NATIONAL HOLDINGS CORPORATION The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. This Report may contain certain statements of a forward-looking nature relating to future events or future business performance. Any such statements that refer to our estimated or anticipated future results or other non-historical facts are forward-looking and reflect our current perspective of existing trends and information. These statements involve risks and uncertainties that cannot be predicted or quantified and, consequently, actual results may differ materially from those expressed or implied by such forward-looking statements. Such risks and uncertainties include, among others, risks and uncertainties detailed under the section titled "Risks Factors" of our Form 10-K for the year endedSeptember 30, 2020 . Any forward-looking statements contained in this Quarterly Report on Form 10-Q speak only as of the date of this Report. We undertake no obligation to update publicly any forward-looking statement, whether as a result of new information, future events or otherwise, except as required by law. OVERVIEW We are engaged in independent brokerage and advisory services and asset management services, investment banking, equity research and institutional sales and trading, through our broker-dealer subsidiaries, NSC and WEC. We are committed to establishing a significant presence in the financial services industry by meeting the varying investment needs of our retail, corporate and institutional clients. Our wholly-owned subsidiary, NAM, is a federally-registered investment adviser that provides asset management advisory services to clients for a fee based upon a percentage of assets managed. We also provide tax preparation services through National Tax, which provides tax preparation services to individuals, predominantly in the middle and upper income tax brackets and accounting services to small and midsize companies. NSC and WEC are subject to regulation by, among others, theSEC ,FINRA and is a member of theSIPC . In addition, NSC is licensed to conduct its brokerage activities in all 50 states, plus theDistrict of Columbia andPuerto Rico and theU.S. Virgin Islands . National Tax is also subject to regulation by, among others, the Internal Revenue Service. As ofDecember 31, 2020 , we had approximately 997 associated personnel serving retail and institutional customers, trading and investment banking clients. In addition to our 30 Company offices located inNew York ,New Jersey ,Florida ,Texas ,Massachusetts andWashington , we had approximately 107 other registered offices, owned and operated by independent owners who maintain all appropriate licenses and are responsible for all office overhead and expenses. Our registered representatives offer a broad range of investment products and services. These products and services allow us to generate both commissions (from transactions in securities and other investment products) and fee income (for providing investment advisory services, namely managing clients' accounts). The investment products and services offered include but are not limited to stocks, bonds, mutual funds, annuities, insurance, and managed money accounts. Agreement and Plan of Merger OnJanuary 10, 2021 , we entered into an Agreement and Plan of Merger (the "Merger Agreement") withB. Riley , andB. Riley Principal Merger Corp. III, aDelaware corporation and wholly-owned subsidiary ofB. Riley ("Merger Sub"). The Merger Agreement provides for the acquisition of the Company byB. Riley through a cash tender offer (the "Offer") by Merger Sub for all of our outstanding shares of common stock ("Common Stock"), other than the shares of Common Stock owned byB. Riley and its subsidiaries, for$3.25 per share of Common Stock (the "Offer Price") in cash, without interest, less any applicable withholding taxes. Following the consummation of the Offer, subject to the absence of injunctions or other legal restraints preventing the consummation of the Merger and the satisfaction or waiver the conditions set forth in the Merger Agreement, Merger Sub will merge with and into the Company, with the Company surviving as a wholly owned subsidiary ofB. Riley (the "Merger"), pursuant to the procedure provided for under Section 251(h) of the Delaware General Corporation Law (the "DGCL"), without any additional stockholder approvals. The Merger will be effected as soon as practicable following the time of purchase by Merger Sub of shares of Common Stock validly tendered and not withdrawn in the Offer.B. Riley and its subsidiaries currently own approximately 45% of the issued and outstanding shares of our Common Stock. Our board of directors (the "Board") delegated to a special committee (the "Special Committee") the responsibility and authority to review, evaluate, negotiate and recommend or not recommend to the Board a potential strategic transaction involving the Company. The Special Committee recommended to the Board the approval, execution, delivery and performance by the Company of the Merger Agreement. The Board, acting on the recommendation of the Special Committee, approved the execution, delivery and performance by the Company of the Merger Agreement, approved the acquisition of the Company byB. Riley on the terms and subject to the conditions set forth in the Merger Agreement and resolved to recommend that our stockholders (other thanB. Riley and its subsidiaries) tender their shares of Common Stock to Merger Sub pursuant to the Offer. Under the Merger Agreement, Merger Sub is required to commence the Offer as promptly as reasonably practicable. The Offer commenced onJanuary 27, 2021 and will initially expire at one minute following11:59 P.M. (12:00 midnight),New York City time, on the twentieth (20th) business day following (and including the date of) the commencement of the Offer. The Offer may be extended subject to and in accordance with the terms set forth in the Merger Agreement. Pursuant to the terms of the Merger Agreement, at the effective time of the Merger (the "Effective Time"), (i) each share of Common Stock not tendered pursuant to the Offer (other than any shares of Common Stock (a) owned by us or any of our direct or indirect wholly-owned subsidiary immediately prior to the Effective Time, (b) owned byB. Riley , Merger Sub or any other direct or indirect wholly-owned subsidiary ofB. Riley immediately prior to the Effective Time or (c) held by stockholders who have properly exercised and perfected their demands for appraisal of such shares of Common Stock in accordance with the DGCL and have neither withdrawn nor lost such rights prior to the Effective Time) will each be cancelled and converted into the right to receive the Offer Price, (ii) each outstanding time-based restricted stock unit, whether vested or unvested, with respect to shares of Common Stock (each, a "Company RSU") and each outstanding performance-based restricted stock unit, whether vested or unvested, with respect to shares of Common Stock (each, a "Company PSU") shall be converted into the right to receive an amount of cash equal to the full number of shares of Common Stock underlying such Company RSU or Company PSU multiplied by the Offer Price, and (iii) each outstanding stock option, whether vested or unvested, with respect to shares of Common Stock (each, a "Company Option") shall be converted into the right to receive an amount of cash equal to the number of shares of Common Stock underlying such Company Option multiplied by the excess, if any, of the Offer Price over the Company Option's exercise price. For the avoidance of doubt, any Company Option with an exercise price greater than or equal to the Offer Price shall be cancelled for no consideration. Concurrently with the execution of the Merger Agreement, we entered into an agreement withB. Riley (the "Termination Agreement") pursuant to which (i) we waived the standstill obligations ofB. Riley pursuant to that certain Agreement, datedNovember 14, 2018 , between the Company andB. Riley (the "Standstill Agreement") and (ii) the Standstill Agreement will terminate effective upon the consummation of the Merger. 26 --------------------------------------------------------------------------------
COVID-19 Update and Action The COVID-19 outbreak continues to cause significant disruption in business activity and the financial markets both globally and inthe United States . As a result of the spread of COVID-19, economic uncertainties have arisen which have negatively impacted and are likely to continue to negatively impact our businesses, financial condition, results of operations, cash flows, strategies and prospects. The extent of the impact of COVID-19 on our operational and financial performance will depend on certain developments, including the duration and spread of the outbreak and impact on our clients, employees, vendors and the markets in which we operate our businesses, all of which are uncertain at this time and cannot be predicted. The extent to which COVID-19 may impact our financial condition or results of operations cannot be reasonably estimated at this time. The Company's management put cost-savings plans into effect to mitigate the cash drain that potential, downward pressure on its business might cause. In particular, the Company's management made the very difficult decision to downsize its staff, significantly reduce compensation for many employees and implement moratoriums in variable spending categories. We continue to be cautious due to events that may be driven by the evolution of this pandemic that are unknown, are highly uncertain, and cannot be predicted as it relates to the Company's clients, employees, vendors, and the markets in which the Company operates its businesses. RESULTS OF OPERATIONS
Three Months Ended
Summary Our first quarter endedDecember 31, 2020 resulted in a 33% increase in revenues and a 29% increase in operating expenses as compared to the comparative period last year. Lower margin commission and investment advisory revenue growth outpaced higher margin investment banking revenues, which we attribute to overall market dynamics and volatility associated with the COVID-19 pandemic, and which contributed to the overall increase in operating expenses. Additionally, theWinslow andUnited Advisors acquisitions completed in fiscal year 2020 contributed to the increase in revenues. Revenues Total revenues increased$16,641,000 , or 33%, to$67,832,000 , in the current quarter as compared to$51,191,000 recorded in the comparative period last year. Three Months Ended December 31, Increase (Decrease) 2020 2019 Amount Percent Commissions$ 33,613,000 $ 23,167,000 $ 10,446,000 45 % Net dealer inventory gains (losses) 1,330,000 1,192,000 138,000 12 % Investment banking 15,242,000 15,227,000 15,000 0 % Investment advisory 12,730,000 7,389,000 5,341,000 72 % Interest and dividends 885,000 1,394,000 (509,000 ) (37 )% Transaction fees and clearing services 2,509,000 1,775,000 734,000 41 % Tax preparation and accounting 1,412,000 931,000 481,000 52 % Other 111,000 116,000 (5,000 ) (4 )% Total Revenues$ 67,832,000 $ 51,191,000 $ 16,641,000 33 % Commissions increased$10,446,000 , or 45%, to$33,613,000 in the current quarter as compared to$23,167,000 recorded in the comparatively period last year. This increase is mainly attributable to an increase in trading commission revenue and$1,191,000 in incremental revenue due to theWinslow andUnited Advisors acquisitions. Customer trading volumes across the industry increased compared to the prior year period, which we attribute to COVID-19 related market volatility. Net dealer inventory gains (losses), increased$138,000 , or 12%, to$1,330,000 in the current quarter as compared to$1,192,000 recorded in the comparative period last year.
Investment banking fees increased
Investment advisory fees increased$5,341,000 , or 72%, to$12,730,000 in the current quarter as compared to$7,389,000 recorded in the comparative period last year. This increase is primarily due to the incremental revenue as a result of theWinslow andUnited Advisors acquisitions as well as an increase in assets under management, due to increased registered representative recruiting, market valuation levels, and the continuing reallocation of some client assets to our investment advisory business. Interest and dividend income decreased$509,000 , or 37%, to$885,000 in the current quarter as compared to$1,394,000 recorded in the comparative period last year. This decrease is attributable to the drop in the Federal funds rate, as interest rates overall are near zero. Transaction fees and clearing services increased$734,000 , or 41%, to$2,509,000 in the current quarter as compared to$1,775,000 recorded in the comparative period last year. This increase is primarily attributable to an increase in customer trading volumes as noted above. Tax preparation and accounting fees increased$481,000 , or 52%, to$1,412,000 in the current quarter as compared to$931,000 recorded in the comparative period last year. This increase is attributable to revenue generated by new business acquisitions.
Other revenue decreased
27
--------------------------------------------------------------------------------Operating Expenses Total operating expenses increased$15,597,000 , or 29% to$69,128,000 in the current quarter as compared to$53,531,000 recorded in the comparative period last year. Three Months Ended December 31, Increase (Decrease) 2020 2019 Amount Percent
Commissions, compensation and fees
$ 12,614,000 29 % Clearing fees 2,564,000 1,502,000 1,062,000 71 % Communications 984,000 674,000 310,000 46 % Occupancy 1,302,000 1,168,000 134,000 11 % License and registration 863,000 1,024,000 (161,000 ) (16 )% Professional fees 3,145,000 2,194,000 951,000 43 % Interest 20,000 14,000 6,000 43 % Depreciation and amortization 846,000 530,000 316,000 60 % Other administrative expenses 2,669,000 2,304,000 365,000 16 % Total Operating Expenses$ 69,128,000 $ 53,531,000 $ 15,597,000 29 % Commissions, compensation, and fees increased$12,614,000 , or 29%, to$56,735,000 in the current quarter as compared to$44,121,000 recorded in the comparative period last year. Commissions, compensation, and fees include expenses based on commission revenue earned, investment banking and investment advisory revenues, as well as compensation to our non-broker employees. This increase is primarily related to higher commissions revenue and therefore higher variable compensation expense. Commissions is our lowest margin business. Additionally,$3,764,000 in incremental expense is due to theWinslow andUnited Advisors acquisitions.
Clearing fees increased
Communications expenses increased$310,000 , or 46%, to$984,000 in the current quarter as compared to$674,000 recorded in the comparative period last year. This increase is primarily due to the incremental expense as a result of theWinslow andUnited Advisors acquisitions.
Occupancy expenses increased
License and registration expense decreased by$161,000 , or 16%, to$863,000 in the current quarter as compared to$1,024,000 recorded in the comparative period last year. This decrease is primarily due to cost saving measures implemented during the past year. Professional fees increased by$951,000 , or 43% to$3,145,000 in the current quarter as compared to$2,194,000 recorded in the comparative period last year. This increase is primarily related to legal and consulting fees related to theB. Riley proposal.
Interest expense increased by
Depreciation and amortization expenses increased$316,000 , or 60% to$846,000 in the current quarter as compared to$530,000 recorded in the comparative period last year due to higher amortization expense for new customer list intangibles as a result of new business acquisitions. Other administrative expenses increased$365,000 , or 16%, to$2,669,000 in the current quarter as compared to$2,304,000 recorded in the comparative period last year. This increase is primarily due to higher insurance costs. 28 --------------------------------------------------------------------------------
NON-GAAP INFORMATION
Management considers earnings before interest, taxes, depreciation and
amortization, or EBITDA, as adjusted, an important indicator in evaluating our
business on a consistent basis across various periods. Due to the significance
of non-recurring items, EBITDA, as adjusted, enables our Board and management to
monitor and evaluate our business on a consistent basis. We use EBITDA, as
adjusted, as a primary measure, among others, to analyze and evaluate financial
and strategic planning decisions regarding future operating investments and
potential acquisitions. We believe that EBITDA, as adjusted, eliminates items
that are not part of our core operations, such as interest expense and
amortization expense associated with intangible assets, or items that do not
involve a cash outlay, such as stock-related compensation. EBITDA, as adjusted
should be considered in addition to, rather than as a substitute for pre-tax
income (loss), net income (loss) and cash flows from operating activities.
The following table presents a reconciliation of EBITDA, as adjusted, to net
income (loss) attributable to common shareholders as reported in accordance with
generally accepted accounting principles, or GAAP:
Three Months Ended
December 31,
2020 2019
Net income (loss) attributable to common
shareholders, as reported $ (859,000 ) $ (1,593,000 )
Interest expense 20,000 14,000
Income taxes (428,000 ) (725,000 )
Depreciation 251,000 242,000
Amortization 595,000 288,000
EBITDA (421,000 ) (1,774,000 )
Non-cash compensation expense 781,000 907,000
Forgivable loan amortization 241,000
163,000
Professional fees associated with theB. Riley proposal 653,000
-
Unrealized loss (gain) on the firm's warrant portfolio 20,000 (143,000 ) EBITDA, as adjusted$ 1,274,000 $ (847,000 )
EBITDA, adjusted for non-cash compensation expense, forgivable loan
amortization, professional fees associated with the
29
--------------------------------------------------------------------------------Liquidity and Capital Resources
Average balance during
Ending balance at first three months of fiscal
December 31, year ending September 30,
2020 2019 2021 2020
Cash $ 27,965,000 $ 21,820,000 $ 27,646,000 $ 26,132,000
Receivables from broker-dealers and
clearing organizations 5,198,000 1,990,000 4,283,000 2,740,000
Securities owned (excludes warrants) 1,471,000 5,128,000 1,454,000 3,441,000
Accrued commissions and payroll payable, accounts payable and accrued expenses 27,367,000 20,095,000 26,234,000 23,664,000 AtDecember 31, 2020 and 2019 respectively, 32% and 30% of our total assets consisted of cash, securities owned and receivables from clearing brokers and other broker-dealers. The level of cash used in each asset class is subject to fluctuation based on market volatility, revenue production and trading activity in the marketplace. NSC is subject to the Net Capital Rule, which, among other things, requires the maintenance of minimum net capital. AtDecember 31, 2020 , NSC had net capital of$3,875,125 which was$2,875,125 in excess of its required minimum net capital of$1,000,000 . NSC is exempt from the provisions of Rule 15c3-3 since it is an introducing broker-dealer that clears all transactions on a fully disclosed basis and promptly transmits all customer funds and securities to clearing brokers. WEC is also subject to the Net Capital Rule, which, among other things, requires the maintenance of minimum net capital and requires that the ratio of aggregate indebtedness to net capital, both as defined under the Net Capital Rule, shall not exceed 15 to 1. AtDecember 31, 2020 , WEC had net capital of$777,629 which was$618,479 in excess of its required minimum net capital of$159,150 . WEC's ratio of aggregate indebtedness to net capital was 3.1 to 1. WEC is exempt from the provisions of Rule 15c3-3 since it is an introducing broker-dealer that clears all transactions on a fully disclosed basis and promptly transmits all customer funds and securities to clearing brokers. Advances, dividend payments and other equity withdrawals from NSC and WEC are restricted by the regulations of theSEC , and other regulatory agencies. These regulatory restrictions may limit the amounts that NSC and WEC may dividend or advance to us. During the first three months of fiscal 2021 and 2020, NSC and WEC were in compliance with the rules governing dividend payments and other equity withdrawals. We extend unsecured credit in the normal course of business to our brokers. The determination of the appropriate amount of the reserve for uncollectible accounts is based upon a review of the amount of credit extended, the length of time each receivable has been outstanding, and the specific individual brokers from whom the receivables are due. The objective of liquidity management is to ensure that we have ready access to sufficient funds to meet commitments, fund deposit withdrawals and efficiently provide for the credit needs of customers. Our primary sources of liquidity include our cash flow from operations and the sale of our securities and other financing activities. We believe that we have sufficient funds from operations to fund our ongoing operating requirements for at least the next twelve months. However, we may need to raise funds to enhance our working capital and for strategic purposes. We do not have any material commitments for capital expenditures. We routinely purchase computer equipment and technology to maintain or enhance the productivity of our employees and such capital expenditures amounted to$79,000 and$121,000 during the first three months of fiscal 2021 and 2020, respectively. Certain of our subsidiaries have received loans from theSmall Business Administration's Payroll Protection Plan program, a significant part of theU.S. government's pandemic stimulus. We anticipate that our use of proceeds from the PPP loans may result in loans being forgiven. See Note 22 of the notes to the condensed consolidated financial statements for additional information. 30 --------------------------------------------------------------------------------
Cash Flows - Operating Activities
Net cash provided by (used in) operating activities was
During the three months ended
•
consisting primarily of (i)
$846,000 of depreciation and amortization expense, and (iii)$951,000 of amortization of right-of-use assets; and
• Changes in operating assets and liabilities consisting primarily of (i) a
organizations (ii) a
(iii) a
offset by (i) a
other liabilities, and (ii) a $1,807,000 decrease in other receivables.
During the three months ended
•
consisting primarily of (i)
$530,000 of depreciation and amortization expense, and (iii)$700,000 of amortization of operating lease assets; and
• Changes in operating assets and liabilities consisting primarily of (i) a
liabilities, (ii) a
increase in prepaid expenses. These items were partially offset by (i) a
$2,680,000 decrease in securities owned and (ii) a $1,549,000 decrease in
receivables from broker dealers and clearing organizations.
Cash Flow - Investing Activities
Net cash used in investing activities was$312,000 and$1,878,000 for the three months endedDecember 31, 2020 and 2019, respectively. Net cash used in investing activities during the three months endedDecember 31, 2020 and 2019 was primarily attributable to the acquisition of businesses.
Cash Flow - Financing Activities
Net cash used in financing activities was$472,000 and$417,000 for the three months endedDecember 31, 2020 and 2019, respectively. Net cash used in financing activities for the three months endedDecember 31, 2020 , was primarily attributable to (i)$85,000 for repurchase of common stock for tax withholding, (ii)$276,000 of contingent considerations payments, and (iii)$60,000 for principal payments under finance obligations. Net cash used in financing activities for the three months endedDecember 31, 2019 , was primarily attributable to (i)$139,000 for repurchase of common stock for tax withholding, (ii)$112,000 of contingent considerations payments, and (iii)$108,000 for principal payments under finance obligations.
OFF-BALANCE SHEET ARRANGEMENTS
We do not have any off-balance sheet arrangements that have or are reasonably likely to have a material current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources. INFLATION We believe inflation has not had a material effect on our financial condition as ofDecember 31, 2020 , andSeptember 30, 2020 , or on our results of operations and cash flows for the three months endedDecember 31, 2020 and 2019.
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