<PAGE>
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For Quarter Ended March 31, 1998 Commission File Number 33-21409
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DELTA CLEARING CORP.
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(exact name of registrant as specified in its charter)
Delaware 13-3456486
(state or other jurisdiction of (IRS employer
incorporation or organization) identification no.)
525 Washington Boulevard
Jersey City, New Jersey 07310
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(address of principal executive offices) (zip code)
(201) 418-8900
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(telephone number)
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
--- ---
This Form 10-Q pertains to 250,000 put and call option contracts on
U.S. Treasury securities to be issued from time to time by Delta Clearing
Corp.
Indicate number of shares outstanding of each of the issuer's classes
of common stock as of May 14, 1998: 900,000 shares of common stock, par value
$.01 per share.
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TABLE OF CONTENTS
PART I. Financial Information Page
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Item 1 Financial Statements
Statements of Financial Condition
at March 31, 1998 and December 31, 1997 2
Statements of Operations,
three months ended March 31, 1998 and 1997 3
Statements of Cash Flows,
three months ended March 31, 1998 and 1997 4
Notes to Financial Statements 5
Item 2 Management's Discussion and Analysis of
Financial Condition and Results of Operations 7
PART II. OTHER INFORMATION
Item 1 - 5 Not Applicable 11
Item 6 Exhibits and Reports on Form 8-K 11
Signatures 12
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<CAPTION>
DELTA CLEARING CORP.
STATEMENTS OF FINANCIAL CONDITION
MARCH 31, 1998 AND DECEMBER 31, 1997
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March 31, December 31,
1998 1997
(Unaudited)
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<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash $ 2,335,386 $ 2,872,259
Margin accounts of participants 95,155,893 62,909,574
Investment in U.S. Treasury securities,
at amortized cost 1,974,528 1,948,178
Prepaid expenses and other current assets 189,202 203,110
-------------------- --------------------
Total current assets 99,655,009 67,933,121
OFFICE FURNITURE AND EQUIPMENT - At cost, net of
accumulated depreciation of $370,441 at March 31, 1998
and $333,236 at December 31, 1997 189,049 218,506
CAPITALIZED SOFTWARE DEVELOPMENT COSTS - At cost,
net of amortization of $58,407, at March 31, 1998 and
$30,270 at December 31, 1997 350,394 353,128
OTHER ASSETS 25,849 25,849
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TOTAL ASSETS $ 100,220,301 $ 68,530,604
==================== ====================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Margin Payable $ 95,155,893 $ 62,909,574
Accounts payable and accrued expenses 406,242 349,416
Deferred revenue 69,085 42,438
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Total current liabilitiess 95,631,220 63,301,428
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SUBORDINATED BORROWINGS 3,200,000 3,200,000
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STOCKHOLDERS' EQUITY:
Common stock, $.01 par value, 2,500,000 shares authorized,
900,000 shares issued and outstanding 9,000 9,000
Additional paid-in-capital 9,210,600 9,210,600
Accumulated deficit (7,776,762) (7,081,214)
-------------------- --------------------
Total stockholders' equity 1,442,838 2,138,386
Less unamortized deferred stock options (53,757) (109,210)
-------------------- --------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 100,220,301 $ 68,530,604
==================== ====================
See Notes to Financial Statements.
</TABLE>
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<TABLE>
<CAPTION>
DELTA CLEARING CORP.
STATEMENTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 1998 AND 1997 (Unaudited)
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1998 1997
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<S> <C> <C>
REVENUES:
Clearing Fees:
Repurchase and reverse repurchase agreements $ 43,147 $ 341,466
Options 150 2,000
Investment Income 60,585 67,457
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Total revenues 103,882 410,923
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EXPENSES:
Clearing expenses 85,065 336,755
Employee compensation and benefits 364,793 318,512
Professional fees 89,904 113,695
Depreciation and amortization 120,795 35,710
Occupancy 36,820 37,986
Interest expense 46,046 14,696
Other 56,007 60,200
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TOTAL EXPENSES 799,430 917,554
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NET LOSS $ (695,548) $ (506,631)
=============== ===============
NET LOSS PER SHARE BASIC $ (0.77) $ (0.56)
=============== ===============
</TABLE>
See Notes to Financial Statements.
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<TABLE>
<CAPTION>
DELTA CLEARING CORP.
STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED MARCH 31, 1998 AND 1997 (Unaudited)
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1998 1997
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<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (695,548) $ (506,631)
Adjustments to reconcile net loss to
net cash used in operating activities:
Accretion of interest on investments in
U.S. Treasury securities (26,350) (45,101)
Depreciation and amortization 120,795 35,710
Decrease in prepaid expenses
and other current assets 13,908 4,681
Increase in deferred revenue 26,647 362
Increase in accounts payable and
accrued expenses 56,826 70,915
----------------- -----------------
Net cash used in operating activities (503,722) (440,064)
----------------- -----------------
CASH FLOWS USED BY INVESTING ACTIVITIES
Proceeds from (payments for):
Purchase of U.S. Treasury securities - (1,400,078)
Maturity of U.S. Treasury securities - 1,435,000
Purchase of office furniture and equipment (7,748) (5,803)
Capitalized software development costs (25,403) -
----------------- -----------------
Net cash (used in) provided by investing activities (33,151) 29,119
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CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of subordinated debt - 651,000
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NET (DECREASE) INCREASE IN CASH AND CASH
EQUIVALENTS (536,873) 240,055
CASH AND CASH EQUIVALENTS,
BEGINNING OF PERIOD 2,872,259 1,670,883
----------------- -----------------
CASH AND CASH EQUIVALENTS,
END OF PERIOD $ 2,335,386 $ 1,910,938
================= =================
SUPPLEMENTAL CASH FLOWS DISCLOSURES:
Interest paid $ - $ -
================= =================
</TABLE>
See Notes to Financial Statements.
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DELTA CLEARING CORP.
NOTES TO FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION:
The accompanying unaudited financial statements have been prepared in
accordance with applicable requirements for the preparation of quarterly
reports on Form 10-Q. In the opinion of management of Delta Clearing Corp.
(the "Company") all adjustments (consisting of only normal recurring accruals)
that are necessary for a fair presentation of the financial position and
results of operations for the interim periods have been included. Such results
of operations are not necessarily indicative of the results to be anticipated
for the entire year or any other interim period.
2. COMMITMENTS AND CONTINGENCIES:
The Company currently provides two services to its customers
("Participants"): The clearance and settlement of transactions involving U.S.
Treasury and mortgage-backed securities sold under agreement to repurchase and
U.S. Treasury and mortgage-backed securities purchased under agreement to
resell (collectively "Repos"); and the issuance, clearance and settlement of
put and call options written on U.S. Treasury securities ("Options"). In
conjunction with the Company's Options business, the Company has the authority
to issue up to 250,000 option contracts. The Company issues each put option or
call option and interposes itself in each transaction, acting as writer to
each purchasing Participant and as the purchaser of a matching put or matching
call from each writing Participant. The Company acts solely as an intermediary
in principal transactions, maintaining a "matched book" for both Repos and
Options. The Company, therefore, is not subject to market risk with respect to
these transactions, except to a limited extent in the event of a default by a
Participant in the performance of its obligations. To control this risk, the
Company collects, on a daily or intra-day basis, margin from Participants who
clear and settle Repos or Options through the Company which is deemed
sufficient to cover adverse movements in the value of these positions. To
further control this risk, the Company enforces compliance with its clearing
agency procedures (the "Procedures"), which mandate regulatory and internal
guidelines, control maximum system exposure and establish Participant capital
adequacy standards.
The Company maintains a credit enhancement facility (the "CEF") which
is currently comprised of a $100 million surety bond issued by Capital Markets
Assurance Corporation (with maximum coverage of any Participant equal to $30
million), to secure payment of the obligations owed to the Company by a
Participant in the event of a failure by a Participant in connection with any
financial deficiency associated with the liquidation of a Participant account
with regard to such Participant's default. The credit facility provides an
added measure of protection for the Company and is not a requirement under
Section 17A of the Securities Exchange Act of 1934. Under the credit
enhancement facility agreement, as amended, the Company is required to
maintain a net worth (excess of all assets over all liabilities, excluding up
to $4 million of
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subordinated notes issued to shareholders of the Company) of $4 million. Under
the terms of the Procedures, each Participant account is a party to the CEF
and the Company is the beneficiary. Accordingly, any reimbursement obligation
arising as a consequence of a draw under the credit enhancement facility
becomes the obligation of the individual defaulting Participant. The credit
enhancement facility expires on January 27, 2001.
At March 31, 1998 and 1997, the Company had a matched book of Repos
with notional amounts of $24.957 billion and $27.255 billion, respectively. At
March 31, 1998 and 1997, the Company had no issued matched put and call
options on U.S. Treasury securities outstanding.
On October 18, 1995, the Company purchased various software and
hardware relating to the operation of its clearing business (the "Platform")
from Exco RMJ Trading Corp. (a subsidiary of Exco, plc.) for $250,000. This
amount is included in office furniture and equipment on the statements of
financial condition. As additional compensation for its purchase of the
Platform and in consideration for an agreement from Exco RMJ Trading Corp. not
to compete with the Company, the Company agreed to pay 20% of its pre-tax
operating income (exclusive of interest income) for five full fiscal years
from the date of purchase and certain other amounts up to an additional
maximum price of $2.25 million. Through March 31, 1998, no contingent amounts
have been paid to Exco RMJ Trading Corp.
The Company leases its principal executive office space under a lease
that expires on February 4, 2007. The lease agreement calls for the Company to
make rental payments totaling approximately $1,372,000 over the remaining term
of the lease.
On March 31, 1998, the Company had subordinated borrowings with
affiliates in amounts totaling $2,604,000 from Intercapital Group Limited
(INCAP) and $596,000 from Dow Jones Markets Holdings, Inc. These amounts are
payable on demand, and bear interest payable equal to the London Interbank
Offered Rate ("LIBOR") for three-month deposits of U.S. dollars. On May 6,
1998, INCAP, the holder of subordinated notes totaling $2,604,000 payable by
the Company, amended such notes to provide that INCAP shall not be entitled to
make demand for payment on or prior to January 1, 2000. At March 31, 1998,
LIBOR was 5.7188%.
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Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The Company commenced operations on January 12, 1989 immediately
following the issuance of the Company's Clearing Agency Order (the "Order") by
the Securities and Exchange Commission ("the Commission"). Also following the
issuance of the Order, the Company commenced solicitation of a number of
qualified financial institutions as Participants. At March 31, 1998, 28
Participants were enrolled and authorized by the Company for clearance and
settlement of Repos transactions while 36 Participants were enrolled and
authorized by the Company for clearance and settlement of Options
transactions. These Participant enrollment levels reflect little change from
March 31, 1997 as the Company continues to focus on the development and
enhancement of new and existing services rather than an expansion of its
Participant base. While the growth of the Company's U.S. Treasury Repos
product slowed due to the effects of competition, the Company's clearance and
settlement services for mortgage backed Repos experienced modest growth in its
first full quarter of operation. The Company is currently the sole provider of
this service and hopes to capitalize on this unique position. The Company
believes the introduction of new related products may reinvigorate the growth
of its U.S. Treasury Repos product while providing additional sources of
revenue. The Company anticipates that a renewed growth in its Participant base
may occur should interest in the Company's new and existing services
materialize. The success of its new services and the ability of the Company to
recapture market share relative to its existing services is still to be
determined, however, a modest increase in U.S. Treasury Repos activity was
present toward the latter part of the first quarter. Regarding the Company's
Options business, efforts to reintroduce these clearance and settlement
services have not met with success. The Company continues to experience only
minimal activity and is currently undertaking an evaluation of the cost /
benefit associated with continuing to offer such services. The Company expects
to complete this evaluation by May 31, 1998.
The Company has performed a comprehensive review of its computer
applications to consider the potential impact of date sensitive calculations
related to the year 2000 ("Y2K"). As a result of this review, the Company has
determined that the operational systems relating to its Repos applications are
in full Y2K compliance. However, the Company has adopted a Y2K project plan to
provide comprehensive documentation in support of this assertion. This project
plan undertakes to acquire all vendor Y2K compliance certifications and, where
applicable, to upgrade to certified versions of vendor software. Additionally,
all requisite testing and potential modifications are contemplated for such
upgrades. Upgrades will be performed in accordance with current operating
system and database maintenance agreements. To further ensure compliance with
regard to these applications the Company has appointed a Y2K committee that
has adopted a rigorous agenda for monthly reevaluation of ongoing and new
transactions in a test environment. This test environment will provide a
complete universe of transaction types to identify any diversion from Y2K
compliance. The Y2K committee is comprised of Company personnel and it is
anticipated that internal staff will largely complete this project. The
Company does not expect to spend any significant amounts with outside
contractors relative to the
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completion of these tasks. The Repos applications account for approximately
99% of the Company's current revenue source.
Regarding the operational systems relating to the Company's Options
application, Y2K conversion will be required. The Company has developed a plan
to rewrite the Options application onto the platform currently utilized by the
Repos applications. In order to protect against any possible Y2K
irregularities with regard to the Options application, the Company has
instituted a policy to limit the term of Option trades submitted to the
Company for clearance and settlement services to a period not to exceed one
year. This restriction will allow the Company an opportunity to perform a cost
/ benefit analysis to determine whether the growth of the Options business
warrants the required internal resources to facilitate a rewrite of the
Options application. As mentioned above, such cost / benefit analysis will be
completed by May 31, 1998. Should this analysis determine that the benefit of
continuing the Options business does not outweigh the cost, the Company will
discontinue such business. Alternatively, should the business warrant
continuation, the implementation of the Options application rewrite plan will
commence. Management believes that with the planned rewrite of the Options
application, the Y2K compliance issue will be resolved on a timely basis and
will not pose significant operational problems for the Company. Rewrite and
testing of the Options application is expected to cost approximately $100,000.
Approximately 90% of this estimate relate to internal staff costs. Management
believes that all costs associated with Y2K will not have a material effect on
the Company's financial condition.
For the three months ended March 31, 1998, the Company cleared
approximately $38 billion notional of matched U.S. Treasury Repos versus
approximately $1,006 billion for the three months ended March 31, 1997. The
Company continued to experience the effects of competition associated with
these services and through January and February 1998 saw virtually no
activity. However, the Company's mortgage backed Repos services experienced
modest growth throughout the three months ended March 31, 1998 and in the
month of March 1998, the Company's U.S. Treasury Repos services experienced
renewed Participant activity. For the three months ended March 31, 1998, the
Company cleared approximately $14 billion notional of mortgage backed Repos,
where the Company did not offer such service in the three months ended March
31, 1997. The Company also issued 50 matched option contracts to Participants
during the three months ended March 31, 1998. On March 31, 1998, margin
accounts of Participants held by the Company amounted to approximately $95
million. During the three months ended March 31, 1998 margin accounts of
Participants held by the Company fluctuated from a high of about $104 million
to a low of approximately $56 million due to Participants' clearing activity.
For the three months ended March 31, 1998 and 1997, the Company
reported total revenue of $103,882 and $410,923, respectively, reflecting a
decrease of approximately 75% in 1998. This decrease included an approximate
87% decrease in clearing fees earned on the clearance and settlement by the
Company of Repos to $43,147 in 1998 from $341,466 in 1997. Repo Clearing fees
attributable to U.S. Treasury instruments decreased to $11,391 in 1998 from
$341,466 in 1997, primarily reflecting the effects of competition as discussed
above. The
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Company's mortgage backed Repos service, introduced by the Company on October
20, 1997, accounted for $31,756 of clearing fee revenue for the three months
ended March 31, 1998. Options clearing fees fell from $2,000 in 1997 to $150
in 1998 reflecting only sporadic instances of trades submitted to the Company
for clearance and settlement in both the three months ended March 31, 1998 and
1997. Investment income of $60,585 in 1998 decreased approximately 10% from
$67,457 in 1997 as a result of lower available funds for investment.
Clearing expenses are comprised, principally, of fees payable to the
providers of the Company's CEF, as well as fees charged by the Company's
clearing bank. The cost of the CEF amounted to $49,918 for the three months
ended March 31, 1998 and $231,250 for the three months ended March 31, 1997.
This decrease of approximately 78% was the result of a fee reduction granted
by the CEF provider in April 1997 attributable to the Company's decision to
effectuate a 60% reduction in the coverage amount maintained under the CEF
from $250 million to $100 million in December 1997. The decision to reduce the
coverage amount was based on the volume of clearance activity. As the volume
of clearance activity increases, the Company will reevaluate the coverage
amount and increase such when and if appropriate. Clearing bank fees were also
significantly reduced decreasing approximately 84% from $105,505 in 1997 to
$16,922 in 1998 reflecting the diminished volume of clearance activity
experienced by the Company. For the three months ending March 31, 1998, the
Company also incurred other clearing costs amounting to $18,225 for pricing
services purchased by the Company to facilitate its mortgage backed Repos
business. Such costs were not present during the three months ended March 31,
1997.
Professional fees decreased approximately 21% to $89,904 for the
three months ended March 31, 1998 versus $113,695 in 1997. In 1997, the
Company continued the development of several new products incurring
significant legal expense relative to regulatory rule filings with the
Commission. While additional development occurred in 1998, such activity was
much reduced. Employee compensation and benefits during the three months ended
March 31, 1998, increased by approximately 15% to $364,793 versus $318,512 in
1997. This increase was the result of the Company's creation of an internal
systems development department in the second half of 1997. Depreciation and
amortization increased approximately 238% from $35,710 for the three months
ended March 31, 1997 to $120,795 in 1998. Included in 1998 is $55,453 of
amortization of options issued to shareholders as well as $28,137 of amortized
software development. Such amortization of options and software development
costs was not present during the three months ended March 31, 1997.
Depreciation of the Company's fixed assets amounted to $37,205 in 1998 versus
$35,710 in 1997. This approximate 4% increase reflects an increase in the
Company's systems asset base in 1998 as compared to 1997. Other expenses
decreased approximately 7% in 1998 to $56,007 from $60,200 in 1997. This
decrease reflects the Company's continued efforts to cut costs in the area of
other general and administrative expenses.
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The Company's liquidity currently comes from two sources. The
liquidity for the clearance of Repos is provided through the Participant's
performance of their agreements and, to the extent required, a liquidity
facility in the amount of $250 million provided by the Bank of New York. All
other liquidity needs are met through the Company's capital resources of
approximately $1.4 million obtained from the issuance of its Common Stock in
1989. Due to operating losses associated with the Company's Repos clearing
services and increased competition in this area, the Company's capital has
been reduced. Through March 31, 1998, the Company had obtained subordinated
borrowings from affiliates in amounts totaling $2,604,000 from Intercapital
Group Limited and $596,000 from Dow Jones Markets Holdings, Inc., payable on
demand. On May 6, 1998, Intercapital Group Ltd. agreed to amend the earliest
demand date on its notes to January 1, 2000.
While the Company expects that its existing capital resources and
subordinated borrowings will be sufficient to meet its capital and liquidity
requirements for the foreseeable future, the Company's management has engaged
in active discussions with a number of institutions with respect to such
institutions obtaining an equity shareholding in the Company. While management
cannot predict the success of these discussions or the timing of equity
participation, if any, it is the Company's intention to secure additional
capital through such equity participation. In the interim, on April 3, 1998,
the Company entered into an agreement with Intercapital Group Ltd. whereby
Intercapital Group Ltd. affirmed that it would make available financial
resources to the Company in order for the Company to maintain compliance with
the CEF through January 1, 1999. Such financial resources are to be made
available at such time and in such amounts as the Board of Directors of the
Company identifies, which is commensurate with the then prevailing level of
business activity effected through and by the Company. In addition to these
measures, management hopes that new related products, such as mortgage backed
Repos, recently introduced, coupled with additional products planned for the
future, will reinvigorate the growth of its existing clearance services while
providing additional sources of revenue.
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DELTA CLEARING CORP.
PART II. OTHER INFORMATION
Item 1 - 5 Not Applicable
Item 6 Exhibits And Reports On Form 8-K
(a) Exhibits
Exhibit No.
27 Financial Data Schedule
(b) Form 8-K
No reports on Form 8-K have been filed during the quarter
for which this Report is filed.
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DELTA CLEARING CORP.
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, on May 14, 1998.
DELTA CLEARING CORP.
\s\ Stephen K. Lynner
-----------------------
Stephen K. Lynner
President
\s\ Ronald H. Buckner
-----------------------
Ronald H. Buckner
Chief Financial Officer
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<TABLE> <S> <C>
<ARTICLE> 5
<CURRENCY> U.S.
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> MAR-31-1998
<EXCHANGE-RATE> 1
<CASH> 2,335,386
<SECURITIES> 1,974,528
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 99,655,009
<PP&E> 189,049
<DEPRECIATION> 370,441
<TOTAL-ASSETS> 100,220,301
<CURRENT-LIABILITIES> 95,631,220
<BONDS> 3,200,000
0
0
<COMMON> 9,000
<OTHER-SE> 1,389,081
<TOTAL-LIABILITY-AND-EQUITY> 100,220,301
<SALES> 43,297
<TOTAL-REVENUES> 103,882
<CGS> 0
<TOTAL-COSTS> 495,904
<OTHER-EXPENSES> 303,526
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (695,548)
<INCOME-TAX> 0
<INCOME-CONTINUING> (695,548)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (695,548)
<EPS-PRIMARY> (.77)
<EPS-DILUTED> (.77)
</TABLE>
