October 12, 1999
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Re: National Discount Brokers Group, Inc.
Report on Form 10-Q for the Three Months Ended August 31, 1999
Gentlemen:
Enclosed please find the following material submitted on behalf of National
Discount Brokers Group, Inc. ("Company"):
One complete copy of the Company's report on Form 10-Q for the Three Months
Ended August 31, 1999 including financial statements and exhibits.
Thank you for your attention to this matter.
Very truly yours,
/s/ Matthew S. Stadler
Matthew S. Stadler
Chief Financial Officer and
Principal Accounting Officer
<PAGE>
CONFORMED
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[X] Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For Quarter Ended August 31, 1999
OR
[ ] Transition Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the transition period from to
-------------- -------------
Commission file number 1-9480
---------------------------------------------------------------------
National Discount Brokers Group, Inc.
----------------------------------------------------------------------
(Exact name of Registrant as specified in its charter)
Delaware 22-2394480
----------------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
10 Exchange Place Centre, Jersey City, New Jersey 07302
----------------------------------------------------------------------
(Address of principal executive offices) (Zip 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 the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
16,985,218 shares of Common Stock, par value $.01 per share, were
outstanding on September 30, 1999.
<PAGE>
NATIONAL DISCOUNT BROKERS GROUP, INC.
AND SUBSIDIARIES
INDEX
<TABLE>
<CAPTION>
PAGE
<S> <C>
Part I - Financial Information
Item 1. - Financial Statements
Condensed Consolidated Statements of Financial Condition -
August 31, 1999 (Unaudited) and May 31, 1999...................................................3
Condensed Consolidated Statements of Operations and Comprehensive Income (Unaudited) -
Three Months Ended August 31, 1999 and 1998....................................................4
Condensed Consolidated Statements of Cash Flows (Unaudited) -
Three Months Ended August 31, 1999 and 1998....................................................6
Notes to Condensed Consolidated Financial Statements (Unaudited) -
August 31, 1999................................................................................8
Item 2. - Management's Discussion and Analysis of
Financial Condition and Results of Operations.................................................11
Item 3. -Quantitative and Qualitative Disclosures About Risk............................................15
Part II - Other Information
Item 1. - Legal Proceedings.............................................................................16
Item 6. - Exhibits and Reports on Form 8-K..............................................................17
Signatures..............................................................................................18
</TABLE>
Forward Looking Statements
Statements regarding the Company's expectations as to its future operations
and financial condition and certain other information contained in this Form
10-Q or in documents incorporated herein by reference constitute forward looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995. Although the Company believes that its expectations are based on
reasonable assumptions within the bounds of its knowledge of its business and
operation, there can be no assurance that actual results will not differ
materially from its expectations. Factors which could cause actual results to
differ from expectations include a general downturn in the economy, changes in
the level of activity of securities markets in which the Company participates,
changes in government policy or regulation and unforeseen costs and other
effects related to legal proceedings or investigations of governmental and
self-regulatory organizations.
<PAGE>
ITEM 1 - FINANCIAL STATEMENTS
NATIONAL DISCOUNT BROKERS GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
August 31,
1999 May 31,
ASSETS (Unaudited) 1999
-------------------- -------------------
<S> <C> <C>
Cash and cash equivalents $ 157,572,057 $ 411,629
Receivables:
Clearing brokers 95,409,500 86,509,122
Other 1,747,291 2,901,799
Securities owned, at market value 45,283,646 46,466,749
Securities not readily marketable, at fair value 600,000 500,000
Investment in discontinued operations - 28,341,746
Loans and notes receivable 194,989 1,094,989
Furniture, fixtures, equipment, and leasehold improvements - at
cost, net of accumulated depreciation and amortization of $15,454,040
at August 31, 1999 and $15,304,535 at May 31, 1999 17,234,063 14,837,114
Computer software - at cost, net of accumulated amortization of
$3,500,354 at August 31, 1999 and $3,624,381 at May 31, 1999 6,328,104 4,996,223
Exchange membership (market value $1,520,000 at May 31, 1999) 351,496
Secured demand notes receivable - 27,000,000
Deferred tax asset 935,604 825,797
Other assets 2,203,866 3,054,144
-------------------- -------------------
Total assets $ 327,509,120 $ 217,290,808
-------------------- -------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Securities sold, not yet purchased, at market value $ 14,388,602 $ 11,723,172
Accrued compensation, accounts payable
and accrued expenses 42,488,384 46,296,949
Loan payable 15,000,000
Income taxes payable 16,456,285 2,275,481
-------------------- -------------------
Total liabilities 73,333,271 75,295,602
-------------------- -------------------
Commitments and contingencies
Stockholders' equity:
Preferred stock - $.01 par value;
authorized 1,000,000 shares; none issued - -
Common stock - $.01 par value; authorized
50,000,000 shares; issued 17,333,201 shares at
August 31, 1999 and 14,343,201 at May 31, 1999 173,332 143,432
Additional paid-in capital 157,403,447 65,828,938
Retained earnings 100,754,335 80,181,611
-------------------- -------------------
258,331,114 146,153,981
Less: Treasury stock - at cost, 347,983 shares at
August 31, 1999 and 348,277 shares at May 31, 1999 (4,155,265) (4,158,775)
-------------------- -------------------
Total stockholders' equity 254,175,849 141,995,206
-------------------- -------------------
Total liabilites and stockholders' equity $ 327,509,120 $ 217,290,808
-------------------- -------------------
The accompanying notes are an integral part of the condensed consolidated financial statements.
</TABLE>
3
<PAGE>
NATIONAL DISCOUNT BROKERS GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended August 31,
-----------------------------------------
1999 1998
-----------------------------------------
<S> <C> <C>
Revenue:
Firm securities transactions, net $ 34,475,151 $ 19,555,971
Commission income 12,315,179 8,844,094
Realized gain on securities - 117,446
Interest and dividends 4,752,091 2,262,953
Fee income 1,333,885 894,660
Other 145,842 73,030
-------------------- -------------------
Total revenue 53,022,148 31,748,154
-------------------- -------------------
Expenses:
Compensation and benefits 18,349,009 12,621,331
Clearing and related brokerage charges 11,997,648 9,400,108
Communications 3,127,264 3,325,157
Depreciation and amortization 3,877,522 1,684,861
Advertising costs 7,554,728 1,838,530
Occupancy costs 1,737,694 608,277
Equipment rental 532,650 125,766
Professional fees 500,408 717,210
Technology expense 1,158,087 219,089
Travel and entertainment 976,935 524,834
Repairs and maintenance 585,811 578,331
Interest 85,498 3,502
Other 1,737,856 835,846
-------------------- -------------------
Total expenses 52,221,110 32,482,842
-------------------- -------------------
Income (loss) from continuing operations
before income taxes 801,038 (734,688)
Income taxes (benefit):
Federal, currently payable (receivable) 265,560 (142,417)
State and local, currently payable 210,342 112,345
-------------------- -------------------
Total current income tax expense (benefit) 475,902 (30,072)
-------------------- -------------------
Federal, deferred (23,967) (38,332)
State and local, deferred (85,840) (15,842)
-------------------- -------------------
Total deferred income tax benefit (109,807) (54,174)
-------------------- -------------------
Total income taxes from continuing operations 366,095 (84,246)
-------------------- -------------------
Net income (loss) from continuing operations 434,943 (650,442)
-------------------- -------------------
Discontinued operations:
Income (loss) from discontinued operations,
net of taxes 82,994 (684,881)
Gain on sale of discontinued operations,
net of taxes 20,054,787 -
-------------------- -------------------
20,137,781 (684,881)
-------------------- -------------------
Net income (loss) $ 20,572,724 $ (1,335,323)
-------------------- -------------------
</TABLE>
(Continued)
4
<PAGE>
NATIONAL DISCOUNT BROKERS GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(Unaudited)
(Continued)
<TABLE>
<CAPTION>
Three Months Ended August 31,
-----------------------------------------
1999 1998
-----------------------------------------
<S> <C> <C>
Other comprehensive income (loss), before tax:
Unrealized loss on investment securities available for sale $ - $ (891,838)
Income tax benefit related to items of other
comprehensive income (loss) - (303,225)
-------------------- -------------------
Other comprehensive income (loss), net of tax - (588,613)
-------------------- -------------------
Comprehensive income (loss) $ 20,572,724 $ (1,923,936)
-------------------- -------------------
Net income (loss) per common and common
equivalent share
Basic:
Net income (loss) from continuing operations $ 0.02 $ (0.04)
Net income (loss) from discontinued operations,
net of taxes 0.01 (0.05)
Gain on sale of discontinued operations,
net of taxes 1.24 -
-------------------- -------------------
Net income (loss) $ 1.27 $ (0.09)
-------------------- -------------------
Weighted average common shares outstanding 16,205,035 14,090,148
-------------------- -------------------
Diluted:
Net income (loss) from continuing operations $ 0.02 $ (0.04)
Net income (loss) from discontinued operations,
net of taxes 0.01 (0.05)
Gain on sale of discontinued operations,
net of taxes 1.22 -
-------------------- -------------------
Net income (loss) $ 1.25 $ (0.09)
-------------------- -------------------
Weighted average common shares outstanding 16,491,870 14,103,516
-------------------- -------------------
The accompanying notes are an integral part of the condensed consolidated financial statements.
</TABLE>
5
<PAGE>
NATIONAL DISCOUNT BROKERS GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended August 31,
-----------------------------------------
1999 1998
-------------------- -------------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) from continuing operations $ 434,943 $ (650,442)
Net income (loss) from discontinued operations 82,994(684,881)
Gain on sale of discontinued operations, net of taxes 20,054,787 -
Non-cash items included in net income (loss):
Depreciation and amortization 3,877,522 1,845,820
Gain on sale of securities not readily marketable - (49,075)
Loss of Equitrade allocated to minority partners - (2,521,904)
Provision for deferred taxes (109,807) (54,173)
(Increase) decrease in operating assets:
Receivables:
Clearing brokers (8,900,378) 42,572,929
Other 1,154,508 (96,089)
Securities owned, at market value 1,183,103 (7,550,823)
Other assets (net of deposits made on furniture, fixtures and
equipment, leasehold improvements and computer software) 1,603,812 (160,412)
Increase (decrease) in operating liabilities:
Securities sold, not yet purchased, at market value 2,665,430 (20,826,949)
Accrued compensation, accounts payable and accrued expenses (3,808,565) (4,433,164)
Income taxes payable 14,180,804 (2,053,277)
(Increase) decrease in operating assets due to sale of Equitrade:
Investment in discontinued operations 28,341,746 -
Exchange membership 351,496 -
-------------------- -------------------
Net cash provided by operating activities 61,112,395 5,337,560
-------------------- -------------------
Cash flows from investing activities:
Proceeds from sale of securities not readily marketable - 49,075
Notes issued - (900,000)
Principal collected on notes receivable 900,000 14,673
(Purchases) sales of furniture, fixtures and
equipment, and leasehold improvements, net (5,260,782) 165,345
Deposits made on furniture, fixtures and equipment,
leasehold improvements and computer software (753,534) (287,147)
Purchases of computer software (2,345,570) (449,710)
Payment for purchase of intangible asset - (450,000)
Purchase of investment securities not readily marketable (100,000) -
Issuance of subordinated notes receivable - (900,000)
Principal collected on subordinated notes receivable 27,000,000 -
Repayment of loan (15,000,000) -
-------------------- -------------------
Net cash provided by (used in) investing activities 4,440,114 (2,757,764)
-------------------- -------------------
</TABLE>
(Continued)
6
<PAGE>
NATIONAL DISCOUNT BROKERS GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Continued)
<TABLE>
<CAPTION>
Three Months Ended August 31,
-----------------------------------------
1999 1998
-------------------- -------------------
<S> <C> <C>
Cash flows from financing activities:
Proceeds from issuance of common stock $ 91,603,950 $ -
Proceeds from exercise of options 3,969 -
Purchase of treasury stock - (1,695,295)
Capital withdrawals by minority interest - (879,394)
-------------------- -------------------
Net cash provided by (used in) financing activities 91,607,919 (2,574,689)
-------------------- -------------------
Net increase in cash and cash equivalents 157,160,428 5,107
Cash and cash equivalents at beginning of period 411,629 1,039,121
-------------------- -------------------
Cash and cash equivalents at end of period $ 157,572,057 $ 1,044,228
-------------------- -------------------
The accompanying notes are an integral part of the condensed consolidated financial statements.
</TABLE>
7
<PAGE>
NATIONAL DISCOUNT BROKERS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
August 31, 1999
Note 1 - Business and organization
National Discount Brokers Group, Inc. ("NDB Group") is a holding company
whose principal wholly owned subsidiaries are Triak Services Corp., doing
business as National Discount Brokers ("NDB.com"), and Sherwood Securities Corp.
("Sherwood Securities"). NDB Group and its subsidiaries, collectively referred
to as the "Company", are primarily engaged in the securities business and in
providing related financial services.
NDB Group and another wholly owned subsidiary, SHD Corporation ("SHD"),
also owned membership interests in Equitrade Partners, L.L.C., a Delaware
limited liability company ("Equitrade"). Equitrade was a registered specialist
on the New York Stock Exchange ("NYSE"). On June 18, 1999, the Company sold its
46.845% membership interest in Equitrade to a subsidiary of Spear Leeds &
Kellogg, L. P. for cash. See Note 7, "Discontinued Operations".
Note 2 - Basis of presentation
The accompanying unaudited condensed consolidated financial statements do
not include all of the information and notes required by generally accepted
accounting principles for complete condensed consolidated financial statements.
In the opinion of management, all adjustments considered necessary for a fair
presentation of condensed consolidated financial condition and results of
operations for the periods presented have been included. All adjustments are of
a normal and recurring nature. It is suggested that these condensed consolidated
financial statements be read in conjunction with the condensed consolidated
financial statements and the related notes included in the Company's 1999 Annual
Report on Form 10-K. Certain prior year amounts have been reclassified to
conform to the three months ended August 31, 1999 presentation.
Note 3 - Net income per common share
Net income per common share is computed using the weighted average number
of shares of common stock and common stock equivalents outstanding. Common stock
equivalents comprise stock issuable under stock options. The treasury stock
method of accounting was used in computing the common stock equivalents for the
computation of diluted earnings per common share.
Note 4 - Commitments and contingencies
Certain significant legal proceedings and matters were previously disclosed
in Item 3, Legal Proceedings, of the Company's Annual Report on Form 10-K for
the year ended May 31, 1999, and the disclosures regarding such matters are
incorporated herein by reference. Many aspects of the business of the Company
involve substantial risks of potential liability. In recent years, there has
been an increasing incidence of litigation involving the securities industry,
including class action suits that generally seek substantial damages. Companies
engaged in the underwriting and distribution of securities are exposed to
substantial liability under federal and state securities laws. The Company is,
from time to time, involved in proceedings with, and investigations by,
governmental and self-regulatory agencies.
The Company has been named as a defendant in a number of lawsuits and
arbitrations and is the subject of investigations that allege, among other
things, violations of Federal and state securities laws and other laws. A
substantial settlement or judgement in any of these cases could have a material
adverse effect on the Company. Except as described disclosed in Item 3 to the
Company's Form 10-K for the year ended May 31, 1999 and this Form 10-Q,
management of the Company believes that none of these pending lawsuits,
arbitrations and investigations is likely to have a material adverse effect on
its financial condition, results of operations or liquidity, although the
Company cannot be certain of this.
8
<PAGE>
In connection with the NASD arbitration action against Sherwood Securities
by Weiss, Peck & Greer, L.L.C. ("WPG") reported in Item 3 to the Company's Form
10-K for the fiscal year ended May 31, 1999, WPG and Sherwood Securities agreed
to non-binding mediation by the NASD. A mediation session was held on September
24, 1999. The attempted mediation was not successful.
Note 5 - Net capital requirements
As registered broker-dealers, Sherwood Securities and NDB.com are subject
to the Securities Exchange Act of 1934 Uniform Net Capital Rule 15c3-1 (the
"Rule"). As of August 31, 1999, the net capital of Sherwood Securities and
NDB.com exceeded their required net capital under the Rule by $63,342,000 and
$6,650,000, respectively.
The Rule also provides that equity capital may not be withdrawn or cash
dividends be paid if the resulting net capital would be less than the amount
required under the Rule. Accordingly, at August 31, 1999 the payment of
dividends and advances to the Company by Sherwood Securities and NDB.com is
limited to $63,142,000 and $6,600,000, respectively, under the most restrictive
of these requirements.
Note 6 - Segments
Under the provisions of Statement of Financial Accounting Standards No.
131, "Disclosures about Segments of an Enterprise and Related Information", the
Company has two reportable segments: discount brokerage and market making.
NDB.com transacts all business that will be reported in the Company's discount
brokerage segment. Its revenues are principally in the form of retail commission
income, distribution assistance fees from mutual funds and interest earned on
its customers' balances held at its clearing broker. Sherwood Securities
represents the Company's market making segment, which primarily derives its firm
securities transaction revenues from the spread between the price paid when a
security is bought and the price received when a security is sold. "All Other"
category revenues consist principally of interest and realized gains/losses on
securities available for sale.
Revenue from the transactions with other segments within the Company
(referred to as intersegment revenues) is recorded at market value, as if the
transactions were with third parties.
The Company evaluates the performance of its segments based on profit or
loss from operations before income taxes. No single customer accounted for more
than 10% of the Company's condensed consolidated revenues. Information on
segment assets is not disclosed because it is not used for evaluating segment
performance and deciding how to allocate resources to segments. Substantially
all of the Company's revenues and assets are attributable to or located in the
U.S.
Financial information for the Company's reportable segments is presented
in the following table, which excludes the Company's discontinued operations,
Equitrade.
<TABLE>
<CAPTION>
Three Months Ended August 31, 1999
Discount Market Making
Brokerage All Other Total
<S> <C> <C> <C> <C>
Revenue from external sources $15,397,000 $35,889,000 $ 1,736,000 $53,022,000
Intersegment revenue 1,753,000 5,000 216,000 1,974,000
------------- ----------- ------------- -----------
Total revenue $17,150,000 $35,894,000 $ 1,952,000 $54,996,000
----------- ----------- ----------- -----------
Profit (loss) before income taxes $(7,278,000) $ 7,100,000 $ 979,000 $ 801,000
</TABLE>
9
<PAGE>
<TABLE>
<CAPTION>
Three Months Ended August 31, 1998
Discount Market Making
Brokerage All Other Total
<S> <C> <C> <C> <C>
Revenue from external sources $10,918,000 $20,597,000 $ 233,000 $31,748,000
Intersegment revenue 1,352,000 42,000 599,000 1,993,000
----------- ----------- ------------ -----------
Total revenue $12,270,000 $20,639,000 $ 832,000 $33,741,000
----------- ----------- ------------- -----------
Profit (loss) before income taxes $(1,383,000) $ 15,000 $ 633,000 $ (735,000)
</TABLE>
The following table is a reconciliation of reportable profit (loss) before
income taxes to the Company's condensed consolidated totals.
<TABLE>
<CAPTION>
Three Months Ended
August 31, 1999 August 31,
1998
<S> <C> <C>
Total loss before income taxes
for reportable segments $ (178,000) $ (1,368,000)
Other profit 979,000 633,000
-------------- -------------
Total consolidated profit (loss)
before income taxes $ 801,000 $ (735,000)
-------------- ------------
</TABLE>
Note 7 - Discontinued Operation
On June 18, 1999, the Company sold its 46.845% membership interest in
Equitrade. As such, the operations of Equitrade have been reflected in
discontinued operations for all periods reported. Prior to the allocation of
minority interest and income taxes, revenue and expenses for the three months
ended August 31, 1999 applicable to this discontinued operation were
approximately $1,728,000 and $1,570,000, respectively, and for the three months
ended August 31, 1998 were approximately $(2,205,000) and $1,609,000,
respectively. The gain on the sale was approximately $20,055,000, net of taxes
and other expenses directly related to the sale.
10
<PAGE>
Item - 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Results of Operations
The results of continuing operations of National Discount Brokers Group,
Inc. ("NDB Group") and subsidiaries (collectively, the "Company") for the three
months ended August 31, 1999 reflect primarily the activities of Triak Services
Corp., doing business as National Discount Brokers ("NDB.com") and Sherwood
Securities Corp. ("Sherwood Securities"). NDB.com is an on-line deep discount
brokerage firm specializing in trade execution for individual investors.
Sherwood Securities is primarily engaged in the securities business as a
wholesale market maker in Nasdaq National Market System and other
over-the-counter securities.
The results of continuing operations of the Company for the period ended
August 31, 1999 reflect primarily the activities of NDB.com and Sherwood
Securities.
On June 18, 1999, NDB Group and its wholly owned subsidiary, SHD Corp.,
sold their 46.845% aggregate membership interests in Equitrade Partners, L.L.C
("Equitrade"). As a result, the results of operations of Equitrade have been
segregated and reflected as discontinued operations in the Condensed
Consolidated Statements of Income and Comprehensive Income. The Company
recognized a gain on the sale of Equitrade of $20,055,000, net of taxes and
other expenses directly related to the sale.
The Company's condensed consolidated net income from continuing operations
for the three months ended August 31, 1999 was $435,000 compared to a loss of
$650,000 for the three months ended August 31, 1998, an increase of $1,085,000
or 167%. For the quarter ended August 31, 1999, Sherwood Securities had net
income of $3,778,000 compared to a net loss of $47,000 for the quarter ended
August 31, 1998 while NDB.com had net a net loss of $4,250,000 for the quarter
ended August 31, 1999, compared to a net loss of $915,000 for the quarter ended
August 31, 1998.
Total revenue from continuing operations of the Company increased by
$21,274,000, or 67%, from $31,748,000 for the quarter ended August 31, 1998 to
$53,022,000 for the quarter ended August 31, 1999. The reasons for the increase
in revenues are set forth below.
Revenue from firm securities transactions generated by Sherwood Securities
increased to $34,475,000 for the quarter ended August 31, 1999, up $14,919,000,
or 76%, from $19,556,000 for the equivalent period in 1998 even though trading
profits per ticket decreased from $16.84 to $15.48. The increased activity in
the equity markets, particularly trading volume in internet and high technology
related stocks, resulted in increases of 92% and 49% in Sherwood Securities'
ticket and share volume, respectively, for the quarter ended August 31, 1999 as
compared to the first fiscal quarter a year ago. These increases in ticket and
share volume were more than enough to make up for the decrease in the trading
profits per ticket.
The Company's commission income, primarily generated by NDB.com, increased
to $12,315,000 for the quarter ended August 31, 1999, up $3,471,000, or 39%,
from $8,844,000 for the same period in the prior year. This increase occurred
primarily due to the rise in NDB.com's average daily ticket count, which was
approximately 8,200 tickets per day for the three months ended August 31, 1999
as compared to approximately 5,800 for the three months ended August 31, 1998.
Interest and dividend income increased to $4,752,000 for the quarter ended
August 31, 1999, up $2,489,000, or 110%, from $2,263,000 for the quarter ended
August 31, 1998. The increase is due to several factors. First, there were
larger average amounts of cash available to earn interest. This was primarily
due to the Company taking in cash of approximately $177,000,000 in connection
with the underwritten public offering of its common stock that closed on June
25, 1999 and the sale of its membership interests in Equitrade on June 18, 1999.
In addition, the average customer debit and credit balances that are held with
NDB.com's clearing broker continued to rise.
11
<PAGE>
Fee income generated by NDB.com increased to $1,334,000 for the three
months ended August 31, 1999, up $439,000, or 49%, from $895,000 for the
comparable period of the prior year. The increase is principally due to NDB.com
receiving higher distribution assistance fees from money market funds, as
customers' balances in those funds have increased since the prior year.
Total expenses for the three months ended August 31, 1999 increased by
$19,738,000, or 61%, from $32,483,000 for the quarter ended August 31, 1998 to
$52,221,000 for the quarter ended August 31, 1999. The reasons for the increase
in expenses are set forth below.
Compensation and benefits increased to $18,349,000 for the three months
ended August 31, 1999, up $5,728,000, or 45%, from $12,621,000 for the same
period in the prior year. As a percentage of revenue, however, compensation and
benefits decreased to 35% for the quarter ended August 31, 1999 from 40% for the
comparable quarter in fiscal 1998. The increase was primarily due to a rise in
compensation to Sherwood Securities' traders and salesmen resultant from the
increase in Sherwood Securities' net trading revenue and profitability.
Similarly, based on the increasing profitability of the Company, management and
employee bonuses have increased. Finally, the number of employees increased to
702 employees as of August 31, 1999, from 506 employees as of August 31, 1998.
Clearing and related brokerage charges increased to $11,998,000 for the
quarter ended August 31, 1999, up $2,598,000, or 28%, from $9,400,000 for the
equivalent period last year. As a percentage of revenue, clearing and related
brokerage charges decreased to 23% for the quarter ended August 31, 1999 from
30% for the quarter ended August 31, 1998. The increase in clearing and related
charges for the three months ended August 31, 1999 was mainly due to increases
in Sherwood Securities' and NDB.com's ticket counts of 92% and 40%,
respectively, for the quarter. Partially offsetting these increases, and leading
to the decrease in clearing and related brokerage charges as a percentage of
revenue, was a decrease in per ticket rates negotiated with NDB.com's clearing
broker as of February 1999.
Depreciation and amortization increased to $3,878,000 for the three
months ended August 31, 1999, up $2,193,000, or 130%, from $1,685,000 for the
quarter ended August 31, 1998. This increase can be attributed to two main
factors. NDB.com and Sherwood Securities incurred additional charges for the
write-off of obsolete computer equipment and software in connection with
upgrades of their brokerage operations. Also contributing to the increase is
depreciation and amortization incurred on fixed asset, leasehold improvement and
computer software additions by Sherwood Securities and NDB.com aggregating
approximately $5,300,000 and $9,300,000, respectively, during the period from
September 1998 through August 1999.
Advertising costs increased to $7,555,000 for the quarter ended August 31,
1999, up $5,716,000, or 311%, from $1,839,000 for the same quarter in 1998. The
increase is due to additional media buys and the costs to produce a new line of
advertisements for NDB.com.
Occupancy costs increased to $1,738,000 for the quarter ended August 31,
1999, up $1,130,000, or 186%, from $608,000 for the quarter ended August 31,
1998. The increase is principally due to NDB.com having signed two additional
leases for office locations.
Professional fees decreased to $500,000 for the three months ended August
31, 1999, down $217,000, or 30%, from $717,000 for the comparable period in
1998, primarily due to a decrease in legal fees.
Technology expense increased to $1,158,000 for the quarter ended August 31,
1999, up $939,000, or 429%, from $219,000 for the same quarter in 1998. The
increase is primarily due to rising fees paid to consultants in order to
maintain, test and enhance NDB.com's website and Sherwood Securities'
proprietary trading system.
Travel and entertainment increased to $977,000 for the quarter ended August
31, 1999, up $452,000, or 86%, from $525,000 for the quarter ended August 31,
1998. The increase is due mainly to an increase in the number of Sherwood
Securities' institutional and broker-dealer sales personnel and additional
efforts by this sales force to attract new customers and maintain existing
relationships.
12
<PAGE>
Other expenses increased to $1,738,000 for the three months ended August
31, 1999, up $902,000, or 108%, from $836,000 for the quarter ended August 31,
1998. The increase is due primarily to an increase in employment agency fees and
tuition and conference fees for both Sherwood Securities and NDB.com.
The Company's effective tax rate was approximately 46% for the three-month
period ended August 31, 1999 as compared to 11% for the three months ended
August 31, 1998. Even though the Company recognized a loss before income taxes
in the quarter ended August 31, 1998, certain expenses were not deductible for
tax purposes. This had the effect of offsetting much of the tax benefit that
otherwise would have been available to the Company.
For the three months ended August 31, 1999, a deferred tax benefit of
approximately $110,000, included in income tax expense, relates to the future
taxability of certain temporary book to tax basis differences. In conjunction
with the deferred tax asset the Company has recorded, no valuation allowance has
been established because, in management's judgment, it was concluded that it was
more likely than not that the benefit would be realized.
Liquidity
The Company's tangible assets are highly liquid, but subject to market
price fluctuation, with more than 91% consisting of cash or assets readily
convertible into cash (principally firm securities positions, receivables from
brokers and cash). The Company's operations have generally been financed by
internally generated funds.
From time to time, the Company has borrowed funds in connection with its
trading activities. The Company currently has no committed lines of credit and
such borrowings were done on an "as needed" basis. Management is reviewing
alternatives to meeting these funding requirements.
NDB Group's broker-dealer subsidiaries, Sherwood Securities and NDB.com, are
subject to the SEC's minimum net capital requirement, which is designed to
measure the general financial soundness and liquidity of broker-dealers. As of
August 31, 1999, Sherwood Securities and NDB.com had approximately $63,342,000
and $6,650,000, respectively, in excess of the SEC required minimum net capital.
The net capital rule imposes financial restrictions upon Sherwood Securities'
and NDB.com's businesses, which are more severe than those imposed on most other
businesses.
Cash flows from operations will vary on a daily basis as the Company's
portfolio of marketable securities changes. The Company's ability to convert
marketable securities owned into cash is determined by the depth of the market
and the size of the Company's securities positions in relation to the market as
a whole. The portfolio mix also affects the regulatory capital requirements
imposed on Sherwood Securities and NDB.com, which directly affects the amount of
funds available for operating, investing and financing activities.
As a result of the sale of Equitrade on June 18, 1999, the Company received
approximately $85,000,000 in cash comprised principally of a pre-tax gain of
approximately $36 million (net of bonus to the Company's chief executive officer
of approximately $6,000,000), the return of capital of approximately
$28,000,000, the repayment of subordinated notes receivable of $27,000,000 and
the repayment of other notes and interest receivable of approximately
$3,000,000. As part of the sale, the Company repaid its $15,000,000 loan to
Spear, Leeds & Kellogg, LP.
On June 25, 1999, the Company closed an underwritten public offering of
2,990,000 shares of its common stock, which resulted in its receipt of
approximately $91,600,000 in proceeds net of underwriters' discounts and
commissions and expenses related to the offering.
On July 15, 1999, NDB Group made an additional capital contribution of
$10,000,000 to NDB.com. These funds were necessary for NDB.com to carry out its
advertising plan.
The Company anticipates that it will spend an additional $15,000,000 over
the next three months for its subsidiaries' ongoing technological infrastructure
upgrades and intends to finance these upgrades with funds received from the
underwritten public offering of its common stock that closed on June 25, 1999.
13
<PAGE>
Cash flows from the Company's investment activities are directly related to
market conditions.
Effects of Inflation
The Company's assets are not significantly affected by inflation because
they are primarily monetary in nature. Management believes that replacement
costs of furniture, equipment and leasehold improvements will not materially
affect operations. However, the rate of inflation affects the Company's
principal expenses such as employee compensation, rent and communications, which
may not be readily recoverable from increased revenues. Because of market forces
and competitive conditions in the securities industry, a broker-dealer may be
unable to restructure its profit margins in order to recover increased costs
related to inflation. Consequently, the Company must rely on increased volume
for this purpose. However, the Company has significant cash balances on deposit
with financial institutions, including money market accounts, as well as with
its principal clearing brokers on which interest is paid which, in the event
there are higher interest rates which normally result from inflation, would
offset some of the costs.
Year 2000 Compliance
This material is subject to the Year 2000 Information and Readiness
Disclosure Act of 1998.
State of Readiness. The Company is preparing for the issues associated with
the year 2000, including changes in the programming of internal and vendor
computer systems. The year 2000 problem is pervasive and complex as virtually
every computer operation will be affected by the rollover of the two-digit year
value to 00. The issue is whether computer systems will properly recognize date
sensitive information when the year changes to 2000. Systems that do not
properly recognize such information could generate erroneous data or cause a
system to fail. The Company's plan to deal with the year 2000 issue is a
five-step plan, which includes both information technology ("IT") and
non-information technology ("non-IT") systems. IT systems include the Company's
trading system, the Company's accounting software and the NDB.com WebstationTM.
Non-IT systems include the Company's headquarters' water, sprinkler and elevator
systems. The five steps are awareness, assessment, renovation, validation and
implementation. Awareness required the notification to all employees,
particularly senior management, of the potential year 2000 problem. Assessment
included taking inventory of every product or service produced or used by the
Company that relies on the use of dates. The date could be used to store,
search, retrieve or calculate information. The awareness and assessment phases
of the plan were 100% complete as of August 31, 1999. Renovation, which has also
been substantially completed as of August 31, 1999, includes the conversion of
year 2000 non-compliant systems into year 2000 compliant systems. The Company
believes that internal software and hardware identified as non-compliant have
been made compliant or replaced, in all material respects, as of the date of
this report. The Company has internally verified compliance of its new NDB.com
WebstationTM. Validation comprises the testing of all systems by using test data
with dates that include the year 2000. This is the certification phase of the
Company's production platforms. Implementation will be a final review of all
year 2000 production systems, IT and non-IT, in service. The Company has
constructed a dedicated year 2000 test development environment to eliminate
potential risks to the production platforms for use in the validation phase of
this plan. As of August 31, 1999, the Company has completed, in all material
respects, the validation and implementation phases. The Company is dependent
upon services rendered by third parties, such as telecommunications, electric
and clearance, which may have a material effect on operations. These essential
service providers have indicated to the Company that they will be year 2000
compliant in time to meet the Company's schedule, although management presently
has no assurance that such plans will be implemented on a timely basis. Sherwood
Securities continues to conduct market tests with communication lines pursuant
to which it receives order flow. Not all of these tests have been successfully
completed as of the date of this report. However, both NDB.com and Sherwood
Securities intend to continue to enhance and modify mission critical systems, as
necessary, after August 31, 1999. The Company intends to test each enhancement
or modification to determine if it is Year 2000 compliant. The Company is aware
that its clearing brokers may not be willing to modify their systems until after
January 1, 2000 in response to requests by the Company to make changes to
accommodate enhancements to its systems.
14
<PAGE>
Costs. The Company estimates that it will spend $500,000 for software
modifications, hardware and testing related to year 2000. Through August 31,
1999, the Company has spent approximately $343,000 of which $140,000 was
incurred during the quarter ended August 31, 1999. The Company does not track
internal costs related to year 2000 issues, which consist primarily of payroll
expenses and, as a result, the foregoing estimate and actual expenditures do not
include such internal costs. The Company has assessed that business interruption
is the most reasonably likely worst case year 2000 scenario, although the effect
upon the Company's results of operations, liquidity and financial condition is
unknown.
Contingency Plan. At this time, the Company has formulated contingency
plans should internal systems, vendors or customers fail to become compliant or
fail to operate as a result of year 2000 problems. In case of a non-replaceable
vendor suffering a failure in the year 2000, the Company could be materially
affected.
Item 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT RISK
The Company's principal business activities are, by their nature, risky
and volatile and are directly affected by many national and international
factors. Any one of these factors may cause a substantial decline in the
securities markets, which could materially adversely affect the Company's
business. Managing risk is critical to the Company's profitability and to
reducing the likelihood of earnings volatility. The Company's risk management
policies and procedures have been established to continually identify, monitor
and manage risk. The major types of risk that the Company faces include credit
risk, legal risk, operating risk and market risk.
Credit risk is the potential for loss due to a customer or counterparty
failing to perform its contractual obligations. The Company clears its
securities transactions through unaffiliated clearing agents. Under the terms of
its clearing agent agreements, the Company's clearing agents have the right to
charge it for losses that result from its customers' failure to fulfill their
contractual obligations. In order to mitigate risk, the Company's policy is to
monitor the credit standing of its customers and maintain collateral to support
margin loans to customers. Further, a significant portion of the Company's
assets is held at one or more clearing agents. Therefore, it would incur
substantial losses if one of the Company's clearing agents were to become
insolvent or otherwise unable to meet its financial obligations.
Operating risk is the potential for loss due to deficiencies in control
processes or computer and technological systems. The Company relies heavily on
various computer and communications systems to operate its business, including
NDB.com's web site. The Company relies particularly on third parties such as
Nasdaq, telephone companies, online service providers, clearing agents, data
processors and software and hardware vendors. The Company's business could be
negatively impacted by unanticipated disruptions in service to customers, slower
response times, delays in trading, failed settlement of trades, decreased
customer service and satisfaction, incomplete or inaccurate accounting or
processing of trades, and delays in the Company's introduction of new products
and services. The Company attempts to mitigate operating risk by employing
experienced personnel, maintaining an internal control system, and maintaining
backup and recovery functions.
Legal risk is the risk associated with non-compliance with legal and
regulatory requirements, and counterparty non-performance based upon non-credit
related conditions, such as legal authority or capacity. The SEC, NASD, and
other agencies extensively regulate the U.S. securities industry. The Company is
required to comply strictly with the rules and regulations of these agencies.
Further, there are frequent changes in the laws and regulations affecting the
securities industry and the securities markets. If the Company fails to comply
with any of these laws, rules, or regulations, it is subject to censure, fines,
cease-and-desist orders or suspensions of its business. Additionally, the SEC
and NASD have strict rules that require it to maintain sufficient net capital.
If it fails to maintain the required net capital, the SEC or the NASD may
suspend or revoke its broker-dealer licenses. In addition, the Company may be
subject to lawsuits or arbitration claims by customers, employees or other third
parties in the different jurisdictions in which it conducts business. The
Company has established procedures in accordance with legal and regulatory
requirements that are designed to reasonably ensure compliance in these matters.
15
<PAGE>
Market risk is the risk of loss that may result from changes in interest
and foreign exchange rates, equity and commodity prices and the correlations
among them. The Company's current operations and trading activity limit its
exposure to the interest rate and equity price exposure components of market
risk.
Interest rate risk is the possibility of a loss in the value of financial
instruments from changes in interest rates. The Company's primary exposure to
interest rate risk arises from its interest earning assets (mainly deposits at
clearing brokers, loans and notes receivable and U.S. Treasury obligations) and
funding sources (loans payable). The Company attempts to mitigate this risk by
only holding U.S. Treasury obligations with maturities of one year or less.
Included in the Company's inventory of financial instruments held for
trading purposes are government securities with a fair value of $6.2 million at
August 31, 1999. The interest rate risk, which arises from short term treasury
rates, associated with these positions is not material to the Company's
financial position, results of operations or cash flows. All other financial
instruments exposed to interest rate risk are held for purposes other than
trading. For these instruments, the interest rate risk is not material, as the
underlying value will not vary with changes in interest rates.
Equity price risk generally means the risk of loss that may result from the
potential change in the value of a financial instrument as a result of absolute
and relative price movements, price volatility or changes in liquidity, over
which the Company has no control. The Company's market making activities expose
its capital to significant equity price risk. To mitigate this risk, senior
management monitors profits and losses on a real-time basis throughout the
trading day. Further, from the Company's system-generated reports, senior
management reviews positions, mark-to-market valuations, and daily profits and
losses on individual security positions. Additionally, traders are required to
maintain positions meeting a specified potential profit/loss ratio, which is
monitored by management.
The Company maintains inventories for trading purposes in exchange-listed,
Nasdaq and other over-the-counter securities on both a long and short basis. The
fair value of these securities at August 31, 1999, was $39.1 million in long
positions and $14.4 million in short positions. The potential loss in fair
value, using a hypothetical 10% decline in prices, is estimated to be $2.5
million as of August 31, 1999. A 10% hypothetical decline was used to represent
a significant yet plausible market change.
Other financial instruments exposed to equity rate risk are held for
purposes other than trading. This includes investments by the Company in three
privately held corporations. These investments were valued at their fair value,
$600,000 at August 31, 1999, in the Company's condensed consolidated financial
statements under the heading "Securities not readily marketable". The potential
loss in fair value, using a hypothetical 10% decline in prices, is estimated to
be $60,000 as of August 31, 1999.
PART II - OTHER INFORMATION
Item 1 - LEGAL PROCEEDINGS
Certain significant legal proceedings and matters were previously disclosed
in Item 3, Legal Proceedings, of the Company's Annual Report on Form 10-K for
the year ended May 31, 1999, and the disclosures regarding such matters are
incorporated herein by reference. Many aspects of the business of the Company
involve substantial risks of potential liability. In recent years, there has
been an increasing incidence of litigation involving the securities industry,
including class action suits that generally seek substantial damages. Companies
engaged in the underwriting and distribution of securities are exposed to
substantial liability under federal and state securities laws. The Company is,
from time to time, involved in proceedings with, and investigations by,
governmental and self-regulatory agencies.
The Company has been named as a defendant in a number of lawsuits and
arbitrations and is the subject of investigations that allege, among other
things, violations of Federal and state securities laws and other laws. A
substantial settlement or judgement in any of these cases could have a material
16
<PAGE>
adverse effect on the Company. Except as described disclosed in Item 3 to the
Company's Form 10-K for the year ended May 31, 1999 and this Form 10-Q,
management of the Company believes that none of these pending lawsuits,
arbitrations and investigations is likely to have a material adverse effect on
its financial condition, results of operations or liquidity, although the
Company cannot be certain of this.
In connection with the NASD arbitration action against Sherwood Securities
by Weiss, Peck & Greer, L.L.C. ("WPG") reported in Item 3 to the Company's Form
10-K for the fiscal year ended May 31, 1999, WPG and Sherwood Securities agreed
to non-binding mediation by the NASD. A mediation session was held on September
24, 1999. The attempted mediation was not successful.
Item 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Exhibit 11 - Computation of Net Income Per Common Share
Exhibit 27 - Financial Data Schedule
(b) The Company filed one report on Form 8-K during the quarter ended
August 31, 1999. The report, dated June 18, 1999, was filed in
regard to the Company's sale of its membership interests in
Equitrade Partners, L.L.C. and the signing of an amendment to one of
the Company's leases.
17
<PAGE>
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.
National Discount Brokers Group, Inc.
--------------------------------------
Date: October 11, 1999 By: Arthur Kontos
---------------------------- --------------------------------------
Arthur Kontos
Chief Executive Officer
Date: October 11, 1999 By: Matthew S. Stadler
---------------------------- --------------------------------------
Matthew S. Stadler
Chief Financial Officer and
Principal Accounting Officer
18
<PAGE>
NATIONAL DISCOUNT BROKERS GROUP, INC. AND SUBSIDIARIES
COMPUTATION OF NET INCOME PER COMMON SHARE
<TABLE>
<CAPTION>
Three Months Ended August 31,
Basic Diluted
---------------- --------------- ------------- ----------------
1999 1998 1999 1998
---------------- --------------- ------------- ----------------
<S> <C> <C> <C> <C>
Common stock and common stock equivalents:
Average common stock outstanding 16,205,035 14,090,148 16,205,035 14,090,148
Average common stock equivalents
issuable under stock options - - 286,835 13,368
---------------- --------------- ------------- ---------------
Total average common stock and common stock
equivalents used for earnings per share computation 16,205,035 14,090,148 16,491,870 14,103,516
---------------- --------------- ------------- ---------------
Income:
Net income (loss) from continuing operations $ 434,943 $ (650,442) $ 434,943 $ (650,442)
Net income (loss) from discontinued operations,
net of taxes 82,994 (684,881) 82,994 (684,881)
Gain on sale of discontinued operations,
net of taxes 20,054,787 - 20,054,787 -
---------------- --------------- ------------- --------------
Net income (loss) $ 20,572,724 $ (1,335,323) $20,572,724 $ (1,335,323)
---------------- --------------- ------------- --------------
Net income (loss) per common and common equivalent share:
Net income (loss) from continuing operations $ 0.02 $ (0.04) $ 0.02 $ (0.04)
Net income (loss) from discontinued operations,
net of taxes 0.01 (0.05) 0.01 (0.05)
Gain on sale of discontinued operations,
net of taxes 1.24 - 1.22 -
---------------- --------------- ------------- --------------
Net income (loss) $ 1.27 $ (0.09) $ 1.25 $ (0.09)
---------------- ---------------- ------------- --------------
</TABLE>
<TABLE> <S> <C>
<ARTICLE> BD <LEGEND> This schedule contains summary financial
information extracted from the financial statements for the three months ended
August 31, 1999 and is qualified in its entirety by reference to such financial
statements.
- --------------------------------------------------------------------------------
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> May-31-2000
<PERIOD-START> Jun-1-1999
<PERIOD-END> Aug-31-1999
<CASH> 157,572,057
<RECEIVABLES> 97,351,780
<SECURITIES-RESALE> 0
<SECURITIES-BORROWED> 0
<INSTRUMENTS-OWNED> 45,283,646
<PP&E> 17,234,063
<TOTAL-ASSETS> 327,509,120
<SHORT-TERM> 0
<PAYABLES> 58,944,669
<REPOS-SOLD> 0
<SECURITIES-LOANED> 0
<INSTRUMENTS-SOLD> 14,388,602
<LONG-TERM> 0
0
0
<COMMON> 173,332
<OTHER-SE> 254,002,517
<TOTAL-LIABILITY-AND-EQUITY> 327,509,120
<TRADING-REVENUE> 34,475,151
<INTEREST-DIVIDENDS> 4,752,091
<COMMISSIONS> 12,315,179
<INVESTMENT-BANKING-REVENUES> 0
<FEE-REVENUE> 1,333,885
<INTEREST-EXPENSE> 85,498
<COMPENSATION> 18,349,009
<INCOME-PRETAX> 801,038
<INCOME-PRE-EXTRAORDINARY> 20,572,724
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 20,572,724
<EPS-BASIC> 1.27
<EPS-DILUTED> 1.25
</TABLE>
