................ 5,731,265 $57,313 $8,440,007 $ 547,250 $(30,135 $ 9,934 $9,024,369 ============================================================================== Balance at October 1, 2004.................. 5,738,326 $57,383 $8,536,244 $ 899,189 $(30,135) $12,346 $9,475,027 Exercised options........................... 1,972 20 3,925 3,945 Stock based compensation.................... 9,945 9,945 Stock issued to directors and employees..... 2,000 20 45,620 45,640 Comprehensive income: Net income .......................... 355,223 Sale of investment securities........ (12,346) Comprehensive income............ 342,877 ------------------------------------------------------------------------------ Balance at December 31, 2004................ 5,742,298 $57,423 $8,595,734 $1,254,412 $(30,135) ------ $9,877,434 ============================================================================== See Notes to Condensed Consolidated Financial Statements. 5 INVESTORS CAPITAL HOLDINGS, LTD. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY NINE MONTHS ENDED DECEMBER 31, 2004 AND 2003 (UNAUDITED) ACCUMULATED COMMON STOCK ADDITIONAL RETAINED OTHER --------- ------- PAID-IN EARNINGS TREASURY COMPREHENSIVE SHARES AMOUNT CAPITAL STOCK INCOME (LOSS) TOTAL ------------------------------------------------------------------------------ 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.................... 270,815 270,815 Stock Issued (employees).................... 10,000 100 (100) Comprehensive income: Net income........................... 492,993 Net unrealized gain on securities.... 11,921 Comprehensive income............ ------------------------------------------------------------------------------ Balance at December 31, 2003................ 5,731,265 $57,313 $8,440,007 $ 547,250 $(30,135) $ 9,934 $9,024,369 ============================================================================== Balance at April 1, 2004.................... 5,731,598 $57,316 $8,520,931 $ 844,670 $(30,135) $12,157 $9,404,939 Exercised options ...................... 8,700 87 17,284 17,371 Stock based compensation.................... 11,899 11,899 Stock Issued (employees).................... 2,000 20 45,620 45,640 Comprehensive income: Net income........................... 409,742 Sale of investment securities........ (12,157) Comprehensive income............ 397,585 ------------------------------------------------------------------------------ Balance at December 31, 2004................ 5,742,298 $57,423 $8,595,734 $1,254,412 $(30,135) ------- $9,877,434 ============================================================================== See Notes to Condensed Consolidated Financial Statements. 6 INVESTORS CAPITAL HOLDINGS, LTD. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) Nine Months Ended December 31, ------------------------- 2004 2003 ---------- ---------- Cash flows from operating activities: Net income.................................................................... $ 409,742 $ 492,993 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization............................................. 125,337 102,705 Issuance of employee stock................................................ 45,640 ------- Change in deferred taxes.................................................. 5,458 (90,272) Stock option compensation................................................. 11,899 270,815 Gain on sale of investment securities........................... 44,182 ------- Unrealized (gain) on investment in unconsolidated affiliates.............. (66,447) (19,311) Changes in operating assets and liabilities: Decrease (increase) in marketable securities.............................. 37,967 (13,877) Decrease (increase) in accounts receivable................................ 275,438 (1,478,010) Decrease in receivables from officers, prepaid expenses and other assets.. 186,461 132,532 Decrease in income taxes receivable....................................... ------- 60,113 (Decrease) increase in taxes payable...................................... (482,874) 298,164 Increase in accounts payable and other liabilities........................ 183,996 286,505 Increase in accrued expenses and unearned revenue......................... 1,240,003 714,618 (Decrease) increase in commissions payable................................ (558,641) 284,727 ---------- ---------- Net cash provided by operating activities............................. 1,458,161 1,041,702 ---------- ---------- Cash flows from investing activities: Purchases of property and equipment........................................... (195,480) (89,681) (Increase) Decrease in loans receivable from registered representatives....... (211,961) 14,977 ---------- ---------- Net cash used in investing activities................................. (407,441) (74,704) ---------- ---------- Cash flows from financing activities: Exercise of stock options..................................................... 17,372 ------ Payments on notes payable and NASD settlement................................. (211,303) (185,539) ---------- ---------- Net cash used in financing activities................................. (193,931) (185,539) ---------- ---------- Net increase in cash and cash equivalents.......................................... 856,789 781,459 Cash and cash equivalents, beginning of period..................................... 8,112,567 7,090,643 ---------- ---------- Cash and cash equivalents, end of period........................................... $8,969,356 $7,872,102 ========== ========== Supplemental disclosures of cash flow information: Interest paid................................................................. $ 32,091 $ 10,030 ========== ========== Income taxes paid............................................................. $ 780,000 $ 75,300 ========== ========== See Notes to Condensed Consolidated Financial Statements. 7 INVESTORS CAPITAL HOLDINGS, LTD. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS FOR THE QUARTER ENDED DECEMBER 31, 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 our retail mutual funds. 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 nine-month period ending December 31, 2004 are not necessarily indicative of the results that may be expected for the year ended March 31, 2005. 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. 8 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 our mutual funds 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 December 31, -------------------------- 2004 2003 ----------- ----------- Non-interest revenues: ICC, investment services .................... $12,949,927 $12,774,202 EPA, asset management services............... 497,481 661,229 ICH, investments gain........................ 27,211 5,294 ----------- ----------- Total................................... $13,474,619 $13,440,725 =========== =========== Revenues from transactions with other operating segments: ICC.......................................... $ 263,710 $ 319,964 EPA.......................................... 29,301 137,127 ----------- ----------- Total................................... $ 293,011 $ 457,091 =========== =========== Interest and dividend income: ICC.......................................... $ 65,453 $ 48,359 ICH.......................................... 40,790 30,085 ----------- ----------- Total................................... $ 106,243 $ 78,444 =========== =========== Depreciation and amortization expense: ICC............................... $ 42,685 $ 33,593 EPA............................... 2,306 1,731 ----------- ----------- Total........................ $ 44,991 $ 35,324 =========== =========== 9 INVESTORS CAPITAL HOLDINGS, LTD. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS FOR THE QUARTER ENDED DECEMBER 31, 2004 (UNAUDITED) 2. SEGMENT INFORMATION (Continued) Three Months Ended December 31, -------------------------- 2004 2003 ----------- ----------- Income tax provision (benefit): ICC.......................................... $ 287,198 $ 294,555 EPA.......................................... (60,955) (86,396) ICH.......................................... 25,073 (10,891) ------------ ------------ Total................................... $ 251,316 $ 197,268 =========== ============ Income (loss): ICC.......................................... $ 412,441 $ 388,559 EPA.......................................... (92,151) (128,198) ICH.......................................... 34,934 46,269 ----------- ------------ Total................................... $ 355,224 $ 306,630 =========== ============ Period end total assets: ICC.......................................... $10,176,382 $ 7,578,161 EPA.......................................... 582,167 598,484 ICH.......................................... 5,684,044 5,759,529 Corporate items and eliminations............. (2,368,349) (1,254,335) ----------- ----------- Total................................... $14,074,244 $12,681,839 =========== =========== 10 INVESTORS CAPITAL HOLDINGS, LTD. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS FOR THE QUARTER ENDED DECEMBER 31, 2004 (UNAUDITED) Nine Months Ended December 31, -------------------------- 2004 2003 ----------- ----------- Non-interest revenues: ICC, investment services .................... $38,556,388 $32,612,804 EPA, asset management services............... 1,462,480 1,830,270 ICH, investments (loss) gain ................ 22,214 19,311 ----------- ----------- Total................................... $40,041,082 $34,462,385 =========== =========== Revenues from transactions with other operating segments: ICC.......................................... $ 822,625 $ 678,596 EPA.......................................... 91,403 290,827 ----------- ----------- Total................................... $ 914,028 $ 969,423 =========== =========== Interest and dividend income: ICC.......................................... $ 171,990 $ 131,889 ICH.......................................... 123,175 105,093 ----------- ----------- Total................................... $ 295,165 $ 236,982 =========== =========== Depreciation and amortization expense: ICC.......................................... $ 118,958 $ 97,513 EPA.......................................... 6,379 5,192 ----------- ----------- Total................................... $ 125,337 $ 102,705 =========== =========== 11 INVESTORS CAPITAL HOLDINGS, LTD. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS FOR THE QUARTER ENDED DECEMBER 31, 2004 (UNAUDITED) 2. SEGMENT INFORMATION (Continued) Nine Months Ended December 31, --------------------------- 2004 2003 ------------ ------------ Income tax provision (benefit): ICC......................................... $ 417,469 $ 534,636 EPA......................................... (167,462) (207,713) ICH......................................... 56,970 62,582 ----------- ----------- Total.................................. $ 306,977 $ 389,505 =========== =========== Income (loss): ICC......................................... $ 579,749 $ 714,268 EPA......................................... (250,434) (283,097) ICH......................................... 80,427 61,822 ----------- ----------- Total.................................. $ 409,742 $ 492,993 =========== =========== Period end total assets: ICC......................................... $10,176,382 $ 7,578,161 EPA......................................... 582,167 598,484 ICH......................................... 5,684,044 5,759,529 Corporate items and eliminations............ (2,368,349) (1,254,335) ----------- ----------- Total.................................. $14,074,244 $12,681,839 =========== =========== 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 December 31, 2004, the Company was the co-defendant in several lawsuits with claims of approximately $2.9 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 $176,000 for the three months ended December 31, 2004 related to legal fees incurred 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. 12 INVESTORS CAPITAL HOLDINGS, LTD. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS FOR THE QUARTER ENDED DECEMBER 31, 2004 (UNAUDITED) 4. STOCK BASED COMPENSATION (Continued) Three Months Ended Nine Months Ended December 31, December 31, -------------------------- ------------------------ 2004 2003 2004 2003 ---------- --------- --------- --------- Net income, as reported $ 355,223 $306,630 $409,742 $492,993 Deduct: Total stock-based employee compensation expense determined under fair value-based method for all awards, net of related tax effects -- 5,063 -- 8,553 ---------- --------- --------- --------- Pro forma net income $ 355,223 $301,567 $409,742 $484,440 ========== ========= ========= ========= Earnings per share: Basic - as reported $ .06 $ .05 $ .07 $ .08 Diluted - as reported .06 .05 .07 .08 Basic - pro forma .06 .05 .07 .08 Diluted - pro forma .06 .05 .07 .08 ITEM 2. Management's Discussion and Analysis Management's discussion and analysis reviews our consolidated financial condition as of December 31, 2004 and March 31, 2004, the consolidated results of operations for the three months and nine months ended December 31, 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. Forward-Looking Statements The statements, analyses, and other information contained herein relating to trends in the operations and financial results of Investors Capital Holdings, Ltd. (the "Company"), the markets for the Company's products, the future development of the Company's business, and the contingencies and uncertainties to which the Company may be subject, as well as other statements including words such as "anticipate," "believe," "plan," "estimate," "expect," "intend," "will," "should," "may," and other similar expressions, are "forward-looking statements" under the Private Securities Litigation Reform Act of 1995. Such statements are made based upon management's current expectations and beliefs concerning future events and their effects on the Company. The Company's actual results may differ materially from the results anticipated in these forward-looking statements. These forward-looking statements are subject to risks and uncertainties including, but not limited to, the risks that (1) losses may be incurred if our investment professionals fail to comply with regulatory requirements; (2) the loss of either Theodore E. Charles or Timothy B. Murphy may adversely affect our business and financial condition through the loss of significant business contacts, which would have to be replaced; (3) customer fraud could harm our earnings and profits by requiring us to expend time, money and incur actual loss, exposing us to the potential for arbitration; (4) investment professional and employee fraud and misconduct could harm our profits and earnings by causing us to expend time, money and incur actual loss, with the latter exposing us to the potential for litigation; (5) without implementation of adequate internal controls and the maintenance thereof, our ability to make money could be severely restricted by regulatory sanctions being applied against our broker-dealer subsidiary, and could result in us paying substantial fines and 13 limit our ability to make money; (6) involvement in material legal proceedings could have a significant impact on our earnings and profits if we are found liable for such claims; (7) a change in our clearing firm could result in the inability of our customers to transact business in a timely manner due to delays and errors in the transfer of their accounts, which, on a temporary basis, could affect our earnings and profits. Readers are also directed to other risks and uncertainties discussed, as well as to further discussion of the risks described above, in other documents filed by the Company with the United States Securities and Exchange Commission. The Company specifically disclaims any obligation to update or revise any forward-looking information, whether as a result of new information, future developments, or otherwise. Overview We are a financial services holding company that, through our subsidiaries, provides 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 among other financial services institutions, 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. Critical Accounting Policies The condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. 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. 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 or a representative 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 14 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 December 31, 2004 compared with Three Months Ended December 31, 2003 Total consolidated revenue of $13.6 million for the quarter ended December 31, 2004 was relatively consistent compared with total consolidated revenue of $13.5 million for the quarter ended December 31, 2003. The consistency in revenue is primarily due to general market conditions in the first half of the quarter ended December 31, 2004. Consolidated commissions, advisory, and other fee income of $13.2 million for the quarter ended December 31, 2004, increased by $.2 million or 1.3%, compared with consolidated commissions, advisory, and other fee income of $13.0 million for the quarter ended December 31, 2003. This consolidated comparative increase is attributed primarily to a $.4 million increase in revenue provided by Investors Capital Corporation (ICC). The increase in ICC product sales is derived from the $.5 million increase in advisory services which are the result of ICC's dual designation as a Registered Investment Advisor, Investors Capital Advisors (ICA). Other factors contributing to the overall increase in sales volume include the $.3 million decrease in corporate bonds; the $.5 million increase in government bonds; the $1.0 million decrease in mutual funds and variable annuity products; the $.3 million increase in listed stock trades; the $.3 million increase in Over The Counter stock trades; and $.1 million increase in all other ICC products. Offsetting the consolidated comparative increase derived from consolidated commissions, advisory, and other fee income from ICC was a $.2 million decrease in advisory and other fee income from EPA. This was a result of the transfer of assets under management over to ICA from EPA. Therefore, the overall increase was driven by income generated by the ICC brokerage business. Net marketing revenues of approximately $.3 million decreased by approximately $.1 million for the quarter ended December 31,2004, compared to net marketing income of approximately $.4 million for the quarter ended December 31,2003. This decrease was mainly attributable to the reporting the Company's preferred marketing programs on an individual event basis as compared to a consolidated event basis during the same comparative reporting period. Finally, other income increased by approximately $.1 million for the same quarter ended December 31, 2004 when compared to quarter ended December 31, 2003. Other income increased as a result of an increase in the average daily balance in the Company's trading accounts. Additionally, the Company realized a gain from the sale of investment securities as well as income from the sale of subscriptions. Consolidated commissions and advisory fees of $10.5 million for the quarter ended December 31,2004, decreased by $.3 million or 2.5% compared to $ 10.8 million for the quarter ended December 31,2003. This change can be attributed to a decrease of $.2 million in commission expenses incurred by ICC. The decrease in commission expense is the direct result of insurance proceeds from our errors and omissions policy of approximately $.2 million. Excluding this error reimbursement, cost of sales as a percentage basis of commissions, advisory and other fee income was 81.0% in 2004 compared to 83.0% in 2003. The Company reported consolidated operating income of approximately $.6 million for the quarter ended December 31,2004, compared with operating income of approximately $.5 million for the quarter ended December 31, 2003. This 20.1% increase in consolidated operating income is primarily the result of an increase in gross profit of approximately $.3 million offset by a rise in operating expenses of approximately $.2 million. 15 Gross profit by product type, illustrating both the dollar and percentage increase or decrease, is presented in the following table: % of Qtr. Ended Qtr. Ended Gross Profit Gross Profit 2004-2003 December 2004 December 2004 Product Type $ increase (decrease) increase change % Margin Change $ Gross Profit % Gross Profit - ------------------------------------------------------------------------------------------------------------------------ Commissions-Mutual $(149,712) (44.9)% (12.5)% $1,052,193 34.5% Funds & Variable Annuities - ------------------------------------------------------------------------------------------------------------------------ Commissions-Trading 408,594 122.6 % 113.8 % 767,774 25.1% - ------------------------------------------------------------------------------------------------------------------------ Commissions-Insurance 10,103 3.0 % 13.9 % 82,774 2.8% Products - ------------------------------------------------------------------------------------------------------------------------ Commissions-Underwriting (3,768) (1.1)% (46.0)% 4,432 ---% - ------------------------------------------------------------------------------------------------------------------------ Advisory Services & 69,387 20.8 % 17.2 % 474,011 15.5% Administration Fees - ------------------------------------------------------------------------------------------------------------------------ Licensing Revenue 102,026 30.7 % 62.0 % 266,509 8.7% - ------------------------------------------------------------------------------------------------------------------------ Net Marketing Revenue (173,178) (52.0)% (40.7)% 251,918 8.3% - ------------------------------------------------------------------------------------------------------------------------ Other Income & 69,715 20.9 % 83.3 % 153,453 5.1% Revenues - ------------------------------------------------------------------------------------------------------------------------ Total $ 333,167 100.0 % N/A $3,053,064 100.0% - -------------------------------===========---------------======-----------========--------===========----------======--- Mutual fund, variable annuity, and trading activities represented 77.7% of the total increase in gross profit margin. Net marketing revenues, insurance products, advisory services, licensing revenue, underwriting fees, and other income comprised 22.3% of the gross profit change. A margin decrease of $.3 million or 12.5% was realized from sales of mutual funds and variable annuity products. Trading activities increased on a marginal basis by $.4 million or 113.8% between quarters ended December 31, 2004 and December 31, 2003. As a percentage of the December 31, 2004 total gross profit, mutual funds and variable annuity products constitute 34.5% of the overall profit margin while trading activity represents 25.1%. The remainder of the profit margin is comprised of advisory services, 15.5%; net marketing revenues, 8.3%; and licensing, insurance products, underwriting and other income and revenues, 16.6%. At December 31, 2004, unearned licensing revenue of over $1.5 million was collected for insurance premiums and other deferred revenue items. Consolidated administrative expenses of approximately $2.1 million for the quarter ended December 31, 2004 increased by approximately $.2 million or 8.31%, compared with expenses of approximately $1.96 million for quarter ended December 31, 2003. This increase is a result of an approximate $.2 million increase in compensation and benefits based on the hiring of additional personnel to accommodate growth. We invested in the Company's management team by hiring individuals with industry expertise in an effort to increase sales and restructure the product mix. Regulatory, legal, and professional fees were consistent for the comparative periods. Other administrative expenses decreased by approximately $.02 million or 9.4% primarily from reduced postage and reduced administration from one of our programs. Finally, occupancy expenses increased by approximately $.03 million from occupying additional office and storage space, and depreciation of our fixed assets. Consolidated selling expenses were approximately $.3 million for the quarter ended December 31, 2004, an amount that increased by approximately $.07 million or about 26.9% from $.3 million for the quarter ended December 31, 2003. This increase can be attributed to a rise in advertising costs by over $.04 million and a rise in communication costs by over $.03 million. The increase in advertising related expenses were primarily the result of an increase in travel related expenses of over approximately $14 thousand, a $12 thousand increase in meals & entertainment, and a $18 thousand increase in general advertising and marketing. The increase in communication expenses came from increases in telephone, website consulting, and printing. 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 new allocation percentage tested on a quarterly basis effective April 1,2004. The December 31,2004 time study resulted in a 10% allocation. December 2004 December 2003 - -------------------------------------------------------------------------------- ICC $263,710 $319,964 - -------------------------------------------------------------------------------- EPA 29,301 137,127 - -------------------------------------------------------------------------------- Total $293,011 $457,091 - ---------------------------------========-----------------========-------------- 16 The Company recorded a consolidated income tax provision of $.3 million for the quarter ended December 31, 2004 compared with consolidated income taxes of $.2 million for the quarter ended December 31, 2003. This increase of approximately $.1 million or 27.4% can be attributed to the Company experiencing a more profitable quarter ended December 31, 2004 than the quarter ended December 31,2003. The Company's consolidated net income was $.4 million for the quarter ended December 31, 2004 compared with consolidated net income of $.3 million for the quarter ended December 31, 2003. This increase of approximately $.1 million or 15.8% can be attributed to an increase in operating income over the same period. This fluctuation in operating income led to a rise in income before taxes of approximately $.1 million or 20.4% for the quarter ended December 31, 2004 compared to quarter ended December 31, 2003. Nine Months Ended December 31, 2004 compared with Nine Months Ended December 31, 2003 Total consolidated revenue of $40.3 million for the nine months ended December 31, 2004 increased by $5.6 million or 16.1% compared with total consolidated revenue of $34.7 million for the nine months ended December 31, 2003. Consolidated commissions, advisory, and other fee income of $39.3 million for the nine months ended December 31, 2004, increased by $5.3 million or 15.7%, compared with consolidated commissions, advisory, and other fee income of $34.0 million for the nine months ended December 31, 2003. The $5.7 million increase was driven by commissions generated from the ICC's brokerage business and other fees during the nine months ended December 31, 2004. Specifically, this increase is as follows: $1.18 million increase from advisory services, which is a direct result of obtaining dual designation as a Registered Investment Advisor ICA (Investors Capital Advisors). Other factors contributing to this increase in sales volume is a $.2 million decrease in corporate bonds; a $1.4 million increase in government bonds; a $1.4 million decrease in mutual funds and variable annuity products; a $.7 million increase in listed stock trades; a $.4 million increase in Over The Counter stock trades; and a $.7 million increase in all other ICC products. Offsetting those increases was a $.4 million decrease in advisory and other fee income from EPA for the comparative periods as a result the noted transfer of assets under management. Consolidated net marketing revenues of approximately $707 thousand increased by approximately $214 thousand or 43.4% for the nine months ended December 31, 2004, compared to consolidated net marketing revenue of $493 thousand for the nine months ended December 31, 2003. This growth is the result of improved marketing initiatives as well as the expansion in the "Partnership for Wealth Program" which benefited the liaison between the fund company and corresponding representatives. Finally, other income increased by approximately $81 thousand for nine months ended December 31, 2004 when compared to nine months ended December 31, 2003 due to the increase in the daily average balance in our trading accounts. 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 $32.4 million for the nine months ended December 31, 2004 increased by $4.5 million or 16.0% compared to $27.9 million for the nine months ended December 31, 2003. This change is attributed largely to an increase of $4.6 million in commission expenses incurred by ICC. Generally, the increase in commission expense is the direct result of an increase in gross revenues, as noted above. The increase in average representative payout for comparative periods increased proportionately to revenues from commission, advisory and other fee income on a direct correlation of 1 to 1. The average payout, on a percentage basis for the comparative periods mentioned above, was 82.5% for 2004 and 82.3% for 2003. The Company's consolidated operating income of approximately $749 thousand for the nine months ended December 31, 2004, compared with operating income of approximately $900 thousand for the nine months ended December 31, 2003. This 16.8% decrease is primarily the result of additional operating expenses of approximately $1.3 million offset by an increase in gross profit of about $1.2 million. Due to the increased sales volume in products a larger commission was paid out to our registered representative. 17 Gross profit by product type, illustrating both the dollar and percentage change, is presented in the following table: % of 9 Months Ended 9 Months Ended Gross Profit Gross Profit 2004-2003 December 2004 December 2004 Product Type $ increase (decrease) increase change % Margin Change $ Gross Profit % Gross Profit - ----------------------------------------------------------------------------------------------------------------------- Commissions-Mutual Funds & Variable Annuities $ 77,094 6.7 % 2.5 % $3,193,451 40.3% - ----------------------------------------------------------------------------------------------------------------------- Commissions-Trading 63,607 5.5 % 4.0 % 1,637,757 20.7% - ----------------------------------------------------------------------------------------------------------------------- Commissions-Insurance Products 165,486 14.3 % 163.9 % 266,427 3.4% - ----------------------------------------------------------------------------------------------------------------------- Commissions-Underwriting (26,229) (2.3)% (82.3)% 5,632 ---% - ----------------------------------------------------------------------------------------------------------------------- Advisory Services & Administration Fees 227,967 19.7 % 24.2 % 1,171,458 14.8% - ----------------------------------------------------------------------------------------------------------------------- Licensing Revenue 353,465 30.4 % 145.4 % 596,515 7.6% - ----------------------------------------------------------------------------------------------------------------------- Net Marketing Revenue 213,958 18.5 % 43.4 % 706,869 8.9% - ----------------------------------------------------------------------------------------------------------------------- Other Income & Revenues 84,138 7.2 % 32.7 % 341,641 4.3% - ----------------------------------------------------------------------------------------------------------------------- Total $1,159,486 100.0 % N/A $7,919,750 100% - -------------------------------==========-------------======-------------=====--------===========------------====----- As a percentage of the increase in gross profit, contributions from mutual funds and variable annuities represented 6.7% of the total increase while net marketing revenues comprised 18.5% of the increase. Contributions from licensing, insurance products, and advisory services made up 64.4% of the increase while trading had an increase to the margin of 5.5%. A margin increase of $77,094 or 2.5% was realized from sales of mutual funds and variable annuity products and trading activities increased on a marginal basis by $63,607 or 4.0% for comparative nine months ended December 31, 2004 and December 31, 2003. As a percentage of the nine months ended December 31, 2004 gross profit, mutual funds and variable annuity products constitute 40.3% of the overall profit margin while trading activity represents 20.7%. The remainder of the profit margin is comprised of advisory services,14.8%; net marketing revenues, 8.9%; and licensing, insurance products, underwriting and other income and revenues, 15.3%. At December 31, 2004, unearned licensing revenue of over $1.5 million was collected for insurance premiums and other deferred revenue items. Consolidated administrative expenses of $6.2 million for the nine months ended December 31, 2004 increased by $1.1 million or 21.3%, compared with administrative expenses of $5.1 million for the nine months ended December 31, 2003. This fluctuation is a result of the $820 thousand increase in compensation and benefits expense based on the acquisition of additional personnel to accommodate growth. We invested in our management team by hiring individuals with industry expertise in an effort to increase sales and restructure the product mix. Regulatory, legal and professional fees increased by $226 thousand due to added costs incurred for legal representation for litigation. The ratio of administrative expenses to gross profit has risen to 78.4% for the nine months ended December 31, 2004 from 75.7% for the nine months ended December 31, 2003. This is the result of lower profit margin retention that did not accommodate the rise in fixed costs. Consolidated selling expenses were $963 thousand for the nine months ended December 31, 2004, an increase of $221 thousand or 29.9% from $742 thousand for the nine months ended December 31, 2003. This increase is attributed to a rise in advertising costs of $144 thousand and a rise in communications costs of $78 thousand. The increase in advertising costs is the result of an increase in travel expenses of $115 thousand. The increase in communications relates to additional telephone and printing expenses for marketing the business of brokerage and advisory services, as well as to promote the Eastern Point Advisors Rising Dividend Growth Fund. 18 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 recent time study prepared by management, the allocation of these expenses between subsidiaries has changed from a 30% allocation to a new allocation percentage tested on a quarterly basis effective April 1, 2004. A June 30, 2004, September 30, 2004 and December 31, 2004 time study resulted in a 10% allocation. December 2004 December 2003 - -------------------------------------------------------------------------------- ICC $822,625 $678,596 - -------------------------------------------------------------------------------- EPA 91,403 290,827 - -------------------------------------------------------------------------------- Total $914,028 $969,423 - -----------------------------------========----------------========------------- The Company reported consolidated income taxes of about $307 thousand for the nine months ended December 31, 2004, compared with consolidated income taxes of about $390 thousand for the nine months ended December 31, 2003. This decrease of approximately $83 thousand or 21.2% can be attributed to the Company's decrease in profitability during the same period last year. The Company generated a consolidated net income of about $410 thousand for the nine months ended December 31, 2004, compared with net income of about $493 thousand for the nine months ended December 31, 2003. This decrease of $83 thousand or about 16.9% in consolidated net income can be attributed to additional operating expenses to accommodate the increase in sales. Operating expenses increased proportionately higher than its gross profit, resulting in a decrease in net income for the comparative nine month period. Although the Company's profitability for the nine months ended December 31, 2004 was $83 thousand less than that for nine months ended December 31, 2003, management is committed to grow the company. Management is currently investing resources to grow assets in their advisory services sector. In addition, a new investment center in Portsmouth, New Hampshire has opened where the company can offer financial services directly to clients from our own financial advisors. Recruiting centers were opened in Los Angeles and Philadelphia. Management continues to develop their insurance business by offering a diversified product range and insurance services to financial representatives. Finally, the operational model in the trading department 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 is primarily based on the use of capital in an efficient manner. Historically, we have financed our operations mostly through private equity and we have generated cash flow internally without requiring debt service. As of December 31, 2004, cash and cash equivalents totaled $8.9 million compared to $8.1 million as of March 31, 2004. Working capital was $8.7 million as of December 31, 2004 compared to $8.6 million as of March 31, 2004. The ratio of current assets to current liabilities was 3.1 to 1 as of December 31, 2004 compared to 3.2 to 1 as of March 31, 2004. As of December 31, 2004, the net capital ratio for the broker-dealer was 5.11 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 December 31, 2004, we had net capital of $1.1 million as compared to net capital of $1.8 million as of March 31,2004. This resulted in excess net capital of $.7 million and $1.5 million, respectively, for the applicable periods. Net cash provided by operating activities of $1.5 million for the nine months ended December 31, 2004 increased by $.5 million compared to net cash provided by operating activities of over $1 million for the nine months ended December 31, 2003. The change resulted primarily from an increase in collections of accounts receivable offset by payments to commissions payable and income taxes payable. In addition, this increase in cash provided by operating activities came from an increase in collection of license fee renewals. Also, over $1.5 million was collected for unearned licensing revenue for insurance premiums and other deferred revenue items. 19 Net cash used in investing activities increased by $333 thousand for the nine months ended December 31, 2004 compared to the nine months ended December 31, 2003. The increase in cash used resulted from the purchase of fixed assets in addition to the issuance of new loans to registered representatives. Net cash used in financing activities increased by $8 thousand for the nine months ended December 31, 2004 compared to the nine months ended December 31, 2003. The increase in cash used resulted from final payment of the NASD note and a reclassification of current liability to a note payable offset by cash received from the exercise of stock options. 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. 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. 20 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. 21 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: February 11, 2005 22